<PAGE>
================================================================================
U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the quarterly period ended September 30, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from to
-------------- --------------
Commission File Number 0-16580
TELENETICS CORPORATION
(Name of small business issuer in its charter)
CALIFORNIA 33-0061894
---------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
25111 ARCTIC OCEAN
LAKE FOREST, CALIFORNIA 92630
(Address of principal executive offices)
Issuer's telephone number: (949) 455-4000
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes X No
--- ---
The number of shares outstanding of the registrant's only class of Common
Stock, no par value per share, was 9,923,579 on November 15, 1999.
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<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
<TABLE>
TELENETICS CORPORATION
Condensed Balance Sheets
(Unaudited)
September 30, 1999
ASSETS
------
<CAPTION>
<S> <C>
Current Assets:
Cash $ 4,873
Accounts receivable, net 1,932,362
Receivable from related parties 155,659
Inventories 1,640,536
Prepaid expenses and other current assets 171,116
--------------
Total current assets 3,904,546
Property, plant and equipment, net 739,920
Goodwill, net 408,680
Investments in technology, net 474,324
Intangibles, net 93,179
Other assets 72,769
--------------
$ 5,693,418
==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Bank overdraft $ 74,079
Revolving line of credit 940,501
Current portion of related party debt 25,762
Current portion of long-term debt 28,972
Subordinated unsecured promissory notes 696,513
Accounts payable 1,201,870
Accrued expenses 469,189
Advance payments from customers 12,333
Income taxes payable 173,746
-------------
Total current liabilities 3,622,965
Related party debt, less current portion 250,000
Long-term debt, less current portion 42,652
-------------
Total liabilities 3,915,617
-------------
Shareholders' equity:
Preferred stock, no par value. Authorized 5,000,000 shares;
Series A 7% Convertible Redeemable Preferred Stock;
issued and outstanding 756,884 shares 794,638
Series B Convertible Preferred Stock; issued and
outstanding 128,571 shares 249,106
Series C 7.0% Convertible Preferred Stock; issued and outstanding
400,000 shares 550,000
Common stock, no par value. Authorized 25,000,000 shares;
issued and outstanding 9,923,579 shares 11,809,643
Accumulated deficit (11,625,586)
-------------
Total shareholders' equity 1,777,801
-------------
$ 5,693,418
=============
See accompanying notes to condensed financial statements.
2
</TABLE>
<PAGE>
<TABLE>
TELENETICS CORPORATION
Condensed Statements of Operations
(Unaudited)
<CAPTION>
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Net sales $ 2,690,313 $ 606,153 $ 10,316,338 $ 1,939,187
Cost of sales 1,549,382 412,232 7,147,024 1,137,987
--------------- --------------- --------------- ---------------
Gross Profit 1,140,931 193,921 3,169,314 801,200
Selling, general and
Administrative expenses 1,080,719 359,459 2,320,636 1,002,259
Engineering and product
development expenses 229,464 95,768 540,229 215,382
--------------- --------------- --------------- ---------------
Income (loss) from operations (169,252) (261,306) 308,449 (416,441)
Interest expense (97,678) (44,340) (254,938) (194,623)
Debt termination costs (1,725) - (86,190) -
Other income 239 - 36,573 27,497
--------------- --------------- --------------- ---------------
Income (loss) before income taxes (268,416) (305,646) 3,894 (583,567)
Income taxes - - 829 800
--------------- --------------- --------------- ---------------
Net income (loss) $ (268,416) $ (305,646) $ 3,065 $ (584,367)
=============== =============== =============== ===============
Earnings (loss) per common share:
Basic $ (.03) $ (.03) $ -- $ (.07)
=============== =============== =============== ===============
Diluted $ (.03) $ (.03) $ -- $ (.07)
=============== =============== =============== ===============
Common shares used in computing
earnings (loss) per common share:
Basic 9,825,754 8,821,241 9,644,125 8,359,561
=============== =============== =============== ===============
Diluted 9,825,754 8,821,241 9,644,125 8,359,561
=============== =============== =============== ===============
See accompanying notes to condensed financial statements.
