SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
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 No.: 1-5270
SOFTNET SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
New York 11-1817252
-------------------------------- ---------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
650 Townsend Street, Suite 225, San Francisco, CA 94043
- ------------------------------------------------- --------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (415) 365-2500
520 Logue Avenue, Mountain View, CA 94043
- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last report
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 latest practicable date.
Class Outstanding at January 31, 1998
------------------------------- --------------------------------
Common stock, par 8,785,253
value $.01 per share
<PAGE>
SOFTNET SYSTEMS, INC.
INDEX
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of December 31, 1998 and
September 30, 1998
Condensed Consolidated Statements of Operations for the three
months ended December 31, 1998 and 1997
Condensed Consolidated Statements of Cash Flows for the three
months ended December 31, 1998 and 1997
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
As of December 31, 1998 and September 30, 1998
(In thousands, except share data)
December 31, September 30,
1998 1998
---------- -----------
(Unaudited)
ASSETS
Current assets:
Cash $ 4,329 $ 12,504
Accounts receivables, net 3,819 3,105
Current portion of gross
investment in leases 1,239 1,579
Inventories 1,195 1,345
Prepaid expenses 1,146 882
-------- ---------
Total current assets 11,728 19,415
Restricted cash 800 800
Property and equipment, net 9,880 6,523
Gross investment in leases,
net of current portion 1,717 1,863
Other assets 1,089 1,124
Costs in excess of fair value of
net assets acquired, net 683 955
Net assets associated with
discontinued operations 3,813 3,875
-------- ---------
$ 29,710 $ 34,555
======== =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued expenses $ 10,862 $ 9,423
Current portion of long-term debt 1,855 1,821
Current portion of capital leases 913 632
Deferred revenue 173 100
-------- ---------
Total current liabilities 13,803 11,976
-------- ---------
Long-term debt, net of current portion 9,430 10,236
-------- ---------
Capital lease obligations,
net of current portion 518 327
-------- ---------
Commitments and contingencies
Redeemable convertible preferred
stock, $.10 par value 25,000 shares
authorized, 17,877 shares issued
and outstanding 15,754 18,187
-------- ---------
Shareholders' deficit:
Preferred stock, $.10 par value,
3,975,000 shares authorized,
none issued and outstanding - -
Common stock, $.01 par value,
25,000,000 shares authorized,
8,631,087 and 8,191,550 shares
outstanding, respectively 86 82
Deferred stock compensation (303) (188)
Capital in excess of par value 46,653 43,700
Accumulated deficit (56,231) (49,765)
-------- ---------
Total shareholders' deficit (9,795) (6,171)
-------- ---------
$ 29,710 $ 34,555
======== ========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
For the Three Months Ended December 31, 1998 and 1997
(In thousands, except per share data)
(Unaudited)
1998 1997
--------- ----------
Net sales $ 4,296 $ 2,875
Cost of sales 2,967 2,249
--------- ----------
Gross profit 1,329 626
--------- ----------
Operating expenses:
Selling 3,009 557
Engineering 1,146 581
General and administrative 2,862 1,178
Amortization of goodwill
and transaction costs 322 322
--------- ----------
Total operating expenses 7,339 2,638
--------- ----------
Loss from continuing operations (6,010) (2,012)
Other income (expense):
Interest expense (569) (330)
Other income 217 72
--------- ----------
Loss from continuing operations
before income taxes (6,362) (2,270)
Provision for income taxes - -
--------- ----------
Loss from continuing operations
before discontinued operations (6,362) (2,270)
Income (loss) from discontinued operations 139 (108)
--------- ----------
Net loss $ (6,223) $ (2,378)
========= ==========
Preferred dividends (243) -
--------- ----------
Net loss applicable to common shares $ (6,466) $ (2,378)
========= ==========
Basic and diluted earnings (loss) per share:
Continuing operations $ (0.76) $ (0.33)
Discontinued operations 0.02 (0.01)
Preferred dividends (0.03) -
--------- ----------
Net loss applicable to common shares $ (0.77) $ (0.34)
========= ==========
Shares used to compute basic and
diluted earnings (loss) per share 8,374 6,941
--------- ----------
The accompanying notes are an integral part of these
condensed consolidated financial statements.
