<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 June 30, 2000.
[ ] 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
(Exact name of small business issuer as specified 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)
(949) 455-4000
(Issuer's telephone number)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report)
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 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 [ ]
As of August 18, 2000, there were 15,299,502 shares of the Company's common
stock outstanding.
================================================================================
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
TELENETICS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
JUNE 30, 2000
(Unaudited)
ASSETS
June 30,
2000
-------------
Current assets:
Cash $ 2,559
Accounts receivable 1,911,399
Receivable from related parties 178,240
Inventories 2,242,723
Prepaid expenses and other current assets 315,429
-------------
Total current assets 4,650,350
Property, plant and equipment, net 850,404
Goodwill, net 343,003
Investments in technology and other intangible assets, net 3,486,090
Other assets 95,751
-------------
Total assets $ 9,425,598
=============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank overdraft $ 309,798
Revolving line of credit 115,860
Subordinated promissory notes 683,363
Current portion of related party debt 250,000
Current portion of obligations under capital leases 23,348
Accounts payable 1,643,339
Accrued expenses 859,947
Advance payments from customers 69,172
-------------
Total current liabilities 3,954,827
Note Payable 325,000
Subordinated promissory notes 683,070
Obligations under capital leases, less current portion 47,910
-------------
Total liabilities 5,010,807
-------------
Shareholders' equity:
Preferred stock, no par value. Authorized 5,000,000 shares;
no shares issued and outstanding --
Common stock, no par value. Authorized 25,000,000 shares;
issued and outstanding 15,018,502 shares 21,958,446
Subscriptions receivable (73,250)
Unearned compensation (709,537)
Accumulated deficit (16,760,868)
-------------
Total shareholders' equity 4,414,791
-------------
$ 9,425,598
=============
See accompanying notes to condensed consolidated financial statements.
F-1
<PAGE>
<TABLE>
TELENETICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<CAPTION>
Three Months Three Months Six Months Six Months
Ended June 30, Ended June 30, Ended June 30, Ended June 30,
2000 1999 2000 1999
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net sales $ 1,345,769 $ 3,787,975 $ 4,273,783 $ 7,626,025
Costs of sales 882,735 2,759,806 2,822,532 5,597,642
-------------- -------------- -------------- --------------
Gross profit 463,034 1,028,169 1,451,251 2,028,383
Selling, general and
administrative expenses 1,921,918 848,618 3,446,847 1,239,917
Engineering and
product development expenses 692,234 155,587 1,252,076 310,765
-------------- -------------- -------------- --------------
Income (loss) from operations (2,151,118) 23,964 (3,247,672) 477,701
Interest expense (130,379) (68,487) (235,108) (157,260)
Debt termination costs (1,756) (84,465) (9,527) (84,465)
Litigation settlement (448,213) -- (448,213) --
Other income -- 36 -- 36,334
-------------- -------------- -------------- --------------
Income (loss) before income taxes (2,731,466) (128,952) (3,940,520) 272,310
Income taxes 800 -- 1,600 829
-------------- -------------- -------------- --------------
Net income (loss) $ (2,732,266) $ (128,952) $ (3,942,120) $ 271,481
============== ============== ============== ==============
Earnings (loss) per common share:
Basic $ (.19) $ (.02) $ (.29) $ .03
============== ============== ============== ==============
Diluted $ (.19) $ (.02) $ (.29) $ .03
============== ============== ============== ==============
Common shares used in
computing earnings (loss) per common share:
Basic 14,452,964 9,576,066 13,610,089 9,551,751
============== ============== ============== ==============
Diluted 14,452,964 9,576,066 13,610,089 11,044,096
============== ============== ============== ==============
See accompanying notes to condensed consolidated financial statements.
F-2
</TABLE>
<PAGE>
<TABLE>
TELENETICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<CAPTION>
Six Months Six Months
Ended June 30, Ended June 30,
2000 1999
--------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (3,942,120) $ 271,481
Adjustments to reconcile net income (loss) to net cash
used in operations:
Depreciation and amortization 254,330 80,787
Stock issued for services 44,693 25,000
Compensation for non-employee stock options 346,778 --
Amortization of unearned compensation for
Employee stock and options 141,263 --
Stock and warrants issued in connection
Settlement of litigation 448,213 --
Warrants issued in connection with
debt to equity conversion -- 17,797
Provision for doubtful accounts 28,500 --
Benefits from debt relief 9,527 (36,160)
Changes in operating assets and liabilities:
Accounts receivable (364,268) 122,612
Inventories (336,484) 1,903,028
Prepaid and other assets (234,650) (266)
Accounts payable 221,831 (1,343,623)
Accrued expenses 147,943 15,489
Advance payment from customers (20,687) (1,309,279)
--------------- --------------
Net cash used in operating activities (3,255,131) (253,134)
--------------- --------------
Cash flows from investing activities:
Purchases of property, plant and equipment (185,771) (22,426)
Payments for business acquisitions (188,395) (378,901)
Other assets (42,311) (121,430)
Amounts collected from (advanced to) related parties (19,618) (54,981)
--------------- --------------
Net cash used in investing activities (436,095) (577,738)
--------------- --------------
Cash flows from financing activities:
Bank overdraft (8,789) 41,618
Proceeds from (repayment on) obligation under
factoring agreement -- (289,627)
Net proceeds from (repayment of) revolving line
of credit (681,942) 29,228
Repayments of long-term debt (202,521) --
Repayments of related party debt (110,000) (40,553)
Proceeds from subscription receivable -- 224,959
Proceeds from subordinated notes payable 871,000 --
Proceeds from exercise of warrants and options 2,576,567 45,000
Proceeds of Common Stock offerings 1,330,950 --
Proceeds of Series A 7.0% Convertible Redeemable
Preferred Stock offering -- 881,843
Debt issuance costs -- (61,149)
Dividends on preferred stock (12,095) --
Offering costs (70,030) --
--------------- --------------
Net cash provided by financing activities 3,693,140 831,319
--------------- --------------
Net increase in cash 1,914 447
Cash, beginning of period 645 --
--------------- --------------
Cash, end of period $ 2,559 $ 447
=============== ==============
See accompanying notes to condensed consolidated financial statements.
F-3
</TABLE>
<PAGE>
<TABLE>
TELENETICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Unaudited)
<CAPTION>
Six Months Six Months
Ended June 30, Ended June 30,
2000 1999
-------------- --------------
<S> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 80,294 $ 129,283
=============== ==============
Income taxes -- --
=============== ==============
Supplemental disclosures of non-cash investing and financing activities:
Issuance of common stock upon conversion of preferred stock:
Class "A" $ 775,976 --
Class "B" 249,106 --
Class "C" 550,000 --
--------------- --------------
1,575,082 --
=============== ==============
Issuance of common stock upon conversion of debt 197,983 68,000
=============== ==============
Issuance of common stock for services 153,720 --
=============== ==============
Issuance of common stock upon exercise of warrants
pursuant to subscription agreements 121,875 --
=============== ==============
Warrants issued in connection with issuance
of subordinated promissory notes 10,013 --
=============== ==============
Subordinated promissory note issued in exchange
for related party note payable 62,500 --
=============== ==============
Issuance of common stock in connection with
acquisition 2,070,000 --
=============== ==============
Subordinated promissory note issued in connection
with acquisition 325,000 --
=============== ==============
Issuance of common stock for services in connection
with common stock offering in process 406,200 --
=============== ==============
Issuance of Series A 7.0% Convertible Redeemable
Preferred Stock upon conversion of debt -- 185,000
=============== ==============
Issuance of preferred stock upon business acquisitions:
Series B Convertible Preferred Stock (Greenland) -- 185,000
=============== ==============
Series C 7.0% Convertible Preferred Stock
(Sunnyvale General Devices and Instruments) -- 550,000
=============== ==============
See accompanying notes to condensed consolidated financial statements.
