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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
OR
|_| 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
COYOTE NETWORK SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 36-2448698
------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4360 Park Terrace Drive, Westlake Village, CA 91361
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(Address of principal executive offices) (Zip Code)
(818) 735-7600
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(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
|X| YES |_| NO
At February 15, 1999, the Registrant had issued and outstanding an aggregate
of 10,537,010 shares of its common stock.
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<PAGE>
COYOTE NETWORK SYSTEMS, INC.
AND SUBSIDIARIES
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets........................................ 2
Statement of Operations............................... 3
Statement of Cash Flows............................... 4
Notes to Financial Statemnts.......................... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............... 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................... 14
Item 6. Exhibits and Reports on Form 8-K...................... 14
Signatures ...................................................... 15
1
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Dollars In Thousands)
<TABLE>
<CAPTION>
December 31, March 31,
1998 1998
------------ ----------
Assets (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,140 $ 3,746
Marketable securities --- 16
Receivables 4,079 715
Inventories 3,300 2,122
Notes receivable - current 5,597 4,596
Other current assets 7,723 1,409
---------- ----------
Total current assets 22,839 12,604
Property and equipment, net 5,822 2,391
Capitalized software development 1,048 ---
Intangible assets, net 7,480 3,542
Net assets of discontinued operations 217 909
Notes receivable - non-current 2,291 1,170
Other assets 3,069 1,359
---------- ----------
$ 42,766 $ 21,975
========== ==========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 10,186 $ 1,920
Deferred revenue and customer deposits 2,546 1,900
Accrued loss reserve 3,054 2,200
Accrued professional fees and litigation costs 176 805
Other accrued liabilities 3,156 1,130
Notes payable 7,442 ---
Current portion of long-term debt 141 141
---------- ----------
Total current liabilities 26,701 8,096
Long-term debt 1,534 5,349
Other liabilities 447 470
Commitments and contingencies (Note 4) --- ---
Shareholders' equity:
Preferred stock - $.01 par value.
Authorized 5,000,000 shares; 700 issued --- ---
Common stock - $1 par value. Authorized 30,000,000 shares,
issued 11,145,090 and 9,151,920 shares 11,145 9,152
Additional paid-in capital 116,401 102,360
Accumulated deficit (107,705) (97,695)
Treasury stock at cost (5,757) (5,757)
----------- -----------
Total shareholders' equity 14,084 8,060
---------- ----------
$ 42,766 $ 21,975
========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
2
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COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)
(In Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>
3 Months Ended 9 Months Ended
------------------------- --------------------------
Dec. 31, Dec. 31, Dec. 31, Dec. 31,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Net sales $ 12,931 $ 1,659 $ 35,288 $ 2,709
Cost of goods sold 10,236 516 22,765 958
---------- --------- ---------- ---------
Gross profit 2,695 1,143 12,523 1,751
Selling and administrative expenses 3,968 3,056 10,063 9,182
Engineering, research and development 2,595 1,395 6,963 2,692
---------- --------- ---------- ---------
Total operating expenses 6,563 4,451 17,026 11,874
---------- --------- ---------- ---------
Operating income (loss) (3,868) (3,308) (4,503) (10,123)
Interest expense (221) (150) (263) (273)
Non-operating income --- 44 --- 48
Non-operating expense (105) --- (985) (5,522)
----------- --------- ----------- ----------
Loss from continuing operations (4,194) (3,414) (5,751) (15,870)
Loss from discontinued operations --- --- (900) ---
---------- ----------- ----------- -------
Net loss $ (4,194) $ (3,414) $ (6,651) $ (15,870)
=========== ========== =========== ==========
Loss per common share (basic & diluted):
Continuing operations $ (.41) $ (.44) $ (.60) $ (2.37)
Discontinued operations --- --- (.09) ---
---------- --------- ----------- -------
Net loss per common share (basic & diluted) $ (.41) $ (.44) $ (.69) $ (2.37)
=========== ========= =========== ==========
Weighted average number of common shares outstanding 10,216 7,844 9,604 6,685
(basic & diluted) ========== ========= ========== =========
</TABLE>
See notes to condensed consolidated financial statements.
