<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-KSB
AMENDMENT NO. 2
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 1998
Commission file number 0-20462
CHATCOM, INC.
(Name of Small Business Issuer in Its Charter)
CALIFORNIA 95-3746596
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9600 TOPANGA CANYON BOULEVARD, CHATSWORTH, CALIFORNIA 91311
(Address of principal executive offices)
818/709-1778
(Issuer's telephone number)
Securities registered under Section 12(b) of the Exchange Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- -------------------
None None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, no par value
(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes X No
----- -----
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [_]
State issuer's revenues for its most recent fiscal year: $7,271,000.
As of June 25, 1998, the aggregate market value of the common stock
held by non-affiliates of the Registrant computed by reference to The Nasdaq
Stock Market's closing price for the Registrant's Common Stock on June 25, 1998,
was approximately $4,764,000.
The number of shares outstanding of the Registrant's only class of
common stock, as of June 25, 1998, was 11,591,215.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's definitive proxy statement for its Annual Meeting of
Shareholders which is anticipated to be filed within 120 days of March 31,1998,
is incorporated by reference in response to Part III of this Annual Report on
Form 10-KSB.
Page 1
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the Company's security holders
during the fourth quarter of the Company's fiscal year ended March 31, 1998.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock (the "Common Stock") currently trades on The
Nasdaq Stock Market, listed under SmallCap issues, and is quoted under the
symbol "CHAT." The Common Stock began trading on The Nasdaq Stock Market in
February 1993 under the symbol "AOSC." On February 23, 1996, the Company's
Common Stock began trading under the symbol "CHAT" as a result of the change of
the name of the Company from Astro Sciences Corporation to ChatCom, Inc. As a
result of the Company's inability to satisfy the continued listing requirements
of The Nasdaq SmallCap Market, Nasdaq has instituted proceedings to delist the
Company's Common Stock from The Nasdaq SmallCap Market. An oral hearing before
the National Association of Securities Dealers, Inc. Board of Governers has been
scheduled on July 16, 1998 to review the Company's qualification to be listed on
The Nasdaq SmallCap Market. There can be no assurance that the Company will
prevail at the hearing. See "Description of Business - Cautionary Statements
and Risk Factors - Listing on The Nasdaq Stock Market."
The following table presents the range of the high and low bid prices for
the Common Stock for the periods indicated. The information has been obtained
from the Nasdaq Stock Market Summary of Activity and reflect inter-dealer
prices, without retail mark-up, mark-down or commission and may not represent
actual transactions. There are currently more than 24 known market makers for
the Common Stock.
<TABLE>
<CAPTION>
Fiscal Year 1998 Fiscal Year 1997
---------------------------- -----------------------------
Quarter High Bid Low Bid High Bid Low Bid
------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
First Quarter $2.81 $1.63 $4.44 $1.75
Second Quarter $1.75 $1.13 $3.13 $1.63
Third Quarter $2.03 $0.16 $3.22 $2.25
Fourth Quarter $0.94 $0.34 $3.56 $2.38
</TABLE>
As of June 15, 1998, there were 618 stockholders of record of the Common
Stock.
No dividends have been declared or paid on the Common Stock by the Company.
The provisions of the Company's outstanding shares of preferred stock prohibit
the payment of dividends on the Common Stock while shares of such preferred
stock are outstanding. The Company does not intend to pay any cash dividends on
the Common Stock in the foreseeable future. Instead, it is anticipated that the
Company will retain earnings, if any, to finance its operations and growth.
Page 25
<PAGE>
Liquidity and Capital Resources
- -------------------------------
The Company recorded net losses of $7.8 million and $4.6 million during
fiscal 1998 and fiscal 1997, respectively. During fiscal 1998, cash decreased
$788,000 primarily due to the negative cash flow from operations of $2.7
million. The negative cash flow from operations during fiscal 1998 was
comprised primarily of the net loss ($7.8 million) and an increase in
inventories ($1.3 million), primarily as a result of the inventories returned
from Macon during the second half of fiscal 1998 (approximately $1.8 million at
cost). These decreases were partially offset by an increase in accounts payable
($3.1 million), due primarily to the Company's delay in paying suppliers as a
result of the Company's liquidity problems, and by non cash charges primarily
related to depreciation and amortization ($350,000) and inventory obsolescence
($1,409,000).
Net cash used for investing activities during fiscal 1998 ($187,000) was
the result of expenditures related to computers and manufacturing equipment.
Net cash provided by financing activities during fiscal 1998 ($2.1 million)
was primarily the result of the issuance of 1,100 shares of Series E Preferred
Stock ($937,000), the issuance of convertible subordinated debt ($890,000), and
the issuance of Common Stock ($300,000).
As of March 31, 1998, the Company had negative working capital of $1.3
million, as compared to working capital of $3.2 million as of March 31, 1997.
The Company is taking significant steps to reduce its monthly overhead costs
which the Company believes will be sufficient, in conjunction with the proposed
financing described below, to enable the Company to continue its operations
through at least March 31, 1999. These steps have included (a) recent work
force reduction from 80 to 42 employees, with additional employee reductions
contemplated, (b) a reduction in the use of consultants, (c) substantial
reductions in travel and entertainment expenses, (d) reductions in selling
costs, including revamping of sales overrides and commissions and closures of
all satellite offices (except for Canada). The Company will continue to sell
its existing product line, while the Company completes the development
(scheduled for the second half of the current fiscal year) of BrighStar. The
Company believes that its BrightStar product has significant sales potential in
the telephony and supercomputer areas. To the extent required to meet is
liquidity needs, the Company may consider the sale or licensing of this product
line either prior or subsequent to completion of its development. There can be
no assurance, however, that the Company will be able to sufficiently reduce its
monthly overhead costs and to generate additional funding through its BrightStar
product or by obtaining other sufficient financing so that the Company can avoid
being forced to significantly reduce or suspend its operations or seek
protection under bankruptcy laws in the immediate future.
The Company must immediately provide additional liquidity to meet its
current obligations and maintain its operations and is actively seeking
additional financing to meet its immediate needs. On June 6, 1998, the Company
received written notice from Vermont Research Products, Inc. ("VRPI"), the
holder of the Company's Series F and Series G Preferred Stock and the Company's
single largest creditor, of VRPI's decision (which has not been agreed to by the
Company) to surrender its Series F & Series G Preferred Stock as a result of
VRPI's contention that the Company failed to timely file a registration
statement covering the underlying Common Shares. On June 11, 1998, the Company
received a $100,000 loan from VRPI (the "VRPI Loan"). The VRPI Loan provides
for interest at the rate of 15% per annum, is secured by the Company's foreign
accounts receivable and is due on July 11, 1998. During the 30 day period ending
July 11, 1998 (the "Study Period"), VRPI will conduct an examination of the
Company's technology and finances in order to determine if an investment in the
Company is warranted. The VRPI Loan contains certain restrictions, including,
among others, the use of the loan proceeds for only those expenses necessary to
continue the Company's operations during the
Page 31
<PAGE>
Study Period and the Company's agreement not to issue stock or incur debt,
except for the Company's proposed line of credit (described below) with any
party other than VRPI and those persons or entities who choose to participate
with VRPI in connection with any further financing of the Company. VRPI has
informed the Company that it has prepared, but not filed, a lawsuit against the
Company and certain of its officers and directors and has agreed not to file the
complaint during the Study Period. On July 7, 1998 VRPI provided an additional
$100,000 of financing to the Company. No assurances can be given that VRPI will
provide additional financing to the Company or that VRPI will not take legal
action against the Company.
