UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period
ended June 30, 1996
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the transition period
from ___________ to __________
Commission File Number 0-15596
SPECTRUM INFORMATION TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 75-1940923
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
2700 Westchester Avenue,
Purchase, New York 10577
(Address of principal executive offices) (Zip Code)
(914) 251-1800
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
------ ------
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the close of the latest
practicable date.
Common stock, $.001 par value, 76,675,448 outstanding at July 31,
1996.
<PAGE>
SPECTRUM INFORMATION TECHNOLOGIES, INC. AND SUBSIDIARIES
(Debtors in Possession)
FORM 10-Q
JUNE 30, 1996
INDEX
PART I. FINANCIAL INFORMATION Page No.
--------
Consolidated Balance Sheets 1
Consolidated Statements of Income (Loss) 3
Consolidated Statements of Cash Flows 4
Notes to Consolidated Financial Statements 6
Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
PART II. OTHER INFORMATION 18
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Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
Consolidated Balance Sheets
(Amounts in thousands)
Assets June 30, March 31,
1996 1996
- --------------------------------------------------------------------------
(Unaudited)
Current assets:
Cash and cash equivalents $11,549 $13,002
Marketable securities 788 873
Accounts receivable (net of
allowance for doubtful
accounts of $80) 725 1,437
Prepaid expenses and other current
assets 455 229
------------- -------------
Total current assets 13,517 15,541
------------- -------------
Furniture, fixtures and equipment 450 426
------------- -------------
450 426
Less - accumulated depreciation (246) (222)
------------- -------------
Net property and equipment 204 204
------------- -------------
Intangible assets, net 354 360
------------- -------------
Total assets $14,075 $16,105
============= =============
See accompanying notes to consolidated financial statements.
1
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Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
Consolidated Balance Sheets
(Amounts in thousands)
Liabilities and Stockholders' Equity June 30, March
1996 31, 1996
- ---------------------------------------------------------------------------
(Unaudited)
Current Liabilities
Accounts payable $ 1,934 $ 3,643
Accrued liabilities 1,989 1,386
------------ -------------
Total current liabilities 3,923 5,029
------------ -------------
Liabilities subject to compromise:
Accounts payable and accrued
liabilities 1,455 1,485
Reserve for litigation 4,719 4,719
Reserve for restructuring 1,972 2,067
Net liabilities of discontinued
operations 531 531
Other liabilities 185 185
------------ -------------
Total liabilities subject to
compromise 8,862 8,987
------------ -------------
Total liabilities 12,785 14,016
------------ -------------
Commitments and contingencies
Stockholders' Equity:
Common stock, $.001 par value, 110,000
shares authorized 76,675
issued, respectively 77 77
Paid-in capital 63,961 63,961
Accumulated deficit (62,284) (61,501)
------------ -------------
1,754 2,537
Treasury stock, 100 shares at cost (300) (300)
Unrealized loss on marketable
securities (164) (148)
------------ -------------
Total stockholders' equity 1,290 2,089
------------ -------------
Total liabilities and
stockholders' equity $14,075 $16,105
============ =============
See accompanying notes to consolidated financial statements.
2
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Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
Consolidated Statements of Operations
(Amounts in thousands, except per share amounts)
Three months ended June 30, 1996 1995
- --------------------------------------------------------------------------
(Unaudited) (Unaudited)
Revenues:
Licensing revenue $ 758 $ 829
Merchandise sales, net 50 202
------------ ------------
Total revenues 808 1,031
------------ ------------
Operating costs and expenses:
Cost of revenues 24 123
Selling, general and administrative 1,334 2,127
------------ ------------
Total operating costs and
expenses 1,358 2,250
------------ ------------
Operating loss (550) (1,219)
------------ ------------
Chapter 11 administrative expenses (329) (890)
------------ ------------
Other income (expense), net 96 (59)
------------ ------------
Loss from continuing operations (783) (2,168)
------------ ------------
Discontinued operations:
Gain on disposal of Computer Bay - 2,539
Income from operations of Spectrum
Global - 270
------------ ------------
Income from discontinued operations - 2,809
------------ ------------
Net income (loss) $(783) $ 641
============ ============
Net income (loss) per common share:
Loss from continuing operations $ (.01) $ (.03)
Gain on disposal of discontinued - .04
operations
------------ ------------
Net income (loss) $ (.01) $ .01
============ ============
See accompanying notes to consolidated financial statements.
3
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Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
Consolidated Statements of Cash Flows
(Amounts in thousands)
Three months ended June 30, 1996 1995
- -------------------------------------------------------------------------
(Unaudited) (Unaudited)
Cash flow from operating activities:
Net income (loss) $ (783 ) $ 641
Adjustments to reconcile net loss to
net cash used by
continuing activities:
Depreciation and amortization 30 156
Gain on Chapter 7 conversion of
Computer Bay - (2,539)
Deferred income - (400)
Loss on sale of equipment - 97
(Increase) decrease in:
Accounts receivable 712 (544)
Prepaid expenses and other assets (157) 1,044
Increase (decrease) in:
Accounts payable, accrued (1,107) 1,502
liabilities and other liabilities
Liabilities subject to compromise (124) (70)
------------ -----------
Net cash used by continuing
operations (1,429) (113)
Net cash used by discontinued
operations - (1,696)
- -------------------------------------------------------------------------
Net cash used by operating
activities (1,429) (1,809)
- -------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sale of Axcell product
line - 500
Proceeds from sale of marketable
securities - (12)
Purchase of property and equipment (24) 3
------------ -----------
Net cash (used) provided by
continuing operations (24) 491
Net cash used by discontinued
operations - (57)
- -------------------------------------------------------------------------
Net cash (used) provided by
investing activities (24) 434
- -------------------------------------------------------------------------
Cash flow from financing activities:
- -------------------------------------------------------------------------
Net cash provided (used) by
financing activities - -
4
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- -------------------------------------------------------------------------
Net decrease in cash and cash
equivalents (1,453) (1,375)
Cash and cash equivalents, unrestricted,
beginning of year 13,123 4,696
------------ -----------
Cash and cash equivalents, unrestricted,
end of year 11,670 3,321
- -------------------------------------------------------------------------
Total cash and cash equivalents, end of
year (including cash
amounts in net assets of discontinued
operations) $11,670 $3,321
============ ===========
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ - $ -
Cash paid during the year for income
taxes $ 2 $ 2
See accompanying notes to consolidated financial statements.
5
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Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
1. Summary of Significant Accounting Policies
(a) Business
Spectrum Information Technologies, Inc., a Delaware
corporation ("Spectrum") and its subsidiaries
(collectively, the "Company") own a portfolio of
pioneering patents (legacy assets) relating to
commercially practicable methods of data transmission
over circuit-switched cellular networks. Since January
1995, Spectrum's management has been implementing a
strategy that refocuses the business direction of the
Company. Spectrum's business objective is to further
develop its core proprietary technology and become a
leading provider of value-added mobile communications
software and related products. Spectrum's proprietary
wireless data transmission technology enables
transmission of data between portable computer devices
over cellular telephone networks. Spectrum licenses
its technology to leading manufacturers of integrated
circuits, modems and other related data communications
product providers. Spectrum also develops direct
connect cellular data transmission activation kits
(software drivers and cables) and markets them to the
Company's licensees. These two components -
development and marketing of activation kits and
technology licensing - are the primary sources of
operating revenues which constitute the core business
of the Company. (See Item 2 - Management's Discussion
and Analysis of Financial Condition and Results of
Operations Risk Factors).
(b) Bankruptcy Proceedings
On January 26, 1995 (the "Petition Date"), as part of
new management's effort to stem the Company's
substantial financial losses and focus on developing
its core technology, the Company, together with its
wholly-owned subsidiaries, Computers Unlimited of
Wisconsin, Inc., a Wisconsin corporation d/b/a
Computer Bay ("Computer Bay"), Dealer Services
Business Systems, Inc., a Delaware corporation d/b/a
Data One ("Data One") and Cellular (collectively, the
"Debtors"), filed petitions for relief under Chapter
11 of the Federal Bankruptcy Code (the "Chapter 11
proceeding"). Upon motion by the Debtors, the United
States Bankruptcy Court for the Eastern District of
New York (the "Bankruptcy Court") converted the action
for Computer Bay to a case under Chapter 7 of the
Bankruptcy Code. A trustee is overseeing the
liquidation of Computer Bay's assets and the Company
no longer has control over the Computer Bay estate.
The Company has filed a separate liquidating plan of
reorganization for Data One, which was unanimously
supported by Data One's
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voting creditors. (Note 3).
In March 1996, the Bankruptcy Court approved the
Company's Third Amended Disclosure Statement (the
"Disclosure Statement") with respect to the Third
Amended Consolidated Plan of Reorganization Proposed
by Spectrum and Cellular (the "Plan") dated as of
March 18, 1996 finding the Disclosure Statement
adequate for distribution and vote by interested
parties. As contemplated by the Plan, the bankruptcy
estates of Spectrum and Cellular have been
substantively consolidated. The Plan, if confirmed and
consummated, provides all administrative creditors
with full payment (unless a lesser amount is agreed
upon or ordered by the Bankruptcy Court) and all
general unsecured creditors with 100% of the value of
their claims plus 6% interest per annum from the
filing date thereon. It also settles the class action
lawsuits of approximately $676,000,000 filed against
the Company by the payment of a minimal amount of cash
and the delivery of approximately 45% of the equity
ownership in Spectrum to a trustee to be distributed
to the members of the class. Although existing
Spectrum shareholders will be substantially diluted
under the terms of the Plan, such shareholders should
obtain the majority of the 45% equity ownership in
Spectrum set aside for existing shareholders and
certain creditors. The Plan also calls for management,
employees and non-executive directors of the Company
to receive the remaining 10% ownership.