3
</TABLE>
<PAGE>
<TABLE>
TELENETICS CORPORATION
Condensed Statements of Cash Flows
(Unaudited)
<CAPTION>
Nine Months Nine Months
Ended Ended
1999 1998
--------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 3,065 $ (584,367)
Adjustments to reconcile net income (loss) to net cash
Depreciation and amortization 164,576 9,717
Stock issued for services 25,000 6,350
Warrants issued in connection with
debt to equity conversion 19,522 --
Benefits from debt relief (36,160) --
Changes in operating assets and liabilities:
Accounts receivable 142,616 (163,780)
Inventories 1,811,052 (436,500)
Prepaid expenses and other current assets (5,012) (13)
Accounts payable (1,258,796) 62,324
Accrued expenses 200,257 (25,460)
Advance payment from customers (1,395,641) 653,234
--------------- ---------------
Net cash used in operating activities (329,521) (478,495)
--------------- ---------------
Cash flows from investing activities:
Purchases of property, plant and equipment (603,857) (41,238)
Payments for business acquisitions (676,004) --
Other assets (30,094) --
Amounts collected from (advanced to) related parties (49,297) 9,219
--------------- ---------------
Net cash used in investing activities: (1,359,252) (32,019)
--------------- ---------------
Cash flows from financing activities:
Bank overdraft 48,969 --
Proceeds from (repayment on) obligation under factoring
agreememt (289,627) 420,450
Net proceeds from revolving line of credit 940,501 --
Repayments of long-term debt (8,754) 113,551
Repayments of related party debt (40,553) (25,000)
Proceeds from subscription receivable 224,959 --
Exercise of warrants and options 61,420 --
Dividends on preferred stock (18,013) --
Proceeds of Series A 7.0% Convertible Redeemable
Preferred Stock offering 835,893 --
Debt issuance costs (61,149) --
--------------- ---------------
Net cash provided by financing activities 1,693,646 509,001
--------------- ---------------
Net increase in cash 4,873 (1,513)
Cash, beginning of period -- 13,205
--------------- ---------------
Cash, end of period $ 4,873 $ 11,692
=============== ===============
See accompanying notes to condensed financial statements.
4
</TABLE>
<PAGE>
<TABLE>
TELENETICS CORPORATION
Condensed Statements of Cash Flows (Continued)
(Unaudited)
<CAPTION>
Nine Months Nine Months
Ended Ended
September 30, September 30,
1999 1998
--------------- ---------------
<S> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 209,426 $ 203,164
Income taxes -- --
Supplemental disclosures of non-cash investing
and financing activities:
Issuance of stock options for service contract 100,200 --
Issuance of Common Stock upon conversion of debt 64,836 167,525
Issuance of Series A 7.0% Convertible Redeemable
Preferred Stock upon conversion of debt 224,550 --
Issuance of Common Stock upon business acquisition
(Sierra Digital) 190,000 --
Issuance of preferred stock upon business acquisitions:
Series B Convertible Preferred Stock (Greenland) 249,106 --
Series C 7.0% Convertible Preferred Stock
(Sunnyvale General Devices and Instruments) 550,000 --
Issuance of note payable to related party in exchange
for decrease in accounts payable -- 257,035
See accompanying notes to condensed financial statements.
5
</TABLE>
<PAGE>
TELENETICS CORPORATION
Notes to Condensed Financial Statements
1. Basis of Presentation
---------------------
The condensed financial statements included herein have been prepared by
Telenetics Corporation (the "Company"), without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations. The Company believes that the
disclosures are adequate to make the information presented not misleading when
read in conjunction with the Company's financial statements for the nine month
transition period ended December 31, 1998. The financial information presented
reflects all adjustments, consisting only of normal recurring adjustments, which
are, in the opinion of management, necessary for a fair statement of the results
for the interim periods presented. The results of operations for the nine months
ended September 30, 1999 are not necessarily indicative of the results to be
expected for the full year ended December 31, 1999 or any other period.
2. Earnings (Loss) Per Common Share
--------------------------------
Basic earnings (loss) per share are computed by dividing earnings available
to common shareholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share reflect per share
amounts that would have resulted from the dilutive potential effect of common
stock instruments. The net income (loss) for the three months and nine months
ended September 30, 1999 have been adjusted by $33,145 and $51,158 respectively
for dividends during such periods on the Company's preferred stock to arrive at
the basic earnings (loss) per share of Common Stock.
3. Revolving Line of Credit
------------------------
On April 2, 1999, the Company entered into a revolving line of credit
agreement for borrowings of up to $3,000,000, which is collateralized by
substantially all assets of the Company. Borrowings under this revolving line of
credit are based on 80% of eligible accounts receivable. Interest is payable
monthly at the greater of the bank's prime rate plus 3% or 10.75%, with
principal and accrued interest due October 2, 2000.
4. Asset Purchase Agreements
-------------------------
On April 5, 1999, the Company entered into an agreement with Greenland
Corporation to purchase its AirLink(TM) wireless technology and related
intellectual property rights, as well as assume certain contracts in exchange
for 128,571 shares of the Company's Series B Convertible Preferred Stock. The
Series B Convertible Preferred Stock has a liquidation preference of $7.00 per
share, aggregating $900,000, which is subordinated to the liquidation preference
of the Company's Series A 7.0% Convertible Redeemable Preferred Stock. In
addition, each share of the Series B Convertible Preferred Stock is initially
convertible into one share of Common Stock, subject to certain adjustments. The
value of this intangible asset will be amortized on a straight-line basis over a
five-year period.