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
For the Three Months Ended December 31, 1998 and 1997
(In thousands)
(Unaudited)
1998 1997
---------- ----------
Cash flows from operating activities:
Net loss $ (6,223) $ (2,378)
Adjustments to reconcile net loss to
net cash used in operating activities:
(Income) loss from discontinued operations (139) 108
Depreciation and amortization 850 469
Amortization of deferred stock compensation 30 -
Provision for bad debts 60 10
Changes in operating assets and liabilities:
Accounts receivable (774) 270
Gross investment in leases 486 244
Inventories 150 (102)
Prepaid expenses (264) (152)
Accounts payable and accrued expenses 1,439 439
Deferred revenue 73 312
---------- ----------
Net cash used in operating
activities of continuing operations (4,312) (780)
---------- ----------
Net cash provided by operating activities
of discontinued operations 222 54
---------- ----------
Cash flows from investing activities:
Purchase of property and equipment (3,084) (76)
Other (100) -
---------- ----------
Net cash used in investing activities
of continuing operations (3,184) (76)
---------- ----------
Net cash used in investing activities
of discontinued operations (12) (26)
---------- ----------
Cash flows from financing activities:
Repayment of long-term debt (439) (424)
Borrowings under revolving credit note 8,697 2,017
Payments under revolving credit note (9,030) (475)
Additional costs of issuance of
convertible preferred stock (54) -
Net proceeds from issuance of
convertible preferred stock - 4,600
Restricted cash - (4,600)
Proceeds from exercise of warrants 190 42
Capitalized lease obligations paid (245) (15)
---------- ----------
Net cash provided by (used in) financing
activities of continuing operations (881) 1,145
---------- ----------
Net cash used in financing activities of
discontinued operations (8) (304)
---------- ----------
Increase (decrease) in cash (8,175) 13
Cash, beginning of period 12,504 37
---------- ----------
Cash, end of period $ 4,329 $ 50
========== ==========
Cash paid during the period for:
Interest $ 308 $ 420
Income taxes - -
Supplemental non-cash transactions
Common stock issued for the
conversion of preferred stock 2,600 -
Common stock issued for the
conversion of subordinated notes - 208
Value assigned to common warrants
issued upon the issuance of
preferred stock - 435
Preferred dividends paid with the issuance of -
Additional preferred stock 221 -
Common stock 22 -
Equipment acquired by capital lease 717 -
Deferred compensation associated with
the issuance of common stock options 146 -
The accompanying notes are an integral part of these
condensed consolidated financial statements.
<PAGE>
SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
1. Basis of Presentation
The financial information, except for the balance sheet as of September 30,
1998, included herein is unaudited; however, such information reflects all
adjustments (consisting solely of normal recurring adjustments) which are, in
the opinion of management, necessary for a fair presentation of the condensed
consolidated statements of financial position, results of operations and cash
flows as of and for the interim periods ended December 31, 1998 and 1997.
The Company's annual report on Form 10-K/A for the fiscal year ended September
30, 1998, as filed with the Securities and Exchange Commission, should be read
in conjunction with the accompanying Condensed Consolidated Financial
Statements. The Condensed Consolidated Balance Sheet as of September 30, 1998
was derived from the Company's audited Consolidated Financial Statements.
The results of operations for the three months ended December 31, 1998 are based
in part on estimates that may be subject to year-end adjustments and are not
necessarily indicative of the results to be expected for the full year.
The financial statements for the three months ended December 31, 1997 have been
restated for the effects of the discontinued operations of the
telecommunications segment (see Note 2). Certain reclassifications have been
made to conform with the current presentation.
2. Discontinued Operations
In July 1998, the Company's Board of Directors adopted a plan to discontinue
operations of its telecommunications segment. This segment consists of the
Company's wholly owned subsidiary Kansas Communications, Inc. ("KCI"), along
with KCI's Milwaukee operations purchased from Executone Management Systems,
Inc. Accordingly, the operating results of the telecommunications segment have
been segregated from continuing operations and reported as a separate line item
on the statement of operations. The assets and liabilities of such operations
have been reflected as a net asset.
On February 12, 1999, KCI was sold to Convergent Communications Services, Inc.
for an aggregate purchase price of approximately $6.5 million, subject to
adjustment in certain events. Proceeds from the sale consist of cash, notes and
shares of Convergent Communications Services, Inc.'s parent company common stock
(see Note 6).
Operating results of the discontinued telecommunications segment are as follows
for the three months ended December 31 (in thousands):
1998 1997
--------- ---------
Revenues $ 3,633 $ 3,949
Income (loss) before income taxes 194 (108)
Provision for income taxes (55) -
Net income (loss) 139 (108)
Assets and liabilities of the discontinued telecommunications segment are as
follows (in thousands):
December 31, September 30,
1998 1998
---------- ---------
Current assets:
Cash $ - $ -
Accounts receivable, net 1,847 1,734
Inventories 2,490 2,248
Prepaid expenses 99 36
--------- ---------
4,436 4,018
Property, plant and equipment, net 398 427
Goodwill, net 1,639 1,663
Other noncurrent assets 22 21
--------- ---------
$6,495 $6,129
========= =========
Current liabilities:
Accounts payable $1,710 $1,582
Current portion, capital
lease obligation 30 32
Deferred revenue 901 593
--------- ---------
2,641 2,207
Capital lease obligation,
net of current portion 41 47
--------- ---------
$2,682 $2,254
========= =========
Net assets associated with
discontinued operations $3,813 $3,875
========= =========
3. Debt
Long-term debt is summarized as follows (in thousands):
December 31, September 30,
1998 1998
---------- ----------
Bank Debt $ 6,667 $ 7,416
Convertible subordinated notes 3,951 3,951
Other 667 690
---------- ----------
11,285 12,057
Less current portion (1,855) (1,821)
---------- ----------
$ 9,430 $ 10,236
========== ==========
4. Redeemable Convertible Preferred Stock
On November 23, 1998 and November 24, 1998, the Company issued an aggregate of
413,018 shares of common stock pursuant to the conversion of the remaining
3,100.78 shares of the Company's outstanding Series A Convertible Preferred
Stock. The Series A Convertible Preferred Stock, including accrued dividends,
was converted into common shares at the conversion price of $7.56 per share.