3
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COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
9 MONTHS ENDED
---------------------------------
Operating activities: Dec. 31, 1998 Dec. 31, 1997
------------- -------------
<S> <C> <C>
Net loss $ (6,651) $ (15,870)
Adjustments to reconcile loss to net cash provided (used) by
operating activities:
Depreciation and amortization 1,165 565
Gain on sale of land (20) ---
Provision for loss on discontinued operations 900 ---
Provision for common stock warrants issued 485 494
Provision for CTL Class A/B Unit Convertibility --- 5,522
Net change in discontinued operations (208) 345
Changes in current assets and liabilities 593 1,610
---------- ----------
Net cash provided (used) by operating activities $ (3,736) $ (7,334)
Investing activities:
Increase in promissory note --- (840)
Sale of CNC common and preferred stock respectively --- 397
Capitalized software development (1,048) ---
Purchases of property and equipment (2,397) (132)
Purchase of marketable securities --- (244)
Proceeds from sales of marketable securities 16 ---
Proceeds from sale of land 67 ---
Proceeds of discontinued operations --- 2,861
Change in notes receivable 270 ---
Net change in discontinued operations --- (470)
Investment in affiliate (400) ---
Cash investment in INET (1,333) ---
----------- ---------
Net cash provided (used) by investing activities $ (4,825) $ 1,572
Financing activities:
Repayments of long-term debt $ (142) $ (141)
Common stock issued 752 7,601
Preference stock issued net of expenses 6,345 ---
Changes in notes payable --- 250
Payment of note payable --- (98)
Convertible note issued, net of expenses --- 4,635
Net change in discontinued operations --- 229
---------- ----------
Net cash provided by financing activities $ 6,955 $ 12,476
---------- ----------
Increase (decrease) in cash and cash equivalents (1,606) 6,714
Cash and cash equivalents:
At beginning of the period 3,746 81
---------- ----------
At end of the period $ 2,140 $ 6,795
========== ==========
Non-cash transactions:
Issuance of common stock warrants to investment banker and placement agent 485 494
Note payable to related party --- 98
Change in convertibility of Class A/B Units --- 5,552
Conversion of note payable to common stock --- 250
Conversion of convertible notes and interest into common stock 3,407 2,545
Discount granted for investment in affiliate 900 ---
Issuance of common stock for INET acquisition 1,686 ---
5% Dividend paid in common stock 3,359 ---
</TABLE>
See notes to condensed consolidated financial statements
4
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COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three months and nine months ended
December 31, 1998, are not necessarily indicative of the results that may be
expected for the fiscal year ending March 31, 1999. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's annual report on Form 10-K for the fiscal year ended March 31,
1998.
The computation of loss per common share is determined by using the
weighted average number of shares of common stock outstanding during each
period.
Recent Suspension of Trading in the Company's Common Stock
- ----------------------------------------------------------
On December 9, 1998, an Internet publication published articles questioning
the Company's reported equipment sale through Comdisco, Inc. (which recently
filed a schedule 13G indicating that it beneficially owned 6.6% of the Company's
common stock) to Crescent Communications. The articles implied that Crescent
Communications did not exist, leading to the conclusion that the sale was not
valid. The articles also discussed the filing of the 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 common stock reached approximately 2.2 million shares, a number
significantly in excess of the historical trading level, and the Company common
stock price declined more than 50%. As a result of the articles and the
significant trading in the common stock, the Nasdaq National Market suspended
trading in the Company 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 (the "Commission") have asked the Company to
provide documents and other material about the Crescent Communications
transaction. 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 inquiries confidential, the Company does
not know the status of the inquiry. Inquiries by the Commission and/or the
Nasdaq National Market may cause disruption in the trading of the Company's
common stock and/or divert the attention of management. In addition, any adverse
determination from these inquiries could have a material adverse effect on the
Company.
