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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10 - Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
Commission File Number 0-11630
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TERAFORCE TECHNOLOGY CORPORATION
(exact name of registrant as specified in its charter)
DELAWARE 76-0471342
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) Identification No.)
1240 EAST CAMPBELL ROAD, RICHARDSON, TEXAS 75081
(Address of principal executive offices) (Zip code)
469-330-4960
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
There were 87,088,850 shares of Common Stock outstanding as of October 31, 2001.
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TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
INDEX
PAGE
----
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
Consolidated Condensed Balance Sheets of the Company
at September 30, 2001 (unaudited) and December 31, 2000 2
Consolidated Condensed Statements of Operations of the Company (unaudited) for
the three months and nine months ended
September 30, 2001 and 2000 3
Consolidated Condensed Statements of Cash Flows of the Company
(unaudited) for the nine months ended September 30, 2001 and 2000 4
Notes to Consolidated Condensed Financial Statements 5
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 9
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 14
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS 15
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 15
SIGNATURES 16
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
(Thousands of dollars, except share data)
September 30, December 31,
2001 2000
------------- -------------
(unaudited)
Assets
Current assets:
Cash and cash equivalents $ 189 $ 5,587
Investments 53 110
Accounts receivable net of allowances of $1,604 in 2001
and $1,691 in 2000 1,148 5,558
Receivable from affiliate 780 --
Assets held for sale -- 4,893
Inventories 3,952 2,175
Prepaid expenses 205 482
------------- -------------
Total current assets 6,327 18,805
Property and equipment, net 1,282 1,188
Goodwill, net 2,850 3,354
Investment in joint venture 1,250 --
Other assets 275 657
------------- -------------
$ 11,984 $ 24,004
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable $ 4,850 $ 100
Accounts payable 1,799 2,121
Accrued liabilities 1,394 2,372
------------- -------------
Total current liabilities 8,043 4,593
------------- -------------
Stockholders' equity:
Common stock, $.01 par value. Authorized 200,000,000 shares;
87,088,850 and 86,098,850 shares issued in 2001 and 2000,
respectively 871 861
Additional paid-in capital 181,898 181,381
Accumulated deficit (177,241) (161,244)
------------- -------------
5,528 20,998
Less 400,474 shares of common stock in treasury - at cost (1,587) (1,587)
------------- -------------
Total stockholders' equity 3,941 19,411
------------- -------------
$ 11,984 $ 24,004
============= =============
See accompanying notes to consolidated condensed financial statements.
2
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Statements of Operations
(Thousands of dollars, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
(unaudited)
Net revenues $ 1,154 $ 4,162 $ 8,831 $ 13,776
Cost of revenue 2,491 4,196 10,239 13,785
---------- ---------- ---------- ----------
Gross profit (loss) (1,337) (34) (1,408) (9)
---------- ---------- ---------- ----------
Expenses:
Engineering and development 1,276 1,590 4,033 4,165
Selling and administrative 2,296 3,376 8,385 9,513
Costs related to sale of assets 1,570 -- 1,570 --
Amortization of goodwill 168 168 504 504
---------- ---------- ---------- ----------
5,310 5,134 14,492 14,182
---------- ---------- ---------- ----------
Operating loss (6,647) (5,168) (15,900) (14,191)
---------- ---------- ---------- ----------
Other income (expense):
Interest expense (69) (13) (88) (786)
Interest income and other (31) 554 (9) 1,108
---------- ---------- ---------- ----------
(100) 541 (97) 322
---------- ---------- ---------- ----------
Net loss $ (6,747) $ (4,627) $ (15,997) $ (13,869)
========== ========== ========== ==========
Dividends on preferred stock -- -- -- 966
---------- ---------- ---------- ----------
Loss allocable to common stockholders $ (6,747) $ (4,627) $ (15,997) $ (14,835)
========== ========== ========== ==========
Basic and diluted loss per share $ (0.08) $ (0.05) $ (0.19) $ (0.18)
========== ========== ========== ==========
Weighted average number of common shares
outstanding (thousands) 86,689 85,615 86,242 82,358
========== ========== ========== ==========
See accompanying notes to consolidated condensed financial statements.
