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, 2000
[ ] 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 0-21999
-----------------------
NHANCEMENT TECHNOLOGIES INC.
(Exact name of registrant as specified in its charter)
DELAWARE 84-1360852
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
6663 OWENS DRIVE
PLEASANTON, CALIFORNIA 94588
(Address of principal executive offices)
(925) 251-3200
(Registrant's telephone number)
----------------
Check 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
past 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days.
YES [X] NO [ ]
As of February 13, 2001, there were 12,849,890 shares of Common Stock
outstanding.
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements........................................ 3
Condensed Consolidated Balance Sheets at December 31, 2000 and September 30, 2000.. 3
Condensed Consolidated Statements of Operations and Comprehensive Loss for the
three months ended December 31, 2000 and 1999...................................... 4
Condensed Consolidated Statements of Cash Flows for the three months ended
December 31, 2000 and 1999......................................................... 5
Notes to Condensed Consolidated Financial Statements............................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations......................................................................... 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk......................... 31
PART II. OTHER INFORMATION 32
Item 1. Legal Proceedings.................................................................. 32
Item 2. Changes in Securities and Use of Proceeds.......................................... 32
Item 4. Submission of Matters to a Vote of Security Holders................................ 33
Item 6. Exhibits and Reports on Form 8-K................................................... 34
2
PART I. FINANCIAL STATEMENTS
ITEM 1. Condensed Consolidated Financial Statements
NHANCEMENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31, September 30,
2000 2000
------------ ------------
ASSETS (unaudited)
CURRENT ASSETS
Cash and cash equivalents......................................... $ 4,515,000 $ 5,603,000
Restricted cash................................................... 117,000 116,000
Accounts receivable, net of allowance for
doubtful accounts of $402,000 and $402,000....................... 3,952,000 3,907,000
Receivable from related party..................................... 250,000 --
Inventory......................................................... 461,000 550,000
Equipment at customers under integration.......................... 1,983,000 1,708,000
Prepaid expenses and other........................................ 691,000 313,000
------------ ------------
TOTAL CURRENT ASSETS 11,969,000 12,197,000
Property and equipment, net....................................... 6,703,000 3,395,000
Capitalized software, net......................................... 19,201,000 18,366,000
Goodwill and other intangible assets, net......................... 2,242,000 2,443,000
Other assets...................................................... 2,368,000 2,384,000
------------ ------------
TOTAL ASSETS $ 42,483,000 $ 38,785,000
============ ============
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Lines of credit................................................... $ -- $ 343,000
Accounts payable.................................................. 4,531,000 5,269,000
Accrued liabilities............................................... 3,237,000 2,478,000
Deferred revenue.................................................. 3,197,000 2,919,000
Income tax payable................................................ 358,000 280,000
Advances for preferred stock...................................... -- 3,500,000
Capital lease obligations, current portion........................ 6,540,000 3,072,000
------------ ------------
TOTAL CURRENT LIABILITIES 17,863,000 17,861,000
Capital lease obligations, net of
Current portion.................................................. 5,069,000 4,717,000
------------ ------------
TOTAL LIABILITIES 22,932,000 22,578,000
REDEEMABLE CONVERTIBLE PREFERRED STOCK............................... 4,932,000 --
STOCKHOLDERS' EQUITY
Common stock...................................................... 127,000 123,000
Additional paid-in capital........................................ 59,047,000 49,261,000
Unearned stock-based compensation................................. (1,883,000) (2,012,000)
Accumulated deficit............................................... (42,416,000) (30,809,000)
Accumulated other comprehensive loss.............................. (256,000) (356,000)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 14,619,000 16,207,000
------------ ------------
TOTAL LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY $ 42,483,000 $ 38,785,000
============ ============
See notes to condensed consolidated financial statements.
3
NHANCEMENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(unaudited)
Three Months Ended
December 31,
2000 1999
------------ ------------
NET REVENUES:
Products and integration services.................................. $ 1,273,000 $ 4,040,000
Other services..................................................... 4,842,000 4,301,000
------------ ------------
TOTAL NET REVENUES 6,115,000 8,341,000
Cost of revenues:
Products and integration services.................................. 1,490,000 3,012,000
Other services..................................................... 2,871,000 2,812,000
------------ ------------
TOTAL COST OF REVENUES 4,361,000 5,824,000
GROSS PROFIT 1,754,000 2,517,000
OPERATING EXPENSES
Selling, general and administrative................................ 5,167,000 2,503,000
Amortization of goodwill and other intangibles..................... 201,000 159,000
------------ ------------
TOTAL OPERATING EXPENSES 5,368,000 2,662,000
INCOME (LOSS) FROM OPERATIONS (3,614,000) (145,000)
OTHER INCOME (EXPENSE)
Interest income.................................................... 108,000 37,000
Interest expense................................................... (464,000) (115,000)
Other.............................................................. 104,000 (64,000)
------------ ------------
Total other expense (252,000) (142,000)
Income (loss) before income tax (3,866,000) (287,000)
Provision for income tax........................................... 115,000 37,000
------------ ------------
NET INCOME (LOSS) (3,981,000) (324,000)
Preferred dividends................................................ (7,626,000) (2,000)
------------ ------------
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS $(11,607,000) $ (326,000)
============ ============
BASIC AND DILUTIED NET LOSS PER COMMON SHARE $ (0.92) $ (0.04)
============ ============
SHARES USED IN PER SHARE CALCUATIONS - BASIC
AND DILUTED 12,575,500 8,188,500
============ ============
COMPREHENSIVE INCOME (LOSS)
Net income (loss) $ (3,981,000) $ (324,000)
Other comprehensive income (loss)
Translation gain (loss) 100,000 41,000
------------ ------------
COMPREHENSIVE INCOME (LOSS) $ (3,881,000) $ (283,000)
============ ============
See notes to condensed consolidated financial statements.
4
NHANCEMENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended
December 31,
-------------------------------------
2000 1999
------------ -----------
CASH FLOWS FROM OPERATING ACTIVITES
Net income (loss) ................................................... $ (3,981,000) $ (324,000)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization........................................ 435,000 100,000
Amortization of goodwill............................................. 201,000 159,000
Gain on sale of fixed assets......................................... -- 1,000
Stock-based compensation relating to stock
options and warrants................................................ (1,445,000) 305,000
Other................................................................ -- 56,000
Changes in operating assets and liabilities:
Accounts receivable................................................ (45,000) (1,768,000)
Inventory.......................................................... (186,000) (288,000)
Prepaid expenses and other......................................... (378,000) (60,000)
Other assets....................................................... 16,000 (22,000)
Accounts payable and other current liabilities..................... 951,000 1,672,000
Income tax payable................................................. 78,000 26,000
Deferred revenue................................................... 278,000 275,000
------------ -----------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (4,076,000) 132,000
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Restricted cash...................................................... (1,000) (1,000)
Proceeds loaned to related party..................................... (250,000) --
Proceeds on sale of property and equipment........................... -- 17,000
Development of software assets....................................... (272,000) (175,000)
Purchase of property and equipment................................... (260,000) (236,000)
------------ -----------
NET CASH USED IN INVESTING ACTIVITIES (783,000) (395,000)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowing under line of credit....................................... 4,673,000
Repayment under line of credit....................................... (343,000) (3,862,000)
Proceeds from issuance of Series B preferred
stock............................................................... 5,262,000 --
Issuance cost of Series B preferred stock............................ (303,000) --
Proceeds from warrants and options exercised
for common stock.................................................... 784,000 --
Principal payments on capital lease obligations...................... (1,729,000) (24,000)
------------ -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 3,671,000 787,000
Effect of exchange rate changes on cash 100,000 68,000
------------ -----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1,088,000) 592,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD $ 5,603,000 $ 2,329,000
------------ -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,515,000 $ 2,921,000
============ ===========
See notes to condensed consolidated financial statements.
5
NHANCEMENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
---------------------------------------------------------------------------------------------------------------------------------
Supplemental disclosures for cash flow information: Cash paid during the period
for:
Interest $ 441,000 $ 91,000
Income taxes $ 37,000 $ 5,000
NONCASH TRANSACTIONS:
Property and equipment acquired under capital leases $ 3,483,000 $ 8,000
Deemed dividend on beneficial conversion feature of
Series B Preferred Stock $ 7,626,000 $ --
Issuance of warrants to underwriters in conjunction
with sale of Series B Preferred Stock $ 1,107,000 $ --
Modification of warrant exercise price in
conjunction with sale of Series B Preferred Stock $ 1,847,000 $ --
Liability for future issuance of common stock to
underwriters in conjunction with sale of Series B
Preferred Stock $ 573,000 $ --
Payable for purchases of property and equipment financed
under capital leases during quarter $ 1,503,000 $ --
Software assets acquired under capital leases $ 563,000 $ --
Services provided by a related party in lieu of
payment on a note payable $ -- $ 53,000
---------------------------------------------------------------------------------------------------------------------------------
See notes to condensed consolidated financial statements.
6
NHANCEMENT TECHNOLOGIES INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The condensed consolidated financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC"). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. However, the Company believes that the
disclosures are adequate to make the information presented not misleading. The
balance sheet as of September 30, 2000 is derived from the Company's audited
financial statements included in its Form 10-KSB for the fiscal year ended
September 30, 2000 but does not include all disclosures required by generally
accepted accounting principles in the United States. These condensed
consolidated financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-KSB for the fiscal year ended September 30, 2000.
