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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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[X} Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange
Act of 1934, for the fiscal year ended March 31, 1999
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[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934, for the transition period from to
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Commission file number 1-5486
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COYOTE NETWORK SYSTEMS, INC.
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Delaware 36-2448698
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4360 Park Terrace Drive, Westlake Village, California 91361
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 735-7600
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act: Common Stock,
$1.00 par value
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. [X] YES [ ] 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 the 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. [ ]
On July 12, 1999, the aggregate market value of the voting stock of the
Registrant held by stockholders who were not affiliates of the Registrant was
$58,353,000 based on the closing sale price of $5.00 of the Registrant's common
stock on The Nasdaq National Stock Market. At July 12, 1999, the Registrant had
issued and outstanding an aggregate of 12,702,350 shares of its common stock.
For purposes of this Report, the number of shares held by non-affiliates was
determined by aggregating the number of shares held by Officers and Directors of
Registrant, and by others who, to Registrant's knowledge, own more than 10% of
Registrant's common stock, and subtracting those shares from the total number of
shares outstanding.
DOCUMENTS INCORPORATED BY REFERENCE - PARTS OF REGISTRANT'S PROXY
STATEMENT FOR THE ANNUAL MEETING OF STOCKHOLDERS ARE INCORPORATED
BY REFERENCE INTO PART III OF THIS REPORT.
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PART I
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Forward-Looking Statements
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All statements other than historical statements contained in this Report on Form
10-K constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Without limitation, these forward
looking statements include statements regarding new products to be introduced by
us in the future, statements about our business strategy and plans, statements
about the adequacy of our working capital and other financial resources, and in
general statements herein that are not of a historical nature. Any Form 10-K,
Annual Report to Shareholders, Form 10-Q, Form 8-K or press release of ours may
include forward-looking statements. In addition, other written or oral
statements which constitute forward-looking statements have been made or may in
the future be made by us, including statements regarding future operating
performance, short and long-term sales and earnings estimates, backlog, the
status of litigation, the value of new contract signings, industry growth rates
and our performance relative thereto. These forward-looking statements rely on a
number of assumptions concerning future events, and are subject to a number of
uncertainties and other factors, many of which are outside of our control, that
could cause actual results to differ materially from such statements. These
include, but are not limited to: risks associated with recent operating losses,
no assurance of profitability, the need to increase sales, liquidity deficiency
and the other risk factors set forth herein (see Item 7 - Risk Factors). We
disclaim any intention or obligation to update or revise any forward-looking
statements whether as a result of new information, future events or otherwise.
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ITEM 1. BUSINESS
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General
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Coyote Network Systems, Inc. is engaged in the telecommunications business.
Specifically, through our various affiliated entities, we sell
telecommunications equipment, international long distance services and network
services, primarily to entrepreneurial carriers, e.g., domestic and
international long distance providers, competitive local exchange carriers
(CLECs) and Internet service providers (ISPs). Our telecommunications products
are designed to route telephone calls in an efficient, cost-effective manner. We
also sell competitively priced wholesale international long distance services,
primarily to entrepreneurial carriers and we market retail international long
distance services, primarily to affinity groups, i.e., groups that share a
common characteristic such as language or culture. In addition, we provide
telecom network support services, i.e., network design and integration,
facilities management, switch provisioning, billing administration and customer
support services. Through our joint venture, TelecomAlliance, we plan to provide
carriers with wholesale long distance and Internet services at new price points,
and to provide them with telecom equipment, billing administration, customer
support services and a path to access voice over data networks.
Our principal executive offices are located at 4360 Park Terrace Drive, Westlake
Village, California 91361 and our telephone number is (818) 735-7600.
Industry Overview
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New carrier services, evolving technologies, and the Internet mark today's
telecom industry. As telecom carriers expand into new markets with
revenue-generating services, we believe they need to differentiate themselves
with tailored voice, data, video and Internet services. We believe the ability
of carriers to provide "bundled" local, long distance and Internet service is
critical to their success.
According to industry analysts, some of the more nimble competitive long
distance carriers will grow sales and earnings as they gain market share at the
expense of larger incumbent carriers and weaker rivals, and gradually expand
into other services. The industry consolidation, which is a result of today's
competitive pressures, is expected to create a more benevolent, i.e., rational
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business environment for the survivors. International telephony is expected to
grow in the mid-teens rate, in terms of minutes of use, over the next few years
and carriers that are ahead of the pack in expanding into other services, such
as prepaid calling cards, 800 number services, Internet telephony, and data
services could grow faster.
Additionally, the telecommunications industry is in a period of rapid
technological evolution, marked by the introduction of competitive product and
service offerings, such as the utilization of IP (Internet Protocol) and ATM
(Asynchronous Transfer Mode) networks, and the Internet for voice and data
communications.
A survey of Fortune 1000 telecom and datacom managers by Killen & Associates
shows that respondents expect 18% of all voice traffic to be IP-based by 2002,
and to reach 33% by 2005. Probe Research expects the combined U.S. voice and fax
over IP services market to reach 36 billion minutes by 2002. Jupiter
Communications believes that established service providers should integrate IP
telephony into their suite of services to prevent market erosion by nimble
competitors. Voice compression is a benefit of IP telephony. Today's compression
standards enable a toll quality call to be completed using a fraction of the
bandwidth for an uncompressed call. We are committed to delivering leading edge
technologies, such as compressed voice over IP.
From the standpoint of U.S.-based long distance providers, the industry can be
divided into two major segments: the U.S. international market, consisting of
all international calls billed in the U.S., and the overseas market, consisting
of all international calls billed in countries other than the U.S. The U.S.
international market has experienced substantial growth in recent years, with
gross revenues from international long distance services rising from
approximately $8.0 billion in 1990 to approximately $19.3 billion in 1997,
according to Federal Communications Commission ("FCC") data.
The 1984 deregulation of the U.S. telecommunications industry enabled the
emergence of a number of new long distance companies in the U.S. Currently,
there more than 500 U.S. long distance companies, most of which are small or
medium-sized companies. To be successful, these small and medium-sized companies
need to offer their customers a full range of services, including international
long distance. However, most of these carriers do not have the critical mass to
receive volume discounts on international traffic from the larger
facilities-based carriers such as AT&T Corp. ("AT&T"), MCI Worldcom ("MCI") and
Sprint Corporation ("Sprint"). In addition, these small and medium-sized
companies generally have only limited capital resources to invest in
international facilities. New international carriers emerged to take advantage
of this demand for less expensive international bandwidth. These entrepreneurial
multinational carriers acted as aggregators of international traffic for smaller
carriers, taking advantage of larger volumes to obtain volume discounts on
international routes (resale traffic), or investing in facilities when volume on
particular routes justified such investments. Over time, as these international
carriers became established and created high quality networks, they began to
carry overflow traffic from the larger long distance providers seeking lower
rates on certain routes. Our wholesale international long distance company and
Telecom Alliance are designed, among other things, to obtain volume discounts
and other economies by aggregating a number of emerging carriers.
Deregulation and privatization have also allowed new long distance providers to
emerge in foreign markets. By eroding the traditional monopolies held by single
national providers, many of which are wholly or partially government owned, such
as Post Telegraph & Telephone operators ("PTTs"), deregulation is providing
U.S.-based providers the opportunity to negotiate more favorable agreements with
PTTs and emerging foreign providers. In addition, deregulation in certain
foreign countries is enabling U.S.-based providers to establish local switching
and transmission facilities in order to terminate their own traffic and begin to
carry international long distance traffic originated in that country. We believe
that growth of traffic originated in markets outside of the U.S. will be higher
than the growth in traffic originated within the U.S. due to recent deregulation
in many foreign markets, relative economic growth rates and increasing access to
telecommunications facilities in emerging markets.
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International Switched Long Distance Services
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International switched long distance services are provided through switching and
transmission facilities that automatically route calls to circuits based upon a
predetermined set of routing criteria. The call typically originates on a local
exchange carrier's network and is transported to the caller's domestic long
distance carrier. The domestic long distance provider then carries the call to
an international gateway switch such as the ones we sell. An international long
distance provider picks up the call at its gateway and sends it directly or
through one or more other long distance providers to a corresponding gateway
switch operated in the country of destination. Once the traffic reaches the
country of destination, it is then routed through that country's domestic
telephone network to the party being called.
International long distance providers can generally be categorized by their
ownership and use of switches and transmission facilities. The largest U.S.
carriers, such as AT&T, MCI and Sprint, primarily utilize owned transmission
facilities and generally use other long distance providers to carry their
overflow traffic. Since only very large carriers have transmission facilities
that cover the more than 200 countries to which major long distance providers
generally offer service, a significantly larger group of long distance providers
own and operate their own switches but either rely solely on resale agreements
with other long distance carriers to terminate their traffic or use a
combination of resale agreements and owned facilities in order to terminate
their traffic as shown below. One other category, "switchless resellers", rely
entirely on third parties to switch and terminate their traffic. Such switchless
resellers generally attempt to purchase enough minutes to obtain volume
discounts and then resell the time at a mark-up. These "switchless resellers"
and emerging carriers are the principal market for our DSS Switches and Carrier
IP Gateways, which are designed specifically to require less investment than the
equipment used by large telecommunications companies and, accordingly, to be
cost effective for emerging telecom companies.
Operating Agreements
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Under traditional operating agreements, international long distance traffic is
exchanged under bilateral agreements between international long distance
providers in two countries. Operating agreements provide for the termination of
traffic in, and return traffic to, the international long distance providers'
respective countries at a standard "accounting rate" with that international
provider. Under a traditional operating agreement, the international long
distance provider that originates more traffic compensates the long distance
provider in the other country by paying a net amount based on the difference
between minutes sent and minutes received and the settlement rate.
A carrier gains ownership rights in a digital fiber optic cable by purchasing
direct ownership in a particular cable prior to the time the cable is placed in
service, acquiring an "Indefeasible Right of Use" ("IRU") in a previously
installed cable, or by leasing or obtaining capacity from another long distance
provider that either has direct ownership or IRUs in the cable. In situations
where a long distance provider has sufficiently high traffic volume, routing
calls across directly owned or IRU cable is generally more cost-effective on a
per call basis than the use of short-term variable capacity arrangements with
other long distance providers or leased cable. However, direct ownership and
acquisition of IRUs require a company to make an initial investment of its
capital based on anticipated usage. We do not currently own IRUs; however, part
of our business plan is to acquire IRUs to carry our international traffic and
sell excess capacity to customers and resellers.
Transit Arrangements
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In addition to utilizing an operating agreement to terminate traffic delivered
from one country directly to another, an international long distance provider
may enter into transit arrangements pursuant to which a long distance provider
in an intermediate country carries the traffic to a country of destination. Such
transit arrangements involve agreement among the providers in all the countries
involved and are generally used for overflow traffic or where a direct circuit
is unavailable or not volume justified.
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Resale Arrangements
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Resale arrangements typically involve the wholesale purchase and sale of
transmission and termination services between two long distance providers on a
variable, per minute basis. The resale of capacity, which was first permitted in
the U.S. market in the 1980s enabled the emergence of new international long
distance providers that rely at least in part on capacity acquired on a
wholesale basis from other long distance providers. International long distance
calls may be routed through a facilities-based carrier with excess capacity, or
through multiple long distance resellers between the originating long distance
provider and the facilities-based carrier that ultimately terminates the
traffic. Resale arrangements set per minute prices for different routes, which
may be guaranteed for a set time period or subject to fluctuation following
notice. The resale market for international capacity is constantly changing, as
new long distance resellers emerge and existing providers respond to fluctuating
costs and competitive pressures. In order to be able to effectively manage costs
when utilizing resale arrangements, long distance providers need timely access
to changing market data and must quickly react to changes in costs through
pricing adjustments or routing decisions. We sell competitively priced wholesale
international long distance services to entrepreneurial carriers through a
network comprised of foreign termination agreements, gateway switches, leased
facilities and resale arrangements with other carriers.
Alternative Termination Arrangements
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As the international telecommunications market has become deregulated, service
providers have developed alternative arrangements to reduce their termination
costs by, for example, routing traffic via third countries to obtain lower
settlement rates or using international private line facilities to bypass the
settlement rates applicable to traffic routed over the public switched telephone
network ("PSTN"). These arrangements include International Simple Resale
("ISR"), traffic refiling and the acquisition of transmission and switching
facilities in foreign countries. Refiling of traffic takes advantage of
disparities in settlement rates between different countries. An originating
operator typically refiles traffic by sending it first to a third country that
enjoys lower settlement rates with the destination country whereupon it is
forwarded or refiled to the destination country thereby resulting in a lower
overall termination cost. The difference between transit and refiling is that,
with respect to transit, the operator in the destination country typically has a
direct relationship with the originating operator and is aware of the
arrangement, while with refiling, the operator in the destination country
typically is not aware that it is terminating refiled traffic originated in
another country. While the United States has taken no position with respect to
whether refiling comports with international regulation, refiling is illegal in
many countries. With ISR, a long distance provider completely bypasses the
settlement system by connecting an international private line ("IPL") to the
PSTN on one or both ends. While ISR currently is only sanctioned by U.S. and
other regulatory authorities on some routes, ISR services are increasing and are
expected to expand significantly as deregulation of the international
telecommunications market continues. In addition, new market access agreements,
such as the World Trade Organization ("WTO") Basic Telecommunications Agreement
(the "WTO Agreement"), have made it possible for many international service
providers to establish their own transmission and switching facilities in
certain foreign countries, enabling them to self-correspond and directly
terminate traffic. In our capacity as a wholesaler and retailer of traffic we
engage in ISR and traffic refiling. (See "Government Regulation").
The highly competitive and rapidly changing international telecommunications
market has created a significant opportunity for carriers that can offer high
quality, low cost international long distance service. Deregulation,
privatization, the expansion of the resale market and other trends influencing
the international telecommunications market are driving decreased termination
costs, a proliferation of routing options, and increased competition. Successful
companies among both the emerging and established international long distance
companies will need to aggregate enough traffic to lower costs of both
facilities-based or resale opportunities, maintain systems which enable analysis
of multiple routing options and provide a variety of services, invest in
facilities and switches and remain flexible enough to locate and route traffic
through the most advantageous routes. We are seeking to take advantage of these
market conditions both as a provider of necessary equipment targeted to emerging
entrepreneurial carriers and as a provider of retail and wholesale international
long distance services.
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Principal Products and Services
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Our primary equipment products include telecommunications switches ("DSS
Switches") and IP gateways ("Carrier IP Gateways ") designed to route voice
traffic over the PSTN, Internet Protocol (IP) networks, and the Internet. Our
equipment business consists of designing, developing, engineering, and marketing
telecommunications switches and IP gateways. The DSS Switch provides
cost-effective and versatile access to the PSTN. Examples of DSS Switch
applications include their use by entrepreneurial carriers that use DSS Switches
to provide domestic and international long distance services, debit and credit
card services and 800 number in-bound translation service.
The Carrier IP Gateway is a scalable IP solution designed to meet the needs of
domestic and international long distance carriers, CLECs and ISPs by improving
the efficiency of costly dedicated long distance T1 lines. The Carrier IP
Gateway offers carriers a cost effective, efficient Signaling System 7 (SS7)
solution that provides seamless routing of phone calls between the PSTN and
IP-based networks. The Carrier IP Gateway can handle voice as well as fax and,
when used with the DSS Switch can scale from 1 T1 to 80 T1s. The Carrier IP
Gateway is standards based and communicates with virtually any Class 4 or Class
5 switch using E&M signaling.
We are using our scalable DSS Switch to route international long distance calls
for our wholesale and retail long distance operations. The DSS Switch enables us
to enter new expanding markets and capture calls at a low per minute, per
customer cost, creating a competitive advantage over traditional wireline
carriers.
We believe that the timely development of new products and the addition of new
long distance routes are essential for us to compete in the telecom market. We
expect to continue to devote substantial resources, subject to our financial
ability to do so, to engineering new products as well as to obtaining such
products through acquisitions, joint ventures and strategic alliances.
We also provide wholesale international long distance services, primarily to
entrepreneurial carriers through a network comprised of foreign termination
agreements, international gateway switches, leased transmission facilities and
resale arrangements with other long distance service providers.
In addition, we provide a range of long distance services, primarily for
affinity groups such as French and Japanese speaking people in the U.S. Services
include 1-800/888 numbers, calling card and prepaid debit card services,
international callback, security codes and access codes.
We provide entrepreneurial carriers with network integration and customer
support services, including consulting services, network design, switch
provisioning, outsourcing, on-site technical support, remote monitoring, 7x24
customer support, billing administration and help desk support.
Business Strategy
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A fundamental component of our strategy is to provide a total solution to
entrepreneurial carriers. We provide telecom equipment, international long
distance and network services. We are targeting specific market segments:
telecom equipment, wholesale and retail international long distance and network
services. We plan to partner with and/or take minority positions in
entrepreneurial carriers. We also plan to complement our strategy through
acquisitions of entrepreneurial carriers with a goal to convert them to
switch-based and voice over IP. We plan to expand our market presence
internationally through acquisitions and plan to secure cable routes to
strategic international countries.
- - Today, we design, develop and market telecom switches and IP gateways.
- - We also provide international and affinity based long distance and network
services, which include facilities management, billing and customer support
services.
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- - Our technology enables small and medium-sized carriers and resellers to
optimize their resources, improve their margins and offer value-added
services at competitive prices.
- - We are able to offer our customers a complete solution, including telecom
equipment, international long distance and network services.
- - We are seeking to leverage this complete solution primarily to
entrepreneurial carriers, by either entering into a strategic partnership
with them or by acquiring them.
- - We plan to create a network of switched resellers, to generate synergies
among these carriers, to increase the amount and the quality of services
they can offer their customers, to cross-sell our equipment and services
and to reduce costs at all levels.
We have a four-pronged approach to generate growth relative to this strategy:
1. Expand our market for selling telecom equipment, international long
distance and network services to entrepreneurial carriers.
2. Create synergies by combining partly or wholly owned switched resellers
into a network, optimizing interconnectivity among the participants, and
reducing costs - thus further increasing the value and the market appeal of
both the carrier and the network.
3. Acquire IRUs to carry our international traffic and sell excess capacity to
resellers and customers.
4. Use these sources of revenues (switch and gateway sales, international long
distance services, customer contracts, and minutes sold on IRUs) to develop
a financial mechanism to warrant further acquisitions and to extend our
technology position.
- - The success of our strategy depends on our ability to provide a total
solution of telecom equipment, international long distance and network
services and on our capacity to find carriers that can be integrated into
our network. Our success is also dependent on obtaining additional
financing.
- - We believe that our decision to focus on international and "affinity-based"
entrepreneurial carriers should yield positive results in creating
synergies and generating increased revenues. Affinity-based carriers
typically have higher margins, primarily due to focused marketing efforts,
requiring less marketing expense. Such groups also typically have a
stronger customer allegiance since there are group-based.
- - We also plan to market our telecom equipment, international long distance
and network services in Europe, where market liberalization is in its early
stages. To do so, for example, we may increase our equity position in
companies such as Systeam S.p.A., a Rome, Italy-based telecom company, and
seek alliances with European companies to permit them to market our
products and services in Europe and permitting us to market their products
and services in the U.S.
- - Our joint venture, TelecomAlliance, plans to provide entrepreneurial
carriers with switching equipment, long distance as well as data and
Internet services, network design and operations, access to financing,
facilities management, billing administration, customer support services
and access to a path to voice over data networks. TelecomAlliance plans to
carry up to 550 million minutes of traffic per month for its members.
- - TelecomAlliance is intended to be a stand-alone operation initially limited
to up to 30 switchless resellers.
The fulfillment of our strategy is subject to a number of contingencies,
including our obtaining adequate financing to pursue our objectives.
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STRATEGY IMPLEMENTATION
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General Framework
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We have identified initiatives to turn our strategic vision into reality.
Consolidating and Expanding Our Technology Position
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We plan to continue to develop, acquire, take equity positions in and/or
contract with companies that have leading-edge technologies and that serve
customers with cost-competitive solutions, including IP gateways, alternative
transmission and packet- and revenue-generating applications. For example, our
Carrier IP Gateway combines the high bandwidth efficiency of an IP link with
compression equipment, thereby increasing bandwidth efficiency. Besides being
more efficient, new networks, such as IP, ATM and the Internet, typically bypass
conventional long distance carriers, who must pay local access charges.
We plan to bundle local, long distance, data and video services in focused
markets to better serve our customers with value-added, cost-competitive
solutions. We also plan to add Internet services, international facilities and
IRUs.
Acquiring and Integrating Switchless Affinity-Based Resellers
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We are pursuing an acquisition strategy and will continue to target companies
where complementary technologies, international long distance and network
services can provide our customers with cost-competitive, revenue generating
solutions.
- - Acquisition Criteria: We will continue to look for companies that are
customer-oriented, currently profitable or that can be profitable within 12
months, synergistic with our existing companies, have strong management and
enhance long-term shareholder value.
- - Acquisition Targets: We will continue to look for international long
distance companies that market to affinity groups. We plan to use packet
technology and value-added applications to complement them.
- - Management Strategy: We will seek to motivate management to grow their
company. Generally, we plan to only centralize treasury, finance and
accounting functions, information systems (where appropriate), switching
and carrier operational services, and staff functions, i.e., human
resources.
- - Integration Strategy: We expect to realize synergies, revenue growth and
cost savings by selling telecom equipment and digital technologies, and by
interconnecting local carriers with domestic and international long
distance providers. Our companies will be expected to "hand off" much of
their traffic to our other companies which have "landing rights," thereby
reducing or eliminating termination fees. In addition, we will provide our
companies with telecom equipment, international long distance and network
services to help improve their margins and profits.
We believe entrepreneurial carriers have several reasons to work with us:
- - We deliver cost-competitive, value-added solutions.
- - We provide telecom equipment, international long distance and network
services.
- - We can facilitate debt and/or lease financing.
- - We can provide billing and collection services.
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- - We can integrate networks and provide the equipment and services to
support them.
- - We can provide space for their switching equipment.
- - We can increase the value of their company.
- - We can improve their margins due to economies of scale and synergies.
- - We enable them to provide new revenue generating services.
- - We can provide them with a strategy for growth.
- - We can provide them with a path to voice over data networks.
- - We offer them the potential of a logical exit strategy.
Sales and Marketing
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To meet the needs of our customers, we market our products and services through
the coordinated efforts of our direct sales force, independent agents and
systems integrators.
Our equipment sales are targeted to entrepreneurial carriers, such as CLECs,
switchless resellers and international and domestic long distance providers.
Many of the equipment sales are coupled with service contracts or contemplate
additional equipment sales as the end-user customer progresses with the
implementation of their business plan. Our receipt of the additional service or
equipment revenues is subject to the ability of our customers to implement their
business plans. In many instances, we facilitate sales by arranging for third
party lease financing. In such instances, we often provide warrants and other
financial inducements to the lease company to facilitate the financing.
We primarily market our wholesale long distance services directly to carriers
and through independent agents. We primarily market our retail long distance
services through our agents and focused sales and marketing activities, e.g.,
advertising in local ethnic newspapers.
Customers and Customer Concentration
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Our equipment products are targeted at markets for small-to-medium sized telecom
switches and IP gateways. Potential customers for our telecommunications
equipment include, among others, entrepreneurial telecommunications carriers
such as CLECs, switchless resellers, incumbent local exchange carriers (ILECs),
wholesale and retail international and domestic long distance providers and
ISPs. We market retail international long distance services to affinity groups.
Our equipment revenues in fiscal 1999 were from shipments to 16 end-user
customers, seven of which were sold through third party lessors and which
accounted for approximately 93% of the total equipment revenues. In fiscal 1998,
we shipped equipment to 12 customers, on of which accounted for approximately
40% of such equipment revenues for fiscal 1998 were derived from sales to one
customer through a third party lessor.
Among the companies that have taken delivery of our switches are Apollo Telecom,
BD Communications, Cellular XL, Concentric Network Corporation, Crescent
Communications, Dakota Carrier Services, DTA/I:COMM Networks, Lightcom
International, Inc., Mercury Telecom (USA), Mony Travel Inc., Rhinos
International, Telesys S.A., Vancouver Telephone Company, Wireless USA, and
WorldWave Communications.