On June 15, 1998, the Company entered into a commitment letter with ALCO
Financial Services, Inc. ("ALCO") pursuant to which ALCO has agreed, subject to
certain conditions, to provide the Company with a maximum $750,000 line of
credit. Under the proposed terms of the line of credit, which would remain in
effect for a period of one year, the Company would be able to borrow from ALCO
based on eligible accounts receivable and inventory, at prime plus seven
percent. The line of credit would also include certain other fees and conditions
and would grant to ALCO a blanket lien on all assets of the Company. The line
of credit is subject to a review by ALCO of the Company's inventory and the
execution of final documentation. There can be no assurance that the line of
credit will ultimately be effected, and the Company will require additional
financing to meet its near term obligations even if the ALCO financing is
consummated.
The Company is seeking additional public or private financing to meet its
longer term capital needs. If additional funds are raised through the issuance
of equity securities, it is likely that the Company will be required to sell
such securities at a substantial discount to the current market price for the
Common Stock, the percentage ownership of the then current shareholders of the
Company will be reduced, and such equity securities may have rights, preferences
or privileges senior to those of the holders of the Company's Common Stock. No
assurance can be given that additional financing will be available or that, if
available, it will be available on terms favorable to the Company or its
shareholders.
The Company has incurred operating losses in each of its last three fiscal
years, and has experienced operating losses for the past six consecutive fiscal
quarters and is continuing to incur operating losses subsequent to March 31,
1998. Any increase in the outstanding number of shares of the Common Stock or
other securities convertible or exercisable for Common Stock may have an adverse
effect on the market price of the Common Stock and may hinder efforts to arrange
future financing. Even if the Company successfully completes any debt or equity
financings it is currently attempting to consummate, if the Company continues to
experience operating losses in the future that result in a significant
utilization of its liquid resources, the Company's liquidity and its ability
over the long-term to continue operations could be materially adversely
affected.
The Company had no material commitments for capital expenditures as of
March 31, 1998.
Year 2000
---------
The Company is currently working to resolve the potential impact of the
year 2000 on the processing of date-sensitive information by the Company's
computerized information systems. The year 2000 problem is the result of
computer programs being written using two digits (rather than four) to define
the applicable year. Any of the Company's programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000, which could result in miscalculation or system failures. Based on
preliminary information, costs of addressing potential problems are currently
not expected to have a material adverse impact on the
Page 32
<PAGE>
Company's financial position, results of operations or cash flows in future
periods. The Company's internal accounting and other information and certain
non-information systems will need to be upgraded. The total hardware and
software costs of such upgrade are not expected to exceed $50,000. The Company
intends to effect these upgrades in order to avoid any delays or disruptions to
its operations that could occur should it be required to replace its current
systems with manual systems in the year 2000. The Company's server products
incorporate chips of other manufacturers that must be year 2000 compliant. In
August 1997 the Company commenced contacting its existing customers to alert
them to the need to replace certain of the chips in the Companies product that
are not year 2000 compliant. The cost to the customer for upgrading these chips
is relatively low and the Company does not anticipate that its own costs in
connection with this upgrade process will be material.
ITEM 7. FINANCIAL STATEMENTS
The Company's financial statements appear on pages 41 to 66 of this Annual
Report on Form 10-KSB, following Part IV.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Previously reported.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The information required by this Item will be contained in the Company's
definitive proxy statement for its 1998 Annual Meeting of Shareholders, and is
incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION
The information required by this Item will be contained in the Company's
definitive proxy statement for its 1998 Annual Meeting of Shareholders, and is
incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be contained in the Company's
definitive proxy statement for its 1998 Annual Meeting of Shareholders, and is
incorporated herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANACTIONS
The information required by this Item will be contained in the Company's
definitive proxy statement for its 1998 Annual Meeting of Shareholders, and is
incorporated herein by reference.
Page 33
<PAGE>
<TABLE>
<CAPTION>
CHATCOM, INC.
- -------------
BALANCE SHEETS
MARCH 31, 1998 AND 1997 (in thousands)
- --------------------------------------------------------------------------------------------------------------
Notes 1998 1997
----- -------- --------
<S> <C> <C> <C>
ASSETS 6
CURRENT ASSETS:
Cash and cash equivalents $ 381 $ 1,169
Accounts receivable, net of allowances of
$50,000 (1998) and $109,000 (1997) 849 1,334
Inventories 3 2,636 2,721
Prepaid expenses and other
current assets 92 108
-------- --------
Total current assets 3,958 5,332
EQUIPMENT AND FIXTURES, Net 4,17 388 651
DEPOSITS 22 24
-------- --------
TOTAL $ 4,368 $ 6,007
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable 7 $ 2,904 $ 1,427
Accrued expenses 5 1,074 687
Current portion of notes payable 7,10 1280
Current portion of capital lease
obligations 17 15 23
-------- --------
Total current liabilities 5,273 2,137
-------- --------
LONG-TERM LIABILITIES: -
Notes payable - less current portion 7 20
Capital Lease obligation - less current portion 17 22 12
-------- --------
Total long-term liabilities 42 12
-------- --------
COMMITMENTS AND CONTINGENCIES 6,7,17
REDEEMABLE PREFERRED STOCK:
Series E Convertible Redeemable Preferred Stock, $1,100,000
redemption value net of $163,000 of offering costs, authorized
2,000 shares; issued and outstanding 1,100 shares 11,13 937
-------- --------
STOCKHOLDERS' EQUITY (DEFICIT) :
Preferred Stock, no par value, authorized 1,000,000 shares:
Series D Convertible Preferred Stock, $1,000 stated value per share,
authorized 5,000 shares, issued and outstanding
2,496 shares 10,13 1,407 1,407
Series F Convertible Preferred Stock, $1,000 stated value
per share, authorized 2,000 shares; issued and
outstanding 945 shares 7,13 945
Series G Convertible Preferred Stock, $1,000 stated value
per share, authorized 500 shares; issued and
outstanding 400 shares 7,13 400
Common Stock, no par value, authorized, 25,000,000 shares
issued and outstanding, 11,591,215
(1998) and 9,826,892 (1997) shares 12,13 11,025 10,090
Additional paid-in capital 17 2,839 2,404
Accumulated deficit (18,500) (10,043)
-------- --------
Total stockholders' equity (deficit) (1,884) 3,858
-------- --------
TOTAL $ 4,368 $ 6,007
======== ========
</TABLE>
See accompanying independent auditors' reports and notes to financial
statements.
Page 45
<PAGE>
<TABLE>
<CAPTION>
CHATCOM, INC.