The public dialogue and inquiries have focused attention on Crescent
Communications and Gene Curcio, its president. On September 24, 1998, the
Company announced that it had signed a three-year equipment and service contract
with Crescent Communications, Inc. valued at more than $37 million. As reported
in the Company's December 10, 1998 press release, Comdisco, Inc. purchased the
initial $12 million of equipment pursuant to Crescent's order and leased it to
5
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Crescent. The Company was paid in full for that purchase by Comdisco and
Comdisco cannot recover any of the $12 million purchase price from the Company
if Crescent fails to make any lease payments due under Comdisco's lease
agreement with Crescent. As previously disclosed, the Company has deferred
recognition of approximately $2.5 million of this sale related to its equity
interest in Crescent and amounts reserved for service contingencies.
While the Company remains committed to Crescent's development and to
delivering an additional approximately $16 million in equipment remaining under
Crescent's network order, plus $9 million in services once Crescent's network is
operational, it should be noted that Crescent's development is not within the
Company's control and that such future sales and deliveries may or may not
occur. Due diligence performed by the Company indicated that Crescent has
letters of intent for more than 30 million minutes per month to international
locations. The Company's future sales to Crescent will depend upon Crescent's
ability 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, the Company does not intend to
make any additional equipment deliveries without Crescent first obtaining third
party financing, which has not yet been obtained.
In responding to the December 1998 articles and follow-up questions from
the Internet publication and in an effort to defend Crescent's right as a
private company to refuse to discuss its business with the press, the Company
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 the
Company entered into the equipment sale and services agreements with Comdisco
and Crescent, the Company was aware that Mr. Curcio was an entrepreneur who had
been involved with start-up companies, not all of which were ultimately
successful. The Company's 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. The Company did not and cannot warrant the
individual business history of Crescent or its founder or that of any end user
of its products. Because the Company will be providing the operational support
for Crescent under a service contract, the Company did not and does not believe
that such information materially relates to the benefits the Company is seeking
from its relationship with Crescent.
Liquidity
- ---------
Primarily as a result of the negative publicity and consequent trading
disruption described above, the Company has experienced significant delays in
completing equipment supply contracts most of which require customer lease
financing. The disruption has also delayed the Company's ability to arrange
financing required to complete certain acquisitions and to provide additional
working capital. As a consequence of these delays, the Company's plans and
liquidity have been significantly impacted. The Company is currently in the
process of seeking to raise funds through debt and equity financing and if this
process is successful, management believes that it will provide adequate
liquidity to meet the Company's planned capital and operating requirements
through March 31, 1999. 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.
6
<PAGE>
NOTE 2 DISCONTINUED OPERATIONS
On November 20, 1996, 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") performed
through its operating subsidiary Coyote Technologies, LLC ("CTL") from the
following businesses:
Segment Company
Telecommunications equipment distribution C&L
Wire installation and service Valley
Wholesale distribution of meat and seafood Entree/APC
The Restructuring provided for a spin-off of the non-CTL businesses,
through a special dividend to the Company's shareholders. Consequently, the
Company reported the results of operations of the telecommunications equipment
distribution segment, the voice and data network wire installation and service
segment and the wholesale distribution of meat and seafood segment separately as
discontinued operations. Subsequently, the Company received a purchase offer for
a majority of the assets of 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.
As a result of the sale of APC's assets, the Company's Board of Directors
terminated the original Restructuring plan for a spin-off of the non-CTL
businesses. The Company adopted a revised Restructuring plan to sell C&L and
Valley. The revised Restructuring plan was approved by the Board of Directors in
February 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"). Under the terms of the agreement,
the Company received $2,300,000, which was paid in cash in June 1998, and
$811,000 paid by the assumption by TSC of the Company's entire liability under
certain promissory notes to and among the Company and other shareholders of
Valley dated August 1995.
As of February 11, 1999, the Company had collected all cash related to the
sale of discontinued operations except $470,000 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 ended
September 30, 1998. The asset book value as of December 31, 1998, was $217,000
net of mortgages applicable to the property.
NOTE 3 ACQUISITIONS
In February 1999, the Company announced that it signed a definitive
agreement to acquire controlling interest in Systeam S.p.A., by increasing its
equity position to 60% from 9%, for approximately $5 million, including $1.5
million for working capital and 880,000 unregistered shares of Coyote common
stock. The transaction is subject to various, customary closing conditions.