While our customer base continues to grow, many of our customers are
entrepreneurial carriers with limited financial resources. Their ability to pay
for our equipment and services is often dependent on obtaining third party
financing. The timeliness of such financings will continue to be an important
ingredient in our results. Our recent agreements with RCC Finance and PrinVest
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are aimed at providing this necessary part of our program. In certain of these
lease transactions, we issue warrants and other financial inducements to the
leasing company to facilitate financing to our end-user customer. We recognize
profit on these transactions as payments are received.
A component of our long-term strategy is our expansion into international
markets as evidenced by our investment in Systeam, S.p.A. and our OEM (original
equipment manufacturer) agreement with Tokyo-based Apollo KK. In order to effect
this strategy, we are seeking strategic alliances with companies that have
established international distribution channels. We also recently obtained a
Class II carrier license and a point of presence (POP) in Japan. A Class II
license enables us to originate and terminate traffic in that country and a POP
is the physical place where a long distance carrier connects to a local exchange
carrier's network.
Our wholesale international long distance services are offered primarily to
U.S.-based entrepreneurial carriers.
Customer Service and Support
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We service and provide support for our products and services. We, or an
authorized third party, provide customer training in connection with the
installation of our products and services. We have entered into agreements with
third parties, including certain suppliers of equipment incorporated into our
products, to provide support for our products. Our products may be sold with a
service plan under which we provide ongoing technical assistance and
maintenance.
We provide network operations and support services to our customers. The
services include network operations and on-site facilities support, network
design and consulting services, switch provisioning, outsourcing, on-site
technical support, remote monitoring and billing administration.
Research and Development, Manufacturing and Supply
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In fiscal 1999, we made a strategic decision to invest approximately $11.0
million in engineering, research and development efforts with the goal of
providing new and enhanced features to the existing DSS Switch and developing
the Carrier IP Gateway. The purpose of these investments was to address the
expanded customer and technical demands of the existing carrier marketplace
while preparing us to successfully participate in the Internet Protocol based
market.
Our Switch Server Architecture (SSA) is a scalable, open, standards-based
platform designed to meet the needs of entrepreneurial carriers. The SSA meets
those needs by reducing network costs and enabling revenue generation through
enhanced service applications. Carrier and service provider costs are reduced by
routing voice and fax traffic over inexpensive IP networks. The SSA allows
carrier and service providers to realize the cost reductions of next-generation
IP-telephony networks while maintaining interoperability with legacy PSTN
networks.
The SSA employs internally-developed and OEM hardware and software components
which enables us to quickly provide complete turnkey products and services to
our customers. The SSA provides an industry-standard and open call-processing
model which allows our application developers to quickly develop and/or
integrate third-party revenue-generating enhanced services.
The research and development focus described above has been conducted in
accordance with detailed design specifications developed by us. We engage
contract engineers and independent laboratories to perform some of the research
and development work. These efforts typically involve expertise in the following
areas: automatic test systems, telecommunications and engineering processes,
UNIX software, operation administration maintenance and provisioning ("OAM&P"),
telecommunication signaling systems, telecommunications and data communications
9
<PAGE>
software and Internet software. In virtually all of these instances, we own the
results of the research and development performed.
Where an application requires the customization of existing contractor
proprietary software, we typically enter into a license agreement with the
contractor.
We retain the responsibility of successfully integrating the contractor's work
product with our various products.
Certain software and hardware for our switch and IP gateway products are
licensed or procured from other vendors under OEM arrangements, or are developed
jointly with other vendors pursuant to research and development joint ventures,
partnerships or similar arrangements. Other hardware and/or software components,
such as subscriber and data line cards and core switch software were developed
by us or our contractors.
General purpose hardware components are also used in the switches and IP
gateways, which lowers costs and enables us, if we choose, to acquire such
components from more than one vendor.
We perform certain systems integration and test functions in house. In addition,
we outsource some of our manufacturing and procurement of raw materials used in
manufacturing to outsource vendors, including APW and I-PAC Manufacturing, Inc.
Our outsource vendors have facilities to provide a turnkey product which
includes the manufacturing or procurement of board, chassis, and system level
assemblies. We conduct final assembly and testing of our products at our
facilities and then ship the products directly to our end-user customer sites
via a third-party transportation company.
Certain software and hardware associated with adjunct and peripheral equipment
to provide certain functions and features are licensed or procured under OEM
arrangements from other vendors.
Proprietary Rights
- -------------------------------------------------
We use a combination of trade secrets, industry know-how, confidentiality,
non-compete agreements and tight control of our software to protect the products
and features that we believe give us competitive advantages. We are currently
engaged in litigation alleging that our use of the name Coyote infringes on the
rights of the plaintiff.
Wholesale and Retail Facilities
- --------------------------------------------------
We provide long distance service to international countries through a flexible
network comprised of various foreign termination relationships, international
gateway switches, leased facilities and resale arrangements with long distance
providers. We plan to grow our revenues by capitalizing on the deregulation of
international telecommunications markets.
Competition in the Telecommunications Industry
- --------------------------------------------------------------
The telecommunications equipment markets are highly competitive. We compete with
telecommunications equipment providers, including Nortel, Cisco Systems, Lucent
Technologies, Newbridge Networks, and Digital Switch Corporation, which have the
resources and expertise to compete in the smaller-scale telecom switch and IP
gateway market. In addition, it is possible that large communication carriers
with financial resources significantly greater than ours may enter the telecom
equipment market. Some of these large carriers, such as AT&T, MCI Worldcom and
Sprint, could initiate and support prolonged price competition to gain market
share.
10
<PAGE>
The international telecommunications long distance market is also intensely
competitive and subject to rapid change. Our competitors in the international
wholesale long distance market and the retail international long distance market
include:
- - large, multinational corporations;
- - smaller service providers in the U.S. and overseas that have emerged as a
result of deregulation;
- - switchless and switch-based resellers of international long distance
services;
- - international joint ventures and alliances;
- - dominant telecommunications operators that previously held various
monopolies established by law over the telecommunications traffic in their
countries; and
- - U.S. based and foreign long-distance providers that have the authority from
the Federal Communications Commission (the "FCC") to resell and terminate
international telecommunications services.
Many of these competitors have considerably greater financial and other
resources and more extensive domestic and international communications networks
than us. In addition, consolidation in the telecommunications industry could
create even larger competitors with greater financial and other resources, and
could also affect us by reducing the number of potential customers for our
services.
International competition also may increase as a result of the competitive
opportunities created by a Basic Telecommunications Agreement concluded by
members of the World Trade Organization (WTO) in April 1997. Under the terms of
the WTO agreement, starting February 1998, the United States and more than 65
countries have committed to open their telecommunications markets to competition
and foreign ownership and to adopt measures to protect against anti-competitive
behavior.
Government Regulation
- --------------------------------------------------------------
Our U.S. interstate and international telecommunications service offerings
generally are subject to the regulatory jurisdiction of the FCC. Certain
telecommunication services offered by the Company in the U.S. may also be
subject to the jurisdiction of state regulatory authorities, commonly known as
public utility commissions ("PUCs"). Our telecommunications service offerings
outside the U.S. are also generally subject to regulation by national regulatory
authorities. In addition, U.S. and foreign regulatory authorities may affect our
international service offerings as a result of the termination or transit
arrangements associated therewith. U.S. or foreign regulatory authorities may
take actions or adopt regulatory requirements which could adversely affect us.
Our business plan depends on a large degree on the deregulation of the telecom
market.
Environmental Regulation
- --------------------------------------------------------------
Compliance with federal, state and local regulations relating to environmental
protection have not had a material effect upon our capital expenditures,
operating results or competitive position.
Employees
- --------------------------------------------------------------
As of May 27, 1999, we had 154 employees. In addition, we retain from time to
time, on a contract basis, a number of people for specific projects. We believe
that our future growth and success will depend in large part upon our ability to
continue to attract and retain highly qualified people. We have no collective
bargaining agreement with our employees.
11
<PAGE>
================================================================================
Glossary
================================================================================
Affinity Group - People or organizations that share a common bond, including
language, religious or ethnic background, profession or occupation, college or
university.
AGT - American Gateway Telecommunications - An 80% owned subsidiary of Coyote
Network Systems, Inc. AGT is headquartered in Houston and provides wholesale
long distance services.
ATM - Asynchronous Transfer Mode - Very high-speed transmission technology. ATM
is a high bandwidth, low-delay, packet-like switching and multiplexing
technique. It is generally believed to be the preferred technology for high
bandwidth networks and is fully compatible with IP technology. ATM also is
compatible with fiber optic technology. In ATM, info is segregated into 53-byte
fixed-size cells, consisting of header and information fields.
Bandwidth - In telecommunications, bandwidth is the width of a communications
channel. In analog communications, bandwidth is generally measured in Hertz -
cycles per second. In digital communications, bandwidth is typically measured in
bits per second. A voice conversation in analog format is typically 3,000 hertz.
In digital communications, a voice conversation encoded in PCM (Pulse Code
Modulation) is 64,000 bits per second. The higher the bandwidth, the greater the
capacities of the communications channel.
Class 4 Switch - The fourth level in the traditional telephone switching
hierarchy - major switching center to which toll calls from Class 5-end office
switching centers are sent.
Class 5 Switch - An end office in the traditional telephone switching hierarchy.
Residential and business customer's telephone service, including carrier
provided features, are provided from Class 5 switching platforms.
CAP - Competitive Access Provider - An alternative carrier that originally
competed with incumbent local exchange carriers for traffic to and from long
distance providers. Today, most CAPs compete across the board with other local
telephone companies over a wide range of services.
CLEC - Competitive Local Exchange Carrier - New carriers which compete with the
incumbent local exchange carrier. CAPs, cable companies, long distance
companies, incumbent local exchange carriers operating out of their traditional
franchise territories, new entrants and wireless companies can be CLECs.
CNS - Coyote Network Systems, Inc.
CCS - Coyote Communications Services, LLC.
CTL - Coyote Technologies, LLC.
E&M Signaling - Ear and Mouth Signaling - The "E" or "ear" lead receives open or
ground signaling from the signaling equipment. The "M" or "mouth" lead transmits
a ground or battery conditions to the signaling equipment.
E1 - A digital transmission link with the capacity of 2,048,000 bits per second
(bps). An E1 uses two pairs of normal twisted wires, the same wires utilized in
homes. An E1 can be channelized into 30 voice or data channels, each handling
64,000 BPS. Two additional channels of 64 Kbps each are used for signaling and
framing respectively. An E1 may also be utilized for IDSN-PRI and advanced
services including Fame Relay, IP and ATM. E1 is the unit of base telephone
trunking outside the United States. In the United States, T1 is the standard.
12
<PAGE>
E3 - A service carrying 16 E1s with a data rate of 34,368,000 BPS.
FoN or FoIP - Fax messages sent over the Internet.
Frame Relay - A packet type network service generally used for data transmission
including LAN to LAN, LAN to Mainframe and Mainframe to Mainframe. In some
networks, generally enterprise networks, Voice-over-Frame Relay has been a
successful application.
Gateway - A gateway is an entrance and exit into a communications network.
Gateways are often located as access points into a network or connecting two
different networks.
ILD - International Long Distance Carrier.
ILEC - Incumbent Local Exchange Carrier - The telephone company that had an
exclusive franchise in a defined geographic area prior to telephone
deregulation. ILECs include the Regional Bell Operating Companies, GTE,
Cincinnati Bell, Southern New England Telephone, Rochester Telephone and other
independent telephone companies.
INET - INET Interactive Network System, Inc. - A 100% owned subsidiary of Coyote
Network Systems, Inc. INET is based in Los Angeles and provides retail long
distance services, primarily to affinity groups.
IP - Internet Protocol - Part of the TCP/IP family of protocols describing
software that tracks the Internet address of nodes, route outgoing messages, and
recognizes incoming messages. IP was originally developed by the US Department
of Defense to support interworking of dissimilar computers across a network.
IP Telephony - Telephone service over an IP network. It may be a private IP
network or the public Internet.
IRU - Indefeasible right of use. A measure of currency in the underseas cable
business. The owner of the IRU has the right to use that portion of the cable
for the time provided for. An IRU is to a submarine cable what a lease is to a
building.
ISP - Internet Service Provider.
IXC - Inter-exchange Carrier - A long distance carrier.
Landing Rights - The right to carry traffic into and out of a country. The
respective governments grant the right to bring traffic into a country.
LAN - Local Area Network.
LD - Long distance services.
OAM&P - Operations, Administration, Maintenance and Provisioning - Back office
activities.
OEM - Original Equipment Manufacturer.
PCM - Pulse Code Modulation - The most common method of encoding an analog voice
signal into a digital bit stream.
Point of Presence - POP - Physical place where a long distance carrier connects
with a local exchange carrier's network. Ports - An entrance to or exit from a
device or an entire network.
13
<PAGE>
PTT - Post Telephone & Telegraph - The PTTs provide telephone and
telecommunications services in most foreign countries. Their governments have
traditionally owned them. In some countries, privatization and deregulation has
mapped a future with less government control for some PTTs.
PSTN - Public Switched Telephone Network - The public network used for telephone
communications.
Public Internet - The Internet, a public network using IP. There are also
private or dedicated IP networks which are not part of the public Internet.
SSA - Switch Server Architecture - A network architecture strategy developed by
Coyote Technologies, LLC, which allows interworking of voice and data networks
and the applications operating on these networks.
Server - A shared computer on a network that can be as simple as a regular PC on
a local network set aside to handle print request to a single printer. Usually,
it is the fastest and brawniest PC or workstation or largest computer around. It
may be used as a depository and a distributor of large amounts of data. It may
also be the gatekeeper controlling access to voice mail, electronic mail,
facsimile services and other applications. Today, servers can be found
throughout local area networks and across the wide area networks, including the
Internet. Generally, they can be characterized as applications platforms. In
some contextual uses of the word server, the word refers only to software
running on the application platform. Generally, however, server refers to
hardware, operating systems, and applications software.
SS7 - Signaling System 7 - A signaling system that works with the telephone
network to improve call processing and allows for more advanced network
applications to work with the telephone network. In the United States, SS7-ANSI
is the prevailing standard. Outside the United States, SS7-ITU (or sometimes
referred to as C7) is the prevailing standard.
Switchless Reseller - A reseller of long distance (or local) services who does
not own a telephone switch. These carriers must arrange for leasing of switch
capacity from other carriers.
Switched Reseller - A reseller of long distance (or local) services who own at
least one telephone switch.
T1 - A digital transmission link with the capacity of 1,544,000 BPS. A T1 uses
two pairs of normal twisted wires, the same wires utilized in homes. A T1 can be
channelized into 24 voice or data channels, each handling 64,000 BPS. A T1 may
also be utilized for IDSN-PRI and advanced services including Fame Relay, IP and
ATM. T1 is the unit of base telephone trunking in the United States. Overseas,
E1 is the standard.
T3 - A service consisting of 28 T1s or 44,736,000 BPS.
TCP - Transmission Control Protocol - TCP is the transport layer in a TCP/IP
network. It provides for reliable, sequenced and unduplicated delivery of bytes
to a remote or local user.
Trunk - A communication line between two switching systems.
VAR - Value Added Reseller.
VoATM - Voice-over-ATM (See ATM).
VoIP - Voice-over-IP (See IP).
WAN - Wide Area Network - Includes voice and data networks connecting non-local
sites. The PSTN, the Internet and networks carrying data traffic are generally
included in the definition of the WAN.
14
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- --------------------------------------------------------------------------------
ITEM 2. PROPERTIES
- --------------------------------------------------------------------------------
Our executive offices are located in approximately 23,000 square feet of office
space in Westlake Village, California currently leased by us under a five-year
lease expiring February 2003. We also lease 21,000 square feet of office space
in Richardson, Texas to support our engineering requirements under a seven-year
lease expiring April 2005. We currently lease 3,000 square feet of space in
Houston, Texas under a five-year lease expiring in April 2003, however, we plan
to move to a 4,000 square foot office space in the Dallas area in the near
future. We also lease 8,000 square feet of office space in Los Angeles,
California under a five-year lease expiring March 2004. Additionally, we lease
5,100 square feet of office space in Norcross, Georgia under a five-year lease
expiring October 2003. We own a 91,000 square-foot building in Atlanta, Georgia,
which was formerly used by a discontinued company. This property is in the
process of being sold.
- --------------------------------------------------------------------------------
ITEM 3. LEGAL PROCEEDINGS
- --------------------------------------------------------------------------------
Coyote Network Systems, Inc. (The Diana Corporation) Securities Litigation (Civ.
No. 97-3186) We were a defendant in a consolidated class action, In re The Diana
Corporation Securities Litigation, that was pending in the United States
District Court for the Central District of California. The consolidated
complaint asserted claims against us and others under Section 10(b) of the
Securities Exchange Act of 1934, alleging essentially that we were engaged,
together with others, in a scheme to inflate the price of our stock during the
class period, December 6, 1994 through May 2, 1997, through false and misleading
statements and manipulative transactions.
On or about February 25, 1999, the parties executed and submitted to the court a
formal Stipulation of Settlement, dated as of October 6, 1998. Under the terms
of the settlement, all claims asserted or that could have been asserted by the
class are to be dismissed and released in return for a cash payment of $8.0
million (of which $7.25 million was paid by our D&O insurance carrier on behalf
of the individual defendants and $750,000 was paid by Concentric Network
Corporation, an unrelated defendant) and the issuance of three-year warrants to
acquire 2,225,000 shares of our common stock at prices per share increasing each
year from $9 in the first year, to $10 in the second year and $11 in the third
year. The cash portion of the settlement was previously paid into an escrow fund
pending final court approval. Charges relating to the warrants were fully
reserved by us in fiscal 1998.
On June 9, 1999, the Court rendered its Final Judgment and Order approving the
settlement set forth in the Stipulation of Settlement. No objections to the
approval of the settlement were filed.
We are also involved with other proceedings or threatened actions incident to
the operation of our businesses. It is our opinion that none of these matters
will have a material adverse effect on our financial position, results of
operations or cash flows.
- --------------------------------------------------------------------------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- --------------------------------------------------------------------------------
Not applicable.
15
<PAGE>
================================================================================
PART II.
================================================================================
================================================================================
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
- --------------------------------------------------------------------------------
Our common stock was listed on The Nasdaq National Market under the symbol CYOE
on November 5, 1998. Prior to such date, our common stock was included for
quotation on the NASD OTC Bulletin Board under the symbol CYOE. The table below
sets forth by quarter, the high and low sales prices of our common stock on The
Nasdaq National Market, and the high and low bid prices per share for our common
stock obtained from trading reports of The Nasdaq National Market subsequent to
November 5, 1998. The sales prices have been adjusted to reflect the 5% stock
dividend paid on November 4, 1998. Prices set forth below from prior to our
November 5, 1998, listing on The Nasdaq National Market reflect inter-dealer
prices without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
FISCAL 1999 FISCAL 1998
Quarter High Low Quarter High Low
------- ---- --- ------- ---- ---
First $ 9.167 $3.720 First $5.580 $1.235
Second 10.119 4.533 Second 9.762 2.679
Third 16.500 6.071 Third 8.274 4.539
Fourth $ 9.125 $4.125 Fourth $6.429 $3.303
At June 11, 1999, we had 1,224 stockholders of record.
We have not declared any cash dividends during the last three fiscal years. We
have no plans to pay cash dividends in the foreseeable future. The payment of
cash dividends is restricted by our subordinated debentures, which provide that
our consolidated tangible net worth cannot be reduced to less than an amount
equal to the aggregate principal amount of the subordinated debentures
($1,254,000 as of June 25, 1999).
Sales and Issuance of Unregistered Securities
- ---------------------------------------------------
None except as described below and as previously disclosed in reports filed
pursuant to the Securities and Exchange Act of 1934.
In June 1999, in connection with lease financing provided to our end-user
customers, we issued three warrants to a third-party leasing company. Each of
these warrants is to purchase 30,000 shares of common stock and may be exercised
for three years from the date of issuance at $3.56, $5.56 and $7.56, per share,
respectively
16
<PAGE>
- --------------------------------------------------------------------------------
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------------------------------------------------------
COYOTE NETWORK SYSTEMS, INC.
SELECTED FINANCIAL DATA
(In Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION> As of and for the Years Ended
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
March 31, March 31, March 31, March 30, April 1,
1999 1998 1997 1996 1995
Net sales $ 43,318 $ 5,387 $ 7,154 $ 264 $ ---
======== ======== ======== ======= =======
Earnings (loss) from:
Continuing operations (1)(2) $(13,843) $(34,155) $(12,335) $(2,746) $(2,140)
Discontinued operations (3) (900) --- (8,175) (619) 1,420
Extraordinary items --- --- (508) --- ---
-------- -------- --------- ------- -------
Net loss $(14,743) $(34,155) $(21,018) $(3,365) $ (720)
Earnings (loss) per common share [basic and diluted]:
Continuing operations $ (1.41) $ (4.60) $ (2.23) $ (.59) $ (.48)
Discontinued operations (.09) --- (1.48) (.13) .32
Extraordinary items --- --- (.09) --- ---
-------- -------- -------- ------- ------
Net earnings (loss) per common share $ (1.50) $ (4.60) $ (3.80) $ (.72) $ (.16)
Cash dividends per common share $ --- $ --- $ --- --- ---
======= ======= ======== ======= ======
Total assets $ 41,028 $ 21,975 $ 23,244 $29,092 $24,205
Debt (4) 13,995 5,490 1,958 2,099 2,240
Working capital (deficit) (659) 4,508 6,161 13,282 15,489
Shareholders' equity 6,057 8,060 16,834 24,686 19,729
<FN>
(1) Included in the fiscal 1999 loss is a charge of $2,500,000 in connection
with provisions for losses on investments and on deposits made to long
distance telecom carriers.
(2) Included in the fiscal 1998 loss are the following: a non-cash expense
charge of $5,522,000 for the conversion into our common stock of certain
Class A and B units owned by our directors and employees; legal,
accounting and other professional fees of $1,300,000; charges of
$1,875,000 with respect to non-cash accounting charges associated with
the issuance of our common stock upon conversion of notes issued June
1998; a charge of $2,200,000 in connection with failed acquisitions; and
a non-cash expense of $8,000,000 relating to the issuance of warrants as
part of the settlement of the securities litigation.
(3) The increase in the loss from discontinued operations in fiscal 1997 is
due to a provision of $7,550,000 recorded for restructuring costs,
severance and the estimated loss on disposal of assets of certain
discontinued operations and, in fiscal 1999, is due to a reduction in the
estimated market value of land and buildings which were part of a
discontinued operation.
(4) Includes current portion of long term debt, capital leases, notes payable
and line of credit.
</FN>
</TABLE>
17
<PAGE>
================================================================================
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
General
- --------------------------------------------------------------
In November 1996, we made a strategic decision to dispose of all of our
non-telecommunications switch business segments (the "Restructuring").
Subsequently, on February 3, 1997, our Board of Directors approved the sale of
Atlanta Provision Company to Colorado Boxed Beef Company. On November 20, 1997,
we completed the sale of our telecommunications equipment and distributor
subsidiary, C&L Communications, Inc. to the management of C&L. In March 1998, we
reached an agreement for the sale of our 80% owned wire installation and service
subsidiary, Valley Communications, Inc., to Technology Services Corporation. As
part of the Restructuring, our Board of Directors approved plans changing our
name to Coyote Network Systems, Inc. and in November 1997, our shareholders
approved the name change. Subsequently, the name of our telecommunications
equipment subsidiary, Sattel Communications LLC, was changed to Coyote
Technologies, LLC ("CTL"). Based in Richardson, Texas, CTL has granted
subordinated equity participation interests, which amount to approximately a 20%
effective ownership interest in CTL, to certain of our employees. These
participation interests are convertible into shares of our common stock at the
option of the holder.
