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 June 30, 2001
[ ] 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
-----------------------
APPIANT 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 August 20, 2001, there were 14,267,475 shares of Common Stock
outstanding.
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements. . . . . . . . .
Condensed Consolidated Balance Sheets at June 30, 2001
and September 30, 2000 . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statements of Operations and
Comprehensive Loss for the three and nine months ended
June 30, 2001 and 2000 . . . . . . . . . . . . . . . . . . . 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended June 30, 2001 and 2000 . . . . . . . . . . 5
Notes to Condensed Consolidated Financial Statements . . . . 7
Management's Discussion and Analysis of Financial
Item 2. Condition and Results of Operations . . . . . . . . . . . . 21
Item 3. Quantitative and Qualitative Disclosures about Market
Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
PART II. OTHER INFORMATION. . . . . . . . . . . . . . . . . . . . . . 41
Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . 41
Item 2. Changes in Securities and Use of Proceeds. . . . . . . . . . 43
Item 4. Submission of Matters to a Vote of Security Holders. . . . . 46
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . 47
2
PART I. FINANCIAL STATEMENTS
ITEM 1. Condensed Consolidated Financial Statements
APPIANT TECHNOLOGIES INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, September 30,
2001 2000
(unaudited)
--------------- ---------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents. . . . . . . . . . . . $ 3,977,000 $ 5,603,000
Restricted cash. . . . . . . . . . . . . . . . . 113,000 116,000
Accounts receivable, net of allowance for
doubtful accounts of $344,000 and $402,000. . . 3,368,000 3,907,000
Inventory. . . . . . . . . . . . . . . . . . . . 160,000 550,000
Equipment at customers under integration . . . . 1,368,000 1,708,000
Prepaid expenses and other . . . . . . . . . . . 625,000 313,000
--------------- ---------------
TOTAL CURRENT ASSETS. . . . . . . . . . . . . . . . 9,611,000 12,197,000
Property and equipment, net. . . . . . . . . . . 5,924,000 3,395,000
Capitalized software, net. . . . . . . . . . . . 23,494,000 18,366,000
Goodwill and other intangible assets, net. . . . 11,111,000 2,443,000
Other assets . . . . . . . . . . . . . . . . . . 1,971,000 2,384,000
--------------- ---------------
TOTAL ASSETS. . . . . . . . . . . . . . . . . . . . $ 52,111,000 $ 38,785,000
=============== ===============
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Lines of credit. . . . . . . . . . . . . . . . . $ -- $ 343,000
Accounts payable . . . . . . . . . . . . . . . . 11,907,000 5,269,000
Accrued liabilities. . . . . . . . . . . . . . . 3,889,000 2,478,000
Deferred revenue . . . . . . . . . . . . . . . . 2,179,000 2,919,000
Income tax payable . . . . . . . . . . . . . . . 285,000 280,000
Advances for preferred stock . . . . . . . . . . -- 3,500,000
Accrued liability related to warrants. . . . . . 2,402,000 --
Convertible notes payable. . . . . . . . . . . . 5,771,000 --
Capital lease obligations, current portion . . . 5,612,000 3,072,000
--------------- ---------------
TOTAL CURRENT LIABILITIES . . . . . . . . . . . . . 32,045,000 17,861,000
Capital lease obligations, net of
current portion . . . . . . . . . . . . . . . . 4,435,000 4,717,000
--------------- ---------------
TOTAL LIABILITIES . . . . . . . . . . . . . . . . . 36,480,000 22,578,000
REDEEMABLE CONVERTIBLE PREFERRED STOCK. . . . . . . 253,000 --
STOCKHOLDERS' EQUITY
Common stock . . . . . . . . . . . . . . . . . . 157,000 123,000
Additional paid-in capital . . . . . . . . . . . 80,039,000 49,261,000
Unearned stock-based compensation. . . . . . . . (288,000) (2,012,000)
Accumulated deficit. . . . . . . . . . . . . . . (63,904,000) (30,809,000)
Accumulated other comprehensive loss . . . . . . (626,000) (356,000)
--------------- ---------------
TOTAL STOCKHOLDERS' EQUITY 15,378,000 16,207,000
--------------- ---------------
TOTAL LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY $ 52,111,000 $ 38,785,000
=============== ===============
See notes to condensed consolidated financial statements.
3
APPIANT TECHNOLOGIES INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(UNAUDITED)
Three Months Ended Nine Months Ended
June 30, June 30,
2001 2000 2001 2000
------------- ------------ ------------- ------------
NET REVENUES:
Products and integration services. . . . . $ 1,852,000 $ 1,132,000 $ 5,236,000 $10,347,000
Other services . . . . . . . . . . . . . . 4,272,000 3,142,000 13,503,000 11,269,000
------------- ------------ ------------- ------------
TOTAL NET REVENUES 6,124,000 4,274,000 18,739,000 21,616,000
Cost of revenues:
Products and integration services. . . . . 1,609,000 1,190,000 4,790,000 7,181,000
Other services . . . . . . . . . . . . . . 3,950,000 1,905,000 10,204,000 7,477,000
------------- ------------ ------------- ------------
TOTAL COST OF REVENUES 5,559,000 3,095,000 14,994,000 14,658,000
GROSS PROFIT 565,000 1,179,000 3,745,000 6,958,000
OPERATING EXPENSES
Selling, general and administrative. . . . 3,746,000 2,497,000 13,766,000 9,255,000
Research and development . . . . . . . . . 965,000 36,000 2,175,000 134,000
Amortization of goodwill and other
intangibles. . . . . . . . . . . . . . . . 558,000 159,000 960,000 478,000
Impairment of equipment and capitalized
software . . . . . . . . . . . . . . . . . 3,699,000 -- 3,699,000 --
------------- ------------ ------------- ------------
TOTAL OPERATING EXPENSES 8,968,000 2,692,000 20,600,000 9,867,000
LOSS FROM OPERATIONS (8,403,000) (1,513,000) (16,855,000) (2,909,000)
OTHER INCOME (EXPENSE)
Interest income. . . . . . . . . . . . . . 39,000 45,000 219,000 159,000
Interest expense . . . . . . . . . . . . . (7,576,000) (1,837,000) (8,929,000) (2,122,000)
Other. . . . . . . . . . . . . . . . . . . 417,000 (167,000) 376,000 (169,000)
------------- ------------ ------------- ------------
Total other expense (7,120,000) (1,959,000) (8,334,000) (2,132,000)
Loss from operations before
income tax (15,523,000) (3,472,000) (25,189,000) (5,041,000)
Provision for income tax . . . . . . . . . 54,000 147,000 280,000 271,000
------------- ------------ ------------- ------------
NET LOSS (15,577,000) (3,619,000) (25,469,000) (5,312,000)
Preferred dividends. . . . . . . . . . . . -- -- (7,626,000) (2,000)
------------- ------------ ------------- ------------
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS. $(15,577,000) $(3,619,000) $(33,095,000) $(5,314,000)
============= ============ ============= ============
BASIC AND DILUTED NET LOSS PER COMMON
SHARE $ (1.05) $ (0.33) $ (2.42) $ (0.54)
SHARES USED IN PER SHARE CALCUATIONS -
BASIC AND DILUTED 14,854,000 10,834,000 13,684,000 9,900,000
COMPREHENSIVE LOSS
Net loss $(15,577,000) $(3,619,000) $(25,469,000) $(5,312,000)
Other comprehensive (loss)
Translation (loss) (11,000) (30,000) (74,000) (28,000)
------------- ------------ ------------- ------------
COMPREHENSIVE LOSS $(15,588,000) $(3,649,000) $(25,543,000) $(5,340,000)
============= ============ ============= ============
See notes to condensed consolidated financial statements.