3
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Statements of Cash Flows
(Thousands of dollars)
Nine Months Ended
September 30,
--------------------------------
2001 2000
-------------- --------------
(unaudited)
Cash flows from operating activities:
Net loss $ (15,997) $ (13,869)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 973 3,130
Amortization of loan discount -- 426
Noncash operating expenses -- 628
Other 667 (638)
Changes in operating assets and liabilities:
Accounts receivable 3,630 (339)
Inventories (1,777) (5,468)
Assets held for sale 2,643 --
Other assets 277 90
Accounts payable and accrued liabilities (1,300) (672)
-------------- --------------
Net cash provided by operating activities (10,884) (16,712)
-------------- --------------
Cash flows from investing activities:
Proceeds from sale of assets 2,250 --
Investment in joint venture (1,250) --
Capital expenditures (321) (1,332)
Software development costs -- (713)
Investment and other 57 (574)
-------------- --------------
Net cash provided by investing activities 736 (2,619)
-------------- --------------
Cash flows from financing activities:
Proceeds from issuance of notes payable 4,750 400
Proceeds from issuance of common shares -- 42,642
Principal payments on notes payable -- (9,654)
Redemption of preferred stock -- (7,493)
Principal payments under capital lease obligations -- (11)
Proceeds from exercise of common stock warrants -- 5,180
Proceeds from exercise of employee stock options -- 950
Preferred stock dividends paid -- (966)
-------------- --------------
Net cash provided by financing activities 4,750 31,048
Net increase (decrease) in cash and cash equivalents (5,398) 11,717
Cash and cash equivalents, beginning of period 5,587 --
-------------- --------------
Cash and cash equivalents, end of period $ 189 $ 11,717
============== ==============
See accompanying notes to consolidated condensed financial statements.
4
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
September 30, 2001
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared
by the Company without audit in accordance with generally accepted accounting
principles for interim financial statements and with instructions to Form 10-Q
and Rule 10-01 of Regulation S-X. In the opinion of management, all adjustments
(consisting only of normal recurring accruals) considered necessary for a fair
presentation have been included.
The accompanying consolidated financial statements do not include
certain footnotes and financial presentations normally required under generally
accepted accounting principles and, therefore, should be read in conjunction
with the audited financial statements included in the Company's Annual Report on
Form 10-K as of December 31, 2000.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board approved for
issuance Statement of Financial Accounting Standards No. 141 (SFAS 141),
Business Combinations. This standard eliminates the pooling method of accounting
for business combinations initiated after June 30, 2001. In addition, SFAS 141
addresses the accounting for intangible assets and goodwill acquired in a
business combination. This portion of SFAS 141 is effective for business
combinations completed after June 30, 2001. The Company does not expect SFAS 141
to have a material effect on the Company's financial position or results of
operations.
In June 2001, the Financial Accounting Standards Board approved for
issuance Statement of Financial Accounting Standards No. 142 (SFAS 142),
Goodwill and Intangible Assets, which revises the accounting for purchased
goodwill and intangible assets. Under SFAS 142, goodwill and intangible assets
with indefinite lives will no longer be amortized, but will be tested for
impairment annually, and in the event of an impairment indicator. SFAS 142 is
effective for fiscal years beginning after December 15, 2001, with early
adoption permitted for companies with fiscal years beginning after March 15,
2001 if their first quarter financial statements have not been previously
issued. The Company expects that adoption of SFAS 142 will reduce operating
expenses by approximately $168,000 per quarter. The Company will adopt SFAS 142
on January 1, 2002.
In August 2001, the Financial Accounting Standards Board Issued
Statement of Financial Accounting Standards No. 144 (SFAS 144), Accounting for
Impairment or Disposal of Long-Lived Assets. SFAS 144 is effective for fiscal
years beginning after December 15, 2001. The Company does not believe that the
implementation of this standard will have any material effect on its financial
position, results of operations or cash flows.