In April 1998, our subsidiary, Coyote Gateway, LLC ("CGL"), acquired
substantially all of the assets of privately held American Gateway
Telecommunications, Inc. ("AGT"), a provider of wholesale international long
distance services, primarily to entrepreneurial carriers. In consideration of
the asset transfer, AGT received a 20% ownership interest in CGL. CGL continues
to operate under the name of AGT. Based in Houston, Texas, AGT provides
wholesale long distance service to international countries through a network
comprised of foreign termination agreements, international gateway switches,
leased transmission facilities and resale arrangements with other long distance
providers. AGT is leveraging CTL's scalable DSS Switch to route international
long distance calls. The DSS Switch enables AGT to enter new markets and capture
calls at a low per minute, per customer cost creating a competitive advantage
over traditional wireline carriers.
On September 30, 1998, we completed the acquisition of INET Interactive Network
System, Inc. ("INET"), through the merger of INET into one of our wholly owned
subsidiaries. INET provides international long distance services to commercial
and residential "affinity" groups. Headquartered in Los Angeles, California,
INET markets international long distance services, primarily to French and
Japanese speaking people in the U.S. INET provides a range of long distance
services including 1+ direct dialing. Other telephone services include 1-800/888
numbers, calling card and prepaid debit card services, international callback,
security codes, and access codes. For high volume customers, INET provides
tailored services including customized billing, telemanagement reports, and call
analysis.
In November 1998, we announced the formation of a joint venture,
TelecomAlliance, with Profitec, Inc. TelecomAlliance is designed to enhance the
growth and liquidity of entrepreneurial carriers. TelecomAlliance plans to
develop and manage a new telecom network, combining voice and data transmission
services, as well as back office services, e.g., billing, customer service and
service provisioning. TelecomAlliance plans to provide its member companies with
wholesale long distance and Internet services at new price points. Profitec,
based in Wallingford, CT, provides billing, back office and financial services
to the telecom reseller market.
In January 1999, we formed Coyote Communications Services LLC ("CCS"), designed
to provide network operations and support services to our customers and other
new, entrepreneurial carriers. Based in Norcross, GA, CCS provides a range of
services, including network operations and on-site facilities support, network
design and consulting services, switch provisioning, outsourcing, on-site
technical support, remote monitoring and billing administration.
As a result of the dispositions, acquisitions and other events described above,
the comparison of year-to-year results may not be meaningful.
18
<PAGE>
Segments
- ----------------------------------------
For the year ended March 31, 1999, our business is reported for two operating
segments: one operating segment is telecommunications equipment and the other
operating segment covers the provision of long distance services. (See Note 13
to the Consolidated Financial Statements).
Results of Operations - Fiscal Year Ended March 31, 1999 versus March 31, 1998
- --------------------------------------------------------------------------------
For the fiscal year ended March 31, 1999, we had revenues of $43.3 million,
representing a $37.9 million, or 704%, increase over the prior fiscal year.
Revenue from the sales of DSS switches and related OEM equipment increased to
$36.6 million in fiscal 1999 from $5.4 million in the prior year. The
international long distance service subsidiaries that were acquired during
fiscal 1999 generated revenues of $6.7 million.
Revenues in fiscal 1999 included shipments of switching equipment to eight new
customers. Most of these contracts were sold and financed through third party
lessors. Total revenues of $35.3 million were financed in this manner in fiscal
1999. Many of the agreements with third party lessors required us to place a
refundable security deposit with the third party lessors based on the equipment
component and gross value of the transaction. The amount of these security
deposits at March 31, 1999 is $2.2 million. At the point that the terms of each
lease transaction are satisfied, the security deposits associated with that
lease will be refunded to us. We have reserved the full amount of these
deposits. In certain of these instances, we have also issued warrants to the
third party lessors as part of the transaction.
One $7.2 million equipment sale to Wireless USA, an emerging domestic and
international long distance service provider, initially resulted in extended
payment terms being granted by us while the customer sought lease financing.
Wireless USA was successful in procuring lease financing and we are awaiting the
final one-third payment due in accordance with the lease agreement. We have
recognized profit on this transaction as payments were received. As of March 31,
1999, a profit deferral of approximately $1.5 million remains on this
transaction representing the final one-third payment due.
Additional profit deferrals of $1.6 million have been made in respect of
transactions that have been financed by third parties and, at March 31, 1999,
final payment to us is pending under the terms of the lease agreements.
The revenue generated from sales of switching equipment is $36.6 million in
fiscal 1999 with a gross margin of 37%. If the fiscal 1999 gross margin for the
switching equipment were not impacted by the security deposits and profit
deferral, the gross margin on revenue of $36.6 million would be $19.0 million,
or 52%. The international long distance service subsidiaries that were acquired
during fiscal 1999 generated a gross margin of $0.9 million, or 13% of long
distance service revenues.
The total gross margin for all lines of business for fiscal 1999 is $14.6
million, or 34% of total revenues, as compared with the fiscal 1998 gross margin
of $2.0 million, or 38% of total revenues. In fiscal 1998, all of the revenues
were derived from the sale of switching equipment systems.
Selling, general and administrative expenses for the current fiscal year were
$17.4 million versus $13.2 million for the same period last year. This increase
is primarily related to the additional operating expenses incurred by the
recently acquired long distance service provider subsidiaries and the increased
sales commissions and expenses associated with the significant increase in
switching equipment sales.
19
<PAGE>
Engineering, research and development expenses for fiscal 1999 are $9.5 million,
or 22% of sales, as compared with $5.0 million, or 92% of sales, for the prior
fiscal year. We have continued to enhance product offerings to meet current and
anticipated customer demand, including further refinement of our client/server
architecture on our switch and the development of voice over Internet Protocol.
The operating loss for fiscal 1999 is $12.4 million versus a fiscal 1998 loss of
$21.7 million. The improvement over the prior year is primarily the result of
the increase in gross profit generated by the increase in revenues and partially
offset by increased operating expenses, including engineering, research and
development activity.
Interest expense for fiscal 1999 is $1.9 million versus $2.3 million for the
prior year. The prior year included a $1.9 million charge related to the
discount from market value of the common stock issued upon conversion of the 8%
convertible notes issued in principal amounts of $2.5 million and $5.0 million
in July 1997 and December 1997, respectively. The 1999 fiscal year expense of
$1.9 million is comprised primarily of financing costs related to the operations
of the international long distance service subsidiaries.
Non-operating income for fiscal 1999 is $0.4 million versus the fiscal 1998
expense of $2.1 million. The current year includes an expense of $0.6 million
associated with issuing warrants as part of securing financing and other charges
of $0.2 million. Offsetting the expense charges is a gain of $0.9 million
related to the sale of Concentric Network Corporation ("CNC") securities and
interest income of $0.3 million. Fiscal 1998 non-operating expense was $2.1
million and included charges of $2.2 million associated with due diligence
expenses, financial consulting fees, and costs of professional services and a
$0.2 million loss on the sale of securities. These fiscal 1998 charges were
offset by other activities totaling $0.3 million.
The net loss for continuing operations for fiscal 1999 is $13.8 million versus
the prior period net loss of $34.2 million. The fiscal 1999 loss represents a
basic and fully diluted loss per common share of $1.41 versus a comparable loss
of $4.60 for the prior year. The loss from discontinued operations for fiscal
1999 is $0.9 million and increases the basic and fully diluted per share loss to
$1.50. The fiscal 1998 loss of $34.2 million included a non-cash expense of $5.5
million related to potential conversion of Class A and B units and a non-cash
expense of $8.0 million for warrants anticipated to be issued in connection with
securities litigation.
Results of Operations - Fiscal Year Ended March 31, 1998 versus March 31, 1997
- --------------------------------------------------------------------------------
CTL had revenues of $5.4 million in fiscal 1998, primarily from the sale of DSS
Switches, compared to revenues of $7.2 million in fiscal 1997. Revenues in
fiscal 1998 included shipments to nine new customers. One of the sales
contracts, which accounted for approximately 40% of the total revenue for fiscal
1998, involved a company that was one of our potential acquisition targets. The
sale, which involved a third party lessor, occurred in March 1998. We have
deferred recognition of gross profit on this sale as if the potential
acquisition was an affiliate at the time of the sale. As a result of this
deferral, the gross margin for fiscal 1998 was reduced to 38% compared to 56% in
the prior year. During fiscal 1997, 94% of revenues were from sales under one
specific contract with Concentric Network Corporation ("CNC") which was
fulfilled and completed in fiscal 1997.
Selling and administrative expenses included $1.3 million for professional audit
and legal costs, primarily related to acquisitions that were not consummated.
Engineering, research and development expenses of $5.0 million in fiscal 1998
increased by almost 25% over the prior fiscal year as we continued to enhance
product offerings. An explanation of our accounting policy for these expenses is
included in Note 1 to the Consolidated Financial Statements.
Operating expenses included a charge of $5.5 million. This non-cash charge
pertained to the Class A and Class B units owned by certain of our directors and
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employees which became convertible into our common stock on September 4, 1997,
when the Board of Directors eliminated the previous measurement requirement of
certain minimum pre-tax profits. (See also Note 12).
Interest expense of $2.3 million included a non-cash charge of $1.9 million
related to the discount from market value of our common stock issued upon
conversion of the 8% convertible notes, which were issued in principal amounts
of $2.5 million and $5.0 million in July 1997 and December 1997, respectively.
The details and terms of the notes are described in Note 8 to the Consolidated
Financial Statements.
Non-operating expense in fiscal 1998 includes a provision charge of $2.2 million
with respect to losses in connection with failed acquisitions, including costs
advanced, costs of due diligence expenses, consulting fees, legal expenses and
other professional services. The components of non-operating income (expense)
are shown in Note 10 to the Consolidated Financial Statements.
Subsequent to 1998 fiscal year end, we reached an agreement in principle to
settle the claims against us which arose out of certain securities litigation
(see Item 3). We recorded a non-cash expense of $8.0 million for the fair market
value of warrants expected to be issued in such settlement in the financial
statements for the fiscal year ended March 31, 1998. Details and terms of the
warrants are described in Note 8 to the Consolidated Financial Statements.
The increase in loss from continuing operations in fiscal 1998 is primarily due
to (i) an increase in general and administrative expense of $1.1 million
primarily related to legal and other expenses incurred in market development and
due diligence examination of potential acquisitions; (ii) an increase in
engineering, research and development expense of $0.9 million (iii) an increase
in interest charges of $2.0 million including a non-cash charge of $1.9 million
with respect to the discount from market value of our common stock issued upon
conversion of the 8% convertible notes described above; (iv) a non-cash expense
of $5.5 million related to the potential conversion of Class A and B Units; (v)
expenses incurred in connection with the failed acquisition previously
described; and (vi) a non-cash expense of $8.0 million for warrants expected to
be issued in connection with securities litigation.
Liquidity and Capital Resources
- ------------------------------------------------
As of March 31, 1999, we had a negative working capital of $0.7 million. In May
1999, as part of our efforts to provide additional working capital, we received
$10.2 million in net proceeds from a private placement. The placement agent
received cash commissions of $352,000 and commissions in the form of common
stock aggregating 131,148 shares and five-year warrants to purchase 176,700
shares at $6.00 per share. From the net proceeds of this placement, we paid $4
million to redeem 100 shares of the 700 shares of 5% Series A Convertible
Preferred Stock which were issued and outstanding as at March 31, 1999. In
connection with the redemption, the conversion price of the remaining $6 million
of Convertible Preferred Stock was fixed at $6.00 per share and the Company
issued the holder of the Convertible Preferred Stock 18-month warrants to
purchase 325,000 shares of common stock at $6.00 per share.
In July 1999, the Company received an offer for a commitment for a stand-by
credit facility from certain shareholders that would provide a funding
commitment to the Company of $3.5 million. This facility would be secured by the
stock of INET, bear 12.5% interest on the outstanding principal balance and be
repayable on March 31, 2000. The Company has also entered into an agreement to
sell its shares of iCompression, Inc. for $1.9 million.
In February 1999, we entered into definitive agreements for a loan to us of
$10.0 million. This loan was intended to be for a five-year term, bear interest
at 8% per year and be secured by our common stock. The loan has not been
received, is long overdue and there can be no assurance that it will be
received. We are now considering what course of action to take.
21
<PAGE>
We used cash from operating activities of $6.1 million during fiscal 1999
compared to using $8.5 million during fiscal 1998. This improvement in operating
cash flow in fiscal 1999 is primarily due to the improvement in the operating
profit generated by the 704% increase in revenues over fiscal 1998.
We used cash for investing activities of $4.5 million during fiscal 1999
compared to $14,000 provided from investing activities in fiscal 1998. Capital
expenditures on equipment purchases and software of $4.8 million in fiscal 1999
represented an increase of $4.2 million above the prior fiscal year. Purchases
were primarily for additional computer and test equipment required to support
the switching equipment segment of the business and software for certain
internet protocol and compression capabilities.
Net cash used in investing activities in fiscal 1999 also included cash paid in
connection with increases in investment in affiliates and acquisitions of $1.7
million. We gained $0.9 million from the sale of investments in fiscal 1999. In
fiscal 1999, we received net cash proceeds of $6.3 million from the issuance of
700 shares of 5% Series A Convertible Preferred Stock and warrants, a portion of
which we redeemed for $4 million and warrants in fiscal 2000. (See Note 8 to the
Consolidated Financial Statements).
As of March 31, 1999, we have notes payable of $8.2 million. These notes are
secured by certain of our assets and by 708,692 shares of our common stock and
bear interest at the bank's prime rate (currently 7.75%) plus 1/2%. These notes
were due on demand. In July 1999, the payment date was extended to December
2001. In addition, we have capital lease obligations of $2.6 million at March
31, 1999, payable through 2004 and a note payable of $0.4 million due February
2000.
We also have a $2.2 million revolving line of credit secured against certain
trade receivables. As at March 31, 1999, $1.1 million has been drawn against the
line, which bears interest at the bank's prime rate plus 4%. The line of credit
expires on February 29, 2000. We have a long-term obligation in the amount of
$1.7 million in connection with principal and interest due on subordinated
debentures, which bear interest of 11.25% per year. The debentures mature in the
year 2002 and interest only is due until such time.
We are currently exploring means of raising capital through debt and equity
financing to fund our immediate working capital needs. In addition, we will need
additional capital to fund our future operations and acquisition strategy. We
believe that we will be able to continue to fund our operations and acquisitions
by obtaining additional outside financing; however, there can be no assurance
that we will be able to obtain the needed financing when needed on acceptable
terms or at all.
Third Party Lease Financing
- ------------------------------------------------
To facilitate the sale of our equipment, we often arrange lease financing for
the purchaser. Parties providing the third party lease financing include
Comdisco and PrinVest and, recently, RCC Financing Group, Ltd. agreed in
principle to provide lease financing to creditworthy customers, with a goal of
providing $50 million by March 31, 2000.
Impact of Inflation
- ------------------------------------------------------------
Inflation has not had a significant impact on net sales or loss from continuing
operations for the three most recent fiscal years.
Backlog
- --------------------------------------------------------------
We only include in our backlog written orders for products and related services
scheduled to be shipped within one year. We do not believe that the level of, or
changes in the levels of, our backlog is necessarily a meaningful indicator of
future results of operations.
22
<PAGE>
================================================================================
RISK FACTORS
================================================================================
Limited Operating History; No Assurance of Profitability
- -------------------------------------------------------------------------
We have a limited operating history and have not yet achieved consistent sales
of our products over any extended period. For the last four fiscal years, we
reported losses from continuing operations. Our net sales from continuing
operations from 1996 to 1999 -- $264,000 in the 1996 fiscal year, $7,154,000 in
the 1997 fiscal year, $5,387,000 in the 1998 fiscal year and $43,318,000 in the
1999 fiscal year -- did not offset our operating and other expenses in each of
these years. To achieve profitability we will need to increase the market
acceptance and sales of our products. However, we cannot assure you that we will
be successful in this effort or that we will become profitable.
Adverse Publicity and Related Suspension of Trading in Coyote Common Stock
- --------------------------------------------------------------------------
On December 9, 1998, TheStreet.com, an Internet publication, published articles
questioning our reported equipment sale through Comdisco, Inc. to Crescent
Communications. The articles implied that Crescent Communications, Inc. did not
exist, leading to the conclusion that the sale was not valid. The article also
discussed a Form S-3 registration statement, indicating that numerous insiders
were "poised to sell huge chunks" of their holdings.
Immediately following the publication of these articles, the trading volume in
our common stock reached approximately 2.2 million shares, a number
significantly in excess of our historical trading level, and our common stock
price declined more than 50%. As a result of the articles and the significant
trading in our common stock, The Nasdaq National Market suspended trading in our
common stock on Thursday, December 10, 1998. After we issued two press releases
responding to the articles and further clarifying the transaction with Crescent
Communications, The Nasdaq National Market resumed trading in the stock on
Friday, December 11, 1998.
Since the publication of the articles referred to above, The Nasdaq National
Market and the Securities and Exchange Commission have asked us to provide
documents and other material about the Crescent Communications transaction and
other transactions. We are cooperating with both The Nasdaq National Market and
the Commission in connection with these requests. However, because of the
Commission's practice of keeping its investigations confidential, we do not know
whether the Commission is in fact investigating the matter and, if so, the
status of such matter. Investigations by the Commission and/or The Nasdaq
National Market may cause disruption in the trading of our common stock and/or
divert the attention of management. In addition, an adverse determination in any
such investigation could have a material adverse effect on us. The Commission
and The Nasdaq National Market could impose a variety of sanctions, including
fines, consent decrees and possibly de-listing. In addition, an investigation by
the Commission could substantially delay or postpone indefinitely the
effectiveness of any registration statement registering the resale of shares of
our common stock.
Risks Associated with our Relationship with Crescent Communications
- -----------------------------------------------------------------------
The public dialogue and investigations focused attention on Crescent
Communications and Gene Curcio, its president. On September 24, 1998, we
announced that we had signed a three-year equipment and service contract with
Crescent Communications valued at more than $37 million. As reported in our
December 10, 1998 press release, Comdisco purchased the initial $12 million of
equipment pursuant to Crescent's order and leased it to Crescent. We were paid
in full for that purchase by Comdisco.
23
<PAGE>
While we remain committed to Crescent's development and to delivering the
approximately $16 million in equipment remaining under Crescent's network order,
plus $9 million in services once Crescent's network is operational, we wish to
further caution you that Crescent's development is not within our control and
that such future sales and deliveries may or may not occur. Crescent has
experienced delays in executing its business plan and to date has not generated
the minimum sales required under the services agreement. There can be no
assurance that Crescent will be successful or that we will receive any revenue
from the services portion of our services contract with Crescent. Our due
diligence in 1998 indicated that Crescent had letters of intent for more than 30
million minutes per month to international locations. Our future sales to
Crescent will depend upon Crescent's ability to successfully implement its
business plan, including its ability to make its system operational, to retain
such minutes and to obtain additional commitments and translate those minutes
and commitments into successful operations and cash flows. As with the initial
delivery to Crescent, we do not intend to make any additional equipment
deliveries without Crescent first obtaining third party financing, which has not
yet been obtained. Accordingly, you should not rely on the receipt of any
additional revenues from Crescent.
In responding to the December 1998 articles and follow-up questions from The
Street.com, and in an effort to defend Crescent's right as a private company to
refuse to discuss its business with the press, we made positive statements
regarding Crescent and its founder, Mr. Curcio, relating to Crescent's
entrepreneurial spirit and Mr. Curcio's 17 years of experience and beneficial
contacts in the telecommunications business. When we entered into the equipment
sale and services agreements with Comdisco and Crescent, we were aware that Mr.
Curcio was an entrepreneur who had been involved with start-up companies, not
all of which were ultimately successful. Our due diligence investigation
regarding Crescent focused on Crescent's ability to obtain minutes to
international locations and was not conducted for the purpose of evaluating Mr.
Curcio's business history or individual creditworthiness. We did not and cannot
warrant the individual business history of Crescent or its founder or that of
any end user of its products. Because we will be providing the operational
support for Crescent under a services contract, we did not and do not believe
that such information materially relates to the benefits we are seeking from our
relationship with Crescent.
Fluctuation in Quarterly Operations Results
- --------------------------------------------------------------
Our quarterly operating results may fluctuate significantly because of a number
of factors, including:
- - the budgeting and spending patterns of our customers and potential customers
in the telecommunications industry;
- - fluctuations in the volume of calls, particularly in regions with relatively
high per-minute rates;
- - the addition or loss of a major customer;
- - the loss of economically beneficial routing options for our traffic;
- - pricing pressure resulting from increased competition;
- - market acceptance of new or advanced versions of our products;
- - technical difficulties or failures with portions of our network;
- - fluctuations in the rates charged by carriers for our traffic and in
other costs associated with obtaining rights to switching and other
transmission facilities; and
- - changes in the staffing levels of our sales, marketing and technical support
and administrative personnel.
Changes in or difficulties experienced by our customers in fulfilling their
business plans, economic conditions and related financing have caused some of
24
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our customers to not meet previously announced estimated purchase requirements.
In addition, some of our contracts contemplate the purchase of additional
equipment or the provision by us of maintenance and other services, which are
dependent on our customers installing their equipment, placing it into service
and otherwise fulfilling their business plans, which may not occur on a timely
basis or at all.
As a result, we believe that period-to-period comparisons of our operating
results may not be meaningful, especially as indicators of our future
performance. In addition, it is difficult for us to predict the occurrence of
any of the above factors. Because we base our expense levels in part on
expectations regarding future sales, we may be unable to adjust spending in a
timely manner to compensate for any unexpected shortfall in sales. A significant
shortfall in demand relative to our expectations, or a material delay in
customer orders, could have a material adverse effect on us.
Reductions in Size and Diversification
- --------------------------------------------------------------
As a part of our business plan, we have sold certain of our businesses to
concentrate on the telecommunications industry. As a result, although we believe
we are now more focused, we have in turn developed into a smaller and less
diversified company with a lower fixed asset and revenue base than we had prior
to this restructuring. Consequently, any decline in operating results after the
restructuring could more immediately and severely affect us.
Risks Inherent in Acquisition Strategy
- --------------------------------------------------------------
As part of our business strategy to grow and expand through acquisitions, we
regularly evaluate future acquisition opportunities. For instance, we
successfully completed the acquisition of American Gateway Telecommunications
("AGT") in April 1998, and we successfully completed the acquisition of INET
Interactive Network System, Inc. ("INET") in September 1998.
Our operations and earnings will be affected by our ability to successfully
integrate the acquisition of any business. The process of integrating acquired
operations presents a significant challenge to our management and may result in
unanticipated costs or a diversion of management's attention from day-to-day
operations. The acquisitions of AGT and INET have placed significant demands on
our financial and management resources. We cannot assure you that we will be
able to successfully integrate AGT, INET or any other operations or businesses
that we may acquire in the future into our operating structure. We also cannot
assure you that our current or future acquisitions will be profitable or that we
will recoup our acquisition costs.
In addition, because the value of our common stock has not yet fully recovered
from its December 9, 1998 decline, we may encounter delays in consummating any
acquisition involving the use of our common stock as consideration. We recently
terminated a pending acquisition of Apollo Telecom, Inc. due to its inability to
satisfy all of the closing conditions. We currently have pending one acquisition
which may involve the issuance of shares of our common stock.
We cannot assure you that the conditions to closing such acquisition will be
met. The timing of contemplated acquisitions may have a direct impact on our
performance.
25
<PAGE>
Risks Related to our Dependence on the Telecommunications Industry
- -------------------------------------------------------------------
Because our customers are concentrated in the telecommunications and Internet
service industries, our future success depends upon such customers' capital
spending patterns and their demand for telecommunications switches ("DSS
Switches"), Internet Protocol (IP) Gateways ("Carrier IP Gateways") and
international long distance services. We are initially targeting the market for
small to medium-sized telecom switches and IP gateways in the United States,
Mexico, South America and the Far East. Historically, there has been little, if
any, demand for telecommunications switches similar in functionality, type and
size to the DSS Switch and the Carrier IP Gateway. Accordingly, we cannot assure
you that potential customers will purchase our switches.
It is also possible that telecommunications companies and other potential
customers will adopt alternative architectures or technologies that are
incompatible with the DSS Switch or the Carrier IP Gateway, which could have a
material adverse effect on our business. The demand for our technology may be
delayed or prevented by a variety of factors over which we have no control. Such
factors include costs, regulatory obstacles, the lack of the requisite
compatible infrastructure, the lack of consumer demand for advanced
telecommunications services and alternative approaches to service delivery.