The unaudited condensed consolidated financial statements included herein
reflect all adjustments (which include only normal recurring adjustments) which
are, in the opinion of management, necessary to state fairly the results for the
interim periods presented. The results of operations for the interim periods
presented are not necessarily indicative of the operating results to be expected
for any subsequent interim period or for the fiscal year ending September 30,
2001.
The consolidated financial statements include the results of our significant
operating subsidiaries: NHancement Technologies North America, Inc. ("NHAN
NA") and Infotel Technologies (Pte) Ltd ("Infotel").
NHAN NA revenues were 39% and 54% of consolidated net revenues for the three
months ended December 31, 2000 and 1999. Infotel revenues were 61% and 46% of
consolidated net revenues for the three months ended December 31, 2000 and 1999.
No revenues have been recorded through December 31, 2000 from the Company's
hosted internet inUnison-TM- unified communication and unified information
portal services.
2. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed based on the weighted average
number of shares outstanding during the period. Diluted net income (loss) per
share is also computed based on the weighted average number of shares
outstanding during the period. Diluted net income (loss) per share does not
include the weighted average effect of dilutive potential common shares
including convertible preferred stock, options and warrants to purchase common
stock and common stock subject to repurchase in any period presented because the
effect is anti-dilutive.
7
The following table presents information necessary to reconcile basic and
diluted net income (loss) per common and common equivalent share:
Three Months Ended
December 31,
----------------------------------------------
2000 1999
--------------------- ---------------------
Net income (loss) $ (3,981,000) $ (324,000)
Preferred stock dividends (7,626,000) (2,000)
-------------- ------------
Basic net income (loss) applicable
to common stock $ (11,607,000) $ (326,000)
============== ===========
Weighted average shares used in
net income (loss) per share - basic and
diluted 12,575,500 8,188,500
------------- -----------
Anti-dilutive securities:
Convertible preferred stock 87,620 439,300
Options and warrants to purchase
common stock 3,774,900 857,500
Other -- 8,400
------------- -----------
Anti-dilutive securities not included in
net loss per share calculation 3,862,520 1,305,200
============= ===========
3. INVENTORY
Inventory consists of systems and system components and is valued at the lower
of cost (first-in, first-out method) or market.
4. RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB 101"),
Revenue Recognition in Financial Statements." SAB 101 summarizes certain of the
SEC's views in applying generally accepted accounting principles to revenue
recognition in financial statements. The Company adopted SAB 101 in the first
quarter of fiscal 2001. The adoption of SAB 101 did not have a material effect
on the Company's financial position or results of operations.
5. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
On October 1, 2000, the Company adopted Statement of Financial Accounting
Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and
Hedging Activities." SFAS 133 requires that all derivatives be recorded on the
balance sheet at fair value. Changes in the fair value of derivatives that do
not qualify for hedge treatment, as well as the ineffective portion of a
particular hedge, must be recognized currently in earnings.
The Company has significant international sales transactions generated by it's
Singapore subsidiary, Infotel. The Company has used forward exchange contracts
to hedge firm purchase commitments that expose the Company to risk as a result
of fluctuations in foreign currency exchange rates. Gains and losses of forward
exchange contracts that were designated as hedges of firm purchase commitments
were deferred in other current liabilities and were included in the measurement
of the underlying transaction. Hedge accounting was only applied if the
derivative reduced the risk of the underlying hedged item and was designated at
inception as a hedge. Derivatives are measured for effectiveness both at
inception and on an ongoing basis. Exchange contracts outstanding at December
31, 2000, which hedged firm purchase commitments had notional amounts of
$439,000 which approximates fair value and matures in June 2001.
8
6. RELATED PARTY RECEIVABLE
On December 20, 2000, the Company's Chief Executive Officer entered into a
promissory note with the Company for $250,000, which bears interest at 8% per
annum. The note was repaid in full in January 2001.
7. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases its principal office facilities in Pleasanton, California and
San Diego, California pursuant to non-cancelable operating leases, which expire
in 2007. NHAN India leases office space that expires in February 2003. Infotel
leases office space in Singapore with the lease expiring in December 2002.
Future minimum rental payments under operating leases as of December 31, 2000
are as follows (in thousands):
FISCAL YEAR
2001 $ 584,000
2002 578,000
2003 447,000
2004 346,000
2005 345,000
thereafter 970,000
----------
$3,270,000
==========
CAPITAL LEASES
In the first quarter of fiscal 2001, the Company entered into additional
financing transactions with Hewlett-Packard, financing approximately $1.1
million related to hardware and other product costs and $2.4 million related
to consulting services.
The Company also leases computer equipment and other software under capital
leases. These leases extend for varying periods through 2004.
Equipment and software under capital leases included in property and equipment
are as follows:
2000 1999
------ ------
Equipment $ 4,991,000 $265,000
Software 10,573,000 --
----------- --------
15,564,000 265,000
----------- --------
Less: accumulated amortization (465,000) (74,000)
----------- --------
$15,099,000 $191,000
=========== ========
9
Capital lease payments are as follows:
FISCAL YEAR
2001 $5,902,000
2002 4,815,000
2003 2,837,000
2004 3,000
----------
13,557,000
Less amount representing interest (1,948,000)
----------
Present value of minimum lease payments 11,609,000
Less current maturities 6,540,000
----------
$5,069,000
==========
Contingencies
In 2000, the Company instituted arbitration proceedings against one of its
customers for breach of contract totaling approximately $610,000, of which
the customer had paid approximately $276,000. The Company is vigorously
pursuing this arbitration matter seeking specific performance and full
payment for amounts outstanding.
In December 2000, a former employee filed suit for wrongful termination in the
Superior Court of Alameda County, State of California. The Company believes the
suit is without merit and is defending it vigorously.
In 1999, the Company retained a professional services firm and agreed to issue a
warrant for the purchase of 30,000 shares of the Company's common stock, at a
price of $8.3438 per share, as partial compensation for the services rendered,
provided certain conditions were met. The conditions were met in February 2000
but the warrant was not issued until November 28, 2000 (See Note 9). The warrant
holder contends that the Company delayed unreasonably in issuing the warrant and
thereby deprived him of the right to sell the underlying shares at a profit. The
Company and the warrant holder are engaged in discussions aimed at resolving the
issue. No lawsuit has been filed.
Management believes that the ultimate outcome of these matters should not
have a material adverse effect on the Company's consolidated financial
position, results of operations and cash flows.
8. REDEEMABLE CONVERTIBLE PREFERRED STOCK
In October 2000, the Company sold 87,620 shares of Series B Preferred Stock
to domestic "accredited investors" for aggregate gross proceeds of $8,762,000,
including $3.5 million received in advance. In connection with this issuance,
the Company also issued to its investment bankers a fully exercisable warrant to
acquire 75,000 shares of its Common Stock at an exercise price of $13.50 per
share and paid a placement fee of 10% of the proceeds, 35% in cash and 65% which
will be paid in common stock to be issued in the second quarter of 2001. Holders
of the Series B Preferred Stock are entitled to a non-cumulative 5% per annum
dividend, payable quarterly in arrears, when, if and as declared by the
Company's Board of Directors, which may be paid in cash or shares of the
Company's Common Stock, in the Company's sole discretion. Each share of Series B
Preferred Stock is immediately convertible into shares of our Common Stock at
10
the lesser of (i) $13.50 per share or (ii) 90% of the average closing bid prices
for the 10 trading days immediately preceding the date of conversion, provided,
that such conversion price shall not be less than $10.00. At any time after the
third anniversary of the Closing, the Company may require the holders of the
Series B Preferred Stock to convert.
Upon voluntary or involuntary liquidation, dissolution or winding up of the
Company, the investors will be entitled to receive, on a pari passu basis with
holders of other shares of Preferred Stock, if any, an amount equal to such
investors investment in the Offering and any declared but unpaid dividends. As a
result, the net proceeds from the sale of the Series B Preferred Stock has been
classified outside of stockholders' equity.
As a result of the beneficial conversion feature described above, the Company
recorded a deemed dividend of $7,626,000 during the three months ended December
31, 2000. In addition, the Company estimated the value of the warrant at
$1,107,000 issued to its investment bankers using the Black-Scholes option
pricing model with the assumptions that follow: expected volatility of 135%,
weighted average risk free interest rate of 5.08%, term of 1 year, and no
expected dividend. The Company recorded this warrant as a cost of financing.
As of February 13, 2000, 86,120 preferred shares have been converted into
861,200 shares of the Company's common stock.
9. STOCKHOLDERS' EQUITY
WARRANTS
On November 28, 2000, the Company issued warrants to purchase 30,000 shares
to a professional services firm in consideration for certain services
rendered to the Company at an exercise price of $8.3438 per share. The
warrants are immediately exercisable and expire in November 2005. The
warrants were valued using the Black-Scholes option pricing model and the
following assumptions: contractual term of five years, a risk free interest
rate of 5.08%, a dividend yield of 0% and volatility of 135%. The fair value
of $413,000 was expensed during the three months ended December 31, 2000.
On November 15, 2000, the Company adjusted the exercise price of warrants to
purchase 120,000 shares of its common stock from $20.82 to 13.50 to obtain a
waiver from the warrant holder allowing the Company to issue Series B
preferred stock to other investors, as well as engage in other financing
transactions. The warrants were originally issued in conjunction with a stock
purchase agreement (See Note 11). The modification to the warrants was valued
using the Black-Scholes option pricing model and the following assumptions:
term of 2.54 years, a risk free interest rate of 6.2%, a dividend of 0% and a
volatility of 135%. The fair value of the warrant of $1,847,000 was accounted
for as a cost of the Series B preferred stock financing.