During the quarter ended December 31, 1998, the Company declared a dividend on
both its outstanding Series B Convertible Preferred Stock and its outstanding
Series C Convertible Preferred Stock, payable on December 31, 1998 to the
respective stockholders of record at the close of business on December 28, 1998.
Dividends for the Series B Convertible Preferred Stock, payable at a rate of 5%,
were paid at the Company's option in the form of 126.56 additional shares of the
Company's Series B Preferred Stock. Dividends for the Series C Convertible
Preferred Stock, payable at a rate of 5%, were paid at the Company's option in
the form of 94.14 additional shares of the Company's Series C Convertible
Preferred Stock.
5. Stock Options and Warrants
The following table summarizes the outstanding options and warrants to purchase
shares of common stock for the three months ended December 31, 1998:
<TABLE>
<CAPTION>
Outstanding
Outstanding Options Outstanding Warrants Options and Warrants
--------------------------- ------------------------ --------------------------
Weighted Weighted
Average Average Weighted
Exercise Exercise Average
Shares Price Shares Price Shares Exercise Price
--------- -------- ------- -------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding as
of September 30, 1998 1,370,125 $ 7.42 832,399 $ 9.27 2,202,524 $ 8.12
--------- -------- ------- -------- --------- --------
Granted 65,000 $ 7.38 - - 65,000 $ 7.38
Exercised - - (26,519) $ 7.39 (26,519) $ 7.39
Canceled (20,700) $ 6.88 (905) $ 6.63 (21,605) $ 6.87
Outstanding as
of December 31, 1998 1,414,425 $ 7.45 804,975 $ 9.33 2,219,400 $ 8.13
--------- -------- ------- -------- --------- --------
</TABLE>
6. Subsequent Events
On January 12, 1999, the Company executed an agreement with a group of
institutional investors whereby the Company issued $12 million in convertible
subordinated loan notes. These notes bear an interest rate of 9% per year and
mature in 2001. These notes are convertible into the Company's common stock with
an initial conversion price of $17.00 per share until July 1, 1999 and,
thereafter, at the lower of $17.00 per share and the lowest five-day average
closing bid price of the Company's common stock during the 30-day trading period
ending one day prior to the applicable conversion date. In connection with these
notes, the Company issued to these investors warrants to purchase an aggregate
of 300,000 shares of the Company's common stock. These warrants, which have an
exercise price of $17 per share, expire in 2003.
On February 5, 1999, a single holder of the Company's 9% Convertible
Subordinated Debentures due September 2000 converted a debenture in the face
amount of $401,516 into 59,483 shares of the Company's common stock. These 9%
debentures have a conversion price of $6.75 per share of common stock.
On February 9, 1999, the Company completed the purchase of Intelligent
Communications, Inc. The purchase price was comprised of: (i) a cash component
of $500,000, less payment of certain expenses, paid at closing; (ii) a
promissory note in the amount of $1.0 million due one year after closing; (iii)
a promissory note in the amount of $2.0 million due two years after closing;
(iv) the issuance of 500,000 shares of the Company's common stock (adjustable
upwards after one year in certain circumstances); and (v) a demonstration bonus
of $1.0 million payable in cash or shares of the Company's common stock at the
Company's option within one year after closing if certain conditions are met.
Approximately $300,000 of the $1.0 million note is payable in cash or in the
Company's common stock at the Company's option, while the balance of this note
is payable in cash or in the Company's common stock at the option of the
holders. The entire amount of the $2.0 million note is payable in cash or the
Company's common stock at the option of the Company.
On February 12, 1999, Kansas Communications, Inc. was sold to Convergent
Communications Services, Inc. ("Convergent Communications") for an aggregate
purchase price of approximately $6.5 million subject to adjustment in certain
events. Convergent Communications paid $100,000 in cash in November 1998 upon
execution of the letter of intent to purchase and paid the remainder of the
purchase price on the closing date as follows: (i) $1.4 million in cash; (ii)
approximately 50,000 shares of Convergent Communications' parent company common
stock with an agreed value of approximately $500,000 ($10.00 per share); (iii) a
promissory note in the amount of $2.0 million which is payable on July 1, 1999
and bears simple interest at the rate of eleven percent per annum; (iv) a
promissory note in the amount of $1.0 million which is payable on the date that
is 12 months following the closing date and bears simple interest at the rate of
eight percent per annum; and (v) a promissory note in an amount of $1.5 million
which is payable on the date which is 12 months following the closing date,
bears simple interest at the rate of eight percent per annum and is subject to
mandatory prepayment in certain events.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
This Form 10-Q contains forward-looking statements that involve risks and
uncertainties. The actual results of SoftNet Systems, Inc. and its subsidiaries
could differ significantly from those set forth herein. Factors that could cause
or contribute to such differences include, but are not limited to, those
discussed in "Factors Affecting the Company's Operating Results" as set forth in
the Company's annual report on Form 10-K/A for the year ended September 30,
1998, as filed with the Securities and Exchange Commission, and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" as
well as those discussed elsewhere in this quarterly report. Statements contained
herein that are not historical facts are forward-looking statements that are
subject to the safe harbor created by the Private Securities Litigation Reform
Act of 1995. Words such as "believes", "anticipates", "expects", "intends" and
similar expressions are intended to identify forward-looking statements, but are
not the exclusive means of identifying such statements. A number of important
factors could cause our actual results for fiscal 1999 and beyond to differ
materially from past results and those expressed in any forward-looking
statements made by us, or on our behalf. We undertake no obligation to release
publicly the results of any revisions to these forward-looking statements that
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
The following discussion of our financial condition and results of operations
should be read in conjunction with, and is qualified in its entirety by
reference to, our Consolidated Financial Statements and the related Notes
thereto appearing in our annual report on Form 10-K/A for the year ended
September 30, 1998, as filed with the Securities and Exchange Commission and our
Condensed Consolidated Financial Statements and related Notes thereto appearing
elsewhere in this quarterly report. Our fiscal year ends September 30 and the
first quarter of the fiscal year ends December 31. "Fiscal 1999" refers to the
twelve months ending September 30, 1999 with similar references to other twelve
month periods ending September 30.
