<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-KSB
AMENDMENT NO. 3
[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.
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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: March 19, 1999 By: /s/ E. Carey Walters
-----------------------------
E. Carey Walters, President and
Chief Executive Officer
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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.
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Recent Sales of Unregistered Securities
- ---------------------------------------
In March 1998, the Company completed a conversion of unsecured debt in
an aggregate amount of $1,345,000 owed to VRPI into the Company's Series F
Preferred Stock ($945,000) and Series G Preferred Stock ($400,000) and warrants
to purchase 285,000 shares of the Company's Common Stock at an exercise price of
$0.35 per share. The Series F Preferred Stock is convertible into shares of
Common Stock at a conversion price equal to the market price of the Common Stock
during the five trading days preceding the applicable date of conversion,
subject to a minimum conversion price of $0.35 and a maximum conversion price of
$0.95. The Series G Preferred Stock is convertible into shares of Common Stock
at a conversion price equal to $0.35.
In March 1998, the Company sold an aggregate of 809,523 shares of
Common Stock to a shareholder of the Company for an aggregate consideration of
$300,000.
In April 1998, the Company issued 800,000 shares of Common Stock and
options to purchase 200,000 shares of Common Stock at an exercise price of $0.50
per share as part of the consideration for the settlement of a lawsuit initiated
by Strategic Growth International, Inc.
In December 1997, the Company issued warrants to purchase 150,000
shares of the Company's Common Stock at an exercise price of $0.375 per share in
connection with the issuance of convertible subordinated notes of $350,000 and
$540,000 issued by the Company in May 1997 and December 1997, respectively.
In November 1997, the Company issued warrants to purchase 20,000
shares of the Company's Common Stock at an exercise price of $1.375 per share as
consideration for the extension of credit to the Company by Troy & Gould
Professional Corporation, general counsel to the Corporation.
The Company believes that the issuances of securities pursuant to the
foregoing transactions were exempt from registration under the Securities Act of
1933, as amended, by virtue of Section 4 (2) thereof as transactions not
involving public offerings. No underwriters were engaged in connection with any
of the foregoing offers or sales of securities and no commissions were paid in
connection with such sales.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
Results of Operations for the Fiscal Year Ended March 31, 1998 Compared to the
- ------------------------------------------------------------------------------
Fiscal Year Ended March 31, 1997
- --------------------------------
The Company recorded a net loss of $7,773,000 for the fiscal year
ended March 31, 1998 ("fiscal 1998"), on revenues of $7,271,000 as compared to a
net loss of $4,601,000 on revenues of $9,103,000 for the fiscal year ended March
31, 1997 ("fiscal 1997").
Sales, Sales Returns, and Costs of Goods Sold
---------------------------------------------
Net sales decreased $1,832,000 or 20%, from $9,103,000 in fiscal 1997
to $7,271,000 in fiscal 1998. The decline in revenues was due primarily to a
decrease in shipments to domestic Value Added Resellers which the Company
believes is attributable to the declining demand for remote control type remote
access solutions; decreased advertising expenditures and marketing support for
VARs during fiscal 1998 due to the Company's cash flow constraints; and the
redirection of the Company's sales and marketing efforts toward the server
consolidation and
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network emulation markets which began during fiscal 1997. The Company also
believes that sales have been adversely impacted by the Company's poor financial
condition to the extent that certain customers may delay purchases from the
Company or order from other suppliers until such time as the Company's financial
condition significantly improves.
Sales returns increased to $3,070,000 in fiscal 1998 compared to
$718,000 in fiscal 1997 and was primarily the result of an agreement entered
into during December 1997 between the Company and its Singapore distributor,
Macon Holdings (S) Pte. Ltd. ("Macon") whereby the Company agreed to permit
Macon to return a majority of the equipment ($2.7 million at sales price,
approximately $1.8 million at cost) previously sold to Macon in the quarterly
periods ended June 30, 1997 ($2.8 million) and September 30, 1997 ($.5 million)
due to Macon's inability to pay for this equipment. Macon has attributed its
inability to pay for such equipment primarily to the Asian economic crisis
during the later part of 1997 as well as less than anticipated market acceptance
of the equipment. Of the amount returned by Macon, approximately $505,000
(approximately $328,000 at cost) was received by the Company during the quarter
ended December 31, 1997 (of which $285,000 at sales price, approximately
$185,000 at cost was accrued for as of September 30, 1997) and approximately
$2.2 million (approximately $1.4 million at cost) was received during the
quarter ended March 31, 1998 (of which approximately $2.1 million at sales price
and, approximately $1.3 million at cost was accrued for during the quarter ended
December 31, 1997). The equipment received from Macon is a type that can be
readily sold to other customers in the event the Company is able to secure
additional orders for such products. Through March 31, 1998, approximately $1.1
million (approximately $705,000 at cost) of the equipment returned from Macon
had been resold by the Company to other customers.