Effective June 1, 1999, the Company acquired all of the assets of Sunnyvale
General Devices and Instruments, Inc. ("GDI") used in GDI's business of
manufacturing communications equipment for the traffic control and
transportation industries and assumed certain liabilities of GDI in exchange for
$350,000 in cash and 400,000 shares of the Company's Series C 7.0% Convertible
Preferred Stock. The Series C 7.0% Convertible Preferred Stock has a liquidation
preference of $1.50 per share, aggregating $600,000, which is subordinate to the
liquidation preference of the Company's Series A 7.0% Convertible Redeemable
Preferred Stock and on a parity with the liquidation preference of the Company's
Series B Convertible Preferred Stock. Each share of Series C 7.0% Convertible
Preferred Stock is initially convertible into one share of Common Stock, subject
to certain adjustments, voluntarily beginning on June 1, 2002 or automatically
upon the occurrence of certain events. The holders of Series C 7.0% Convertible
Preferred Stock are entitled to receive cumulative dividends at the rate of
$0.105 per share per year, payable quarterly. The cost in excess of the net
assets acquired was $437,838, which is being amortized on a straight-line basis
over its estimated useful life of five years.
6
<PAGE>
Effective July 26, 1999, the Company entered into an agreement with Sierra
Digital Communications, Inc. ("SDC") and certain shareholders of SDC to purchase
SDC's millimeter wave radio technology as well as certain other assets in
exchange for $110,000 in cash and an aggregate of 110,594 shares of Common Stock
that are subject to certain registration rights. In connection therewith, the
Company acquired substantially all of the claims of unsecured creditors against
SDC at substantial discounts.
5. Lease
-----
On April 12, 1999, the Company entered into an agreement with an unrelated
party to lease a new corporate and manufacturing facility. The lease has an
initial term of five years and one five-year option to extend. The initial
monthly base rent is $23,871 and the lease includes an annual 3% rent escalation
provision. The lease also provides for certain options for the Company to
purchase the building. The Company expended $382,050 on its portion of the
tenant improvements to the facility, which was occupied in August 1999.
6. Private Equity Offering
-----------------------
On April 9 and 15, 1999, the Company sold an aggregate of 628,571 shares of
Series A 7.0% Convertible Redeemable Preferred Stock at $1.75 per share and five
year warrants to purchase up to 628,571 shares of Common Stock at an exercise
price of $1.875 per share, subject to certain adjustments, in a private equity
offering. In connection with the offering, the Company also issued five-year
warrants to purchase up to 62,857 shares of Common Stock at an exercise price of
$2.10 per share to its placement agent. The cash proceeds of the offering, net
of commissions and offering costs, were $835,893.
The Series A 7.0% Convertible Redeemable Preferred Stock has a liquidation
preference of $1.75 per share, aggregating $1,100,000. In addition, each share
of the Series A 7.0% Convertible Redeemable Preferred Stock is initially
convertible into one share of Common Stock, subject to certain adjustments. The
holders of Series A 7.0% Convertible Redeemable Preferred Stock are entitled to
receive cumulative dividends at the rate of $0.1225 per share per year, payable
quarterly, which dividends are subject to certain increases.
7. Exchange Offer
--------------
Between May 25 and August 11, 1999, the Company conducted an exchange
offering ("Exchange Offering") involving holders of the Company's 10%
Subordinated Unsecured Promissory Notes due 2000 ("Notes") and related warrants
("Note Warrants"). The Exchange Offering gave each holder who was an accredited
investor the opportunity to (i) exercise such holder's Note Warrant in full by
applying a portion of the principal amount of the Note toward ("Exercise
Adjustment") and/or paying in cash the exercise price and (ii) exchange the
holder's Note for shares of the Company's Series A 7.0% Convertible Redeemable
Preferred Stock at an exchange rate of one share of Series A 7.0% Convertible
Redeemable Preferred Stock for each $1.75 principal amount of a Note following
any Exercise Adjustment. In addition, each participating holder was issued one
common stock purchase warrant ("Exchange Warrant") to purchase 7,500 shares of
the Company's Common Stock at $1.875 per share, subject to adjustment, for each
$25,000 in principal amount of a holder's Note prior to any Exercise Adjustment.
The Exchange Warrants will expire on April 15, 2002. As a result of the Exchange
Offering, holders of an aggregate of $314,550 of Notes, 125,820 Note Warrants
and $35,550 in cash were exchanged for 128,313 shares of Series A 7.0%
Convertible Redeemable Preferred Stock, 125,820 shares of Common Stock and
94,365 Exchange Warrants.