F-4
</TABLE>
<PAGE>
TELENETICS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
1. BASIS OF PRESENTATION AND BUSINESS
The accompanying condensed consolidated financial statements 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, although the
Company believes that the disclosures included herein are adequate to make the
information presented not misleading. The unaudited condensed consolidated
financial statements reflect all adjustments, consisting only of normal
recurring adjustments, which are, in the opinion of management, necessary to
fairly state the financial position as of June 30, 2000 and the results of
operations and cash flows for the related interim periods ended June 30, 2000
and 1999. The results of operations for the three months ended June 30, 2000 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2000 or any other period.
The accounting policies followed by the Company and other information
are contained in the notes to the Company's financial statements filed on April
14, 2000 as part of the Company's annual report on Form 10-KSB. This quarterly
report should be read in conjunction with such annual report.
2. INVENTORIES
Inventories consist of the following: June 30, 2000
---------------
Raw materials $ 1,458,723
Work-in-process 692,500
Finished goods 91,500
---------------
$ 2,242,723
===============
3. LITIGATION
The Company is subject to certain legal proceedings, claims and
litigation arising in the ordinary course of business. While the amounts claimed
may be substantial, the ultimate liability cannot presently be determined
because of considerable uncertainties that exist. Therefore, it is possible that
the outcome of such legal proceedings, claims and litigation could have a
material effect on quarterly or annual operating results or cash flows when
resolved in a future period. However, based on facts currently available,
management believes such matters will not have a material adverse effect on the
Company's financial position, results of operations or cash flows.
On August 18, 1999, Drake & Drummond, a Nevada corporation, initiated
an action in the Orange County Superior Court, Central (Case No. 813430) against
the Company alleging, among other things, breach of contract, common count and
declaratory relief arising out of a consulting agreement entered into between
Drake & Drummond and the Company. On October 8, 1999, the Company filed an
answer to the complaint and filed a cross-complaint against Drake & Drummond
alleging, among other things, breach of contract, rescission based upon fraud,
and declaratory relief arising out of the same consulting agreement. Effective,
as of June 30, 2000, the Company and Drake & Drummond settled this litigation.
The settlement was paid with 50,000 shares of the Company's common stock, with a
fair market value of $201,550, and a five-year warrant to purchase up to 200,000
shares of common stock at $5.00 per share.
On October 18, 1999, the Company initiated an action in the Orange
County Superior Court, Central (Case No. 815922) by filing a complaint against
Bibicoff & Associates and Harvey A. Bibicoff, its primary shareholder and chief
executive officer, alleging, among other things, breach of contract, rescission
based upon fraud, breach of fiduciary duty and declaratory relief arising out of
a consulting agreement entered into between defendants and the Company. The
complaint seeks damages according to proof at trial, rescission of the
consulting agreement and restitution of all consideration received by defendants
and a judicial declaration of the rights and liabilities of the parties. On
December 6, 1999, defendants filed an answer to the complaint denying all
material allegations contained therein. Defendants, together with five of the
Company's subordinated promissory note holders and shareholders affiliated with
defendants, concurrently filed a cross-complaint against the Company and Michael
Armani, who is a director and the President and Chief Executive Officer of the
Company, for damages and rescission based upon alleged misrepresentations, false
promises and non-disclosures by the Company and Mr. Armani in connection with
the cross-complainants' purchase of their interests in the Company. The
cross-complaint also contains breach of contract claims arising out of the
consulting agreement between the Company and certain of the defendants and
purported oral contracts between the Company and certain of the
cross-complainants. The Company and Mr. Armani filed an answer to the
cross-complaint denying all material allegations contained therein. The Company
intends to vigorously defend the cross-complaint action. At this point, the
Company cannot determine what impact, if any, the ultimate resolution of this
matter would have on its financial position or results of operations.
F-5
<PAGE>
On January 28, 2000, Aeris Communications, Inc., a California
corporation, initiated an action in the United States District Court for the
Northern District of California (Case No. C00-00328) against the Company
alleging, among other things, patent infringement of two United States patents
held by Aeris Communications. The alleged patent infringement relates to certain
technology the Company acquired in connection with its acquisition of eflex
Wireless, Inc. The court dismissed this action on June 28, 2000.
On June 27, 2000, Racon, Inc., a Washington corporation, and Daniel A.
Blattman initiated an action in the King County Superior Court in the State of
Washington (Case No. 00-2-17912-OSEA) against the Company alleging, among other
things, breach of contract and default on a promissory note arising out of the
Asset Purchase Agreement dated April 21, 2000 between the Company and Racon. The
complaint seeks damages according to proof at trial in an amount not less than
$50,000 with respect to Racon, and not less than $325,0000 with respect to Mr.
Blattman, plus an award of prejudgment and/or default interest and attorneys'
fees. The Company intends to vigorously defend this action. At this point, the
Company cannot determine what impact, if any, the ultimate resolution of this
matter would have on its financial position or results of operations.
4. 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 periods. Diluted earnings per share reflect per share
amounts that would have resulted from the dilutive potential effect of common
stock instruments. The net loss for the three and six months ended June 30, 2000
has been adjusted by $12,095 for dividends during such period on the Company's
preferred stock to arrive at the basic loss per share of common stock.
5. ACQUISITION OF EFLEX WIRELESS, INC.
On January 7, 2000, the Company issued 750,000 shares of common stock,
with a fair market value of $2,070,000, in exchange for all the outstanding
common stock of eflex Wireless, Inc. ("eflex"). The agreement includes a
provision for the issuance up to an additional 6,000,558 shares of common stock,
contingent upon the successful implementation of the acquired technology and
installation of a specified number units ending on the earlier of December 31,
2004 or the date upon which all shares of additional common stock have become
issuable. In connection with the acquisition, the Company entered into certain
employment and consulting agreements for periods up to five years with the
principals of eflex, which include the granting of 1,150,000 options at $1.75
per share, which is at a discount to market.
6. CONVERSION OF PREFERRED STOCK
Between January and March 2000, all shares of each class of preferred
stock were converted to common stock pursuant to formula provisions for an
automatic compulsory conversion based on the public trading price of the
Company's common stock. These provisions were met in January 2000 for the Series
A Preferred Stock, in February 2000 for the Series B Preferred Stock, and in
March 2000 for the Series C Preferred Stock. In connection with the conversion
of preferred stock, the Company issued an aggregate of 1,285,455 shares of
common stock.
7. SUBORDINATED PROMISSORY NOTE OFFERING AND EXERCISE OF WARRANTS
In January 2000, the Company completed its offering of $1,250,000 of
Subordinated Unsecured Promissory Notes due 2001. In February 2000, conditions
enabling the Company to call the warrants issued in connection with this
offering were met. All of the warrants were exercised for cash in the amount of
$1,590,625, reduction in the subordinated promissory notes of $512,500,
subscriptions receivable of $84,375 and repayments of $50,000. After the
exercise of warrants, the aggregate amount of notes remaining outstanding
amounted to $687,500, less unamortized warrant valuation of $5,759.
8. ACQUISITION OF ASSETS OF RACON
In April 2000, the Company entered into an agreement with Racon, Inc.
("Racon") to purchase certain assets related to its microwave business, as well
as assume certain liabilities in exchange for $50,000 in cash and a $325,000
convertible promissory note. At June 30, 2000, the cash payment had not yet been
paid. The convertible promissory note accrues interest at 7.5% and is payable in
monthly installments of interest only through maturity of April 28, 2001, at
which time all unpaid principal and interest are due. The note is convertible at
the option of the holder into common stock at a price of $7.00 per share. The
Company can mandate the conversion at $7.00 per share when the average closing
price of the Company's common stock is at least $9.00 per share for ten
consecutive trading days. Racon was a competitor of Sierra Digital
Communications, Inc. which the Company acquired in July 1999.