- -------------
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED MARCH 31, 1998, 1997 AND 1996 (in thousands, except share data)
- -------------------------------------------------------------------------------------------------------------------------
Preferred Stock Common Stock
------------------------ ------------------------
Number of Number of
Notes Shares Amount Shares Amount
----- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
BALANCE, April 1, 1995 7,534,629 $ 5,859
Exercise of stock options 13 2,000 1
Grant of stock options
Payment of subscription receivable
Issuance of Series B Preferred Stock 8 75 $ 1,294
Net loss
------ ------- ---------- -------
BALANCE, March 31, 1996 75 1,294 7,536,629 5,860
Issuance of Series C Preferred Stock and Warrants 9,13 75 1,277
Issuance of Series D Preferred Stock and Warrants 10,13 2,496 1,407
Issuance of stock purchase warrants 13
Conversion of Series B Preferred Stock 8 (75) (1,294) 1,024,768 1,294
Conversion of Series C Preferred Stock 9 (75) (1,277) 907,098 1,277
Preferred Stock dividends 38,041 809
Exercise of stock options 13 30,000 37
Exercise of stock purchase warrants 13 290,356 813
Net loss
------ ------- ---------- -------
BALANCE, March 31, 1997 2,496 1,407 9,826,892 10,090
Issuance of Series F Preferred Stock 7 945 945
Issuance of Series G Preferred Stock 7 400 400
Preferred Stock dividends 154,800 235
Additional paid in capital arising
from beneficial conversion feature
of Series E Preferred Stock
Deemed dividend on Series E Preferred
Stock arising from amortization of
beneficial conversion feature
Issuance of Common Stock 12 809,523 300
Issuance of Common Stock in settlement 17
of litigation 800,000 400
Net loss
---------------------------------------------------
BALANCE, March 31, 1998 3,841 $ 2,752 11,591,215 $11,025
===================================================
<CAPTION>
CHATCOM, INC.
- -------------
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED MARCH 31, 1998, 1997 AND 1996 (in thousands, except share data)
- -----------------------------------------------------------------------------------------------------------------------------
Additional
Subscription Paid-in Accumulated Stockholders'
Receivable Capital Deficit Equity
------------- ----------- ------------ -------------
<S> <C> <C> <C> <C>
BALANCE, April 1, 1995 $(100) $1,416 $ (2,580) $ 4,595
Exercise of stock options 1
Grant of stock options 20 20
Payment of subscription receivable 100 100
Issuance of Series B Preferred Stock 1,294
Net loss (1,968) (1,968)
----- ------ -------- -------
BALANCE, March 31, 1996 1,436 (4,548) 4,042
Issuance of Series C Preferred Stock and Warrants 48 1,325
Issuance of Series D Preferred Stock and Warrants 915 2,322
Issuance of stock purchase warrants 5 5
Conversion of Series B Preferred Stock
Conversion of Series C Preferred Stock
Preferred Stock dividends (894) (85)
Exercise of stock options 37
Exercise of stock purchase warrants 813
Net loss (4,601) (4,601)
----- ------ -------- -------
BALANCE, March 31, 1997 2,404 (10,043) 3,858
Issuance of Series F Preferred Stock 945
Issuance of Series G Preferred Stock 400
Preferred Stock dividends (316) (81)
Additional paid in capital arising
from beneficial conversion feature
of Series E Preferred Stock 368 368
Deemed dividend on Series E Preferred
Stock arising from amortization of
beneficial conversion feature (368) (368)
Issuance of Common Stock 300
Issuance of Common Stock in settlement
of litigation 67 467
Net loss (7,773) (7,773)
------------------------------------------------------------
BALANCE, March 31, 1998 $2,839 $ $(1,884)
============================================================
</TABLE>
See accompanying independent auditors' reports and notes to financial
statements.
Page 47
<PAGE>
<TABLE>
<CAPTION>
CHATCOM, INC.
- -------------
STATEMENTS OF CASH FLOWS
YEARS ENDED MARCH 31, 1998, 1997 AND 1996 (in thousands)
- ---------------------------------------------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net loss $(7,773) $(4,601) $(1,968)
Adjustments to reconcile net loss
to net cash used in operating activities:
Grant/extension of stock options 20
Depreciation and amortization 350 253 312
Loss on disposal of assets 130 57
Provision for losses on accounts receivable 28 166 37
Interest on subordinated debt 52
Provision for inventory obsolescence 1,409 794 162
Interest on accounts payable 175
Value of common stock and stock options in
in connection with litigation settlement 467
Changes in operating assets and liabilities:
Accounts receivable 457 468 1,455
Inventories (1,324) (34) (521)
Prepaid expenses and other current assets 16 94 119
Deposits 2 (3) (1)
Accounts payable 3,067 (416) (768)
Accrued expenses 254 (294) 171
------- ------- -------
Net cash used in operating
activities (2,690) (3,573) (925)
------- ------- -------
CASH FLOWS FROM INVESTING
ACTIVITIES - Capital expenditures (187) (343) (190)
------- ------- -------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from short-term borrowings 938
Repayments of short-term borrowings (10) (938) (1,075)
Change in restricted cash 500 (500)
Principal payments on capital leases (28) (35) (33)
Proceeds from sale of redeemable preferred stock 937
Proceeds from sale of common stock 300
Payment of preferred stock dividends (10)
Proceeds from issuance of convertible
subordinated debt 890
Collection of subscription receivable 100
Proceeds from issuance of Series B Preferred Stock 1,294
Proceeds from issuance of Series C Preferred Stock 1,325
Proceeds from issuance of Series D Preferred Stock 2,322
Proceeds from issuance of stock purchase warrants 4
Proceeds from exercise of stock purchase warrants 813
Proceeds from exercise of stock options 37 1
------- ------- -------
Net cash provided by financing
activities 2,089 4,018 725
------- ------- -------
NET INCREASE (DECREASE) IN
CASH AND CASH EQUIVALENTS (788) 102 (390)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 1,169 1,067 1,457
------- ------- -------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 381 $ 1,169 $ 1,067
======= ======= =======
</TABLE>
See accompanying independent auditors' reports and notes to financial
statements.
(Continued)
Page 48
<PAGE>
CHATCOM, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED MARCH 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in thousands):
1998 1997 1996
---- ---- ----
Cash paid for income taxes $ 0 $ 0 $ 2
Cash paid for interest $ 0 $ 12 $196
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the fiscal years ended March 31, 1998 ("fiscal 1998") and 1997 ("fiscal
1997"), the Company acquired office equipment under capital leases in the
amount of $30,000 and $22,000, respectively.
During fiscal 1998, the Company accrued dividends related to the Series D
Convertible Preferred Stock of $250,000 and paid dividends of $235,000 through
the issuance of 154,800 shares of common stock which resulted in an increase in
common stock of $235,000 and a decrease in accrued expenses of $235,000.
During fiscal 1998, the Company accrued dividends related to the Series E
Convertible Redeemable Preferred Stock, Series F Convertible Preferred Stock
and Series G Convertible Preferred Stock of $45,000, $14,000 and $6,000,
respectively.
During fiscal 1998, the Company recognized the beneficial conversion feature
associated with the Series E Convertible Redeemable Preferred Stock of $368,000
as an increase in additional paid in capital. The related discount was
amortized over the minimum period in which the preferred shareholders could
realize that return as a deemed dividend.
During fiscal 1998, the Company granted to Strategic Growth International, Inc.
("SGI") 800,000 shares of Common Stock; options to purchase 200,000 shares of
Common Stock; and cash of $100,000 (of which $15,000 was paid to SGI through
March 31, 1998) as payment in connection with a lawsuit settlement. The
transaction resulted in an increase in Common Stock and additional paid-in
capital of $400,000 and $67,000, respectively, and a charge to general and
administrative expenses of $567,000 during the fourth quarter of fiscal 1998.
During Fiscal 1998, $420,000 of accounts payable due to Vermont Research
Products, Inc. was converted into a Note Payable.
During fiscal 1997, the Company accrued dividends related to the Series D
Convertible Preferred stock of $75,000.