Overview
During fiscal 1998, we made a strategic decision to focus on becoming, through
our wholly-owned subsidiary, ISP Channel, Inc. ("ISP Channel"), (which was
formerly known as MediaCity World, Inc.), the dominant cable-based provider of
high-speed Internet access, as well as of other digital communications services,
to homes and businesses in the franchise areas of certain small- and
medium-sized cable systems. As part of this new focus, on February 9, 1999 we
completed the purchase of Intelligent Communications Inc., the former Xerox
Skyway Network. We believe that integrating this new technology into our
existing business plan will allow us to cost effectively provide our ISP Channel
service to smaller systems in more remote areas as well as to certain other
markets including apartment buildings, hotels, hospitals, and schools, thereby
decreasing our cost basis and increasing our potential market size. Also in line
with this strategy, we determined to divest our two other businesses:
Micrographic Technology Corporation ("MTC"), a wholly owned subsidiary offering
document management solutions, and Kansas Communications, Inc. ("KCI"), a wholly
owned subsidiary which sells and services telephone systems, third party
computer hardware and application oriented peripheral products such as voicemail
and video conferencing systems. On February 12, 1999, we completed the
divestiture of KCI. In addition, on November 5, 1998, we entered into a letter
of intent for the sale of MTC. Since July 27, 1998, we have reclassified and
reported KCI in discontinued operations but, at this time, pending shareholder
approval of the sale of MTC (which with KCI, comprised substantially all of our
assets), we continue to classify and report MTC as a continuing business though
it is our current intent to conclude its sale within the next twelve months.
ISP Channel and Intelligent Communications We began providing Internet services
following our acquisition of ISP Channel in June 1996. While we seek to maintain
and build the traditional dial-up Internet access business acquired at, and
built up since, that time, our primary objective is to become the dominant
provider of high-speed Internet access via the existing cable television
infrastructure to homes and businesses in the franchise areas of small- and
medium-sized cable television systems. We commenced marketing this high-speed
service, using cable modems, to select cable operators and potential subscribers
in March 1998. However, we believe that, as a result of our limited financial
resources, we have not fully implemented our marketing strategies, and this
business has, to date, generated only nominal revenues.
On February 9, 1999, we completed the purchase of Intelligent Communications.
The purchase price for this acquisition is described below in Liquidity and
Capital Resources. Through use of its proprietary satellite system, Intelligent
Communications currently provides two-way Internet connectivity to local
Internet service providers ("ISPs"), school systems and businesses, primarily
located in remote and rural areas. Intelligent Communications' VSAT (very small
aperture terminals) network allows connectivity throughout the 48 lower states
as well as in southern Canada and southern Alaska. Intelligent Communications
offers a wide range of Internet services based on its proprietary T1Plus product
that presently offers up to 2 Mbps data transfer rates. It is our intention
that, while Intelligent Communications will continue to market its services to
its current market business, it will also provide ISP Channel with the in-house
ability to bypass many of the high cost terrestrial telephone links that ISP
Channel has historically used to connect the cable head-ends of its affiliated
cable operators to the network operations center of ISP Channel. As a result of
the Intelligent Communications acquisition, we anticipate recording a
significant amount of goodwill in the second quarter of fiscal 1999 which will
adversely affect our earnings and profitability for the foreseeable future. If
the amount of such recorded goodwill is increased or we have future losses and
are unable to demonstrate our ability to recover the amount of goodwill recorded
during such time periods, the period of amortization could be shortened, which
may further increase annual amortization charges. In such event, our business
and financial condition could be materially and adversely affected.
ISP Channel Affiliates As of January 31, 1999, we had contracts for ISP Channel
service with 29 cable operators representing 122 cable systems and approximately
1.5 million homes passed. Twenty of these systems, representing approximately
207,000 homes passed, have been equipped and have begun offering our services.
In addition, we have letters of intent with ten cable operators, representing 39
systems, and approximately 359,000 homes passed. As of January 31, 1999, the
Company had approximately 1,850 residential and business subscribers to our ISP
Channel service.
In order to expand our cable-based Internet subscriber base significantly, we
expect to aggressively pursue affiliation agreements with cable operators which
will provide us with the exclusive right to market cable-based Internet services
to existing cable television subscribers in such cable operators' systems. We
anticipate that this policy of rapid deployment will result in substantial
capital expenditures, operating losses and negative cash flow in the near term.
While we believe that we currently have sufficient cash and financing sources
available to fund our operations through 1999, we cannot assure, however, that
we will be able to access additional capital to finance our strategy in the
longer term or to implement our strategy or achieve positive cash flow or
profitability in a timely fashion, or at all.