4
APPIANT TECHNOLOGIES INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended
June 30,
----------------------------
2001 2000
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITES
Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . $(25,469,000) $ (5,312,000)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Provision for (reduction in) doubtful accounts. . . . . . . . (59,000) (167,000)
Depreciation and amortization . . . . . . . . . . . . . . . . 1,755,000 380,000
Amortization of goodwill. . . . . . . . . . . . . . . . . . . 960,000 478,000
Gain on sale of fixed assets. . . . . . . . . . . . . . . . . -- 1,000
Gain on cancellation of equipment lease . . . . . . . . . . . (157,000) --
Impairment of equipment and capitalized software. . . . . . . 3,699,000
Stock-based compensation. . . . . . . . . . . . . . . . . . . (2,015,000) 1,814,000
Deemed interest expense related to notes payable convertible
at a discount. . . . . . . . . . . . . . . . . . . . . . . . 190,000 --
Deemed interest expense related to notes payable to related
Party convertible at a discount. . . . . . . . . . . . . . . 1,274,000 47,000
Amortization of discount on notes payable to related
party. . . . . . . . . . . . . . . . . . . . . . . . . . . . 950,000 --
Cost of additional warrants issued to related party . . . . . 3,799,000 --
Amortization of discount on notes payable . . . . . . . . . . 171,000 1,596,000
Amortization of issuance costs on notes payable . . . . . . . 17,000 --
Remeasurement of warrant due to registration requirement. . . 1,120,000 --
Changes in operating assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . 1,121,000 2,351,000
Inventory and equipment at customers under integration. . . 729,000 (880,000)
Prepaid expenses and other. . . . . . . . . . . . . . . . . (812,000) (91,000)
Other assets. . . . . . . . . . . . . . . . . . . . . . . . (337,000) (135,000)
Income tax payable. . . . . . . . . . . . . . . . . . . . . 5,000 214,000
Accounts payable and other current liabilities. . . . . . . 3,491,000 (767,000)
Accrued liability related to warrants . . . . . . . . . . . 2,402,000
Deferred revenue. . . . . . . . . . . . . . . . . . . . . . (741,000) 761,000
------------- -------------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES . . . . . . . . (7,907,000) 290,000
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Restricted cash . . . . . . . . . . . . . . . . . . . . . . . 3,000 70,000
Proceeds on sale of property and equipment. . . . . . . . . . -- 17,000
Cash acquired in connection with purchase of Trimark, Inc.. . -- 45,000
Cash acquired in connection with purchase of Quaartz Inc. . . 22,000 --
Acquired software assets. . . . . . . . . . . . . . . . . . . -- (2,000,000)
Capitalization of software development costs. . . . . . . . . (2,198,000) (354,000)
Purchase of property and equipment. . . . . . . . . . . . . . (1,582,000) (727,000)
------------- -------------
NET CASH USED IN INVESTING ACTIVITIES . . . . . . . . . . . . . (3,755,000) (2,949,000)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Funds in escrow . . . . . . . . . . . . . . . . . . . . . . . -- (791,000)
Borrowings under line of credit . . . . . . . . . . . . . . . -- 13,673,000
Repayments under line of credit . . . . . . . . . . . . . . . (343,000) (14,213,000)
Borrowing of notes receivable from related party. . . . . . . (250,000) --
Repayment of notes receivable from related party. . . . . . . 250,000 297,000
Proceeds from draw on equity line . . . . . . . . . . . . . . 1,745,000 --
Proceeds from notes payable and sale of warrants. . . . . . . 5,100,000 --
Repayment of note payable to related party. . . . . . . . . . (100,000) (150,000)
Proceeds from issuance of Series B preferred stock, net of
issuance costs . . . . . . . . . . . . . . . . . . . . . . . 4,959,000 --
Proceeds from issuance of convertible debentures, net of
issuance costs of $403,000 5,397,000
Proceeds from warrants and options exercised for common stock 1,746,000 574,000
Principal payments on capital lease . . . . . . . . . . . . . (2,798,000) (120,000)
Principal payment on notes payable. . . . . . . . . . . . . . -- (119,000)
------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 10,309,000 4,548,000
------------- -------------
Effect of exchange rate changes on cash (273,000) 14,000
------------- -------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,626,000) 1,903,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD $ 5,603,000 $ 2,329,000
------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,977,000 $ 4,232,000
============= =============
See notes to condensed consolidated financial statements.
5
APPIANT TECHNOLOGIES INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
------------------------------------------------------------------------------------------
Supplemental disclosures for cash flow information:
Cash paid during the period for:
Interest $ 647,000 $ 135,000
Income taxes $ 88,950 $ 6,000
NON-CASH TRANSACTIONS:
Property and equipment acquired under capital leases $ 3,654,000 $ 351,000
Accounts payable for purchases of property and equipment $ 2,643,000 $ --
Accounts payable written-off for purchases of property
and equipment returned during third quarter . . . . . . $ 1,564,000
Software assets acquired under capital leases $ 563,000 $ --
Payable for purchases of software asset financed
under capital leases during first quarter $ 1,503,000 $ --
Accounts payable for purchase of software assets $ 767,000 $ --
Deemed dividend on beneficial conversion feature of
Series B Preferred Stock $ 7,626,000 $ --
Recognition of beneficial conversion feature on notes
payable $ 2,548,000 $ --
Allocation of proceeds to fair value of warrants
issued on notes payable $ 5,330,000 $ --
Issuance of warrants to strategic partner in conjunction
with convertible debentures . . . . . . . . . . . . . . $ 546,000
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 $ --
Issuance of common stock to underwriters in conjunction
with sale of Series B Preferred Stock $ 573,000 $ --
Costs of financing on Equity line $ 1,745,000 $ --
Conversion of Series B Preferred Stock into Common
Stock $ 4,678,000 $ --
Conversion of advances to Series B Preferred Stock $ 3,500,000 $ --
Issuance of common stock in Quaartz acquisition $ 8,310,000 $ --
See notes to condensed consolidated financial statements.
6
APPIANT 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 of America. 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 our results as well as the results
of our significant operating subsidiaries: NHancement Technologies North
America, Inc., doing business as Appiant Technologies North America ("APPIANT
NA") and Infotel Technologies (Pte) Ltd ("Infotel").
APPIANT NA revenues were 41% and 58% of consolidated net revenues for the nine
months ended June 30, 2001 and 2000. Infotel revenues were 59% and 42% of
consolidated net revenues for the nine months ended June 30, 2001 and 2000. No
revenues have been recorded through June 30, 2001 from the Company's hosted
internet inUnison(TM) unified communication and unified information portal
services.
2. NET LOSS PER SHARE
Basic net loss per share is computed based on the weighted average number of
shares outstanding during the period. Diluted net loss per share is also
computed based on the weighted average number of shares outstanding during the
period. Diluted net loss per share does not include the weighted average effect
of dilutive potential common shares including convertible preferred stock,
convertible debentures and options and warrants to purchase common stock in any
period presented because the effect is anti-dilutive.
7
The following table presents information necessary to reconcile basic and
diluted net loss per common and common equivalent share:
Three Months Ended Nine Months Ended,
June 30, June 30,
2001 2000 2001 2000
------------- ------------ ------------- ------------
Net loss $(15,577,000) ($3,619,000) $(25,469,000) ($5,312,000)
Preferred stock dividends -- -- (7,626,000) (2,000)
------------- ------------ ------------- ------------
Net loss available to common stockholders - basic (15,577,000) ($3,619,000) (33,095,000) ($5,314,000)
============= ============ ============= ============
Weighted average shares used in net loss per share
- basic and diluted 14,854,000 10,834,000 13,684,000 9,900,000
------------- ------------ ------------- ------------
Anti-dilutive securities:
Convertible preferred stock 36,000 -- 36,000 --
Convertible notes and debentures 2,380,000 -- 2,380,000 --
Options and warrants to purchase
common stock 8,579,000 3,057,000 8,579,000 3,057,000
------------- ------------ ------------- ------------
Anti-dilutive securities not included in
net loss per share calculation 10,995,000 3,057,000 10,995,000 3,057,000
============= ============ ============= ============
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 July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations."
SFAS 141 requires the purchase method of accounting for business combinations
initiated after June 30, 2001 and eliminates the pooling-of-interests method.
The Company believes that the adoption of SFAS 141 will not have a significant
impact on its financial statements.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which is effective for
fiscal years beginning after December 15, 2001. SFAS 142 requires, among other
things, the discontinuance of goodwill amortization. In addition, the Standard
includes provisions upon adoption for the reclassification of certain existing
recognized intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and testing for impairment of existing goodwill and
other intangibles. The Company is currently assessing but has not yet determined
the impact of SFAS 142 on its financial position and results of operations.
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.
8
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. There were no exchange contracts outstanding
at June 30, 2001.
6. WRITE-OFF OF COMPUTER EQUIPMENT AND SOFTWARE ASSETS
In the nine months ended June 30, 2001, the Company entered into lease financing
arrangements with a hardware vendor, under which approximately $1.3 million
related to hardware and related product costs and $2.5 million related to
consulting services were acquired for its first data center in Atlanta, Georgia.
The Company relocated its data center to Sunnyvale, California in June 2001 and
intends to relocate the hardware and related costs of $1,500,000 to this
location and wrote off the remaining net book value of $2.5 million related to
consulting services for the first data center to operating expenses. The
capitalized consulting services related to the installation of the hardware and
the Company determined that they had no future value following the relocation.
The Company is in discussions with the hardware vendor regarding the balance due
under the lease, including revised payment terms and possible forgiveness of a
part or all of the lease payments. On June 29, 2001, the Company returned
various items of computer equipment and related goods related to the first data
center to the vendor for an aggregate purchase price of $1.6 million. The vendor
forgave the balance due under the capital lease of $1.6 million and the
equipment and payable was written off in the three months ended June 30, 2001.
In addition, the Company had capitalized $1.2 million as part of its software
asset related to software and services obtained for billing and provisioning. In
June 2001, the Company concluded that other software would be used as the
primary billing application and that the software did not have any other
alternative future use, and therefore, $1.2 million was written off in the three
months ended June 30, 2001. The Company is in discussions with the vendor
regarding settlement of the related account payable.
7. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases its principal office facilities pursuant to non-cancelable
operating leases in Pleasanton, California, which expires in 2007. Quaartz
leases office space in Santa Clara, California pursuant to non-cancelable
leases, which expire in 2002 and 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 June 30, 2001 are as
follows (in thousands):
9
FISCAL YEAR
2001 $ 503,000
2002 1,928,000
2003 1,627,000
2004 743,000
2005 345,000
Thereafter 970,000
----------
$6,116,000
==========
Capital Leases
In the nine months ended June 30, 2001, the Company entered into additional
financing transactions with a hardware vendor, financing approximately $1.3
million related to hardware and other product costs and $2.5 million related to
consulting services (See Note 6).