During fiscal 1997, 75 shares of Series B Preferred Stock and 75 shares of
Series C Preferred Stock were converted into 1,024,768 and 907,098 shares of
the Company's Common Stock (the "Common Stock"), respectively.
During fiscal 1997, the Company issued 38,041 shares of Common Stock in payment
of accrued dividends of $59,000 relating to Series B Preferred Stock and Series
C Preferred Stock.
During fiscal 1997, the Company recognized preferred stock dividends of
$750,000 as a result of the beneficial conversion features of the Series B
Preferred Stock and Series C Preferred Stock, which resulted in an increase in
accumulated deficit of $750,000 and an increase in Common Stock of $750,000.
(See note 8,9.)
During fiscal 1997, the Company granted warrants to purchase 100,000 shares of
Common Stock to SGI as partial compensation pursuant to a finders' fee
agreement in connection with the placement of the Series D preferred Stock.
The transaction resulted in an increase in additional paid-in capital of $1,000
and a decrease in Series D Preferred Stock of $1,000.
During fiscal 1996, the Company granted 15,000 options to purchase the Common
Stock to directors at an exercise price of $4.03 per share. The market price
on the date of grant was $5.37. The grant of the options resulted in the
recording of compensation expense and additional paid-in capital of $20,000.
During March 1995, the Company issued Common Stock and warrants in exchange for
the receipt of a personal check in the amount of $100,000. Subsequent to the
issuance of the securities, the check proved to be drawn on an account with
insufficient funds. During fiscal 1996, the Company received the $100,000
subscription receivable.
See accompanying independent auditors' reports and notes to financial
statements
Page 49
<PAGE>
CHATCOM, INC.
- -------------
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED MARCH 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business - ChatCom, Inc., a California corporation, is engaged in the
--------
business of developing, integrating, manufacturing and marketing highly-
efficient centralized server and storage management systems.
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. During the years ended March 31,
1998, 1997 and 1996 the Company incurred net losses of $7,773,000,
$4,601,000 and $1,968,000, respectively, and negative cash flows from
operations of $2,700,000, and $3,573,000 and $925,000, respectively, which
raise substantial doubt about its ability to continue as a going concern.
Additionally, revenues during the fourth quarter of fiscal 1998 were lower
than that of the fourth quarter of the previous year. As of March 31,
1998, the Company had negative working capital of $1,335,000, as compared
to working capital of $3,195,000 as of March 31, 1997. The Company is
taking significant steps to reduce its monthly overhead costs which the
Company believes will be sufficient, in conjunction with the proposed
financing described below, to enable the Company to continue its operations
through at least March 31, 1999. These steps have included (a) recent work
force reduction from 80 to 42 employees, with additional employee
reductions contemplated, (b) a reduction in the use of consultants, (c)
substantial reductions in travel and entertainment expenses, (d) reductions
in selling costs, including revamping of sales overrides and commissions
and closures of all satellite offices (except for Canada). The Company
will continue to sell its existing product line, while the Company
completes the development (scheduled for the second half of the current
fiscal year) of BrighStar. The Company believes that its BrightStar
product has significant sales potential in the telephony and supercomputer
areas. To the extent required to meet is liquidity needs, the Company may
consider the sale or licensing of this product line either prior or
subsequent to completion of its development.
The Company must provide additional liquidity to support its current level
of operations or any significant future increase in revenues and is
actively seeking additional financing to meet its immediate needs as well
as its anticipated requirements for the balance of the fiscal year ending
March 31, 1999. The Company, which currently does not have any bank debt,
has received a conditional commitment for a credit line (maximum of
$750,000) and is in the process of reviewing documentation for such a
credit line. On June 11, 1998, the Company received $100,000 from its
largest creditor (the "Creditor") in exchange for issuing a 30 day
promissory note. The note agreement contains numerous conditions and
restrictions including, among others, the prior approval of the Creditor of
any debt or equity financing. The Company is continuing to discuss equity
investments with several potential sources, but has not received a firm
commitment for any equity financing, and there can be no assurance that it
will be able to consummate such transactions in the future. If the Company
does not reduce its burn rate and generate additional funding through its
BrightStar product line or by raising other sufficient financing to meet
its short term needs, the Company will more than likely be unable to
continue its operations. The financial statements do not include any
adjustments that might result should the Company be unable to continue as a
going concern.
Page 50
<PAGE>
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 disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
Cash and Cash Equivalents - The Company considers cash on hand, demand
-------------------------
deposits and short-term investments with original maturities of 90 days or
less to be cash equivalents. At March 31, 1998, the balance of cash and
cash equivalents consisted of cash on hand. At March 31, 1997, the balance
of cash and cash equivalents consisted of cash on hand, demand deposits,
and a certificate of deposit.
Financial Instruments - The carrying value of cash and cash equivalents,
---------------------
accounts receivable, accounts payable accrued expenses and notes payable,
approximate fair value due to the short maturities of such instruments.
The Company's financial instruments that are exposed to concentration of
credit risk consist primarily of its cash and cash equivalents, and
accounts receivable. The Company restricts its investment of cash and cash
equivalents to financial institutions with high credit standing.
Concentrations of credit risk on accounts receivable is minimized to a
certain extent as a result of the large number and geographic dispersion of
the Company's nationwide customer base. However, a significant amount of
accounts receivable are with agencies of the Canadian government. The
Company does not currently forsee a credit risk associated with these
receivables based upon past collection experience. The Company performs
ongoing credit evaluations of its customers' financial condition and
maintains an allowance for potential credit losses. The Company's
historical experience in collection of accounts receivable falls within the
recorded allowances. The Company does not require additional collateral as
securing for its accounts receivable.
Inventories - Inventories are stated at the lower of cost (first-in, first-
-----------
out) or market. The Company reviews its inventories and assesses the
reserve for obsolete and excess inventories required to state inventories
at the lower of cost or market approximately quarterly. The charges to
cost of goods sold for the valuation of obsolete and excess inventories
were $1,409,000, $794,000 and $162,000 for the years ended March 31, 1998,
1997 and 1996, respectively.
Equipment and Fixtures - Equipment and fixtures are stated at cost.
----------------------
Depreciation and amortization are computed on the straight-line method over
the following estimated useful lives of the assets:
Equipment 5 years
Software 3 years
Furniture and fixtures 5 years
Leasehold improvements Lesser of lease
term or 5 years
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of - The
- -----------------------------------------------------------------------
Company adopted the provisions of SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and Long-Lived Assets to Be Disposed Of," on April 1, 1996.
This Statement requires that long-lived assets and certain identifiable
intangibles be reviewed
Page 51
<PAGE>
6. LINE OF CREDIT
On June 15, 1998, the Company entered into a conditional commitment letter
with ALCO Financial Services, Inc. ("ALCO") pursuant to which ALCO has
agreed, subject to certain conditions, to provide the Company with a
maximum $750,000 line of credit. Under the proposed terms of the line of
credit, which would remain in effect for a period of one year, the Company
would be able to borrow from ALCO based on eligible U.S. accounts
receivable and inventory, at prime plus seven percent. The line of credit
would also include certain other fees and conditions and would grant ALCO a
blanket lien on all assets of the Company. The line of credit is subject to
a review by ALCO of the Company's inventory and the execution of final
documentation. There can be no assurance that the line of credit will
ultimately be effected.