F-6
<PAGE>
9. EQUITY DRAW DOWN FACILITY
In June 2000, the Company and an investor entered into an equity draw
down facility pursuant to which the investor committed to purchase up to
$50,000,000 of the Company's common stock over an 18-month period. The Company
must register the shares for resale prior to their issuance to the investor. The
Company periodically may request a draw of an amount between $250,000 and
$3,000,000 of the commitment. On a weekly basis during the 22-day trading period
designated in the draw down request, the amount of money that the investor will
provide to the Company and the number of shares the Company will issue to the
investor in return for that money will be settled based on the formula contained
in the stock purchase agreement that established the equity draw down facility.
The investor will receive a 10% discount to the market price for the 22-day
period, which discount may be increased under certain circumstances, and the
Company will receive the settled amount of the draw down less a $1,500 escrow
fee and a 6% placement fee payable to a placement agent that introduced the
Company to the investor.
In lieu of providing the investor with a minimum draw down commitment,
the Company issued to the investor at the closing a five-year warrant to
purchase up to 308,627 shares of common stock at an exercise price of $4.8602,
which was 120% of the average stock price on the trading day immediately prior
to the closing of the agreement. At each draw down settlement, if any, after
$25,000,000 has been drawn down pursuant to the stock purchase agreement, the
Company must issue to the investor a warrant to purchase up to a number of
shares of common stock equal to 5% of the purchase price of such draw down
divided by the average stock price on the trading day immediately prior to the
date of settlement of the draw down, with such warrant having an exercise price
equal to the lower of $4.8602 or 120% of the average stock price on the trading
day immediately prior to the settlement date.
Pursuant to the placement agent agreement, the Company issued to the
placement agent at the closing of the stock purchase agreement a five-year
warrant to purchase up to 308,627 shares of common stock at an exercise price of
$4.8602 and agreed to issue additional warrants to the placement agent at the
same times and on the same terms that additional warrants may be issued to the
investor as described above.
10. PRIVATE EQUITY OFFERING
During the six months ended June 30, 2000, the Company sold 40,000
shares of common stock at $5.00 per share and 396,912 shares of common stock at
$3.25 per share, less costs of $46,800, in a private equity offering.
11. SUBSEQUENT EVENT
Subsequent to June 30, 2000, the Company completed a private equity
offering of an aggregate of 230,000 shares of common stock for $747,500, less
costs of $27,975. The Company intends to use the proceeds of this offering for
working capital and other corporate purposes.
F-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 consolidated 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 (the "Company") designs and manufactures
wireless and landline remote monitoring products and systems that collect data
from industrial devices such as meters, remote terminal units, traffic
controllers, industrial controls, remote sensors and data loggers. The collected
data is sent through wireless cellular and radio frequency networks or telephone
lines to a host site, direct or via the Internet. The Company is an innovator of
proprietary wireless data-communications solutions for utility, transportation,
oil and gas and other industrial automation applications.
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, data and wireless communications industries, 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.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE MONTHS ENDED JUNE 30, 1999
The following table sets forth, for the periods indicated, certain
financial data as a percentage of net sales:
Three Months ended June 30,
---------------------------
2000 1999
---------- ----------
Net sales..................................... 100.0% 100.0%
Cost of sales................................. 65.5 72.9
---------- ----------
Gross profit.................................. 34.4 27.1
Selling, general and administrative........... 142.8 22.4
Engineering and product development........... 51.4 4.1
---------- ----------
Operating income (loss)....................... (159.8) 0.6
Interest expense.............................. (9.7) (1.8)
Debt termination costs........................ (0.1) (2.2)
Litigation settlement......................... (33.3) --
---------- ----------
Net loss...................................... 203.0% 3.4%
========== ===========
-2-
<PAGE>
NET SALES. Net sales for the three months ended June 30, 2000 were $1.3
million as compared to $3.8 million for the three months ended June 30, 1999, a
decrease of $2.4 million or approximately 64.5%. The decrease in net sales was
primarily a result of decreased sales of the Company's products to Duquesne
Light Company, through its subcontractor Sargent Electric Company, and
engineering and production delays in the Company's new products, which included
delays in the completion of designs, design changes, delays in the completion of
testing and unexpectedly long lead times for certain components. To address
these issues, the Company has named a chief operating officer and is working on
improving its engineering and manufacturing systems.
GROSS PROFIT. Gross profit increased as a percentage of net sales by
7.3% to 34.4% for the three months ended June 30, 2000 as compared to 27.1% for
the same period in 1999. This increase was primarily the result of significant
revenues contributed by the Company's GDI traffic management division, which
typically carries higher gross margins. The Company acquired GDI in June 1999.
The cost of sales decreased by $1.9 million or approximately 68.0% to
approximately $883,000 during the three months ended June 30, 2000 from $2.8
million during the three months ended June 30, 1999. The decrease in cost of
sales resulted primarily from the decrease in the volume of sales.
SELLING GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by approximately $1.1 million, or
approximately 126.5%, to $1.9 million during the three months ended June 30,
2000 from $849,000 during the three months ended June 30, 1999, and increased as
a percentage of net sales from approximately 22.4% during the three months ended
June 30, 1999 to approximately 142.8% during the three months ended June 30,
2000. The increase in expenses resulted primarily from the following: (1) an
increase in amortization expense; (2) an increase in professional fees,
primarily legal costs in association with litigation matters; (3) the existence
of selling, general and administrative expenses for the Company's GDI traffic
management division which was acquired in June 1999; (4) and an increase in
salary expense associated with the Company's rapid internal growth and the
addition of personnel. Amortization expense amounted to $362,000 during the
three months ended June 30, 2000 as compared to $8,000 during the same period in
1999. Amortization expense during the three months ended June 30, 2000 includes
$84,000 in connection with deferred compensation arrangements, and $22,000 in
amortization of goodwill.
ENGINEERING AND PRODUCT DEVELOPMENT. Engineering and product
development expense increased by $537,000 or approximately 344.9% to $692,000
during the three months ended June 30, 2000 from $156,000 during the three
months ended June 30, 1999, and increased as a percentage of sales from
approximately 4.1% during the three months ended June 30, 1999 to approximately
51.4% during the three months ended June 30, 2000. This increase in engineering
and product development expense was primarily attributable to the creation and
support of a research and development operation associated with the Company's
acquisition of the eflex Wireless technology in January 2000. Engineering and
product development expense during the three months ended June 30, 2000 includes
$157,000 in amortization for deferred compensation arrangements in connection
with the eflex acquisition, and $26,000 in amortization of investments in
technology.
INTEREST EXPENSE. Interest expense during the three months ended June
30, 2000 increased by $62,000 or approximately 90.4%, to $130,000, or 9.7% of
net sales from $68,000 or approximately 1.8% of net sales during the same period
for 1999. This increase in interest expense was primarily attributable to
interest on the Company's 10% Subordinated Notes, of which $1,250,000 were
issued in December 1999 and January 2000.
LITIGATION SETTLEMENT. Litigation settlement expense during the three
months ended June 30, 1999 was 0 as compared to litigation settlement expenses
of $448,000 for the same period in 2000, which costs were attributable to the
Drake & Drummond litigation settlement, which settlement was paid with 50,000
shares of the Company's common stock, with a fair market value of $201,550, and
a warrant to purchase up to 200,000 shares of common stock at $5.00 per share.
OTHER INCOME. Other income was 0 during the three months ended June 30,
2000, as compared to $36 during the three months ended June 30, 1999.
-3-
<PAGE>
NET LOSS. Net loss for the three months ended June 30, 2000 was
approximately $2.7 million or approximately 203.0% of net sales as compared to
net loss of $129,000 or 3.4% of net sales for the three months ended June 30,
1999. The increase in net loss was primarily due to increased operating expenses
and to the decrease in net sales.