The Company believes that sales may fluctuate on a quarterly basis as
a result of a number of factors, including the status of world economic
conditions, fluctuations in foreign currency exchange rates and the timing of
system shipments (the current U.S. list price of the Company's most powerful
system, for example, exceeds $300,000; thus the acceleration or delay of a small
number of shipments from one quarter to another can significantly affect the
results of operations for the quarters involved). Orders and shipments during
the quarter ended June 30, 1998 have been lower than anticipated, which the
Company believes is the result of reduced expenditures for advertising and
marketing programs and the postponment of hiring or replacement of certain
sales personnel due to the Company's continued cash flow constraints, and the
Company's poor financial condition to the extent that it has caused certain
customers to delay purchases from the Company or order from other suppliers.
Additionally, as a result of the Company's poor financial condition, the Company
may not be able to effect the timely procurement of manufacturing components and
thus may need to extend the time normally required to ship finished goods and
may not be able to satisfy delivery requirements of certain customers. For
these reasons, orders and shipments for the quarter ended June 30, 1998 and
subsequent quarters may be adversely affected.
Cost of goods sold were $6.7 million or 92% of net sales during fiscal
1998 compared to $6.8 million or 76% of net sales during fiscal 1997. The
decrease in gross margin in fiscal 1998 compared to fiscal 1997 (8% vs. 24%,
respectively) was primarily the result of an increase to the reserve for
inventory obsolescence, price discounting on a variety of orders due to
competition and increased manufacturing overhead during fiscal 1998 due to
increased indirect labor (primarily related to quality assurance). Although the
cost of certain components (i.e., microprocessors and random access memory
components) during fiscal 1998 were somewhat lower than fiscal 1997, the Company
has not been able to achieve further reductions in component costs due to the
lower quantities purchased during fiscal 1998 as a result of the decrease in
sales described above. The Company's gross margins are affected by several
factors,
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including, among others, sales mix and distribution channels and, therefore, may
vary in future periods from those experienced during fiscal 1998. Additionally,
rapidly changing technology and engineering refinements to the Company's
hardware and software products are relatively common. These changes can cause
the finished goods inventory to experience a relatively short shelf life. The
Company has incurred inventory writedowns in the past. While the Company
maintains valuation allowances for excess and obsolete inventories, which it
believes to be adequate, significant changes in the technology prevailing in the
industry could require the Company to record additional valuation reserves.
During fiscal 1998 and fiscal 1997, the Company recorded significant additions
to its valuation allowance for obsolete and excess inventories in the amounts of
$1,409,000 and $794,000, respectively, which adversely affected gross profit and
net income in the periods in which additional valuation allowances were
recorded. A substantial portion of the increase in inventory reserves for fiscal
1998 was a result of the less than anticipated sales during fiscal 1998 (as
described above) and the increase in inventory balances at March 31, 1998,
primarily as a result of the sales returns from Macon. The Company believes that
its allowance for obsolete and excess inventories that are currently recorded
are sufficient to properly state inventories at their net realizable value.
However, material additions to such allowance might be required in the future if
technology or market conditions affecting the Company's product sales mix change
significantly.
Selling Expense
---------------
Selling expense decreased $92,000, or 3%, to $3,170,000 in fiscal 1998
from $3,262,000 in fiscal 1997. The decrease was primarily the result of
decreased advertising expenses ($285,000) and decreased marketing salaries
($70,000) due to certain cost reductions implemented during the second quarter
of fiscal 1998. The decreases in fiscal 1998 were substantially offset by
increased personnel costs as a result of additional sales personnel and
increased expenses associated with international sales efforts.
General and Administrative Expense
----------------------------------
General and administrative expense increased $495,000, or 21%, to
$2,834,000 in fiscal 1998 from $2,339,000 in fiscal 1997. The increase was
primarily attributable to the cost of a settlement ($567,000) in February 1998
of a lawsuit which was filed against the Company by Strategic Growth
International, Inc., an investor relations consulting firm; increased legal fees
($195,000) due in part to the Company's liquidity problems and an accrual of a
penalty ($106,000 as of March 31, 1998) due to the continued delay in
registering shares in connection with the Company's Series E Convertible
Redeemable Preferred Stock (which is primarily due to the Company's liquidity
problems). These increases were partially offset by lower expeditures related to
investor relations during fiscal 1998 ($135,000). As a result of the Company's
current liquidity problems, a number of vendors have either sued the Company or
have forwarded their accounts to collection. The Company anticipates incurring
substantial legal expenses during fiscal 1999 as well as possible interruption
in the receipt of goods and services due to its liquidity problems.
Severance Expense
-----------------
During fiscal 1998, the Company recorded severance expense of
$100,000 related to the payments that the Company has agreed to pay to a former
executive officer of the Company pursuant to the remaining terms of his
employment contract. There were no terminations during fiscal 1997 that
involved similar agreements.