In addition, the telecommunications industry is in a period of rapid
technological evolution, marked by the introduction of competitive product and
service offerings, such as the use of the Internet for international voice and
data communications. We are unable to predict the effect of technological
changes on our operations, and such changes could have a material adverse effect
on us.
Competition in the Telecommunications Industry
- ----------------------------------------------------------------
The telecommunications switch and IP gateway markets are highly competitive. We
compete with telecommunications equipment providers, including Nortel, Cisco
Systems, Lucent Technologies, Newbridge Networks and Digital Switch Corporation
which have the resources and expertise to compete in the smaller-scale
telecommunications and IP gateway markets. In addition, it is possible that
large communication carriers with financial resources significantly greater than
ours may enter the small to mid-sized telecommunications switch and IP gateway
business. Some of these large carriers, such as AT&T Corporation, MCI Worldcom
Communications and Sprint, could initiate and support prolonged price
competition to gain market share.
The international telecommunications industry is also intensely competitive and
subject to rapid change. Our competitors in the international wholesale long
distance market and the retail international long distance market include:
- - multinational corporations;
- - service providers in the U.S. and overseas that have emerged as a result
of deregulation;
- - switchless and switch-based resellers of international long distance services;
- - international joint ventures and alliances among such companies;
- - dominant telecommunications operators that previously held various
monopolies established by law over the telecommunications traffic in
their countries; and
- - U.S. based and foreign long-distance providers that have the authority
from the Federal Communications Commission (the "FCC") to resell and
terminate international telecommunications services.
26
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Many of these competitors have considerably greater financial and other
resources and more extensive domestic and international communications networks.
In addition, consolidation in the telecommunications industry could not only
create even larger competitors with greater financial and other resources, but
could also affect us by reducing the number of potential customers for our
services.
International competition also may increase as a result of the competitive
opportunities created by a new Basic Telecommunications Agreement concluded by
members of the World Trade Organization (WTO) in April 1997. Under the terms of
the WTO agreement, starting February 1998, the United States and more than 65
countries have committed to open their telecommunications markets to competition
and foreign ownership and to adopt measures to protect against anti-competitive
behavior.
Regulatory Risks
- -----------------------------------------------------------------
In general, the telecommunications industry is highly regulated by federal laws
and regulations issued and administered by various federal agencies, including
the FCC, and by comparable laws, regulations and agencies overseas. In addition,
the U.S. Congress and the FCC may adopt new laws, regulations and policies that
may directly or indirectly affect us in the future. We are unable to predict the
impact of regulations which may be adopted in the future.
Risks Associated with Dependence on a Concentrated Product Line
- -----------------------------------------------------------------
In fiscal 1998 and fiscal 1999, we derived substantially all of our revenues
from the DSS Switch. As a result, any decrease in the overall level of sales of,
or the prices for, the DSS Switch could have a material adverse effect on us.
Our success will depend, in part, upon our ability to enhance the technology for
the DSS Switch and to develop and introduce, on a timely basis, new products,
such as the Carrier IP Gateway, that keep pace with technological developments
and emerging industry standards and address to changing customer requirements in
a cost-effective manner. We cannot guarantee that we will be able to
successfully develop, introduce and market new products, or that our new
products and product enhancements will achieve market acceptance. We have
experienced delays in completing development and introduction of new products
and features, and there can be no assurance that such delays will not recur in
the future. It is also possible that future technological advances in the
telecommunications industry will diminish market acceptance for our products,
which could have a material adverse effect on us.
Furthermore, the DSS Switch contains a significant amount of complex software
that may contain undetected or unresolved errors as products are introduced or
new versions are released. We have in the past discovered software errors in
certain DSS Switch installations. We cannot make any assurance that, despite
significant testing, software errors will not be found in new enhancements of
the DSS Switch and/or the Carrier IP Gateway. Such errors may result in delays
in or loss of market acceptance, either of which could have a material adverse
effect on us.
Risks Associated with Dependence on Manufacturers and Other Key Suppliers
- ----------------------------------------------------------------------------
Our suppliers have from time to time experienced delays in receipt of various
hardware components. Certain components, including microprocessors, are
available from either a single or a limited number of sources. An interruption
in our business with certain manufacturers and suppliers could have a material
adverse effect on us. Some single suppliers are companies which from time to
time allocate parts to telecommunications equipment manufacturers due to market
demand for telecommunications equipment. Many of our potential competitors for
such parts are much larger and may be able to obtain priority allocations from
27
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these shared suppliers, thereby limiting our supply of these components.
Although we have established relationships with alternative suppliers and have
assembled product ourselves, a failure by a supplier to deliver quality products
on a timely basis, or the inability to develop additional alternative sources,
could have a material adverse effect on us.
Limited Protection of Proprietary Technology;
Risk of Third-Party Claims of Infringement
- --------------------------------------------------
We rely on a combination of trade secrets, confidentiality and non-compete
agreements to protect the products and features that we believe give us a
competitive advantage. Nevertheless, we cannot guarantee that such protections
will be adequate to prevent misappropriation of our technology or that our
competitors will not independently develop technologies that are substantially
equivalent or superior to ours. In addition, the laws of many foreign countries
do not protect our intellectual property rights to the same extent as the laws
of the United States. Our failure to protect our proprietary information could
have a material adverse effect on us.
In addition, we may be subject to litigation that will require us to defend
against claimed infringements of the rights of others or to determine the scope
and validity of the proprietary rights of others. In this connection, we are
currently involved in a litigation alleging that our use of the name "Coyote"
infringes on the rights of the plaintiff. There can be no assurance that we will
prevail in such litigation. Litigation also may be necessary to enforce and
protect trade secrets and other intellectual property rights that we own. Any
such litigation could be costly or cause diversion of management's attention,
either of which could have a material adverse effect on us. Furthermore, an
adverse determination in any such litigation could result in the loss of
proprietary rights, subject us to significant liabilities, require us to seek
licenses from third parties (which they may not be willing to grant) or prevent
us from manufacturing or selling our products.
Risks Associated with Customer Concentration
- ---------------------------------------------------
For fiscal 1999, we shipped equipment to sixteen customers, seven of which
accounted for approximately 93% of our total equipment revenues. In the 1998
fiscal year, we shipped equipment to 12 customers, one of which accounted for
approximately 40% of our total revenues. Furthermore, in the 1997 fiscal year,
we derived approximately 94% of our revenues from sales to Concentric Network.
We expect that our results of operations in any given period will continue to
depend to a significant extent upon sales to a limited number of customers. As a
consequence, the loss of one or more major customers could have a material
adverse effect on us.
Difficulties in Managing Growth
- ---------------------------------------------------
We have experienced growth in the number of our employees and the scope of our
operations. To manage potential future growth effectively, we must improve our
operational, financial and management information systems and hire, train,
motivate and manage our employees. Our future success also will depend on our
ability to attract and retain qualified technical, sales, marketing, network
operations and management personnel, for whom competition is intense. In some
instances, we have experienced delays in filling sales and engineering
positions. We cannot predict that we will effectively achieve or manage growth,
and our failure to do so could delay product development cycles or otherwise
have a material adverse effect on us.
No Dividends
- ----------------------------------------------------
We have not paid cash dividends to stockholders in the last six years, and we do
not anticipate paying cash dividends to stockholders for the foreseeable future.
28
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Risks Associated with International Operations
- --------------------------------------------------------------
We plan to increase our expansion into international markets. Accordingly, our
business will be increasingly subject to certain risks inherent in international
operations. For example, we may encounter problems in obtaining necessary
permits and operation licenses in foreign jurisdictions. Other risks include:
- - unexpected changes in regulatory environments;
- - changes in political and economic conditions;
- - fluctuations in exchange rates; and
- - difficulties in staffing and managing operations.
We have not experienced any material adverse effects with respect to our foreign
operations arising from such factors. However, problems associated with such
risks could arise in the future. Finally, managing operations in multiple
jurisdictions could place further strain on our ability to manage our overall
growth.
Need for Additional Capital to Finance Growth and Capital Requirements
- ----------------------------------------------------------------------
We anticipate requiring additional capital to carry out our immediate business
plans and to meet our anticipated short-term working capital needs and there can
be no guarantee that we will obtain such capital on favorable terms or at all.
Although we have entered into a definitive agreement with respect to a $10
million loan, such loan has not yet been received and is long overdue. There is
no assurance that such financing will be consummated on a timely basis, or at
all. We will need to raise additional capital from the equity or debt capital
markets to carry out our business plan and such needs could be increased if:
- - we find one or more additional attractive acquisition opportunities;
- - our cash flow from operations does not meet our working capital and
capital expenditure requirements; or
- - our growth exceeds current expectations.
We cannot guarantee that we will succeed in obtaining such capital on favorable
terms, or at all. If additional funds are raised by our issuing equity
securities, stockholders may experience dilution of their ownership interest and
such securities may have rights senior to those of the holders of our common
stock. If additional funds are raised by our issuing debt, we may be subject to
certain limitations on our operations, including limitations on the payment of
dividends.
If adequate funds are not available or not available on acceptable terms, we may
have to reduce the scope of our planned expansion of operations; we also may be
unable to take advantage of acquisition opportunities, develop or enhance
services or respond to competitive or business pressures, all of which could
have a material adverse effect on us. In addition, until we achieve higher sales
and more favorable operating results, our ability to obtain funding from outside
sources of capital could be restricted. We cannot be certain that we will
maintain sufficient liquidity over an extended period of time to achieve our
operating goals or develop successful operations through acquisitions.
29
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Dependence on Third Parties to Finance our Customers
- ---------------------------------------------------------------
Many of our customers are entrepreneurial telecommunications companies with
limited financial resources. Their ability to pay for our equipment and services
is often dependent on their ability to obtain financing. Although we have
arranged such financing in the past for certain customers, there can be no
assurance that we will be able to arrange such financing in the future. In
addition, to induce such third parties to make lease financing available to our
customers, in some cases we have issued warrants to buy our common stock and
made other financial considerations to the third party leasing companies, and we
may need to provide such inducements in the future.
Volatility of Stock Price
- --------------------------------------------------------------
The market price of our common stock has been volatile and may be affected by
several factors, including actual or anticipated fluctuations in our operating
results or the announcement of potential acquisitions. Other factors include:
- - changes in federal and international regulations;
- - activities of the voice and data equipment vendors;
- - domestic and international service providers;
- - industry consolidation;
- - conditions and trends in the international telecommunications market;
- - adoption of new accounting standards affecting the telecommunications
industry;
- - changes in recommendations and estimates by securities analysts; and
- - general market conditions and other factors.
In addition, the stock market has from time to time experienced significant
price and volume fluctuations that have
particularly affected the market prices for the shares of emerging growth
companies. These broad market fluctuations may adversely affect the market price
of our common stock.
Existing Stockholders May be Able to Exercise Significant Control Over Us
- -------------------------------------------------------------------------
As of June 3, 1999, our officers and directors, as a group, beneficially owned
7.4% of our outstanding common stock. In addition, according to filed Schedules
13D and 13G, as of the dates of such filings, Comdisco beneficially owned 5.6%
of our outstanding common stock. Alan J. Andreini beneficially owned 9.1% and
the Kiskiminetas Springs School owned 8.1% of our common stock. Additionally,
Richard L. Haydon beneficially owned 11.7% of our common stock and Ardent
Research Partners beneficially owned 4.6% of our common stock. Such stockholders
may have significant influence on us, including influence over the outcome of
any matter submitted to a vote of the stockholders, including the election of
directors and the approval of significant corporate transactions.
30
<PAGE>
Recently Issued Accounting Standards
- --------------------------------------------------------------
In June 1998, the AICPA issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The Company will adopt the standard in
January 2000 and does not expect the adoption to have any material impact on the
Company's financial position or results of operations.
Year 2000 Compliance
- --------------------------------------------------------------
We have completed a comprehensive assessment of our DSS Switch and Carrier IP
Gateway operating systems and our internal computer systems and applications to
identify those that might be affected by computer programs using two digits
rather than four to define the applicable year, including the related leap year
concern (the "Year 2000 issue"). We have used primarily internal personnel to
identify those systems and applications that are affected by the Year 2000
issue.
Specifically, we tested the current versions of the DSS Switch, Administrative
and Maintenance Terminal ("AMT") and Call Management System ("CMS"), which are
the customer products most susceptible to the Year 2000 issue. Those tests were
conducted by internal personnel and outside consultants who are involved with
specific product development and maintenance. Additionally, we tested our
internal computer systems and applications using internal personnel. Those
systems include corporate finance, internal communications and production. The
testing also includes working with key third party vendors to insure that the
products they sell to us are Year 2000 compliant.
The results of the testing program to date, including key vendor responses,
indicates that the customer products and internal systems are Year 2000
compliant. Responses have been received from a majority of vendors, but not all
vendors have assured us that they will be Year 2000 compliant in time. As a
contingency, we are creating an alternative list of third party vendors in case
a critical third party does not achieve compliance.
Our internal systems rely primarily on widely recognized "mass market" software
and hardware that vendors have represented to be Year 2000 compliant.
Because of the fluid nature of this issue, Year 2000 due diligence and
compliance testing is ongoing and by necessity must include any new, adjunct, or
upgraded products implemented with the external or internal user.
To date, the costs associated with the Year 2000 have not been material to us.
Based upon the status of our Year 2000 compliance assessment to date, we do not
have a formal contingency plan in the event that an area of our operation does
not become Year 2000 compliant. A formal plan will be adopted if it becomes
evident that there will be an area of non-compliance in our systems or those of
a critical third party.
Although we expect to achieve Year 2000 compliance, there are potential risks if
we do not become or are late in becoming compliant. Such risks might include the
impairment of our ability to process and deliver customer orders, manufacture
compliant equipment and perform other critical business functions that could
have a material impact on financial performance. Those risks would include
potential claims against us for the non-compliance of our products. The costs of
defending and settling such claims could have a material impact on our financial
statements.
The information presented is based on management's estimates that were made
using assumptions of future events. Uncontrollable factors such as the
compliance of the systems of third parties and the availability of resources
could materially increase the cost or delay the date of our Year 2000
compliance.
31
<PAGE>
================================================================================
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- --------------------------------------------------------------------------------
COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
Report of Arthur Andersen LLP, Independent Public Accountants............... 33
Report of PricewaterhouseCoopers LLP, Independent Accountants............... 34
Consolidated Balance Sheets................................................. 35
Consolidated Statements of Operations....................................... 36
Consolidated Statements of Changes in Shareholders' Equity.................. 37
Consolidated Statements of Cash Flows....................................... 38
Notes to Consolidated Financial Statements.................................. 39
32
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Coyote Network Systems, Inc.
We have audited the accompanying consolidated balance sheet of Coyote Network
Systems, Inc. (a Delaware corporation and formerly, The Diana Corporation) and
subsidiaries as of March 31, 1999 and 1998, and the related consolidated
statements of operations, shareholders' equity and cash flows for the years 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 audits.
We conducted our audits 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 audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Coyote Network
Systems, Inc. and its subsidiaries as of March 31, 1999 and 1998, and the
results of their operations and their cash flows for the years then ended, in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Los Angeles, California
July 13, 1999
33
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
The Diana Corporation
In our opinion, the consolidated financial statements listed in the
index appearing under Item 14(a)(1) and (2) of this report present fairly, in
all material respects, the results of operations and cash flows of The Diana
Corporation and its subsidiaries (the "Company") for the year ended March 31,
1997, in conformity with generally accepted accounting principles. 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 of these statements in accordance with
generally accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for the opinion expressed
above.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 2, the
Company initiated a restructuring plan during fiscal 1997 which resulted in
Sattel Communications LLC ("Sattel") becoming the sole operating company
comprising the Company's continuing operations. Sattel has a limited operating
history and has not yet achieved significant sales of its products. The
Company's other operating companies were sold or are held for sale as of March
31, 1997. As discussed in Note 15, management believes the Company will have
sufficient cash resources, including proceeds from those net assets held for
sale, to fund its operations for the fiscal year ending March 31, 1998. However,
any material delay during fiscal 1998 in the timing of disposal and the ultimate
receipt of cash proceeds by the Company with respect to the net assets held for
sale could have a material adverse effect on the Company. In addition, the
Company's viability is further dependent on Sattel achieving sales levels and
operating results sufficient to fund the Company's operations. Finally, as
discussed in Note 7, the Company is subject to uncertainties relating to class
action litigation asserted against the Company and other potential claims by
investors, the ultimate effects of which on the Company's financial position,
results of operations and cash flows cannot presently be determined.
PRICEWATERHOUSECOOPERS LLP
Milwaukee, Wisconsin
September 22, 1997, except as to the last paragraph of Note 8,
which is as of November 4, 1998
34
<PAGE>
COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in Thousands)
<TABLE>
<CAPTION>
Assets March 31, 1999 March 31, 1998
-------------- --------------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 1,225 $ 3,746
Marketable securities --- 16
Receivables, net of allowance of $402 and $480 at 12,292 715
March 31, 1999 and 1998, respectively
Inventories 2,130 2,122
Notes receivable - current 2,367 4,596
Other current assets 4,323 1,409
--------- --------
Total current assets 22,337 12,604
Property and equipment, net 8,192 2,391
Capitalized software development 1,604 ---
Intangible assets, net 5,620 3,542
Net assets of discontinued operations 234 909
Notes receivable - non-current 871 1,170
Investments 1,550 750
Other assets 620 609
--------- --------
$ 41,028 $ 21,975
========= ========
Liabilities and Shareholders' Equity
Current liabilities:
Lines of credit $ 1,133 $ ---
Accounts payable 8,161 1,920
Deferred revenue and customer deposits 7,811 1,900
Accrued loss reserve --- 2,200
Accrued professional fees and litigation costs 676 805
Other accrued liabilities 3,900 1,130
Current portion of long-term debt and capital lease obligations 1,315 141
--------- --------
Total current liabilities 22,996 8,096
Notes payable 8,183 ---
Long-term debt 1,534 5,349
Capital lease obligations 1,830 ---
Other liabilities 428 470
Commitments and contingencies (Note 7) --- ---
Shareholders' equity:
Preferred stock - $.01 par value: authorized 5,000,000 shares,
700 issued, liquidation preference of $10,000 per share 7,000 ---
Common stock - $1 par value: authorized 30,000,000 shares,
issued 11,167,456 and 9,151,920 shares 11,167 9,152
Additional paid-in capital 109,649 102,360
Accumulated deficit (116,002) (97,695)
Treasury stock at cost (5,757) (5,757)
---------- ---------
Total Shareholders' equity 6,057 8,060
--------- --------
$ 41,028 $ 21,975
========= ========
</TABLE>
See notes to consolidated financial statements.
35
<PAGE>
COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(In Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>
Fiscal Year Ended
---------------------------------------------
March 31, March 31, March 31,
1999 1998 1997
----------- ---------- ---------
<S> <C> <C> <C>
Net sales $ 43,318 $ 5,387 $ 7,154
Cost of goods sold 28,748 3,363 3,132
--------- ---------- --------
Gross profit 14,570 2,024 4,022
--------- ---------- --------
Selling and administrative expenses 17,404 13,214 12,112
Engineering, research and development 9,546 5,022 4,060
A & B unit conversion expense --- 5,522 ---
--------- ---------- --------
Total operating expenses 26,950 23,758 16,172
--------- ---------- --------
Operating loss (12,380) (21,734) (12,150)
Interest expense (1,893) (2,334) (52)
Non-operating income (expense) 430 (2,087) (1,337)
Securities litigation warrant expense --- (8,000) ---
Minority interest --- --- 368
Income tax credit --- --- 836
--------- --------- -------
Loss from continuing operations (13,843) (34,155) (12,335)
Loss from discontinued operations (900) --- (625)
Estimated loss on disposal of discontinued operations --- --- (7,550)
--------- --------- --------
Loss before extraordinary items (14,743) (34,155) (20,510)
Extraordinary items --- --- (508)
--------- --------- --------
Net loss $ (14,743) $(34,155) $(21,018)
========== ========= =========
Loss per common share (basic & diluted):
Continuing operations $ (1.41) $ (4.60) $ (2.23)
Discontinued operations (0.09) --- (1.48)
Extraordinary items --- --- (.09)
---------- --------- --------
Net loss per common share (basic & diluted) $ (1.50) $ (4.60) $ (3.80)
========== ========= ========
Weighted average number of common shares outstanding 9,814 7,423 5,535
========== ========= ========
(basic & diluted)
</TABLE>
See notes to consolidated financial statements.
36
<PAGE>
COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity
(Dollars in Thousands)
<TABLE>
<CAPTION>
COMMON STOCK
--------------- Unrealized TREASURY STOCK Total
Preferred Number Additional Accum- Loss on --------------- Share-
Stock of Par Paid in ulated Marketable Number of holders'
Amount Shares Value Capital Deficit Securities Shares Cost Equity
--------- --------- ------ ---------- ------- ----------- --------- ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at March 30, 1996 $ --- 5,526,282 $5,526 $59,456 $ (34,776) $ (876) 877,692 $(4,644) $24,686
Net loss --- --- --- --- (21,018) --- --- --- (21,018)
5% stock dividend --- 250,893 251 7,474 (7,746) --- --- --- (21)
Realized loss on securities --- --- --- --- --- 876 --- --- 876
Acquisition of SCC minority interest, net --- --- --- 385 --- --- 35,000 (2,203) (1,818)
Issuance of common stock --- 230,000 230 12,630 --- --- (200,000) 1,058 13,918
Other --- --- --- 179 --- --- (4,000) 32 211
------ --------- ------ -------- -------- ------- --------- ------ -------
Balance at March 31, 1997 --- 6,007,175 6,007 80,124 (63,540) --- 708,692 (5,757) 16,834
Net loss --- --- --- --- (34,155) --- --- --- (34,155)
Exercise of stock options --- 442,956 443 1,812 --- --- --- --- 2,255
Amendment of A & B units
convertible to common stock --- --- --- 5,522 --- --- --- --- 5,522
Issuance of common stock, net --- 1,880,750 1,881 1,481 --- --- --- --- 3,362
Common stock issued on debt conversion --- 821,039 821 2,734 --- --- --- --- 3,555
Non-cash expense --- --- --- 10,687 --- --- --- --- 10,687
------ --------- ------ -------- -------- ------- -------- ------ -------
Balance at March 31, 1998 --- 9,151,920 9,152 102,360 (97,695) --- 708,692 (5,757) 8,060
Net loss --- --- --- --- (14,743) --- --- --- (14,743)
5% stock dividend --- 497,623 497 2,859 (3,359) --- --- --- (3)
Exercise of stock options --- 105,713 106 352 --- --- --- --- 458
B Unit conversions --- 73,500 73 (73) --- --- --- --- ---
Common stock issued on debt conversion --- 1,068,750 1,069 2,337 --- --- --- --- 3,406
Issuance of common stock, net --- 269,950 270 1,716 --- --- --- --- 1,986
Issuance of 700 preference shares, net 7,000 --- --- (655) --- --- --- --- 6,345
Preferred share dividend --- --- --- --- (205) --- --- --- (205)
Non-cash warrant expense --- --- --- 753 --- --- --- --- 753
------ ---------- ------- -------- --------- ------- -------- ------ -------
Balance at March 31, 1999 $7,000 11,167,456 $11,167 $109,649 $(116,002) $ --- 708,692 $(5,757) $ 6,057
====== ========== ======= ======== ========== ======= ======== ======== =======
</TABLE>
See notes to consolidated financial statements
37
<PAGE>
COYOTE NETWORK SYSTEMS, INC AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In Thousands)
Fiscal Year Ended
<TABLE>
<CAPTION>
---------------------------------------
March 31, March 31, March 31,
Operating activities: 1999 1998 1997
---------- ---------- ---------
<S> <C> <C> <C>
Loss before extraordinary items $(14,743) $(34,155) $ (20,510)
Adjustments to reconcile loss to net cash used In operating activities:
Depreciation and amortization 1,880 787 478
Loss (gain) on sales of marketable securities (877) 155 736
Gain on sale of land (20)
Write-down of CNC preferred stock --- --- 1,060
Minority interest --- --- (368)
Expense related to amendments to A & B Units --- 5,522 ---
Provision for loss on discontinued operations 900 --- 7,550
Net change in discontinued operations (225) 145 (3,862)
Changes in current assets and liabilities 6,207 8,489 (3,164)
Other - non-cash financing and warrant expense 753 10,582 221
-------- -------- ---------
Net cash used in operating activities (6,125) (8,475) (17,859)
--------- --------- ----------
Investing activities:
Purchases of property and equipment (3,217) (1,021) (1,914)
Increase in other assets (1,604) --- ---
Purchases of marketable securities --- (736) ---
Proceeds from sale of marketable securities 893 1,777 1,353
Change in notes receivable 1,050 (2,466) (5,000)
Proceeds from sale of CNC preferred stock --- --- 2,500
Proceeds from sale of land 67 --- ---
Cash payment on acquisition (1,333) --- ---
Increase in investments in affiliate (400) --- ---
Net proceeds from the sale of APC and C&L assets --- 2,861 640
Net change in discontinued operations --- (401) (985)
Other items --- --- 283
-------- -------- --------
Net cash (used) provided by investing activities (4,544) 14 (3,123)
--------- -------- --------
Financing activities:
Increase in borrowings on line of credit 1,133 --- ---
Increase in notes payable 262 --- ---
Repayments of long-term debt (142) (141) (141)
Convertible preferred stock issued, net of expenses 6,345 --- ---
Common stock issued 758 5,366 13,918
Convertible debt issued --- 6,474 ---
Net change in discontinued operations --- 275 3,314
Other items (208) 152 (508)
--------- -------- -------
Net cash provided by financing activities 8,148 12,126 16,583
-------- -------- -------
Increase (decrease) in cash and cash equivalents (2,521) 3,665 (4,399)
Cash and cash equivalents:
At beginning of year 3,746 81 4,480
-------- -------- -------
At end of year $ 1,225 $ 3,746 $ 81
======== ======== =======
</TABLE>
See notes to consolidated financial statements.