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999
The following table sets forth, for the periods indicated, certain
financial data as a percentage of net sales:
Six Months ended June 30,
-------------------------
2000 1999
---------- ----------
Net sales.......................................... 100.0% 100.0%
Cost of sales...................................... 66.0 73.4
---------- ----------
Gross profit....................................... 34.0 26.6
Selling, general and administrative expenses....... 80.7 16.3
Engineering and product development expenses....... 29.3 4.1
---------- ----------
Operating income (loss)............................ (76.0) 6.3
Interest expense................................... (5.5) (2.1)
Debt termination costs............................. (0.2) (1.1)
Litigation settlement.............................. (10.5) --
Other income....................................... -- 0.5
---------- ----------
Net income (loss).................................. (92.2)% 3.6%
========== ==========
NET SALES. Net sales for the six months ended June 30, 2000 were $4.3
million as compared to $7.6 million for the six months ended June 30, 1999, a
decrease of $3.4 million or approximately 44.0%. The decrease in net sales was
primarily a result of decreased sales of the Company's products to Duquesne
Light Company, through its subcontractor Sargent Electric Company, and
engineering and production delays in the Company's new products, which included
delays in the completion of designs, design changes, delays in the completion of
testing and unexpectedly long lead times for certain components. To address
these issues, the Company has named a chief operating officer and is working on
improving its engineering and manufacturing systems.
GROSS PROFIT. Gross profit increased as a percentage of net sales by
7.4% to 34.0% for the six months ended June 30, 2000 as compared to 26.6% for
the same period in 1999. This increase was primarily the result of significant
revenues contributed by the Company's GDI traffic management division, which
typically carries higher gross margins. The Company acquired GDI in June 1999.
The cost of sales decreased by $2.8 million or approximately 49.6% to
approximately $2.8 million during the six months ended June 30, 2000 from $5.6
million during the six months ended June 30, 1999. The decrease in cost of sales
resulted primarily from the decrease in the volume of sales.
SELLING GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by approximately $2.2 million, or
approximately 178.0%, to $3.4 million during the six months ended June 30, 2000
from $1.2 million during the six months ended June 30, 1999, and increased as a
percentage of net sales from approximately 16.3% during the six months ended
June 30, 1999 to approximately 80.7% during the six months ended June 30, 2000.
The increase in expenses resulted primarily from the following: (1) the
existence of selling, general and administrative expenses for the Company's GDI
traffic management division which was acquired in June 1999; (2) an increase in
professional fees, primarily legal costs in association with litigation matters;
and (3) an increase in salary expense associated with the Company's rapid
internal growth and the addition of personnel. Amortization expense amounted to
$440,000 during the six months ended June 30, 2000 as compared to $15,000 during
the same period in 1999. Amortization expense during the six months ended June
30, 2000 includes $170,000 in connection with deferred compensation
arrangements, and $44,000 in amortization of goodwill.
-4-
<PAGE>
ENGINEERING AND PRODUCT DEVELOPMENT. Engineering and product
development expense increased by $941,000 or approximately 302.9% to $1.3
million during the six months ended June 30, 2000 from $311,000 during the six
months ended June 30, 1999, and increased as a percentage of sales from
approximately 4.1% during the six months ended June 30, 1999 to approximately
29.3% during the six months ended June 30, 2000. This increase in engineering
and product development expense was primarily attributable to the creation and
support of a research and development operation associated with the Company's
acquisition of the eflex Wireless technology in January 2000. Engineering and
product development expense during the six months ended June 30, 2000 includes
$315,000 in amortization for deferred compensation arrangements in connection
with the eflex acquisition, and $52,000 in amortization of investments in
technology.
INTEREST EXPENSE. Interest expense during the six months ended June 30,
2000 increased by $78,000 or approximately 49.5%, to $235,000, or 5.5% of net
sales from $157,000 or approximately 2.1% of net sales during the same period
for 1999. This increase in interest expense was primarily attributable to
interest on the Company's 10% Subordinated Notes, of which $1,250,000 were
issued in December 1999 and January 2000.
LITIGATION SETTLEMENT. Litigation settlement expense during the three
months ended June 30, 1999 was 0 as compared to litigation settlement expenses
of $448,000 for the same period in 2000, which costs were attributable to the
Drake & Drummond litigation settlement, which settlement was paid with 50,000
shares of the Company's common stock, with a fair market value of $201,550, and
a warrant to purchase up to 200,000 shares of common stock at $5.00 per share.
OTHER INCOME. Other income was 0 during the six months ended June 30,
2000, as compared to $36,000 during the six months ended June 30, 1999.
NET LOSS. Net loss for the six months ended June 30, 2000 was
approximately $3.9 million or approximately 92.2% of net sales as compared to
net income of $271,000 or 3.6% of net sales for the six months ended June 30,
1999. The increase in net loss was primarily due to increased operating expenses
and to the decrease in net sales.
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended June 30, 2000, the Company financed its
operations and capital expenditures primarily through proceeds from private
placement of stock as explained below and proceeds under the Company's revolving
line of credit. As of June 30, 2000, the Company had approximately $4.7 million
in backlog orders for its products.
As of June 30, 2000, the Company had working capital of approximately
$696,000 and an accumulated deficit of approximately $16.8 million. As of that
date, the Company had a net bank overdraft of $310,000 and $1.9 million in
accounts receivable. The Company also had promissory notes outstanding in the
aggregate amount of approximately $1.4 million (net of $15,600 of unamortized
discount) as of June 30, 2000, of which $75,000 was due to related parties.
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% (12.6% at June 30,
2000) 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
$3.0 million. As of June 30, 2000, the Company had borrowings of approximately
$116,000 under the line of credit.
Between November 15, 1999 and December 31, 1999, the Company issued
$312,500 of 10% Subordinated Unsecured Promissory Notes due 2001. The Company
closed the note offering in January 2000 after issuing additional notes totaling
$937,500. Included with the sale of the notes were warrants to purchase one
share of common stock of the Company for each dollar amount of the notes
purchased, with an exercise price of $1.75 per share. In February 2000,
conditions enabling the Company to call the warrants issued in connection with
this offering were met. All of the warrants were exercised for cash in the
amount of $1,590,625, reduction in the subordinated promissory notes of
$512,500, subscriptions receivable of $84,375. After the exercise of warrants
and repayments of $50,000, the aggregate amount of notes remaining outstanding
as of June 30, 2000 was $687,500, less unamortized warrant valuation of $5,759.
In April 2000, the Company completed a private equity offering of
40,000 shares of common stock at a price of $5.00 per share, with gross proceeds
of $200,000. In June 2000, the Company closed another private equity offering of
an aggregate of 396,912 shares of its common stock at $3.25 per share, with
gross proceeds aggregating $1.3 million. The Company intends to use the proceeds
of these private offerings for working capital and other corporate purposes.
-5-
<PAGE>
The cash proceeds from the offering of 10% Subordinated Unsecured
Promissory Notes due 2001, 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 such products and costs associated with the
Company's continued growth and expansion.
The Company does not believe that cash flow from operations and its
revolving line of credit with Celtic Capital Corporation will be adequate to
fund its continuing operations over the next twelve months, including the
Company's plans to exploit the technology obtained in connection with the
Company's acquisition of eflex. The Company will require additional sources of
liquidity through debt and/or equity financing, which sources the Company
believes it has identified, including the Company's equity line of credit with
Helenville Holdings Limited, the terms of which have been finalized but which
does not become effective until the shares to be issued to, and the shares
underlying warrants to be issued to, such investor are registered under the
Securities Act of 1933, as amended. However, there can be no assurance that any
additional financing will be available to the Company on a timely basis or 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. In addition, any debt financing
or other financing of securities senior to common stock will likely include
financial and other covenants that will restrict the Company's flexibility. At a
minimum, the Company expects these covenants to include restrictions on the
Company's ability to pay dividends on its common stock. Any failure to comply
with these covenants would have a material adverse effect on the Company's
business, prospects, financial condition and results of operations.