10. SEGMENT REPORTING
The Company defines operating segments as components of an enterprise about
which separate financial information is available that is evaluated regularly by
the chief operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance. The operating segments
11
disclosed are managed separately, and each represents a strategic business unit
that offers different products and serves different markets.
The Company's reportable operating segments include NHAN NA, Infotel, and other,
which includes corporate operations. NHAN NA, includes the Company's legacy
operations, Triad and NHAN SWG. NHAN NA legacy operations include systems
integration and distribution of voice processing and multimedia messaging
equipment, technical support and ongoing maintenance. Triad, which provides
profile selling services to corporate and credit union clients, has been
classified as part of NHAN NA for internal reporting purposes rather than as a
separate segment. The quarter ended December 31, 1999 has been reclassified to
conform to the current fiscal year presentation. Triad derives substantially all
of its revenue from sales in the U.S. NHAN SWG was formed late in fiscal 1999 to
design, develop, market and sell the inUnison-TM- portal services. NHAN SWG did
not generate revenue in 2000 or 1999. The following table presents NHAN NA's net
revenue by country and is attributed to countries based on location of the
customer:
For the three months ended
December 31,
----------------------------------------
2000 1999
------------------ ------------------
United States $1,600,000 $4,543,000
India 766,000 --
---------- ----------
$2,366,000 $4,543,000
========== ==========
Infotel is a distributor and integrator of telecommunications and other
electronics products operating in Singapore and provides radar system
integration, turnkey project management, networking and test instrumentation
services. Infotel derives substantially all of its revenue from sales in
Singapore. There are no intersegment revenues.
The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies in the Company's
Annual Report on Form 10-KSB for our fiscal year ended September 30, 2000.
NHAN NA INFOTEL OTHER(1) TOTAL
THREE MONTHS ENDED December 31, 2000
Net sales to external customers $ 2,366,000 $ 3,749,000 $ -- $ 6,115,000
Net income (loss) (4,761,000) 224,000 556,000 (3,981,000)
Total assets 14,187,000 10,206,000 18,090,000 42,483,000
THREE MONTHS ENDED December 31, 1999
Net sales to external customers $ 4,543,000 $ 3,798,000 $ -- $ 8,341,000
Net income (loss) 199,000 263,000 (786,000) (324,000)
Total assets 8,809,000 7,226,000 2,892,000 18,927,000
(1) Other includes corporate expenses. Additionally, management reports
include goodwill for Infotel in total assets.
11. SUBSEQUENT EVENTS
In Fiscal Year 2000 the Company entered into a common stock purchase agreement
(the "equity line agreement"), dated May 24, 2000 and amended as of June 30,
2000 with an investment corporation under which the Company may require the
investment corporation to purchase up to $50 million of its common stock. Under
12
the terms of the equity line agreement, the Company is under no obligation to
sell its common stock to the investment corporation. However, the Company may
make up to a maximum of twelve requests for the purchase of its common stock
with no single purchase exceeding $4 million unless otherwise agreed to by the
investment corporation. In addition, the equity line agreement does not require
the investment corporation to purchase the Company's common stock if it would
result in the investment corporation owning more than 9.9% of the Company's
outstanding common stock. The purchase price of the common stock is 92% of the
volume weighted average price per share of the Company's common stock over the
eighteen-day period prior to the date the Company requests the investment
corporation to purchase its common stock. In addition, the investment
corporation will receive a 2% placement fee and an escrow agent fee from the
proceeds due to the Company. In conjunction with the stock purchase agreement,
the Company issued a warrant to purchase 120,000 shares of its common stock. The
warrant exercise price was subsequently adjusted to $13.50 per share on November
15, 2000 in exchange for securing a waiver from the investment corporation
allowing us to issue Series B preferred stock to other investors, as well as
engage in other financing transactions. The Black-Scholes option pricing model
was used to value the warrants and the following assumptions: contractual term
of 3 years, a risk free interest rate of 5.8%, a dividend yield of 0% and a
volatility of 135%. The fair value of $2,144,000 was accounted for as a
non-current asset. As and when stock is purchased under the equity line
agreement, the costs will be reclassified from "Other assets" to "Additional
paid in capital", on a dollar for dollar basis with the amount of proceeds
received from the sale of common stock.
In January 2001, the Company requested that the investment corporation
purchase $1.5 million of common stock under the equity line agreement. On
February 7, 2001, $750,000 of cash was received from the investment
corporation, and the remaining $750,000 is expected to be received by
February 28, 2001. Accordingly, the Company will reclassify the $1.5 million
of common stock issued to the investment corporation from "Other Assets" to
"Additional paid-in capital" upon receipt of the proceeds and issuance of the
stock.
On February 8, 2001, The Company announced that it signed a definitive merger
agreement (the "Agreement") to acquire Quaartz Inc. Under the terms of the
Agreement, the Company would issue 1.5 million shares of common stock for
purposes of the transaction in exchange for all of the outstanding shares and
options of Quaartz. The acquisition is subject to Quaartz's shareholders'
approval and various other closing conditions. The acquisition will be
accounted for using the purchase method of accounting.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The statements contained in this Report on Form 10-Q that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, including statements regarding our
expectations, hopes, intentions or strategies regarding the future.
Forward-looking statements include statements regarding: future product or
product development; future research and development spending and our product
development strategies, including our new inUnison-TM- unified communications
and unified information applications; the levels of international sales; future
expansion or utilization of production capacity; future expenditures; and
statements regarding current or future acquisitions, and are generally
13
identifiable by the use of the words "may", "should", "expect", "anticipate",
"estimates", "believe", "intend", or "project" or the negative thereof or other
variations thereon or comparable terminology.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause our actual results, performance or achievements (or
industry results, performance or achievements) expressed or implied by these
forward-looking statements to be materially different from those predicted. The
factors that could affect our actual results include, but are not limited to,
the following:
- general economic and business conditions, both nationally and in
the regions in which we operate;
- adoption of our new recurring revenue service model;
- competition;
- changes in business strategy or development plans;
- delays in the development or testing of our products;
- technological, manufacturing, quality control or other problems
that could delay the sale of our products;
- our inability to obtain appropriate licenses from third parties,
protect our trade secrets, operate without infringing upon the
proprietary rights of others, or prevent others from infringing
on our proprietary rights;
- our inability to retain key employees;
- our inability to obtain sufficient financing to continue to
expand operations; and
- changes in demand for products by our customers.
Certain of these factors are discussed in more detail elsewhere in this Report
and the Annual Report on Form 10-KSB for the fiscal year ended September 30,
2000,including under the caption "Risk Factors; Factors That May Affect
Operating Results".
We do not undertake any obligation to publicly update or revise any
forward-looking statements contained in this Report or incorporated by
reference, whether as a result of new information, future events or otherwise.
Because of these risks and uncertainties, the forward-looking events and
circumstances discussed in this Report might not transpire.
OVERVIEW
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") should be read in conjunction with the consolidated
financial statements included herein. In addition, you are urged to read this
report in conjunction with the risk factors described herein. The discussion of
financial condition includes changes taking place or believed to be taking place
in connection with: our execution of our new, unified communications and unified
information hosted business model; the software, voice processing, data
14
processing and communications industry in general and how we expect these
changes to influence future results of operations; and liquidity and capital
resources, including discussions of capital financing activities and
uncertainties that could affect future results.
We are a software applications and services company that has changed its
business model to specialize in unified communications and unified information
(UC/UI) solutions. Our new business model is to provide our hosted, IP-based
unified communications and unified information portal and applications branded
under the name "inUnison-TM-" in a recurring revenue model.
Our consolidated financial statements include our results as well as the
results of our significant operating subsidiaries: NHancement Technologies
North America, Inc. ("NHAN NA"), Infotel Technologies (Pte) Ltd ("Infotel"),
and Nhancement Acquisition Corp. (formerly, Trimark Incorporated, d/b/a
"Triad Marketing").
For our legacy operations, the Company derives its revenue primarily from its
NHAN NA, which includes the results of Triad Marketing, and Infotel
subsidiaries. Generally, revenue derived from NHAN NA relates to the
distribution and integration of voice processing and multimedia messaging
equipment manufactured by others and maintenance services. The revenue derived
from Infotel primarily relates to the distribution and integration of
telecommunications and other electronic products, and providing services
primarily for radar system integration, turnkey project management and test
instrumentation and networking. Equipment sales and related integration services
revenue is recognized upon acceptance and delivery if a signed contract exists,
the fee is fixed or determinable, collection of the resulting receivable is
reasonably assured, and product returns are reasonably estimable. Provisions for
estimated warranty costs and returns are made when the related revenue is
recognized. Revenue from maintenance services related to ongoing customer
support is recognized ratably over the period of the maintenance contact.
Maintenance service fees are generally received in advance and are
non-refundable. Service revenue is recognized as the related services are
performed. Revenues from projects undertaken for customers under fixed price
contracts are recognized under the percentage-of-completion method of accounting
for which the estimated revenue is based on the ratio of cost incurred to costs
incurred plus estimated costs to complete. When the Company's current estimates
of total contract revenue and cost indicate a loss, the Company records a
provision for estimated loss on the contract.
As we are in the process of launching our new, hosted unified communications and
unified information applications business model, our results for the three
months ended December 31, 2000 reflect generally the results of our legacy
business in North America, as well as that of Infotel. Our revenues for the
three months ended December 31, 2000 were derived solely from our legacy
businesses. We have increased significantly our headcount in the United States
(sales, sales engineering, operations, marketing, and engineering) and in India
(engineering, sales and marketing) for our new business model. As of December
31, 2000 we had 232 employees worldwide.