The Bankruptcy Court set April 22, 1996 as the
deadline for voting on the Plan. Each class entitled
to vote on the Plan accepted the Plan. Over 97% of
Spectrum's voting unsecured creditors, representing
over 99% of the total dollar amount voted, voted to
accept the Plan. Under the Bankruptcy Code, a class
accepts a plan if two-thirds in amount and a majority
in number of the holders of claims voting cast ballots
in favor of acceptance. Holders of Spectrum's common
stock representing approximately 27,600,000 shares
returned ballots, with over 95% of those shares voted
in favor of confirmation. A class of equity interests
is deemed to have accepted a plan if the plan is
accepted by holders of at least two-thirds of the
allowed interests that have voted on the plan. The
Bankruptcy Court initially scheduled a confirmation
hearing for May 3, 1996, which has since been
rescheduled for August 14, 1996. The Bankruptcy Court
has rescheduled the confirmation hearing several times
at the Company's request while the Company was
awaiting a ruling by the United States District Court
for the Eastern District of New York in a coverage
dispute with certain of the Company's former insurance
carriers. On July 15, 1996, the District Court issued
a decision favorable to the Company, and the insurance
carriers stated that they intended to appeal certain
aspects of the decision (Notes 3 and 4). If the
Bankruptcy Court confirms the
7
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Plan at the scheduled confirmation hearing,
consummation of the Plan and its effective date will
remain contingent upon District Court approval of the
Class Action Settlement.
(c) Basis of Presentation
The accompanying consolidated financial statements of
the Company have been prepared on the basis that it is
a going concern, which contemplates the realization of
assets and the satisfaction of liabilities, except as
otherwise disclosed, in the normal course of business.
However, as a result of Chapter 11 proceedings and
circumstances relating to this event, including the
Company's recurring losses from continuing operations,
such realization of assets and liquidation of
liabilities is subject to significant uncertainty.
Further, the Company's ability to continue as a going
concern is dependent upon the confirmation of the
Company's Plan by the Bankruptcy Court (Note 1(b)),
achievement of the business objectives described in
Note 1(a) and profitable operations therefrom and the
ability to generate sufficient cash from operations
and financing sources to meet the restructured
obligations. (See Item 2 - Management's Discussion and
Analysis of Financial Condition and Results of
Operations for a discussion of Risk Factors.) Except
as otherwise disclosed, the consolidated financial
statements do not include any adjustments to reflect
the possible future effects on the recoverability and
classification of assets or the amounts and
classification of liabilities that may result from the
possible inability of the Company to continue as a
going concern. The Company continues to monitor
expenses in order to conserve cash. In addition, the
Plan (Note 1(b)) contemplates the settlement of all
significant litigation. However, there can be no
assurance that these events will occur according to
management's plans. The financial statements for the
quarter ended June 30, 1996, reflect accounting
principles and practices set forth in AICPA Statement
of Position 90-7, "Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code", which the
Company adopted as of January 26, 1995, the date of
the Company's Chapter 11 filing (Note 3). The net
assets of Spectrum, Cellular and Data One, excluding
intercompany payables of approximately $11,506,000,
were approximately $1,290,000 at June 30, 1996.
As part of the restructuring process, Spectrum has
included in its Plan the consolidation of the
Company's bankruptcy estate with that of Cellular.
Spectrum and Cellular are now conducting the Company's
core business on an operating basis as a single entity
(Notes 1(b) and 5).
(d) Principles of Consolidation
These consolidated financial statements include the accounts and
results of operations of the Company and its wholly owned
8
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subsidiaries, Data One and Spectrum Cellular, as of and
for the three months ended June 30, 1996 and 1995.
Effective October 17, 1995, the Company sold its
Spectrum Global subsidiary to a buying group including
certain former members of management. Upon conversion
of Computer Bay's Chapter 11 case to a case under
Chapter 7, on May 25, 1995, which mandates the
liquidation of Computer Bay, control of Computer Bay
has been transferred from the Company to the Computer
Bay trustee. As a result, the net liabilities of
Computer Bay have been eliminated from the
consolidated financial statements of the Company. The
Company discontinued the operations of its Data One
subsidiary during fiscal year 1994, its Computer Bay
subsidiary during fiscal year 1995 and its Spectrum
Global subsidiary during fiscal year 1996. All
intercompany transactions have been eliminated.
The unaudited interim consolidated financial
statements have been prepared on a basis substantially
consistent with the audited statements for the fiscal
year ended March 31, 1996. Certain information and
footnote disclosures normally included in financial
statements were prepared in accordance with generally
accepted accounting principles and have been condensed
or omitted pursuant to the rules and regulations of
the Securities and Exchange Commission. The Company
believes that the disclosures contained herein are
adequate to make the information presented not
misleading. The unaudited financial statements should
be read in conjunction with the audited financial
statements and accompanying notes in the Company's
annual report on Form 10-K for the fiscal year ended
March 31, 1996.
In the opinion of management, the accompanying
unaudited consolidated financial statements reflect
all adjustments that are necessary to present fairly
the Company's financial position as of June 30, 1996,
and the results of its operations and its cash flows
for the interim periods presented.
(e) Long Lived Assets
In March, 1995 the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard ("SFAS") No.
121, "Accounting For the Impairment of Long Lived Assets and for
Long Lived Assets to the Disposed of." The Company has adopted
SFAS No. 121 as of April 1, 1996. The adoption of SFAS No. 121
was not material.
(f) Income (Loss) Per Common Share
The computation of income (loss) per common share is
based on the weighted average number of common shares
and common stock equivalents (stock options and
warrants), if applicable, assumed to be outstanding
during the year. The weighted average number of shares
used in the computation of income (loss) per common
share
9
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for the quarters ended June 30, 1996 and 1995 are
76,675,448. Common stock equivalents were not included
in the computation of weighted average shares
outstanding because such inclusion would be
anti-dilutive.
(g) Stock-Based Compensation
In October 1995, FASB issued SFAS No. 123, "Accounting
for Stock-Based Compensation," SFAS No. 123
establishes a fair value method for accounting for
stock-based compensation plans either through
recognition or disclosure. The Company has adopted the
employee stock-based compensation disclosure
provisions of SFAS No. 123 on April 1, 1996. The
adoption of this standard did not impact the Company's
consolidated results of operations, financial position
or cash flows.
2. Business Dispositions
Spectrum Global
Effective October 17, 1995, the Company sold its Spectrum
Global subsidiary for net proceeds of approximately
$4,549,000, after expenses of $325,000, to a buying group
including certain former members of management. Spectrum
Global was acquired in fiscal 1994 from the nephew of the
former President of the Company for approximately
$4,120,000. Spectrum Global has been reported as a
discontinued operation for all periods presented.
The following table summarizes the net assets of Spectrum
Global for the periods presented:
(Amounts in thousands) October 17,
1995
- -------------------------------------------------------------
Cash $1,227
Accounts receivable 1,899
Other assets 2,237
Accounts payable (243)
Other liabilities (117)
-------------------
Net assets $5,003
===================
The summary of Spectrum Global's results of discontinued
operations for the periods presented are as follows:
(Amounts in thousands)
Three months ended June 30, 1996 1995
- -------------------------------------------------------------------------
Revenues $- $2,963
Net loss $- $ 271
10
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3. Litigation
Bankruptcy Proceedings
On January 26, 1995 (the "Petition Date"), the Company
and three of its four operating subsidiaries (Computer
Bay, Data One and Cellular) filed petitions for relief
under Chapter 11 of the Bankruptcy Code in the United
States Bankruptcy Court for the Eastern District of
New York (the "Bankruptcy Court"), Case Nos. 195 10690
260, 195 10691 260, 195 10692 260 and 195 10693 260,
respectively (the "Chapter 11 case"). Spectrum Global
did not file for bankruptcy protection. On February 8,
1995, the United States Trustee appointed an Official
Committee of Unsecured Creditors to represent the
creditors of Spectrum (the "Committee"), and another
committee for Computer Bay to represent the interests
of all unsecured creditors whose claims arose before
the Petition Date. No other committees have been
appointed. On May 25, 1995, the Bankruptcy Court, upon
motion by the Debtors, converted the Computer Bay
proceeding to a case under Chapter 7 of the Bankruptcy
Code. A trustee has been appointed to oversee
liquidation of the Computer Bay assets. Spectrum and
Cellular have been substantively consolidated in the
bankruptcy proceeding and are continuing to manage
their affairs and operate their business under Chapter
11 as debtors in possession while awaiting Bankruptcy
Court approval of their proposed plan of
reorganization (Note 1(b)). If the Bankruptcy Court
confirms the Plan at the scheduled confirmation
hearing, consummation of the Plan and its effective
date will remain contingent upon District Court
approval of the Class Action Settlement. If the Plan
is not confirmed and consummated, the alternatives
include: (a) continuation of the pending Chapter 11
cases; (b) alternative plans of reorganization; or (c)
liquidation of Debtors under Chapter 7 or Chapter 11
of the Bankruptcy Code. (See Part II - Item 1 - Legal
Proceedings for a summary of the terms of the Plan and
the principal proceedings in the Chapter 11 case.) A
separate liquidating plan of reorganization under
Chapter 11 has been filed for Data One. A confirmation
hearing on Data One's liquidating plan is scheduled
for August 6, 1996.
Computer Bay Trustee's Claim
On May 25, 1995, the Bankruptcy Court, upon motion by
the Debtors, converted the Computer Bay proceeding to
a case under Chapter 7 of the Bankruptcy Code. An
independent trustee has been appointed to oversee
liquidation of Computer Bay's Chapter 7 estate. The
Computer Bay trustee filed a claim with the
11
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Bankruptcy Court seeking to substantively consolidate
the Computer Bay estate and liabilities with the
estates and liabilities of the Company. The Debtors
filed an objection to this claim on November 20, 1995.
In furtherance of his proofs of claim, on January 11,
1996 the Computer Bay trustee filed a complaint
commencing litigation against the Company seeking to
substantively consolidate the Computer Bay estate with
the Debtor's estate and, in the alternative, seeking
the return of alleged preferences and fraudulent
conveyances in the amount of $4,351,396 (the "Computer
Bay Litigation"). The Debtors filed an answer on
January 23, 1996. On February 27, 1996, the Computer
Bay trustee informed the Company that it would seek
permission from the Bankruptcy Court to add two of the
Company's then executive officers as defendants in
this litigation. The Debtors asserted counterclaims
against the Computer Bay estate in the amount of
$2,430,436.
On March 15, 1996, the Debtors, the Committee and the
Computer Bay trustee agreed to a settlement of the
Computer Bay Litigation, which was approved by the
Bankruptcy Court on March 28, 1996. The settlement
calls for the Computer Bay estate to receive
distributions under the Plan of $600,000 in cash and
$300,000 in Spectrum common stock to be distributed
approximately one month after the Plan's effective
date. Consummation of the settlement is contingent
upon confirmation of the Plan.