38
<PAGE>
COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
- --------------------------------------------------------------------------------
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
Basis of Presentation and Principles of Consolidation
- -----------------------------------------------------------------------
The consolidated group (hereafter referred to as the "Company") included the
following companies during the past three years:
Coyote Network Systems, Inc. ("CNS"), formerly The Diana Corporation
CNS and its wholly-owned non-operating subsidiaries are included in the
consolidated group for all three fiscal years. CNS's activities historically
consisted primarily of corporate administrative and investing activities.
Coyote Technologies, LLC ("CTL"), formerly Sattel Communications, LLC
Since fiscal 1997, CNS has owned 100% of Coyote Technologies, Inc. ["CTI", fka,
Sattel Communications Corp. ("SCC")] (see Note 3). CTI, through its subsidiary
CTL, is a provider of telecommunication switches and IP gateways. CTI has an
ownership interest in CTL, a limited liability company, of approximately 80% and
certain additional preferential rights (see Note 3). Its activities consist
primarily of development, production and sale of scalable telecommunications
switches and Internet protocol based gateway systems to telecommunications
service providers.
Coyote Gateway, LLC ("CGL" dba American Gateway Telecommunications)
On April 16, 1998, the Company established Coyote Gateway, LLC, a Colorado
limited liability company. The Company owns 80% of CGL, and American Gateway
Telecom, Inc., a Texas corporation ("AGT") owns 20%. Its principal activities
consist of the wholesaling of long distance services.
INET Interactive Network System, Inc. ("INET")
On September 30, 1998, the "Company" completed the acquisition of INET
Interactive Network System, Inc. ("INET"), through the merger of INET into a
wholly owned subsidiary of the Company. INET is a provider of international long
distance services to commercial and residential "affinity" groups. INET markets
international long distance services to primarily French and Japanese affinity
groups.
Coyote Communications Services, LLC ("CCS")
Formed in January 1999, CCS provides customer support and consulting services
including network integration, network design, switch provisioning, outsourcing,
on-site technical support, remote monitoring, 7x24 customer support, billing
administration and help desk support.
TelecomAlliance
Formed in November 1998, TelecomAlliance is a joint venture between CNS and
Profitec. TelecomAlliance plans to offer its customers an alternative to
traditional capital-intensive private network provisioning, with a national
multi-service Internet-Protocol based platform that can be leased by a carrier
to extend or supplement their current network, or to build a new network from
scratch. As of March 31, 1999, TelecomAlliance was still in the organizational
phase and had not commenced operations.
Investments in 20-50% owned subsidiaries in which management has the ability to
exercise significant influence are accounted for using the equity method of
accounting. Accounts and transactions between members of the consolidated group
are eliminated in the consolidated financial statements.
Certain prior year balances have been reclassified in order to conform to
current year presentation.
39
<PAGE>
Business Risk
- -------------------------------------------------
As discussed in Note 2 below, the Company has substantially completed a major
restructuring that resulted in the disposition of several operations. The
Company's primary operations are now the production and sale of
telecommunication switches and Internet Protocol based gateways to
telecommunication service providers. The telecommunications equipment market, in
general, is characterized by rapidly changing technology, evolving standards,
changes in end-user requirements and frequent new product introductions and
enhancements. In addition, the purchasers of the Company's switches are
primarily early stage entrepreneurial companies with limited operating histories
and financial resources. Thus, the Company's sales and profit recognition are
heavily dependent on the availability of third party financing for its
customers. The Company is also engaged, through AGT and INET (see Note 4), in
the wholesaling and retailing of international long distance service.
After the restructuring, the Company's operations are similar to those of an
early-stage enterprise and are subject to all the risks associated therewith.
These risks include, among others, uncertainty of markets, ability to develop,
produce and sell profitably its products and services and the ability to finance
operations. Management believes that it has made significant progress on its
business plan in fiscal 1999 and to date in fiscal 2000. Significant actions in
this progress include increasing sales in fiscal 1999, commencing operations of
AGT and INET, resolving the class action lawsuit (See Note 7) and recently
raising additional equity investment (see Notes 8 and 16). However, the Company
remains constrained in its ability to access outside sources of capital until
such time as the Company is able to demonstrate higher levels of sales and more
favorable operating results. Management believes that it will be able to
continue to make progress on its business plan and mitigate the risks associated
with its business, industry and current lack of working capital.
Financial Instruments
- --------------------------------------------------
The carrying values of cash and cash equivalents, marketable securities,
receivables, accounts payable and borrowings at March 31, 1999, and March 31,
1998, approximate fair value.
Marketable Securities
- --------------------------------------------------
The Company accounts for marketable securities in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Under SFAS No. 115, management
determines the appropriate classification of debt securities at the time of
purchase and re-evaluates such designation as of each balance sheet date. Debt
securities are classified as held-to-maturity when the Company has the positive
intent and ability to hold the securities to maturity. Held-to-maturity
securities are stated at amortized cost, adjusted for amortization of premiums
and accretion of discounts to maturity. Such amortization is included in
non-operating income (expense). Marketable equity securities and debt securities
not classified as held-to-maturity are classified as available-for-sale.
Available-for-sale securities are carried at fair value (based on published
market values), with the unrealized gains and losses reported in a separate
component of shareholders' equity. The amortized cost of debt securities is
adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization is included in non-operating income (expense). Realized gains
and losses, interest income and dividends are included in non-operating income
(expense). For purposes of determining the gain or loss on a sale, the cost of
securities sold is determined using the average cost of all shares of each such
security held at the dates of sale.
Gains on sales of available-for-sale securities totaled $877,000, $242,000 and
$0 in fiscal 1999, 1998 and 1997, respectively; and losses totaled $0, $397,000
and $736,000 in fiscal 1999, 1998 and 1997, respectively.
40
<PAGE>
Non-Marketable Securities
- ---------------------------------------------------
Non-marketable securities are accounted for on a lower of cost or market basis.
A write-down to market is recognized on the determination that a permanent
impairment of value has occurred.
Inventories
- --------------------------------------------------
Inventories are stated at the lower of cost or market with cost determined using
the first-in, first-out method. Inventories consist of the following (in
thousands):
March 31, 1999 March 31, 1998
-------------- --------------
Raw materials and work-in-progress $2,645 $ 2,376
Finished goods 253 152
Consigned and with customers 1,074 994
Allowance for excess and obsolete inventory (1,842) (1,400)
------ -------
$2,130 $2,122
====== ======
Property and Equipment
- --------------------------------------------------
Property and equipment are stated at cost. Provisions for depreciation are
computed on the straight-line method for financial reporting purposes over the
estimated useful lives of the assets which range from three to eighteen years.
Depreciation for income tax purposes is computed on accelerated cost recovery
methods. Expenditures which substantially increase value or extend asset lives
are capitalized. Expenditures for maintenance and repairs are charged to expense
as incurred.
Property and equipment consist of the following (in thousands):
March 31, 1999 March 31, 1998
-------------- --------------
Land $ 0 $ 50
Fixtures and equipment 10,249 3,151
------- --------
10,249 3,201
Less accumulated depreciation (2,057) (810)
-------- ---------
$ 8,192 $ 2,391
======= ========
Intangible Assets
- --------------------------------------------------
Intangible assets, net of amortization, consist of the following (in thousands):
March 31, 1999 March 31, 1998
-------------- --------------
Intellectual property rights $ 3,316 $ 3,519
Goodwill 2,167 ---
Other 137 23
-------- --------
$ 5,620 $ 3,542
======= ========
41
<PAGE>
The Company amortizes the intellectual property rights for the DSS Switch over a
20-year period on a straight-line basis. The Company amortizes the goodwill
created through the acquisition of INET in October 1998 over a five-year period
on a straight-line basis. Accumulated amortization was $1.1 million and $0.5 at
March 31, 1999 and 1998, respectively.
In fiscal 1997, the Company adopted the provisions of SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of." This statement establishes accounting standards for the impairment of
long-lived assets, certain identifiable intangibles and goodwill related to
those assets to be held and used and for long-lived assets and certain
identifiable intangibles to be disposed of. The adoption of this standard did
not have a material effect on the Company's consolidated results of operations
or financial position.
Pursuant to SFAS No. 121, long-lived assets and intangible assets are reviewed
for impairment whenever events or circumstances provide evidence that suggest
that the carrying amount of the asset may not be recoverable. Impairment is
generally determined by using estimated undiscounted cash flows over the
remaining amortization period. If the estimates of future undiscounted cash
flows do not support recoverability of carrying value of the asset, a loss is
recognized for the difference between the fair value and carrying value of the
asset.
The Company obtained an independent appraisal in support of the recoverability
of the net book value of property and equipment and the DSS Switch intellectual
property rights at March 31, 1997.
Revenue Recognition
- --------------------------------------------------
Revenue from product sales is generally recognized upon shipment. Revenues
subject to significant future obligations, restrictions or contingencies, or
dependent on future events are deferred until the obligation, restriction or
contingency is resolved or the future event has taken place. Gross profits
related to transactions with customers without established credit-worthiness are
deferred and recognized using the cost recovery method or until a creditworthy
third party (usually a leasing company) assumes the obligation. Revenue related
to long-distance services is recognized at the time of usage.
Credit and Other Concentrations
- --------------------------------------------------
For the year ended March 31, 1999, third party lessors were involved in
approximately 82% of net sales. For the year ended March 31, 1998, a third party
lessor was involved in approximately 40% of net sales and sales to Apollo Inc.
accounted for approximately 19% of net sales (see Note 4). For the year ended
March 31, 1997, Concentric Network Corporation accounted for approximately 94%
of net sales. At March 31, 1999 and 1998, two third-party lessors accounted for
77% and 41% of gross receivables, respectively. The Company performs periodic
credit evaluations of its customers' financial condition and generally does not
require collateral other than, in certain instances, a perfected security
interest in the related equipment. In addition, approximately 11% of inventory
purchased during fiscal 1998 was supplied by Sattel Technologies, Inc.
("STI").
Product Warranty
- --------------------------------------------------
Estimated product warranty costs are charged to operations at the time of
shipment. Warranty costs to date have been insignificant.
42
<PAGE>
Research and Development Costs
- --------------------------------------------------
Engineering, research and development costs include all engineering charges
related to new products and product improvements, and are charged to operations
when incurred. Software development costs are capitalized once technological
feasibility is established.
Income Taxes
- ---------------------------------------------------
The Company accounts for income taxes using the liability method in accordance
with SFAS No. 109, "Accounting for Income Taxes".
Loss Per Common Share
- ---------------------------------------------------
The basic loss per common share is determined by using the weighted average
number of shares of common stock outstanding during each period. Diluted loss
per common share is equal to the basic loss per share. Because of the net losses
in fiscal 1997, 1998 and 1999, the effect of options and warrants are not
included in the calculations of loss per common share. Loss per share amounts
for the years ended March 31, 1997 and 1998 have been restated to reflect the
effect of the Company's 5% stock dividend on November 4, 1998.
Use of Estimates
- ---------------------------------------------------
The preparation of 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 disclosures 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.
Statement of Cash Flows
- ---------------------------------------------------
For purposes of the statement of cash flows, the Company considers all highly
liquid debt instruments with a maturity of three months or less at the date of
purchase to be cash equivalents.
43
<PAGE>
- --------------------------------------------------------------------------------
NOTE 2 DISCONTINUED OPERATIONS
- --------------------------------------------------------------------------------
In November 1996 (and revised in February 1997), the Board of Directors of
Coyote Network Systems, Inc. (the "Company") approved a restructuring plan (the
"Restructuring") to separate its telecom switching equipment business (the "CTL
Business") from the following businesses:
Segment Company
---------- ---------
Telecommunications equipment distribution C&L
Wire installation and service Valley
Wholesale distribution of meat and seafood Entree/APC
On February 3, 1997, the Board of Directors of the Company approved the sale of
a majority of the assets of APC to Colorado Boxed Beef Company ("Colorado"). The
sale closed on February 3, 1997. On November 20, 1997, the Company completed the
sale of its telecommunications equipment distributor subsidiary, C&L
Communications, Inc. ("C&L"), to the management of C&L. In March 1998, the
Company reached agreement on the sale of its 80% owned wire installation and
service subsidiary, Valley Communications Inc. ("Valley"), to Technology
Services Corporation ("TSC").
The components of net assets and liabilities of discontinued operations consist
only of the meat and seafood segment and are as follows (in thousands):
1999 1998
------ ------
Other current assets $ --- $ 7
Property and equipment, net 2,572 2,572
Long term debt (688) (740)
-------- -------
Net non-current assets of discontinued operations $ 1,884 $1,839
Reserve for loss on disposal (1,650) (930)
-------- -------
Net assets of discontinued operations $ 234 $ 909
======= ======
The 1997 estimated loss on disposal of discontinued operations consists of the
following (in thousands):
Estimated operating losses for the disposal period and
loss on disposal of C&L and Valley $ 2,054
Operating losses for the disposal period and loss on
the disposal of APC 2,550
Investment banking fees, including the fair value
of a warrant to purchase common stock 1,100
Professional fees incurred in connection with the spin-off 854
Severance payments to Messrs. Fischer, Runge and Lilly
(see Note 12) 508
Charge due to acceleration of deferred compensation
payments to Messrs. Fisher and Runge (see Note 12) 137
Other 347
------
$ 7,550
The Company believes that the net assets of discontinued operations are recorded
at approximate net realizable value at March 31, 1999.
44
<PAGE>
As of June 18, 1999, the Company had collected all cash related to the sale of
discontinued operations except $410,000 due under a note and the only asset of
discontinued operations was real estate related to the land and buildings of the
discontinued APC operation. The real estate is listed for sale. Based upon an
estimate of the current market value of the real estate, the Company took an
additional charge of $900,000 in the second quarter of fiscal 1999. The asset
book value as of March 31, 1999 was $234,000, net of mortgages and reserves
applicable to the property.
Operating results, net of minority interest, relating to the discontinued
operations for fiscal year 1997 through the measurement date of November 20,
1996 are as follows (in thousands):
Fiscal Year Ending March 31, 1997
------------------------------------------------
Meat Telecomm- Wire
and unications Installation
Seafood Equipment and Service Total
-------- --------- ------------ ----------
Net sales $188,853 $ 19,750 $ 11,540 $ 220,143
======== ========= ========= ==========
Earnings (loss) from
discontinued operations $ (584) $ (51) $ 10 $ (625)
========= ========= ========= ===========
45
<PAGE>
- --------------------------------------------------------------------------------
NOTE 3 CAPITAL STRUCTURE OF CTL
- --------------------------------------------------------------------------------
On May 3, 1996, the Company and STI entered into a Supplemental Agreement by
which the Company acquired an additional 15% ownership interest in SCC. The
acquisition occurred as part of a transaction in which the Company contributed
an additional $10 million in cash to SCC. In lieu of contributing its
proportionate share of the additional funding to SCC, and in exchange for a
release from its obligation related to certain product development efforts, STI
agreed to convey to the Company 15% of SCC, together with 50,000 shares of the
CNS Shares it had acquired pursuant to the Exchange Agreement. This transaction
resulted in a net reduction of approximately $1,825,000 of intangible assets
recorded at March 30, 1996. On October 14, 1996, the Company acquired from STI
its remaining 5% ownership interest in SCC for 15,000 shares of the Company's
common stock. At this time SCC became a wholly-owned subsidiary of the Company.
During fiscal 1997, CTL granted subordinated equity participation interests,
which amount to approximately a 20% effective ownership interest (before
consideration of the subordination provisions) in CTL, to certain employees of
the Company. The Company's effective ownership of CTL is approximately 80% as a
result of these transactions. CTL is a California Limited Liability Company
owned by members (the "Members") owning either of two classes of interests, the
"Class A Units" and the "Class B Units" (collectively, the "Units"). SCC holds
8,000 Class A Units. Additional Class A Units are held by Charles Chandler, a
former employee, and Sydney Lilly, a former director and former Executive Vice
President of the Company. Mr. Chandler and Mr. Lilly hold 350 and 100 Class A
Units, respectively. Aggregate capital contributed to CTL related to these Class
A Units totaled $242,000. Initially, 1,550 Class B Units were issued to
employees of CTL in connection with their continued employment, without capital
contribution therefor.
No compensation expense was recognized in fiscal 1997 upon the granting of the
Class B Units to the employees. The estimated fair value of such units at the
date of grant was considered immaterial to the financial statements based on the
subordinated nature of the interests resulting from the priority distributions
payable to holders of Class A Units. Compensation expense was to be recognized
prospectively when it becomes probable that a conversion or other defined
triggering event will occur. If the Company exercises its option to repurchase
equity interests previously granted to employees, total compensation cost would
be equal to the cash paid upon the repurchase.
Prior to an amendment in September 1997, described in a succeeding paragraph of
this note, the terms of a conversion were that if in the future CTL achieves
cumulative pre-tax profits of at least $15 million over the four most recent
quarters, the members holding Class B Units not subject to the Board of
Directors' authorization discussed below would have the right and obligation
(the "Conversion Rights") to convert their Class B Units into Company common
stock on the basis of 500 shares of Company common stock for each Class B Unit,
subject to adjustment for stock dividends, stock splits, merger, consolidation
or stock exchange. The Conversion Rights are included in Class B Agreements
amended in November 1996 in lieu of provisions of the April 1, 1996 agreement
that provided members holding Class B Units might require CTL to conduct an
initial public offering, upon the achievement of the same cumulative pre-tax
profit measure discussed above, in which the Class B holders would have the
right to convert Class B Units into securities being offered, and would have the
right to have those securities registered under the Securities Act of 1933 (the
"Registration Rights"). If a majority of the Class B Units are redeemed or
purchased by CTL or an affiliate, or if a triggering event (including the
conversion of a majority of the Class B Units) occurs, the individual Class A
holders are entitled to have their Units redeemed, purchased or to participate
on the same terms as the Class B Units, except with an upward adjustment in
price to reflect the priority of distribution associated with the Class A Units.
Pursuant to agreements regarding Class A Units, the holders of Class A Units
other than SCC also have the right, but not the obligation, to require the
Company to purchase all, but not less than all, of such holder's Class A Units
at a price equal to the agreed-upon or appraised fair market value at any time
after April 1, 1999.
46
<PAGE>
As a result of the Company's Restructuring, its continuing operations are only
those of CTL. The Conversion Rights discussed above provided the Class B Unit
holders with an approximately comparable ownership interest in the Company as
they have in CTL.
In September 1997, the Board of Directors authorized an amendment to certain
Class B Units owned by directors and employees of CNS and CTL at June 30, 1997,
to provide for the elimination of the minimum pre-tax profits measure
requirement discussed above and the conversion into Company common stock at the
option of the holder. Consequently, there is a compensation charge of $4,016,000
recorded in the second quarter of fiscal 1998. This charge is based on the value
at September 4, 1997 of 630,000 shares of Company common stock at $6.375 per
share that will be issuable to Class B Unit Holders. Assuming that Class A
Units, other than those held by SCC, are convertible on the same basis as a
result of the Board of Directors' authorization discussed above, an additional
charge of $1,506,000 was also recorded in the second quarter of fiscal 1998
based on 236,250 shares of Company common stock and a per share price of $6.375.
In fiscal 1999, certain Class B Unit holders converted a total of 138 Units into
shares of Company common stock in accordance with the amended terms for
conversion. Certain current and former employees of CTL continue to collectively
own 1,369 Class B Units, representing all of the Class B Units currently
outstanding. The following table reflects the current ownership of the Class B
Units by the management of CTL and others as of June 15, 1999:
Name Class B Units
--------------- -------------
James J. Fiedler 350
Daniel W. Latham 212
David Held 250
Bruce Thomas 250
Others 307
47
<PAGE>
- --------------------------------------------------------------------------------
NOTE 4 ACQUISITIONS
- --------------------------------------------------------------------------------
NUKO
- ------------------------------------------
In December 1997, the Company entered into a letter of intent regarding a merger
with NUKO Information Systems, Inc. ("NUKO"). NUKO is a manufacturer of
compression and transmission technology for a variety of video applications. The
Company subsequently was unable to reach agreement with NUKO on the transaction
and withdrew its offer in March 1998. During negotiations, and in accordance
with the terms of the letter of intent, the Company advanced funds to support
NUKO's ongoing activity. Including the interest, the total funding advanced to
NUKO and now owed to the Company of $1.9 million is secured by a pledge to the
Company of shares of stock owned by NUKO in iCompression, Inc. (fka, Internext
Compression, Inc.). In April 1998, NUKO filed a voluntary petition under Chapter
11 of the U.S. Bankruptcy Code. In May 1999, the Company received an offer to
purchase the collateral for a total price of $1.9 million. The Company has
accepted this offer subject to NUKO's right of first offer to purchase the
shares. This amount is included in notes receivable - current in the
accompanying balance sheet.
Systeam
- ------------------------------------------
In fiscal 1998, the Company invested $750,000 in Systeam, S.p.A. Based in Rome,
Italy, Systeam develops voice, data, video and Internet solutions. This
investment represents an approximately 9% equity ownership of Systeam. In
February 1999, the Company announced that it signed a definitive agreement to
acquire controlling interest in Systeam by increasing its equity position to 60%
from 9%, for approximately $5.0 million in cash, including $1.5 million for
working capital and 880,000 unregistered shares of Company common stock. As part
of the Systeam acquisition, the Company also will acquire an indirect
controlling interest in Smartech, an information technology-consulting firm that
provides software solutions for telecom, financial service and utility
companies. Smartech is 51% owned by Systeam. In March 1999, the Company advanced
to Systeam an additional $550,000 toward the option to achieve the planned 60%
equity position. This amount is included in other assets in the accompanying
balance sheet. The investment in Systeam is accounted for using the cost method.
Coyote Gateway
- --------------------------------------------
On April 16, 1998, the Company established Coyote Gateway, LLC, a Colorado
limited liability company ("CGL"). The Company owns 80% of CGL and American
Gateway Telecommunications, Inc., a Texas corporation ("AGT"), and other
minority investors own 20%. In consideration of its 20% ownership interest, AGT
contributed assets to CGL, consisting of customer contracts for the transmission
of international telephone minutes and vendor and carrier contracts to service
those contracts.