7. CONVERSION OF UNSECURED DEBT
As of February 1, 1998, the Company entered into a Settlement Agreement
with Vermont Research Products, Inc. ("VRPI"), a major supplier of certain
products (which are resold by the Company), for the conversion of a portion
of the amount owed by the Company to VRPI (approximately $2.04 million at
February 1, 1998) into 945 shares of the Company's Series F Convertible
Redeemable Preferred Stock, $1,000 stated value per share, valued at
$945,000 (the "Series F Preferred Stock") and 400 shares of the Company's
Series G Convertible Preferred Stock, $1,000 stated value per share, valued
at $400,000 (the "Series G Preferred Stock"). The Settlement Agreement also
provided for payment terms with respect to the remaining balance owed to
VRPI (approximately $694,000 at February 1, 1998 (the "Remaining Balance").
The Company has the option to redeem the Series F Preferred Stock for a
period of 120 days following the Closing Date (expiring on July 18, 1998)
for a total amount equal to the greater of (a) 115% of the stated value of
the Series F Preferred Stock, or (b) 115% of the aggregate market value of
shares of Common Stock into which the shares of Series F Preferred Stock
are convertible plus accrued dividends. As additional consideration, the
Company issued to VRPI a five-year warrant to purchase 285,000 shares of
Common Stock at an exercise price of $.35 per share. Dividends on the
Series F Preferred Stock and Series G Preferred Stock are payable in cash
or shares of Common Stock, at the election of the Company, at the rate of
9.5% per annum. The Series F Preferred Stock is convertible into shares of
Common Stock at any time through January 31, 2003 at a conversion price
equal to the market price at the time of conversion, but at a conversion
price no greater than $.95 per share and no less than $.35 per share. The
Series G Preferred Stock is convertible into shares of Common Stock at a
conversion price of $.35 per share. The holder of the Series F Preferred
Stock and Series G Preferred Stock are entitled to equal preference with
holders of the Company's Series D and Series E Preferred Stock. The Company
agreed to use its best efforts to register the shares issuable upon the
conversion of the Series F Preferred Stock and Series G Preferred Stock
and upon the exercise of the warrants, with such registration statement to
be declared effective no later than April 29, 1998 (extended to May 29,
1998 under certain circumstances). As long as any amounts of Series F
Preferred Stock or Series G Preferred Stock remain outstanding, VRPI shall
have the right to approve any preferred stock offering by the Company which
rank equal to or senior to those of VRPI's, and approve any debt offering
contemplated by the Company, except for commercial bank lines of credit or
loans secured by the Company's U.S. accounts receivable or inventory. Of
the remaining balance owed to VRPI after the conversion of certain amounts
into the Series F Preferred Stock and the Series G Preferred Stock,
$274,000 represents equipment warehoused by VRPI for the Company and is
payable to VRPI at the time of shipment to any customer of the Company.
The remaining balance owed to VRPI (approximately $420,000 together with
interest at 9.5%
Page 56
<PAGE>
effective February 1, 1998) was converted to a note payable with $5,000
payable upon execution of the Settlement Agreement, $5,000 payable on March
1, 1998, $5,000 payable on April 1, 1998, and $35,000 per month payable
commencing May 1, 1998. Additionally, the Company is required to remit 25%
of its collections of foreign accounts receivable commencing February 1,
1998 as well as 20% of the net proceeds to the Company of any equity
financings (other than commercial bank loan financing or asset based
lending against United States accounts receivable and finished or assembled
good inventory) effected by the Company subsequent to February 1, 1998 plus
the sum of $50,000 upon consummation of each of the first two such
financings. The Company also agreed to pay VRPI's expenses in connection
with this transaction.
During the quarter ended December 31, 1997 and in anticipation of entering
into the above agreement, the Company agreed to VRPI's invoicing the
Company $175,000 for interest charges related to its month-end balances
owed to VRPI throughout 1997. The effective rate of interest was
approximately 17%.
Pursuant to the Settlement Agreement, the Company has paid VRPI the sum of
$50,000 (of which $5,000 was paid upon the execution of the Settlement
Agreement, $5,000 paid on March 1, 1998 and April 1, 1998 and $15,000 was
paid on May 1, 1998). Due to the Company's liquidity crisis, no further
payments have been made to VRPI including any amounts owed in connection
with the Company's issuance of Common Stock in March 1998 ($110,000) (See
Note 12) and in connection with the Company's collection of foreign
accounts receivable (approximately $18,000 as of March 31, 1998) .
On June 6, 1998, the Company received written notice from VRPI of VRPI's
decision (which the Company has not agreed to) to surrender its Series F &
Series G Preferred Stock as a result of VRPI's contention that the
Company failed to timely file a registration statement covering the
underlying Common Shares. On June 11, 1998, the Company received a
$100,000 loan from VRPI (the "VRPI Loan"). The VRPI Loan provides for
interest at the rate of 15% per annum, is secured by the Company's foreign
accounts receivable and is due on July 11, 1998. During the 30 day period
ending July 11, 1998 (the "Study Period"), VRPI will conduct an examination
of the Company's technology and finances in order to determine if an
investment in the Company is warranted. The VRPI Loan contains certain
restrictions, including, among others, the use of the loan proceeds for
only those expenses necessary to continue the Company's operations during
the Study Period and the Company's agreement not to issue stock or incur
debt, except for the Company's proposed line of credit (described above)
with any party other than VRPI and those persons or entities who choose to
participate with VRPI in connection with any further financing of the
Company. VRPI has informed the Company that it has prepared, but not
filed, a lawsuit against the Company and certain of its officers and
directors and has agreed not to file the complaint during the Study Period.
On July 7, 1998 VRPI provided an additional $100,000 of financing to the
Company. No assurances can be given that VRPI, or any other person or
entity, will provide additional financing to the Company or that VRPI will
not take legal action against the Company.
8. SERIES B PREFERRED STOCK
In March 1996, the Company sold 75 shares of Series B Preferred Stock,
$20,000 stated value per share (the "Series B Preferred Stock"), for gross
proceeds of $1,500,000. Offering costs of $206,000, consisting of finders'
fees, legal fees, accounting fees, listing fees and registration costs,
were incurred by the Company. Dividends were payable in cash or Common
Stock, at the option of the Company, at a rate of 6% per annum. The
Page 57
<PAGE>
shares were convertible into Common Stock with a conversion price equal to
the lesser of the average closing bid price for the five trading days prior
to the date of sale or 75% of the average closing bid price for the five
trading days prior to the date of conversion or redemption. As a result of
this beneficial conversion feature, $375,000 was charged to accumulated
deficit and reflected as a preferred stock dividend during fiscal 1997.
During fiscal 1997, the holders of the Series B Preferred Stock converted
all of the outstanding shares into 1,024,768 shares of Common Stock. The
Company paid dividends of $10,000 and 15,535 shares of Common Stock related
to the Series B Preferred Stock.
9. SERIES C PREFERRED STOCK
In May 1996, the Company sold 75 shares of Series C Preferred Stock,
$20,000 stated value per share (the "Series C Preferred Stock"), for gross
proceeds of $1,500,000. Offering costs of $175,000, consisting of finders'
fees, legal fees, accounting fees, listing fees and registration costs,
were incurred by the Company. Dividends were payable in cash or Common
Stock, at the option of the Company, at a rate of 6% per annum. The shares
were convertible into Common Stock with a conversion price equal to the
lesser of the average closing bid price for the five trading days prior to
the date of sale or 75% of the average closing bid price for the five
trading days prior to the date of conversion or redemption. As a result of
this beneficial conversion feature, $375,000 was charged to accumulated
deficit and reflected as a preferred stock dividend during fiscal 1997.