Securities Related Proceedings
On February 9, 1994, the class action filed against
the Company and two of its former officers in May 1993
(In re Spectrum Information Technologies, Inc.
Securities Litigation, United States District Court
for the Eastern District of New York, Civil Action No.
93-2295) (the "Class Action Suits") was supplemented
(i) to extend the end of the class period from May 21,
1993 to February 4, 1994, (ii) to add additional
claims against Spectrum and the individual defendants,
and (iii) to add certain of its then officers as party
defendants. In April 1994, a Second Consolidated
Amended Class Action Complaint was filed adding
additional employees as party defendants. The class
and certain subclasses have been certified. A similar
putative class action filed in the United States
District Court for the Southern District of Texas has
been transferred and consolidated with the Class
Action Suits.
The plaintiffs in the Class Action Suits claim to have
purchased the Company's securities at prices which the
Company and the individual defendants allegedly
artificially inflated by, among other things: (i)
misrepresenting the potential value of the patent
license agreement the Company entered into with AT&T;
(ii)
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improperly accounting for revenues and expenses in
connection with certain license and advertising
agreements; (iii) failing to disclose the existence of
an inquiry initiated by the Securities and Exchange
Commission (the "SEC"); and (iv) making misleading
statements regarding the employment of John Sculley.
In addition, there are claims against certain of the
individual defendants for improper insider trading.
The Company's former management, based on the advice
of its then counsel, believed the Company had good and
meritorious defenses to the claims against it.
On July 20, 1994, the Company, certain of its then
officers and directors, and two former officers and
directors were served with a class action complaint.
The complaint asserts that Spectrum knowingly or
recklessly made material false statements or omitted
material facts in its financial reporting relating to
Computer Bay prior to announcing the restatement of
earnings for the fiscal year 1992 and the first three
quarters of fiscal 1993 to correct inaccurate accruals
of certain items into income. For pretrial purposes,
this litigation has been consolidated with the Class
Action Suits described above.
In November 1995, the Company announced that an
agreement in principle had been reached on a framework
for settlement of the Class Action Suits (the "Class
Action Settlement"). The Class Action Settlement is
contingent on numerous factors including, among other
things, the successful resolution of the Home Action
(See Other Proceedings and Note 4), the negotiation
and execution of a definitive settlement agreement,
the Company's ability to develop and confirm a plan of
reorganization in the Company's pending bankruptcy
proceeding satisfactory to all interested parties,
including the Class Action Plaintiffs, and the
approval of the Class Action Settlement by the
District Court. The Bankruptcy Court approved the
Class Action Settlement on January 19, 1996. The Class
Action Plaintiffs in the Class Action Suits had filed
a claim against the Company in its bankruptcy
proceedings in the amount of approximately $676
million. The Class Action Settlement, if consummated,
will be in satisfaction of that claim as well as any
and all claims of the individual defendants (former
directors and officers) in that suit against the
Company.
Under the terms of the Class Action Settlement, the
Company and the representatives of the Class Action
Plaintiffs have agreed to a framework under which the
Company will issue to the Class Action Plaintiffs in
its plan of reorganization a number of shares of its
Class A Preferred Stock that would be equal to the
number of shares of Distributable Common Stock
available to Spectrum's stockholders and certain
creditors following
13
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confirmation of the Plan. In addition, under the Class
Action Settlement, the Class Action Plaintiffs are to
receive the proceeds, net of certain fees and
expenses, from insurance policies worth $10 million
covering the liabilities of the Company's directors
and officers and, as a result of court supervised
negotiations and at the recommendation of the District
Court, $1,350,000 from the various individual
defendants in the action plus $250,000 from the
Company.
One of the uncertainties surrounding the Class Action
Settlement is that issuers of insurance policies
representing $6 million out of the $10 million of the
insurance necessary to fund the Class Action
Settlement have disclaimed coverage. On July 15, 1996,
the District Court issued a decision favorable to the
Company in this coverage dispute. (See Other
Proceedings and Note 4).
In May 1993, the SEC initiated a confidential and
informal fact gathering inquiry apparently directed
toward statements the Company purportedly made
regarding the potential value of the patent license
agreement it had entered into in fiscal 1994 with
AT&T. On December 6, 1993, following the Company's
dismissal of its outside auditors, the SEC issued a
formal order of investigation. The Company believes
that a focus of the investigation related to
accounting and disclosure issues with respect to
certain of the patent license and advertising
agreements it entered into during fiscal 1994 and also
related to other activities of the Company's previous
management. The accounting treatment at issue in the
investigation, which had been implemented after
consultation with the Company's previous outside
auditors and had been disclosed in the Company's
quarterly filings with the SEC, was revised by
Spectrum when it voluntarily restated its earnings on
February 7, 1994.
In April 1996, the SEC staff informed the Company that
it intended to commence an administrative proceeding
to determine whether during 1993 the Company had
violated certain sections of the Securities Exchange
Act of 1934 and rules promulgated thereunder,
including violations of Rule 10b-5, related to
accounting and disclosure issues with respect to
certain patent and advertising agreements it entered
into during fiscal 1994. In April 1996, the Company
began discussions with the SEC to resolve the SEC's
ongoing investigation. Those discussions contemplate
the entry of an administrative cease and desist order
against the Company, but do not contemplate the
imposition of any financial penalties. The Company's
discussions with the SEC are ongoing.
In connection with this investigation, Salvatore T. Marino, a
current employee and former officer of the Company informed the
14
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Company in April 1996 that the SEC staff intended to
commence a proceeding against him for violations of
certain sections of the Securities Exchange Act of
1934 and rules promulgated thereunder, including
violations of Rule 10b-5, related to accounting and
disclosure issues with respect to certain patent and
advertising agreements the Company entered into during
fiscal 1994 and the exercise of options to purchase
and subsequent sale of Spectrum stock in the relevant
time frame. Mr. Marino has denied any wrongdoing and
responded to the staff's allegations. Upon learning of
the SEC staff's position and pending resolution of
this issue, the Company removed Mr. Marino as an
executive officer.
The United States Attorney's Office for the Eastern
District of New York has informed the Company that it
is the subject of an investigation regarding
violations of securities laws that may have occurred
prior to the appointment of the Company's current
Chief Executive Officer and Board of Directors. The
Company is cooperating fully with the investigation.
Patent Related Proceedings
The Company has instituted an interference proceeding
in the U.S. Patent and Trademark Office to establish
that the Company is the inventor of the claimed
subject matter of U.S. Patent 4,991,197 (the "197
Patent"). This proceeding is based on the Company's
belief that Walker Morris, President of Intelligence
Technology Corporation ("ITC"), a party to a joint
development agreement with the Company, wrongfully
obtained the 197 Patent based on the technology
invented by the Company. The Company has been granted
a patent to cover this invention, U.S. Patent
4,972,457. In the course of the interference
procedure, ITC has allowed deadlines to pass without
taking steps to preserve its right to submit evidence
showing any date of invention earlier than the filing
date of the Walker Morris patent application. The
Company believes that it has persuasive evidence
proving an earlier date of invention than the Walker
Morris filing date, and has preserved its right to
submit such evidence. Shortly before execution of a
settlement agreement under which ITC would concede
priority of invention to the Company and would receive
a restricted field license under U.S. Patent
4,972,457, Walker Morris provided the Company
information regarding a patent application that Walker
Morris alleged was outside the scope of the
interference. The Patent Office granted the Company's
motion, however, to include the newly disclosed patent
in the pending interference. The Company believes that
it will ultimately be awarded dominant rights to both
patents in the interference.
15
<PAGE>
Other Proceedings
In an action against the Company and certain former
employees in the Superior Court of New Jersey,
Middlesex County, entitled Douglas H. Anderson v.
Dealer Service Business Systems, Inc. d/b/a Data One
et al., Docket No. L-11315-92, the plaintiff alleged
breach by the Company of an employment contract and
age discrimination by the plaintiff's employer, Data
One. The plaintiff further alleged that the Company
and certain former employees interfered with his
employment contract and inflicted emotional distress.
Mr. Anderson did not file a proof of claim against the
Company and the Bankruptcy Court ruled on July 16,
1996 that Mr. Anderson was barred from filing such a
claim against the Company. In October 1995, Mr.
Anderson filed a proof of claim against Data One
alleging $1.5 million in damages based on the
allegations described above. Data One objected to this
claim on the grounds that, among other things, it was
not timely filed. Data One and Mr. Anderson have
entered a settlement allowing Mr. Anderson an
unsecured claim against Data One in the amount of
$80,000, with payments made pursuant to the terms of
Data One's liquidating plan of reorganization.
On July 21, 1995, The Home Insurance Company of
Illinois ("The Home"), the Company's former directors'
and officers' primary insurance carrier, commenced an
adversary proceeding (the "Home Action") in the
Company's bankruptcy proceeding. The Honorable
Frederick Block, United States District Judge of the
District Court, subsequently withdrew the reference
with respect to the Home Action such that the
litigation is now pending before him. The Home sought
to rescind a renewal of a directors' and officers'
liability and company reimbursement policy issued in
June 1993 to the Company for the benefit of its
directors and officers (the "Renewal Policy") and
alleged certain material misrepresentations and/or
omissions in the application for the Renewal Policy.
The Home also sought a declaration that coverage is
not afforded under the Renewal Policy for the claims
made against the policy by the Company and certain of
its officers and directors.
In addition to the primary policy, the Company
obtained three excess policies for the insurance year
at issue in the Home Action. Two of the excess
carriers, the Agricultural Excess and Surplus
Insurance Company ("AESIC") and The Aetna Casualty and
Surety Company ("Aetna") have intervened in the Home
Action. AESIC has agreed to be bound by any final
judicial resolution regarding The Home (a similar
agreement was previously reached with the third excess
carrier) and is no longer actively participating in
the Home Action. The District Court heard the trial in
the Home Action on February 28 and 29, 1996 and issued a
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<PAGE>
decision that was favorable to the Company on July 15, 1996.
(Note 4).
From time to time, the Company has been a party to
other legal actions and proceedings incidental to its
business. As of the date of this report, however, the
Company knows of no other pending or threatened legal
actions that could have a material impact on the
financial condition of the Company.