5
INVENTORIES
The components of inventories are as follows:
September 30, December 31,
2001 2000
--------------- ---------------
($ Thousands)
Raw materials $ 3,129 $ 1,859
Work in progress 694 289
Finished goods 129 27
--------------- ---------------
$ 3,952 $ 2,175
=============== ===============
SEGMENTS OF BUSINESS
Net revenue by business segment:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- -------------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
($ Thousands)
Optical networking equipment $ 86 $ 746 $ 2,368 $ 5,214
Design services 229 2,050 2,960 5,238
Digital signal processor (DSP) 814 1,276 3,243 2,676
Other 25 90 260 648
------------ ------------ ------------ ------------
$ 1,154 $ 4,162 $ 8,831 $ 13,776
============ ============ ============ ============
Segment-specific margins (Gross profit less total engineering and
development costs, including capitalized software for the segment):
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- ---------------------------------
2001 2000 2001 2000
------------- ------------- ------------- -------------
($ Thousands)
Optical networking equipment $ (386) $ (1,776) $ (1,079) $ (4,427)
Design services (753) 334 (643) 459
Digital signal processor (DSP) (1,205) (324) (1,698) (643)
Other (269) (35) (2,021) (276)
------------- ------------- ------------- -------------
Subtotal segment specific (2,613) (1,801) (5,441) (4,887)
Capitalized software -- 178 -- 713
All other expenses (4,034) (3,545) (10,459) (10,017)
------------- ------------- ------------- -------------
Operating loss $ (6,647) $ (5,168) $ (15,900) $ (14,191)
============= ============= ============= =============
Assets identifiable only by combined segments:
At September 30, At December 31,
2001 2000
--------------- ---------------
($ Thousands)
Optical networking equipment and other $ 2,857 $ 8,902
Design services and DSP 8,663 8,450
Not allocable to a segment 464 6,652
------------- -------------
Total $ 11,984 $ 24,004
============= =============
6
SALE OF ASSETS
On August 30, 2001 the Company completed the sale of essentially all of
the assets related to the OmniLynx product line to Intelect Technologies, Inc.
("ITI"), which is a joint venture owned 33% by the Company and 67% by Singapore
Technologies Electronics, Ltd. These assets had previously been classified as
Assets Held For Sale and had been adjusted to their estimated net realizable
value of approximately $3,000,000 as of August 30, 2001. Pursuant to this
transaction the Company received a cash payment at closing and will receive
additional payments upon the utilization by ITI of inventory acquired from the
Company and further payments based on the financial position of ITI at certain
dates. The amounts due from ITI have been recorded at the carrying value of the
assets disposed of, less amounts received from ITI. Accordingly, no gain or loss
has been recorded as a result of this transaction. These amounts do not
necessarily reflect the full amounts which may ultimately be received by the
Company. In connection with the sale of the OmniLynx assets, the Company
recognized certain costs related to maintaining the assets until the sale and
the settlement of certain contractual obligations related to those assets.
Concurrently with the sale of the OmniLynx related assets the Company
contributed $1,250,000 to ITI related to its 33% equity interest in the company.
The Company has a minority equity interest in ITI, minority representation on
the board of directors and exercises no day to day control over its operations.
Accordingly, the Company intends to account for its investment in ITI under the
equity method of accounting. As of September 30, 2001 ITI had no material
results from operations.
FINANCING MATTERS
In June 2001 the Company entered into a loan agreement with Bank One,
N.A. The agreement provides for borrowings of up to $4,500,000 on a
non-revolving basis, which amount was fully drawn at September 30, 2001. Amounts
borrowed are to be repaid with the proceeds of certain asset sales with all
outstanding amounts due May 31, 2002. Interest is payable monthly at LIBOR plus
1.75% (5.25125% at September 30, 2001).
The bank facility is secured by letters of credit with an aggregate
face amount of $5,000,000, issued by certain individuals. Pursuant to this
arrangement the Company has entered into a Reimbursement Agreement with these
individuals. This agreement provides that the Company will reimburse the
individuals for any costs associated with the letters of credit, including any
amounts drawn under the letters of credit. The Company has issued to these
individuals warrants for the purchase of 1,200,000 shares of the Company's
common stock. These warrants have an exercise price of $0.75 per share and are
exercisable until May 31, 2004. In addition certain existing warrants for the
purchase of 800,000 shares of the Company's common stock were amended to provide
for an exercise price of $0.75 per share. These warrants had original exercise
prices ranging from $1.50 to $2.998 per share. The fair value of the new
warrants and the amendment to the existing warrants is $141,000 using the
Black-Scholes pricing model. This amount is being amortized over the term of the
loan and included in interest expense. The Company has agreed to grant to the
issuers of the letters of credit a security interest in certain accounts
receivable and inventory in the event the letters of credit are drawn to repay
the bank loan. The Company has also agreed not to pledge any of its assets and
not to incur any additional indebtedness in excess of $1,000,000 without the
prior consent of the issuers.