8. Subsequent Events
-----------------
In October 1999, the Company paid dividends aggregating $33,145 due on
shares of Series A 7.0% Convertible Redeemable Preferred Stock and Series C 7.0%
Convertible Preferred Stock for the quarter ended September 30, 1999.
In October 1999, the Company entered into a binding letter of intent to
acquire all of the outstanding stock of Racon, Inc. in consideration for 500,000
shares of the Company's common stock, and five-year warrants to purchase 250,000
shares of Company's common stock at $2.00.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion and analysis should be read in conjunction with
the Company's Condensed Financial Statements and Notes thereto included
elsewhere in this Quarterly Report on Form 10-QSB. Except for the historical
information contained herein, the following discussion contains certain
forward-looking statements that involve risks and uncertainties, such as
statements of the Company's plans, objectives, expectations and intentions. The
cautionary statements made in this Quarterly Report on Form 10-QSB should be
read as being applicable to all related forward-looking statements wherever they
appear herein. See "Forward-Looking Statements; Cautionary Statement." The
Company's actual results may differ materially from the results discussed in the
forward-looking statements.
OVERVIEW
Telenetics Corporation is an innovator of proprietary wireless
data-communications solutions for utility, transportation and other industrial
automation applications. The Company designs products and systems that collect
data from industrial devices such as meters, remote terminal units, traffic
controllers, industrial controls, remote sensors and data loggers and sends it
through wireless cellular and radio frequency networks or telephone lines to a
host site, direct or via the Internet. The Company's wireless solutions are used
in many applications such as electric utilities' commercial and industrial meter
reading projects, power outage detection, traffic automation projects, flow
measurement and remote monitoring. The Company plans to expand its presence in
many other similar applications and markets by developing products and expanding
its wireless services. The Internet interface with the Company's technology is
currently under development and the Company expects to begin installations in
the year 2000.
The Company's results of operations have been and may continue to be
subject to significant fluctuations. The results for a particular period may
vary due to a number of factors, many of which are beyond the Company's control,
including the timing and nature of revenues from product sales that are
recognized during any particular quarter, the impact of price competition upon
the Company's average selling prices, the availability and pricing of components
for the Company's products, market acceptance of new product introductions by
the Company and its competitors, the timing of expenditures in anticipation of
future sales, product returns, the financial health of the Company's customers,
the overall state of the modem and data communications industry and economic
conditions generally. In addition, the volume and timing of orders received
during a quarter are difficult to forecast. The Company expects that its
quarterly operating results will continue to fluctuate in the future as a result
of these and other factors.
The Company continually seeks to improve its product designs and
manufacturing and assembly approach in order to reduce its costs. The Company
pursues a strategy of outsourcing rather than internally developing its modem
chipsets, which are application-specific integrated circuits that form the
technology base for its modems. By outsourcing the chipset technology, the
Company is able to concentrate its research and development capabilities on
modem system design, leverage the extensive research and development
capabilities of its chipset suppliers, and reduce its development time and
associated costs and risks. This approach enables the Company to quickly develop
new and innovative products while maintaining a relatively low level of research
and development efforts and expenses. The Company also outsources aspects of its
manufacturing to contract assemblers as a means of reducing its fixed labor
costs and capital expenditures and providing the Company with greater
flexibility in its capacity planning.
8
<PAGE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1998
The following table sets forth, for the periods indicated, certain
financial data as a percentage of net sales:
Three Months ended
September 30,
---------------------------
1999 1998
------------- -------------
Net sales......................................... 100.0% 100.0%
Cost of sales..................................... 57.6 68.0
------------- -------------
Gross profit...................................... 42.4 32.0
Selling, general and administrative............... 40.2 59.3
Engineering and product development............... 8.5 15.8
------------- -------------
Operating income (loss)........................... (6.3) (43.1)
Interest expense.................................. (3.6) (7.3)
Debt termination costs............................ (0.1) -
------------- -------------
Net loss.......................................... (10.0)% (50.4)%
============= =============
NET SALES. Net sales for the three months ended September 30, 1999 were
$2.7 million as compared to $0.6 million for the three months ended September
30, 1998, an increase of $2.1 million or approximately 344%. This increase in
revenues was a result of the Company's increased volumes of sales, primarily due
to the inclusion of sales associated with the acquisition of the assets of GDI
effective as of June 1, 1999. Sales for GDI for the three months ended September
30, 1999 were $1.0 million or approximately 37.9% of the Company's total sales.