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 contribute 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.
LOOKING AHEAD
The Company believes that, during 2000, a significant portion of
revenues will be realized from certain opportunities that were uncovered and
developed during fiscal 1999 and during the six-month period ended June 30,
2000. Some of these opportunities are as follows:
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(TM) System and the TrafficWatch(TM)
and patent pending AirWave(TM) module. The Company's acquisition of
millimeter wave radio technology from Sierra Digital is also expected
to contribute to this trend.
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 others that are
currently customers of the Company will result in a significant
increase in its business during 2000.
o GROWTH THROUGH ACQUISITIONS. To expand its markets, the Company's
business strategy includes growth through acquisitions. During the year
ended December 31, 1999, the Company acquired certain assets of
Greenland Corporation as well as all of the assets of GDI and Sierra
Digital. In addition, in January 2000, the Company acquired all of the
outstanding capital stock of eflex Wireless, Inc., and in April 2000,
the Company acquired all of the outstanding capital stock of Racon,
Inc. The Company anticipates continuing this acquisition strategy
during 2000.
-6-
<PAGE>
o DISTRIBUTION. The Company believes that its on-going aggressive plan in
identifying and hiring distributors, VARs and system integrators will
result in additional revenues in this sector in 2000 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 with which the Company has
been involved may result in approximately $2.0 million of 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" sections 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, data and wireless communications industries,
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 its 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
timely manner, which in some cases has 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 losses over the last two
quarters. As a result of its losses, 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 continue to
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 economic 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 that are unrelated to the Company's performance. The
historical results of the Company's operations and financial position
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 experienced certain material adverse impacts associated
with such risks and uncertainties. No assurance can be given that such risks and
uncertainties will not continue to affect the Company's results of operations or
its financial position.
-7-
<PAGE>
RISK FACTORS
In addition to the other information contained in this quarterly report
on Form 10-QSB, the following factors should be considered carefully in
evaluating the Company's business and prospects.
THE COMPANY HAS A HISTORY OF LOSSES AND AN ACCUMULATED DEFICIT WHICH MAY
CONTINUE IN THE FUTURE AND WHICH MAY ADVERSELY IMPACT THE COMPANY'S BUSINESS AND
THE COMPANY'S SHAREHOLDERS.
The Company has incurred net losses in each fiscal year since the
Company's inception, with the exception of the fiscal year ended March 31, 1998,
in which the Company realized nominal net income of $94,000. For the nine month
transition period ended December 31, 1998, the Company reported a net loss of
$249,000. The Company's accumulated deficit through December 31, 1999 was $12.8
million, and as of that date the Company had a total shareholders' equity of
$663,000. The Company realized a net loss of $1.1 million for the twelve months
ended December 31, 1999, as compared to incurring a net loss of $204,000 for the
twelve months ended December 31, 1998. For the six-month period ended June 30,
2000, the Company reported a net loss of $3.9 million. The Company expects its
losses to continue during the remaining two quarters of 2000. The Company also
expects that its losses may continue further into the future. There is no
assurance that the Company will attain profitable operations in the future.
THE COMPANY MAY NEED AND BE UNABLE TO OBTAIN ADDITIONAL FUNDING ON SATISFACTORY
TERMS, WHICH COULD DILUTE THE COMPANY'S SHAREHOLDERS OR IMPOSE BURDENSOME
FINANCIAL RESTRICTIONS ON THE COMPANY'S BUSINESS.
Historically, the Company has relied upon cash from financing
activities to fund most of the cash requirements of its operating and investing
activities. Although the Company has been able to generate some cash from its
operating activities in the past, there is no assurance the Company will be able
to continue to do so in the future. The Company does not believe that cash flows
from operations and its revolving line of credit with Celtic Capital Corporation
will be adequate to fund its continuing operations over the next twelve months,
including its plans to exploit the technology obtained in connection with the
Company's acquisition of eflex. The Company will require additional sources of
liquidity through debt and/or equity financing, which sources the Company
believes it has identified. However, there can be no assurance that any
additional financing will be available to the Company on a timely basis or on
acceptable terms, or at all. The inability to obtain such financing could have a
material adverse effect on the Company's business and financial condition. If
additional funds are raised by issuing equity or convertible debt securities,
options or warrants, further dilution to the Company's existing shareholders may
result. In addition, any debt financing or other financing of securities senior
to common stock will likely include financial and other covenants that will
restrict the Company's flexibility. At a minimum, the Company expects these
covenants to include restrictions on the Company's ability to pay dividends on
the Company's common stock. Any failure to comply with these covenants would
have a material adverse effect on the Company's business, prospects, financial
condition and results of operations.
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 the Company's
proprietary technology and other important assets and could also adversely
affect the Company's ability to continue its product development efforts, which
the Company believes contribute 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.
THE COMPANY'S OPERATING RESULTS IN ONE OR MORE FUTURE PERIODS ARE LIKELY TO
FLUCTUATE SIGNIFICANTLY AND MAY NEGATIVELY IMPACT THE COMPANY'S STOCK PRICE.
The Company's quarterly results have varied significantly in the past
and will likely continue to do so in the future due to a variety 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 on 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 the Company's
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 wireless communication and device products industry and economic
conditions generally. The volume and timing of orders received during a quarter
are difficult to forecast. As a result, it is likely that in some future periods
the Company's operating results will be below the expectations of securities
analysts and investors. If this happens, the trading price of the Company's
common stock would likely be materially and adversely affected.
-8-
<PAGE>
THE COMPANY'S OPERATING RESULTS ARE SIGNIFICANTLY DEPENDENT UPON THE ACCEPTANCE
BY THE UTILITY INDUSTRY OF THE COMPANY'S SYSTEM.
The Company offers automatic meter reading ("AMR") and other remote
monitoring products and services and data generated from such services to
utilities, the transportation industry and other such entities. The Company's
success is almost entirely dependent upon whether these parties accept the
Company's solution for their AMR or other data acquisition requirements and
whether they allow the Company to install wireless data networks for servicing a
substantial number of endpoint monitoring devices including utility meters. The
automation of utility meter reading and data distribution is a relatively new
and rapidly changing market. The Company believes that, as the utility industry
becomes more competitive through various deregulation and privatization
initiatives, there will be an increased need for more accurate, timely and
efficient collection of consumption and other operating data. This will
ultimately accelerate the adoption of AMR, data collection and data distribution
systems and techniques. However, this is entirely dependent upon decisions made
by utilities, other utility industry participants and utility customers over
whom the Company has no control. The Company cannot accurately predict the size
of this market or the Company's potential growth. The Company's system is one
possible solution for AMR and data distribution. It has not been adopted as an
industry standard and it may not be adopted on a broad scale. Competing systems
have been and likely will continue to be selected by utilities and other
potential clients. In the event utilities, other utility industry participants
and utility customers do not adopt the Company's technology or do so less
rapidly than expected by the Company, the Company's future financial results,
including the Company's ability to service its indebtedness and achieve positive
cash flows or profitability, will be materially and adversely affected.
Participants in the utility industry have historically been cautious
and deliberate in making decisions concerning the adoption of new technology.
This process, which can take up to several years to complete, may include the
formation of evaluation committees, a review of different technical options,
technology trials, equipment testing and certification, performance and cost
justifications, regulatory review, one or more requests for vendor quotes and
proposals, budgetary approvals and other steps. Although deregulation and
privatization initiatives may ultimately accelerate the adoption of the
Company's technology, the timing and extent of such adoption cannot be
predicted. Only a limited number of utilities have made a commitment to purchase
the Company's products and services to date. If the Company does not enter into
additional product and/or service contracts or enter into contracts on terms
favorable to the Company, the Company's business, operating results, financial
condition, cash flows and its ability to service its indebtedness will be
materially and adversely affected.