ISP Channel Revenue Sources In providing its Internet services, we receive
revenue from the provision of (i) cable modem-based Internet access services and
(ii) traditional dial-up Internet access services. Currently, we or, in certain
cases, our local cable affiliate, typically charge new cable modem-based
Internet access subscribers a one-time connection fee of $99, which fee includes
modem installation but excludes any required modification of the existing cable
television connection which is usually performed by the local cable affiliate.
Thereafter, each subscriber pays a monthly access fee, which is currently as low
as $39 per month and it is our expectation that such rates will decrease over
time. We anticipate that we will purchase a majority of cable modems used by
subscribers, who will be charged a nominal lease or rental charge. We do not
charge new dial-up subscribers a connection fee, but do charge a monthly access
fee of approximately $20.
In addition to connection fees and monthly access fees, we intend to pursue
additional revenue opportunities from Internet advertising, e-commerce and
Internet-based telephony. We also intend to pursue long distance telephone
services and telephony debit and credit cards. Intelligent Communications is
also anticipated to generate continuing revenue from the sale of VSAT service.
In the future, as digital set-top boxes become available and are introduced into
our affiliated cable systems, we expect to charge those subscribers monthly
access fees comparable to those now charged to traditional dial-up subscribers.
We also expect to charge customers a set-top connection fee to help defray
installation expenses.
For cable-based Internet services, we typically share 25% of monthly access
revenues with cable affiliates for the first 200 subscribers in each system and
50% thereafter. For other services, such as Internet-based telephony, e-commerce
and advertising, we expect to share between 25% and 50% of these revenues with
the cable affiliates. We expect to retain all revenue from cable modem lease and
rental income. Depending on competitive market conditions, these pricing and
revenue sharing parameters could change over time.
Cost of Services Costs to us include installation costs, network and cable
operation costs and personnel and other costs. Commissions paid to cable
affiliates vary by type of connectivity and size of contract.
Installation costs are expected to vary by type of connectivity and type of
customer. We charge new subscribers a one time fee to defray the costs of
installation, which includes labor and overhead. While currently the
installation fee does not cover the entire cost incurred by us, we expect over
time that installation costs will decline as cable modems become more
standardized and are eventually bundled as standard equipment in new personal
computers.
Other network costs include the cost of connection to the public switch
telephone network. Such connections are required, among other reasons, to
service our dial-up customers as well as to provide those cable modem customers
located on a one-way cable system, the return path (or upstream link) to our
equipment located at the cable operator's system hub (or headend). In addition,
we incur costs associated with leasing telecommunications capacity such as fiber
where such capacity is used, among other things, to link our equipment at the
cable system headend back to our network operations center in Mountain View,
California. We anticipate that the utilization of Intelligent Communications'
network as a substitute for third party terrestrial links will provide
significant cost savings to us as it grows. There are two major cost benefits to
us in using Intelligent Communications' VSAT capacity to supplement or replace
our current landline-based communications infrastructure. First, for downstream
Internet traffic, it enables us to simultaneously broadcast data from one single
source to our entire network of headend-based receivers which, in conjunction
with other factors including "caching" produces significant efficiency
improvement over comparable landline systems. Second, for upstream traffic, it
permits us to allocate the necessary capacity required by each headend in
smaller increments (and consequently lower cost) than would be available using
terrestrial links, such as T1 lines.
Sales, Marketing and Operating Expenses Sales, marketing and operating expenses
include the costs of our cable affiliate program, maintenance of our
infrastructure, customer care, content and new business development in addition
to sales and marketing expenses.
Stock Option Compensatory Expenses From October 1998, we have granted to certain
employees an aggregate of 1,345,500 incentive and non-qualified stock options
under our 1998 Stock Incentive Plan at a weighted average price of $8.46 per
option. This plan, and therefore the stock options granted under this plan, are
subject to shareholder approval at our forthcoming annual meeting. If the fair
market value of our common stock at the date of such approval exceeds the grant
price of those options granted under the plan, then we must recognize this
excess as a compensation charge. In this event, we will record the charge
ratably over the vesting period of the stock options with a catch-up adjustment
for that period from the date of grant to the date of plan approval. To
illustrate: if the fair market value of our common stock were $17 at the date of
approval of the plan, we would recognize a charge to earnings of approximately
$718,000 per quarter until the underlying options were fully vested.
Capital Expenditures In order to pursue our business plan, we expect to incur
significant capital expenditures to provide our turnkey solution for cable
operators, principally relating to the installation of headend equipment and the
purchase of customer premise equipment such as cable modems. The cost of headend
equipment has averaged $45,000 per headend for the 20 systems through which we
currently provides service. The cost of cable modems, currently approximately
$179 to $349, is expected to decline over time as economies of scale in
production and new market entrants in the cable modem market push down prices.
However, we recognize that, in line with experience in other subscription
service industries, we will need to subsidize both the cost of installation and
the cable modem equipment for the customer. Such expenditures, however, are
expected to be offset in part by the savings resulting from decreased costs of
installation and prices for such equipment as equipment is standardized and
production volumes increase, respectively.