GROSS PROFIT. Gross profit increased as a percentage of net sales to 42.4%
for the three months ended September 30, 1999 as compared to 32.0% for the same
period in 1998. The increase in gross profit percentage was primarily
attributable to the sales of GDI for the three months ended September 30, 1999,
which had a 44.0% rate of gross profit, together with a more favorable sales mix
of the Company's other products. There was also some benefit from higher
increased absorption of manufacturing overhead due to the increased sales
volume. Cost of sales increased by $1.1 million, or approximately 276% to $1.5
million during the three months ended September 30, 1999 from $0.4 million
during the three months ended September 30, 1998. The increase in cost of sales
resulted primarily from a significant increase in the volume of sales.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $0.7 million or approximately 201%, to $1.1
million during the three months ended September 30, 1999 from $0.4 million
during the three months ended September 30, 1998 but decreased as a percentage
of net sales from 59.3% during the three months ended September 30, 1998 to
40.2% during the three months ended September 30, 1999. The increase in expenses
resulted primarily from the inclusion of expenses of GDI, a significant increase
in professional service expenses associated with the Company's switch to a
national auditing firm and compliance with securities filing requirements, its
efforts to upgrade its accounting procedures, its efforts to re-establish
communication with the financial community and increase in personnel. The
decrease in selling, general and administrative expenses as a percentage of net
sales was primarily due to higher sales volume.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses increased by $0.1 million or approximately 140% to $0.2
million during the three months ended September 30, 1999 from $0.1 million
during the three months ended September 30, 1998 but decreased as a percentage
of net sales from 15.8% during the three months ended September 30, 1998 to 8.5%
during the three months ended September 30, 1999. This increase in engineering
and product development expenses was primarily attributable to increased
engineering salaries and consulting costs associated with the Company's efforts
to bring all aspects of product design, other than modem chipsets, in-house, and
to broaden the Company's product offering. The decrease in spending as a
percentage of net sales was due to certain expenses growing less rapidly than
revenue.
9
<PAGE>
INTEREST EXPENSE. Interest expense during the three months ended September
30, 1999 increased by $53,000 or approximately 120% to $98,000 or 3.6% of net
sales, from $44,000 or 7.3% of net sales in the three months ended September 30,
1998. This increase in interest expense was due to increased borrowings
necessitated by increased working capital requirements to support the Company's
rapid growth in revenue.
DEBT TERMINATION COSTS. During the three months ended September 30, 1999
the Company issued warrants with an estimated value of $2,000 in connection with
the exchange of certain of its subordinated unsecured promissory notes payable
for shares of the Company's Series A 7.0% Convertible Redeemable Preferred
Stock.
NET LOSS. Net loss for the three months ended September 30, 1999 and 1998
was $0.3 million, which represented approximately 10.0% of net sales for the
three months ended September 30, 1999 as compared to 50.4% of net sales in the
three months ended September 30, 1998.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1998
The following table sets forth, for the periods indicated, certain
financial data as a percentage of net sales:
Nine Months ended
September 30,
---------------------------
1999 1998
------------- -------------
Net sales......................................... 100.0% 100.0%
Cost of sales..................................... 69.3 58.7
------------- -------------
Gross profit...................................... 30.7 41.3
Selling, general and administrative............... 22.5 51.7
Engineering and product development............... 5.2 11.1
------------- -------------
Operating income (loss)........................... 3.0 (21.5)
Interest expense.................................. (2.6) (10.0)
Debt termination costs............................ (0.8) -
Other income...................................... 0.4 1.4
------------- -------------
Net income (loss)................................. 0.0% (30.1)%
============= =============
NET SALES. Net sales for the nine months ended September 30, 1999 were
$10.3 million as compared to $1.9 million for the nine months ended September
30, 1998, an increase of $8.4 million or approximately 432%. This increase in
revenues was a result of the Company's increased volumes of sales, primarily due
to increased purchases of the Company's products by Duquesne Light Company
("Duquesne"), through its subcontractor Sargent Electric Corp., and by G. E.
Harris Energy Systems; as well as the inclusion of $1.0 million of sales
associated with the acquisition of the assets of GDI effective as of June 1,
1999.