In September and October of 2001 the Company received advances of
$250,000 and $350,000, respectively, for working capital needs pursuant to a
series of short term notes with an individual. The notes are unsecured and bear
interest at 8% annually which is payable upon the maturity of the notes in
October of 2002.
7
In October 2001 the Company entered into a $1,500,000 revolving bank
credit facility. The facility is secured by the guarantee of an individual.
Amounts outstanding under the facility bear interest at prime, payable monthly.
Any outstanding borrowings are due May 31, 2002 with mandatory prepayments from
the proceeds of certain asset sales and certain other transactions. Pursuant to
this arrangement the Company has entered into a Reimbursement Agreement with
this individual. This agreement provides that the Company will reimburse the
individual for any costs associated with the guarantee. The Company has issued
to the individual warrants for the purchase of 360,000 shares of the Company's
common stock with an exercise price of $0.20 per share and 600,000 warrants with
an exercise price of $0.80 per share. These warrants are exercisable until May
31, 2004. The Company has agreed to grant to the guarantor a security interest
in certain accounts receivable and inventory in the event amounts are drawn
pursuant to the guarantee.
CONTINGENCIES
The insurance carrier, which provides the primary $2 million of
insurance coverage for the shareholder class action lawsuit, United Pacific
Insurance Company, an affiliate of Reliance Insurance Company, has been ordered
liquidated by the insurance commissioner of the state of Pennsylvania. At this
time the Company is unable to determine what amounts, if any, may be available
related to this insurance coverage or what amounts, if any, may be available
from guarantee funds maintained by the insurance commissioner of the state of
Texas. Should the Company not have the full benefit of this coverage it could
have a material adverse impact on the Company.
8
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENT
This Form 10-Q contains certain 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. These forward looking
statements include information about possible or assumed future results of our
operations. Also, when we use any of the words "believes," "expects," "intends,"
"anticipates," or similar expressions, we are making forward looking statements.
Examples of types of forward looking statements include statements on future
levels of net revenue and cash flow, new product development and strategic plans
and benefits. The forward looking statements involve risks and uncertainties
that could cause actual results to differ materially from those expressed in, or
implied by, the forward looking statements. Factors that might cause such a
difference include, but are not limited to, those relating to: general economic
conditions in the markets in which the Company operates; success in the
development and market acceptance of new and existing products; dependence on
suppliers, third party manufacturers and channels of distribution; customer and
product concentration; fluctuations in customer demand; the ability to obtain
and maintain access to external sources of capital; the ability to execute
management's margin improvement and cost control plans; overall management of
the Company's strategic repositioning; and other risk factors detailed from time
to time in the Company's filings with the Securities and Exchange Commission.
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COMPARISON OF THIRD QUARTER AND NINE MONTHS 2001 TO 2000
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The following table shows the revenue and gross profit for the
Company's products:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
($ Thousands)
Net revenue:
Optical networking equipment $ 86 $ 746 $ 2,368 $ 5,214
Design services 229 2,050 2,960 5,238
Digital signal processors (DSP) 814 1,276 3,243 2,676
Other 25 90 260 648
------------ ------------ ------------ ------------
$ 1,154 $ 4,162 $ 8,831 $ 13,776
============ ============ ============ ============
Gross profit (loss):
Optical networking equipment $ -- $ (567) $ -- $ (782)
Design services (752) 335 (642) 460
Digital signal processors (DSP) (547) 226 (36) 563
Other (38) (28) (730) (250)
------------ ------------ ------------ ------------
$ (1,337) $ (34) $ (1,408) $ (9)
============ ============ ============ ============
NET REVENUE
Net revenue from optical networking equipment relates almost
exclusively to the OmniLynx product line. In August 2001 the Company completed a
transaction whereby essentially all of the assets related to the OmniLynx
product line were sold to a newly formed entity, Intelect Technologies, Inc.