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Research and Development Expense
--------------------------------
Research and development expense increased $795,000, or 64%, from
$1,246,000 in fiscal 1997 to $2,041,000 in fiscal 1998. The increase was
primarily attributable to additional personnel ($164,000) and consultants
($268,000) as well as increased expenditures for prototypes ($179,000) due to
the Company's efforts to decrease product development time and increase pre-
production product testing. A majority of the product development expenses
incurred in fiscal 1998 are related to certain products which are expected to be
commercially introduced during the quarter ending September 30, 1998. The timely
commercial introduction of these products are dependent on several factors
including continued employment of key personnel and consultants and the timely
payment to vendors and suppliers of materials and services. There can be no
assurance that the products being developed will be commercially introduced in
September 1998 or at all.
Interest Expense
----------------
Interest expense increased $219,000 from $12,000 in fiscal 1997 to
$231,000 during fiscal 1998, primarily as a result of the Company's acceptance
of a charge for interest ($175,000) by Vermont Research Products, Inc. ("VRPI"),
a major supplier of certain products which are resold by the Company, in
anticipation of the Company entering into an agreement with VRPI whereby VRPI
agreed to convert a portion of the balance owed by the Company to preferred
stock, as well as interest associated with convertible subordinated notes of
$350,000 and $540,000 issued by the Company in May 1997 and December 1997,
respectively.
Results of Operations for the Fiscal Year Ended March 31, 1997 Compared to the
- ------------------------------------------------------------------------------
Fiscal Year Ended March 31, 1996
- --------------------------------
The Company recorded a net loss of $4,601,000 for the fiscal year
ended March 31, 1997 ("fiscal 1997"), on revenues of $9,103,000 as compared to a
net loss of $1,968,000 on revenues of $14,790,000 for the year ended March 31,
1996 ("fiscal 1996").
Sales and Costs of Goods Sold
-----------------------------
Sales decreased $5,687,000, or 39%, from $14,790,000 in fiscal 1996 to
$9,103,000 in fiscal 1997. The Company believes that the decrease in revenues
was attributable in part to a constraint on the number of Pentium Pro chips
allocated by Intel (which problem was subsequently corrected), a large volume of
orders received late in fiscal 1997, which could not be manufactured in time to
ship during fiscal 1997, delays in foreign government orders, a declining demand
for remote control type remote access solutions, decreased marketing efforts
during the last quarter of fiscal 1996 due to cash flow constraints and the
redirection of marketing efforts toward the server consolidation and network
emulation markets during fiscal 1997.
Cost of goods sold decreased $2,988,000, or 30%, from $9,882,000 in
fiscal 1996 to $6,894,000 in fiscal 1997. The decrease was attributable to
decreased product sales in fiscal 1997. The percentage decrease in cost of
sales was less than the percentage decrease in revenues due to fixed costs
contained in cost of sales that did not decrease proportionately with revenues
and a $632,000 increase in additions to inventory reserves for product
obsolescence.
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Selling Expense
---------------
Selling expense decreased $167,000, or 5%, from $3,429,000 in fiscal 1996
to $3,262,000 in fiscal 1997. The decrease was attributable to a decrease in
sales department salaries of $93,000, a decrease in sales commissions of $38,000
and a decrease in advertising expenditures of $172,000. These decreases were
partially offset by an increase in marketing salaries of $85,000. The decrease
in sales salaries was attributable to the resignations of the Vice President of
Sales and a regional sales manager during the first two quarters of fiscal 1997.
The decrease in sales commissions was primarily attributable to the decrease in
revenues in fiscal 1997. Advertising expense decreased as a result of cash flow
constraints during the last quarter of fiscal 1996 and the Company's lack of a
marketing director during the first quarter of fiscal 1997. Marketing
department salaries increased as a result of the hiring of a marketing director
and a marketing communications manager in the first quarter of fiscal 1997.
General and Administrative Expense
----------------------------------
General and administrative expense increased $335,000, or 17%, from
$2,004,000 in fiscal 1996 to $2,339,000 in fiscal 1997. The increase consisted
of a $139,000 increase in salaries, an $84,000 increase in officers' travel, a
$112,000 increase in bad debt expense and the recording of $62,000 in
restructuring expenses related to the elimination of certain positions during
August 1996. These increases were partially offset by a $92,000 decrease in
legal fees. The increase in salaries was primarily attributable to the creation
of an "Office of the President" that involved the hiring of a Senior Vice
President for Business Development and the transfer of the Senior Vice President
of Technology from the research and development cost center to the general and
administrative cost center. The increase in officers' travel was attributable
to an increased number of officers and a concerted effort by the Company to keep
its executive officers in close contact with its customers. The increase in bad
debts was primarily attributable to the financial failure of a large reseller of
the Company's products.
Severance Expense
-----------------
During fiscal 1996, the Company recorded a severance expense of $322,000
related to the payments that the Company has agreed to pay to former executive
officers of the Company pursuant to the remaining terms of their employment
contracts. There were no terminations during fiscal 1997 that involved similar
agreements.