THE COMPANY'S BUSINESS COULD SUFFER IF THE COMPANY IS UNABLE TO OBTAIN
COMPONENTS OF ITS PRODUCTS FROM OUTSIDE SUPPLIERS.
The major components of the Company's products include circuit boards,
microprocessors, chipsets and memory components. Most of these components are
available from multiple sources. However, certain components used in the
Company's products are currently obtained from single or limited sources.
Certain modem chipsets used in the Company's data communications products have
been in short supply and are frequently on allocation by semiconductor
manufacturers. Similar to others in the modem industry, the Company has, from
time to time, experienced difficulty in obtaining certain components. In
addition, the Company is currently experiencing unusually long lead times in
sourcing certain components that are in short supply. The Company does not have
guaranteed supply arrangements with any of its suppliers, and there can be no
assurance that these suppliers will continue to meet the Company's requirements.
In addition, the Company is currently experiencing problems in finding new
suppliers to help satisfy its requirements. The failure to find new suppliers
and shortages of components could not only limit the Company's production
capacity but also could result in higher costs due to the higher costs of
components in short supply or the need to utilize higher cost substitute
components. An extended interruption in the supply of any of these components or
a reduction in their quality or reliability would have a material adverse effect
on the Company's financial condition and results of operations. While the
Company believes that with respect to the Company's single source components the
Company could obtain similar components from other sources, the Company could be
required to alter product designs to use alternative components. There can be no
assurance that severe shortages of components will not occur in the future that
could increase the cost or delay the shipment of the Company's products and have
a material adverse effect on the Company's financial condition and results of
operations. Significant increases in the prices of these components could also
have a material adverse effect on the Company's results of operations because
the Company may not be able to adjust product pricing to reflect the increases
in component costs.
-9-
<PAGE>
THE COMPANY'S LACK OF DIVERSIFICATION MAY AFFECT THE COMPANY'S BUSINESS IF
DEMAND IS REDUCED.
A substantial portion of the Company's business is centered on the sale
of modems and similar data communication devices, which typically accounts for
over 90% of the Company's total revenues. Although the Company's customers
typically standardize the unique or special components that are manufactured for
them by or through the Company to be incorporated in the customers' end product,
in most cases the Company does not have long-term contracts with the Company's
customers. Accordingly, the Company is highly dependent on the successful sales
of these types of products. A significant reduction in sales of these products
resulting from changes in the industry, including the entry of new competitors
into the market, from the introduction of new or improved technology or an
unanticipated shift in the needs of the Company's customers, or for other
reasons, would have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.
THE COMPANY RELIES ON A RELATIVELY LIMITED NUMBER OF CUSTOMERS, AND THE LOSS OF
ANY SIGNIFICANT CUSTOMER COULD MATERIALLY AND ADVERSELY AFFECT THE COMPANY'S
BUSINESS AND FINANCIAL CONDITION.
The Company derives a significant portion of its revenues from a
relatively limited number of customers. The Company anticipates that its five or
six largest customers will continue to account for the majority of the Company's
revenues for the foreseeable future. The loss of any one or more of these major
customers would likely have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.
THE INABILITY TO SHIP ORDERS ON A TIMELY BASIS COULD MATERIALLY AND ADVERSELY
IMPACT THE COMPANY'S BUSINESS AND RESULTS OF OPERATIONS.
The Company has previously experienced and is currently experiencing
problems associated with under-capitalization and engineering and production
delays, including the inability to ship products in a timely manner, which in
some cases has caused customers to cancel a portion or all of their orders. The
cancellation of orders may damage the Company's reputation and could cause it to
lose existing customers or prevent it from obtaining new customers. The failure
to deliver products on time could have a material adverse affect on the
Company's business and results of operations.
THE COMPANY RELIES UPON THE SUCCESSFUL DEVELOPMENT AND PERFORMANCE OF ITS
TECHNOLOGIES AND PRODUCTS.
The Company has made and expects to continue to make substantial
investments in technology development. The Company's success depends, in part,
on its ability to continue to design and manufacture new competitive products
and to enhance its existing products. This product development requires
continued investment in order to maintain the Company's market position. There
can be no assurance that unforeseen problems will not occur with respect to the
development and performance of the Company's technologies or products.
Development schedules for technology products are subject to uncertainty, and
there can be no assurance that the Company will meet its product development
schedules. The Company has previously experienced significant delays and cost
overruns in the design and manufacture of new products and is currently
experiencing delays on certain new product production. There can be no assurance
that delays or cost overruns will not be experienced in the future. Delays can
be caused by a number of factors, including changes in product design or
definition during the development stage, changes in customer requirements,
unexpected behavior of products under certain conditions, failure of third-party
components to meet specifications or lack of availability of such components,
and other factors. Delays in the availability of new products, or the inability
to successfully develop products that meet customer needs, could result in
increased competition, the loss of revenue or increased costs, any of which
would have a material adverse effect on the Company's business, financial
condition and results of operations.
THE COMPANY RELIES HEAVILY ON ITS KEY EMPLOYEES, AND THE LOSS OF THEIR SERVICES
COULD MATERIALLY AND ADVERSELY AFFECT THE COMPANY'S BUSINESS.
The Company's success is highly dependent upon the continued services
of key members of the Company's management, including the Company's Chairman of
the Board, President and Chief Executive Officer, Michael A. Armani, and the
Company's Chief Financial Officer, David Stone. The loss of either Mr. Armani or
Mr. Stone or one or more other key members of management could have a material
adverse effect on the Company. The Company has not entered into any employment
agreement with Mr. Armani or any other executive officer of the Company other
than a written employment offer with Mr. Stone. The Company does not maintain
key-man life insurance policies on any member of management.
-10-
<PAGE>
THE MARKETS IN WHICH THE COMPANY COMPETES ARE HIGHLY COMPETITIVE, AND THE
COMPANY'S GROWTH PROSPECTS COULD BE MATERIALLY AND ADVERSELY AFFECTED IF THE
COMPANY IS UNSUCCESSFUL IN ITS EFFORTS TO COMPETE.
Electronics, communications and utility product companies are beginning
to develop various wireless network meter reading systems as a result of the
deregulation of the electric utility industry and the potential market for other
applications once a common infrastructure is in place. A number of these systems
currently compete, and others may in the future compete, with the Company's
system. Deregulation will likely cause competition to increase. The Company
believes that at this time the Company's most significant direct competitor in
the marketplace is Itron, an established manufacturer and seller of hand-held
and drive-by AMR equipment for utilities. Itron is currently providing to
customers its Genesis(TM) system, a wireless radio network marketed as similar
to the Company's for meter reading purposes. There are other potential
alternative solutions to the Company's network meter reading services, including
traditional wireless solutions. Many of the Company's present and potential
future competitors may have substantially greater financial, marketing,
technical and manufacturing resources, name recognition and experience than the
Company. The Company's competitors may be able to respond more quickly to new or
emerging technologies and changes in customer requirements or to devote greater
resources to the development, promotion and sale of their products and services
than the Company. While the Company believes its technology, including
AirWave(TM), is widely regarded as competitive at the present time, the
Company's competitors may successfully develop products, technologies or
software that are better or more cost effective. In addition, current and
potential competitors may make strategic acquisitions or establish cooperative
relationships among themselves or with third parties that increase their ability
to address the needs of the Company's prospective customers. Accordingly, it is
possible that new competitors or alliances among current and new competitors may
emerge and rapidly gain significant market share. In addition, if the Company
achieves significant success it could draw additional competitors into the
market. Providers of wireless services may in the future choose to enter the
Company's markets. Such existing and future competition could materially and
adversely affect the pricing for the Company's products and services and the
Company's ability to sign new services contracts and maintain existing
agreements. Competition for services relating to non-utility applications may be
more intense than competition for network meter reading services, and additional
competitors may emerge as the Company continues to develop non-utility
applications. The Company may be unable to compete successfully against current
and future competitors, and any failure to do so would have a material adverse
effect on its business, operating results, financial condition and cash flows.