INET
- --------------------------------------------
On September 30, 1998, the Company completed the acquisition of INET Interactive
Network System, Inc. ("INET") through the merger of INET into a wholly owned
subsidiary of the Company. Under the terms of the merger agreement, the Company
made total cash payments of $1.0 million and issued a total of 198,300 shares of
the Company's common stock as consideration for the outstanding shares of INET
capital stock, the cancellation of certain warrants to purchase shares of INET
common stock, the transfer of certain lines of credit and certain contractual
releases. The Company also agreed to forgive and extinguish all loans and
advances in the amount of $433,000 which had been made to INET prior to the
merger, of which $333,000 was advanced in fiscal 1999. As further consideration,
the Company will issue earnout shares of the Company's common stock to the
former INET shareholders in five installments based upon certain earning targets
for the period from October 1, 1998 to March 31, 2001. The maximum amount
payable under the earnout agreement is $2.0 million payable in Company common
stock to be valued at certain average trading prices at the time any earnout is
48
<PAGE>
payable. Since the earnings targets have not yet been achieved, no earnout stock
has been provided as of March 31, 1999. In connection with the acquisition of
INET, the Company recorded goodwill of $2.6 million. (See Note 1 - Intangible
Assets).
Crescent
- ----------------------------------------------
In September 1998, the Company acquired a 19.9% equity position in Crescent
Communications, Inc. ("Crescent"). Crescent is an early stage entity formed to
provide primarily wholesale telecommunication services to select international
markets. The Company acquired this minority interest for the sum of $1.3 million
represented by a cash payment of $0.4 to Crescent and $0.9 in the form of a
discount granted on switching equipment sold to Crescent (through a third-party
lessor) in September 1998, this investment is accounted for using the cost
method. As of March 31, 1999, Crescent was not yet running telecommunications
traffic through its switching equipment and the Company recorded a $0.5
realization reserve on this investment.
Apollo
- -----------------------------------------------
In February 1999, the Company entered into an agreement, subject to certain
conditions, to acquire Apollo Telecom, Inc. ("Apollo"). Apollo subsequently was
unable to meet the stipulated conditions and the Company withdrew its offer in
April 1999. During the negotiations and in connection with the proposed
acquisition, the Company advanced funds to Apollo in part secured by a Class II
Telecommunications License to originate and terminate traffic in Tokyo, Japan.
The total funding advanced to Apollo as at March 31, 1999 was $1.1 million. In
April 1999, subsequent to the withdrawal of the Company's acquisition offer,
Apollo filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code.
The Company subsequently obtained the Japanese license which has an estimated
market value of $220,000.
- --------------------------------------------------------------------------------
NOTE 5 OTHER CURRENT ASSETS
- --------------------------------------------------------------------------------
At March 31, 1999, the Company had deposits with long distance carriers of $5.2
million. In the fourth quarter of fiscal 1999, the Company recorded a reserve of
$2.0 million related to various deposits made with long distance carriers. The
financial viability of some of the carriers has raised concern regarding the
ultimate realization of the deposits. This provision is included in general and
administrative expenses in the accompanying financial statements.
49
<PAGE>
- --------------------------------------------------------------------------------
NOTE 6 DEBT
- --------------------------------------------------------------------------------
Debt consists of the following (in thousands):
March 31, March 31,
1999 1998
--------- ---------
Subordinated debentures due January 2002 $ 1,675 $ 1,817
and capitalized interest
8% Convertible loan due December 2000 --- 3,673
Note payable bearing interest at 10% payable in
monthly installments through February 2000 436 ---
Capital lease obligations 2,568 ---
-------- -------
4,679 5,490
Less current portion (1,315) (141)
-------- -------
$ 3,364 $ 5,349
======== =======
The subordinated debentures consist of principal of $1,254,000 and capitalized
interest of $421,000 at 11.25%. These debentures, which were issued in January
1992, are unsecured. The payment of cash dividends by the Company is restricted
by the subordinated debentures which provide that the consolidated tangible net
worth of the Company cannot be reduced to less than an amount equal to the
aggregate principal amount of the subordinated debentures, or $1,254,000.
Approximate annual amounts payable by the Company on debt and capital leases are
as follows (in thousands):
Capital
Debt Leases Total
------- -------- -------
2000 $ 577 $ 857 $ 1,434
2001 141 696 837
2002 1,393 684 2,077
2003 --- 668 668
2004 --- 150 150
------- ------- -------
2,111 3,055 5,166
Less amount representing interest --- (487) (487)
------- -------- --------
2,111 2,568 4,679
Less current portion (577) (738) (1,315)
-------- -------- --------
$ 1,534 $ 1,830 $ 3,364
======= ======= =======
As of March 31, 1999, the Company has notes payable with PrinVest of $8.2
million secured by certain assets and by 708,692 shares of the Company's common
stock and bearing interest at the bank's prime rate (7.75% at March 31, 1999)
plus 1/2%. The notes were repayable on demand. (See Notes 12 and 15). In July
1999, the payment date was extended to December 2001.
The Company also has a $2.2 million revolving line of credit secured against
certain trade receivables, bearing interest at the bank's prime rate plus 4%. As
of March 31, 1999, $1.1 million has been drawn against this line of credit. This
line of credit is renewable annually on March 1st .
50
<PAGE>
- --------------------------------------------------------------------------------
NOTE 7 COMMITMENTS AND CONTINGENCIES
- --------------------------------------------------------------------------------
The Company leases its facilities and various equipment under non-cancelable
lease arrangements for varying periods. Leases that expire generally are
expected to be renewed or replaced by other leases. Total rental expense under
operating leases in fiscal 1999, 1998 and 1997 was $931,000, $310,000, $279,000,
respectively.
Future minimum payments under non-cancelable operating leases with initial terms
of one year or more for fiscal years subsequent to March 31, 1999 are as follows
(in thousands):
2000.............................. $1,169
2001.............................. 1,097
2002.............................. 1,110
2003.............................. 1,053
2004.............................. 441
---------
$ 4,870
Coyote Network Systems, Inc. (The Diana Corporation) Securities Litigation (Civ.
No. 97-3186) The Company was a defendant in a consolidated class action, In re
The Diana Corporation Securities Litigation, that was pending in the United
States District Court for the Central District of California. The Consolidated
Complaint asserted claims against the Company and others under Section 10(b) of
the Securities Exchange Act of 1934, alleging essentially that the Company was
engaged, together with others, in a scheme to inflate the price of the Company's
stock during the class period, December 6, 1994 through May 2, 1997, through
false and misleading statements and manipulative transactions.
On or about February 25, 1999, the parties executed and submitted to the court a
formal Stipulation of Settlement, dated as of October 6, 1998. Under the terms
of the settlement, all claims asserted or that could have been asserted by the
class are to be dismissed and released in return for a cash payment of $8.0
million (of which $7.25 million was paid by the Company's D&O insurance carrier
on behalf of the individual defendants and $750,000 was paid by Concentric
Network Corporation, an unrelated defendant) and the issuance of three-year
warrants to acquire 2,225,000 shares of the Company's common stock at per share
prices increasing from $9 in the first year, $10 in the second year and $11 in
the third year. The cash portion of the settlement was previously paid into an
escrow fund pending final court approval. The warrants were fully reserved by
the Company in fiscal 1998.
On June 9, 1999, the Court rendered its Final Judgment and Order approving the
settlement set forth in the Stipulation of Settlement. No objections to the
approval of the settlement were filed.
The Company is also involved with other proceedings or threatened actions
incident to the operation of its businesses. It is management's opinion that
none of these matters will have a material adverse effect on the Company's
financial position, results of operations or cash flows.
Nasdaq and Securities Exchange Commission
- ----------------------------------------------------
On December 9, 1998, TheStreet.com, an Internet publication, published articles
questioning the Company's reported equipment sale through Comdisco, Inc. to
Crescent Communications (see Notes 4 and 12). The articles implied that Crescent
Communications, Inc. did not exist, leading to the conclusion that the sale was
not valid. The article also discussed a Form S-3 Registration Statement,
indicating that numerous insiders were "poised to sell huge chunks" of their
holdings. Immediately following the publication of these articles, the trading
volume in the Company's common stock reached approximately 2.2 million shares, a
number significantly in excess of historical trading level, and the common stock
price declined more than 50%. As a result of the articles and the significant
trading in the Company's common stock, The Nasdaq National Market suspended
51
<PAGE>
trading in the Company's common stock on Thursday, December 10, 1998. After the
Company issued two press releases responding to the articles and further
clarifying the transaction with Crescent Communications, The Nasdaq National
Market resumed trading in the stock on Friday, December 11, 1998.
Since the publication of the articles, The Nasdaq National Market and the
Securities and Exchange Commission have asked the Company to provide documents
and other material about the Crescent Communications transaction and other
transactions. The Company is cooperating with both The Nasdaq National Market
and the Commission in connection with these requests. However, because of the
Commission's practice of keeping its investigations confidential, the Company
does not know whether the Commission is in fact investigating the matter and, if
so, the status of such matter. Investigations by the Commission and/or The
Nasdaq National Market may cause disruption in the trading of the common stock
and/or divert the attention of management. In addition, an adverse determination
in any such investigation could have a material adverse effect on the Company.
The Commission and The Nasdaq National Market could impose a variety of
sanctions, including fines, consent decrees and possibly de-listing.
52
<PAGE>
- --------------------------------------------------------------------------------
NOTE 8 SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
Options and Warrants
- ------------------------------------------------------------
The Company has plans under which options to acquire up to 3,090,463 shares of
the Company's common stock may be granted to directors, officers, key employees,
consultants and non-employee directors of the Company and its subsidiaries. At
March 31, 1999, options for 1,256,926 shares were available for grant under
these plans. These plans are administered by the Company's Board of Directors,
which is authorized, among other things, to determine which persons receive
options under each plan, the number of shares for which an option may be
granted, and the exercise price and expiration date for each option. The term of
options granted shall not exceed 11 years from the date of grant of the option
or from the date of any extension of the option term.
The following table summarizes the transactions for the option plans as well as
for warrants issued for the last three fiscal years:
<TABLE>
<CAPTION>
Option Price Per Warrant Price
Options Share Warrants Per Share
<S> <C> <C> <C> <C>
Outstanding at March 30, 1996 971,158 $ 1.95 - 19.05 --- ---
5% stock dividend 53,119 --- --- ---
Granted 135,024 5.00 - 27.00 --- ---
Cancelled (320,941) 19.05 --- ---
--------- -----------
Outstanding at March 31, 1997 838,360 $ 1.95 - 27.00 --- ---
Revalued - cancelled (81,838) 19.05 - 27.00 --- ---
Revalued - granted 81,838 3.00 --- ---
Granted 284,250 3.00 - 7.72 2,329,198 $2.14 - 6.86
Exercised (442,956) 1.95 - 5.55 --- ---
Cancelled (175,680) 5.53 - 27.00 --- ---
--------- -----------
Outstanding at March 31, 1998 503,974 $ 1.95 - 19.05 2,329,198 2.14 - 6.86
5% stock dividend 62,238 --- 149,045 ---
Granted 1,054,994 3.42 - 16.00 651,667 2.86 - 8.33
Exercised (105,713) 2.86 - 9.00 --- ---
Cancelled (205,625) 2.86 - 19.05 --- ---
----------- -----------
Outstanding at March 31, 1999 1,309,868 $1.95 - 16.00 3,129,910 $2.14 - 6.86
Exercisable at March 31, 1999 305,997 3,129,910
</TABLE>
Weighted Average Weighted
Weighted Remaining Average
Option Price Outstanding Average Contractual Exercisable Exercise
Per share Options Exercise Price Life (Years) Options Price
----------- ----------- -------------- -------------- ----------- --------
$1.86 25,526 $1.86 2.76 25,526 $1.86
2.86 - 3.93 637,268 3.49 5.07 206,091 3.06
3.99 - 6.01 268,790 5.00 4.27 60,551 4.63
6.13 - 7.38 291,182 6.66 4.43 13,829 6.18
7.56 - 16.00 87,102 8.71 4.60 --- ---
--------- -------
1,309,868 $4.82 4.69 305,997 $3.41
========= =======
53
<PAGE>
Weighted Average
Warrant Price Outstanding Weighted Average Remaining Contractual
Per share Warrants Exercise Price Life (Years)
------------- ----------- ---------------- ---------------------
$2.14 - 3.81 2,460,728 $2.78 3.28
3.99 - 6.86 142,431 5.68 2.26
8.01 - 8.33 526,751 8.08 3.92
----------
3,129,910 $3.80 3.34
=========
The Company accounts for plans under APB Opinion No. 25, under which the total
compensation expense recognized is equal to the difference between the option
exercise price and the underlying market price of the stock at the measurement
date. The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation."
The following pro forma net loss and net loss per common share information
assumes that compensation cost was recognized for the vested portion of the
awards granted in those years, based on the estimated fair value at the grant
date consistent with the provisions of SFAS No. 123 (in thousand, except per
share amounts):
1999 1998 1997
---- ---- ----
Net loss - as reported $ (14,743) $ (34,155) $(21,018)
- proforma (15,461) (34,439) (21,500)
Net loss per share - as reported (1.50) (4.60) (3.80)
- proforma (1.58) (4.64) (3.88)
The fair value of each grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions for grants in fiscal 1997, 1998 and 1999:
1999 1998 1997
---- ---- ----
Expected stock price volatility 90% - 114.3% 130.90% 93.3%
Risk free interest rate 5.95% 5.95% 6.2%
Expected life 2.0 - 5.0 years 5.0 years 4.8 years
The weighted average exercise prices per share for options outstanding and
exercisable at March 31, 1999 are $4.82 and $3.41, respectively. The weighted
average exercise prices per share for options outstanding and exercisable at
March 31, 1998, are $5.00 and $6.06, respectively. The weighted average fair
value of options granted during fiscal 1997, 1998 and 1999 is $17.65, $3.95 and
$4.04 per share, respectively. The weighted average remaining contractual life
for outstanding options at March 31, 1998 and March 31, 1999 is 3.65 years and
4.69 years, respectively.
In February 1998, the Company's Board of Directors approved and adopted the
establishment of a Non-Employee Director Stock Option Plan and to date has
granted stock options to purchase 20,000 shares of the Company's common stock to
each of the three non-employee directors. These options have a five-year term,
are fully vested and have exercise prices of $3.42 and $4.39 per share. This
plan is included in the above transaction table of options.
In fiscal 1997, the Company recognized compensation expense of $125,000 in
connection with the issuance of restricted stock and the amendment of certain
previously issued stock options.
In connection with the issuance of the convertible notes in July and December
1997, the Company issued 85,648 warrants at fair market value estimated using
54
<PAGE>
the Black-Scholes option-pricing model of $384,000. These costs were originally
capitalized in other assets and amortized over the term of the debt as non-cash
interest expense. Upon conversion, the unamortized portion was credited to
additional paid in capital.
During fiscal 1997, the Company made a commitment to issue a warrant to an
investment banker for services provided in connection with the Restructuring to
purchase 100,000 shares of the Company's common stock at $22.63 per share (see
Note 2). The warrant can be exercised at any time through February 2000. The
Company recorded the fair value of the warrant within discontinued operations
(see Note 2). The fair value of the warrant of $800,000 was estimated using the
Black-Scholes option-pricing model.
In fiscal 1998, the Company issued two warrants to an investment banker for
services provided in connection with the Restructuring to purchase a total of
324,000 shares of the Company's common stock at $2.25 per share. The Company
recorded the fair value of the warrants of $503,000 as an expense in fiscal
1998. The fair value of the warrants of $503,000 was estimated using the
Black-Scholes option-pricing model.
In March 1998, the Company issued a warrant to a leasing company for services
provided in connection with customer financing to purchase 38,800 shares of the
Company's common stock at $4.00 per share. The Company recorded a fair value of
the warrants as an expense in the fourth quarter ended March 31, 1998 of
$123,000 using the Black-Scholes option-pricing model.
In fiscal 1999, the Company issued two five-year term warrants to a leasing
company for services provided in connection with customer financing to purchase
75,000 shares and 70,000 shares of the Company common stock at $8.75 per share
and $8.50 per share, respectively. The Company recorded a fair value of the
warrants of $485,000 as an expense in fiscal 1999. The fair value was estimated
using the Black-Scholes option-pricing model.
Through June 19, 1999, none of the above warrants have been exercised.
At March 31, 1999, the Company had 3,940,285 shares of common stock reserved and
available for warrants and for the conversion of Class A and B Units as
described in Note 12 - Related Party Transactions.
As described in Note 7 above, an agreement has been reached to settle the claims
against the Company and its subsidiaries in The Diana Securities Litigation.
Under the terms of the agreement, the Company anticipates that it will issue
warrants for 2,225,000 shares of the Company common stock with an expected life
of three years from date of issuance. Such warrants will have an exercise price
of $9.00 per share if exercised during the first year from date of issue and an
exercise price of $10.00 per share or $11.00 per share if exercised during the
second year or third year, respectively. The Company recorded the fair value of
the warrants of $8,000,000 as an expense in fiscal 1998. The fair value was
estimated using the Black-Scholes option-pricing model. These warrants are not
included in the above table.
Convertible Preferred Stock and Warrants
- ----------------------------------------------------
In September 1998, the Company entered into a private placement agreement and
issued 700 shares of 5% Series A Convertible Preferred Stock, par value $.01,
with a liquidation value of $10,000 per share. The total cash received by the
Company was $6,345,000 after payment of $655,000 for fees and expenses
associated with the issue. The preferred stock has no voting rights and is
convertible, subject to certain limitations and restrictions, into shares of
common stock, after a minimum holding period of 120 days, based upon a per share
common stock price that will be the lesser of the initial conversion price as
defined in the contract or 87% of the average of the three lowest per share
market values during the ten trading day period prior to an applicable
conversion date. The holders of Preferred Stock are entitled to receive 5%
cumulative dividends per annum. No dividends can be paid or declared on any
Common Stock unless full cash dividends, including past dividends declared, have
been paid on the Preferred Stock. During fiscal 1999, the Company declared and
paid cash dividends of $205,000 on the Preferred Stock.
55
<PAGE>
In conjunction with this agreement, the Company issued warrant rights to the
investment participant to purchase 225,000 shares of common stock at a warrant
exercise price of $8.43 per share. The term of the warrants is three years.
In May 1999, in connection with a private placement, a partial redemption of the
5% Series A Convertible Preferred Stock was consummated and the terms for future
conversion of the remaining balance into Company common stock were revised. (See
Note 16 - Subsequent Events).
Common Stock and Convertible Notes
- --------------------------------------------------
In July 1997, the Company issued 1,880,750 shares of its common stock at $2.00
per share in a private placement. The Company received $3,362,000 from the
private placement, net of fees of $400,000. In addition, warrants to purchase
1,880,750 shares of the Company's common stock at $3.00 per share were issued.
The warrants are exercisable immediately and expire five years from issuance.
Mr. Fiedler, the Company's Chairman and Chief Executive Officer, participated in
the private placement and purchased 175,000 shares of common stock and received
warrants to purchase 175,000 shares of the Company's common stock. In addition,
Mr. Stephen W. Portner, a director, and his daughter collectively participated
in the private placement and purchased 11,250 shares of common stock and
received warrants to purchase 11,250 shares of the Company's common stock. The
common stock and common stock warrants issued in the private placement are
subject to registration rights.
In July 1997, the Company received $2,235,000 upon the issuance of $2,500,000 in
8% convertible notes. As of December 31, 1997, the full value of notes and
accrued interest to the date of conversion had been converted into the Company's
common stock. Common stock totaling 484,964 shares was issued in connection with
conversions of $2,545,000 of convertible notes and accrued interest at a
weighted average conversion price of $5.25 per share, which represented a
conversion price of 80% of the average closing bid price on the conversion date
in accordance with the terms of the notes. A finance charge of $625,000 was
recorded in the fourth quarter of fiscal 1998 in respect of this discount value.
In December 1997, the Company received $4,635,000 upon the issuance of
$5,000,000 in 8% convertible notes. The initial conversion price is the lessor
of $7.00 or 80% of the five-day average closing bid price on a conversion date
with a conversion floor price (the "Conversion Floor Price") of $4.00 per share,
provided that if the average closing bid price for any 20 consecutive trading
days prior to a conversion date is less than $4.00 per share, the Conversion
Floor Price will be adjusted to 80% of such 20 day average closing bid price.
Effective April 7, 1998, in agreement with note holders, the conversion terms
were modified so that the conversion price discount factors be determined with
reference to the closing transaction price of the common stock for the 15
consecutive days prior to a conversion date and the applicable discount factor
be applied to the average closing transaction price of the stock for the five
consecutive trading days prior to the conversion date in order to determine the
conversion price. The applicable discount factors were agreed as follows:
15 Day Average Applicable Discount
Closing Transaction Price
Below $3.00 0%
Between $3.00 - $3.75 10%
$3.75 - $4.25 15%
$4.25 - $4.85 20%
$4.85 - $6.00 25%
Amounts in excess of $6.00 20%
A finance charge of $1,250,000 was recorded in the fourth fiscal quarter ended
March 31, 1998, in respect of the maximum beneficial value available to the
investors based upon the estimated potential discount from market value upon
56
<PAGE>
conversion. The note can be converted equally beginning 45, 75 and 105 days
following December 22, 1997. Interest is payable semi-annually in arrears in the
form of Company common stock based on the above-described conversion price.
As of June 9, 1998, the full value of notes and accrued interest to the date of
conversion had been converted into Company common stock. Common stock totaling
1,404,825 shares was issued in connection with conversions of $5,133,000 of
convertible notes and accrued interest.
In October 1998, the Board of Directors approved the declaration of a 5% common
stock dividend. Based upon an established record date of October 21, 1998, the
Company issued 497,623 shares of common stock on November 4, 1998. Certain
contractual anti-dilution provisions reduced conversion and warrant exercise
prices by a minor amount.
- --------------------------------------------------------------------------------
NOTE 9 INCOME TAXES
- --------------------------------------------------------------------------------
A reconciliation of the income tax credit and the amount computed by applying
the statutory federal income tax rate (34%) to loss from continuing operations
before extraordinary items, minority interest and income tax credit for the last
three fiscal years is as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------- -------- -------
<S> <C> <C> <C>
Credit at statutory rate $(3,097) $(11,613) $(4,604)
Settlements of liabilities of unconsolidated subsidiary (1) (10) (5)
Tax effect of net operating loss not benefited 3,076 11,600 4,500
Refund of federal income taxes paid in a prior year --- --- (836)
Other, net 22 23 109
------- -------- -------
Income tax credit $ --- $ --- $ (836)
======= ======== ========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and income tax purposes. The components of the Company's deferred tax
assets and liabilities of continuing operations are as follows (in thousands):
March 31, March 31,
1999 1998
-------- --------
Federal net operating loss carryforwards $ 16,818 $ 17,814
State net operating loss carryforwards 729 1,367
Reserve for loss on discontinued operations 819 745
Federal capital loss carryforward 4,758 646
Excess and obsolete inventory reserve 337 560
Capitalized interest in CNS debentures 168 225
General business credit 490 145
All others 314 261
-------- --------
Total deferred tax assets 24,433 21,763
Valuation allowance for deferred tax assets (21,879) (19,396)
--------- ---------
Net deferred tax assets 2,554 2,367
Intangible assets (net) 1,407 1,407
All others 1,147 960
-------- --------
Total deferred tax liabilities 2,554 2,367
Net deferred taxes $ --- $ ---
======== ========
The Company has approximately $50,000,000 in both federal and state net
operating loss carryforwards. These carryforwards expire at various dates
through fiscal 2014. The Tax Reform Act of 1986 imposed substantial restrictions
on the utilization of net operating losses in the event of an "ownership change"
as defined in Section 382 of the Internal Revenue Code of 1986. Subsequent to
57
<PAGE>
March 31, 1999, due to the Company's continuing financing efforts, there may be
ownership changes which would significantly limit the Company's ability to
immediately utilize its net operation loss carryforwards.