During fiscal 1997, the holders of the Series C Preferred Stock converted
all of the outstanding shares into 907,098 shares of Common Stock. The
Company paid dividends of 22,506 shares of Common Stock related to the
Series C Preferred Stock.
10. SERIES D PREFERRED STOCK AND CONVERTIBLE SUBORDINATED DEBT
In December 1996, the Company sold 2,496 shares of Series D Voting
Convertible Preferred Stock, $1,000 stated value per share (the "Series D
Preferred Stock") and warrants to purchase 400,000 shares of Common Stock
(the "Warrants"), for gross proceeds of $2,500,000. Offering costs of
$178,000, consisting of cash finders' fees, warrants issued as finders'
fees, legal fees, accounting fees, listing fees and registration costs,
were incurred by the Company. Dividends are payable in cash or Common
Stock, at the option of the Company, at a rate of 10% per annum. The
Series D Preferred Stock is also convertible at the election of the holders
into shares of Common Stock during the one-year period commencing on
December 14, 1997. The actual number of shares of Common Stock into which
the Series D Preferred Stock and any dividends that are payable in shares
of Common Stock are convertible is variable, with the conversion value of
the shares being equal to the market price of the Common Stock (determined
based on the closing sale price of the Common Stock for the ten trading
days preceding the date of conversion). The conversion value of the Common
Stock has a cap of $4.50 per share and, commencing on December 14, 1997,
has a floor of $1.50 per share. The Company has agreed to register the
shares issuable upon conversion of Series D Preferred Stock or upon
exercise of the Warrants. The purchasers of the Series D Preferred Stock
have voting rights for each share of the Series D Preferred Stock
outstanding equivalent to that of 380 shares of Common Stock. Holders of
the Series D Preferred Stock also have the right to elect a majority of the
Company's directors in the event of default by the Company in the payment
of dividends on the Series D Preferred Stock or upon certain other defined
events of default.
On September 11, 1997, the Company, together with a majority of its Board
of Directors, were sued by The High View Fund and The High View Fund, L.P.
(collectively, "High
Page 58
<PAGE>
The Series E Preferred Stock is subject to both a mandatory and voluntary
redemption. If on September 1, 1998 the resale of all of the shares of
Common Stock issuable upon conversion of the then outstanding shares of
Series E Preferred Stock is not at that time duly registered as described
above, the Company, at the demand of any investor, shall redeem such
investor's shares of Series E Preferred Stock for total amount equal to the
market price times the number of shares of Common stock into which such
shares of Series E Preferred Stock are convertible on the date of such
demand, and shall also pay accrued dividends on such shares of Series E
Preferred Stock, whether or not declared, to the redemption date.
Shares of the Series E Preferred Stock may also be redeemed, at the option
of the Company in whole or in part, upon fifteen days written notice, at
any time after the later of January 31, 1998 or 50 days after the effective
date of the registration statement described above, for a total amount
equal to 133% of the stated value of Series E Preferred Stock, and shall
also pay accrued dividends on such shares of Series E Preferred Stock,
whether or not declared, to the redemption date. In case of the redemption
of a part only of the outstanding shares of Series E Preferred Stock, the
shares to be redeemed shall be selected pro rata from each record holder of
such shares. During the first ten business days of such fifteen-day
period, each record holder of shares of the Series E Preferred Stock shall
have the right to convert such shares as provided above.
No assurance can be given that the Company will be able to satisfactorily
meet the conditions required for the sale of the additional 600 shares of
Series E Preferred Stock.
12. COMMON STOCK
During March 1998, the Company completed a sale of 809,523 shares of Common
Stock to an accredited investor at an average price of $0.37 per share
($300,000 of proceeds in the aggregate).
13. STOCK OPTIONS AND WARRANTS
Stock Options
-------------
The Company applies APB Opinion 25 in accounting for its Stock Options
Plans (the "Plans"). Had the Company determined compensation cost based on
the fair value at the grant date for its stock options under SFAS No. 123,
the Company's net loss available to Common Stockholders would have
increased to the pro forma amounts indicated below.
Page 61
<PAGE>
<TABLE>
<CAPTION>
Year Ended March 31
----------------------------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C> <C>
Net loss As reported $(8,457,000) $(5,495,000) $(1,968,000)
available to common per share $ (0.84) $ (0.61) $ (0.26)
stockholders
Pro Forma $(9,180,000) $(4,781,000) $(2,546,000)
per share $ (0.91) $ (0.69) $ (0.34)
</TABLE>
The Company had an incentive stock option plan that expired in April 1995
(the "1985 Plan"), under which options to purchase 400,000 shares of Common
Stock could be granted to officers and employees. Options granted were at
100% of the estimated fair market value on the dates of grant. On November
22, 1994, the shareholders of the Company approved and adopted the
Company's 1994 Stock Option Plan (the "1994 Plan") to replace the expiring
1985 Plan. Under the 1994 Plan, options to purchase up to 2,000,000 shares
of Common Stock may be granted to officers, employees, directors and
consultants of the Company. On February 8, 1996, and on November 21, 1996
the shareholders of the Company approved and adopted amendments to the 1994
Plan, which revised the provision for the granting of formula options to
non-employee directors of the Company. A summary of the status of the
Company's stock option plans is summarized below:
<TABLE>
<CAPTION>
Fiscal Years Ending March 31,
-----------------------------------------------------------------
1998 1997 1996
---- ---- ----
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- -------- ---------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 1,244,350 $2.26 1,003,600 $2.22 339,100 $2.30
Granted 1,859,483 $0.64 392,500 $2.33 798,750 $2.19
Exercised 2,000 $0.45
Lapsed or canceled (1,112,350) $2.06 (151,750) $2.20 (132,250) $2.27
--------- --------- ---------
Outstanding at year end 1,991,483 $0.86 1,244,350 $2.26 1,003,600 $2.22
========= ========= =========
Options exercisable at year end 1,069,483 803,100 459,600
Options available for future grant 8,517 755,650 996,400
Weighted average fair value of options
granted during the year $1.82 $1.98 $0.41
</TABLE>
The following table presents summarized information about stock options
outstanding at March 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------- -------------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Outstanding Contractual Exercise Outstanding Exercise
Range of Exercise Price at 3/31/98 Life Price at 3/31/98 Price
----------------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.38 - $.99 1,471,150 9.92 $0.40 549,150 $0.40
$1.00-$1.99 193,333 2.80 1.75 193,333 1.75
$2.00-$2.99 309,500 7.59 2.34 309,500 2.34
$3.00-$3.99 12,500 0.43 3.49 12,500 3.49
$4.00-$4.03 5,000 7.00 4.03 5,000 4.03
--------- ---------
1,991,483 8.80 0.86 1,069,483 1.26
========= =========
</TABLE>
Page 62
<PAGE>
The fair value of the options granted during the years ended March 31,
1998, 1997 and 1996 was estimated using the Black-Scholes option pricing
model based on groups of options with identical terms assuming a zero
dividend yield and the following:
1998 1997 1996
Actual contractual lives 4 - 10 years 3 - 10 years 3 - 10 years
Volatility rates 94% - 117% 93% 93%
Risk free interest rate 5.6% - 6.7% 6% - 6.5% 6% - 6.5%
At March 31, 1998, no options were outstanding under the 1985 Plan. During
February 1998, the Company cancelled and re-issued 414,400 stock options at
an exercise price of $0.40 per share under the 1994 Plan. Exercise prices
of the cancelled options ranged from $1.25 per share to $5.00 per share. Of
the 414,400 re-issued stock options, 56,400 options became exercisable
immediately. Of the balance of the re-issued options (358,000), one-third
vested at date of issuance, one-third on the first anniversary of the date
of grant, and one-third on the second anniversary of the date of grant. Of
the remaining options granted during fiscal 1998 (1,056,750), 31,750
options became exercisable immediately. Of the balance of these options
(1,025,000), one-third vested at date of issuance, one-third on the first
anniversary of the date of grant, and one-third on the second anniversary
of the date of grant. All options granted during fiscal 1998 expire ten
years from date of grant.