Based in Rome, Italy, Systeam develops voice, data, video and Internet
solutions. 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 February 1999, the Company also announced that it signed a definitive
agreement to acquire Apollo Telecom, Inc. for 350,000 unregistered shares of
7
<PAGE>
Coyote common stock. The transaction is subject to various, customary closing
conditions. Based in Salt Lake City, Utah, Apollo Telecom is an emerging carrier
that offers international long distance voice and data services, calling cards,
paging, cellular, Internet access and customized billing.
In October 1998, the Company announced that it entered into a letter of
intent to acquire a 19% equity position in DTA Communications Network, Inc.
("DTA"), a facilities based provider of wholesale international long distance
telephone services. The parties are negotiating to enter into a definitive
agreement.
NOTE 4 COMMITMENTS AND CONTINGENCIES
The Company is a defendant in a consolidated class action, In re The Diana
Corporation Securities Litigation, pending in the United States District Court
for the Central District of California. Although originally commenced as nine
separate, but substantively similar, actions the separate actions were
consolidated by the Court for all purposes in a stipulation and order entered on
July 23, 1997.
On September 9, 1997, the plaintiffs served a consolidated amended
complaint (the "Consolidated Complaint") on behalf of purchasers of the
Company's common stock during a class period alleged to extend from December 6,
1994 through May 2, 1997. The Consolidated Complaint asserts 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
through false and misleading statements and manipulative transactions. The
Consolidated Complaint seeks unspecified damages, but identifies significant
price movements in the Company's common stock during the putative class period
(a swing of more than $115 per share) to imply that the damages claimed will
exceed the Company's assets.
On December 15, 1997, the Court denied motions by the Company and other
defendants to dismiss the Consolidated Complaint.
On July 9, 1998, the respective counsel for the Plaintiffs and for the
Company executed a letter agreeing in principle, subject to various conditions
and contingencies, to settle the claims against the Company and its subsidiaries
in The Diana Securities Litigation. If consummated, the settlement will require
the Company to issue warrants to acquire 2,500,000 shares of the Company's
common stock. The warrants will be exercisable for three years from the date of
issuance and will have an exercise price of $9 per share in the first year, $10
per share in the second year and $11 per share in the third year, subject to
adjustment in certain events. The Company also agreed that, following the
listing of its common stock on Nasdaq, it would use its best efforts to arrange
for a listing of the warrants on Nasdaq. Among the conditions to the settlement
are that the Plaintiffs also reach a settlement with the individual defendants
in the litigation and their D&O insurance carriers that, ultimately, the
settlement receives court approval. Counsel for the Plaintiffs also offered, in
a letter dated July 10, 1998, to settle the claims against the individual
defendants in exchange for combined policy limits of the Company's D&O insurance
policies.
In October 1998, counsel for the Plaintiffs, the individual defendants and
the D&O carriers executed a further letter embodying an agreement in principle
to settle the claims against the individual defendants for $7.5 million, to be
paid, ultimately, by the D&O carriers. That letter agreement is subject to the
terms of a letter agreement dated November 2, 1998, among counsel for the
Company, the individual defendants and the D&O carriers as to the procedures for
payment of funds. The cash component of the settlement, $7.25 million, has been
paid into an escrow account under a further letter agreement dated October 16,
1998. The parties are in the process of negotiating the terms of a formal
settlement agreement. The parties have agreed to submit the agreement to the
Court by February 26, 1999, and the Court has scheduled a preliminary approval
hearing for March 1999. A final approval hearing is expected to occur sometime
in mid-1999.
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The Company cautions that it is unable to predict with certainty the
ultimate outcome of the action. Among other things, the conditions that there be
a settlement with the individual defendants and the D&O insurers, and the court
approval of any settlement, involve third parties and are not matters which the
Company is in a position to control. However, based upon the circumstances of
the case at this time, the foregoing negotiations and letters, and upon
experience in similar securities class actions, the Company believes that there
is a reasonable likelihood that the settlement described in the preceding
paragraphs, or a similar settlement, will eventually be consummated in this
matter. The Company recorded the fair market value of the warrants of $8,000,000
in the financial statements for fiscal 1998.
Performed Line Products v. Coyote Technologies, LLC, Case No. 3:98 CV
1871-T, in the Federal District Court for the Northern District of Texas. The
Company's subsidiary, Coyote Technologies, LLC, is the defendant in this action.