- --------------------------------------------------------------------------------
NOTE 10 NON-OPERATING INCOME (EXPENSE) AND UNUSUAL ITEMS
- --------------------------------------------------------------------------------
Non-operating income (expense) consists of the following for the last three
fiscal years (in thousands):
1999 1998 1997
------ ------- -------
Write-down of CNC preferred stock $ --- $ --- $(1,060)
Provision for losses --- (2,200) ---
Net gains (losses) on sales of
marketable securities 877 (155) (736)
Interest income 278 141 427
Warrant expense (655) --- ---
Other (70) 127 32
------- ------- -------
$ 430 $(2,087) $(1,337)
====== ======== ========
In June 1996, Concentric Network Corporation ("CNC") executed a Promissory Note
for $5.0 million in favor of the Company for a bridge loan. CNC granted to the
Company a warrant to purchase a split adjusted 36,765 shares of CNC Series D
Preferred Stock ("CNC Preferred Stock") at a split adjusted exercise price of
$20.40 per share (equal to the par value of such shares) as additional
consideration for the bridge loan to CNC. In August 1996, the Promissory Note
and accrued interest receivable were converted into 3,729,110 shares of CNC
Preferred Stock. In September 1996, the Company sold to StreamLogic Corporation
1,838,234 shares, or 49% of its CNC Preferred Stock for $2.5 million. No gain or
loss was recognized in connection with this sale.
In August 1997, CNC completed its Initial Public Offering at an offering price
of $12.00 per share. The CNC Preferred Stock owned by the Company was
automatically converted into CNC common stock immediately prior to the closing
of the IPO. The value of the Company's investment in CNC Preferred Stock was
approximately $1,512,000. The Company deemed this value to be the maximum fair
market value of its holding on an if-converted basis at March 31, 1997 and in
addition, concluded the value of that investment was permanently impaired.
Consequently, the Company recorded a non-operating loss of $1,060,000 in fiscal
1997 related to the impairment of its investment. The Company was prohibited
from selling 75% of its CNC common stock for six months following CNC's IPO. The
Company sold 25% of its CNC common stock in August 1997 at $12.00 per share and
received $396,000 and sold the remaining 75% in the fourth quarter of fiscal
1998 receiving $1,358,000 and recorded a gain on these sales of $242,000 in
fiscal 1998. In March 1999, in connection with a public offering made by CNC,
the Company exercised and sold the CNC common stock represented by the warrant
and recorded a non-operating gain of $877,000.
In September 1997, the Board of Directors authorized an amendment to certain
Class B Units owned by directors and employees of the Company at June 30, 1997,
to provide for the elimination of the minimum pre-tax profits measure
requirement and the conversion into Company common stock at the option of the
holder. An accrued expense charge of approximately $5,522,000 was recorded in
the second quarter of fiscal 1998. This charge is based on the value at
September 4, 1997, of 866,250 shares of Company common stock at $6.375 per share
that will be issuable to the Class A and Class B Unit Holders.
Provisions were made for non-operating expenses of $2.2 million in fiscal 1998
for losses in connection with failed acquisitions, including funds advanced,
costs of professional services, due diligence expenses, financial consulting
fees and losses.
58
<PAGE>
- --------------------------------------------------------------------------------
NOTE 11 EXTRAORDINARY ITEMS
- --------------------------------------------------------------------------------
On October 4, 1996, APC refinanced its revolving line of credit with a new
lender. In connection with the refinancing, APC incurred expenses of $227,000,
which are reflected in the fiscal 1997 Consolidated Statement of Operations as
an extraordinary item.
In February 1997, APC sold a majority of its assets and used part of the
proceeds to repay its revolving line of credit (see Note 2). APC incurred
expenses of $281,000 in connection with the early repayment which are reflected
in the fiscal 1997 Consolidated Statement of Operations as an extraordinary
item.
- --------------------------------------------------------------------------------
NOTE 12 RELATED PARTY TRANSACTIONS
- --------------------------------------------------------------------------------
On November 11, 1996, the Company loaned $300,000 each to James J. Fiedler and
Daniel W. Latham. Mr. Fiedler is the Company's Chairman and Chief Executive
Officer and Mr. Latham is the Company's President and Chief Operating Officer.
Messrs. Fiedler and Latham both executed unsecured Promissory Notes due November
1, 1999 which provide interest at 6.07% per annum compounded on the anniversary
date and payable on November 1, 1999. In addition, each person agreed to
surrender previously awarded options they each held to purchase 150,000 shares
of the Company's common stock.
The Promissory Notes provide for full repayment prior to November 1, 1999 in the
event of the following: (a) upon any transfer of Messrs. Fiedler's or Latham's
Class B Units in CTL (other than to a Permitted Transferee, as defined in the
Agreement Regarding Award of Class B Units (the "Award Agreement")), or by any
such Permitted Transferee (including without limitation certain transfers
contemplated by the Award Agreement) or (b) upon any exchange or conversion of
Class B Units for or into securities registered under the Securities Exchange
Act of 1934, as amended, in accordance with the Award Agreement. In connection
with the employment agreements with Messrs. Fiedler and Latham entered into on
September 4, 1997, the Company's Board of Directors agreed to forgive the notes.
Under the employment agreements, equal one third portions of the notes were
forgiven at September 4, 1997 and, if their respective employments are renewed,
will be forgiven at each of the next two anniversaries of the date of the
employment agreements, provided that each individual remains as an employee of
the Company at each such forgiveness date.
Messrs. Fiedler and Latham used the proceeds of the loan to each purchase 100
non-forfeitable Class B Units of CTL from Mark Jacques, a former officer of CTL,
for an aggregate purchase price of $600,000. On November 12, 1996, CTL entered
into a settlement agreement with Mr. Jacques whereby Mr. Jacques (i) agreed to
the assignment to the Company of the employment agreement between him and CTL
and (ii) retained his remaining 250 Class B Units of CTL. Mr. Jacques was
terminated as an employee of the Company in January 1997. The Company has
accounted for the loans to Messrs. Fiedler and Latham and their purchase of
Class B Units from Mr. Jacques as a settlement with Mr. Jacques and recorded an
expense of $600,000 during the third quarter of fiscal 1997.
The Company entered into Separation Agreements, dated November 20, 1996 (the
"Separation Agreements"), with each of Richard Y. Fisher, Sydney B. Lilly and
Donald E. Runge (the "Departing Officers") that provide for termination of
employment and resignation from all offices and directorships in the Company and
its subsidiaries by the Departing Officers, except for Mr. Lilly's directorship
of the Company. The Separation Agreements provide for payment by the Company, as
of November 29, 1996, of $186,000 and $749,000, respectively, to Mr. Runge and
Mr. Fisher, in settlement of deferred compensation previously earned and
payments of $343,000 to Mr. Fisher and $83,000 to each of Mr. Runge and Mr.
Lilly as severance settlements resulting in total payments to the Departing
Officers of $1,444,000. In accordance with provisions of the Amended and
Restated Employment Agreements entered into by the Company and each of the
Departing Officers on April 2, 1995, each Departing Officer shall be entitled to
have all medical, dental, hospital, optometrical, nursing, nursing home and drug
expenses for themselves and their spouses paid by the Company for life, or in
the case of Mr. Lilly, until March 31, 2000. The Separation Agreement for Mr.
Fisher provides that he shall repay in full a promissory note dated April 11,
1988, in the amount of $42,469. The Separation Agreements further provided that
all stock options of the Departing Officers shall remain exercisable until
December 31, 1997 (April 2, 2000 with respect to 82,688 options granted to Mr.
Lilly on April 2, 1995) and amends existing Stock Option Agreements with Messrs.
59
<PAGE>
Fisher, Lilly and Runge to provide for, among other things, the Company to
maintain the effectiveness of the Form S-8 Registration Statement currently in
effect covering the exercise of the stock options. The Company has made all
required payments under the Separation Agreements.
Certain of the Company's non-employee directors have provided services to the
Company and/or its subsidiaries for which they were compensated. Amounts accrued
or paid to all directors for these services during fiscal 1999, 1998 and 1997
are $0, $50,000 and $4,000, respectively.
In February 1997, APC conveyed its 50% ownership interest in Fieldstone Meats of
Alabama, Inc. to a former officer and director of APC in consideration for past
services as a director and officer of APC for his assistance in the sale of the
APC business.
Mr. Fiedler, the Company's Chairman and Chief Executive Officer, loaned the
Company $250,000 in June 1997. The principal amount of the loan was converted to
common stock in conjunction with Mr. Fiedler's purchase of Company common stock
in a private placement in July 1997. Mr. Latham, the Company's President and
Chief Operating officer, loaned the Company $98,000 subsequent to March 31,
1997. This loan was repaid in July 1997. Mr. Portner, a director, purchased
Company common stock pursuant to the Regulation D private placement. Mr. Fiedler
advanced the Company $220,000 in March 1999, which was repaid in March 1999.
On September 4, 1997, the Board of Directors authorized an amendment to certain
Class B Units owned by directors and employees of CNS and CTL at June 30, 1997.
(See Note 3).
In January 1998, the Board of Directors of the Company approved an interest-free
loan to Daniel W. Latham for a maximum amount of $500,000 to be used solely for
the purpose of providing partial down payment monies on his purchase of a
residence in California. The funding is to be secured by the residential
property and is for a five-year term unless specifically extended by the Board
of Directors. Earlier repayment of the loan will be demanded in the event of
either (1) sale or refinancing of the property; (2) termination of Mr. Latham's
employment either voluntarily or for cause; or (3) sale by Mr. Latham of all, or
substantially all, of his stock in Coyote Network Systems, Inc. As of March 31,
1999, $421,000 was funded under this agreement. In October 1998, the Company
amended the terms of the loan and in agreement with Mr. Latham established an
annual interest rate of 6.5% to be applied to the loans and payable at the
completion of the term.
In September 1998, the Company sold approximately $13.0 million of equipment to
Crescent Communications, Inc. ("Crescent") through a third party leasing
arrangement. In addition to the cash proceeds, the Company received an
approximately 20% ownership interest in Crescent and the Company entered into a
maintenance and service agreement with Crescent. The Company has deferred
recognition of gross profit of approximately $2.5 million on this sale related
to its equity interest in the buyer and amounts reserved for service
contingencies. The entire cash proceeds related to the sale were collected prior
to September 30, 1998.
On September 30, 1998, the Board of Directors of the Company accepted the
tendered resignation of Mr. Lilly as a director of the Company and approved Mr.
Lilly's Amended Separation Agreement ("Amendment"). The Amendment provides for
payments to Mr. Lilly of $50,000 per year for five years to be paid in sixty
monthly installments commencing on October 1, 1999. As of March 31, 1999, Mr.
Lilly had been paid $25,000. The Amendment also extended the time period during
which the Company is required to pay all medical expenses for Mr. Lilly and his
spouse under the Separation Agreement for an additional ten years until March
31, 2010.
Comdisco, Inc., a technology services and finance company, is the beneficial
owner of approximately 6% of the Company's common stock including 515,400 shares
purchased by Comdisco on the open market and 192,990 warrants issued in
connection with lease financing provided by Comdisco to the Company's end-user
customers. During fiscal 1998 and fiscal 1999, Comdisco has provided financing
in a total amount of $24.0 million to four of the Company's customers.
60
<PAGE>
In fiscal 1999, the Company sold 71,650 shares of common stock for $300,000 to
Systeam. (See Note 4).
PrinVest Corporation, a financing and leasing corporation, has a minority
interest of approximately 4% of the Company's subsidiary Coyote Gateway, LLC
(dba AGT). During fiscal 1999, PrinVest has provided financing to AGT ($8.2
million at March 31, 1999) in connection with deposits required to be made by
AGT to other long distance telecommunications carriers and for working capital.
PrinVest has also provided lease financing of the Company's equipment to the
Company's end-user customers. In 1999, PrinVest provided lease financing in the
total amount of $15.0 million to four of the Company's customers. The Company
has pledged 708,692 shares of common stock as collateral on the loans and
advances from PrinVest.
In November 1997, the Company completed the sale of C&L Communications, Inc.
("C&L") to the management of C&L (See Note 2). During the years ended March 31,
1998 and 1999, the Company had the following transactions with C&L.
1999 1998
---------- --------
Purchases from C&L $9,498,000 $0
Sales to C&L $0 $304,000
Redemption of Preferred Stock by C&L $1,500,000 $0
The purchases from C&L consist primarily of compression equipment manufactured
by Newbridge Networks. C&L is a Newbridge dealer and the Company is not.
61
<PAGE>
- --------------------------------------------------------------------------------
NOTE 13 BUSINESS SEGMENT INFORMATION
- --------------------------------------------------------------------------------
In addition to operating the telecom switching equipment business segment, in
fiscal 1999, the Company acquired AGT (April 1998) and INET (September 1998) and
through these subsidiaries operated an international long distance services
business segment. The accounting policies of the segments are the same as those
described in significant accounting policies; however, the Company evaluates
performance based on operating profit. In fiscal 1999, seven customers
represented 93% of CTL's revenue. Also, in fiscal 1999, two third-party leasing
companies, Comdisco and PrinVest Corporation, provided the financing for
substantially all of the customers of CTL. The telecom switching equipment
business segment consists solely of the operations of CTL. In fiscal 1998, CTL
had sales to two domestic customers that comprised 66% of net sales. In fiscal
1997, CTL had sales to one domestic customer that comprised 94% of net sales.
Information by industry segment is as follows (in thousands):
<TABLE>
<CAPTION>
Fiscal Year Ended
--------------------------------------
March 31, March 31, March 31,
1999 1998 1997
---------- ---------- ---------
Net Sales:
<S> <C> <C> <C>
Switching equipment $ 36,562 $ 5,387 $ 7,154
Long distance services 6,756 --- ---
------- -------- -------
$ 43,318 $ 5,387 $ 7,154
======== ======== ========
Operating Loss:
Switching equipment $ (3,868) $(11,267) $ (8,740)
Long distance services (5,950) --- ---
Corporate (2,562) (10,467) (3,410)
-------- ------- --------
$(12,380) $(21,734) $(12,150)
========= ======== =========
Depreciation and amortization:
Switching equipment $ 1,134 $ 787 $ 467
Long distance services 508 --- ---
Corporate 238 --- 11
-------- ------- -------
$ 1,880 $ 787 $ 478
======== ======== ========
Capital expenditures:
Switching equipment $ 2,085 $ 1,021 $ 1,902
Long distance services 1,116 --- ---
Corporate 16 --- 12
-------- -------- -------
$ 3,217 $ 1,021 $ 1,914
======== ======== ========
Identifiable assets:
Switching equipment $ 18,214 $ 11,528 $ 14,811
Long distance services 12,902 --- ---
Discontinued operations 234 909 8,201
Corporate 9,678 9,538 232
-------- -------- --------
$ 41,028 $ 21,975 $ 23,244
======== ======== ========
</TABLE>
62
<PAGE>
- --------------------------------------------------------------------------------
NOTE 14 STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
Supplemental cash flow information relating to continuing operations for the
last three fiscal years is as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- -------
Change in current assets and liabilities:
<S> <C> <C> <C>
Trade receivables $(10,486) $ 3,879 $(4,540)
Inventories (8) 815 (1,850)
Other current assets 6,071 (735) 294
Accounts payable 2,472 (640) 2,076
Other current liabilities 8,158 5,170 856
-------- ------- -------
$ 6,207 $ 8,489 $(3,164)
======== ======= ========
Non-cash transactions:
Expense charge on conversion of A & B units $ --- $ 5,522 $ ---
Convertible debt expense associated with conversion
to common stock below market price (382) 1,875 ---
Acquisitions purchased with common stock 1,686 --- 1,818
Conversion of promissory note and accrued interest
into CNC preferred stock --- --- 5,072
Conversion of debt to common stock 3,789 --- ---
Securities litigation warrant expense --- 8,000 ---
Dividend paid in common stock 3,359 --- 7,725
Sales discount granted for investment in affiliate (900) --- ---
Amounts paid directly by lender (7,921) --- ---
</TABLE>
- --------------------------------------------------------------------------------
NOTE 15 LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------------------------------------------------------
Fiscal 1999 - Year Ended March 31, 1999
- ------------------------------------------------------------
After the restructuring, the Company's operations are similar to those of an
early-stage enterprise and are subject to all the risks associated therewith.
These risks include, among others, uncertainty of markets, ability to develop,
produce and sell profitably its products and services and the ability to finance
operations. Management believes that it has made significant progress on its
business plan in fiscal 1999 and to date in fiscal 2000. Significant actions in
this progress include increasing sales in fiscal 1999, commencing operations of
AGT and INET, resolving the class action lawsuit (See Note 7) and recently
raising additional equity investment (see Notes 8 and 16). However, the Company
remains constrained in its ability to access outside sources of capital until
such time as the Company is able to demonstrate higher levels of sales and more
favorable operating results. Management believes that it will be able to
continue to make progress on its business plan and mitigate the risks associated
with its business, industry and current lack of working capital.
In fiscal 1999, the Company raised $6.3 million, net of fees, from the issuance
of 700 shares of 5% Series A Convertible Preferred Stock (see Note 8). These
funds, together with operating cash on hand at the end of the prior fiscal year
and increases in short-term borrowings, were sufficient to finance the Company's
growth in operating activities experienced during fiscal 1999. However, the
increases in short-term debt and other current liabilities required to support
the operations resulted in a deficiency in current working capital as at March
31, 1999 of $0.7 million.
63
<PAGE>
Subsequent to year-end, the Company continues to be constrained in its ability
to access outside capital, however, management has taken certain actions that
they believe will allow the Company to continue to fund operations at least
until March 2000.
These actions include:
- - Received $10.2 million proceeds from a private placement in May 1999
(See Note 16);
- - Received an offer for a commitment for a stand-by credit facility of
$3.5 million (See Note 16);
- - In July 1999, the Company entered into an agreement to sell its shares
of iCompression, Inc. (See Note 4) for $1.9 million; and
- - Extended the maturity date of the $8.2 million note payable with PrinVest
to December 2001 (See Note 12).
In order to fund the current and future operating and investment activities, the
Company will need to continue to generate cash from its present operations and,
in addition, will require and is seeking further outside investment.
Fiscal 1998 - Year Ended March 31, 1998
- --------------------------------------------------
As discussed below, the Company encountered a liquidity deficiency during the
end of fiscal 1997 and in early fiscal 1998, primarily because (i) certain
customers of CTL were past due on receivables, (ii) CTL granted certain
customers extended payments terms, (iii) CTL's revenue growth has been lower
than expected and (iv) the Company made payments of $2,349,000 in connection
with the Restructuring.
As a result of the liquidity deficiency, the Company had become delinquent on
certain of its working capital obligations. In July and December 1997, the
Company raised $5,597,000 and $4,635,000 respectively, through equity and debt
financing (see Note 7). With completion of the equity and debt financing and the
collection of $4,400,000 of previously delinquent customer receivables and the
receipt of $2,254,000 from the exercise of Company Employee Stock Options, the
Company had more than sufficient funds to finance its operating activities in
fiscal 1998 and ended the fiscal year with an operating cash balance of
$3,700,000.
The Company has now divested the majority of its discontinued operations (APC,
C&L, Valley) and is actively seeking buyers for the remaining land and building
which were formerly part of the APC operations in Atlanta.
In order to fund the current and future operating, acquisition and investment
activities, the Company will need to generate cash from its present and recently
acquired operations and, in addition, will require and is currently seeking
further outside investment. As of July 1, 1998, the Company had an operating
cash balance of approximately $5,000,000.
Fiscal 1997 - Year Ended March 31, 1997
- ----------------------------------------------------
The Company encountered a liquidity deficiency in fiscal 1997 and subsequently,
primarily because (i) certain customers of CTL were past due on receivables,
(ii) CTL has granted certain customers extended payment terms, (iii) CTL's
revenue growth has been lower than expected and (iv) the Company made payments
of $2,349,000 in connection with the Restructuring.
As a result of the liquidity deficiency, the Company had become delinquent on
certain of its working capital obligations. In July 1997, the Company raised
$5,597,000 through equity and debt. After completion of the equity and debt
financings, collection of $4.4 million from CNC, pursuant to the final court
agreement secured by CTL against this customer, and the anticipated sales of
C&L, Valley and APC's real estate discussed further below, management believes
that it will have sufficient resources to provide adequate liquidity to meet the
Company's planned capital and operating requirements through March 31, 1998.
64
<PAGE>
Thereafter, the Company's operations will need to be funded either with funds
generated through operations or with additional debt or equity financing. If the
Company's operations do not provide funds sufficient to fund its operations and
the Company seeks outside financing, there can be no assurance that the Company
will be able to obtain such financing when needed, on acceptable terms or at
all.
The Company is seeking buyers for C&L and Valley. It is anticipated that the
proceeds of the sales of these businesses and assets will be used to fund a
portion of the Company"s capital and operating requirements in fiscal 1998.
Restrictions in the revolving lines of credit of C&L and Valley prevent the
Company from presently accessing funds from these subsidiaries. Such
restrictions in C&L's revolving line of credit may also initially limit the
Company's access to the total proceeds from a sale of Valley prior to any
ultimate sale of C&L given the existing ownership structure of Valley.
- --------------------------------------------------------------------------------
NOTE 16 SUBSEQUENT EVENTS
- --------------------------------------------------------------------------------
On May 27, 1999, the Company sold, pursuant to Rule 506 under Regulation D,
1,767,000 shares of common stock at $6.00 per share in a private placement with
new and existing domestic and international institutional investors. The
placement agent received cash commissions of $352,000 and commissions in the
form of common stock aggregating 131,148 shares and five-year warrants to
purchase 176,700 shares at $6.00 per share. The net proceeds of approximately
$10.2 million are to be used for working capital and to redeem $4 million of the
outstanding Convertible Preferred Stock. In connection with this redemption, the
conversion price of the remaining $6 million of Convertible Preferred Stock was
fixed at $6.00 per share and the Company issued the holder of the Convertible
Preferred Stock 18-month warrants to purchase 325,000 shares of common stock at
$6.00 per share. These warrants may be exercised at any time until December 30,
2000.
The Company has agreed to use its best efforts to file a registration statement
as to the common stock issued in the private placement and underlying the
warrants and Convertible Preferred Stock referred to above.
In July 1999, the Company received an offer for a commitment for a stand-by
credit facility from certain shareholders that would provide a funding
commitment to the Company of $3.5 million. This facility would be secured by the
stock of INET, bear 12.5% interest on the outstanding principal balance and be
repayable on March 31, 2000.
In July 1999, the Company entered into an agreement to sell its shares of
iCompression, Inc. (See Note 4) for $1.9 million.
================================================================================
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
- --------------------------------------------------------------------------------
None.
65
<PAGE>
================================================================================
PART III.
================================================================================
Items 10, 11, 12 and 13. Directors and Executive Officers of the Registrant;
Executive Compensation; Security Ownership of Certain Relationships and Related
Transactions.
The information required by these Items is omitted because the Company is filing
a definitive proxy statement pursuant to Regulation 14A not later than 120 days
after the end of the fiscal year covered by this Form 10-K which includes the
required information. The required information contained in the Company's proxy
statement is incorporated herein by reference.
66
<PAGE>
================================================================================
PART IV.
================================================================================
- --------------------------------------------------------------------------------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------------
Form 10-K
Page Number
(a) Financial Statements and Financial Statement Schedules
(1) The following consolidated financial statements
of Coyote Network Systems, Inc. (formerly The Diana
Corporation) and its subsidiaries are included in Item 8:
Report of Arthur Andersen LLP, Independent Public Accountants 33
Report of PricewaterhouseCoopers LLP, Independent Accountants 34
Consolidated Balance Sheets - March 31, 1999 and March 31, 1998 35
Consolidated Statements of Operations - Fiscal Years Ended
March 31, 1999, March 31, 1998 and March 31, 1997 36
Consolidated Statements of Changes in Shareholders' Equity -
Fiscal Years Ended March 31, 1999, March 31, 1998
and March 31, 1997 37
Consolidated Statements of Cash Flows - Fiscal Years Ended
March 31, 1999, March 31, 1998 and March 31, 1997 38
Notes to Consolidated Financial Statements 39
(2) The following consolidated financial statement schedule of
Coyote Network Systems, Inc. is included in Item 14(d):
Schedule I - Condensed Financial Information of Registrant 73
All other schedules are omitted because the required information is not
present or is not present in amounts sufficient to require submission of
the schedules or because the information required is included in the
consolidated financial statements or the notes thereto.