The Company also leases computer equipment and other software under capital
leases. These leases extend for varying periods through 2004. On July 27, 2001,
the Company entered into a settlement and release agreement with a software
vendor which the Company has a leasing arrangement for the non-exclusive license
of certain software with a remaining balance of $7.4 million (see Note 14).
Equipment and software under capital leases included in property and equipment
and capitalized software are as follows:
June 30, September 30,
2001 2000
------------ ---------------
Equipment $ 5,107,000 $ 1,047,000
Software 10,573,000 10,010,000
------------ ---------------
15,680,000 11,057,000
Less: accumulated amortization (975,000) (144,000)
------------ ---------------
$14,705,000 $ 10,913,000
============ ===============
Future capital lease payments are as follows:
FISCAL YEAR
June 30,
2001
------------
Remainder of 2001 $ 2,885,000
2002 4,972,000
2003 2,697,000
2004 31,000
------------
10,585,000
Less amount representing interest (538,000)
------------
Present value of minimum future
Payments 10,047,000
Less current maturities 5,612,000
------------
$ 4,435,000
============
10
Contingencies
In January 2001, a software vendor (the "vendor") filed a complaint against
Quaartz, a wholly owned subsidiary located in Santa Clara, California (see note
13) for damages for breach of contract in the amount of $130,000 plus interest
and attorneys fees. The vendor alleged that Quaartz breached a software
licensing agreement for the vendor's Intellisync software development engine
wherein Quaartz failed to make 2 payments totaling $65,000 each. In March 2001,
Quaartz filed a cross complaint for breach of contract in the amount of at least
$70,000 plus interest and attorneys fees. These cross-claims are based on
allegations that the software the vendor provided to Quaartz did not include key
synchronization features, which the vendor represented to the Quaartz were
included in the software. Moreover, Quaartz alleges that the software did not
function in accordance with the terms of the licensing agreement. Both parties
have answered to each complaint. In addition the parties have agreed to mediate
the matter and have agreed upon October 19, 2001 to conduct mediation. The
Company has recorded a contingent liability of $130,000 but has not recorded any
contingent assets in relation the cross complaint or any additional costs
related to the defense of the claim.
In order to adapt the office space to the Quaartz's requirements, Quaartz
vacated Suite 101 at their existing premises and moved to Suite 203 in the same
premises. Quaartz did not formally cancel the lease for Suite 101 and is
currently in negotiation with the landlord to settle claims for alleged breach
of the leasehold agreement. In July 2001, the landlord sent a proposal to
Quaartz's management to settle this litigation. This proposal stated an amount
due of $2,580,000. The landlord offered to provide a complete release of all
obligations to the lease for the sum of $559,000. This offer was available until
July 12, 2001 and was not accepted by the Company. Quaartz is currently in
negotiations with the landlord. The vacant office space has been subleased to
another tenant. No amount has been accrued in relation to this contingency.
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. No amount has been accrued
in relation to this contingency.
The Company remains in discussions with two former employees who believe they
were wrongfully denied severance by the Company. The Company disputes these
11
allegations and has claims regarding the failure of such employees to properly
perform their duties and obligations to the Company.
From time to time, we are also involved in other legal actions arising in the
ordinary course of business. While management intends to defend vigorously,
there can be no assurance that any of these complaints or other third party
assertions will be resolved without costly litigation, in a manner that is not
adverse to our financial position, results of operations or cash flow. No
estimate can be made of the possible loss or possible range of loss associated
with the resolution of these contingencies.
On April 24, 2001 a vendor filed suit against the Company in the Superior Court
of California, County of San Diego, claiming breach of contract and anticipatory
breach of contract. The first cause of action sought a principal sum of
$164,000, alleging that the Company failed to fully pay the vendor for public
relations services rendered. The second cause of action sought a principal sum
of $348,000, alleging that the Company failed to pay the vendor for marketing
and advertising services rendered. The final cause of action claimed a principal
sum of $93,000, alleging that the Company did not provide the requisite advance
notice for termination of both the Public Relations Agreement and Marketing
Agreement. During the third fiscal quarter of 2001, the Company has settled the
suit with the vendor for $380,000. The Company had previously established an
accrual of $300,000 for this contingency and recorded an additional accrual of
$80,000 in the three month period ended June 30, 2001.
8. CONVERTIBLE NOTES PAYABLE
In 2000, the Company 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. In the three month period ended
June 30, of 2001, the Company settled with the customer for $164,000. The
Company will recognize revenue for the settled amount when cash is received.
Convertible Promissory Notes Payable
On March 21, 2001, the Company entered into Convertible Promissory Notes Payable
with a related party in the principal amount of $2,500,000 (the "$2,500,000
Notes"). The $2,500,000 Notes accrues interest at 10% per annum and becomes
fully due and payable on May 31, 2001 (the "Maturity Date"). Upon approval by
the Company's shareholders, the principal and accrued interest under the
$2,500,000 Note converts into shares of the Company's common stock at any time
on or after the Maturity Date. The conversion price is equal to 80% of the
average of the five days lowest closing market price of the common stock during
the period beginning on March 16, 2001 and ending on the Maturity Date. If the
principal and accrued interest on the $2,500,000 Note is not paid in full or
converted into Common Stock for any reason other than awaiting shareholder
approval, and otherwise in accordance with the terms on or before the Maturity
Date, then the conversion price shall be reduced 20% for each full week that
this note is not paid or converted, provided that the conversion price shall not
in any event be reduced to less than $1.00. If the shareholders fail to approve
the issuance of equity, the related party may receive cash in the amount of
$250,000 in addition to the repayment of the principal and unpaid accrued
interest at 25% per annum. The $2,500,000 Note is past due and was not converted
to common stock as of June 30, 2001 as it has to be approved by the Company's
shareholders.
In conjunction with the $2,500,000 Note, the Company issued a warrant to
purchase 462,963 shares of its common stock at an exercise price of $2.70 per
share with a term of 7 years (See Note 10). The warrants were valued using the
Black-Scholes option pricing model and the following assumptions: contractual
term of seven years, a risk free interest rate of 5.80%, a dividend yield of 0%
and volatility of 141%. The allocation of note proceeds to the fair value of the
warrant of $950,000 was recorded as a discount on the $2,500,000 Note and
recorded as additional paid in capital. The discount on the $2,500,000 Notes was
amortized over the note maturity period and, as a result, $147,000 was recorded
as non-cash interest expense in the three month period ended March 31, 2001 and
the remaining $803,000 was recorded as non-cash interest expense in the three
months ended June 30, 2001.
As a result of the beneficial conversion feature described above for the
$2,500,000 Note, the Company recorded a charge to additional paid in capital of
$1,274,000, which was recorded as a discount on the note payable. The discount
on the note payable is amortized over its maturity period and, as a result,
$197,000 was recorded as non-cash interest expense in the three month period
12
ended March 31, 2001 and the remaining $1,077,000 was recorded as non-cash
interest expense in the three months June 30, 2001 (See Note 10).
In addition, the Company issued 1,500,000 additional warrants to the same
related party to purchase shares of the Company's common stock at an exercise
price of $2.70 per share due to the failure of the Company's completion of an
equity investment of at least $6 million on or before May 31, 2001. The warrants
were valued using the Black-Scholes option pricing model and the following
assumptions: contractual term of 7 years, a risk free interest rate of 4.775%, a
dividend yield of 0% and volatility of 147%. The fair value of $3,799,000 was
recorded non-cash interest expense in the three months ended June 30, 2001.
On May 31, 2001, the Company entered into Convertible Promissory Notes Payable
with two related parties, the Company's Chief Executive Officer and the Vice
President of Sales, in the principal amount of $100,000 each (the $200,000
Notes"). The $200,000 Notes accrue interest at 14% per annum and became fully
due and payable on June 21, 2001 ("maturity date"). The $200,000 Notes were also
convertible on the maturity date into shares of the Company's common stock at
90% of the conversion price applicable to any security received in any interim
financing subsequent to the date of the notes. If no interim financing was
obtained on or before the maturity date, the $200,000 Notes were convertible
into shares of the Company's common stock at 90% of the closing price on the
trading day immediately preceding the maturity date.
In addition, the Company issued warrants to the same related party's to purchase
20,000 shares each of the Company's common stock at an exercise price of $1.57
per share (See Note 10). The Black-Scholes option pricing model was used to
value the warrants and the following assumptions: contractual term of 5 years, a
risk free interest rate of 4.625%, a dividend yield of 0% and volatility of
147%. The allocation of the $200,000 Note proceeds to the fair value of the
warrants of $44,000 was recorded as a discount on the notes payable and recorded
as additional paid-in capital. The discount on the notes payable was amortized
over the note maturity period and, as a result, $44,000 was recorded as non-cash
interest expense in the three months ended June 30, 2001.
As a result of the beneficial conversion feature described above for the
$200,000 Notes, the Company recorded a charge to additional paid-in capital of
$67,000, which was recorded as a discount on the notes payable. The discount was
amortized over the maturity period and, as a result, the Company recorded
non-cash deemed interest expense of $67,000 in the three month period ended June
30, 2001. The Chief Executive Officer's note was repaid in full on June 21,
2001. The Vice President of Sales' note has not been converted into common stock
and remained outstanding at June 30, 2001.