4. Subsequent Events
On July 15, 1996, the District Court ruled against the
insurance carriers in their attempt to rescind the
directors' and officers' insurance policies at issue
in the Home Action. The Court also ruled that any
losses in the Class Action Suits related to Spectrum's
February 1994 restatement of earnings would be covered
by the policies at issue. The Court concluded that it
could not decide, based on the record before it,
whether the policies at issue would cover claims in
the Class Action Suits related to alleged insider
trading by certain of the Company's former officers
and alleged misstatements regarding John Sculley's
employment with the Company. Home and Aetna have
informed the Company that they intend to appeal
certain aspects of the decision.
Notwithstanding this intended appeal, the parties to
the Class Action Suits and the insurance carriers have
tenatively reached an agreement to implement the Class
Action Settlement. Under this agreement, each insurance
carrier has agreed to contribute the full coverage
available under its disputed insurance policy, up to
$6 million, if they are unsuccessful in the appeal.
This agreement to implement the Class Action Settlement
remains subject to the completion and execution of a
definitive agreement. The parties to the Class Action
Suits and the insurance carriers are preparing a definitive
agreement reflecting this agreement. The Class Action
Settlement also remains contingent upon several
factors, including completion and execution of a
definitive agreement, confirmation of the Plan and
District Court approval.
The Company intends to proceed with the confirmation
of the Plan on August 14, 1996. If confirmed, the Plan
will be consummated after District Court approval of
the Class Action Settlement becomes final.
17
<PAGE>
Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Organization And Business Combination
The Company owns a portfolio of patents relating to
commercially practicable methods to transmit data over
circuit-switched cellular networks. Spectrum, through its
Cellular subsidiary, had operated primarily as an intellectual
property company generating much of its revenues from royalties
associated with the licensing of its proprietary technology.
Beginning in January 1995, however, Spectrum's new management and
Board of Directors began implementing a strategic plan that
fundamentally refocuses the Company. Spectrum's current business
strategy is to become a leading provider of value added mobile
communications software and related products.
Historically, Spectrum had operated as a holding company of
several operating subsidiaries. Beginning in January 1995, when
Spectrum and three of its subsidiaries filed petitions for relief
under Chapter 11 of Federal Bankruptcy Code, and continuing
through the quarter ended June 30, 1996, Spectrum's management
began to restructure the Company to focus on its current business
strategy. Spectrum closed two of its unprofitable subsidiaries,
the liquidations of which are under the supervision of the
Bankruptcy Court. The Company sold the capital stock of its
wholly-owned subsidiary, Spectrum Global, effective October 17,
1995. (See Notes 1(a) and 2 to the Consolidated Financial
Statements). Spectrum Global had not filed for bankruptcy and was
not essential to Spectrum's success in the mobile communications
arena. Finally, as part of the reorganization process, upon
motion by the Debtors, the Bankruptcy Court substantively
consolidated the Company's bankruptcy estate with that of its
Cellular subsidiary. Spectrum and Cellular are now conducting the
Company's core business as a single corporate entity and the
Company intends to merge Spectrum and Cellular. (See Part 2 -
Other Information - Item 1 - Legal Proceedings - Bankruptcy
Proceedings.) The discussion of the business of Spectrum in this
report refers to the business that was formerly conducted by
either Spectrum or Cellular. Spectrum Global, Data One and
Computer Bay are reflected in the consolidated financial
statements as discontinued operations.
Chapter 11 Proceedings
On January 26, 1995, as part of new management's effort to
stem the Company's substantial financial losses and focus on
developing its core wireless technology, the Company together
with its wholly-owned subsidiaries Computer Bay, Data One and
Cellular (collectively, the "Debtors") filed petitions for relief
under Chapter 11 of the Federal
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<PAGE>
Bankruptcy Code. Upon motion by the Debtors, the bankruptcy court
converted the action for Computer Bay to a case under Chapter 7
of the Bankruptcy Code. A trustee is overseeing the liquidation
of Computer Bay's assets and the Company no longer has control
over the Computer Bay estate. Data One has filed a separate
liquidating plan of reorganization.
Due to the Chapter 11 filing, the Company's liquidity
position has been positively affected because the cash
requirements for the payment of accounts payable and other
liabilities, which arose prior to the Chapter 11 filings, are in
most cases deferred until a plan of reorganization is confirmed
by the Bankruptcy Court. The positive effect has also been
enhanced by the Bankruptcy Court approved sale of certain assets,
but has been offset by the increased administrative and
professional fees associated with the Chapter 11 filing and
resolution of claims subject to compromise.
On March 14, 1996, the Bankruptcy Court approved the
adequacy and distribution of the Third Amended Disclosure
Statement with respect to the Third Amended Consolidated Plan of
Reorganization Proposed by Spectrum Information Technologies,
Inc. and Spectrum Cellular Corporation, Debtors in Possession,
Dated as of March 18, 1996. The Company distributed the
Disclosure Statement, along with the associated Plan and voting
ballots, to its creditors and shareholders of record as of March
18, 1996. The Bankruptcy Court set April 22, 1996 as the deadline
for voting on the Plan. Each class entitled to vote on the Plan
accepted the Plan. Over 97% of Spectrum's voting unsecured
creditors, representing over 99% of the total dollar amount
voted, supported the Plan. Under the Bankruptcy Code, a class
accepts a plan if two-thirds in amount and a majority in number
of the holders of claims voting cast ballots in favor of
acceptance. Holders of Spectrum's common stock representing
approximately 27.6 million shares returned ballots, with over 95%
of those shares voted in favor of confirmation. A class of equity
interests is deemed to have accepted a plan if the plan is
accepted by holders of such interest that hold at least
two-thirds of the allowed interests that have voted on the plan.
The Bankruptcy Court initially scheduled a confirmation hearing
for May 3, 1996, which has since been rescheduled for August 14,
1996. The Bankruptcy Court has rescheduled the confirmation
hearing several times at the Company's request while the Company
was awaiting a ruling by the United States District Court for the
Eastern District of New York in a coverage dispute with certain
of the Company's former insurance carriers. On July 15, 1996, the
District Court issued a decision favorable to the Company, and
the insurance carriers stated that they intended to appeal
certain aspects of the decision (Notes 3 and 4). If the
Bankruptcy Court confirms the Plan at the scheduled confirmation
hearing, consummation of the Plan and its effective date will
remain contingent upon District Court approval of the Class
Action Settlement.
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<PAGE>
The adequacy of the Company's capital resources and
long-term liquidity will be determined when a plan of
reorganization is confirmed by the Bankruptcy Court. (See
Liquidity and Capital Resources).
Summary of Operations
The following table sets forth, for the periods indicated,
the percentage relationship that certain items bear to revenue.
This summary provides trend data relating to the Company's normal
recurring operations. Amounts set forth below reflect the
Company's Spectrum Global, Data One and Computer Bay subsidiaries
as discontinued operations.
(Amounts in thousands)
Quarters Ended June 30, 1996 % 1995 %
- ----------------------------------------------------------------------------
Revenues $ 808 100.0 $1,031 100.0
----------- --------- ---------- ---------
Operating costs and
expenses:
Cost of revenues 24 3.0 123 11.9
Selling, general and
administrative 1,334 165.1 2,127 206.3
----------- --------- ---------- ---------
Total operating costs
and expenses 1,358 168.1 2,250 218.2
----------- --------- ---------- ---------
Operating income (loss) $ (550) (68.1) $(1,219) (118.2)
=========== ========= ========== =========
Consolidated Revenues
Consolidated revenues decreased approximately $223,000 or
22% for the quarter ended June 30, 1996 as compared to the
quarter ended June 30, 1995 due to decreases in licensing income
and merchandise sales of approximately $71,000 or 9% and $152,000
or 75%, respectively. Licensing revenues decreased $509,000
primarily because a certain licensee that paid royalties during
the quarter ended June 30, 1995 did not pay royalties during the
quarter ended June 30, 1996. This licensee did not make ongoing
royalty payments because the Company and the licensee converted
an existing license to a paid up license during the quarter ended
March 31, 1996 pursuant to the terms of a Bankruptcy Court
approved settlement. This decrease was offset by an increase in
licensing revenues of approximately $188,000 related to increased
payments made pursuant to a licensing agreement the Company
entered in fiscal 1994 and by approximately $204,000 as a result
of a settlement with a certain licensee for past due royalties.
Merchandise sales decreased partially because of the Company's
sale of the AXCELL (Registered Trademark) product line in July
1995. AXCELL (Registered Trademark) sales were approximately
$132,000 for the
20
<PAGE>
three months ended June 30, 1995. Merchandise sales have also
decreased because the Company has withheld selling cables for use
with Motorola Inc. cellular telephones until the Company fully
implements procedural requirements of the cross-license agreement
with Motorola at which time the Company can sell activation kits.
Operating Costs and Expenses
Operating costs and expenses for the three months ended
June 30, 1996 decreased $892,000 or 40% when compared to the
three months ended June 30, 1995 primarily due to decreased
selling, general and administrative expenses of approximately
$793,000 or 37% and decreased cost of sales of approximately
$99,000 or 80%.
The decrease in selling, general and administrative
expenses for the quarter ended June 30, 1996 was the result of
several factors, including decreases in legal fees (other than
legal fees associated with the Company's bankruptcy proceedings)
of $318,000 or 50%. A majority of the non-bankruptcy related
legal matters involving the Company have been settled as part of
the Plan. Insurance expense decreased approximately $193,000 or
51% for the three months ended June 30, 1996 as compared to the
same period in the prior year primarily because of a reduction in
directors' and officers' insurance premiums. For the quarter
ended June 30, 1996, depreciation and amortization decreased
approximately $118,000 or 79% as compared to the quarter ended
June 30, 1995 primarily because the Company is no longer
depreciating or amortizing certain assets that it disposed during
the fourth quarter of the fiscal year ended March 31, 1996.
Personnel and related expenses and outside services decreased
approximately $79,000 or 13% and $93,000 or 61%, respectively,
for the three months ended June 30, 1996 as compared to the three
months ended June 30, 1995. The decrease in personnel and related
expenses is due primarily to the Company's downsizing of
operations and the decrease in outside services is because the
Company is no longer using outside accounting services.
The decrease in cost of sales is a direct result of the
decreased merchandise sales for the quarter ended June 30, 1996
as compared to the quarter ended June 30, 1995.