(b) Reports on Form 8-K:
The Company did not file any reports on Form 8-K during the fourth
quarter of fiscal 1999.
67
<PAGE>
(c) Exhibits
Exhibit
Number Description
2.1 Stock Acquisition by Merger Agreement, dated as of September 30, 1998,
among Coyote Network Systems, Inc., INET Acquisition, Inc., INET
Interactive Network System, Inc., Claude Buchert, Helene Legendre and First
Rock Trustees, Limited, a Gibraltar corporation, trustee of the Guimauve
Trust, a Gibraltar trust dated September 1, 1994 (incorporated herein by
reference to Exhibit 2.1 of Registrant's Form 8-K filed on October 15,
1998).
3.1 Restated Certificate of Incorporation, as amended September 1, 1992
(incorporated herein by reference to Exhibit 4.1 of Registrant's
Registration Statement on Form S-8 Reg. No. 333-63017).
3.2 By-Laws of Registrant, as amended March 7, 1997.
4.1 Loan and Security Agreement between C&L Communications, Inc. and Sanwa
Business Credit dated January 2, 1996 (incorporated herein by reference to
Exhibit 10.1 of Registrant's Registration Statement on Form S-3 Reg. No.
333-1055).
4.2 First Amendment to Loan and Security Agreement and Waiver Agreement between
C&L Communications, Inc. and Sanwa Business Credit Corporation dated June
27, 1996 (incorporated herein by reference to Exhibit 4.2 of Registrant's
Form 10-K/A for the year ended March 30, 1996).
4.3 Loan and Security Agreement by and between Valley Communications, Inc. and
Sanwa Business Credit Corporation dated March 14, 1996 (incorporated herein
by reference to Exhibit 4.1 of Registrant's Form 10-Q for the period ended
July 20, 1996).
4.4 Certain other long-term debt as described in Note 6 of Notes to
Consolidated Financial Statements which do not exceed 10% of the
Registrant's total assets on a consolidated basis. The Registrant agrees to
furnish to the Commission, upon request, copies of any instruments defining
the rights of holders of any such long-term debt.
4.5 Second Amendment to Loan and Security Agreement and Waiver Agreement
between C&L Communications, Inc. and Sanwa Business Credit Corporation
dated July 10, 1997.
4.6 First Amendment to Loan and Security Agreement by and between Valley
Communications, Inc. and Sanwa Business Credit Corporation dated May 29,
1997.
4.7 Form of Subscription Agreement (incorporated herein by reference to Exhibit
4.1 of Registrant's Form 8-K filed on July 31, 1997).
4.8 Form of Note (incorporated herein by reference to Exhibit 4.2 of
Registrant's Form 8-K filed on July 31, 1997).
4.9 Form of Registration Rights Agreement (incorporated herein by reference to
Exhibit 4.3 of Registrant's Form 8-K filed on July 31, 1997).
4.10 Form of Offshore Warrant Subscription Agreement (incorporated herein by
reference to Exhibit 4.4 of Registrant's Form 8-K filed on July 31, 1997).
68
<PAGE>
4.11 Waiver of Events of Default for Sanwa Business Credit Corporation to C&L
Communications, Inc. dated September 1, 1997.
4.12 Second Amendment to Loan and Security Agreement by and between Valley
Communications, Inc. and Sanwa Business Credit Corporation dated September
16, 1997.
4.13 Stock and Warrant Purchase Agreement dated June 6, 1997 by and between
Coyote Network Systems, Inc. and James J. Fiedler.
4.14 Warrant issued to James J. Fiedler dated June 6, 1997 to purchase shares
of common stock of Coyote Network Systems, Inc.
4.15 Registration Rights Agreement dated June 6, 1997 by and among The Diana
Corporation and James J. Fiedler.
4.16 Form of Subscription Agreement (incorporated herein by reference to
Exhibit 4.1 of Registrant's Form 8-K filed on June 3, 1999).
4.17 Warrant Agreement (incorporated herein by reference to Exhibit 4.2 of
Registrant's Form 8-K/A filed on June 22, 1999).
4.18 Cross Receipt and Agreement (incorporated herein by reference to Exhibit
4.3 of Registrant's Form 8-K filed on June 3, 1999).
10.1 Consulting Agreement dated December 23, 1991 and ending December 23, 1996
between C&L Acquisition Corporation and Jack E. Donnelly (incorporated
herein by reference to Exhibit 10.11 of Registrant's Form 10-K for the
year ended April 3, 1993).
10.2 Amendment to Consulting Agreement between C&L Acquisition Corporation and
Jack E. Donnelly dated March 7, 1995 (incorporated herein by reference to
Exhibit 10.7 of Registrant's Form 10-K for the year ended April 1, 1995).
10.3 1986 Nonqualified Stock Option Plan of The Diana Corporation as amended
(incorporated herein by reference to Exhibit 10.13 of Registrant's Form
10-K for the year ended April 3, 1993).
10.4 1993 Nonqualified Stock Option Plan of Entree Corporation (incorporated
herein by reference to Exhibit 10.12 of Registrant's Form 10-K for the
year ended April 2, 1994).
10.5 Purchase Agreement dated August 14, 1995 by and between C&L Acquisition
Corporation and Henry Mutz, Chris O'Connor and Ken Hurst (incorporated
herein by reference to Exhibit 2.1 of Registrant's Form 8-K/A filed
February 1, 1996).
10.6 First Amendment to Purchase Agreement dated November 20, 1995 by and
between C&L Acquisition Corporation and Henry Mutz, Chris O'Connor and Ken
Hurst (incorporated herein by reference to Exhibit 2.2 of Registrant's
Form 8-K/A filed February 1, 1996).
10.7 Exchange Agreement dated January 16, 1996 by and among The Diana
Corporation and CTL Technologies, Inc. (incorporated herein by reference
to Exhibit 10.2 of Registrant's Registration Statement on Form S-3 Reg.
No. 333-1055).
69
<PAGE>
10.8 1996 Sattel Communications LLC Employees Nonqualified Stock Option Plan
(incorporated herein by reference to Exhibit 10.13 of Registrant's Form
10-K for the year ended March 30, 1996).
10.9 Memorandum of Understanding between Coyote Network Systems, Inc., Sattel
Communications Corp. and Sattel Technologies, Inc. dated May 3, 1996
(incorporated herein by reference to Exhibit 10.15 of Registrant's Form
10-K for the year ended March 30, 1996).
10.10 Second Supplemental Agreement Relating to Joint Venture and Exchange
Agreement Reformation between Coyote Network Systems, Inc., Sattel
Technologies, Inc. and D.O.N. Communications Corp. dated May 3, 1996
(incorporated herein by reference to Exhibit 10.16 of Registrant's Form
10-K for the year ended March 30, 1996).
10.11 Third Supplemental Agreement Relating to Joint Venture between The Diana
Corporation and Sattel Technologies, Inc. dated October 14, 1996
(incorporated herein by reference to Exhibit 10.3 of Registrant's
Amendment No. 2 to Form S-3 filed October 21, 1996).
10.12 Operating Agreement of Sattel Communications, LLC (incorporated herein by
reference to Exhibit 10.17 of Registrant's Form 10-K/A for the year ended
March 30, 1996).
10.13 Amendment to the Operating Agreement of Sattel Communications LLC
(incorporated herein by reference to Exhibit 10.18 of Registrant's Form
10-K/A for the year ended March 30, 1996).
10.14 Second Amendment to the Operating Agreement of Sattel Communications LLC
(incorporated herein by reference to Exhibit 10.19 of Registrant's Form
10-K/A for the year ended March 30, 1996).
10.15 Asset Purchase Agreement dated January 31, 1997 by and among Atlanta
Provision Company, Inc. and Colorado Boxed Beef Company (incorporated
herein by reference to Exhibit 10.1 of Registrant's Form 8-K filed March
3, 1997).
10.16 Agreement Regarding Class A Units dated October 2, 1996 by and between
Sydney B. Lilly and Sattel Communications LLC (incorporated herein by
reference to Exhibit 10.2 of Registrant's Form 8-K filed March 3, 1997).
10.17 Amended and Restated Agreement Regarding Award of Class B Units dated
November 11, 1996 by and between James J. Fiedler and CTL Communications
LLC (incorporated herein by reference to Exhibit 10.3 of Registrant's Form
8-K filed March 3, 1997).
10.18 Amended and Restated Agreement Regarding Award of Class B Units dated
November 11, 1996 by and between Daniel W. Latham and Sattel
Communications LLC (incorporated herein by reference to Exhibit 10.4 of
Registrant's Form 8-K filed March 3, 1997).
10.19 Amendment to Stock Option Agreements dated November 20, 1996 by and
between Coyote Network Systems, Inc. and Richard Y. Fisher (incorporated
herein by reference to Exhibit 10.5 of Registrant's Form 8-K filed March
3, 1997).
10.20 Separation Agreement dated November 20, 1996 by and between The Diana
Corporation and Richard Y. Fisher (incorporated herein by reference to
Exhibit 10.6 of Registrant's Form 8-K filed March 3, 1997).
70
<PAGE>
10.21 Amendment to Stock Option Agreements dated November 20, 1996 by and
between Coyote Network Systems, Inc. and Sydney B. Lilly (incorporated
herein by reference to Exhibit 10.7 of Registrant's Form 8-K filed March
3, 1997).
10.22 Separation Agreement dated November 20, 1996 by and between The Diana
Corporation and Sydney B. Lilly (incorporated herein by reference to
Exhibit 10.8 of Registrant's Form 8-K filed March 3, 1997).
10.23 Amendment to Stock Option Agreements dated November 20, 1996 by and
between Coyote Network Systems, Inc. and Donald E. Runge (incorporated
herein by reference to Exhibit 10.9 of Registrant's Form 8-K filed March
3, 1997).
10.24 Separation Agreement dated November 20, 1996 by and between The Diana
Corporation and Donald E. Runge (incorporated herein by reference to
Exhibit 10.10 of Registrant's Form 8-K filed March 3, 1997).
10.25 Employment Agreement dated November 27, 1996 by and between The Diana
Corporation and R. Scott Miswald (incorporated herein by reference to
Exhibit 10.11 of Registrant's Form 8-K filed March 3, 1997).
10.26 Form of Indemnification Agreement dated November 26, 1996 or November 27,
1996 between Coyote Network Systems, Inc. and (i) Bruce C. Borchardt, (ii)
Jack E. Donnelly, (iii) James J. Fiedler, (iv) Jay M. Lieberman and (v) R.
Scott Miswald (incorporated herein by reference to Exhibit 10.12 of
Registrant's Form 8-K filed March 3, 1997).
10.27 Loan Agreement and Promissory Note dated November 11, 1996 by and between
Coyote Network Systems, Inc. and James J. Fiedler (incorporated herein by
reference to Exhibit 10.13 of Registrant's Form 8-K filed March 3, 1997).
10.28 Loan Agreement and Promissory Note dated November 11, 1996 by and between
Coyote Network Systems, Inc. and Daniel W. Latham (incorporated herein by
reference to Exhibit 10.14 of Registrant's Form 8-K filed March 3, 1997).
10.29 Employment Agreement dated September 4, 1997 by and between Coyote Network
Systems, Inc. and James J. Fiedler. (incorporated herein by reference to
Exhibit 10.29 of Registrant's Form 10-K filed September 23, 1997).
10.30 Employment Agreement dated September 4, 1997 by and between Coyote Network
Systems, Inc. and Daniel W. Latham. (incorporated herein by reference to
Exhibit 10.30 of Registrant's Form 10-K filed September 23, 1997).
10.31 Agreement dated November 17, 1995 between Valley Communications, Inc. and
Communications Workers of America Local 9412 (incorporated herein by
reference to Exhibit 10.1 of Registrant's Form 10-Q for the period ended
July 20, 1996).
10.32 Limited Liability Company Agreement of SatLogic LLC dated as of September
12, 1996 (incorporated herein by reference to Exhibit 10.3 of Registrant's
Form 10-Q/A for the period ended July 20, 1996).
71
<PAGE>
10.33 Stockholder Protection Rights Agreement dated as of September 10, 1996
between Coyote Network Systems, Inc. and ChaseMellon Shareholder Services,
L.L.C. as Rights Agent (incorporated herein by reference to Exhibit 1 of
Registrant's Form 8-A filed September 11, 1996).
10.34 1998 Non-Employee Director Stock Option Plan dated February 19, 1998
(incorporated herein by reference to Exhibit 10.34 of Registrant's Form
10-K filed July 14, 1998).
10.35 Merger Agreement dated November 19, 1997, by and among Coyote Network
Systems, Inc.; Soncainol, Inc.; and Michael N. Sonaco, James G. Olson and
William H. Cain (incorporated herein by reference to Exhibit 10.1 of
Registrant's Form 8-K filed December 5, 1997).
10.36 Stock Purchase Agreement dated March 31, 1998, between C&L Acquisitions,
Inc. and Technology Services Corporation (incorporated herein by reference
to Exhibit 99.1 of Registrant's Form 8-K filed June 19, 1998).
10.37 Employment Agreement effectively dated April 1, 1998, by and between
Coyote Network Systems, Inc. and James J. Fiedler (incorporated herein by
reference to Exhibit 10.1 of Registrant's Form 10-Q filed August 14,
1998).
10.38 Employment Agreement effectively dated April 1, 1998, by and between
Coyote Network Systems, Inc. and Daniel W. Latham (incorporated herein by
reference to Exhibit 10.2 of Registrant's Form 10-Q filed August 14,
1998).
10.39 Non-Compete Agreement between C&L Acquisitions, Inc. and Technology
Services Corporation, dated March 31, 1998 (incorporated herein by
reference to Exhibit 99.2 of Registrant's Form 8-K filed June 19, 1998).
10.40 Convertible Preferred Stock Purchase Agreement between the Company and JNC
Opportunity Fund, dated August 31, 1998 (incorporated herein by reference
to Exhibit 10.3 of Registrant's Form 10-Q filed November 16, 1998).
10.41 Amendment to Separation Agreement between the Company and Sydney B. Lilly
effective September 30, 1998.
21 Subsidiaries of Registrant
23 Consent of Independent Accountants
27 Financial Data Schedule
72
<PAGE>
COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
Schedule I - Condensed Financial Information of Registrant
Statements of Operations
(In Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>
Fiscal Year Ended
March 31, 1997
-----------------
<S> <C>
Administrative expenses $ (3,410)
Interest expense (52)
Non-operating expense (326)
Income tax credit 836
Equity in loss of unconsolidated subsidiaries (9,383)
---------
Loss from continuing operations (12,335)
Loss from discontinued operations (8,175)
Loss before extraordinary items (20,510)
Extraordinary items (508)
Net loss $(21,018)
=========
Loss per common share (basic & diluted):
Continuing operations $ (2.23)
Discontinued operations (1.48)
Extraordinary items (.09)
---------
Net loss per common share $ (3.80)
=========
Weighted average number of common shares outstanding 5,535
========
</TABLE>
See notes to condensed financial information and notes to
consolidated financial statements.
73
<PAGE>
COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
Schedule I - Condensed Financial Information of Registrant (Continued)
Statements of Cash Flows
(In Thousands)
<TABLE>
<CAPTION>
Fiscal Year Ended
March 31, 1997
-----------------
Operating activities:
<S> <C>
Loss before extraordinary items $(20,510)
Adjustments to reconcile loss to
net cash used by operating activities:
Equity in loss of unconsolidated subsidiaries 17,558
Other (595)
Changes in current assets and liabilities 1,231
-------
Net cash used by operating activities (2,316)
--------
Investing activities:
Proceeds from sales of marketable securities 1,353
Changes in investments in and advances to
unconsolidated subsidiaries (15,945)
Other 100
Net cash used by investing activities (14,492)
--------
Financing activities:
Repayments of long-term debt (141)
Common stock funding 13,918
Extraordinary items (508)
--------
Net cash provided by financing activities 13,269
-------
Decrease in cash (3,539)
Cash at the beginning of the year 3,567
-------
Cash at the end of the year $ 28
========
Non-cash transactions:
Purchase of minority interest with common stock 1,818
</TABLE>
See notes to condensed financial information and
notes to consolidated financial statements.
74
<PAGE>
COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
Schedule I - Condensed Financial Information of Registrant (Continued)
Notes to Condensed Financial Information
- --------------------------------------------------------------------------------
NOTE 1 BASIS OF PRESENTATION
- --------------------------------------------------------------------------------
The condensed financial information includes the accounts of the parent company.
Substantially all investments in and advances to unconsolidated subsidiaries are
eliminated in the consolidated financial statements. In fiscal 1997, other
income includes interest income of $69,000 that is eliminated in the
consolidated financial statements. Intercompany profits between related parties
are eliminated in these financial statements.
75
<PAGE>
================================================================================
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 this 14th day of July,
1999.
COYOTE NETWORK SYSTEMS, INC.
By /s/ James J. Fiedler
_____________________________________
James J. Fiedler, Chairman of
the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of and the in the
capacities and on the dates indicated.
Signature Title Date
/s/ James J. Fiedler Chairman of the Board and July 14, 1999
---------------------- Chief Executive Officer
James J. Fiedler (Principal Executive Officer)
/s/ Daniel W. Latham President, Chief Operating Officer July 14, 1999
---------------------- and Director
Daniel W. Latham
/s/ Brian A. Robson Executive Vice President, July 14, 1999
- ---------------------- Chief Financial Officer and Secretary
Brian A. Robson (Principal Financial and Accounting Officer)
/s/ Jack E. Donnelly Director
- ----------------------
Jack E. Donnelly July 14, 1999
/s/ Stephen W. Portner Director July 14, 1999
----------------------
Stephen W. Portner
76
<PAGE>
AMENDMENT TO SEPARATION AGREEMENT
THIS AMENDMENT TO SEPARATION AGREEMENT ("Amendment") is entered
into as of August ___, 1998, by and between COYOTE NETWORK SYSTEMS, a Delaware
corporation (the "Company") and SYDNEY B. LILLY ("Lilly").
RECITAL
The Company, through its predecessor, The Diana Corporation, and
Lilly are parties to that certain Separation Agreement dated November 20, 1996.
Subsequent to that Separation Agreement, Lilly provided substantial services to
the Company for which he has not already received compensation. Lilly has also
provided long term service to the Company as an officer and a director. Lilly
has informed the Company that he has decided not to seek reelection as a
Director of the Company when his term expires at the earlier of the Company's
1998 annual meeting or September 30, 1998.
NOW, THEREFORE, the Company and Lilly agree to amend that
Separation Agreement as follows:
1. Compensation
As a further severance settlement to that provided in the
Separation Agreement, the Company shall pay to Lilly $50,000 per year in sixty
(60) monthly installments of $4,166.67 on or before the first day of each month
beginning October 1, 1998. The Company also hereby extends the time period
during which it is required to pay all medical expenses for Lilly and his spouse
under the Separation Agreement for an additional ten years until March 31, 2010.
2. Stock Registration
The Company shall, on or before October 31, 1998, file a
registration statement on Form S-3, if eligible to do so, to register the shares
of Common Stock of Coyote Network Systems, Inc. into which the Class A Units of
Sattel Communications LLC (the "Class A Units") held by Mr. Lilly are
convertible (the "Conversion Shares"), and will keep that registration statement
or a successor registration statement in effect until 30 days after the
conversion of the Class A Units, such that the Conversion Shares will be
registered and freely tradable by Mr. Lilly. In connection with this
registration obligation, the Company and Mr. Lilly acknowledge that the Company
is not presently eligible to make a filing under Form S-3 and such eligibility
will depend on factors beyond the Company's control, such as listing of the
Company's common stock on an exchange. In the event that the Company remains
ineligible to make a Form S-3 filing on or before October 31, 1998, the Company
agrees to use its best efforts to register the conversion shares as soon as
possible. If such registration has not occurred by March 31, 1999, Mr. Lilly
shall have the right to demand registration on any form available to the
Company. The registration of the Conversion Shares will be effected at the
Company's expense.
<PAGE>
3. Severability.
If any provision of this Amendment is held by a court of competent
jurisdiction to be invalid, void or unenforceable as to a particular
application, then such provision shall be deemed modified to exclude such
application, and such provision in all other applications, and all other
provisions of this Amendment and Separation Agreement shall continue in full
force and effect without being modified, impaired or invalidated in any way.
Both the Company and Lilly intend that this Amendment and the Separation
Agreement be given the maximum force, effect and application permissible under
applicable law.
4. Assignability
This Amendment and the Separation Agreement may not be assigned by
either the company or Lilly without the prior written consent of the other.
5. Waiver of Default
Any waiver by either the Company or Lilly of a breach of any
provision in this Agreement shall not operate or be construed as a waiver of any
subsequent breach of the same or any other provision of this Agreement.
6. Applicable Law.
This Amendment shall be construed under and enforced in accordance
with the laws of the State of California.
7. Attorney's Fee
In the event suit is brought by either the Company or Lilly for
enforcement of this Amendment, the prevailing party shall recover, as additional
costs, reasonable attorneys' fees and costs as determined by the court.
8. Miscellaneous.
Except as modified of this Amendment all of the terms, covenants
and conditions of the Separation Agreement shall continue in full force and
effect. This Amendment is not intended to be, and shall not constitute, a
substitution or novation of the Separation Agreement. This Amendment may be
signed in counterparts, all of which shall be taken together as a single
instrument.
<PAGE>
IN WITNESS WHEREOF, the parties have caused this Amendment to be
duly executed as of the date first above written.
COYOTE NETWORK SYSTEMS SYDNEY B. LILLY
By: /s/ James J. Fielder /s/ Sydney B. Lilly
__________________________________ ___________________________________
James J. Fiedler
Chairman and Chief Executive Officer
By: /s/ Daniel W. Latham
__________________________________
Daniel W. Latham
President and Chief Operating Officer
COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
SUBSIDIARIES OF THE REGISTRANT
All significant subsidiaries of the Registrant have been listed.
Indentations indicate indirectly owned subsidiaries which are owned by the named
subsidiary.
State of
Subsidiaries of the Registrant Incorporation
- ------------------------------ -------------
Coyote Communications Services, LLC Colorado
Coyote Gateway, LLC Colorado
Coyote Technologies, Inc. Nevada
Coyote Technologies, LLC California
INET Interactive Network System, Inc. California
Entree Corporation Delaware
Atlanta Provision Company, Inc. Georgia
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-3 and in the Registration Statement on Form S-8 listed
below of Coyote Network Systems, Inc., formerly The Diana Corporation, of our
report dated September 22, 1997, except as to the last paragraph of Note 8,
which is as of November 4, 1998, relating to the financial statements and
financial statement schedule of The Diana Corporation, which appears in this
Annual Report on Form 10-K.
1. Registration Statement on Form S-3
(Registration No. 33-88392)
2. Registration Statement on Form S-8
(Registration No. 33-67188)
3. Registration Statement on Form S-3
(Registration No. 333-1055)
PricewaterhouseCoopers LLP
Los Angeles, California
July 14, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS LEGEND CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF COYOTE NETWORK SYSTEMS, INC. AS OF AND FOR
THE YEAR ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 1225
<SECURITIES> 0
<RECEIVABLES> 12292
<ALLOWANCES> 0
<INVENTORY> 2130
<CURRENT-ASSETS> 22337
<PP&E> 10072
<DEPRECIATION> (1880)
<TOTAL-ASSETS> 41028
<CURRENT-LIABILITIES> 22996
<BONDS> 1534
0
7000
<COMMON> 11167
<OTHER-SE> (12110)
<TOTAL-LIABILITY-AND-EQUITY> 41028
<SALES> 43318
<TOTAL-REVENUES> 43318
<CGS> 28748
<TOTAL-COSTS> 28748
<OTHER-EXPENSES> 26950
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1893
<INCOME-PRETAX> (13843)
<INCOME-TAX> 0
<INCOME-CONTINUING> (13843)
<DISCONTINUED> (900)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (14743)
<EPS-BASIC> (1.50)
<EPS-DILUTED> (1.50)
</TABLE>