("ITI"), which is a joint venture owned 33% by the Company and 67% by Singapore
Technologies Electronics, Ltd. Prior to this transaction being completed the
Company had
9
significantly curtailed the operations related to OmniLynx, which resulted in
significantly lower revenues in the three and nine month periods ended September
30, 2001 as compared to the comparable periods of 2000. Intelect Technologies,
Inc. did not have material activity through September 30, 2001.
Revenues from design services declined significantly during the three
months ended September 30, 2001. The dramatic downturn in the telecommunications
industry experienced in recent months has caused the demand for engineering
design services to decline as customers have delayed or cancelled development
projects. The Company has seen indications of an increase in demand for such
services; however, uncertainty over the state of the United States economy and
the general uncertainty brought about by the events of September 11, 2001 may
disrupt any such recovery. At this time management is uncertain as to the timing
and the extent of the recovery in the demand for the Company's design services,
especially as they relate to the telecommunications industry. Management is
currently involved in a series of discussions with potential strategic partners
for the long-term utilization of the Company's design services. The ultimate
outcome of these discussions cannot be determined at this time.
During the quarter ended September 30, 2001 the Company experienced
what management believes is a temporary decline in revenue related to sales of
its digital signal processor ("DSP") products. While a portion of the Company's
historical business has been related to the telecommunications industry, the
majority of on-going business opportunities relate to the sale of products which
are utilized in the defense electronics industry. Prior to September 11, 2001
funding for various new defense and intelligence related programs had been
delayed pending the Bush administration's reassessment of the military and its
priorities. This situation resulted in delays in new orders throughout the
industry. The events of September 11, 2001 temporarily added to these delays and
exacerbated scheduling, production and shipping difficulties.
Based on subsequent developments and activity in the early part of the
fourth quarter of 2001, management expects shipments and the resulting revenue
related to DSP products to increase sequentially in the fourth quarter of 2001.
The Company's DSP products, including those based on Texas Instruments' digital
signal processors and those based on the PowerPC processor, can be and are
utilized in a variety of defense and intelligence gathering applications. These
applications include airborne surveillance, radar processing, laser targeting,
missile systems, "smart" munitions, as well as other applications requiring
high-density computing platforms. Recently the Company has seen an increase in
activity regarding its defense electronics business. However, the magnitude and
timing of the impact of this activity on the Company's revenue and results of
operations cannot be determined at this time.
GROSS PROFIT
As of December 31, 2000 all assets related to the OmniLynx product line
were adjusted to the lower of cost and net realizable value. Accordingly, sales
of these products during 2001 produced no gross profit.
In the three and nine month periods ended September 30, 2001 the
Company's design services operations produced a gross loss of $752,000 and
$642,000 respectively, as compared to gross profits in the comparable periods in
2000. These losses reflect the cost of the Company's staff of design engineers
while revenues from such operations have declined substantially as discussed
above.
The Company's DSP product operations reflect a gross loss of $547,000
for the third quarter of 2001 and $36,000 for the first nine months of 2001.
These amounts reflect a charge of approximately $500,000 related to the
adjustment in the carrying value of inventories. This charge resulted from an
10
evaluation of current component costs and the adjustment of certain finished
goods and work in progress to estimated net realizable value. Absent this charge
the gross profit in the 2001 periods declined as a percentage of sales as
compared to the comparable periods in 2000 due to certain fixed costs which have
been put in place related to higher sales volumes experienced earlier in 2001
and which management expects in future periods.
Other gross loss for the nine month periods ended September 30, 2001
and 2000 include amounts related to production facilities associated with the
OmniLynx product line which was sold in August 2001.