PLP alleges that Coyote is infringing upon the "Coyote" trademark that PLP has
registered in connection with its cable and enclosure product line. PLP also
asserts claims under the Texas Deceptive Trade Practices Act. PLP seeks
permanent injunctive relief preventing Coyote Technologies' use of any form of
the name "Coyote," and unspecified damages for past alleged infringement. The
Company defends on the basis that its DSS 10000 product does not infringe upon
the use of the Coyote name for PLP's very dissimilar products. The Company
intends to vigorously defend the action.
Superior Street Capital Advisors, LLC v. Coyote Network Systems, Inc., Case
No. 98 L 11488, in the Circuit Court for Cook County, Illinois. The Company is
the defendant in this case in which Superior Street alleges that Coyote has
breached a consulting contract. An Answer to the Complaint has not yet been
filed. However, the Company intends to defend this action vigorously.
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.
NOTE 5 SHAREHOLDERS' EQUITY
Common Stock Dividend
- ---------------------
In October 1998, the Board of Directors approved the declaration of a 5%
common stock dividend to holders of record as of October 21, 1998. The Company
issued 497,623 shares of common stock on November 4, 1998, in payment of such
stock dividend. Certain contractual anti-dilution provisions reduced conversion
and warrant exercise prices by a minor amount.
Common Stock Options and Warrants
- ---------------------------------
Since September 30, 1998, the Company's Board of Directors has granted to
certain executives and directors options to purchase a total of 178,706 shares
of Company common stock. During the quarter ended December 31, 1998, certain
employees exercised options and purchased a total of 79,347 shares of the
Company common stock under the terms of the Company's Employees Stock Option
Plan.
NOTE 6 LINE OF CREDIT
As of December 31, 1998, Coyote Gateway, LLC ("CGL") has an established a
line of credit of $8,100,000 secured by CGL's trade receivables and by 708,692
treasury shares of the Company's common stock. As of December 31, 1998,
$7,442,000 had been drawn against this line of credit.
9
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NOTE 7 YEAR 2000 COMPLIANCE
The Company believes that its DSS Switch and Carrier IP Gateway operating
systems and internal computer systems are Year 2000 compliant. The Company does
not anticipate that it will incur significant expenditures to ensure that such
systems will function properly with respect to dates in the Year 2000 and
beyond. The Company has designed and tested the current version of its DSS
Switch, Administration and Maintenance Terminal ("AMT") and Call Management
System ("CMS") products, which are the products most susceptible to Year 2000
related problems. The Company found no problems with the date rollover issue or
the Year 2000 leap year issue. The products continued processing calls without
interruption during the test cycles. The Company plans to continue testing all
products and components as other adjuncts are integrated and tested.
The Company is also conducting a review of its significant suppliers and
other third parties to ensure that those parties have appropriate plans to
remedy any Year 2000 issues where their systems connect with the Company's
systems or otherwise have an impact on Company operations. The Company is
continuing to request and receive Year 2000 certification documents from third
party software suppliers. The Company has verified third party software used in
the development and operation of DSS, AMT and CMS products to be Year 2000
compliant.
To date, costs related to the Year 2000 issues have not been material to
financial condition or operations of the Company. The Company does not have a
documented Year 2000 contingency plan to cope with a worst case scenario. The
Company intends to complete documentation of a contingency plan by March 31,
1999.
There can be no assurance that a failure of the CTL switching product
operating systems or that the systems of third parties on which the Company's
systems and operations rely to be Year 2000 compliant will not have a material
adverse affect on the Company's business, financial condition or operating
results.
10
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANICAL CONDITION AND
RESULTS OF OPERATIONS
Results of Operations
- ---------------------
For the third quarter ended December 31, 1998, the Company's revenues were
$12.9 million from the sale of DSS switching and related equipment as well as
revenues from the Company's international long distance service subsidiaries
which were acquired during fiscal 1999. This represents an increase in total
revenues of $11.3 million (680%) over the corresponding quarter of fiscal 1998.
Revenues for the nine months ended December 31, 1998, were $35.3 million, an
increase of $32.6 million (1,203%) over the corresponding nine months of the
prior fiscal year.