Research and Development Expense
--------------------------------
Research and development expense increased $332,000, or 36%, from $914,000
in fiscal 1996 to $1,246,000 for fiscal 1997. The increase was primarily
attributable to an effort by the Company to decrease development time and
increase pre-production product testing. The increase included net workforce
increases in the Company's engineering staff and a $178,000 increase in
prototyping and consulting expenses.
Interest Expense
----------------
Interest expense decreased $171,000, or 93%, from $183,000 in fiscal 1996
to $12,000 in fiscal 1997, due to the retirement of virtually all of the
Company's debt financing during the first quarter of fiscal 1997.
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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 its
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
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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. In the event the Company is unable to obtain additional financing to
sustain its operations it will pursue a sale or merger of the Company, although
the Company has not had any substantive merger discussions with any third
parties and there can be no assurance that the Company would be able to enter
into any such discussions or consummate any such transactions.
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 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 $25,000 and are not expected to entail any
significant technical or timing difficulties. The Company plans to make the
foregoing upgrade during 1999. Should the Company, however, fail to make the
necessary upgrade, it would be forced to replace its current systems with manual
systems in the year 2000. The use of manual systems could result in certain
billing or shipping delays, but the Company does not believe that these delays,
if any, would have a material adverse effect on the Company. 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 produce 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.
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FINANCIAL STATEMENTS
Page 11
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INDEPENDENT AUDITORS' REPORT
- ----------------------------
To the Board of Directors of
ChatCom, Inc.
Chatsworth, California:
We have audited the accompanying balance sheet of ChatCom, Inc., (the "Company")
as of March 31, 1998, and the related statements of operations, stockholders'
equity (deficit), and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ChatCom, Inc. as of March 31,
1998, and the results of its operations and its cash flows for the year then
ended in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company's recurring losses and negative cash flows
from operations raise substantial doubt about its ability to continue as a going
concern. Management's plans concerning these matters are also described in Note
1. The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
GROBSTEIN, HORWATH & COMPANY LLP
Sherman Oaks, California
July 6, 1998
Page 12
<PAGE>
INDEPENDENT AUDITORS' REPORT
- ----------------------------
To the Board of Directors of
ChatCom, Inc.
Chatsworth, California:
We have audited the accompanying balance sheet of ChatCom, Inc., (the "Company")
as of March 31, 1997, and the related statements of operations, stockholders'
equity, and cash flows for each of the two years in the period ended March 31,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ChatCom, Inc. as of March 31,
1997, and the results of its operations and its cash flows for each of the two
years in the period ended March 31, 1997 in conformity with generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company's recurring losses and negative cash flows
from operations raise substantial doubt about its ability to continue as a going
concern. Management's plans concerning these matters are also described in Note
1. The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
DELOITTE & TOUCHE LLP
Los Angeles, California
June 20, 1997
Page 13
<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 14
<PAGE>
CHATCOM, INC.
- -------------
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
YEARS ENDED MARCH 31, 1998, 1997 AND 1996 (in thousands, except share and per share data)
- ------------------------------------------------------------------------------------------------------------------------------------
Notes 1998 1997 1996
----- ---- ---- ----
<S> <C> <C> <C> <C>
NET SALES:
Gross sales $ 10,341 $ 9,821 $ 16,046
Returns 2 (3,070) (718) (1,256)
----------- ---------- ----------
Net sales 7,271 9,103 14,790
----------- ---------- ----------
COST OF GOODS SOLD 6,671 6,894 9,882
----------- ---------- ----------
GROSS PROFIT 600 2,209 4,908
----------- ---------- ----------
OPERATING EXPENSES:
Selling expense 3,170 3,262 3,429
General and administrative expense 16,17 2,834 2,339 2,004
Research and development expense 2,041 1,246 914
Compensation expense related to stock options 13 20
Severance expense 14 100 322
----------- ---------- ----------
Total operating expenses 8,145 6,847 6,689
----------- ---------- ----------
LOSS FROM OPERATIONS (7,545) (4,638) (1,781)
INTEREST INCOME 4 49
INTEREST EXPENSE 7,10 (231) (12) (183)
----------- ---------- ----------
LOSS BEFORE PROVISION FOR
INCOME TAXES (7,772) (4,601) (1,964)
PROVISION FOR INCOME TAXES 15 (1) (4)
----------- ---------- ----------
NET LOSS (7,773) (4,601) (1,968)
DIVIDENDS ON PREFERRED STOCK (684) (894)
----------- ---------- ----------
NET LOSS AVAILABLE TO COMMON
STOCKHOLDERS $ (8,457) $ (5,495) $ (1,968)
=========== ========== ==========
BASIC NET LOSS PER COMMON SHARE $ (0.84) $ (0.61) $ (0.26)
=========== ========== ==========
Weighted average number of common shares 10,068,865 8,965,743 7,536,629
</TABLE>
See accompanying independent auditors' reports and notes to financial
statements.