ENGINEERING AND DEVELOPMENT (E&D) EXPENSE
Engineering and development costs decreased $314,000 in the third
quarter of 2001 as compared to the same period in 2000. For the nine months
ended September 30, 2001, engineering and development costs were $132,000 lower
than in the comparable period last year. Engineering and development costs by
product line are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
($ Thousands)
Optical networking equipment $ 385 $ 1,032 $ 1,078 $ 2,932
Digital signal processor (DSP) 658 551 1,662 1,207
Other 233 7 1,293 26
------------ ------------ ------------ ------------
E & D expense $ 1,276 $ 1,590 $ 4,033 $ 4,165
============ ============ ============ ============
Costs related to optical networking products in 2001 represent on-going
development activities associated with the Aegean product line, which is
currently under development. Engineering activities related to DSP products
during the third quarter and the first nine months of 2001 were primarily
associated with the four processor or "quad" version of the PowerPC processor
base line of products. Other engineering and development costs in the first nine
months of 2001 include $622,000 of on-going developmental activities associated
with the Centauri product line and $671,000 of costs related to the engineering
organization involved with the OmniLynx product line. In connection with the
curtailment of the OmniLynx operations, on-going development activities were
halted in the first quarter of 2001. The Company has not incurred material
engineering costs associated with the OmniLynx product line subsequent to the
first quarter of 2001.
SELLING AND ADMINISTRATIVE EXPENSE
Selling and administrative expenses decreased $1,080,000, (32%) in the
third quarter of 2001 as compared to the same quarter last year. For the nine
months ended September 30, 2001, selling and administrative expenses declined
$1,128,000, (12%) versus the comparable period last year. Selling and
administrative expenses associated with the OmniLynx product line have been
eliminated as of August 30, 2001. This decline has been offset, in part, by
increased selling and support activities related to the Company's DSP business.
COSTS RELATED TO SALE OF ASSETS
In connection with the sale of the OmniLynx related assets in the third
quarter of 2001 the Company recorded a charge of $1,570,000. This amount
includes costs associated with maintaining the assets until the sale and costs
associated with the settlement of certain obligations related to those assets.
11
INTEREST EXPENSE
Interest expense for the third quarter and first nine months of 2001
relates primarily to the credit agreement entered into in June of 2001. Such
expense for the nine months ended September 30, 2000 includes amounts related to
a credit agreement, which was repaid in March of 2000. The Company expects to
have higher interest expense for the balance of 2001 due to increased borrowings
for working capital.
DIVIDENDS ON PREFERRED STOCK
Preferred stock dividends of $966,000 in the first half of 2000
represent accrued dividends and a 10% redemption premium paid to effect the
redemption of the Company's Series A Preferred Stock in March of 2000.
Subsequent to this redemption the Company has no preferred stock outstanding.
--------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
--------------------------------------------------------------------------------
As of September 30, 2001 the Company had cash and temporary investments
of $242,000, and a working capital deficit of $1,716,000. For the nine months
ended September 30, 2001 earnings before interest, taxes, depreciation and
amortization ("EBITDA") was approximately negative $14,927,000.
During the first nine months of 2001 accounts receivable decreased by
$3,630,000 in large part due to collections related to the operations of
Intelect Network Technologies. During this same period assets held for sale
decreased by $4,893,000, reflecting the sale of these assets. As of September
30, 2001 inventories increased $1,777,000 from levels at December 31, 2000
reflecting an increase in components and work in progress related to the
Company's DSP products activities.
As of September 30, 2001 the Company had funded debt of $4,850,000
consisting of a $4,500,000 bank loan agreement entered into in June of 2001 and
short-term notes payable. The bank loan agreement matures on May 31, 2002 and is
repayable from the proceeds of certain assets sales. This facility is
non-revolving in that amounts cannot be repaid and then re-borrowed. Interest is
payable monthly at LIBOR plus 1.75%, which amounted to 5.25125% at September 30,
2001. The bank agreement is secured by letters of credit with an aggregate face
amount of $5,000,000 issued by certain individuals. In connection with this
agreement the Company has entered into a Reimbursement Agreement with those
individuals. Pursuant to this agreement the Company has agreed to reimburse the
individuals for any costs associated with the letters of credit including any
amounts drawn against them. The Company has agreed to grant to the issuers of
the letters of credit a security interest in certain accounts receivable and
inventory in the event the letters of credit are drawn to repay the bank loan.
The Company has also agreed not to pledge any of its assets and not to incur any
additional indebtedness in excess of $1,000,000 without the prior consent of the
issuers.
In October 2001 the Company entered into a $1,500,000 revolving bank
credit agreement which is secured by the guarantee of an individual. Amounts
outstanding under this facility are due May 31, 2002 and are repayable from the
proceeds of the sale of certain assets or the settlement of certain litigation.
As of October 31, 2001 the Company had received advances of $800,000 under this
facility.