GROSS PROFIT. Gross profit decreased as a percentage of net sales to 30.7%
for the nine months ended September 30, 1999 as compared to 41.3% for the same
period in 1998. This decrease was primarily attributable to higher material
costs as a percentage of sales in the Company's new products and unusually large
discounts given to two major customers to secure large contracts. Cost of sales
increased by $6.0 million, or approximately 528% to $7.1 million during the nine
months ended September 30, 1999 from $1.1 million during the nine months ended
September 30, 1998. The increase in cost of sales resulted from a significant
increase in the volume of sales as well as the higher material costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $1.3 million or approximately 132%, to $2.3
million during the nine months ended September 30, 1999 from $1.0 million during
the nine months ended September 30, 1998, but decreased as a percentage of net
sales from 51.7% during the nine months ended September 30, 1998 to 22.5% during
the nine months ended September 30, 1999. The increase in expenses resulted
primarily from a significant increase in professional service expenses
associated with the Company's switch to a national auditing firm and compliance
with securities filing requirements, its efforts to upgrade its accounting
procedures, and its efforts to re-establish communication with the financial
10
<PAGE>
community. The increase was also due to the inclusion of four months of expenses
of GDI and an increase in personnel. The decrease in selling, general and
administrative expenses as a percentage of net sales was primarily due to higher
sales volume and the fact that certain expenses required to establish the
infrastructure necessary to support higher revenues had been incurred in prior
periods.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses increased by $0.3 million or approximately 151% to $0.5
million during the nine months ended September 30, 1999 from $0.2 million during
the nine months ended September 30, 1998, but decreased as a percentage of net
sales from 11.1% during the nine months ended September 30, 1998 to 5.2% during
the nine months ended September 30, 1999. This increase in engineering and
product development expenses was primarily attributable to increased engineering
salaries and consulting costs associated with the Company's efforts to bring all
aspects of product design, other than modem chipsets, in-house, and to broaden
the Company's product offering. The decrease in spending as a percentage of net
sales was due to certain expenses growing less rapidly than revenue.
INTEREST EXPENSE. Interest expense during the nine months ended September
30, 1999 increased by $60,000 to $255,000 or 2.6% of net sales, from $195,000 or
10.0% of net sales in the nine months ended September 30, 1998. This increase in
interest expense is attributable to the Company's increased borrowings
necessitated by increased working capital requirements to support the Company's
rapid growth in revenue, which is partially offset by a significantly reduced
interest rate in connection with the Company's new revolving line of credit.
DEBT TERMINATION COSTS. During the nine months ended September 30, 1999,
the Company incurred $67,000 in costs related to the termination of its
factoring arrangement and the settlement of a related debt issuance obligation.
In addition, the Company issued warrants with an estimated value of $19,000 in
connection with the exchange of certain of its subordinated unsecured promissory
notes payable for shares of the Company's Series A 7.0% Convertible Redeemable
Preferred Stock.
OTHER INCOME. Other income increased by $9,000 to $36,000 during the nine
months ended September 30, 1999 from $27,000 during the nine months ended
September 30, 1998. Other income in both periods was primarily attributable to
the resolution of certain liabilities for amounts less than the carrying value
of those obligations.
NET INCOME (LOSS). Net income for the nine months ended September 30, 1999
was $3,000 or approximately 0.0% of net sales as compared to a net loss of
$584,000 or 30.1% of net sales in the nine months ended September 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 1999, the Company financed its
operations and capital expenditures primarily through working capital, proceeds
from the offering of its Series A 7.0% Convertible Redeemable Preferred Stock,
and proceeds under its revolving line of credit. As of September 30, 1999, the
Company had approximately $2,200,000 in backlog orders for its products.
As of September 30, 1999, the Company had working capital of $282,000 and
an accumulated deficit of $11,626,000. As of that date, the Company had a net
bank overdraft of $74,000 and $1,932,000 in accounts receivable. The Company
also had promissory notes outstanding in the aggregate amount of $1,020,000
(exclusive of $48,000 of unamortized discount) as of September 30, 1999, of
which $351,000 is due to related parties. Management's internal cash projections
estimate that such borrowings will remain outstanding until their maturity.
On April 2, 1999, the Company secured a revolving line of credit with
Celtic Capital Corporation, a division of Foothill Capital Corporation. The line
of credit bears interest, at the greater of prime rate plus 3% or 10.75% per
annum, is collateralized by substantially all of the assets of the Company and
expires on October 2, 2000. The borrowing base under the line of credit is 80%
of eligible accounts receivable up to a maximum borrowing of $3,000,000. As of
September 30, 1999, the Company had borrowings of $941,000 under the line of
credit.
In April 1999, the Company sold an aggregate of 628,571 shares of its
Series A 7.0% Convertible Redeemable Preferred Stock at $1.75 per share and
five-year warrants to purchase an aggregate of 628,571 shares of the Company's
Common Stock with an exercise price of $1.875 per share in a private equity
offering to six accredited investors. The cash proceeds of the offering, net of
commissions and estimated offering costs, were approximately $836,000. In
11
<PAGE>
connection with this offering, the Company also issued five-year warrants to
purchase up to 62,857 shares of common stock at an exercise price of $2.10 per
share to its placement agent.
The cash proceeds from the private equity offering of Series A 7.0%
Convertible Redeemable Preferred Stock, together with current and anticipated
borrowings under the Company's line of credit with Celtic Capital Corporation,
have been, and will continue to be, used as working capital to fund research and
development costs associated with the Company's products, costs associated with
manufacturing and marketing the Company's products and costs associated with the
continued growth and expansion of the Company.