Page 15
<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 16
<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 17
<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 18
<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. In the event the Company is unable to obtain additional
financing to sustain its operations it will pursue a sale or merger of the
Company, although the Company has not had any substantive merger
discussions with any third parties and there can be no assurance that the
Company would be able to enter into any such discussions or consummate any
such transactions.
Page 19
<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 for impairment whenever events or changes
in circumstances indicates that the carrying amount of the asset may not be
recoverable. Recoverability of assets to be held and used in the future is
measured by a comparison of the carrying amount of the asset to future net cash
flows expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or fair value less
costs to sell. Adoption of this statement did not have a material impact on the
Company's financial position or results of operations.
Advertising costs - Advertising costs are expensed as incurred.
- -----------------
Advertising costs for the year ended March 31, 1998, 1997 and 1996 were
$304,000, $564,000 and $723,000, respectively.
Software Costs - The Company capitalizes the cost of purchased software.
- --------------
These costs are amortized over three years.
Research and Development - All research and development costs are expensed as
- ------------------------
incurred.
Page 20
<PAGE>
Revenue Recognition - The Company records revenue for sales of hardware
-------------------
and software products at the time the title to the product is transferred
to the customer. The Company does not have significant obligations to
provide hardware or software upgrades or service beyond a standard warranty
period of one year. The cost to provide standard warranty services for
previously sold products is estimated quarterly and accrued.
At the time an extended warranty agreement is sold, the proceeds are
recorded as deferred revenue and amortized to income on a straight-line
basis over the extended warranty period. Sales of extended warranty
agreements began in February 1994. Extended warranty agreements in the
amounts of $85,000, $139,000 and $94,000 were sold during the years ended
March 31, 1998, 1997 and 1996, respectively. Deferred revenue related to
extended warranty agreements of $141,000 and $147,000 were included in
accrued expenses at March 31, 1998 and 1997, respectively.
Sales to Foreign Customers - Sales to foreign customers accounted for
--------------------------
approximately 16% and 13% of net sales for the year ended March 31, 1998
and 1997, respectively. Sales to foreign customers for the year ended March
31, 1996 were not material.
Major Customers - The Company had sales to individual customers in the
---------------
amount of $690,000, $1,177,000 and $853,000 during the years ended March
31, 1998, 1997 and 1996, respectively.
Income Taxes -Deferred income tax assets and liabilities are computed
------------
annually for differences between the financial statement and income tax
bases of assets and liabilities. Such deferred income tax asset and
liability computations are based on enacted tax law and rates applicable in
periods in which the differences are expected to reverse. If necessary, a
valuation allowance is established to reduce deferred tax assets to the
amount expected to be realized. Income tax expense is the tax payable or
refundable for the year and the change in deferred income tax assets and
liabilities during the year.
Earnings per Share - Earnings per common share are computed in accordance
------------------
with SFAS No. 128 "Earnings per Share." Basic earnings per common share
are computed based on the weighted average number of common shares
outstanding during the periods. Diluted earnings per common share were
computed giving effect to all dilutive potential common shares outstanding
during the periods. The computation of diluted earnings per common share
was antidilutive in all periods; therefore, only basic earnings per common
share have been presented.
Securities which could potentially dilute basic earnings per common share
in the future that were not included in the computation of diluted earnings
per common share because to do so would have been antidilutive for the
periods presented include the Company's Series D, E, F and G convertible
preferred stocks (See Notes 7, 10 and 11), outstanding warrants and stock
options (See Note 13).
Stock Options - The Company adopted SFAS No. 123, "Accounting for Stock-
-------------
Based Compensation," on April 1, 1996. SFAS No. 123 requires expanded
disclosures of stock-based compensation arrangements with employees and
encourages (but does not require) compensation cost to be measured based on
fair value of the equity instrument awarded. Companies are permitted,
however, to continue to apply APB Opinion No. 25, which recognizes
compensation cost based on the intrinsic value of the equity instrument
awarded. The Company continues to apply APB Opinion No. 25 to its stock-
based compensation awards to employees and has disclosed the required pro
forma effect on net loss and loss per share. (See Note 13).
2. SALES RETURNS
In January 1997, the Company executed a Memorandum of Understanding with
Macon Holdings (S) Pte. Ltd. ("Macon") whereby Macon, headquartered in
Singapore, was appointed a Master Distributor of the Company's products in
the Asia Pacific Region. The terms that governed the business dealings and
relationship between the Company
Page 21
<PAGE>
and Macon were subsequently memorialized in a Master Distributor Agreement
dated December 5, 1997 (the "Distribution Agreement"). The Distribution
Agreement also provided for the scheduled repayment of the outstanding
balance owed by Macon and granted Macon the exclusive rights to distribute
the Company's products in the Asia Pacific region provided that Macon
purchase a minimum of $3.0 million of equipment (net of returns) from the
Company through the period ending December 31, 1998. In the event Macon
does not purchase the required minimum, the Company retained the right to
sell directly into the territory and appoint additional distributors or
resellers in the territory.