Our new business model for providing unified communications and unified
information in a hosted, recurring revenue service model makes us one of the
first companies in this new market. We anticipate competition in this relatively
new market space to increase significantly. We will continue to invest heavily
in software development, the build out of our production operations and both
customer and subscriber acquisition.
15
RESULTS OF OPERATIONS
The following table shows results of operations, as a percentage of net sales,
for the three months ended December 31, 2000 and 1999:
Three Months Ended
December 31,
2000 1999
----------- ----------
Net revenues 100.0% 100.0%
Cost of sales 71.3% 69.8%
Gross profit 28.7% 30.2%
Selling, general and administrative 84.5% 30.0%
Amortization of goodwill and
Other intangibles 3.3% 1.9%
Loss from operations (59.1%) (1.7%)
Other income (expense) (4.1%) (1.7%)
Loss before income taxes (63.2%) (3.4%)
Income tax expense 1.9% 0.4%
Loss from continuing operations (65.1%) (3.8%)
Net loss (65.1%) (3.8%)
Net Revenues
For the three months ended December 31, 2000, our net revenues were $6.1 million
as compared to $8.3 million for the same period ending December 31,
1999, representing a decrease of $2.2 million or 26.5%. Our net revenues for the
three months ended December 31, 2000 were adversely affected by our transition
to our new business model for providing unified communications and unified
information applications in our inUnison-TM- portal in a hosted service,
recurring revenue model. The decline also represents an overall decline in our
legacy revenues following our announced business model change.
NHAN NA's net revenues were $2.4 million for the three months ended December 31,
2000 as compared to $4.5 million for the period ending December 31, 1999. The
quarter-to-date decrease in NHAN NA net revenues came from reduced enterprise
information center product sales, as well as lower legacy system sales within
our existing customer base.
Net revenues for our Infotel subsidiary remained constant at $3.7 million for
the three months ended December 31, 2000 as compared to $3.8 million for the
three months ended December 31, 1999.
Our legacy business backlog increased to $8.1 million at December 31, 2000 as
compared to $5.3 million as of December 31, 1999. NHAN NA's order backlog
decreased to $2.0 million from $2.9 million at December 31, 1999, and Infotel's
backlog increased to $6.1 million at December 31, 2000 from $2.4 million at
December 31, 1999.
Gross Margin
Our gross margin for the three months ended December 31, 2000 was $1.8 million
or 28.7% of net revenues, as compared to $2.5 million or 30.2% for the three
months ended December 31, 1999. NHAN NA's gross margin on a stand-alone basis
for the three months ended December 31, 2000 was $0.8 million or 33.5%, as
16
compared to $1.5 million or 33.6% for the three months ended December 31, 1999.
Infotel's gross margin percentage on a stand-alone basis remained constant at
25.7% for the three months ended December 31, 2000 and 25.9% for the three
months ended December 3, 1999. This decrease in gross margin was due to the
reduction in legacy revenues as we execute our new business model coupled with
the fixed nature of operating costs.
Research and Development
Our industry is characterized by rapid technological change and product
innovation. We have changed our business model that requires significant focus
on developing new applications to be offered in our hosted inUnison-TM- portal,
as well as integrating third party applications. We are also conducting research
and development into our own advanced speech recognition to be offered in our
portal. We believe that continued timely development of products for both
existing and new markets is necessary to remain competitive. Therefore, we
devote significant resources to programs directed at developing new and enhanced
products, as well as new applications for existing products. Our capitalized
research and development expenditures increased to $272,000 in three months
ended December 31, 2000 from $175,000 in the three months ended December 31,
1999, reflecting our increased investment in research and development. We have
adopted AICPA Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed and Obtained for Internal Use," ("SOP 98-1") and capitalize
our research and development costs related to software development. We will
begin amortizing these costs when the capitalized software is substantially
complete and ready for its intended use.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses ("SG&A"), including non-cash
charges related to options and warrants and amortization of goodwill and other
intangibles, as a percentage of net sales increased to 87.8% of net revenues for
the three months ended December 31, 2000, as compared to 31.9% for three months
ended December 31, 1999. This increase is due to the addition of United States
sales and marketing personnel and related expenses, coupled with the reduction
in revenues in NHAN NA as we execute our new business model. SG&A for NHAN NA on
a stand-alone basis increased to $5.0 million or 212.0% for the three months
ended December 31, 2000 from $1.1 million or 23.9% in the three months ended
December 31, 1999. The increase as a percentage of net revenues was due
primarily to an increase in sales and marketing and general and administrative
personnel and related expenses coupled with a decline in legacy system and
maintenance revenue. On a stand-alone basis, Infotel's SG&A as a percentage of
revenues remained constant at 17.3% for the three months ended December 31, 2000
and 17.4% for the three months ended December 31, 1999. Our amortization of
goodwill and other intangibles for the three months ended December 31, 2000
increased to $201,000 or 3.2% of net revenue from $159,000 or 1.9% of net
revenue for the three months ended December 31, 1999.
During fiscal year 2000, we recorded unearned stock-based compensation of $2.1
million in connection with stock option grants. We are amortizing this amount
over the vesting periods of the applicable options, resulting in amortization
expense of $129,000 in the three months ended December 31, 2000. During the
three months ended December 31, 2000 we incurred non-cash compensation charges
of $413,000 related to warrants for services. We recorded a reduction in
non-cash compensation charges of $1.9 million resulting from the effect of
variable accounting for warrants issued to employees. The stock-based
compensation will
17
continue to be remeasured each reporting period until the awards are exercised
or cancelled.
Interest income and other
Our interest income and other increased to $212,000 or 3.5% in the three months
ended December 31, 2000 from net expense of $27,000 or (0.3%) in the three
months ended December 31, 1999. The increase in interest income and other
results from higher cash balances available for investment, together with
investments in short-term commercial paper, generating returns higher than
previously earned.
Interest expense
Our interest expense increased to $464,000 or 7.6% in the three months ended
December 31, 2000 from $115,000 or 1.4% in the three months ended December 31,
1999. The increase in interest expense resulted form higher capital lease
obligations during the three months ended December 31, 2000.
Income taxes
We currently have approximately $15.7 million in United States federal net
operating loss carry-forwards. The use of approximately $8 million of these
net operating losses are subject to an annual limitation of $250,000. At
December 31, 2000, we provided a 100% valuation allowance against our United
States deferred tax asset. We believe that since sufficient uncertainty
exists regarding the realization of the deferred tax asset, a full valuation
allowance is required. Income tax of $115,000 relates to the provision for
income tax for Infotel.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our capital requirements through a combination
of sales of equity securities, convertible and other debt offerings, bank
borrowings, asset-based secured financing, structured financing and cash
generated from operations.
During the three months ended December 31, 2000 net cash used in operating
activities was $4.1 million. Net cash used to fund operating activities
reflects our net loss, net of non-cash charges, offset by an increase in
accounts payable. Net cash provided by investing and primarily financing
activities totaled $2.9 million consisting of proceeds from the issuance of
Series B preferred stock and proceeds from the exercise of stock options and
warrants, which were offset by the repayments of our line of credit, payments
of our capital lease obligations, purchases of property and equipment,
development of software assets and proceeds loaned to a related party.
Our principal sources of liquidity at December 31, 2000 were as follows. In
October 2000, we sold 87,620 shares of our Series B Preferred Stock to U.S.
accredited investors for $100 per share, for aggregate gross proceeds of
$8,762,000. Holders of the Series B Preferred Stock are entitled to a
non-cumulative 5% per annum dividend, payable quarterly in arrears, when, if and
as declared by our Board of Directors, which may be paid in cash or shares of
our Common Stock, in our sole discretion. Each share of Series B Preferred Stock
is immediately convertible into shares of our Common Stock at the lesser of (i)
$13.50 per share or (ii) 90% of the average closing bid prices for the 10
trading days immediately preceding the date of conversion, provided, that such
18
conversion price shall not be less than $10.00. At any time after the third
anniversary of the Closing, we may require the holders of the Series B
Preferred Stock to so convert. Shares of our Common Stock issued upon
conversion of the Series B Preferred Stock may be resold pursuant to a Form
S-3 shelf registration statement that we will file. As of February 13, 2001,
86,160 preferred shares have been converted into 861,200 shares of the
Company's common stock.
The Company has entered into a common stock purchase agreement (the "equity line
agreement"), dated May 24, 2000 and amended as of June 30, 2000 with an
investment corporation under which the Company may require the investment
corporation to purchase up to $50 million of its common stock. Under the terms
of the equity line agreement, the Company is under no obligation to sell its
common stock to the investment corporation. However, the Company may make up to
a maximum of twelve requests for the purchase of its common stock with no single
purchase exceeding $4 million unless otherwise agreed to by the investment
corporation. The purchase price of the common stock is 92% of the volume
weighted average price per share of the Company's common stock over the
eighteen-day period prior to the date the Company requests the investment
corporation to purchase its common stock. In addition, the investment
corporation will receive a 2% placement fee and an escrow agent fee from the
proceeds due to the Company. In January 2001, the Company requested that the
investment corporation purchase $1.5 million of stock under the equity line
agreement and this purchase is expected to be completed by the end of February
2001.
Infotel has a credit line with a major Singapore bank for S$3.5 million
(approximately US$2.0 million) with interest at 1.25% above the bank prime rate
to be used for Infotel's overdraft protection, letters of credit, letters of
guarantee, foreign exchange and revolving credit. We guarantee this credit line.