Pursuant to a provision contained in the Series D Preferred Stock purchase
agreement, certain of the options which were granted during fiscal 1998 are
subject to the approval by the holders of the Series D Preferred Stock. As
of March 31, 1998, the Company has not received such approval from the
holders of the Series D Preferred Stock.
All outstanding options under the 1994 Plan expire between three and ten
years from the date of grant. Pursuant to the terms of the 1994 Plan, the
options granted to employees have an exercise price equal to the market
value of the Common Stock on the date of grant. Accordingly, no
compensation expense was recorded with respect to the granting of employee
options.
Pursuant to the terms of a settlement agreement, the Company, during
February 1998, issued 200,000 non-qualified stock options at an exercise
price of $0.50 per share. The non-qualified stock option is fully
exercisable and expires three years from date of grant (see Note 17 B.)
In August 1994, the Company extended the exercise terms of 744,000 non-
qualified options (which consisted of 44,000 options granted to directors
in fiscal 1992 for service on the Board of Directors, 400,000 options
granted to officers of the Company in fiscal 1992 pursuant to the terms of
their employment agreements, and 300,000 options that were granted to
directors in fiscal 1991 in connection with loan guarantees) to expire at a
date ten years from the original grant date. All of the options were
originally granted to directors and officers, some of whom are major
shareholders, of the Company prior to the end of fiscal 1992 and have an
exercise price of $0.60 per share. All of the 744,000 options are
exercisable as of March 31, 1998 of which 700,000 expire on January 31,
2002 and 44,000 expire on March 31, 2003.
In fiscal 1993, the Company granted options to purchase 30,000 shares of
Common Stock to a consultant, which were exercisable at a price of $1.25
per share. On April 15, 1996, the consultant exercised all of the options.
Page 63
<PAGE>
Stock Purchase Warrants
-----------------------
In connection with the private placement of Series E Preferred Stock, the
Company issued warrants to purchase 254,545 shares of Common Stock at a
price of $1.25 per share. The foregoing warrants expire on December 31,
2002.
During fiscal 1998, the Company issued warrants to purchase 20,000 shares
of Common Stock at a price of $1.375 per share, to Troy & Gould
Professional Corporation, the Company's principal law firm, in
consideration of extending credit to the Company in connection with
rendering legal services. The foregoing warrants expire on November 19,
2000.
In connection with the issuance of the $540,000 in convertible subordinated
notes during fiscal 1998, the Company issued warrants to purchase 150,000
shares of Common Stock at a price of $0.375 per share. The foregoing
warrants expire on December 13, 2001.
In connection with the issuance of the Series F Preferred Stock and Series
G Preferred Stock, the Company issued warrants to purchase 285,000 shares
of Common Stock at a price of $0.35 per share. The foregoing warrants
expire on January 31, 2003.
In connection with the private placement of Series D Preferred Stock in
December 1996, the Company issued warrants to purchase 400,000 shares of
Common Stock at a price of $3.125 per share and the Company issued warrants
to purchase 100,000 shares of Common Stock at a price of $3.125 per share
pursuant to a finders' fee agreement. All of the foregoing warrants expire
on December 13, 2001.
In connection with the private placement of Series C Preferred Stock, the
Company issued warrants to purchase 30,000 shares of Common Stock at a
price of $3.00 per share pursuant to a finders' fee agreement The warrants
expire on May 31, 2000.
From December 1994 through March 1995, the Company sold units consisting of
Common Stock and warrants through a private placement. In conjunction with
this offering, warrants to purchase 1,877,500 shares at an exercise price
of $3.00 per share were issued. The warrants which originally expired on
December 31, 1997, were extended (during November 1997) to December 31,
1998, and may be called by the Company if certain conditions are met in the
future. The warrants become callable by the Company after the Common Stock
underlying the warrants is registered and the Common Stock has had a
closing bid price of at least $3.60 for the most recent ten consecutive
trading days. In May 1996, a private placement of preferred stock by the
Company caused the exercise price and the number of shares subject to such
warrants to be adjusted pursuant to the antidilution provisions contained
in the warrant agreements. The adjustments increased the number of shares
subject to the warrants to 2,011,604 and decreased the exercise price to
$2.80 per share. Subsequent to the adjustment pursuant to the antidilution
provisions, 290,356 warrants were exercised.
In fiscal 1992, the Company issued warrants to purchase 625,000 shares of
Common Stock at $0.80 per share in connection with the private placement of
1,250,000 shares of Common Stock. The warrants expire on March 5, 1999.
In May 1996, a private placement of preferred stock by the Company caused
the exercise price and the number of shares subject to such warrants to be
adjusted pursuant to the antidilution provisions contained in the warrant
agreements. The adjustments increased the number of shares subject to the
warrants to 666,667 and decreased the exercise price to $0.75 per share.
Page 64
<PAGE>
B. During fiscal 1998, the Company paid a finder's fee of $110,000 to
Maximum Partners, Ltd. ("Maximum"), an investment banking firm, in
connection with the Company's Series E Preferred Stock financing. Mark D.
Lubash, Managing Director of Maximum, is a shareholder of the Company and
son of A. Charles Lubash, a member of the Company's Board of Directors and
former Chief Executive Officer of the Company. During fiscal 1996, the
Company paid Maximum a finder's fee in the amount of $150,000 related to
the placement of the Series B Preferred Stock. In fiscal 1997, Maximum
received $150,000 and warrants to purchase 30,000 shares of Common Stock at
an exercise price of $3.00 per share as a finder's fee for the placement of
the Series C Preferred Stock.
17. COMMITMENTS AND CONTINGENCIES
A. The Company leases its primary operating facility in Chatsworth,
California under an operating lease expiring on November 30, 1998. The
Company leases sales offices in Ottawa, Canada which expires on October 31,
1998 and a vehicle and certain equipment under capital lease agreements
that expire at various times during the fiscal year ending March 31, 2000.
Rent expense under such lease agreements in fiscal years 1998, 1997 and
1996 was $137,000, $172,000 and $153,000, respectively.
The Company has financed the purchase of office equipment through capital
lease agreements. The obligations are collateralized by the leased
equipment, which had a net book value of $30,000 and $41,000 at March 31,
1998 and 1997, respectively.