During the quarterly periods ended June 30, 1997 and September 30, 1997,
the Company shipped equipment to Macon totaling $2.8 million and $.5
million, respectively ($3.3 million in the aggregate). These sales were
made to Macon on an "open account" basis with payment terms generally 30
days from date of invoice. Payments made by Macon for the quarterly periods
ended June 30, 1997, September 30, 1997 and December 31, 1997 totaled
$250,000, $257,000, and $80,000, respectively. No payments have been
received from Macon subsequent to December 31, 1997. As a result of Macon's
inability to effect timely payments of its obligations to the Company,
which Macon has attributed primarily to the Asian economic crisis during
the later part of 1997 as well as less than anticipated market acceptance
of the equipment, the Company and Macon agreed to permit Macon to return to
the Company all equipment which remained unpaid and unsold by Macon
(approximately $2.7 million at sales price, approximately $1.8 million at
cost). Of the amount returned by Macon, approximately $505,000
(approximately $328,000 at cost) was received by the Company during the
quarter ended December 31, 1997 (of which $285,000 at sales prices,
approximately $185,000 at cost was accrued for as of September 30, 1997)
and $2.2 million at sales price (approximately $1.4 million at cost) was
received during the quarter ended March 31, 1998 (of which $2.1 million at
sales prices, approximately $1.3 million at cost was accrued for during the
quarter ended December 31, 1997). The equipment received from Macon is a
type that can be readily sold to other customers in the event the Company
is able to secure additional orders for these products. As a result of the
significant increase in inventory due primarily to the product returns from
Macon described above as well as price decreases due to technological
obsolescence (and anticipated future price decreases) of certain components
associated with the returned equipment, the Company recorded an increase to
its reserve for obsolescence of approximately $400,000 during the quarter
ended December 31, 1997. Through March 31, 1998, approximately $1.1 million
(approximately $705,000 at cost) of the equipment returned from Macon had
been resold by the Company to other customers. The Company anticipates
selling the balance during the next twelve months and expects to recover
the carrying value of the returned equipment.
As a result of Macon's inability to remit timely on its prior obligations
to the Company, the Company anticipates that all future sales to Macon will
be on letter of credit or cash payment-in-full in advance of shipment.
Page 22
<PAGE>
3. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
March 31,
---------------------------------
1998 1997
---- ----
<S> <C> <C>
Raw materials $ 766,000 $1,508,000
Work-in process 459,000 1,056,000
Finished goods 3,192,000 1,121,000
----------- ----------
Inventory at cost 4,417,000 3,685,000
Less: Reserve for obsolescence (1,781,000) (964,000)
----------- ----------
$ 2,636,000 $2,721,000
=========== ==========
</TABLE>
4. EQUIPMENT AND FIXTURES
Equipment and fixtures consist of the following:
<TABLE>
<CAPTION>
March 31,
---------------------------------
1998 1997
---- ----
<S> <C> <C>
Equipment $ 694,000 $1,006,000
Software 75,000 137,000
Furniture and fixtures 33,000 181,000
Leasehold improvements 89,000 74,000
--------- ----------
891,000 1,398,000
Less accumulated depreciation
and amortization (503,000) (747,000)
--------- ----------
$ 388,000 $ 651,000
========= ==========
</TABLE>
5. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
March 31,
---------------------------------
1998 1997
---- ----
<S> <C> <C>
Accrued payroll and related expenses $ 255,000 $252,000
Accrued bonuses and commissions 17,000 29,000
Accrued dividends on preferred stock 155,000 75,000
Reserve for severance 54,000
Accrued royalties 35,000 35,000
Legal settlement (Note 17B.) 85,000
Legal and accounting 61,000
Interest 52,000
Late penalty-share registration
(Series E Preferred Stock) 106,000
Deferred revenue 100,000 147,000
Accrued warranty expense 15,000 15,000
Other liabilities 193,000 80,000
---------- ----------
$1,074,000 $687,000
========== ==========
</TABLE>
Page 23
<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 24
<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 25
<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 View"), holders of 2,496 shares of the Company's
Series D Preferred Stock and lenders of a $350,000 convertible subordinated
loan made to the Company in May 1997 (the "$350,000 Loan). The lawsuits,
filed in U.S. Federal District Court, Southern District of New York and in
the State Court of New York, sought damages from the defendants for alleged
wrongful actions relating to securities fraud and not informing High View
regarding the extent of the Company's financial problems.