MTC We have signed a letter of intent to sell MTC. Either through the currently
contemplated transaction or otherwise, we expect to dispose of this business
during fiscal 1999. MTC develops and manufactures sophisticated, automated
electronic document management and film-based imaging solutions for customers
with large-scale, complex, document-intensive requirements. MTC's hardware and
software products are based on an industry standard client-server architecture,
providing flexibility to connect to a wide variety of information systems and
produce output to various storage media, including optical disk, magnetic disk
and tape, CD-ROM, and microfilm and microfiche, spanning the entire document
lifecycle. MTC's electronic and film-based imaging hardware systems typically
range in price between $200,000 and $1,000,000, and may represent a significant
capital commitment by MTC's customers, leading to a lengthy sales cycle of up to
24 months. Accordingly, MTC's operating results may fluctuate significantly from
period to period.
Results of operations for the First Quarter of Fiscal 1999 compared to the same
period in Fiscal 1998
Consolidated net sales increased $1.4 million, or 49.4%, to $4.3 million for the
three months ended December 31, 1998, as compared to $2.9 million for the same
period in 1997. For the three months ended December 31, 1998, sales in the
document management segment increased $1.2 million, or 44.9%, to $3.9 million,
as compared to $2.7 million for the same period in 1997. For the document
management segment, sales of its computer output microfiche equipment ("COM")
increased $836,000 to $994,000 for the three months ended December 31, 1998 and
sales of its consumable product lines, such as spare parts and film supplies
increased $323,000 to $2.3 million for the three months ended December 31, 1998.
Domestic COM sales contributed $474,000, or 47.7%, of the total COM sales for
the three months ended December 31, 1998, representing an increase of $472,000
in domestic COM sales, as compared to the same period in 1997. Net sales in the
Internet segment increased $229,000, or 106.5%, to $444,000 for the three months
ended December 31, 1998, as compared to $215,000 for the same period in 1997.
Net sales associated with the Internet segment's cable based services increased
$223,000 to $270,000 for the three months ended December 31, 1998, as compared
to $47,000 for the same period in 1997. Net sales associated with the segment's
non-cable based dial-up and business-to-business Internet access offerings
increased $6,000 to $174,000 as compared to $168,000 for the same period in
1997.
Consolidated gross profit increased $703,000, or 112.3%, to $1.3 million for the
three months ended December 31, 1998, as compared to $626,000 for the same
period in 1997, with profit margins increasing to 30.9% from 21.8% for the same
period in 1997. The percentage increase is primarily related to the increase in
the document management segment's COM sales, which historically have contributed
the highest product profit margins. For the three months ended December 31,
1998, gross profit in the document management segment increased $635,000, or
96.7%, to $1.3 million, as compared to gross profit of $657,000 for the same
period in 1997. For the three months ended December 31, 1998, gross profit
margins in the document management segment increased to 33.5%, from 24.7% for
the same period in 1997. Gross profit in the Internet segment increased $68,000
to $37,000 for the three months ended December 31, 1998, as compared to a
gross deficit of $31,000 for the same period in 1997. For the three
months ended December 31, 1998, gross profit margins for the Internet segment
were 8.2%.
Operating expenses (selling, engineering, general and administrative) increased
$4.7 million to $7.0 million for the three months ended December 31, 1998, as
compared to $2.3 million for the same period in 1997. The increase in operating
expenses is entirely related to the increase in the administrative, engineering,
sales and marketing efforts associated with the Internet segment's ISP Channel
cable based service offering. The expenses associated with these operations
increased $4.8 million for the three months ended December 31, 1998, as compared
to the same period in 1997. This increase includes our corporate operating
expenses, as these expenses are now directly related to the operations of the
Internet segment, given management's strategic refocusing towards the ISP
Channel cable based service offering.
Amortization expense associated with goodwill remained constant in the
comparative periods.
Consolidated interest expense increased $239,000, or 72.4%, to $569,000 for the
three months ended December 31, 1998, as compared to $330,000 for the same
period in 1997. Interest expense associated with the operations of the Internet
segment increased $291,000 to $296,000 for the three months ended December 31,
1998, as compared to $5,000 for the same period in 1997, primarily due to lease
financing associated with the capital expansion needs of the segment's ISP
Channel cable based service offering. Interest expense associated with our
outstanding indebtedness decreased by $52,000, primarily as the result of lower
outstanding bank debt.
We made no provision for income taxes for the three months ended December 31,
1998, as a result of our net operating loss carry-forward.
We recognized income from operations with respect to our discontinued
telecommunications segment of $139,000 for the three months ended December 31,
1998, as compared to a loss from operations of $108,000 for the same period in
1997.
For the three months ended December 31, 1998, we had a net loss applicable to
common shares of $6.5 million, or a loss per share of $0.77, compared to a net
loss of $2.4 million for the same period in 1997, or a loss per share of $0.34.
Liquidity and Capital Resources
Over the past year, our growth has been funded through a combination of private
equity, bank debt and lease financings. As of December 31, 1998, the Company had
approximately $4.3 million of unrestricted cash. In addition, on January 12,
1999, we executed an agreement with a group of institutional investors whereby
we issued $12.0 million in convertible subordinated loan notes. These notes bear
an interest rate of 9% per year and mature in 2001. These notes are convertible
into our common stock with an initial conversion price of $17.00 per share until
July 1, 1999 and, thereafter, at the lower of $17.00 per share and the lowest
five-day average closing bid price of our common stock during the 30-day trading
period ending one day prior to the applicable conversion date. In connection
with these notes, we issued to these investors warrants to purchase an aggregate
of 300,000 shares of our common stock. These warrants, which have an exercise
price of $17 per share, expire in 2003. We have also received a secured $3.0
million loan from a financial lender and are in negotiations with a further two
lenders with regard to a $7.5 million senior secured credit facility. We
believe, as a result of this, that we currently have sufficient cash and
financing commitments to meet our funding requirements over the next year.