Between May 25 and August 11, 1999, an aggregate of $315,000 of Notes,
125,820 Note Warrants and $36,000 in cash were exchanged for 128,313 shares of
Series A 7.0% Convertible Redeemable Preferred Stock, 125,820 shares of Common
Stock and 94,365 Exchange Warrants in the Exchange Offering.
In July 1999, the Company entered into an agreement with SDC and certain
shareholders of SDC to purchase SDC's millimeter waive radio technology as well
as certain other assets in exchange for $110,000 in cash and an aggregate of
110,594 shares of Common Stock that are subject to certain registration rights.
In connection therewith, the Company acquired substantially all of the claims of
unsecured creditors against SDC at substantial discounts.
In August 1999, the Company occupied its new corporate and manufacturing
facility, pursuant to a lease with an initial term of five years and one
five-year option to extend. In connection therewith the Company has, through
September 30, 1999, incurred costs for tenant improvements of $382,000;
furniture, fixtures and equipment of $282,000; as well as moving costs of
$12,000.
The Company does not believe that cash flow from operations and its
revolving line of credit with Celtic Capital Corporation alone, will be adequate
to fund all of its operations for the next twelve months. The Company will
require additional sources of liquidity through debt and/or equity financing,
which it believes it has identified. However, there can be no assurance that any
additional financing will be available to the Company on acceptable terms, or at
all. The inability to obtain such financing could have a material adverse effect
on the Company's business, financial condition and results of operations. If
additional funds are raised by issuing equity or convertible debt securities,
options or warrants, further dilution to the existing shareholders of the
Company may result.
If adequate funds are not available, the Company may also be required to
delay, scale back or eliminate its product development efforts or to obtain
funds through arrangements with strategic partners or others that may require
the Company to relinquish rights to certain of its technologies or potential
products or other assets. Accordingly, the inability to obtain such financing
could result in a significant loss of ownership and/or control of its
proprietary technology and other important Company assets and could also
adversely affect the Company's ability to continue its product development
efforts, which the Company believes contributes significantly to its competitive
advantage. If any of such circumstances were to arise, the Company's business,
financial condition and results of operations could be materially and adversely
affected.
YEAR 2000 COMPLIANCE
The Company has identified substantially all of its major hardware and
software platforms in use and is continually modifying and upgrading its
software and information technology ("IT") and non-IT systems. The Company has
modified its current financial software to be Year 2000 ("Y2K") compliant. The
Company does not believe that, with upgrades of existing software and/or
conversion to new software, the Y2K issue will pose significant operational
problems for its internal computer systems. The Company expects all systems to
be Y2K compliant by November 30, 1999 through the use of internal and external
resources. The Company has incurred insignificant costs to date associated with
Y2K compliance and the Company presently believes estimated future costs will
not be material. However, the systems of other companies on which the Company
may rely also may not be timely converted, and failure to convert by another
company could have an adverse effect on the Company's systems. The Company
presently believes the Y2K problem will not pose significant operational
problems and is not anticipated to have a material effect on its financial
position or results of operations in any given year. However, actual results
could differ materially from the Company's expectations due to unanticipated
technology difficulties or project delays by the Company or its suppliers. If
the Company and third parties upon which it relies are unable to address the
issue in a timely manner, it could result in a material financial risk to the
Company. In order to assure that this does not occur, the Company has developed
a contingency plan and plans to devote all resources required to attempt to
resolve any significant Y2K issues in a timely manner.
12
<PAGE>
LOOKING AHEAD
The Company believes that during 1999 a significant portion of revenues will be
realized from certain opportunities that were uncovered and developed during the
nine-month period ended September 30, 1999. Some of these opportunities are as
follows:
o TRANSPORTATION INDUSTRY. The Company anticipates that its
significant activities within the transportation industry and
close work with several departments of transportation such as
CALTRANS, Los Angeles Department of Transportation, Wyoming
Department of Transportation, Pennsylvania Department of
Transportation and several other departments of transportation
that are currently customers of the Company, will result in a
significant increase in the Company's business during 1999.
o GROWTH THROUGH ACQUISITIONS. To expand its markets, the Company's
business strategy includes growth through acquisitions. During the
nine months ended September 30, 1999, the Company acquired certain
assets of Greenland Corporation as well as all of the assets of
GDI and SDC.
o WIRELESS SOLUTIONS. The Company believes that a significant
portion of its future revenues will be generated through sales of
its wireless products, the cellular-based Omega AMR(TM) System and
the TrafficWatch(TM) and patent pending AirWave(TM) module. The
recent acquisition of millimeter wave radio technology from SDC is
also expected to contribute to this trend.
o DISTRIBUTION. The Company believes that its on-going aggressive
plan in identifying and hiring distributors, value added resellers
and system integrators will result in additional revenues in this
sector in 1999 and beyond.
o INTERNATIONAL BUSINESS. The Company anticipates a significant
increase in international business. Current opportunities in
China, Mexico, India, Spain and several other countries that the
Company has been involved with may result in approximately $1
million of additional revenues during the next 18 months.