We have maintained a $2.5 million receivables-based credit line that allows NHAN
NA to draw down this line based on the level and quality of its approved
receivables. At the end of fiscal year 2000, the Company renewed this agreement.
At December 31, 2000, there was no balance outstanding on this line.
On June 9, 2000, the Company entered into a Project Development Agreement
("PDA") with Hewlett-Packard to help design and build its Personalized
Communication Hub network architecture and infrastructure. Ninety percent of
the total project costs totaling $609,000 related to consulting services and
one hundred percent of the hardware and other product costs totaling $400,000
were financed by capital leases structured by Hewlett-Packard. In October
2000, we financed with Hewlett-Packard an additional $3.5 million, $1.1
million related to hardware and other product costs and $2.4 million related
to consulting services.
Despite our negative working capital of $5.9 million at December 31, 2000, we
believe that our anticipated cash flows from both operations and available
to us through financing arrangements that are presently in plan are sufficient
to meet our operating and capital requirements for at least the next 12 months.
Our capital requirements in the next 12 months will mainly result from hardware
and software purchases and professional services to launch our hosted services,
as well as costs to develop and execute customer subscriber acquisition
programs, marketing and advertising. We anticipate financing hardware, software
and related consulting services through structured financing from our vendors
and partners. Other financing requirements for customer and subscriber
acquisition marketing will need to be financed through equity and debt offerings
and cash generated from operations. We could be required, or could
19
elect, to raise additional funds during that period, and we may need to raise
additional capital in the future. Additional capital may not be available at
all, or may only be available on terms unfavorable to us. Any additional
issuance of equity or equity-related securities will be dilutive to our
stockholders.
RISK FACTORS; FACTORS THAT MAY AFFECT OPERATING RESULTS
The following risk factors may cause actual results to differ materially from
those in any forward-looking statements contained in the MD&A or elsewhere in
this report or made in the future by us or our representatives. Such
forward-looking statements involve known risks, unknown risks and uncertainties
and other factors which may cause the actual results, performance or
achievements expressed or implied by such forward-looking statements to differ
significantly from such forward-looking statements.
WE HAVE CURRENTLY RECORDED A NET LOSS, WE HAVE A HISTORY OF NET LOSSES AND WE
CANNOT BE CERTAIN OF FUTURE PROFITABILITY.
We recorded a net loss of $4.0 million on net revenues of $6.1 million for the
three months ended December 31, 2000. We also sustained significant losses for
the fiscal years ended September 30, 2000 and 1999. We also anticipate incurring
a net loss for our fiscal year ended September 30, 2001.
We anticipate continuing to incur significant sales and marketing, product
development and general and administrative expenses and, as a result, we will
need to generate significantly higher revenue to sustain profitability as we
build our organization for our new inUnison-TM- business model. In addition, we
anticipate beginning amortizing capitalized software and other assets that we
have purchased or developed for our new inUnison-TM- business model in our
fiscal year 2001. We cannot be certain that we will continue to realize
sufficient revenue to return to or sustain profitability.
Our consolidated financial condition and results of operations may be
adversely affected if we fail to continue to produce positive operating
results. This could also:
- adversely affect the future value of our common stock;
- adversely affect our ability to obtain debt or equity financing on
acceptable terms to finance our operations; and
- prevent us from engaging in acquisition activity.
OUR EQUITY AND DEBT FUNDING SOURCES MAY BE INADEQUATE TO FINANCE FUTURE
ACQUISITIONS.
The acquisition of complementary businesses, technologies and products has been
and may continue to be key to our business strategy. Our ability to engage in
acquisition activities depends on us obtaining debt or equity financing, neither
of which may be available or, if available, may not be on terms acceptable to
us. Our inability to obtain this financing may prevent us from executing
successfully our acquisition strategy.
Further, both debt and equity financing involve risks. Debt financing may
require us to pay significant amounts of interest and principal payments,
reducing our cash resources we need to expand or transform our existing
businesses. Equity financing may be dilutive to our stockholders' interest in
20
our assets and earnings.
A NUMBER OF FACTORS COULD CAUSE OUR FINANCIAL RESULTS TO BE WORSE THAN EXPECTED,
RESULTING IN A DECLINE IN OUR STOCK PRICE.
We plan to increase significantly our operating expenses to expand our sales and
marketing activities, develop and execute customer and subscriber acquisition
programs, broaden our customer support capabilities, develop new distribution
channels, fund increased levels of research and development, and build our
operational infrastructure. Any delay in generating or recognizing revenue,
whether from our legacy business or from our new unified communications and
unified information business, could cause our quarterly operating results to be
below the expectations of public market analysts or investors, if any, which
could cause the price of our common stock to fall.
We may experience a delay in generating or recognizing revenue because of a
number of reasons. We have experienced delays and could experience further
delays in completing our production environment for our new hosted
inUnison-TM- unified communications and unified information business. We are
dependent on our business partners and vendors to supply us with hardware,
software, consulting services, hosting, and other support to launch and
operate our new business.
Our quarterly revenue and operating results have varied significantly in the
past and may vary significantly in the future due to a number of factors,
including:
- Fluctuations in demand for our products and services;
- Unexpected product returns or the cancellation or rescheduling of
significant orders;
- Our ability to develop, introduce, ship and support new products and
product enhancements, and to project manage orders and installations;
- Announcement and new product introductions by our competitors;
- Our ability to develop and support customer relationships with service
providers and other potential large customers;
- Our ability to achieve required cost reductions;
- Our ability to obtain sufficient supplies of sole or limited sourced
third party products;
- Unfavorable changes in the prices of the products and components we
purchase;
- Our ability to attain and maintain production volumes and quality levels
for our products;
- Our ability to retain key employees;
- The mix of products and services sold;
- Costs relating to possible acquisitions and integration of technologies
Or businesses; and
21
- The effect of amortization of goodwill and purchased intangibles
Resulting from existing or future acquisitions.
Due to the foregoing factors, we believe that period-to-period comparisons of
our operating results should not be relied upon as an indicator of our future
performance.
OUR REVENUES WILL LIKELY DECLINE IF WE DO NOT DEVELOP AND INTEGRATE THE
COMPANIES WE ACQUIRE.
On February 8, 2001, we announced that we had signed a definitive agreement to
acquire Quaartz Inc., a development stage company that specializes in advanced
personalization technology. The acquisition is subject to various closing
conditions. There can be no assurance that if and when this acquisition is
completed, it will be effectively assimilated into our business. The integration
of Quaartz will place a burden on our management and infrastructure. Such
integration is subject to risks commonly encountered in making such
acquisitions, including, among others, loss of key personnel of the acquired
company, the difficulty associated with assimilating and integrating the
personnel, operations and technologies of the acquired company, the potential
disruption of our ongoing business, the maintenance of uniform standards,
controls, procedures, and employees. There can be no assurance that we will be
successful in overcoming these risks or any other problems encountered in
connection with our acquisition of Quaartz.
We may continue to pursue other acquisition opportunities. Acquisitions involve
a number of special risks, including, but not limited to:
- adverse short-term effects on our operating results;
- the disruption of our ongoing business;
- the risk of reduced management attention to existing operations;
- our dependence on the retention, hiring and training of key personnel and
the potential risk of loss of such personnel;
- our potential inability to integrate successfully the personnel,
operations, technology and products of acquired companies;
- unanticipated problems or unknown legal liabilities; and
- adverse tax or financial consequences.
Two of our prior acquisitions, namely the acquisition of Voice Plus (now known
as NHancement Technologies North America, Inc.) and Advantis Network & Systems
Sdn Bhd, a Malaysian company, in the past yielded operating results that were
significantly lower than expected. In fact, the poor performance of Advantis led
to its divestiture less than one year after we acquired the company.
The legacy business of Triad Marketing has declined as we have focused the
people and technologies of the Triad business on our new inUnison-TM- UC/UI
business.
Accordingly, no assurances can be given that the future performance of our
subsidiaries will be commensurate with the consideration paid to acquire these
companies. If we fail to establish the needed controls to manage growth
22
effectively, our consolidated operating results, cash flows and overall
financial condition will be adversely affected.
OUR SALE OF SHARES UPON CONVERSION OF OUR OUTSTANDING SERIES B PREFERRED STOCK
AT A PRICE BELOW THE MARKET PRICE OF OUR COMMON STOCK WILL HAVE A DILUTIVE
IMPACT ON OUR STOCKHOLDERS.
We have issued Series B Preferred Stock to certain investors that may be
converted into common stock at a discount to the then-prevailing market price of
our common stock. The issuance of shares upon conversion of the Series B
Preferred Stock may have a dilutive impact on our stockholders. Sales resulting
from the conversion of the Series B Preferred Stock could have an immediate
adverse effect on the market price of the common stock. To the extent that any
of our existing or future Series B Preferred Stock holders convert their
securities and sell the underlying shares into the market, the price of our
shares may decrease due to the additional shares entering the market.
OUR NEW PRODUCTS AND STRATEGIC PARTNERING RELATIONSHIPS MAY NOT BE SUCCESSFUL.
Our inUnison-TM- UC/UI product applications are designed to provide our
customers with hosted unifying communications and unifying information
solutions. Our inUnison-TM- applications will utilize CISCO Systems' unified
communications platform, Unified Open Network Exchange("Uone"). While we believe
that our inUnison-TM- applications running on the Uone platform will provide our
customers with scaled, carrier grade IP-based solutions, we cannot assure you
that our customers will accept or adopt them. Moreover, we will need to
integrate our existing products and applications onto CISCO's Uone platform,
together with various third party applications. These integration efforts could
prove unsuccessful, and could result in product delays and cost overruns. We
cannot assure you that CISCO or other software vendors whose software products
we license or incorporate into our inUnison-TM- portal will continue to support
their products. If these vendors discontinue their support, our business would
be adversely affected.