On September 25, 1997, the parties entered into settlement agreements
(comprised principally of a Stock Exchange Agreement, Registration Rights
and Look-up Agreement and Warrant Agreements; collectively, the "Settlement
Agreements") related to both cases whereby High View agreed to exchange
their 2,496 shares of Series D Preferred Stock (representing the entire
Series D Preferred Stock issued by the Company) for a total of 2,000,000
shares of the Company's Common Stock and to convert the $350,000 Loan, plus
$15,173 of accrued interest thereon, into 292,138 shares of the Company's
Common Stock (the "Exchange Transaction"). The Exchange Transaction also
included the exchange of High View's warrants to purchase 400,000 shares of
Common Stock, exercisable at $3,125 per share (the "Old Warrants"), issued
to High View in connection with the issuance of the Series D Preferred
Stock in exchange for warrants to purchase 1,000,000 shares of the
Company's Common Stock at an exercise price of $1.75 per share. The
Settlement Agreements also required the Company to reimburse High View in
the amount of $15,000 for legal expenses incurred in connection with the
settlement.
During December 1997, High View alleged in a draft complaint (which was not
filed) that the Company and its directors fraudulently induced High View to
enter into the Exchange Transaction. On December 31, 1997, the Company
terminated and cancelled the Exchange Transaction effective as of September
25, 1997 pursuant to an agreement with High View and certain of its
affiliates (the "High View Group") dated December 30, 1997 (the "New
Agreement"). Pursuant to the New Agreement, the Settlement Agreements
entered into in connection with the Exchange Transaction were terminated
and cancelled and all transactions purported to be effected pursuant to the
Settlement Agreements were rescinded. As a result of the cancellation, (i)
High View continues to hold the Series D Preferred Stock and the Old
Warrants that were issued by the Company in December 1996; (ii) High View
continues to be the payee of the $350,000 Loan; and (iii) the Stock
Purchase Agreement by and among the Company and High View dated December 9,
1996 continues to be in full force and effect.
In addition, pursuant to the New Agreement, the High View Group made
additional loans to the Company in the amount of $540,000 (the "Additional
Loans") to help the Company meet its working capital shortfall. The
Additional Loans are evidenced by 9.5% convertible subordinated notes in
the aggregate principal amount of $540,000 (the "Additional Notes"). In
connection with the issuance of the Additional Notes, the Company also
issued to the High View Group warrants to purchase an aggregate of 150,000
shares of Common Stock (the "Additional Warrants"). The Additional Notes
mature on January 1, 1999 and bear interest on the outstanding principal
amount at the rate of 9.5% per annum, payable semiannually in cash or
shares of Common Stock at the election of the Company. The Additional Notes
are convertible into shares of Common Stock, at the election of the holder,
at a conversion price equal to the greater of (i) $0.35 or (ii) 75% of the
average market price of the Common Stock during the ten trading days
preceding the conversion date, subject to a maximum conversion price of
$0.95. Payment of the Additional Notes is subordinated to the he prior
payment of indebtedness the Company may from time to time owe to any bank
or other financial institution (but excluding trade creditors). The
Additional Warrants expire on December 13, 2001 and have an exercise price
of $0.375 per share. Pursuant to the New Agreement, the $350,000 Loan was
evidenced by convertible subordinated notes having terms substantially the
same as the terms of the Additional Notes. The Company has agreed to
register the shares of Common Stock issuable upon conversion of the
Additional Loans, the $350,000 Loan, and upon exercise of the Additional
Warrants. Under the terms of the New Agreement, High View released the
Company and its officers and directors from any claims that they might have
arisen from the Exchange Transaction contemplated by the Settlement
Agreements. The New Agreement also required the Company to reimburse High
View in the amount of $40,000 for legal expenses incurred in connection
with the settlement.
Page 26
<PAGE>
11. SERIES E CONVERTIBLE REDEEMABLE PREFERRED STOCK
On September 26, 1997 the Company entered into Stock Purchase Agreements (the
"Agreements") whereby the Company agreed to sell to two accredited investors up
to 1,700 shares of Series E Convertible Redeemable Preferred Stock, $1,000
stated value per share (the "Series E Preferred Stock"), and warrants to
purchase 432,727 shares of Common Stock at a price of $1.25 per share (the
"Series E Warrants"). Pursuant to the Agreements, a total of 1,100 shares of
Series E Preferred Stock and 254,545 of the Series E Warrants were sold by the
Company on September 26, 1997 for gross proceeds of $1,100,000. The sale of the
Series E Preferred Stock and the Series E Warrants were exempt from the
registration requirements of the Securities Act of 1933, as amended, pursuant to
Regulation D promulgated thereunder. The Company received various
representations and warranties from the investors, including a representation
that the investors are "accredited investors" within the meaning of Regulation
D. Offering costs of $163,000, consisting primarily of cash finders' fees and
legal fees, were incurred by the Company. Dividends on the Series E Preferred
Stock are payable in cash or Common Stock, at the option of the Company, at a
rate of 8% per annum. The sale of the additional 600 shares of Series E
Preferred Stock and 178,182 Series E Warrants ($600,000 of gross offering
proceeds) is scheduled to occur within five days following the Company's
satisfaction of certain conditions which include, among others, a registration
statement covering the sale of the shares issuable upon conversion of the Series
E Preferred Stock and upon the exercise of the Series E Warrants is declared
effective; the market price of the Company's Common Stock for the ten trading