THE COMPANY'S INABILITY TO SUCCESSFULLY DEVELOP AND EXPAND ITS SYSTEM COULD
MATERIALLY AND ADVERSELY AFFECT ITS BUSINESS.
The Company's initial target market is the monitoring, control and
automation of utilities' electric, gas and water meters and distribution
networks. Unforeseen problems may occur with respect to the Company's
technology, products or services, and the Company may not successfully complete
the development and commercial implementation of the Company's technology on a
wide scale. The Company must continue to expand and upgrade its ability to
implement successfully the Company's wireless networks. The Company may not be
able to develop successfully a full range of endpoint devices. The Company's
future success will also depend, in part, on the Company's ability to enhance
the Company's existing hardware, software and wireless communications
technology. Significant technological advances occur rapidly and frequently in
the telecommunications industry. The advent of computer-linked electronic
networks, fiber optic transmission, advanced data digitization technology,
cellular and satellite communications capabilities, specialized mobile radio
services and other commercial mobile radio services have radically expanded
communications capabilities and market opportunities. Future advances may render
the Company's technology obsolete or less cost effective than competitive
systems or erode the Company's market position. Competitors may be capable of
offering significant cost savings or other benefits to the Company's customers.
Consequently, the Company may be unable to offer competitive services or obtain
appropriate new technologies on a timely basis or on satisfactory terms. The
Company's future performance will also depend significantly on the Company's
ability to respond to future regulatory changes. The Company must make continued
substantial investments to develop its technology. The Company has encountered
product development delays in the past affecting both software and hardware
components of the Company's system and the Company expects to incur such delays
in the future.
-11-
<PAGE>
BECAUSE THE COMPANY BELIEVES THAT PROPRIETARY RIGHTS ARE MATERIAL TO ITS
SUCCESS, MISAPPROPRIATION OF THESE RIGHTS OR CLAIMS OF INFRINGEMENT OR LEGAL
ACTIONS RELATED TO INTELLECTUAL PROPERTY COULD ADVERSELY IMPACT THE COMPANY'S
FINANCIAL CONDITION.
The Company does not hold any patents. The Company currently relies on
a combination of contractual rights, copyrights, trademarks and trade secrets to
protect its proprietary rights. Historically, the Company's management believed
that because of the rapid pace of technological change in the modem and wireless
communication and device products industry, the legal intellectual property
protection for the Company's products was a less significant factor in the
Company's success than the knowledge, abilities and experience of the Company's
employees, the frequency of the Company's product enhancements, the
effectiveness of the Company's marketing activities and the timeliness and
quality of the Company's support services. However, the Company now believes
that several of the Company's current products and some products in development
could benefit from patent protection. Accordingly, the Company has retained the
services of a patent and trademark law firm to file patent applications for
those products with the United States Patent and Trademark Office and have
several patents pending. Although the Company relies to a great extent on trade
secret protection for much of its technology, there can be no assurance that the
Company's means of protecting its proprietary rights will be adequate or that
the Company's competitors or customers will not independently develop comparable
or superior technologies or obtain unauthorized access to the Company's
proprietary technology.
The Company owns, licenses or has otherwise obtained the right to use
certain technologies incorporated in its products, including certain technology
the Company acquired through its acquisition of eflex. In addition, the Company
purchases modem chipsets that incorporate sophisticated modem technology. The
Company may receive infringement claims from third parties relating to the
Company's products and technologies, such as the patent infringement action
filed against the Company by Aeris Communications, Inc. In such event, the
Company intends to investigate the validity of any such claims and, if the
Company believes the claims have merit, the Company intends to respond through
licensing or other appropriate actions. Certain of these claims may relate to
technology included in modem chipsets or other components purchased by the
Company from third-party vendors for incorporation into the Company's products.
In such event, the Company would forward these claims to the appropriate vendor.
If the Company or the Company's component manufacturers were unable to license
or otherwise provide any such necessary technology on a cost-effective basis,
the Company could be prohibited from marketing products containing that
technology, incur substantial costs in redesigning products incorporating such
technology, or incur substantial costs defending any legal action taken against
the Company, all of which could have a material adverse effect on the Company's
business, prospects, financial condition and results of operations.
THERE ARE RISKS THAT THE COMPANY'S PRODUCTS MAY BE RETURNED BY THE COMPANY'S
CUSTOMERS.
The Company is exposed to the risk of product returns from the
Company's customers due to defective products or product components. Returned
used products are tested, repaired and used as warranty replacements. Products
returned to the Company due to faulty work by the Company's subcontractors are
returned to the subcontractors for credit against future purchase orders.
Historically, product returns have not had a material impact on the Company's
operations or financial condition. While the Company believes that product
returns should not be material in future periods, it is expected that a
relatively modest number of returns will continue. However, there can be no
assurance that significant levels of product returns will not occur in the
future, which may have a material adverse effect on the Company's operations.
THE COMPANY'S FAILURE TO MANAGE GROWTH EFFECTIVELY COULD IMPAIR ITS BUSINESS.
The Company's strategy envisions a period of rapid growth that may put
a strain on the Company's administrative and operational resources. While the
Company believes that it has established a significant infrastructure to support
growth, the Company's ability to effectively manage growth will require the
Company to continue to expand the capabilities of the Company's operational and
management systems and to attract, train, manage and retain qualified engineers,
technicians, salesperson and other personnel. There can be no assurance that the
Company will be able to do so. If the Company is unable to successfully manage
its growth, the Company's business, prospects, financial condition and results
of operations could be adversely affected.
-12-
<PAGE>
THE COMPANY'S STOCK PRICE IS SUBJECT TO SIGNIFICANT VOLATILITY WHICH COULD
RESULT IN LITIGATION AGAINST THE COMPANY.
The trading prices of the Company's common stock could be subject to
wide fluctuations in response to quarter-to-quarter variations in the Company's
operating results, material announcements of technological innovations, price
reductions, significant customer orders or establishment of strategic
partnerships by the Company or its competitors or providers of alternative
products, general conditions in the modem and data communications industry, or
other events or factors, many of which are beyond the Company's control. In
addition, the stock market as a whole and individual stocks have experienced
extreme price and volume fluctuations, which have often been unrelated to the
performance of the related corporations. The Company's operating results in
future quarters may be below the expectations of market makers, securities
analysts and investors. In any such event, the price of the Company's common
stock will likely decline, perhaps substantially. In the past, following periods
of volatility in the market price of a company's securities, securities class
action litigation has occurred against the issuing company. There can be no
assurance that such litigation will not occur in the future with respect to the
Company. Such litigation could result in substantial costs and a diversion of
management's attention and resources, which could have a material adverse effect
on the Company's business, prospects, financial condition and results of
operations. Any adverse determination in such litigation could also subject the
Company to substantial liabilities.
-13-
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On August 18, 1999, Drake & Drummond, a Nevada corporation, initiated
an action in the Orange County Superior Court, Central (Case No. 815922) against
the Company alleging, among other things, breach of contract, common count and
declaratory relief arising out of a consulting agreement entered into between
Drake & Drummond and the Company. On October 8, 1999, the Company filed an
answer to the complaint and filed a cross-complaint against Drake & Drummond
alleging, among other things, breach of contract, rescission based upon fraud,
and declaratory relief arising out of the same consulting agreement. Effective
as of June 30, 2000, the Company and Drake & Drummond settled this litigation.