However, we experienced and continue to experience negative operating margins
and negative cash flow from operations, as well as an ongoing requirement for
substantial additional capital investment. We expect that we will need to raise
substantial additional capital to accomplish our business plan over the next
several years. Our future cash requirements for our business plan expansion will
depend on a number of factors including (i) the number of cable affiliate
contracts, (ii) cable modem and associated costs of equipment, (iii) the rate at
which subscribers purchase our Internet service offering and (iv) the level of
marketing required to acquire and retain subscribers and to attain a competitive
position in the marketplace. In addition, we may wish to selectively pursue
possible acquisitions of businesses, technologies, content or products
complementary to ours in the future in order to expand our Internet presence and
achieve operating efficiencies. We expect to seek additional funding through the
sale of public or private debt and/or equity securities or through a bank credit
facility. We expect we may raise as much as $150 million in debt and/or equity
financing during fiscal 1999. If additional funds are raised through the
issuance of equity or convertible debt securities, the percentage ownership of
our shareholders will be reduced, shareholders may experience additional
dilution and such securities may have rights, preferences or privileges senior
to those of our common stock. We can give no assurance as to the availability or
terms upon which such financing might be available.
At December 31, 1998, our current ratio was 0.85 to 1 with working capital
deficit of $2.1 million. This compares with a current ratio of 1.62 to 1 and
working capital of $7.4 million at September 30, 1998.
For the three months ended December 31, 1998, cash flows used in operating
activities of continuing operations were $4.3 million, as compared to $780,000
for the same period in 1997. Cash flows used in investing activities of
continuing operations were $3.2 million for the three months ended December 31,
1998, as compared to $76,000 for the same period in 1997. Cash flows used in
financing activities of continuing operations were $881,000 for the three months
ended December 31, 1998, as compared to cash flows provided by financing
activities of continuing operations of $1.1 million for the same period in 1997.
On February 5, 1999, a single holder of our 9% Convertible Subordinated
Debentures due September 2000 converted a debenture in the face amount of
$401,516 into 59,483 shares of our common stock. These 9% debentures have a
conversion price of $6.75 per share. We have also extended the maturity of our
revolving credit facility, which has a maximum borrowing capacity of $9.5
million, through January 15, 2000.
Acquisition of Intelligent Communications On February 9, 1999, we completed the
purchase of Intelligent Communications, Inc. The purchase price was comprised
of: (i) a cash component of $500,000, less payment of certain expenses, paid at
closing; (ii) a promissory note in the amount of $1.0 million due one year after
closing; (iii) a promissory note in the amount of $2.0 million due two years
after closing; (iv) the issuance of 500,000 shares of our common stock
(adjustable upwards after one year in certain circumstances); and (v) a
demonstration bonus of $1.0 million payable in cash or shares of our common
stock at our option within one year after closing if certain conditions are met.
Approximately $300,000 of the $1.0 million note is payable in cash or in our
common stock at our option, while the balance of this note is payable in cash or
in our common stock at the option of the holders. The entire amount of the $2.0
million note is payable in cash or in our common stock at our option.
Sale of KCI On February 12, 1999, Kansas Communications, Inc. was sold to
Convergent Communications Services, Inc. ("Convergent Communications") for an
aggregate purchase price of approximately $6.5 million subject to adjustment in
certain events. Convergent Communications paid $100,000 in cash in November 1998
upon execution of the letter of intent to purchase and paid the remainder of the
purchase price on the closing date as follows: (i) $1.4 million in cash; (ii)
approximately 50,000 shares of Convergent Communications' parent company common
stock with an agreed value of approximately $500,000 ($10.00 per share); (iii) a
promissory note in the amount of $2.0 million which is payable on July 1, 1999
and bears simple interest at the rate of eleven percent per annum; (iv) a
promissory note in the amount of $1.0 million which is payable on the date that
is 12 months following the closing date and bears simple interest at the rate of
eight percent per annum; and (v) a promissory note in an amount of $1.5 million
which is payable on the date which is 12 months following the closing date,
bears simple interest at the rate of eight percent per annum and is subject to
mandatory prepayment in certain events.
Sale of MTC On November 5, 1998, we agreed to sell our document management
business, Micrographic Technology Corporation ("MTC") to Global Information
Distribution GmbH ("GID") for an aggregate purchase price of approximately $5.1
million. GID paid $100,000 as a non-refundable deposit upon acceptance of the
GID term sheet. GID will pay us the remaining $5.0 million at the closing.
The cash proceeds from the sale of MTC and KCI will be used in part to repay our
revolving credit facility with West Suburban Bank. As of December 31, 1998,
there was approximately $4.8 million outstanding under this facility. The
balance of the proceeds will be used to pay for transaction costs associated
with the sales of MTC and KCI and to increase our cash position. We cannot
assure, however, that the sale of MTC will close on the terms described or at
all.