OPERATING ACTIVITIES
Net cash used in operations for the nine months ended September 30,
2001 consisted of the $15,997,000 net loss, offset by $1,640,000 of non-cash
charges and a net decrease of $3,473,000 in other
12
operating assets and liabilities. The non-cash charges were primarily
depreciation and amortization of intangible assets and amortization of deferred
financing costs. Approximately $5,500,000 of the Company's operating loss in the
first nine months of 2001 related to the operations associated with the OmniLynx
product line. Substantially all of the assets related to these operations were
sold effective August 30, 2001. Accordingly, the majority of the costs
associated with these operations have been eliminated.
INVESTING ACTIVITIES
Cash provided and used in investing activities during the first nine
months of 2001, consisted primarily of $321,000 for fixed asset additions and
amounts related to the sale of OmniLynx assets and the investment in ITI.
LIQUIDITY OUTLOOK
Management has taken steps during the first nine months of 2001 to
reduce its operating losses and position the Company to produce positive cash
flow from operations. Among these steps has been the sale of the assets related
to the OmniLynx product line and the elimination of essentially all costs
related to those operations. As discussed above, the dramatic downturn in the
telecommunications industry, uncertainty concerning general economic conditions
and the effects from the events of September 11, 2001 have caused revenues from
the Company's design services operations and, to a lesser extent, DSP products
business to be less than would have otherwise been expected. In addition, the
environment discussed above has made the process for obtaining third party
financing for the Company's new product initiatives, Aegean Networks and
Centauri NetSystems, difficult and more time consuming than might otherwise have
been expected. Therefore the Company has continued to generate operating losses,
despite the efforts to reduce these losses. These losses have been funded by the
liquidation of existing working capital, including amounts related to the
OmniLynx product line, and by the proceeds from short-term borrowings.
As stated above the Company has seen indications of an improvement in
the demand for design services, and activity related to its DSP products has
been increasing recently. However, there can be no assurance as to the magnitude
or the timing of any increases in the Company's revenues from such operations.
Should such increases not develop within a reasonable period of time the Company
may be forced to sell certain assets or to significantly curtail certain of
these operations. Furthermore, should third party capital or other means of
financing the on-going development of the Company's new product initiatives not
be found, or not be available on terms which the Company finds acceptable, the
Company may find it necessary to suspend certain of these activities.
Until such time as the Company's operations begin to generate positive
cash flow, the Company will likely be dependent upon outside sources of capital.
These sources include short-term credit arrangements with commercial banks or
others, such as those recently entered into by the Company, the sale of debt or
equity securities and proceeds from the sale of certain assets. There can be no
assurance that such amounts will be available when needed by the Company or that
they will be available in sufficient amounts or under terms which the Company
finds acceptable. If the Company is unable to gain access to such capital it may
be forced to sell additional assets or to further curtail operations.
CONTINGENT LIABILITIES
As discussed in "ITEM 3 - Legal Proceedings" in the Company's Annual
Report on Form 10-K, the Company is exposed to certain contingent liabilities
which, if resolved adversely to the Company, would adversely affect its
liquidity, its results of operations, and/or its financial position.
13
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board approved for
issuance Statement of Financial Accounting Standards No. 141 (SFAS 141),
Business Combinations. This standard eliminates the pooling method of accounting
for business combinations initiated after June 30, 2001. In addition, SFAS 141
addresses the accounting for intangible assets and goodwill acquired in a
business combination. This portion of SFAS 141 is effective for business
combinations completed after June 30, 2001. The Company does not expect SFAS 141
to have a material effect on the Company's financial position or results of
operations.
In June 2001, the Financial Accounting Standards Board approved for
issuance Statement of Financial Accounting Standards No. 142 (SFAS 142),
Goodwill and Intangible Assets, which revises the accounting for purchased
goodwill and intangible assets. Under SFAS 142, goodwill and intangible assets
with indefinite lives will no longer be amortized, but will be tested for
impairment annually, and in the event of an impairment indicator. SFAS 142 is
effective for fiscal years beginning after December 15, 2001, with early
adoption permitted for companies with fiscal years beginning after March 15,
2001 if their first quarter financial statements have not been previously
issued. The Company expects that adoption of SFAS 142 will reduce operating
expenses by approximately $168,000 per quarter. The Company will adopt SFAS 142
on January 1, 2002.