Switching equipment sales in the quarter, which were effected by the lack
of previously planned lease financing, included a sale of $7.2 million to
Wireless USA, an emerging domestic and international long distance service
provider. The Company has granted extended payment terms to this customer which
is in the process of seeking lease financing for its capital purchases. In view
of the extended payment terms and its comparatively short operating history, the
Company has conservatively deferred recognition of the profit of $3.7 million
attributable to this sale, until payment is received or all contingencies are
removed.
As a result of this deferral, the gross profit for the third quarter of
fiscal 1999 was $2.7 million and represented a gross margin of 21% of total
revenues. If the profit of $3.7 million had not been deferred, the gross margin
would have been 51% of total revenues for the third quarter of fiscal 1999. The
gross margin for the second quarter of fiscal 1999 was 39% and the gross margin
for the third quarter of fiscal 1998 was 69%. The gross margin for the nine
months ended December 31, 1998, was 35% and would have been 46% if the profit
had not been deferred. The gross margin for the corresponding nine month period
of the prior fiscal year was 65%.
Selling, general and administrative expenses in the third quarter were $4.0
million (30% of total revenue), which represented an increase of $0.9 million
over the corresponding quarter of fiscal 1998. This increase is primarily
related to the additional operating expenses incurred by the recently acquired
long distance service provider subsidiary (INET), which operating results are
included in the Company consolidation for the third quarter of fiscal 1999.
Selling, general and administrative expenses for the nine months ended December
31, 1998, were $10.1 million, which represented an increase of $0.9 million over
the corresponding period of the prior fiscal year.
Engineering, research and development expenses for the third quarter of
$2.6 million (20% of total revenues) represents a $1.2 million increase over the
corresponding period for the prior fiscal year. The Company continued to enhance
product offerings, including further development of its client/server
architecture as well as the Company's rollout of voice over Internet Protocol
(IP) and IP/ATM (Asynchronous Transfer Mode) as an enhancement to the current
product line. Engineering, research and development expenses for the nine months
ended December 31, 1998, were $7.0 million compared to $2.7 million in the
corresponding period of the prior fiscal.
The operating loss for the quarter was $3.9 million compared to an
operating profit of $0.3 million in the prior quarter and $3.3 million operating
loss for the corresponding quarter of fiscal 1998. The loss is primarily due to
the conservative approach adopted regarding the deferral of earnings on
equipment sales and to the additional operating expenses related to the recently
acquired subsidiary (INET). The operating loss for the nine months of fiscal
1999 was $4.5 million compared to $10.1 million operating loss in the
corresponding period of fiscal 1998.
The net loss for the quarter was $4.2 million and represented a basic and
fully diluted loss per common share of $.41 compared to the prior quarter loss
of $1.4 million or $.14 per share, and the loss of $3.4 million or $.44 per
share in the corresponding period of the prior fiscal year. The net loss for the
nine months of fiscal 1999 was $6.7 million or $.69 per share compared to a net
loss of $15.9 million or $2.37 per share for the corresponding period of fiscal
1998.
11
<PAGE>
Liquidity and Capital Resources
- -------------------------------
The Company used $14.1 million of cash during the third quarter of fiscal
1999 compared to a positive cash flow of $11.2 million in the prior quarter and
of $12.5 million generated during the first six months of the fiscal year. As a
result of the negative publicity and consequent trading disruption described in
the Notes to the Financial Statements for the third quarter of fiscal 1999, the
Company has experienced significant delays in completing equipment supply
contracts most of which require customer lease financing. The disruption has
also delayed the Company's ability to arrange financing required to complete
certain acquisitions and to provide additional working capital. As a consequence
of these delays, the Company's plans and liquidity have been significantly
impacted.
Due to the delays encountered in obtaining third party lease financing, the
Company granted extended payment terms to its customer Wireless USA. The
extended terms are evidenced by a promissory note payable over 42 months
commencing in January 1999 with interest payable in arrears on the maturity date
of the note. The note is partially secured by a personal guarantee from the
president of Wireless USA.
Net cash used in operating activities during the quarter was $13.4 million
primarily due to the delays referred to above, the provision of the above
extended payment terms together with the funding required to support operating
expenses and inventory requirements associated with the business growth.