On May 31, 2001, the Company also entered into Convertible Promissory Notes
Payable with the same terms as the $200,000 Notes, with a related party in the
principal amount of $150,000 and a non-related party in the principal amount of
$250,000 (the "$400,000 Notes"). These $400,000 Notes were rolled into the
convertible debentures payable issued on June 8, 2001 (the "June 8, 2001
Debentures").
In addition, the Company issued warrants to purchase 30,000 and 50,000,
respectively, shares of the Company's common stock at an exercise price of $1.57
per share (See Note 10). The Black-Scholes option pricing model was used to
value the warrants and the following assumptions: contractual term of 5 years, a
13
risk free interest rate of 4.625%, a dividend yield of 0% and volatility of
147%. The allocation of the $400,000 Note proceeds to the fair value of the
warrants of $88,000 was recorded as a discount on the notes payable and recorded
as additional paid-in capital. The discount on the notes payable was fully
amortized and, as a result, $88,000 was recorded as non-cash interest expense in
the three month period ended June 30, 2001.
As a result of the beneficial conversion feature described above, the Company
recorded a charge to additional paid-in capital of $133,000, which was recorded
as a discount on the $400,000 Notes. The discount on the $400,000 Notes payable
was amortized to the note extinguishment date and, as a result, $51,000 was
recorded as non-cash interest expense in the three months ended June 30, 2001.
On the extinguishment date, the Company calculated the intrinsic value of the
beneficial conversion feature of $44,000, reversed the beneficial conversion
charge previously recorded and recorded additional non-cash interest expense of
$39,000.
June 8, 2001 Convertible Debentures Payable
On June 8, 2001, the Company entered into a Convertible Debentures purchase
agreement with certain investors in the aggregate principal amount of
$2,400,000. The investors were obtained through a strategic partnering
agreement. The June 8, 2001 Debentures accrue interest at 8% per annum, payable
in common stock at the time of conversion. The conversion price is equal to
lower of 110% of the average of any three closing bid prices selected by the
investor during the 15 trading days prior to conversion or $2.44.
In connection with the June 8, 2001 Debentures, the Company issued warrants to
purchase 1,081,000 shares of the Company's common stock at an exercise price of
$2.89 per share (See Note 10). The Black-Scholes option pricing model was used
to value the warrants and the following assumptions: contractual term of 5
years, a risk free interest rate of 4.625%, a dividend yield of 0% and
volatility of 147%. The allocation of the June 8, 2001 Debenture proceeds to the
fair value of the warrants of $1,282,000 was recorded as a discount on the
Debenture and recorded as a warrant liability due to the Company's requirement
to register the common stock. The common stock issuable pursuant to the
conversion and exercise of the Debenture and warrant respectively must be
registered within 30 days after the closing date of the next round of financing.
The discount on the Debentures is amortized over the note maturity period and,
as a result, $39,000 was recorded as non-cash interest expense in the three
month period ended June 30, 2001. In addition, due to the registration
requirement the warrants need to be remeasured to their estimated value each
reporting period until they are registered. As a result, the Company has
recorded $1,120,000 of non-cash deemed interest expense during the three months
ended June 30, 2001. The warrants were remeasured at June 30, 2001 using the
Black-Scholes option pricing model using the following assumptions: contractual
term of 5 years, a risk-free interest rate of 4.63%, a dividend yield of 0% and
volatility of 147%. The liability related to the warrants total $2,402,000 at
June 30, 2001.
As a result of the beneficial conversion feature described above for the June 8,
2001 Debentures, the Company recorded a charge to additional paid-in capital of
$1,118,000, which was recorded as a discount on the notes payable. The discount
on the notes payable is amortized over the note maturity period and, as a
result, $34,000 was recorded as non-cash interest expense in the three month
period ended June 30, 2001.
14
At any time until August 30, 2001, if the Company raises at least $25 million,
the Company shall have the right to redeem all outstanding debentures at a price
equal to 115% of par plus accrued dividends. If the debentures are redeemed, the
investor shall retain 60% of all issued warrants. Within 30 days after the
closing date of the interim financing, the Company is required to file a
registration statement for resale of all common stock issuable pursuant to the
funding.
The Company issued warrants to purchase 200,000 shares of the Company's common
stock to its strategic partner for finding investors for the June 8, 2001
Debentures at an exercise price of $1.60 per share (See Note 10). The
Black-Scholes option pricing model was used to value the warrants and the
following assumptions: contractual term of 5 years, a risk free interest rate of
4.63%, a dividend yield of 0% and volatility of 147%. The fair value of $546,000
was accounted for as a convertible debentures issuance costs and recorded as a
deferred charge. The issuance cost is amortized over the note maturity period
and, as a result, $17,000 was recorded as a non-cash interest expense in the
three month period ended June 30, 2001.
9. 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% paid
in common stock 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 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 5.8%, term of 1 year, and no
expected dividend. The Company recorded this warrant as a cost of financing.
15
As of June 30, 2001, 83,120 preferred shares have been converted into 831,200
shares of the Company's common stock and 4,500 preferred shares remain
outstanding.
10. STOCKHOLDERS' EQUITY
WARRANTS
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 allowing us 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 "Stock Purchase Agreement").
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.
On November 28, 2000, the Company issued a warrant to purchase 30,000 shares to
a professional services firm in consideration for certain services rendered to
us at an exercise price of $8.34 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 March 21, 2001, the Company issued a warrant, subject to adjustments pursuant
to the terms of the Warrant, to purchase 462,963 shares of its common stock with
an exercise price of $2.70 per share to a related party in conjunction with a
Convertible Promissory Note (See Note 8). The warrant is immediately exercisable
and expires in 7 years. As of May 31, 2001, the Company had not completed an
equity investment in the Company in the aggregate principal amount of at least
$6 million, and the Company had not prepaid the note payable and accrued
interest in cash or common shares. As a result, the Company issued an additional
warrant on May 31, 2001 to purchase 1,500,000 shares of Common Stock with an
exercise price of $2.70. The warrant is immediately exercisable and expires in 7
years.
On April 9, 2001, the Company issued a warrant to purchase 200,000 shares of its
common stock with an exercise price of $2.00 to a customer in connection with a
Master Service Agreement. The warrant is immediately exercisable and expires in
5 years. The warrants were valued using the Black-Scholes option pricing model
and the following assumptions: contractual term of 5 years, a risk free interest
rate of 4.625%, a dividend yield of 0% and volatility of 147%. The fair value of
$449,000 was accounted for as a deferred cost of sales and recorded as an "other
asset." The deferred cost of sales is amortized over the Master Service
Agreement term and, as a result, $34,000 was recorded as non-cash cost of sales
in the three months ended June 30, 2001.
On May 31, 2001, the Company issued warrants to purchase 120,000 shares of its
common stock with an exercise price of $1.57 per share to certain investors in
conjunction with the $200,000 Notes and $400,000 Notes (See Note 8). The
warrants are exercisable immediately and expire in 5 years.
16
On June 8, 2001, the Company issued warrants to purchase 1,081,000 shares of its
common stock with an exercise price of $2.89 per share to certain investors in
conjunction with June 8, 2001 Debentures (See Note 8). The warrants are
exercisable immediately and expire in 5 years.
On June 8, 2001, the Company issued warrants to purchase 200,000 shares of its
common stock to its strategic partner at an exercise price of $1.60 (See Note
8). The warrants are immediately exercisable and expire in 5 years.
COMMON STOCK
On May 23, 2001, the Company acquired all of the outstanding stock of Quaartz
Inc. and issued 1,500,00 shares of its common stock with an estimated value of
$8.3 million to former Quaartz shareholders (See Note 12).
STOCK PURCHASE AGREEMENT
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
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 (see "Warrants" above). 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.
During the second quarter, the Company requested that the investment corporation
purchase $1.745 million of stock under the equity line agreement. Accordingly,
the Company received net proceeds of $1.745 million under the equity line and,
accordingly, reclassified $1.745 million from "Other Non-Current Assets" to
"Additional paid-in capital" upon receipt of the proceeds and issuance of the
stock. If at termination of the agreement the proceeds received from the sale of
common stock are less than the costs associated with this agreement, then the
residual costs remaining in "Other Assets" will be charged to expense.
17
11. 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
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 APPIANT NA, Infotel, and
other, which includes corporate operations. APPIANT NA, includes the Company's
enterprise operations, Triad and NHAN SWG. APPIANT NA enterprise 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 APPIANT NA for internal reporting purposes rather
than as a separate segment. The Company acquired Quaartz on May 23, 2001, an
application and service provider primarily involved in software development
projects for the Company. The results of Quaartz have been included with those
of Appiant NA since the date of acquisition. The periods ended June 30, 2000
have 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 2001 or 2000. The
following table presents APPIANT NA's net revenue by country and is attributed
to countries based on location of the customer:
For the three months ended For the nine months ended
June 30, June 30,
-------------------------- --------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
United States $ 1,964,000 $ 1,825,000 $ 4,673,000 $ 12,606,000
India 567,000 -- 3,038,000 --
------------ ------------ ------------ ------------
$ 2,531,000 $ 1,825,000 $ 7,711,000 $ 12,606,000
============ ============ ============ ============
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.