Operating Loss
For the quarter ended June 30, 1996, the Company's
operating loss decreased approximately $668,000 to $550,000, as
compared to $1,219,000 for the quarter ended June 30, 1995. This
55% reduction is due to decreased operating costs and expenses of
approximately $892,000 or 40%, which was offset by decreased
revenues of approximately $223,000 or 22%.
21
<PAGE>
Other Income and Expense
For the three months ended June 30, 1996, other income
increased approximately $156,000 or 261% as compared to the three
months ended June 30, 1995 primarily due to a decrease in other
expense of approximately $98,000 or 100% and increased interest
income of approximately $54,000 or 139%. Interest income
increased because the Company had higher cash balances for the
quarter ended June 30, 1996 than during the quarter ended June
30, 1995.
Discontinued Operations
The Company has recorded a gain of $2,539,000 by writing
off the net liabilities of its Computer Bay subsidiary as a
result of the conversion of Computer Bay's bankruptcy filing into
a Chapter 7. On October 17, 1995, the Company sold its Spectrum
Global subsidiary which is reflected as a discontinued operation.
Income from Spectrum Global's operations for the three months
ended June 30, 1995 was $270,000.
Liquidity and Capital Resources
Since inception, the Company has experienced significant
operating losses and operating cash flow deficits which
ultimately caused the Company to file for bankruptcy protection
under Chapter 11 on January 26, 1995. The Company continues to
review expenses in order to conserve cash.
During the quarter ended June 30, 1996, working capital
(current assets less current liabilities) decreased by
approximately $918,000 primarily because of a decrease in cash
and cash equivalents of $1,453,000. Cash was used to reduce
accounts payable and accrued liabilities related to legal fees
and costs associated with the Company's pending bankruptcy by
approximately $1,107,000, but was offset by the decrease in
accounts receivable of approximately $712,000 due to receipts of
payments pursuant to a certain licensing agreement.
Net cash used by operating activities decreased from
$1,809,000 for the three months ended June 30, 1995 to $1,429,000
for the quarter ended June 30, 1996. The decrease was primarily
because the discontinued operations of Computer Bay and Spectrum
Global used approximately $1,696,000 during the quarter ended
June 30, 1995 and used no cash during the quarter ended June 30,
1996. The decrease was offset by an increase in net cash used by
continuing operations. Net cash used by continuing operations
increased from $113,000 for the quarter ended June 30, 1995 to
$1,429,000 for the quarter ended June 30, 1996. This increase is
22
<PAGE>
primarily because the Company paid the Third Interim Fee
Application for professionals retained in connection with its
bankruptcy proceeding during the quarter ended June 30, 1996, but
did not pay any such fees during the quarter ended June 30, 1995.
Net cash used by investing activities was $24,000 for the
quarter ended June 30, 1996, compared to net cash provided by
investing activities of $434,000 for the same quarter last fiscal
year. The decrease is primarily because the Company received a
deposit of $500,000 related to the sale of the AXCELL(R) product
line during the quarter ended June 30, 1995.
Capital expenditures amounted to approximately $24,000 for
the three months ended June 30, 1996. These expenditures are
primarily related to the outfitting of new offices in the
Atlanta, Georgia and Boston, Massachusetts areas. Capital
expenditures for the year ended March 31, 1997 are expected to be
approximately $263,000.
The adequacy of the Company's capital resources and
long-term liquidity will be determined when a plan of
reorganization is confirmed by the Bankruptcy Court. Confirmation
of the Company's proposed Plan will adversely impact the
Company's short term liquidity because of the cash payments that
the Company will make pursuant to the Plan to holders of secured,
administrative and unsecured claims. Assuming the Plan is
confirmed in accordance with the assumptions and business plan
set forth in the Disclosure Statement, however, the Company will
have adequate capital resources and liquidity to fund its
operations. The Company's long term liquidity is largely
dependent upon the Company's ability to generate a positive cash
flow from its reorganized business and, if necessary, raise
additional capital. Further, if the Company's proposed Plan is
not confirmed and no alternative plan of reorganization is
approved, such uncertainties raise substantial doubt about the
Company's ability to continue as a going and the Company may be
forced to liquidate under either Chapter 7 or Chapter 11 of the
Bankruptcy Code.
Risk Factors
The Company's management believes that developing a product
based strategy is essential to the long term success of the
Company as a going concern. Leveraging the Company's proprietary
wireless driver software assets and capabilities into a mobile
communications software business offers near term opportunity to
achieve turnaround. Management's strategy, as described above and
elsewhere throughout this report, however, contains forward
looking tactics and statements that are subject to significant
risk and uncertainty. Failure to successfully implement this
23
<PAGE>
strategy will raise substantial doubt about the Company's ability
to continue as a going concern.
Spectrum has suffered significant losses from continuing
operations in each fiscal year since inception. Even after the
Company's recent restructuring, management does not believe that
the expected royalty revenues associated with the licensing of
its existing proprietary technology will be sufficient to reverse
losses given the expenses associated with maintaining this
royalty revenue stream. Under the current strategy, management
expects to have a continued negative cash flow while it develops
and markets a new line of mobile communications software
products. Unlike its competitors, the Company's limited financial
resources do not allow the Company significant room to err in its
product development and marketing.
Risks associated with the current strategy include, but are
not limited to, overcoming the negative image Spectrum has
developed in the past and its ability to rebuild credibility in
the marketplace; successfully developing software products that
bring value to mobile communications software markets; developing
relationships with existing licensees, some of which are current
competitors, into channels for distribution of new products;
developing new channels for distribution; hiring key technical
and marketing staff to implement the strategy; competing
successfully within markets where competitors have significantly
more resources and access to capital than the Company;
realization of market forecasts by industry specialists regarding
wireless and mobile communications market growth; limited capital
investment upon exiting Chapter 11; the timeliness of
confirmation of the Plan and its effective date; and the ability
of the Company to raise additional capital, if necessary. The
following specific risk factors should be considered in
evaluating Spectrum's ability to achieve a successful turnaround.
Bankruptcy Proceedings. District Court approval of the Class
Action Settlement (Notes 3 and 4, and Part II - Other Information
Item 1 - Legal Proceedings - Securities Related Proceeding) is a
condition precedent to consummation and the effective date of the
Plan. (See Notes 3 and 4). If the Class Action Settlement is not
approved, it is highly unlikely that the Plan, as written, will
be consummated. If the Plan is not consummated, the alternatives
include: (a) continuation of the pending Chapter 11 cases; (b)
alternative plans of reorganization; or (c) liquidation of the
Debtors under Chapter 7 or Chapter 11 of the Bankruptcy Code.
Each alternative raises substantial doubts about the Company's
ability to continue as a going concern.
24
<PAGE>
Past Operating History. The Company's future must be considered
in light of the risks associated with the past difficulties and
negative press encountered by Company. To address these risks,
the Company must, among other things, rebuild management and
technical credibility with current and potential customers,
continue to attract, retain and motivate qualified persons, and
continue to upgrade its technologies and commercialize products
and services incorporating such technologies. There can be no
assurance that the Company will be successful in addressing such
risks. The Company has incurred net losses since inception and
expects to continue to operate at a loss for the foreseeable
future until new product development and market acceptance of its
products are achieved.
Developing Market; Acceptance of the Company's Products. The
market for the Company's software and services has only recently
begun to develop, is rapidly evolving and is characterized by an
increasing number of market entrants who have introduced or
developed products and services for mobile communication. As is
typical in the case of a growing industry, demand and market
acceptance for recently introduced products and services are
subject to a high level of uncertainty. While the Company
believes that its software products will offer advantages for
mobile communications, there can be no assurance that the
Company's products for mobile communication will become widely
adopted.
Because the market for the Company's products and services
is evolving, it is difficult to predict the future growth rate,
if any, and size of this market. There can be no assurance that
the market for the Company's products and services will develop,
that the Company's products or services will be adopted, or that
mobile PC users in the business sector will use wireless networks
for data communication. If the market fails to develop, develops
more slowly than expected or becomes saturated with competitors,
or if the Company's products do not achieve market acceptance,
the Company's business, operating results and financial condition
will be materially adversely affected.
Competition. The market for mobile communications software and
services is relatively new, becoming intensely competitive,
rapidly evolving and subject to rapid technological change. The
Company expects competition to persist, intensify and increase in
the future. Almost all of the Company's current and potential
competitors have longer operating histories producing software
products, greater name recognition, larger installed customer
bases and significantly greater financial, technical and
marketing resources than the Company. Such competition could
materially adversely affect the Company's business, operating
25
<PAGE>
results or financial condition. The Company's key current
competitors include Megahertz, a subsidiary of U.S. Robotics,
Motorola and AT&T, all of which are licensees of the Company.
New Product Development and Technological Change. Substantially
all of the Company's current and near term revenues are expected
to be derived from the licensing of its proprietary technology
and sale of its associated activation kits. Accordingly, broader
acceptance of the Company's activation products by customers is
essential to the Company's near term success. The Company's
ability to design, develop, test and support new software
products and enhancements on a timely basis that meet changing
customer needs and respond to technological developments and
emerging industry standards is also critical to the Company's
long term success. There can be no assurance that the Company
will be successful in developing and marketing new software
products and enhancements that meet changing customer needs and
respond to such technological changes or evolving industry
standards. The Company's activation kit products are designed for
use primarily with circuit switched cellular networks. Future
sales of the Company's products will be dependent, in part, on
software products that are independent of networks and are
functional to support mobile user needs, anyplace, anytime. The
Company's inability to successfully expand its product offerings
will have a material adverse effect on the Company's business,
operating results or financial condition.
Evolving Distribution Channels. The Company's strategy is to
develop multiple distribution channels. The Company has
historically sold its activation kit products only through some
of its licensees which are original equipment manufacturers
("OEMs"). The Company expects to increasingly utilize other OEMs
which have competing products and has recently begun marketing
efforts to these potential customers. In the future, the Company
plans to utilize value added resellers ("VARs") as a channel for
more advanced software products. The Company expects that
increased sales through certain OEMs and VARs will adversely
affect the Company's average selling prices and gross margins due
to the lower unit prices that are typically charged when selling
through indirect channels. Moreover, there can be no assurance
that the Company will be able to attract VARs that will be able
to market the Company's products effectively. Consequently, the
Company may be adversely affected should it fail to adequately
penetrate either channel. The inability to recruit, manage or
retain important VARs, or their inability to penetrate their
respective market segments, could materially adversely affect the
Company's business, future business, operating results or
financial condition.