Further, we expect to continue incurring substantial expenditures for
equipment, systems, research and development, consultants and personnel to
implement this new business model. As a result, our consolidated operating
results and cash flows may be adversely affected, and we anticipate incurring
a net loss for our fiscal year ended September 30, 2001. Although we believe
that this new product offering will ultimately result in profitable
operations, there can be no assurance that the implementation of our new
business model will be successful.
CONTINUED RAPID GROWTH WILL STRAIN OUR OPERATIONS AND REQUIRE US TO INCUR COSTS
TO UPGRADE OUR INFRASTRUCTURE.
With the launch of our new hosted inUnison-TM- business model, we have
experienced a period of rapid growth and expansion that has placed, and
continues to place, a significant strain on our resources. Indeed, our
worldwide head count grew approximately 31% in the three months ended
December 31, 2000 and 121% in our fiscal year ended September 30, 2000.
Unless we manage this growth effectively, we may make mistakes in operating
our business such as inaccurate sales forecasting, incorrect production
planning, managing headcount, or inaccurate financial reporting, either or
all of which may result in unanticipated fluctuations in our consolidated
operating results and adverse cash flow
23
and financing requirements. We expect our anticipated growth and expansion to
strain our management, operational and financial resources. Our management team
has had limited experience managing such rapidly growing companies on a public
or private basis. To accommodate this anticipated growth, we will be required
among other things to:
- Improve existing and implement new operations, information and financial
systems, procedures and controls;
- Recruit, train, manage, and retain additional qualified personnel
including sales, marketing, research and development personnel;
- Manage multiple relationships with our customers, our customers'
customers, our strategic partners, suppliers and other third parties; and
- Acquire additional office space and remote offices in numerous locations
within and without the United States that will require space planning and
infrastructure to support these additional locations.
We may not be able to install adequate control systems in an efficient and
timely manner, and our current or planned financial, operational and personnel
systems, procedures and controls may not be adequate to support our future
operations. We will need to install various new management information system
tools, processes and procedures, continue to modify and improve our existing
information technology infrastructure, and invest in training our people to meet
the increasing needs associated with our growth. The difficulties associated
with installing and implementing these new systems, procedures and controls may
place a significant burden on our management and our internal resources. In
addition, as we grow internationally, we will have to expand our worldwide
operations and enhance our communications infrastructure. Any delay in the
implementation of such new or enhanced systems, procedures or controls, or any
disruption in the transition to such new or enhanced systems, procedures or
controls, could adversely affect our ability to accurately forecast sales
demand, manage our hosted applications, and record and report financial and
management information on a timely and accurate basis.
THE UC/UI MARKET IS YOUNG AND UNTESTED. WE HAVE NOT COMMENCED PROVIDING UC/UI
SERVICES IN A HOSTED SERVICE MODEL TO OUR CUSTOMERS UNDER OUR NEW BUSINESS
MODEL.
The UC/UI market is in its infancy, and indeed we are one of the first companies
in unified information. Despite very positive and upbeat forecasts by a number
of leading industry analysts of the market potential for unified communications
and unified information applications, we have not yet commenced providing our
applications to our customers in a hosted service model. There is no assurance
that our UC/UI applications will be adopted or, if adopted, that they will be
successful in the marketplace. There is no assurance that our business model of
offering our applications in a hosted, recurring revenue model will be
successful. We may offer our UC/UI application in a license model to accommodate
customer demand for non-hosted solutions. Our current business plan is a new
plan, and to the extent that we fail to execute it successfully, compete with
new entrants to this market space, or otherwise are unable to build the
infrastructure necessary to provide such services to our customers, our results
and cash flows will be negatively impacted and we could face serious needs for
additional financing.
24
WE PRESENTLY GENERATE LEGACY VOICEMAIL SYSTEMS AND ENTERPRISE INFORMATION
REVENUES.
For the three months ended December 31, 2000, legacy voicemail systems revenues
(which includes customer premises equipment revenues) accounted for
approximately 2.9% of Company's total revenues and 7.4% of our North American
revenues. Revenue from the sales of enterprise information center products
accounted for approximately 44.6% of our North America revenue for the three
months ended December 31, 2000. The projected decline in our legacy business
will have an adverse effect on our revenues and financial performance.
Management believes that future revenues from legacy voicemail systems and
enterprise information center products will steadily decline due to the
introduction of inUnison-TM-. Our ability to transition our product sales to our
UC/UI hosted, recurring revenue model will be critical to our future growth.
THE SALES CYCLE FOR OUR NEW HOSTED APPLICATIONS MAY BE LONG, AND WE MAY INCUR
SUBSTANTIAL NON-RECOVERABLE EXPENSES OR DEVOTE SIGNIFICANT RESOURCES TO SALES
THAT DO NOT OCCUR OR OCCUR WHEN ANTICIPATED.
The timing of our recurring revenues from our hosted inUnison-TM- unified
communications and unified information applications is difficult to predict
because we are launching a new business model and because the unified
communications and unified information market is relatively new. Our success
will depend in large measure on market demand and acceptance of these
applications and technologies, our ability to create a brand for our
applications and technologies, our ability to target and sell customers and
to drive demand for our applications to their customers, our ability to
develop pricing models and to set pricing for our applications, and our
ability to build market share. We plan initially to provide our hosted
applications to service providers such as wireless service providers (WSPs),
internet service providers (ISPs), application service providers (ASPs) and
competitive local exchange carriers (CLECs). We will need to create sales
tools, service provider subscriber use models, methodologies and programs to
work with our service provider customers to help devise cooperative
advertising and sales campaigns to market and sell our inUnison-TM-
applications to their customer. The sales process and sale cycle may vary
substantially from customer to customer, and our ability to forecast
accurately the sale opportunity for any customer, or to drive adoption of our
inUnison-TM- applications in our customers' subscribers may be limited. There
is no assurance that we will be successful in selling our applications or
achieving targeted subscriber adoption, and our consolidated operating and
cash flow requirements will be negatively impacted should we fail to achieve
our targets within the time frames that we forecast.
Our customers may require various testing and test markets of our hosted
applications before they decide to contract with us to provide our hosted
inUnison-TM- applications to their subscribers. We may incur substantial sales
and marketing and operational expenses and expend significant management effort
to carry out these tests. Consequently, if sales forecasted from a specific
customer for a particular quarter are not realized within the time frames that
we have forecasted, we may be unable to compensate for the shortfall, which
could harm our operating and cash flow results.
WE RELY UPON OUR DISTRIBUTOR AND SUPPLIER RELATIONSHIPS.
Our current North American legacy operations depend upon the integration of
hardware, software, and communications and data processing equipment
25
manufactured by others into systems designed to meet the needs of our customers.
Although we have agreements with a number of equipment manufacturers, a major
portion of our revenues has been generated from the sale of products
manufactured by three companies. We rely significantly on products manufactured
and services provided by ADC Telecommunications, Inc., Baypoint Innovations, a
division of Mitel, Inc., and Interactive Intelligence, Inc. Any disruption in
our relationships with ADC Telecommunications, Inc., Baypoint Innovations, or
Interactive Intelligence, Inc. would have a significant adverse effect on our
business for an indeterminate period of time until new supplier relationships
could be established. Our customers as well may decide not to purchase ADC
products and solutions. Any interruption in the delivery of products by key
suppliers would materially adversely affect our results of operations and
financial conditions.
Some of our current suppliers may currently or, at some point, compete with us
as we roll out our inUnison-TM- UC/UI applications. Any potential competition
from our suppliers could have a material negative impact on our business and
financial performance.
WE ARE DEPENDENT UPON SIGNIFICANT CUSTOMERS.
We have serviced approximately 1,000 customers worldwide. However, the revenues
from our two largest customers in the three months ended December 31, 2000
accounted for approximately 12.5% and 12.3% of total revenues. No other customer
accounted for over 5% of total revenues during this period. This concentration
of revenue has resulted in additional risk to our operations, and any disruption
of orders from our largest customers would adversely affect on our results of
operations and financial condition.
Infotel, our Singapore subsidiary, offers a wide range of infrastructure
communications equipment products. It has an established business providing test
measuring instrumentation and testing environments, and is the regional
distributor and test and repair center for Rohde & Schwarz test instruments.
Infotel is also a networking service provider, and manages data networks for
various customers. Infotel's financial performance depends in part on a steady
stream of revenues relating to the services performed for Rohde & Schwarz test
instruments. Infotel's revenues constituted approximately 61.3% of our total
revenues for the three months ended December 31, 2000. Any material change in
our relationship with our manufacturers, including but not limited to Rohde &
Schwarz, would materially adversely affect our results of operations and
financial condition.
OUR MARKETS ARE HIGHLY COMPETITIVE, AND IF WE DO NOT COMPETE EFFECTIVELY, WE MAY
SUFFER PRICE REDUCTIONS, REDUCED GROSS MARGINS AND LOSS OF MARKET SHARE.
The markets for our legacy voice processing and enterprise information software
businesses are highly competitive, and competition in this industry is expected
to further intensify with the introduction of new product enhancements and new
competitors. With such competition may come more aggressive pricing and reduced
margins. We currently compete with a number of larger integrated companies that
provide competitive voice-processing products and services as subsets of larger
product offerings. Our existing and potential competitors include many large
domestic and international companies that have better name and product
recognition in the market for our products and services and related software, a
larger installed base of customers, and substantially greater financial,
marketing and technical resources than ourselves.