APPIANT NA INFOTEL OTHER(1) TOTAL
THREE MONTHS ENDED June 30, 2001
Net revenue to external customers $ 2,531,000 $ 3,593,000 $ -- $ 6,124,000
Net Income (loss) (8,260,000) 158,000 (7,475,000) (15,577,000)
Total assets 25,323,000 10,014,000 16,774,000 52,111,000
THREE MONTHS ENDED June 30, 2000
Net revenue to external customers $ 1,826,000 $ 2,448,000 $ -- $ 4,274,000
Net Income (loss) (2,236,000) 347,000 (1,730,000) (3,619,000)
Total assets 9,645,000 8,778,000 18,045,000 36,468,000
NINE MONTHS ENDED June 30, 2001
Net revenue to external customers $ 7,711,000 $11,028,000 $ -- $ 18,739,000
Net Income (loss) (18,332,000) 771,000 (7,908,000) (25,469,000)
Total assets 12,888,000 10,014,000 16,774,000 52,111,000
18
NINE MONTHS ENDED June 30, 2000
Net revenue to external customers $ 12,606,000 $ 9,010,000 $ -- $ 21,616,000
Net Income (loss) (1,441,000) 919,000 (4,790,000) (5,312,000)
Total assets 9,645,000 8,778,000 18,045,000 36,468,000
(1) Other includes corporate expenses. Additionally, management reports include
goodwill for Infotel in total assets.
12. ACQUISITION
Effective May 23, 2001, Appiant Technologies, Inc. ("Appiant") acquired all of
the outstanding stock of Quaartz, Inc. ("Quaartz"). The total purchase price of
$9.1 million consisted of the following:
(a) 1,500,000 shares of Appiant's common stock with an estimated value of
$8,310,000, calculated by multiplying the number of shares issued by
Appiant by $5.54, which represents the average price of Appiant's stock for
the period two days preceding through two days following Appiant's
announcement of the Merger, which occurred on February 8, 2001,
(b) An estimated $342,000 of acquisition expenses, and
(c) an estimated fair value of $429,000 relating to 92,387 stock options issued
by Appiant in relation to the cancellation of all of the stock options held
by Quaartz employees. The stock options were valued using the Black-Scholes
option pricing model with the following assumptions: fair market value of
Appiant stock of $5.54, exercise price of $4.50, estimated life of the
options of 4 years, volatility of 147%, dividend rate of 0%, and risk-free
interest rate of 4.375%.
The acquisition has been accounted for using the purchase method of accounting
and accordingly the purchase price has been allocated to the tangible and
intangible assets acquired and liabilities assumed on the basis of their
respective fair values on the acquisition date.
The preliminary allocation of the purchase price is as follows, (as of May 23,
2001):
Tangible assets,
Primarily property
and equipment $ 393,000
Workforce $ 1,223,000
Technology $ 2,790,000
Liabilities assumed $ (4,000,000)
Goodwill $ 8,675,000
-------------
$ 9,081,000
=============
The following unaudited pro forma financial information for nine months ended
June 30, 2001 and the year ended September 30, 2000 assumes the Quaartz
acquisition occurred as of the beginning of the respective periods, after giving
effect to certain adjustments, including amortization of intangible assets. The
pro forma results have been prepared for comparative purposes only and are not
19
necessarily indicative of the results of operations that may occur in the future
or that would have occurred had the acquisition of Quaartz been affected on the
dates indicated.
Liabilities assumed are as follows:
Fair value of notes payable to related party
(principal amount $3,000,000) $ 2,729,000
Contingent liability to software vendor
(see Note 7) $ 130,000
Accrued payroll costs $ 350,000
Line of credit $ 300,000
Accounts payable and other accrued liabilities $ 320,000
The notes payable to the related party are comprised of $1,000,000 relating to a
recourse note and $2,000,000 relating to a non-recourse note, both of which were
originally due on December 31, 2000. No interest is payable on either of these
notes.
The line of credit provides for unsecured borrowings of up to $300,000, and is
due on June 30, 2001 and bears interest at a rate equal to the Wall Street
Journal prime rate (9.5% at September 30, 2000). Under this line of credit, the
Company is not required to maintain any financial covenants.
Nine Months Ended Year Ended
June 30, September 30,
2001 2000
------------------- --------------------
Net revenues $ 18,845,000 $ 26,929,000
Net loss (41,799,000) (28,649,000)
Basic and diluted net loss per common share $ (2.79) $ (2.43)
Shares used in per share calculations - basic and
diluted 14,980,000 11,803,000
The results of operations of Quaartz have been included with those of the
Company since the date of acquisition, May 23, 2001.
During the nine months ended June 30, 2001, payments of $1,215,000 were made to
Quaartz for services provided to the Company, primarily in conjunction with
software development projects. As a result, the Company recorded capitalized
software of $562,000, research and development expense of $229,000, and selling,
general and administrative expense of $424,000.
13. RESTRUCTURING CHARGE
The Company restructured its operations, closing a number of remote divisions
and implementing a 20% work force reduction in the quarters ended March 31, 2001
and June 30, 2001. Restructuring charges consisted principally of severance
payments to former Officers and Executives and operational and administrative
employees of APPIANT NA. A total of 68 employees were terminated in March 2001
and April 2001 and a total of $302,000 was expensed to selling, general and
administrative in the three months ended March 31, 2001 and $61,000 was expensed
to selling, general and administrative in the three months ended June 30, 2001.
All amounts accrued have been paid at June 30, 2001.
20
14. SUBSEQUENT EVENT
On July 27, 2001, the Company entered into a settlement agreement and release
with a software vendor from whom the Company leases software. The software
vendor relieved the Company of $7.4 million outstanding under its capital lease
and loaned the Company $3 million on a Promissory Note. The note will be due and
payable upon the nine month anniversary of the note if the Company continues to
use the software license. If, before the nine month anniversary date, the
Company returns the software to the lender no amount shall be payable under this
note.
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
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;
21
- 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
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 IP-based unified
communications and unified information portal and applications branded under the
name "inUnison(TM)" in a hosted 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., doing business as Appiant Technologies ("APPIANT NA"), Infotel
Technologies (Pte) Ltd ("Infotel") and Quaartz Inc. ("Quaartz").
For our enterprise operations, the Company derives its revenue primarily from
its APPIANT NA, which includes the results of our Triad subsidiary. Generally,
revenue derived from APPIANT 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
22
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 unified communications and unified
information applications business model, our results for the three and nine
months ended June 30, 2001 reflect generally the results of our enterprise
business in North America, as well as that of Infotel. Our revenues for the
three and nine months ended June 30, 2001 were derived solely from our
enterprise businesses. We have restructured 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 June 30,
2001 we had 185 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.
RESULTS OF OPERATIONS
The following table shows results of operations, as a percentage of net
revenues, for the three and nine months ended June 30, 2001 and 2000:
Three Months Ended Nine Months Ended
June 30, June 30,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of sales 90.8% 72.4% 80.0% 67.8%
Gross profit 9.2% 27.6% 20.0% 32.2%
Selling, general and administrative 61.2% 58.4% 73.5% 42.8%
Research and development 15.8% 0.8% 11.6% 0.6%
Amortization of goodwill and
Other intangibles 9.0% 3.8% 5.1% 2.3%
Impairment of equipment and
capitalized software 60.4% -- 19.7% --
Loss from operations (137.2%) (35.4%) (89.9%) (13.5%)
Other expense (116.3%) (45.8%) (44.5%) (9.9%)
Loss from operations before income
taxes (253.5%) (81.2%) (134.4%) (23.4%)
Provision for income tax 0.9% 3.4% 1.5% 1.3%
Loss from operations (254.4%) (84.6%) (135.9%) (24.7%)
Net loss (254.4%) (84.6%) (135.9%) (24.7%)
Net Revenues
For the three months ended June 30, 2001, our net revenues were $6.1
million as compared to $4.3 million for the same period ending June 30,
23
2000, representing an increase of $1.9 million or 43%. For the nine months ended
June 30, 2001, our net revenues were $18.7 million as compared to $21.6 million
for the same period ending June 30, 2000. Our net revenues for the nine months
ended June 30, 2001 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 year to date decline also represents an overall decline in our
enterprise revenues following our announced business model change.
APPIANT NA's net revenues were $2.5 million for the three months ended June 30,
2001 as compared to $1.8 million for the same period ending June 30, 2000.
APPIANT NA's net revenues were $7.7 million for the nine months ended June 30,
2001 as compared to $12.6 million for the same period ending June 30, 2000. The
quarterly increase represents increased call center solutions sales in India.
The year to date decrease in APPIANT NA net revenues came from reduced
enterprise information center product sales, as well as lower enterprise system
sales within our existing customer base.
Net revenues for our Infotel subsidiary were $3.6 million for the three months
ended June 30, 2001 as compared to $2.4 million for the same period ending June
30, 2000. For the nine months ended June 30, 2001, Infotel's net revenues were
$11.0 million as compared to $9.0 million for the same period ending June 30,
2000. The increase represents increased demand from key customers and the
Singapore government within test instrument products and networking.
Our corporate-wide backlog decreased to $3.8 million at June 30, 2001 as
compared to $7.1 million as of June 30, 2000. APPIANT NA's order backlog
decreased to $1.4 million from $2.7 million at June 30, 2000, and Infotel's
backlog decreased to $2.4 million at June 30, 2001 from $4.4 million at June 30,
2000.
Gross Margin
Our gross margin for the three months ended June 30, 2001 was $565,000 or 9.2%
of net revenues, as compared to $1.2 million or 27.6% for the three months ended
June 30, 2000. Our gross margin for the nine months ended June 30, 2001 was $3.7
million or 20.0% of net revenues, as compared to $7.0 million or 32.2% for the
nine months ended June 30, 2000.