Future minimum lease payments are as follows:
Year Ending Operating Capital
March 31, Leases Leases
----------- --------- -------
1999 $101,000 $22,000
2000 0 10,000
2001 0 6,000
-------- -------
$101,000 38,000
========
Less interest 1,000
Less current portion 15,000
-------
$22,000
=======
B. On January 15, 1998, the Company was sued by Strategic Growth
International, Inc. ("SGI"), an investor relations consulting firm. The
lawsuit, filed in U.S. Federal District Court, Central District of
California, sought damages from the Company for the balance of certain
finder's fees ($191,500) alleged by SGI to be owed by the Company to SGI in
connection with the Company's financings from The High View Fund and The
High View Fund, L.P. and for amounts alleged by SGI to be owed to SGI for
consulting services ($75,841) and the economic value of stock options for
66,666 shares of the Company's Common Stock that SGI was to receive in
connection with SGI's consulting services. SGI also sought reimbursement
for its legal fees in connection with the lawsuit and obtained an
attachment order against certain of the Company's assets in connection with
this lawsuit. As of March 31, 1998, the parties agreed to settle the
lawsuit. The terms of the settlement included the Company's issuance to SGI
of 800,000 shares of Common Stock, the granting to SGI of options to
purchase 200,000 shares of the
Page 67
<PAGE>
Company's Common Stock at an exercise price of $.50 per share (the closing
bid price on February 5, 1998 which was the date the parties agreed to the
settlement terms), the payment of $10,000 for SGI's legal fees, and the
payment of $100,000 in cash to SGI, $25,000 of which was paid by the
Company on February 9, 1998, with the balance ($75,000) payable in equal
consecutive monthly installments of $15,000, beginning April 9, 1998. The
Company has agreed to register the foregoing shares under the Securities
Act of 1933, including shares issuable upon the exercise of the stock
options.
As a result of the settlement, the Company recorded a charge to general
administrative expenses of approximately $567,000 for the estimated value
of the settlement, during the quarter ending March 31, 1998. The settlement
amount was made up of the following: $400,000 from the issuance of 800,000
shares of common stock, valued at $0.50 per share, a $100,000 cash
settlement of which $25,000 was paid in February 1998 with the balance
payable $15,000 per month beginning in April 1998, and $67,000 attributed
to the value of the options issued to SGI. The option were valued using the
Black-Scholes option pricing model based on a contractual life of 3 years,
a volatility rate of 108%, a zero dividend, and a risk free rate of 6.5%.
C. As a result of the Company's continuing liquidity problems during
fiscal 1998, the Company has been sued for non-payment by several suppliers
of products and services, and numerous other vendors have forwarded their
accounts with the Company to collection agencies. From January 1, 1998
through June 20, 1998, the company had settled seven lawsuits with its
suppliers and vendors involving alleged non-payment. Approximately $586,000
of liabilities were reduced by 40% ($234,000) resulting in a settled
balance of $352,000. The agreements included a payment moratorium
(typically two months). No gain on restructuring their accounts has been
recognized currently, because in the event the Company is unable to timely
meet its payment obligations of these renegotiated debts, any discounts
afforded the Company to date would be canceled and the original amount
would be reinstated (less any payments made by the Company). The Company
has continued to purchase from substantially all of its suppliers during
its liquidity crisis, including those who have initiated lawsuits for non-
payment, provided that the Company pay for products and services at time of
receipt by the Company.
18. YEAR-END ADJUSTMENTS
The Company increased its reserve for inventory obsolescence by $1,100,000
during the fourth quarter ended March 31, 1998.
Page 68
<PAGE>
JAMES D. EDWARDS has served as a director of the Company since November
1995. Mr. Edwards served as the President, Chief Executive Officer and Director
of Tricord Systems, Inc. (a computer hardware manufacturer) from May 1989 to May
1995. He is a director of Capital Associates, Inc. (an equipment leasing
company), and Netstar, Inc. (a network hardware manufacturer), which are both
public companies.
E. CAREY WALTERS has served as the Company's President and Chief Executive
Officer and as a director of the Company since March 1998. Mr. Walters is a co-
founder and was the Executive Vice President of The Sabine Group (a network
services company) from 1997 through February 1998. He served as the Vice
President Americas and Strategic Accounts for Objective Systems Integrators, an
operations systems support software company from 1996 to 1997. From 1993 to
1995, Mr. Walters served as the Vice President Alliance Services and General
Manager Strategic Alliances at Ameritech. He was an early participant at
InteCom Inc. (a voice/data PBX manufacturer) holding various positions over a
ten year period (1981 to 1991), including Vice President Contracts and Business
Development and Vice President Sales. Mr. Walters came to InteCom from EDS
(Financial Services Division) where he was the Markets Manager.
GORDON L. ALMQUIST has served as the Company's Vice President of Finance
and Chief Financial Officer since November 1997 and as the Company's Chief
Operating Officer since February 1998. From September 1991 through April 1997,
Mr. Almquist served as the Vice President, Finance and Chief Financial Officer
of 3D Systems Corporation, a developer, manufacturer and marketer of rapid
prototyping systems to a broad range of global industries. From March 1990 to
September 1991 he served as Vice President, Finance and Administration of
Quadratron Systems Incorporated, a developer and marketer of office automation
software. From November 1989 to February 1990, Mr. Almquist served as a
financial consultant; and from August 1988 to October 1989, Mr. Almquist served
as Vice President, Finance and Treasurer of Premier Pump and Pool Products, Inc.
From January 1978 to July 1988, Mr. Almquist served in various financial
management positions (most recently as Vice President, Finance, Treasurer and
Secretary) for Bishop Incorporated, a corporation which was engaged in the
marketing and distribution of drafting and engineering equipment and supplies
for the electronics and architectural industries. Mr. Almquist is a Certified
Public Accountant.
RUSSELL JACKSON has served as the Company's Senior Vice President, Research
& Development and Chief Technology Officer since February 1996. Mr. Jackson
served as the Senior Vice President of J&L Information Systems, a former
operating division of the Company, from August 1988 to February 1996.
Directors serve until the next annual meeting of the Company's shareholders
or until their successors are elected or appointed. Officers are elected by and
serve at the discretion of the Board of Directors. There are no family
relationships among the officers or directors of the Company.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 (the "Exchange Act")
requires the Company's directors and executive officers, and persons who own
more than 10 percent of a registered class of the Company's equity securities,
to file reports of ownership and changes in ownership with the Securities and
Exchange Commission (the "Commission"). Directors, executive officers and
greater than 10 percent shareholders are required by the Commission's
regulations to furnish the Company with copies of all Section 16(a) forms they
file. Based solely on a review of the copies of the forms furnished to the
Company and the representations made by the reporting persons to the Company,
the Company believes that during the fiscal year ended March 31, 1998, its
directors, executive officers and 10 percent shareholders complied with all
filing requirements under Section 16(a) of the Exchange Act, with the exception
of the following: except that Mr.Walters was late in reporting his initial
statement of beneficial ownership upon being appointed as an officer; Mr. Lubash
has not filed Form 4s to report nine sales of the Company's securities under
Rule 144 or a Form 5 to report such sales; Mr. Lazik has not filed a Form 4 or a
Form 5 to report a sale of the Company's securities under Rule 144; and Messrs.
Grady, Spievak, Picheny, Lazik, Almquist, Edwards, Gordon and Sayer have not
filed Form 4s or Form 5s to report options granted to them by the Company.
Page 3
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
Registrant has caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized.
CHATCOM, INC.
a California corporation
Dated: October 16, 1998 By: /s/ E. Carey Walters
-----------------------------
E. Carey Walters, President and
Chief Executive Officer
Page 2