In August 2001, the Financial Accounting Standards Board Issued
Statement of Financial Accounting Standards No. 144 (SFAS 144), Accounting for
Impairment or Disposal of Long-Lived Assets. SFAS 144 is effective for fiscal
years beginning after December 15, 2001. The Company does not believe that the
implementation of this standard will have any material effect on its financial
position, results of operations or cash flows.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's bank loan agreement bears interest at a variable rate,
LIBOR plus 1.75%. A 100 basis point increase in LIBOR would result in an
increase in interest expense of approximately $11,250 per quarter, assuming the
full amount of the $4,500,000 facility was outstanding for the entire period.
14
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
Shareholder Class Action. A shareholders class action lawsuit was filed
on November 16, 1999 in the U. S. District Court for the Northern District of
Texas purported to have been filed on behalf of all persons and entities who
purchased the Company's common stock during the period between February 24, 1998
and November 17, 1998. The named defendants include the Company and certain
former and present officers and directors of the Company. The complaint alleges
that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934 and Rule 10b-5 promulgated thereunder by making false and misleading
statements concerning the Company's reported financial results during the
period, primarily relating to revenue recognition, asset impairment and
capitalization issues. The plaintiffs seek unspecified monetary damages,
interest, costs and expenses. In March 2001, the Company's motion to dismiss the
suit was denied and preliminary discovery has begun in the case. The court has
set a preliminary date for trial of April 7, 2003. The Company believes the case
is without merit and intends to defend the suit vigorously in all aspects.
The insurance carrier, which provides the primary $2 million of
insurance coverage for this matter, United Pacific Insurance Company, an
affiliate of Reliance Insurance Company, has been ordered liquidated by the
insurance commissioner of the state of Pennsylvania. At this time the Company is
unable to determine what amounts, if any, may be available related to this
insurance coverage or what amounts, if any, may be available from guarantee
funds maintained by the insurance commissioner of the state of Texas. Should the
Company not have the full benefit of this coverage it could have a material
adverse impact on the Company.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
A. Listed below are all Exhibits filed as part of this report.
Exhibit No. Exhibit
----------- -------
4.1 Form of Promissory Note dated October 12, 2001 in favor of
Bank One, N.A.
4.2 Form of Warrant in favor of Oscar S. Wyatt, Jr., with an
exercise price of $0.20 per share expiring on May 31, 2004
4.3 Form of Warrant in favor of Oscar S. Wyatt, Jr., with an
exercise price of $0.80 per share expiring on May 31, 2004
4.4 Promissory Note dated October 5, 2001
4.5 Promissory Note dated October 12, 2001
10.1 Loan Agreement, dated October 12, 2001 between the Company and
Bank One, N.A.
10.2 Reimbursement Agreement dated October 12, 2001 between the
Company and Oscar S. Wyatt, Jr.
B. The Company has not filed any report on Form 8-K during the period
covered by this Report, except as follows:
Form 8-K, dated August 30, 2001, as amended, reporting under Item 2
the Company's position of certain assets and filing various exhibits
and financial statements under Item 7.
15
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
TERAFORCE TECHNOLOGY CORPORATION
(Registrant)
Date: November 14, 2001 By: /s/ ROBERT P. CAPPS
Robert P. Capps
-------------------------------------------------
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: November 14, 2001 By: /s/ HERMAN M. FRIETSCH
-------------------------------------------------
Herman M. Frietsch
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
16
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
4.1 Form of Promissory Note dated October 12, 2001 in favor of
Bank One, N.A.
4.2 Form of Warrant in favor of Oscar S. Wyatt, Jr., with an
exercise price of $0.20 per share expiring on May 31, 2004
4.3 Form of Warrant in favor of Oscar S. Wyatt, Jr., with an
exercise price of $0.80 per share expiring on May 31, 2004
4.4 Promissory Note dated October 5, 2001
4.5 Promissory Note dated October 12, 2001
10.1 Loan Agreement, dated October 12, 2001 between the Company and
Bank One, N.A.
10.2 Reimbursement Agreement dated October 12, 2001 between the
Company and Oscar S. Wyatt, Jr.