days preceding the additional closing date exceeds $1.00 per share; and the
funding from a strategic investor of at least $1,000,000 from the sale of equity
securities of the Company. One-half of the Series E Preferred Stock is
convertible at the election of the holder into shares of the Company's Common
Stock commencing on the 51st day after the closing date and all of the Series E
Preferred Stock is convertible commencing on the 91st day after such closing
date. The conversion value to determine the number of shares of Common Stock
into which the Series E Preferred Stock is convertible is the lesser of $1.375
or 75% of the average of the closing bid prices of the Common Stock during the
five trading days immediately preceding the conversion date. The Series E
Warrants are exercisable for five years commencing January 1, 1998. The Company
has agreed to register the shares issuable upon the conversion of the Series E
Preferred Stock and upon the exercise of the Series E Warrants. The Registration
Rights Agreement provides that in the event the registration statement is not
declared effective on or before December 25, 1997, the Company shall pay the
investors, on January 24, 1998 and on each successive date which is 30 days
after the previous payment date (pro rated for partial periods) until such
registration statement is declared effective, payments in the amount of 3% of
the purchase price of outstanding Series E Preferred Stock ($1,100,000), in cash
or shares of the Company's Common Stock at the election of the investor. As of
March 31, 1998, such registration statement has not yet been filed, and the
Company owed such investors payments in the amount of $105,600.
Page 27
<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 28
<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 29
<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.
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<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.
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<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
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<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.
D. One of the Company's suppliers recently notified the Company of a
certain purchase commitment allegedly made by the Company to the supplier
in the amount of approximately $640,000. Although the Company believes
that it has not entered into such a purchase commitment and has requested
the supplier to provide documents and information to support the alleged
purchase commitment, there can be no assurance that the Company is not
obligated to purchase the parts and components from the supplier. Although
the supplier has not commenced legal proceedings in connection with the
alleged purchase commitment, the Company may incur substantial legal
expenses in the event such legal proceeding is instituted. The Company
believes that the majority of parts and components in question is of a
type that cannot be readily resold by the Company. The supplier has not
shipped the parts and components to 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.
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<PAGE>
PART III
Safe Harbor Statement under the Private Securities Litigation Reform Act of
---------------------------------------------------------------------------
1995.
- ----
This Amendment to the Annual Report contains forward-looking statements
within the meaning of the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, such as statements of the Company's plans,
objectives, expectations and intentions, that involve risks and uncertainties
that could cause actual results to differ materially from those discussed in
such forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in the section
entitled "Cautionary Statements and Risk Factors" as well as those discussed
elsewhere in the Annual Report.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
MANAGEMENT OF THE COMPANY
The following sets forth certain information with respect to the directors
and executive officers of Chatcom, Inc. (the "Company"):
<TABLE>
<CAPTION>
DIRECTOR
NAME AGE POSITIONS WITH THE COMPANY SINCE
---- --- -------------------------- -----
<S> <C> <C> <C>
Richard F. Gordon, Jr. 68 Chairman of the Board 1982
A. Charles Lubash 66 Director 1982
James D. Edwards 57 Director 1995
E. Carey Walters 49 President, Chief Executive Officer 1998
and Director
Gordon L. Almquist 48 Vice President of Finance, Chief --
Operating Officer and Chief Financial
Officer
Russell Jackson 47 Senior Vice President, Research & --
Development and Chief Technology
Officer
</TABLE>
RICHARD F. GORDON, JR. has served as a director of the Company since 1982,
and had served as the Company's President from April 1982 to August 1991.
During January and February 1998, Mr. Gordon served as an Interim Chief
Executive Officer of the Company. Mr. Gordon is the founder and has served as
the President of Dick Gordon Enterprises, Inc. (a marketing and promotional
firm) since May 1995. He served as the President of Space Age America, Inc. (an
aerospace consulting firm) from August 1991 to September 1995. Mr. Gordon is a
director of Action Products International, Inc., a public company.
A. CHARLES LUBASH has served as a director of the Company since 1982. Mr.
Lubash served as the Company's President and Chief Executive Officer from August
1991 to July 1995, as the Company's Vice Chairman of the Board from July 1995 to
June 1996 and as a consultant to the Company from June 1996 to February 1998 and
from 1988 to 1991.
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<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 eight required Form 4s to report nine sales of the Company's
securities or a Form 5 to report such sales; Mr. Lazik has not filed a Form 4 or
a Form 5 to report one sale of the Company's securities; Messrs. Grady, Spievak,
Picheny, Lazik, Almquist, Edwards, Gordon and Sayer have not filed a form 4 or
Form 5 one to report one grant of options to them by the Company; and Mr.
Spievak has not filed two Form 4s or a Form 5 to report two grants of options
made to him by the Company.
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