26
<PAGE>
The Company plans to develop a sales force and expand its
telemarketing. There can be no assurance that such internal
expansion will be successfully completed, that the cost of such
expansion will not exceed the revenues generated, or that the
Company's sales and marketing organization will be able to
successfully compete against the significantly more extensive and
well-funded sales and marketing operations of many of the
Company's current or potential competitors. The Company's
inability to effectively manage its internal expansion could have
a material adverse effect on the Company's business, operating
results or financial condition.
Management of Growth. The timely execution necessary for the
Company to fully exploit the market window for its products and
services requires an effective planning and management process.
Since February 1, 1996, the Company has increased its engineering
staff from two to six employees. To manage its growth, the
Company must continue to implement and improve its operational
and financial systems and to expand, train and manage its
employee base. There can be no assurance that the Company will be
able to successfully implement these activities on a timely
basis. Further, the Company will be required to manage multiple
relationships with various customers and other third parties.
Although the Company believes that it has made adequate
allowances for the costs and risks associated with this
expansion, there can be no assurance that the Company's systems,
procedures or controls will be adequate to support the Company's
operations or that the Company's management will be able to
achieve in a timely manner the expansion necessary to fully
exploit the market window for the Company's products and
services. If the Company is unable to manage growth effectively,
the Company's business, operating results and financial condition
will be materially adversely affected.
Dependence on Key Personnel. The Company's performance is
substantially dependent on the performance of its executive
officers and key employees, most of whom have worked together for
only a short period of time. Given the Company's early stage of
transition and restructuring, the Company is dependent on its
ability to retain and motivate high quality personnel, especially
its management and highly skilled development teams. The loss of
the services of any of its executive officers or other key
employees could have a material adverse effect on the business,
operating results or financial condition of the Company.
The Company's future success also depends on its continuing
ability to identify, hire, train and retain other highly
qualified technical personnel. Competition for such personnel is
intense, and given Spectrum's past history, there can be no
27
<PAGE>
assurance that the Company will be able to attract, assimilate or
retain other highly qualified technical and managerial personnel
in the future. The inability to attract and retain the necessary
technical and managerial personnel could have a material adverse
effect upon the Company's business, operating results or
financial condition.
Limited Capital Resources. If the Company successfully emerges
from Chapter 11 bankruptcy, it will have limited cash assets to
invest in product development and marketing and selling. It is
critical, therefore, to the Company's business, operating,
results and financial condition that timely product introduction
and market acceptance is achieved. Any delays or reduction in
product shipments will have a materially adverse effect on the
Company's business, operating results and financial condition.
Market Listing; Volatility of Stock Price. Spectrum was delisted
from the NASDAQ National Market in April 1995. Since then, the
Company's common stock has been traded on the NASD OTC Bulletin
Board. If the Company successfully emerges from Chapter 11, there
can be no assurance that an active public market for the common
stock will develop or be sustained. Further, the market price of
the Company's common stock is likely to be highly volatile and
could be subject to wide fluctuations in response to exiting
Chapter 11, quarterly variations in operating results,
announcements of technological innovations or new products by the
Company or its competitors, or other events or factors. In
addition, the Company is planning to apply for listing on one of
the major exchanges in the future. There can be no assurances the
Company will be accepted for listing.
Shares Eligible for Future Sale. Sale of a substantial number of
shares of common stock in the public market following the
Company's emergence from Chapter 11 through the distribution of
preferred stock to class action plaintiffs and the conversion of
preferred stock to common stock could adversely affect the future
market price for the common stock. (See Note 3 and Part II Other
Information Item 1 - Legal Proceedings - Bankruptcy Related
Proceedings).
28
<PAGE>
Spectrum Information Technologies, Inc. and Subsidiaries
(Debtors in Possession)
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Bankruptcy Proceedings
On January 26, 1995 (the "Petition Date"), the Company and
three of its four operating subsidiaries (Computer Bay, Data One
and Cellular) filed petitions for relief under Chapter 11 of the
Bankruptcy Code in the United States Bankruptcy Court for the
Eastern District of New York (the "Bankruptcy Court"), Case Nos.
195 10690 260, 195 10691 260, 195 10692 260 and 195 10693 260,
respectively (the "Chapter 11 case"). Spectrum Global did not
file for bankruptcy protection. On February 8, 1995, the United
States Trustee appointed an Official Committee of Unsecured
Creditors to represent the creditors of Spectrum (the
"Committee"), and another committee for Computer Bay to represent
the interests of all unsecured creditors whose claims arose
before the Petition Date. No other committees have been
appointed. On May 25, 1995, the Bankruptcy Court, upon motion by
the Debtors, converted the Computer Bay proceeding to a case
under Chapter 7 of the Bankruptcy Code. A trustee has been
appointed to oversee liquidation of the Computer Bay assets.
Spectrum and Cellular have been substantively consolidated in the
bankruptcy proceeding and are continuing to manage their affairs
and operate their business under Chapter 11 as debtors in
possession while awaiting Bankruptcy Court approval of their
proposed plan of reorganization. During June 1996, the Bankruptcy
Court authorized Data One to distribute a separate liquidating
plan of reorganization under Chapter 11. All of the voting
creditors supported confirmation of this plan. A confirmation
hearing on Data One's liquidating plan is scheduled for August 6,
1996.
Although the Debtors are authorized to operate their
business as debtors in possession, they may not engage in
transactions outside the ordinary course of business without
first complying with the notice and hearing provisions of the
Bankruptcy Code and obtaining Bankruptcy Court approval. The
Committee may review and object to transactions involving the
Company that are outside of the ordinary course of the Company's
business, may consult with the Company concerning the
administration of the Company's Chapter 11 case, and may
participate in the formulation of a plan of reorganization. The
Company is required to pay certain expenses of the Committee,
including counsel and other professional fees, to the extent
allowed by the Bankruptcy Court. Other parties in
29
<PAGE>
interest in the Chapter 11 case are also entitled to be heard on
motions made in the Chapter 11 case, including motions for
approval of transactions outside the ordinary course of business.
Principal Proceedings in the Chapter 11 Case
Stay of Litigation
Pursuant to section 362 of the Bankruptcy Code, the
commencement of the Debtors' Chapter 11 cases operates as stays,
applicable to all entities, of the following: (i) the
commencement or continuation of a judicial, administrative, or
other proceeding against the Debtors that was or could have been
commenced prior to commencement of the Debtors' Chapter 11 cases,
or to recover for a claim that arose before the commencement of
the Debtors' Chapter 11 cases; (ii) the enforcement of any
judgment against the Debtors that arose before the commencement
of the Debtors' Chapter 11 cases; (iii) the taking of any action
to obtain possession of or to exercise control over the Debtors'
property; (iv) the creation, perfection or enforcement of any
lien against the Debtors' property; (v) the taking of any action
to collect, assess or recover a claim against the Debtors that
arose before the commencement of the Debtors' Chapter 11 cases;
or (vi) the setoff of any debt owing to the Debtors that arose
prior to the commencement of the Debtors' Chapter 11 cases
against a claim held by such creditor or party in interest
against the Debtors that arose before the commencement of the
Debtors' Chapter 11 cases. Any entity may apply to the Bankruptcy
Court for relief from the automatic stay so that it may enforce
any of the aforesaid remedies that are automatically stayed by
operation of law at the commencement of the Debtors' Chapter 11
cases.
Executory Contracts
As debtors in possession, the Debtors have the right, under
the relevant provisions of the Bankruptcy Code, to assume or
reject executory contracts, including real property leases.
Certain parties to such executory contracts with the Debtors,
including parties to such real property leases, may file motions
with the Bankruptcy Court seeking to require the Debtors to
assume or reject those contracts or leases. In this context,
"assumption" means that the Debtors cure or provide adequate
assurance that they will cure all existing defaults under a
contract or lease and provide adequate assurance of future
performance under the contract or lease. "Rejection," which is a
remedy available under the relevant provisions of the Bankruptcy
Code, means that the Debtors are relieved of their obligations to
perform further under the contract or lease. Rejection of an
executory contract or lease is treated as a breach of that
contract immediately before the date of filing
30
<PAGE>
of the petition and gives the nondebtor party the right to assert
a claim against the bankruptcy estate for damages arising out of
the breach which shall be allowed or disallowed as if such claims
had arisen before the date of the filing of the petition.
On June 27, 1996, the Bankruptcy Court approved the
employment contracts of its Chief Technical Officer and Vice
President Software Engineering.
Computer Bay Trustee's Claim
On May 25, 1995, the Bankruptcy Court, upon motion by the
Debtors, converted the Computer Bay proceeding to a case under
Chapter 7 of the Bankruptcy Code. An independent trustee has been
appointed to oversee liquidation of Computer Bay's Chapter 7
estate. The Computer Bay trustee filed a claim with the
Bankruptcy Court seeking to substantively consolidate the
Computer Bay estate and liabilities with the estates and
liabilities of the Company. The Debtors filed an objection to
this claim on November 20, 1995. In furtherance of his proofs of
claim, on January 11, 1996 the Computer Bay trustee filed a
complaint commencing litigation against the Company seeking to
substantively consolidate the Computer Bay estate with the
Debtor's estate and, in the alternative, seeking the return of
alleged preferences and fraudulent conveyances in the amount of
$4,351,396 (the "Computer Bay Litigation"). The Debtors filed an
answer on January 23, 1996. On February 27, 1996, the Computer
Bay trustee informed the Company that it would seek permission
from the Bankruptcy Court to add two of the Company's then
executive officers as defendants in this litigation. The Debtors
asserted counterclaims against the Computer Bay estate in the
amount of $2,430,436.
On March 15, 1996, the Debtors, the Committee and the
Computer Bay trustee agreed to a settlement of the Computer Bay
Litigation, which was approved by the Bankruptcy Court on March
28, 1996. The settlement calls for the Computer Bay estate to
receive distributions under the Plan of $600,000 in cash and
$300,000 in Spectrum common stock to be distributed approximately
one month after the Plan's effective date. Consummation of the
settlement is contingent upon consummation of the Plan.