APPIANT NA's gross margin on a stand-alone basis for the three months ended June
30, 2001 was ($0.2) million or (7.6%), as compared to $0.1 million or 6.8% for
the three months ended June 30, 2000. APPIANT NA's gross margin for the nine
months ended June 30, 2001 was $0.9 million or 11.2%, as compared to $3.9
million or 31.7% for the nine months ended June 30, 2000. This decrease in gross
margin was due to the reduction in enterprise revenues as we execute our new
business model coupled with the fixed nature of operating costs along with
subscriber acquisition costs related to an inUnison(TM) customer for which no
revenue has been recognized to date. The costs are being amortized over the
life of the master service agreement, 3 years, and $34,000 was expensed in the
three months ended June 30, 2001.
Infotel's gross margin percentage on a stand-alone basis decreased to 21.1% for
the three months ended June 30, 2001 as compared to 36.4% for the three months
ended June 30, 2000. For the nine months ended June 30, 2001, Infotel's gross
margin percentage was 26.1% and 29% for the same period ending June 30, 2000.
This decrease in gross margin was due to the product mix from which the revenue
was comprised.
24
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 70.2% of net revenues for
the three months ended June 30, 2001, as compared to 62.2% for three months
ended June 30, 2000. SG&A for the nine months ended June 30, 2001 was $14.7
million or 78.6% as compared to $9.7 million or 45.1% for the nine months ended
June 30, 2000. This increase is due to the addition of United States of America
sales and marketing personnel and related expenses associated with the
inUnison(TM) product launch, coupled with the reduction in revenues in APPIANT
NA as we execute our new business model.
SG&A for APPIANT NA on a stand-alone basis increased to $3.2 million or 126.7%
for the three months ended June 30, 2001 from $2.6 million or 105.6% in the
three months ended June 30, 2000. APPIANT NA's SG&A for the nine months ended
June 30, 2001 was $12.1 million or 156.4% as compared to $3.9 million or 33.1%.
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 associated with the new inUnison(TM) product launch coupled with a
decline in enterprise system and maintenance revenue.
On a stand-alone basis, Infotel's SG&A as a percentage of net revenues decreased
to 15.1% for the three months ended June 30, 2001 as compared to 19.7% for the
three months ended June 30, 2000. The decrease as a percentage of revenue is
mainly due to the increase in revenue. For the nine months ended June 30, 2001,
Infotel's SG&A as a percentage of net revenues decreased to 15.5%, as compared
to 18% for the same period ending June 30, 2000.
Our amortization of goodwill and other intangibles for the three months ended
June 30, 2001 increased to $558,000 or 9% of net revenue from $159,000 or 3.8%
of net revenue for the three months ended June 30, 2000. For the nine months
ended June 30, 2001, amortization of goodwill and other intangibles increased to
$960,000 or 5.1% of net revenues from $478,000 or 2.3% of net revenues for the
nine months ended June 30, 2000. The increase relates to the acquisition of
Quaartz on May 23, 2001.
During fiscal year 2000, we recorded non-cash unearned stock-based compensation
of $2.1 million in connection with stock option grants. During the three months
ended June 30, 2001, we reduced unearned stock-based compensation by $401,000
and non-cash compensation expense by $107,000 as a result of terminations due to
restructuring. During the nine months ended June 30, 2001, we reduced unearned
stock-based compensation by $1.7 million and non-cash compensation expense by
$292,000 as a result of terminations due to restructuring. We are amortizing
the unearned stock-based compensation over the vesting periods of the applicable
options, resulting in non-cash amortization expense of $23,000 in the three
months ended June 30, 2001 and $82,000 in the nine months ended June 30, 2001.
During the nine months ended June 30, 2001 we incurred non-cash compensation
charges of $413,000 related to warrants for services. We recorded a reduction
in non-cash compensation charges of $2.2 million during the nine months ended
June 30, 2001 resulting from the effect of variable accounting for warrants
issued to employees. The stock-based compensation will not be remeasured each
reporting period as the warrants have expired.
25
The Company restructured its operations, closing a number of remote divisions
and implementing a 20% work force reduction in the two quarters ended June 30,
2001. Restructuring charges, which have all been paid, consisted principally of
severance payments to former Officers and Executives and operational and
administrative employees of APPIANT NA. A total of 68 employees were terminated
in the two quarters ended June 30, 2001 and a total of $363,000 was expensed.
The Company estimates cost savings of $8.5 million annually as a result of the
restructuring.
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 also conducted research and
development into our own advanced speech recognition to be offered in our
portal. This speech recognition research and development is no longer necessary
as our speech recognition licensor has agreed to make the changes unique to our
inUnison(TM) product. 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 development expenditures increased to $2.2 million in the nine
months ended June 30, 2001 from $134,000 in the nine months ended June 30, 2000,
reflecting our increased investment in software 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, which we believe will begin in the fourth
quarter of fiscal 2001. Costs not directly related to the development of our
software asset are recorded as research and development expenses.
Our research and development expenses as a percentage of net revenues increased
to 15.8% for the three months ended June 30, 2001, as compared to 0.8% for the
three months ended June 30, 2000. For the nine months ended June 30, 2001, our
research and development expenses as a percentage of net revenues increased to
11.6%, as compared to 0.6% for the nine months ended June 30, 2000. This
increase is due to the addition of United States research and development
personnel and related expenses associated with our new inUnison(TM) product
launch.
Impairment of equipment and capitalized software
In the nine months ended June 30, 2001, the Company entered into lease financing
arrangements with a hardware vendor, under which approximately $1.3 million
related to hardware and related product costs and $2.5 million related to
consulting services were acquired for its first data center in Atlanta, Georgia.
The Company relocated its data center to Sunnyvale, California in June 2001 and
intends to relocate the hardware and related costs of $1,500,000 to this
location and wrote off the remaining net book value of $2.5 million related to
consulting services for the first data center to other operating expenses. The
consulting services related to the installation of the hardware and the Company
determined that they had no future value following the relocation. The Company
is in discussions with the hardware vendor regarding the balance due under the
lease, including revised payment terms and possible forgiveness of a part or all
of the lease payments. On June 29, 2001, the Company returned various items of
26
computer equipment and related goods related to the first data center to the
vendor for an aggregate purchase price of $1.6 million. The vendor forgave the
balance due under the capital lease of $1.6 million and the equipment and
payable was written off in the three months ended June 30, 2001.
In addition, the Company had capitalized $1.2 million as part of its software
asset related to software and services obtained for billing and provisioning.
In June 2001, the Company concluded that other software would be used as the
primary billing application and that the software did not have any other
alternative future use, and therefore, $1.2 million was written off in the three
months ended June 30, 2001. The Company is in discussions with the vendor
regarding settlement of the related account payable.
Interest income
Our interest income decreased to $39,000 or 0.6% in the three months ended June
30, 2001 from $45,000 or 1% in the three months ended June 30, 2000. Our
interest income increased to $219,000 or 1.2% in the nine months ended June 30,
2001 from $159,000 or 0.7% in the nine months ended June 30, 2000. The increase
in interest income and other results from short-term investments in commercial
paper in the first quarter of 2001 resulting in higher returns than previously
earned.
Interest expense
Our interest expense increased to $7.6 million or 123.7% in the three months
ended June 30, 2001 from $1.8 million or 43% in the three months ended June 30,
2000. For the nine months ended June 30, 2001, our interest expense increased
to $8.9 million or 47.6% from $2.1 million or 9.8% in the nine months ended June
30, 2000. The increase in interest expense resulted form higher capital lease
obligations during the three and nine months ended June 30, 2001, and a total of
$7.5 million of deemed interest related to the warrants and beneficial
conversion charges corresponding to convertible notes issued in the nine month
period ended June 30, 2001 (see Note 8 of the notes to the financial
statements).
Other income (expense)
Our other income (expense) increased to net expense of $3.3 million or 53.6% in
the three months ended June 30, 2001 from net expense of $167,000 or 3.9% in the
three months ended June 30, 2000. Our other expense increased to $3.3 million
or 17.7% in the nine months ended June 30, 2001 from $169,000 or 0.8% in the
nine months ended June 30, 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
June 30, 2001, 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 $227,000 relates to the provision for
income tax for Infotel.
27
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our capital requirements through a combination
of sales of equity securities, convertible notes and other debt offerings, bank
borrowings, asset-based secured financing, structured financing and cash
generated from operations.
During the nine months ended June 30, 2001 net cash used in operating
activities was $7.9 million. Net cash used to fund operating activities reflects
our net loss, net of non-cash charges, offset by an increase in accounts payable
and other current liabilities. Net cash provided by investing and financing
activities totaled $6.5 million consisting of proceeds from the issuance of
convertible debentures, proceeds from a convertible promissory note with a
related party, proceeds from draws on our equity line, 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
receivable-based credit line, payments of our capital lease obligations,
purchases of property and equipment and development of software assets.
Our principal sources of liquidity at June 30, 2001 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
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 August 15, 2001, 83,120 preferred shares
have been converted into 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. During the three months ended March 31, 2001, the
Company received $1.745 million of cash under the equity line agreement. If at
termination of the agreement the proceeds received from the sale of common stock
are less than the costs associated with this agreement, then the residual costs
remaining in "Other Assets" will be charged to expense.