The settlement was paid with 50,000 shares of the Company's common stock and a
five-year warrant to purchase up to 200,000 shares of common stock at $5.00 per
share.
On October 18, 1999, the Company initiated an action in the Orange
County Superior Court, Central (Case No. 815922) by filing a complaint against
Bibicoff & Associates and Harvey A. Bibicoff, its primary shareholder and chief
executive officer, alleging, among other things, breach of contract, rescission
based upon fraud, breach of fiduciary duty and declaratory relief arising out of
a consulting agreement entered into between defendants and the Company. The
complaint seeks damages according to proof at trial, rescission of the
consulting agreement and restitution of all consideration received by defendants
and a judicial declaration of the rights and liabilities of the parties. On
December 6, 1999, defendants filed an answer to the complaint denying all
material allegations contained therein. Defendants, together with five of the
Company's subordinated promissory note holders and shareholders affiliated with
defendants, concurrently filed a cross-complaint against the Company and Michael
Armani, who is a director and the President and Chief Executive Officer of the
Company, for damages and rescission based upon alleged misrepresentations, false
promises and non-disclosures by the Company and Mr. Armani in connection with
the cross-complainants' purchase of their interests in the Company. The
cross-complaint also contains breach of contract claims arising out of the
consulting agreement between the Company and certain of the defendants and
purported oral contracts between the Company and certain of the
cross-complainants. The Company and Mr. Armani filed an answer to the
cross-complaint denying all material allegations contained therein. The Company
intends to vigorously defend the cross-complaint that was filed against it. At
this point, the Company cannot determine what impact, if any, the ultimate
resolution of this matter would have on its financial position or results of
operations.
On January 28, 2000, Aeris Communications, Inc., a California
corporation, initiated an action in the United States District Court for the
Northern District of California (Case No. C00-00328) against the Company
alleging, among other things, patent infringement of two United States patents
held by Aeris Communications. The alleged patent infringement relates to certain
technology the Company acquired in connection with its acquisition of eflex. The
court dismissed this action on June 28, 2000.
On June 27, 2000, Racon, Inc., a Washington corporation, and Daniel A.
Blattman initiated an action in the King County Superior Court in the State of
Washington (Case No. 00-2-17912-OSEA) against the Company alleging, among other
things, breach of contract and default on a promissory note arising out of the
Asset Purchase Agreement dated April 21, 2000 between the Company and Racon. The
complaint seeks damages according to proof at trial in an amount not less than
$50,000 with respect to Racon, and not less than $325,0000 with respect to Mr.
Blattman, plus an award of prejudgment and/or default interest and attorneys'
fees. The Company intends to vigorously defend this action. At this point, the
Company cannot determine what impact, if any, the ultimate resolution of this
matter would have on its financial position or results of operations.
-14-
<PAGE>
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Recent Sales of Unregistered Securities.
In April 2000, the Company issued an aggregate of 40,000 shares of
common stock at $5.00 per share to six investors in a private offering.
In April 2000, in connection with the Company's acquisition of certain
assets of Racon, Inc., the Company executed a promissory note in the amount of
$325,000, which principal and accrued but unpaid interest is convertible, at any
time at the option of the holder, or at the option of the Company when the
average closing price of the Company's common stock for ten consecutive trading
days is at least $9.00 per share, into shares of common stock of the Company at
a price of $7.00 per share.
In May 2000, the Company issued 16,429 shares of common stock upon the
exercise of warrants issued in connection with the offering of shares of the
Company's Series A 7.0% Convertible Redeemable Preferred Stock in April 1999.
The warrants were exercisable at $1.875 per share.
In May 2000, the Company issued 20,000 shares of common stock to a
consultant upon the exercise of incentive stock options issued pursuant to the
Company's 1998 Stock Option Plan. The options were exercisable at $2.18 per
share.
In June 2000, the Company issued 100,000 shares of common stock as
compensation to a financial and investor relations consultant.
Between May and June 2000, the Company issued an aggregate of 396,912
shares of common stock at $3.25 per share to 13 investors in a private offering.
In addition, the Company issued a warrant to purchase up to 81,200 shares of
common stock to a finder in connection with the offering.
In June 2000, the Company issued an option to purchase up to 50,000
shares of common stock at an exercise price of $6.00 per share as compensation
to a financial and investor relations consultant.
In June 2000, the Company issued 50,000 shares of common stock and
warrants to purchase up to 200,000 shares of common stock at an exercise price
of $5.00 per share in connection with the settlement of litigation.
In June 2000, the Company issued 2,745 shares of common stock at prices
ranging from $4.00 to $4.50 per share as compensation to a management and
business consultant.
In June 2000, the Company issued warrants to purchase up to an
aggregate of 617,254 shares at an exercise price of $4.8602 to an investor and
to the Company's placement agent in connection with the closing of the Company's
equity line of credit.
In June 2000, the Company issued incentive stock options to 12
employees to purchase an aggregate of 240,000 shares of common stock pursuant to
the Company's 2000 Stock Option Plan. The options are exercisable at $3.812 per
share.
The issuances of securities of the Company 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, 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.
Dividends.
Pursuant to the terms of the Company's 10% Subordinated Unsecured
Promissory Notes due 2000 and 10% Subordinated Unsecured Promissory Notes due
2001, the Company is restricted in its ability to declare and pay dividends and
redeem or repurchase any shares of its common stock. The Company was in
compliance with all covenants of these notes at June 30, 2000.
In addition, pursuant to state law, the Company may be restricted from
paying dividends to its holders of common stock as a result of its accumulated
deficit as of June 30, 2000.
-15-
<PAGE>
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) The Annual Meeting of Shareholders of the Company was held on
June 6, 2000.
(b) Omitted pursuant to Instruction 3 to Item 4 of Form 10-QSB.
(c)(i) PROPOSAL ONE: Approval of amendment of the Company's Restated
and Amended Bylaws:
For: 6,952,111
Against: 86,658
Abstain: 19,655
(c)(ii) PROPOSAL TWO: Election of six directors:
For Against Withheld
--- ------- --------
Michael A. Armani 11,438,537 0 13,025
Edmund P. Finamore 11,438,537 0 13,025
George Levy, M.D. 11,436,537 0 15,025
Terry S. Parker 11,386,337 0 65,225
Thomas Povinelli 11,438,537 0 13,025
Shala Shashani 11,438,537 0 13,025
(c)(iii) PROPOSAL THREE: Approval of the adoption of the Company's 1999
Employee Stock Purchase Plan:
For: 6,972,778
Against: 56,056
Abstain: 29,590
(c)(iv) PROPOSAL FOUR: Approval of the adoption of the Company's 2000
Stock Option Plan:
For: 6,960,637
Against: 73,428
Abstain: 24,359
(c)(v) PROPOSAL FIVE: Authorization of the issuance of options and
warrants to purchase up to a specified percentage of the
Company's common stock and the ratification of certain
issuances and grants made prior to such authorization:
For: 6,870,132
Against: 119,702
Abstain: 68,590
(c)(vi) PROPOSAL SIX: Approval of the issuance of an aggregate of
2,098,043 shares of common stock in connection with the
Company's stock purchase transaction with eflex:
For: 6,912,561
Against: 126,068
Abstain: 19,795
-16-
<PAGE>
(c)(vii) PROPOSAL SEVEN: Ratification of the appointment of BDO
Seidman, LLP as the Company's independent certified public
accountants for the fiscal year beginning January 1, 2000:
For: 11,421,086
Against: 15,586
Abstain: 14,890
(d) Not applicable.
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.
None.
-17-
<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: August 21, 2000 By: /s/ DAVID L. STONE
-------------------------------------
David L. Stone
Chief Financial Officer and Secretary
(principal financial and accounting
officer)
-18-
<PAGE>
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
27.1 Financial Data Schedule
-19-