The Debtors' Exclusivity Period
For 120 days after the Petition Date, the Company has the
exclusive right to propose and file a plan of reorganization with
the Bankruptcy Court. If the Company files a plan of
reorganization during the 120-day exclusivity period, no other
party may file a plan of reorganization until 180 days after the
Petition Date, during which period the Company has the exclusive
31
<PAGE>
right to solicit acceptance of the plan. If the Company fails to
file a plan during the 120-day exclusivity period or such
additional time period ordered by the Bankruptcy Court (the
"Exclusivity Period") or, after such plan has been filed, fails
to obtain acceptance of such plan from Impaired Classes during
the exclusive solicitation period or such additional time period
ordered by the Bankruptcy Court, any party in interest, including
a creditor, an equity security holder, a committee of creditors,
or an indenture trustee, may file a plan of reorganization in the
Chapter 11 proceedings. Additionally, if the Bankruptcy Court
were to appoint a Chapter 11 trustee, any party in interest may
file a plan, regardless of whether any additional time remains in
the Company's Exclusivity Period. The Company filed a plan of
reorganization (the Plan) dated as of March 18, 1996. No other
party may file an alternative plan unless the Plan is not
confirmed.
Setting of the Bar Date for Prepetition Claims
By order of the Bankruptcy Court, the bar date for filing
proofs of claim in the Chapter 11 proceedings was established as
September 7, 1995.
The Debtors' Proposed Plan of Reorganization
The Plan, if confirmed by the Bankruptcy Court, will settle
all material litigation now pending and provide all general
unsecured creditors with 100% of the value of their claims plus
6% interest per annum from the filing date thereon. The Company
has segregated approximately $3.5 million for the payment of
general unsecured claims, the priority non-tax claim and the
Company's cash contribution to the settlement of the class action
lawsuits. To date, the Company has reconciled the majority of the
general unsecured creditor claims, with interest, in the amount
of approximately $2.6 million. Several outstanding claims remain
that the Company is attempting to reconcile before the effective
date of the Plan (the "Effective Date"). The Company does not
believe that the reconciliation of such claims will have a
material effect on the reserve established for payment to
unsecured creditors. The Plan also provides for the payment of
approximately $264,000 on the Effective Date to the holder of the
one priority nontax claim filed against Spectrum. The Plan will
also settle all of the class action lawsuits filed against the
Company by the payment of $250,000 by the Company and the
delivery of approximately 45% of the equity ownership in
reorganized Spectrum to a trustee to be distributed to the
members of the class. (See Securities Related Proceedings and
Note 3.) Under the terms of the proposed Plan, existing
shareholders will be substantially diluted but should obtain the
majority of the 45% equity ownership in reorganized
32
<PAGE>
Spectrum set aside for such shareholders and certain creditors.
This should hold true even after the issuance of $300,000 of
stock to the Chapter 7 trustee of Computer Bay in connection with
the recent settlement of his claim. Holders of allowed
administrative claims (as agreed upon or ordered by the
Bankruptcy Court) will be paid in full under the Plan. The
Company intends to seek a waiver of accrued professional fees
that to date have been held back by the Bankruptcy Court. There
can be no assurance, however, that the Company will be successful
obtaining such waiver.
The Bankruptcy Court has scheduled a confirmation hearing
for August 14, 1996. If the Bankruptcy Court confirms the Plan at
the scheduled confirmation hearing, consummation of the Plan and
its Effective Date will remain contingent upon District Court
approval of the Class Action Settlement.
The Company will amend its certificate of incorporation and
by-laws on the Effective Date. The Amended Certificate contains
certain provisions affecting the rights of shareholders,
corporate governance, and the transferability of Class A
Preferred Stock and Reorganized Spectrum Common Stock (as defined
below). Under the amended certificate of incorporation, the
authorized capital stock of the Company shall be comprised of (i)
10 million shares of reorganized Spectrum common stock
("Reorganized Spectrum Common Stock"), (ii) 1.5 million shares of
Class A preferred stock reserved for issuance in connection with
the settlement of the Class Action that was filed against the
Company in 1993 ("Class A Preferred Stock") and (iii) 2 million
shares of preferred stock ("Preferred Stock"). A description of
the amount of shares that will be issued within each class is set
forth below.
Issued and outstanding shares of the Company's common stock
will be canceled on the Effective Date and replaced with one (1)
share of Reorganized Spectrum Common Stock for each seventy-five
(75) shares of existing common stock. The Company currently has
authorized 110 million shares of common stock, of which
approximately 76.7 million are issued and outstanding. Therefore,
approximately 1 million shares of Reorganized Spectrum Common
Stock will be issued to existing shareholders on the Effective
Date. An additional $300,000 of Reorganized Spectrum Common Stock
will be issued to the Computer Bay trustee in connection with the
settlement of his claim (collectively, the Reorganized Spectrum
Common Stock issued to existing shareholders and the Computer Bay
trustee is defined as "Distributable Common Stock"). Stock
options issued under the Company's existing stock option plans
will also be reverse split at a 75 to 1 ratio and repriced
accordingly.
Pursuant to the Class Action Settlement, the Company will
issue a number of shares of Class A Preferred Stock equal to the
33
<PAGE>
number of shares of Distributable Common Stock. The Class A
Preferred Stock is convertible to Reorganized Spectrum Common
Stock at any time within two years of its date of issuance and
automatically converts to Reorganized Spectrum Common Stock at
the expiration of two years.
As part of a bonus or success fee to employees, officers
and all non-executive directors for confirming a plan of
reorganization, the Company will also issue Reorganized Spectrum
Common stock pursuant to the two incentive compensation programs
described in the Plan, the Spectrum 1996 Stock Incentive Plan and
the Spectrum 1996 Incentive Deferral Plan, which collectively
authorize the issuance of an aggregate number of shares of
Reorganized Spectrum Common Stock equal to one-ninth (1/9) of the
aggregate number of shares of Distributable Common Stock and
Class A Preferred Stock (i.e., 10% of the reorganized equity
ownership) to directors, officers and employees of the Company on
the Effective Date. Except for 300 shares of Reorganized Spectrum
Common Stock that will be distributed to directors on the
Effective Date, the distribution of stock to directors, officers
and employees pursuant to such incentive programs shall be
distributed in three equal installments. The first installment
shall be distributed during the three day period commencing three
days after Reorganized Spectrum files its Quarterly Report on
Form 10-Q for its fiscal quarter ending June 30, 1997; the second
installment shall be distributed during the three day period
commencing three days after Reorganized Spectrum files its
Quarterly Report on Form 10-Q for its fiscal quarter ending
December 31, 1997; and the third installment shall be distributed
during the three day period commencing three days after
Reorganized Spectrum files its Quarterly Report on Form 10-Q for
its fiscal quarter ending June 30, 1998. Under the Stock
Incentive Plan, employees, officers and directors will also be
eligible to receive future grants of performance based incentive
awards with respect to an aggregate number of shares equal to an
additional one-ninth (1/9) of the aggregate number of shares of
Distributable Common Stock and Class A Preferred Stock. Also, on
the Effective Date, the Company will distribute a $300,000
success bonus among all employees.
Implementation of the Plan does not contemplate issuance of
the remainder of the 10 million authorized shares of Reorganized
Spectrum Common Stock, the remainder of the 1.5 million shares of
Class A Preferred Stock, or the 2 million shares of authorized
preferred stock. The details of the Plan, the proposed
recapitalization, and copies of the certificate of incorporation
and by-laws are set forth in detail in the Plan and associated
Disclosure Statement, which the Company filed with the SEC on its
Current Report on Form 8-K dated as of March 26, 1996.
34
<PAGE>
If the Plan of is not confirmed and consummated, the
alternatives include: (a) continuation of the pending Chapter 11
cases; (b) alternative plans of reorganization; or (c)
liquidation of Debtors under Chapter 7 or Chapter 11 of the
Bankruptcy Code.
Securities Related Proceedings
On February 9, 1994, the class action filed against the
Company and two of its former officers in May 1993 (In re
Spectrum Information Technologies, Inc. Securities Litigation,
United States District Court for the Eastern District of New
York, Civil Action No. 93-2295) (the "Class Action Suits") was
supplemented (i) to extend the end of the class period from May
21, 1993 to February 4, 1994, (ii) to add additional claims
against Spectrum and the individual defendants, and (iii) to add
certain of its then officers as party defendants. In April 1994,
a Second Consolidated Amended Class Action Complaint was filed
adding additional employees as party defendants. The class and
certain subclasses have been certified. A similar putative class
action filed in the United States District Court for the Southern
District of Texas has been transferred and consolidated with the
Class Action Suits.
The plaintiffs in the Class Action Suits claim to have
purchased the Company's securities at prices which the Company
and the individual defendants allegedly artificially inflated by,
among other things: (i) misrepresenting the potential value of
the patent license agreement the Company entered into with AT&T;
(ii) improperly accounting for revenues and expenses in
connection with certain license and advertising agreements; (iii)
failing to disclose the existence of an inquiry initiated by the
Securities and Exchange Commission (the "SEC"); and (iv) making
misleading statements regarding the employment of John Sculley.
In addition, there are claims against certain of the individual
defendants for improper insider trading. The Company's former
management, based on the advice of its then counsel, believed the
Company had good and meritorious defenses to the claims against
it.
On July 20, 1994, the Company, certain of its then officers
and directors, and two former officers and directors were served
with a class action complaint. The complaint asserts that
Spectrum knowingly or recklessly made material false statements
or omitted material facts in its financial reporting relating to
Computer Bay prior to announcing the restatement of earnings for
the fiscal year 1992 and the first three quarters of fiscal 1993,
to correct inaccurate accruals of certain items into income. For
pretrial purposes, this litigation has been consolidated with the
Class Action Suits described above.
In November 1995, the Company announced that an agreement in
35
<PAGE>
principle had been reached on a framework for settlement of the
Class Action Suits (the "Class Action Settlement"). The Class
Action Settlement is contingent on numerous factors including,
among other things, the successful resolution of the Home Action
(Other Proceedings), the negotiation and execution of a
definitive settlement agreement, the Company's ability to develop
and confirm a plan of reorganization in the Company's pending
bankruptcy proceeding satisfactory to all interested parties,
including the Class Action Plaintiffs, and the approval of the
Class Action Settlement by the District Court. The Bankruptcy
Court approved the Class Action Settlement on January 19, 1996.