On March 21, 2001, the Company entered into a Convertible Promissory Note with a
related party in the principal amount of $2,500,000. The convertible note
28
accrues interest at 10% per annum and became fully due and payable on May 31,
2001 (the "Maturity Date"). The note is now past due. Upon approval by the
Company's shareholders, the principal and accrued interest under this Note
convert into shares of the Company's common stock at any time on or after the
Maturity Date. The conversion price is equal to 80% of the average of the five
days lowest closing market price of the common stock during the period beginning
on March 16, 2001 and ending on the Maturity Date. If the principal and accrued
interest on this note is not paid in full or converted into Common Stock for any
reason other than awaiting shareholder approval, and otherwise in accordance
with the terms on or before the Maturity Date, then the conversion price shall
be reduced 20% for each full week that this note is not paid or converted,
provided that the conversion price shall not in any event be reduced to less
than $1.00. If the shareholders fail to approve the issuance of equity, the
related party may receive cash in the amount of $250,000 in addition to the
repayment of the principal and unpaid accrued interest at 25% per annum.
On May 31, 2001, the Company entered into Convertible Promissory Notes with two
related parties, the Chief Executive Officer and the Vice President of Sales, in
the principal amount of $100,000 each. The promissory notes accrue interest at
14% per annum and became fully due and payable on June 21, 2001 ("maturity
date"). The notes were also convertible on the maturity date into shares of the
Company's common stock at 90% of the exercise of conversion price applicable to
any security received in any interim financing subsequent to the date of the
notes. If no interim financing was obtained on or before the maturity date, the
notes were convertible into shares of the Company's common stock at 90% of the
closing price on the trading day immediately preceding the maturity date. The
note payable to the Chief Executive Officer was repaid before June 30, 2001.
On May 31, 2001, the Company also entered into Convertible Promissory Notes,
described above, with a related party in the principal amount of $150,000 and a
non-related party in the principal amount of $250,000. These notes were rolled
into the convertible debentures on June 8, 2001.
On June 8, 2001, the Company entered into a Convertible Debentures purchase
agreement with certain investors in the aggregate principal amount of
$2,400,000. The investors were obtained through a strategic partnering
agreement. The convertible debentures accrue interest at 8% per annum, payable
in common stock at the time of conversion. The conversion price is equal to
lower of 110% of the average of any three closing bid prices selected by the
investor during the 15 trading days prior to conversion or $2.44.
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
APPIANT 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 June 30, 2001, there was no balance outstanding on this line.
As noted under "Impairment of equipment and capitalized software" the Company is
currently in discussions with the vendor regarding settlement of $3.5 million of
related accounts payable.
29
Despite our negative working capital of $22.4 million at June 30, 2001,
we believe that our anticipated cash flows from both operations and available
to us through financing arrangements and fundraising efforts that are presently
in place 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 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 $25.5 million on net revenues of $18.7 million for the
nine months ended June 30, 2001. We also sustained significant losses for
the fiscal years ended September 30, 2000 and 1999. We also anticipate incurring
a net operating 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 thereafter sustain profitability.
Our 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.
30
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
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 enterprise 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 may experience continuing 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;
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- 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
- 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.
Effective May 23, 2001, Appiant Technologies acquired all of the outstanding
stock of Quaartz Inc., a development stage company that specializes in advanced
personalization technology. The integration of Quaartz, as a wholly-owned
subsidiary, 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 a
wholly-owned subsidiary's personnel, operations and technologies of the acquired
company. 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.
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
32
fail to establish the needed controls to manage growth effectively, our
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,
AND THE CONVERSION OF OUR CONVERTIBLE PROMISSORY NOTES AND CONVERTIBLE
DEBENTURES 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, convertible promissory notes and
convertible debentures 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 these financial instruments may have a
dilutive impact on our stockholders. Sales resulting from the conversion of
these financial instruments could have an immediate adverse effect on the market
price of the common stock. To the extent that any of our existing or future
financial instruments 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. As of June 30, 2001, 83,120 preferred shares have
been converted into 831,200 shares of the Company's common stock. As of June
30, 2001, none of the convertible promissory notes or convertible debentures
have been converted into shares of the Company's common stock.
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 a 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 the 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 the 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 operating results and cash
flows may be adversely affected, and we anticipate incurring a net operating
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 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. Although we reduced our headcount 24% in
the two quarters ended June 30, 2001, we have experienced rapid growth in the
past. 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,
33
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 operating
results and adverse cash flow 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
34
results and cash flows will be negatively impacted and we could face serious
needs for additional financing.
WE PRESENTLY GENERATE ENTERPRISE VOICEMAIL SYSTEMS AND ENTERPRISE INFORMATION
REVENUES.
For the three months ended June 30, 2001, enterprise voicemail systems revenues
(which includes customer premises equipment revenues) accounted for
approximately 32% of Company's total revenues and 78% of our North American
revenues. Revenue from the sales of enterprise information center products
accounted for approximately 22% of our North America revenue for the three
months ended June 30, 2001. Management believes that future revenues from
enterprise voicemail systems and enterprise information center products may
decline due to the Company's focus on 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) UC/UI
applications is difficult to predict because we are launching a new business
model and because the UC/UI 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 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 enterprise operations depend upon the integration of
hardware, software, and communications and data processing equipment
35
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 three major suppliers. Any disruption in our
relationships with the suppliers would have a significant adverse effect on our
business for an indeterminate period of time until new supplier relationships
could be established. 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 June 30, 2001 accounted
for approximately 12% and 9 % 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 59% of our total
revenues for the nine months ended June 30, 2001. 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 enterprise 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.
With the launch of our inUnison(TM) UC/UI hosted applications, Management
anticipates there may be a decline in our enterprise business revenues and
related gross margins as we focus on our UC/UI business. Any unforeseen delays
36
in connection with the launch of our inUnison(TM) business plan, coupled with a
decline in our enterprise 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, and these relationships are important to our success. In the
case of a software vendor partner, our partnering relationship includes having
been appointed as a Vendor Ecosystem Partner and a Vendor 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 their product.
Our partner also has committed to introducing customers to us.
Vendors also provided structured financing for their products and
services needed to launch our UC/UI hosted services.
The loss or deterioration of our relationships with any partner could have a
material adverse affect on our UC/UI business and financial performance. While
we believe that our partnering relationships 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 59% of our
revenues for the nine months ended June 30, 2001, 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;
- 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
37
- 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. 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. Management changes often have a disruptive impact on businesses and
can lead to the loss of key employees because of the uncertainty inherent in
change. For the last several years, we've had significant changes in our key
personnel. We cannot be certain that we will be successful in attracting and
retaining key personnel worldwide. 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.
38
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.
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
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
39
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 enterprise 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 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 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.
40
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
June 30, 2001, our cash and cash equivalents consisted of demand deposits held
by large institutions in the U.S. As of June 30, 2001 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 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 rates. We do not otherwise hold or issue derivative financial
instruments for trading or speculative purposes. 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. There were no exchange contracts
outstanding at June 30, 2001.
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PART II
ITEM 1. LEGAL PROCEEDINGS
In January 2001, a software vendor (the "vendor") filed a complaint against
Quaartz, a wholly owned subsidiary located in Santa Clara, California (see note
13) for damages for breach of contract in the amount of $130,000 plus interest
and attorneys fees. The vendor alleged that Quaartz breached a software
licensing agreement for the vendor's Intellisync software development engine
wherein Quaartz failed to make 2 payments totaling $65,000 each. In March 2001,
Quaartz filed a cross complaint for breach of contract in the amount of at least
$70,000 plus interest and attorneys fees. These cross-claims are based on
allegations that the software the vendor provided to Quaartz did not include key
synchronization features, which the vendor represented to the Quaartz were
included in the software. Moreover Quaartz alleges that the software did not
function in accordance with the terms of the licensing agreement. Both parties
have answered to each complaint. In addition the parties have agreed to mediate
the matter and have agreed upon October 19, 2001 to conduct mediation. The
Company has recorded a contingent liability of $130,000 but has not recorded any
contingent assets in relation the cross complaint or any additional costs
related to the defense of the claim.
In order to adapt the office space to the Quaartz's requirements, Quaartz
vacated Suite 101 at their existing premises and moved to Suite 203 in the same
premises. Quaartz did not formally cancel the lease for Suite 101 and is
currently in negotiation with the landlord to settle claims for alleged breach
of the leasehold agreement. In July 2001, the landlord sent a proposal to
Quaartz's management to settle this litigation. This proposal stated an amount
due of $2,580,000. The landlord offered to provide a complete release of all
obligations to the lease for the sum of $559,000. This offer was available
until July 12, 2001 and was not accepted by the Company. Quaartz is negotiating
with the landlord for a stock settlement. The vacant office space has already
been subleased to another tenant. No amount has been accrued in relation to
this contingency.
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. No amount
has been accrued in relation to this contingency.
The Company remains in discussions with two former employees who believe they
were wrongfully denied severance by the Company. The Company disputes these
allegations and has claims regarding the failure of such employees to properly
perform their duties and obligations to the Company.
The Company is not subject to any other material litigation nor, to its
knowledge, is other litigation threatened against it.
From time to time, we are also involved in other legal actions arising in the
ordinary course of business. While management intends to defend vigorously,
there can be no assurance that any of these complaints or other third party
assertions will be resolved without costly litigation, in a manner that is not
adverse to our financial position, results of operations or cash flow. No
estimate can be made of the possible loss or possible range of loss associated
with the resolution of these contingencies.