26
With the launch of our inUnison-TM- UC/UI hosted applications, we anticipate a
decline in our legacy business revenues and related gross margins as we focus on
our UC/UI business. Any delays in the anticipated launch of our inUnison-TM-
business plan, coupled with a decline in our legacy business, would have a
significant adverse impact on our financial performance and financing
requirements. We anticipate increasing competition in the unified messaging and
unified communications markets.
Infotel competes against several large companies in Singapore that are better
capitalized. Although Infotel has in the past managed to compete successfully
against these larger companies on the basis of its engineering, systems and
product management expertise, no assurances can be given that this expertise
will allow Infotel to compete effectively with these larger companies in the
future. Further, various large manufacturers headquartered outside of Singapore
have established their own branch offices in Singapore and also compete with
Infotel.
WE RELY HEAVILY ON OUR STRATEGIC PARTNERS IN OUR NEW BUSINESS MODEL, AND WITHOUT
SUPPORT FROM OUR PARTNERS OUR BUSINESS COULD SUFFER.
We have built significant, valuable strategic partnering relationships with a
number of partners including Cisco Systems and Hewlett-Packard, and these
partnering relationships are important to our success. In the case of CISCO, our
partnering relationship includes having been appointed as a CISCO Ecosystem
Partner and a CISCO Powered Network member; enjoying cooperative marketing
support; receiving or being entitled to receive support in the form of
non-recurring engineering subsidies; and receiving or being entitled to receive
structured financing for CISCO product. CISCO is supporting or will also be
supporting sales of our UC/UI applications by granting to CISCO sales personnel
incentive sales quota credit for helping to sell our UC/UI applications. CISCO
also has committed to introducing customers to us. Hewlett-Packard also is an
important strategic partner that will assist us in designing, implementing and
operating our backend solution to provide our UC/UI applications in a hosted,
carrier grade environment. Hewlett-Packard has been providing consulting
services in the design, build out and operation of our backend architecture.
They have also provided structured financing for Hewlett-Packard products and
services needed to launch our UC/UI hosted services. Hewlett-Packard may also
jointly market and sell our UC/UI applications. We may have Hewlett-Packard host
our applications in their data centers and to provide various levels of customer
support.
The loss or deterioration of our relationships with either CISCO or
Hewlett-Packard could have a material adverse affect on our UC/UI business and
financial performance. While we believe that our partnering relationships with
CISCO, Hewlett-Packard and other third parties are strong, we cannot assure you
that these relationships will continue or that they will have a positive impact
on our success.
OUR INTERNATIONAL OPERATIONS INVOLVE RISKS THAT MAY ADVERSELY AFFECT OUR
OPERATING RESULTS.
Infotel, our Singapore subsidiary, accounted for approximately 61.3% of our
revenues for the three months ended December 31, 2000, and approximately 45.2%
of our revenues for the fiscal year ended September 30, 2000. There are risks
associated with our international operations, including, but not limited to:
- our dependence on members of management of Infotel and the risk of loss
of customers in the event of the departure of key personnel;
27
- unexpected changes in or impositions of legislative or regulatory
requirements;
- potentially adverse taxes and tax consequences;
- the burdens of complying with a variety of foreign laws;
- political, social and economic instability;
- changes in diplomatic and trade relationships; and
- foreign exchange and translation risks.
Any one or more of these factors could negatively affect the performance of
Infotel and result in a material adverse change in our business, results of
operations and financial condition.
We anticipate that the market for our inUnison-TM- UC/UI business will be
global. We anticipate that we will be expanding our business operations for our
UC/UI applications outside the United States, and project that we will launch
our UC/UI business in Asia from our existing Singapore operations in our fiscal
year 2001. However, we do not yet have established operations for our UC/UI
applications outside of the United States, and our business could suffer
material adverse results if we cannot build an international organization to
launch our UC/UI applications outside of the United States in time to meet
market demand or alternative solutions or standards.
OUR STOCK PRICE COULD EXPERIENCE PRICE AND VOLUME FLUCTUATIONS.
The markets for securities such as our common stock historically have
experienced extreme price and volume fluctuations. Factors that may adversely
affect the market price of our common stock include, but are not limited to, the
following:
- new product developments and our ability to innovate, develop and deliver
on schedule our inUnison-TM- UC/UI applications;
- technological and other changes in the voice-messaging, unified
communications, and unified information;
- fluctuations in the financial markets;
- general economic conditions;
- competition; and
- quarterly variations in our results of operations.
OUR MANAGEMENT TEAM IS CRUCIAL TO OUR SUCCESS.
Our business depends heavily upon the services of its executives and certain key
personnel, including Douglas S. Zorn, our President and Chief Executive Officer,
John R. Zavoli, our Chief Financial Officer and General Counsel, Ken Murray, our
Chief Operating Officer, Ram Mani, our Chief Technology Officer, and Richard
Glover, our Chief Marketing Officer. Management changes often have
28
a disruptive impact on businesses and can lead to the loss of key employees
because of the uncertainty inherent in change. In 1999 and 2000, we had
significant changes in our key personnel. We cannot be certain that we will be
successful in attracting and retaining key personnel worldwide - particularly in
the Silicon Valley, greater San Francisco Bay and San Diego areas where we
operate - as the employment markets there are intensely competitive. The loss of
the services of any one or more of such key personnel, if not replaced, or the
inability to attract such key personnel, could harm our business. While hiring
efforts are underway to fill the vacancies created by the departure of other key
employees, there is no assurance that these posts will be filled in the near
future. The loss of these or other key employees could have a material adverse
impact on our operations. Furthermore, the recent changes in management may not
be adequate to sustain our profitability or to meet our future growth targets.
FAILURE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS WILL HARM OUR
ABILITY TO COMPETE.
We are in the process of filing for trademark and patent protection on selected
product names, technologies and processes which we have developed, and we
currently rely and have relied on general common law and confidentiality and
non-disclosure agreements with our key employees to protect our trade secrets.
We also have recently applied for trademark protection for the names Appiant
Technologies and inUnison. Our success depends on our ability to protect our
intellectual property rights. Our efforts to protect our intellectual property
may not be sufficient against unauthorized third-party copying or use or the
application of reverse engineering, and existing laws afford only limited
protection. In addition, existing laws may change in a manner that adversely
affects our proprietary rights. Furthermore, policing the unauthorized use of
our product is difficult, and expensive litigation may be necessary in the
future to enforce our intellectual property rights.
OUR PRODUCTS COULD INFRINGE THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS,
RESULTING IN COSTLY LITIGATION AND THE LOSS OF SIGNIFICANT RIGHTS.
We may be subject to legal proceedings and claims for alleged infringement of
proprietary rights of others, particularly as the number of products and
competitors in our industry grow and functionalities of products overlap. This
risk may be higher in a new market in which a large number of patent
applications have been filed but are not yet publicly disclosed. We have limited
ability to determine which patents our products may infringe and to take
measures to avoid infringement. Any litigation could result in substantial costs
and diversion of management's attention and resources. Further, parties making
infringement claims against us may be able to obtain injunctive or other
equitable relief, which could prevent us from selling our products or require us
to enter into royalty or license agreements which are not advantageous to us.
IF WE FAIL TO ADEQUATELY RESPOND TO RAPID TECHNOLOGICAL CHANGES, OUR EXISTING
PRODUCTS WILL BECOME OBSOLETE OR UNMARKETABLE.
Advances in technology could render our products and applications obsolete and
unmarketable. We believe that to succeed we must enhance our existing software
products and underlying technologies, develop new products and technologies on a
timely basis, and satisfy the increasingly sophisticated requirements of our
29
customers. We may not respond successfully to technological change, evolving
industry standards or customer requirements. If we are unable to respond
adequately to these changes, our revenues could decline. In connection with the
introduction of new products and enhancements, we have in the past experienced
development delays and unfavorable development cost variances that are not
unusual in the software industry. To date, these delays have not had a material
impact on our revenues. If new releases or products are delayed or do not
achieve broad market acceptance, we could experience a delay or loss of revenues
and customer dissatisfaction.
IF OUR SOFTWARE CONTAINS DEFECTS, WE COULD LOSE CUSTOMERS AND REVENUES.
Software applications as complex as ours often contain unknown and undetected
errors or performance problems. Many defects are frequently found during the
period immediately following the introduction of new software or enhancements to
existing software. Furthermore, software which we may license from third parties
for inclusion in our inUnison-TM- portal may also have undetected errors or may
require significant integration, testing or re-engineering work to operate
properly and as represented to our customers. Although we attempt to resolve all
errors that we believe would be considered serious by our customers, both our
software and any third party software that we license may not be error-free.
Undetected errors or performance problems may be discovered in the future, and
errors that were considered minor by us may be considered serious by our
customers. This could result in lost revenues or delays in customer acceptance,
and would be detrimental to our reputation which could harm our business.
FLUCTUATIONS IN OPERATING RESULTS COULD CONTINUE IN THE FUTURE.