The Class Action Plaintiffs in the Class Action Suits had filed a
claim against the Company in its bankruptcy proceedings in the
amount of approximately $676 million. The Class Action
Settlement, if consummated, will be in satisfaction of that claim
as well as any and all claims of the individual defendants
(former directors and officers) in that suit against the Company.
Under the terms of the Class Action Settlement, the Company
and the representatives of the Class Action Plaintiffs have
agreed to a framework under which the Company will issue to the
Class Action Plaintiffs in its plan of reorganization a number of
shares of its Class A Preferred Stock that would be equal to the
number of shares of Distributable Common Stock available to
Spectrum's stockholders and certain creditors following
confirmation of Spectrum's plan of reorganization. (See
Bankruptcy Proceedings). In addition, under the Class Action
Settlement, the Class Action Plaintiffs are to receive the
proceeds, net of certain fees and expenses, from insurance
policies worth $10 million covering the liabilities of the
Company's directors and officers and, as a result of court
supervised negotiations and at the recommendation of the District
Court, $1,350,000 from the various individual defendants in the
action plus $250,000 from the Company.
One of the uncertainties surrounding the Class Action
Settlement is that issuers of insurance policies representing $6
million out of the $10 million of the insurance necessary to fund
the Class Action Settlement have disclaimed coverage. On July 15,
1996, the District Court issued a decision favorable to the
Company, and the insurance carriers stated that they intended to
appeal certain aspects of the decision. (See Other Proceedings
and Note 4).
In May 1993, the SEC initiated a confidential and informal
fact gathering inquiry apparently directed toward statements the
Company purportedly made regarding the potential value of the
patent license agreement it had entered into in fiscal 1994 with
AT&T. On December 6, 1993, following the Company's dismissal of
its outside auditors, the SEC issued a formal order of
investigation.
36
<PAGE>
The Company believes that a focus of the investigation related to
accounting and disclosure issues with respect to certain of the
patent license and advertising agreements it entered into during
fiscal 1994 and also related to other activities of the Company's
previous management. The accounting treatment at issue in the
investigation, which had been implemented after consultation with
the Company's previous outside auditors and had been disclosed in
the Company's quarterly filings with the SEC, was revised by
Spectrum when it voluntarily restated its earnings on February 7,
1994.
In April 1996, the SEC staff informed the Company that it
intended to commence an administrative proceeding to determine
whether during 1993 the Company had violated certain sections of
the Securities Exchange Act of 1934 and rules promulgated
thereunder, including violations of Rule 10b-5, related to
accounting and disclosure issues with respect to certain patent
and advertising agreements it entered into during fiscal 1994. In
April 1996, the Company began discussions with the SEC to resolve
the SEC's ongoing investigation. Those discussions contemplate
the entry of an administrative cease and desist order against the
Company, but do not contemplate the imposition of any financial
penalties. The Company's discussions with the SEC are ongoing.
In connection with this investigation, Salvatore T. Marino,
a current employee and former officer of the Company informed the
Company in April 1996 that the SEC staff intended to commence a
proceeding against him for violations of certain sections of the
Securities Exchange Act of 1934 and rules promulgated thereunder,
including violations of Rule 10b-5, related to accounting and
disclosure issues with respect to certain patent and advertising
agreements the Company entered into during fiscal 1994 and the
exercise of options to purchase and subsequent sale of Spectrum
stock in the relevant time frame. Mr. Marino has denied any
wrongdoing and responded to the staff's allegations. Upon
learning of the SEC staff's position and pending resolution of
this issue, the Company removed Mr. Marino as an executive
officer.
The United States Attorney's Office for the Eastern
District of New York has informed the Company that it is the
subject of an investigation regarding violations of securities
laws that may have occurred prior to the appointment of the
Company's current Chief Executive Officer and Board of Directors.
The Company is cooperating fully with the investigation.
37
<PAGE>
Patent Related Proceedings
The Company has instituted an interference proceeding in
the U.S. Patent and Trademark Office to establish that the
Company is the inventor of the claimed subject matter of U.S.
Patent 4,991,197 (the "197 Patent"). This proceeding is based on
the Company's belief that Walker Morris, President of
Intelligence Technology Corporation ("ITC"), a party to a joint
development agreement with the Company, wrongfully obtained the
197 Patent based on the technology invented by the Company. The
Company has been granted a patent to cover this invention, U.S.
Patent 4,972,457. In the course of the interference procedure,
ITC has allowed deadlines to pass without taking steps to
preserve its right to submit evidence showing any date of
invention earlier than the filing date of the Walker Morris
patent application. The Company believes that it has persuasive
evidence proving an earlier date of invention than the Walker
Morris filing date, and has preserved its right to submit such
evidence. Shortly before execution of a settlement agreement
under which ITC would concede priority of invention to the
Company and would receive a restricted field license under U.S.
Patent 4,972,457, Walker Morris provided the Company information
regarding a patent application that Walker Morris alleged was
outside the scope of the interference. The Patent Office granted
the Company's motion, however, to include the newly disclosed
patent in the pending interference. The Company believes that it
will ultimately be awarded dominant rights to both patents in the
interference.
Other Proceedings
In an action against the Company and certain former
employees in the Superior Court of New Jersey, Middlesex County,
entitled Douglas H. Anderson v. Dealer Service Business Systems,
Inc. d/b/a Data One et al., Docket No. L-11315-92, the plaintiff
alleged breach by the Company of an employment contract and age
discrimination by the plaintiff's employer, Data One. The
plaintiff further alleged that the Company and certain former
employees interfered with his employment contract and inflicted
emotional distress. Mr. Anderson did not file a proof of claim
against the Company and the Bankruptcy Court ruled on July 16,
1996 that Mr. Anderson was barred from filing such a claim
against the Company. In October 1995, Mr. Anderson filed a proof
of claim against Data One alleging $1.5 million in damages based
on the allegations described above. Data One and Mr. Anderson
have entered a settlement allowing Mr. Anderson an unsecured
claim against Data One in the amount of $80,000, with payments
made pursuant to the terms of Data One's liquidating plan of
reorganization.
On July 21, 1995, The Home Insurance Company of Illinois ("The
Home"), the Company's former directors' and officers' primary
insurance carrier, commenced an adversary proceeding (the "Home
Action") in the Company's bankruptcy proceeding. The Honorable
38
<PAGE>
Frederick Block, United States District Judge of the District
Court, subsequently withdrew the reference with respect to the
Home Action such that the litigation is now pending before him.
The Home sought to rescind a renewal of a directors' and
officers' liability and company reimbursement policy issued in
June 1993 to the Company for the benefit of its directors and
officers (the "Renewal Policy") and alleged certain material
misrepresentations and/or omissions in the application for the
Renewal Policy. The Home also sought a declaration that coverage
is not afforded under the Renewal Policy for the claims made
against the policy by the Company and certain of its officers and
directors.
In addition to the primary policy, the Company obtained
three excess policies for the insurance year at issue in the Home
Action. Two of the excess carriers, the Agricultural Excess and
Surplus Insurance Company ("AESIC") and The Aetna Casualty and
Surety Company ("Aetna") have intervened in the Home Action.
AESIC has agreed to be bound by any final judicial resolution
regarding The Home (a similar agreement was previously reached
with the third excess carrier) and is no longer actively
participating in the Home Action. The District Court heard the
trial in the Home Action on February 28 and 29, 1996 and issued a
decision on July 15, 1996.
On July 15, 1996, the District Court ruled against the
insurance carriers in their attempt to rescind the directors' and
officers' insurance policies at issue in the Home Action. The
Court also ruled that any losses in the Class Action Suits
related to Spectrum's February 1994 restatement of earnings would
be covered by the policies at issue. The Court concluded that it
could not decide, based on the record before it, whether the
policies at issue would cover claims in the Class Action Suits
related to alleged insider trading by certain of the Company's
former officers and alleged misstatements regarding John
Sculley's employment with the Company. Home and Aetna have
informed the Company that they intend to appeal certain aspects
of the decision.
Notwithstanding this intended appeal, the parties to the
Class Action Suits and the insurance carriers have tentatively
reached an agreement to implement the Class Action Settlement.
Under this agreement, each insurance carrier has agreed to contribute
the full coverage available under its disputed insurance policy, up
to $6 million, if they are unsuccessful in the appeal. This
agreement to implement the Class Action Settlement remains subject
to the completion and execution of a definitive agreement. The
Class Action Settlement also remains contingent upon several
factors, including completion and execution of a definitive
agreement, confirmation of the Plan and District Court approval.
The Company intends to proceed with the confirmation of the
39
<PAGE>
Plan on August 14, 1996. If confirmed, The Plan will be
consummated after District Court approval of the Class Action
Settlement becomes final.
From time to time, the Company has been a party to other
legal actions and proceedings incidental to its business. As of
the date of this report, however, the Company knows of no other
pending or threatened legal actions that could have a material
impact on the financial condition of the Company.
40
<PAGE>
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits
No.
27 Financial Data Schedule
B. Reports on Form 8-K
None
41
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereto duly authorized.
Dated: August 6, 1996
SPECTRUM INFORMATION TECHNOLOGIES, INC.
By /s/ Donald J. Amoruso
---------------------------------
Donald J. Amoruso
President, Chief Executive Officer and
Chairman of the Board of Directors
By /s/ Barry J. Hintze
---------------------------------
Barry J. Hintze
Controller and
Principal Accounting Officer
42
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SPECTRUM
INFORMATION TECHNOLOGIES, INC. AND SUBSIDIARIES (DEBTORS IN POSSESSION)
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1996
<PERIOD-END> MAR-31-1997
<CASH> 11,549
<SECURITIES> 788
<RECEIVABLES> 805
<ALLOWANCES> 80
<INVENTORY> 0
<CURRENT-ASSETS> 13,517
<PP&E> 450
<DEPRECIATION> 246
<TOTAL-ASSETS> 14,075
<CURRENT-LIABILITIES> 3,923
<BONDS> 0
0
0
<COMMON> 77
<OTHER-SE> 1,213
<TOTAL-LIABILITY-AND-EQUITY> 14,075
<SALES> 808
<TOTAL-REVENUES> 808
<CGS> 24
<TOTAL-COSTS> 1,358
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (783)
<INCOME-TAX> 0
<INCOME-CONTINUING> (783)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (783)
<EPS-PRIMARY> (.01)
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</TABLE>