42
On April 24, 2001 a vendor filed suit against the Company in the Superior Court
of California, County of San Diego, claiming breach of contract and anticipatory
breach of contract. The first cause of action seeks a principal sum of
$164,000, alleging that the Company failed to fully pay the vendor for public
relations services rendered. The second cause of action seeks a principal sum
of $348,000, alleging that the Company failed to pay the vendor for marketing
and advertising services rendered. The final cause of action claims a principal
sum of $93,000, alleging that the Company did not provide
the requisite advance notice for termination of both the Public Relations
Agreement and Marketing Agreement. During the third fiscal quarter of 2001, the
Company has settled the suit with the vendor for $380,000. The Company had
previously established an accrual of $300,000 for this contingency and recorded
an additional accrual of $80,000 in the third fiscal quarter of 2001.
In 2000, the Company 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. In the third fiscal quarter of
2001, the Company settled with the customer for $164,000. The Company will
recognize revenue for the settled amount when cash is received.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On June 8, 2001, the Company issued warrants to purchase 1,081,000 shares of its
common stock with an exercise price of $2.89 per share to certain investors in
conjunction with Convertible Debentures with a principal amount of $2.4 million.
The warrants expire in 5 years.
On June 8, 2001, the Company issued warrants to purchase 200,000 shares of its
common stock to its strategic partner for finding investors at an exercise price
of $1.60. The warrants expire in 5 years.
On May 31, 2001, the Company issued warrants to purchase 120,000 shares of its
common stock with an exercise price of $1.57 per share to certain investors in
conjunction with convertible promissory notes with a principal amount of
$600,000. The warrants expire in 5 years.
On May 24, 2000, we issued warrants to purchase 120,000 shares of common stock
to an investment corporation in lieu of providing them 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 the investment
corporation allowing us to issue Series B Preferred Stock to other investors.
The warrants were originally issued in conjunction with a stock purchase
agreement (See "Stock Purchase Agreement").
On April 9, 2001, the Company issued warrants to purchase 200,000 shares of its
common stock with an exercise price of $2.00 to a customer in connection with a
Master Service Agreement.
On May 31, 2001, the Company entered into Convertible Promissory Notes Payable
with two related parties, the Company's Chief Executive Officer and the Vice
President of Sales, in the principal amount of $100,000 each (the $200,000
Notes"). The $200,000 Notes accrue interest at 14% per annum and became fully
due and payable on June 21, 2001 ("maturity date"). The $200,000 Notes were
also convertible on the maturity date into shares of the Company's common stock
at 90% of the conversion price applicable to any security received in any
interim financing subsequent to the date of the notes. If no interim financing
was obtained on or before the maturity date, the $200,000 Notes were convertible
into shares of the Company's common stock at 90% of the closing price on the
trading day immediately preceding the maturity date.
In addition, the Company issued warrants to the same related party's to purchase
20,000 shares each of the Company's common stock at an exercise price of $1.57
per share (See Note 10). The Black-Scholes option pricing model was used to
value the warrants and the following assumptions: contractual term of 5 years,
a risk free interest rate of 4.625%, a dividend yield of 0% and volatility of
147%. The allocation of the $200,000 Note proceeds to the fair value of the
43
warrants of $44,000 was recorded as a discount on the notes payable and recorded
as additional paid-in capital. The discount on the notes payable was amortized
over the note maturity period and, as a result, $44,000 was recorded as non-cash
interest expense in the three months ended June 30, 2001.
On May 31, 2001, the Company also entered into Convertible Promissory Notes
Payable with the same terms as the $200,000 Notes, with a related party in the
principal amount of $150,000 and a non-related party in the principal amount of
$250,000 (the "$500,000 Notes"). These $500,000 Notes were rolled into the
convertible debentures payable issued on June 8, 2001 (the "June 8, 2001
Debentures").
In addition, the Company issued warrants to purchase 30,000 and 50,000,
respectively, shares of the Company's common stock at an exercise price of $1.57
per share (See Note 10). The Black-Scholes option pricing model was used to
value the warrants and the following assumptions: contractual term of 5 years,
a risk free interest rate of 4.625%, a dividend yield of 0% and volatility of
147%. The allocation of the $500,000 Note proceeds to the fair value of the
warrants of $88,000 was recorded as a discount on the notes payable and recorded
as additional paid-in capital. The discount on the notes payable was fully
amortized and, as a result, $88,000 was recorded as non-cash interest expense in
the three month period ended June 30, 2001.
June 8, 2001 Convertible Debentures Payable
On June 8, 2001, the Company entered into a Convertible Debentures purchase
agreement with certain investors in the aggregate principal amount of
$2,400,000. The investors were obtained through a strategic partnering
agreement. The June 8, 2001 Debentures accrue interest at 8% per annum, payable
in common stock at the time of conversion. The conversion price is equal to
lower of 110% of the average of any three closing bid prices selected by the
investor during the 15 trading days prior to conversion or $2.44.
In connection with the June 8, 2001 Debentures, the Company issued warrants to
purchase 1,081,000 shares of the Company's common stock at an exercise price of
$2.89 per share (See Note 10). The Black-Scholes option pricing model was used
to value the warrants and the following assumptions: contractual term of 5
years, a risk free interest rate of 4.625%, a dividend yield of 0% and
volatility of 147%. The allocation of the June 8, 2001 Debenture proceeds to the
fair value of the warrants of $1,282,000 was recorded as a discount on the
Debenture and recorded as a warrant liability due to the Company's requirement
to register the common stock. The common stock issuable pursuant to the
conversion and exercise of the Debenture and warrant respectively must be
registered within 30 days after the closing date of the next round of financing.
The discount on the Debentures is amortized over the note maturity period and,
as a result, $39,000 was recorded as non-cash interest expense in the three
month period ended June 30, 2001. In addition, due to the registration
requirement the warrants need to be remeasured to their estimated value each
reporting period until they are registered. As a result, the Company has
recorded $1,120,000 of non-cash deemed interest expense during the three months
ended June 30, 2001. The warrants were remeasured at June 30, 2001 using the
Black-Scholes option pricing model using the following assumptions: contractual
term of 5 years, a risk-free interest rate of 4.63%, a dividend yield of 0% and
volatility of 147%. The liability related to the warrants total $2,402,000 at
June 30, 2001.
44
On March 21, 2001, the Company entered into a Convertible Promissory Note with a
related party in the principal amount of $2,500,000. The convertible note
accrues interest at 10% per annum and becomes fully due and payable on May 31,
2001 (the "Maturity Date"). Upon approval by the Company's shareholders, the
principal and accrued interest under this Note convert into shares of the
Company's common stock at any time on or after the Maturity Date. The
conversion price is equal to 80% of the average of the five days lowest closing
market price of the common stock during the period beginning on March 16, 2001
and ending on the Maturity Date. If the principal and accrued interest on this
note is not paid in full or converted into Common Stock for any reason other
than awaiting shareholder approval, and otherwise in accordance with the terms
on or before the Maturity Date, then the conversion price shall be reduced 20%
for each full week that this note is not paid or converted, provided that the
conversion price shall not in any event be reduced to less than $1.00.
In conjunction with the Convertible Promissory Note, the Company issued a
warrant to purchase 462,963 shares of its common stock at an exercise price of
$2.70. In addition, as of May 31, 2001, the Company had not completed an equity
investment in the Company in the aggregate principal amount of at least
$6,000,000 (the "Financing"), and the Company had not prepaid the note payable
and accrued interest in cash or common shares. As a result, the Company issued
an additional warrant on May 31, 2001 to purchase 1,500,000 shares of Common
Stock with an exercise price of $2.70. The warrant expires in 7 years.
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 $8.34.
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 August 15,
2000, 86,120 preferred shares have been converted into 861,200 shares of the
Company's common stock.
On May 23, 2001, the Company acquired all of the outstanding stock of Quaartz
Inc. and issued 1,500,00 shares of its common stock with an estimated value of
$8.3 million to former Quaartz shareholders.
45
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
By a special meeting of the shareholders on March 16, 2001 our stockholders
approved the following proposals:
- To elect six directors to our board of directors to hold office until the next
annual meeting of stockholders, or until their respective successors shall be
duly elected and qualified.
- Approval of an amendment to the Company's Amended and Restated Certificate of
Incorporation to increase the number of authorized shares of common stock, par
value $0.01 per share, of the Company from 20,000,000 to 40,000,000 shares of
common stock.
- Approval of an amendment to the Company's Amended and Restated Certificate of
Incorporation to change the Company name to "Appiant Technologies Inc."
- Approval of the Company's Employee Stock Purchase Plan.
- Ratification of the appointment of PriceWaterhouse Coopers LLP as the
Company's independent accountants.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBIT INDEX
--------------------------------------------------------------------------------
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT
--------------------------------------------------------------------------------
10.65
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(b) Reports on Form 8-K
On June 6, 2001, we filed a report on Form 8-K to announce our acquisition of
Quaartz Inc. effective May 23, 2001.
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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: August 20, 2001 NHANCEMENT TECHNOLOGIES INC.
By: /s/ DOUGLAS S. ZORN
--------------------------------------
Douglas S. Zorn
President and Chief Executive Officer
48