Our operating results may vary from period to period as a result of the length
of our sales cycle, purchasing patterns of potential customers, the timing of
the introduction of new products, software applications and product enhancements
by us and our competitors, technological factors, variations in sales by
distribution channels, timing of stocking orders by resellers, competitive
pricing, and generally nonrecurring system sales. For our legacy business, sales
order cycles have ranged generally from one to twelve months, depending on the
customer, the type of solution being sold, and whether we will perform
installation, integration and customization services. The period from the
execution of a purchase order until delivery of system components to us,
assembly, configuration, testing and shipment, may range from approximately one
to several months. These factors may cause significant fluctuations in operating
results in the future. The sales order cycle for our inUnison-TM- UC/UI
applications in a hosted services model can only be projected at this time as we
are presently negotiating our first contracts with prospective customers. To the
extent that we do not sign up customers to our inUnison-TM- UC/UI applications
according to our plan, our financial performance and results from operations
could suffer.
WE NEED SIGNIFICANT CAPITAL TO OPERATE OUR BUSINESS AND MAY REQUIRE ADDITIONAL
FINANCING. IF WE CANNOT OBTAIN SUCH ADDITIONAL FINANCING, WE MAY NOT BE ABLE TO
CONTINUE OUR OPERATIONS.
We need significant capital to design, develop and commercialize our products.
Currently available funds may be insufficient to fund operations. We may be
required to seek additional financing sooner than currently anticipated or may
be required to curtail our activities. Based on our past financial performance,
coupled with our return to incurring operating losses with our transition to
30
our new business model, our ability to obtain conventional credit has been
substantially limited. Our ability to raise capital may also be limited or, if
available, be very costly and possibly dilutive to our shareholders.
CERTAIN PROVISIONS OF OUR CHARTER AND DELAWARE LAW MAY HAVE ANTI-TAKEOVER
EFFECTS.
The terms of our Certificate of Incorporation, as amended, and our ability to
issue up to 2,000,000 shares of "blank check" preferred stock may have the
effect of discouraging proposals by third parties to acquire a controlling
interest in us, which could deprive stockholders and of the opportunity to
consider an offer to acquire their shares at a premium. In addition, under
certain conditions, Section 203 of the Delaware General Corporate Law would
impose a three-year moratorium on certain business combinations between us and
an "interested stockholder" (in general, a stockholder owning 15% or more of our
outstanding voting stock). The existence of such provisions may have a
depressive effect on the market price of our common stock in certain situations.
WE ARE HEADQUARTERED IN CALIFORNIA, AND WE MAY BE SUBJECT TO RISKS ASSOCIATED
WITH THE LOSS OF ELECTRIC POWER.
The State of California has recently been subject to rolling blackouts of
electrical power associated with lack of adequate electric power, power
generation, and power reserves. In the Silicon Valley area where we are
headquartered, the California Independent Service Operator ("Cal-ISO") that
regulates much of the State's power and power grid has declared numerous stage 3
alerts that have resulted in unannounced rolling power blackouts throughout the
San Francisco and greater Silicon Valley areas. While we plan to host our
applications in "class 5" data centers located outside the State of California
that should provide for uninterrupted production and service delivery of our
applications to our customers, any disruption in electrical power in California
where we operate, or the continued uncertainty surrounding unannounced power
blackouts, could have a material adverse impact on our operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to our operations result primarily from changes in
interest rates and changes in foreign currency exchange rates.
Interest Rate Risk. The Company's exposure to market risk for changes in
interest rates relates to our short term investments and line of credit. At
December 31, 2000, our cash and cash equivalents consisted of demand deposits
and commercial paper held by large institutions in the U.S. As of December 31,
2000 there was no balance outstanding under the line of credit. We believe that
a 10% change in the long-term interest rates would not have a material effect on
our consolidated financial condition, results of operations or cash flows.
Foreign Currency Risk. All of our non-U.S. operations are subject to inherent
risks in conducting business abroad, including fluctuation in the relative value
of currencies. We manage this risk and attempt to reduce such exposure in part
through forward exchange contracts to hedge firm purchase commitments that
expose the Company to risk as a result of fluctuations in foreign currency
exchange rats. We do not otherwise hold or issue derivative financial
instruments for trading or speculative purposes. Hedge accounting was only
31
applied if the derivative reduced the risk of the underlying hedged item and was
designated at inception as a hedge. Derivatives are measured for effectiveness
both at inception and on an ongoing basis. Exchange contracts outstanding at
December 31, 2000 had notional amounts of $439,000 million, which approximates
fair value, and mature in June 2001.
PART II
ITEM 1. LEGAL PROCEEDINGS
In 2000, we instituted arbitration proceedings against one of our customers for
breach of contract totaling approximately $610,000, of which the customer had
paid us approximately $276,000. The Company is vigorously pursuing this
arbitration matter seeking specific performance and full payment for amounts
outstanding.
In December 2000, a former employee filed suit against the Company for wrongful
termination in the Superior Court of Alameda County, State of California. The
former employee is seeking monetary damages. We believe the suit is without
merit and are defending it vigorously.
In 1999, the Company retained a professional services firm and agreed to issue a
warrant for the purchase of 30,000 shares of the Company's common stock, at a
price of $8.3438 per share, as partial compensation for the services rendered,
provided certain conditions were met. The conditions were met in February 2000
but the warrant was not issued until November 28, 2000. The warrant holder
contends that the Company delayed unreasonably in issuing the warrant and
thereby deprived him of the right to sell the underlying shares at a profit. The
Company and the warrant holder are engaged in discussions aimed at resolving the
issue. No lawsuit has been filed.
The Company is not subject to any other material litigation nor, to its
knowledge, is other litigation threatened against it.
The costs and other effects (whether civil or criminal), settlements,
judgments and investigations, claims and changes in those matters, and
developments or assertions by or against us relating to intellectual property
rights and intellectual property licenses, could have a material adverse
effect on our business, financial condition and operating results. Management
believes, however, that the ultimate outcome of any and all pending
litigation and other matters should not have a material adverse effect on the
Company's consolidated financial position, results of operations or cash
flows.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On May 24, 2000, we issued 120,000 warrants to purchase shares of common stock
to Kedrick Investments Limited ("Kedrick") in lieu of providing Kedrick with a
minimum aggregate drawdown commitment pursuant to the common stock purchase
agreement entered into on May 24, 2000 in a transaction exempt from registration
under Section 4(2) (as defined below). The warrants are immediately exercisable
and expire three years from the date of issuance. The warrant exercise price on
the date of issuance was $20.82 per share, and was subsequently adjusted to
$13.50 per share on November 15, 2000 in exchange for securing a waiver from
Kedrick allowing us to issue Series B Preferred Stock to other investors.
32
Pursuant to the equity line agreement entered into on May 24, 2000, we
requested that the investment corporation purchase $1.5 million of our common
stock and this purchase is expected to be completed by the end of February
2001. This purchase is exempt from registration under Section 4(2) as defined
below.
In October 2000, we sold 87,620 shares of our Series B Preferred Stock to
U.S. accredited investors for $100 per share, for aggregate gross proceeds of
$8,762,000 in a transaction exempt from registration under Section 4(2) and
Rule 506 of the Securities Act of 1933, as amended ("Section 4(2)"). In
connection with this issuance, the Company also issued to its investment
bankers warrants to acquire 75,000 shares of its Common Stock at an exercise
price of $13.50 per share. Holders of the Series B Preferred Stock are
entitled to a non-cumulative 5% per annum dividend, payable quarterly in
arrears, when, if and as declared by our Board of Directors, which may be
paid in cash or shares of our Common Stock, in our sole discretion. Each
share of Series B Preferred Stock is immediately convertible into shares of
our Common Stock at the lesser of (i) $13.50 per share or (ii) 90% of the
average closing bid prices for the 10 trading days immediately preceding the
date of conversion, provided, that such conversion price shall not be less
than $10.00. At any time after the third anniversary of the Closing, we may
require the holders of the Series B Preferred Stock to convert. Shares of our
Common Stock may be resold pursuant to a Form S-3 shelf registration
statement that we will file. As of February 13, 2000, 86,120 preferred shares
have been converted into 861,200 shares of the Company's common stock.
On November 28, 2000, we issued warrants to purchase 30,000 shares of common
stock to a professional services firm in consideration for certain services
rendered to us in a transaction exempt from registration under Section 4(2). The
warrants are immediately exercisable until November 28, 2005. The exercise price
per share of this warrant is $8.3438.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the three months
ended December 31, 2000.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBIT INDEX
--------------------------------------------------------------------------------
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT
--------------------------------------------------------------------------------
4.34 Warrant dated November 28, 2000 issued to Jack T.
Zahran (1)
--------------------------------------------------------------------------------
10.61 Series B Preferred Stock Purchase Agreement dated
as of October 31, 2000, by and between NHancement
Technologies Inc. and certain investors. (2)
--------------------------------------------------------------------------------
10.62 Shelf Registration Agreement dated as of October
31, 2000, by and between NHancement Technologies
Inc. and certain investors. (2)
--------------------------------------------------------------------------------
10.63 Master Agreement to lease equipment entered into
as of July 25, 2000 with Hewlett-Packard.
-------------------------------------------------------------------------------
(1) Incorporated by reference to the identically numbered exhibit in the
Company's Annual Report on Form 10-KSB as filed with the Securities
and Exchange Commission on January 12, 2001.
(2) Incorporated by reference from Issuer's Current Report on Form 8-K as
filed with the Securities and Exchange Commission on November 13,
2000.
(b) Reports on Form 8-K
On November 13, 2000, we filed a report on Form 8-K with regard to our Series B
Preferred Stock Purchase Agreement.
34
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: February 14, 2001 NHANCEMENT TECHNOLOGIES INC.
By: /s/ DOUGLAS S. ZORN
--------------------------------------
Douglas S. Zorn
President and Chief Executive Officer
35