FORWARD-LOOKING STATEMENTS; CAUTIONARY STATEMENT
Certain of the statements contained in this report, including those under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and especially those contained under "Liquidity and Capital
Resources" and "Looking Ahead," are "forward-looking statements" that involve
risks and uncertainties. The actual future results of the Company could differ
materially from those statements. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in this Quarterly
Report on Form 10-QSB and risks associated with managing the Company's growth.
While the Company believes that these statements are accurate, the Company's
business is dependent upon general economic conditions and various conditions
specific to the modem and data communications industry, and future trends and
results cannot be predicted with certainty. In particular:
o Although the Company's business strategy includes growth through
acquisitions, identifying and pursuing acquisition opportunities and
integrating acquired products and businesses requires a significant
amount of management time and skill. There can be no assurance that the
Company will be able to continue to identify suitable acquisition
candidates, consummate additional acquisitions on acceptable terms or
successfully integrate any acquired business into the Company's
operations. There also can be no assurance that any future acquisition
will not have an adverse effect upon the Company's operating results,
particularly in the fiscal quarters immediately following consummation
of the acquisition while the acquired business is being integrated into
the Company's operations.
o In the past, the Company has experienced problems associated with
under-capitalization, including the inability to ship products in a
13
<PAGE>
timely manner, which in some cases caused customers to cancel a portion
or all of their orders. Although the Company believes that it has
identified sources of liquidity that will be adequate to fund its
operations for the next twelve months, there can be no assurance that
sufficient funds will be available or that the Company will not in the
future experience problems associated with under-capitalization.
o The Company has experienced significant growth during the last 18
months. As a result of this rapid growth, the Company has had to raise
equity capital to fund its liquidity needs. The timing of which has, on
occasion, resulted in the Company being required to purchase product
components at less than optimal price points. As a result, the
Company's gross margins on many of its product lines may fluctuate on a
quarterly basis.
o The Company has limited experience in marketing and selling its
products in international markets. International customs, standards,
approvals and political and economical uncertainties may adversely
affect the Company's ability to ship its products internationally in a
timely and profitable manner.
o The trading price of the Company's Common Stock, like other technology
stocks, is subject to significant volatility due to factors impacting
the overall market which are unrelated to the Company's performance.
The historical results of operations and financial position of the
Company are not necessarily indicative of future financial performance.
If revenues or earnings fail to meet securities analysts' expectations,
there could be an immediate and significant adverse impact on the
trading price of the Company's Common Stock.
The Company has not experienced a material adverse impact of such risks and
uncertainties and does not anticipate such an impact. However, no assurance can
be given that such risks and uncertainties will not affect the Company's future
results of operations or its financial position.
14
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
In April 1999, the Company issued (i) 628,571 shares of its Series A
7.0% Convertible Redeemable Preferred Stock and (ii) five-year warrants to
purchase up to 628,571 shares of Common Stock at an exercise price of $1.875 per
share for cash consideration, net of commissions and estimated offering costs,
of $836,000. The Company also issued five-year warrants to purchase up to 62,857
shares of Common Stock at an exercise price of $2.10 per share to the Company's
placement agent in connection with the above-described issuance of preferred
stock.
In April 1999, the Company issued 128,571 shares of its Series B
Convertible Preferred Stock in connection with the acquisition of certain assets
of Greenland Corporation.
In June 1999, the Company issued 400,000 shares of its Series C 7.0%
Convertible Preferred Stock in connection with the acquisition of the assets
of GDI.
Between May 25 and August 11, 1999, an aggregate of $315,000 of Notes,
125,820 Note Warrants and $36,000 in cash were exchanged for 128,313 shares of
Series A 7.0% Convertible Redeemable Preferred Stock, 125,820 shares of Common
Stock and 94,365 Exchange Warrants in the Exchange Offering.
In July 1999, the Company issued 110,594 shares of Common Stock in
connection with the acquisition of the millimeter wave radio technology and
other assets of SDI.
The issuances of the Company's securities in the above-referenced
transactions were effected in reliance upon the exemption from registration
under Section 4(2) of the Securities Act of 1933, as amended (the "Securities
Act"), as transactions not involving a public offering. Exemption from the
registration provisions of the Securities Act is claimed on the basis that such
transactions did not involve any public offering and the purchasers were
sophisticated with access to the kind of information registration would provide.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K.
On July 15, 1999 the Company filed a Form 8-K reporting on
the acquisition of all of the assets GDI.
15
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
TELENETICS CORPORATION
Dated: November 15, 1999 By: /S/ DAVID L. STONE
----------------------
David L. Stone
Chief Financial Officer
(principal financial and accounting officer)
16
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