Net cash used in investing activities during the third quarter of fiscal
1999 was $1.1 million consisting of $0.8 million for the purchase of
manufacturing and test equipment and $0.3 million in engineering software and
development.
Financing activity during the quarter provided $0.4 million from the
issuance of the Company common stock upon the exercise of stock options under
the terms of the Company's employee stock option plan.
At December 31, 1998, the Company has a negative working capital of $3.9
million. The Company is currently in the process of seeking to raise funds
through debt and equity financing to resolve its immediate working capital
issues. In addition to an immediate need, the Company will need significant
funds to fund its future operations and acquisitions already contracted for and
other acquisitions. Management believes that it will be able to continue to fund
its operations and acquisitions by obtaining additional outside financing,
however there can be no assurance that the Company will be able to obtain the
needed financing when needed on acceptable terms or at all. In addition, any
future equity financing or convertible debt financing would cause the Company's
shareholders to incur dilution in common stock holdings as a percentage of the
total outstanding shares.
Under the Systeam acquisition agreement, the Company is obligated to pay
$3.5 million by March 18, 1999. The Company is currently seeking to raise funds
to meet this obligation. However, if the Company in unable to obtain the funds
by March 18, 1999, the Company may ask Systeam to extend such date. There can be
no assurance that an extension will be granted and this agreement maybe
terminated, which could have a material adverse effect on the Company.
Under the terms of the Preferred Stock Agreement, the Company is obligated
to pay certain penalties aggregating $280,000 as of February 1, 1999. The
Company is currently negotiating to redeem the Preferred Stock, or a portion
thereof, subject to obtaining the required financing and a waiver of such
penalties.
12
<PAGE>
Forward Looking Statements
- --------------------------
All statements other than historical statements contained in this Report on
Form 10-Q 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 the Company in the future, statements about the Company's business
strategy and plans, statements about the adequacy of the Company's 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 the Company 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 the
Company, including statements regarding future operating performance, short- and
long-term revenue and earnings estimates, backlog, the status of litigation, the
value of new contract signings, and industry growth rates and the Company's
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 the Company's
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 in general the other risk factors set forth in the
Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1998.
The Company disclaims any intention or obligation to update or revise any
forward looking statements whether as a result of new information, future events
or otherwise.
13
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Please see Note 4 to the Condensed Consolidated Financial Statements herein
and Note 6 to the Consolidated Financial Statements included in the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1998, for
information on various legal proceedings. There are no material developments to
report at this time.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
27 Financial Data Schedule
b) A Form 8-K/A was filed by the Company on December 11, 1998,
which covered:
Item 7. Financial Statements and Exhibits
Item 7 of the Current Report on Form 8-K of Coyote Network
Systems, Inc. dated September 30, 1998, filed with the Securities
and Exchange Commission on October 15, 1998, was amended in its
entirety to reflect that Financial Statements and Pro Forma
financial information of the acquired business were not required
to be filed.
14
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DATE: February 16, 1999 COYOTE NETWORK SYSTEMS, INC.
By: /s/ James J. Fiedler
-----------------------------------------
James J. Fiedler
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Brian A. Robson
-----------------------------------------
Brian A. Robson
Executive Vice President,
Chief Financial Officer and Secretary
(Principal Financial & Accounting Officer)
15
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS LEGEND CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS OF COYOTE NETWORKS SYSTEMS, INC. AS
OF AND FOR THE QUARTER ENDED DECEMBER 31, 1998, AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,140
<SECURITIES> 0
<RECEIVABLES> 4,079
<ALLOWANCES> 0
<INVENTORY> 3,300
<CURRENT-ASSETS> 22,839
<PP&E> 7,687
<DEPRECIATION> (1,865)
<TOTAL-ASSETS> 42,766
<CURRENT-LIABILITIES> 26,701
<BONDS> 1,534
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<SALES> 12,931
<TOTAL-REVENUES> 12,931
<CGS> 10,236
<TOTAL-COSTS> 10,236
<OTHER-EXPENSES> 6,563
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 221
<INCOME-PRETAX> (4,194)
<INCOME-TAX> 0
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