Year 2000 Issues
Many computer programs have been written using two digits rather than four to
define the applicable year. This poses a problem at the end of the century
because such computer programs would not properly recognize a year that begins
with "20" instead of "19". This, in turn, could result in major system failures
or miscalculations, and is generally referred to as the "Year 2000 Issue" or
"Y2K Issue". We have formulated a Y2K Plan to address our Y2K issues and has
created a Y2K Task Force headed by the Director of I/S and Data Services to
implement the plan. Our Y2K Plan has six phases:
1) Organizational Awareness - educate our employees, senior management, and
the board of directors about the Y2K issue.
2) Inventory - complete inventory of internal business systems and their
relative priority to continuing business operations. In addition, this
phase includes a complete inventory of critical vendors, suppliers and
services providers and their Y2K compliance status.
3) Assessment - assessment of internal business systems and critical vendors,
suppliers and service providers and their Y2K compliance status.
4) Planning - preparing the individual project plans and project teams and
other required internal and external resources to implement the required
solutions for Y2K compliance.
5) Execution - implementation of the solutions and fixes.
6) Validation - testing the solutions for Y2K compliance.
Our Y2K Plan will apply to two areas:
o internal business systems
o compliance by external customers and providers
Internal Business Systems Our internal business systems and workstation business
applications will be a primary area of focus. We are in the unique position of
completing the implementation of new enterprise-wide business solutions to
replace existing manual processes and/or "home grown" applications during 1999.
These solutions are represented by their vendors as being fully Y2K compliant We
have few, if any, "legacy" applications that will need to be evaluated for Y2K
compliance.
We have completed the Inventory and Assessment Phases of substantially all
critical internal business systems. We expect the Planning Phase to be completed
by March 31, 1999. The Execution and Validation Phases will be completed by
August 31, 1999. We expect to be Y2K compliant on all critical systems, which
rely on the calendar year before December 31, 1999.
Some non-critical systems may not be addressed until after January 2000.
However, we believe such systems will not cause significant disruptions in our
operations.
Compliance by External Customers and Providers We are in the process of the
inventory and assessment phases of our critical suppliers, service providers and
contractors to determine the extent to which our interface systems are
susceptible to those third parties' failure to remedy their own Y2K issues. We
expect that assessment will be complete by May 1999. To the extent that
responses to Y2K readiness are unsatisfactory, we intend to change suppliers,
service providers or contractors to those that have demonstrated Y2K readiness;
but can not be assured that we will be successful in finding such alternative
suppliers, service providers and contractors. We do not currently have any
formal information concerning the status of our customers but have received
indications that most of our customers are working on Y2K compliance.
Risks Associated with Y2K We believe the major risk associated with the Y2K
Issue is the ability of our key business partners and vendors to resolve their
own Y2K Issues. We will spend a great deal of time over the next several months,
working closely with suppliers and vendors, to assure their compliance.
Should a situation occur where a key partner or vendor is unable to resolve
their Y2K issue, we will be in a position to change to Y2K compliant partners
and vendors.
Cost to Address Y2K Issues Since we are in the unique position implementing new
enterprise wide business solutions to replace existing manual processes and/or
"home grown" applications., there will be little, if any, Y2K changes required
to existing business applications. All of the new business applications
implemented (or in the process of being implemented in 1999) are represented as
being Y2K compliant.
We currently believe that implementing our Y2K Plan will not have a material
effect on our financial position.
Contingency Plan We have not formulated a contingency plan at this time but
expect to have specific contingency plans in place prior to September 30, 1999.
Summary We anticipate that the Y2K Issue will not have a material adverse effect
on our financial position or results of operations. There can be no assurance,
however, that the systems of other companies or government entities, on which we
rely for supplies, cash payments, and future business, will be timely converted,
or that a failure to convert by another company or government entities, would
not have a material adverse effect on our financial position or results of
operations. If third party service providers and vendors, due to Y2K Issues,
fail to provide us with components, materials, or services which are necessary
to deliver our services and product offerings, with sufficient electrical power
and transportation infrastructure to deliver our services and product offerings,
then any such failure could have a material adverse effect on our ability to
conduct business, as well as our financial position and results of operations.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to
the increase or decrease in the amount of interest income we can earn on our
investment portfolio and on the increase or decrease in the amount of interest
expense we must pay with respect to our various outstanding debt instruments.
The risk associated with fluctuating interest expense is limited, however, to
the exposure related to those debt instruments and credit facilities which are
tied to market rates. We do not use derivative financial instruments in our
investment portfolio. We ensure the safety and preservation of our invested
principal funds by limiting default risks, market risk and reinvestment risk. We
mitigate default risk by investing in safe and high-credit quality securities.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Not applicable.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. Not applicable.
Item 2. Changes in Securities. Not applicable.
Item 3. Defaults upon Senior Securities. Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders. Not applicable.
Item 5. Other Information. Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K
On January 26, 1999, the Company filed a Form 8-K reporting the
issuance of $12 million of the Company's 9% Senior Subordinated
Convertible Notes due January 1, 2001.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SOFTNET SYSTEMS, INC.
/s/ Douglas S. Sinclair
- -----------------------
Douglas S. Sinclair
Chief Financial Officer
Dated: February 16, 1999
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This schedule contains summary information extracted from Form 10-Q for the
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