UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10 - K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 2002
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 E. CAMPBELL, RICHARDSON, TEXAS
75081
(Address of Principal Executive Offices and Zip Code)
469-330-4960
(Registrant's Telephone Number, Including Area Code)
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Securities Registered Pursuant to Section 12 (b) of the Act
NONE
Securities Registered Pursuant to Section 12 (g) of the Act
COMMON STOCK PAR VALUE $0.01 PER SHARE
(Title of Class)
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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities and Exchange Act of 1934). Yes No X
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The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $19,872,133 as of June 28, 2002 (based upon the
average of the highest bid and lowest asked prices on such date as reported on
the OTC Bulletin Board). All directors, officers and 5% or greater shareholders
are presumed to be affiliates for purposes of this calculation.
There were 118,422,183 shares of Common Stock outstanding as of March 31, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
None
TABLE OF CONTENTS
Section Page Number
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ITEM 1 - Business 3
ITEM 2 - Properties 16
ITEM 3 - Legal Proceedings 16
ITEM 4 - Submission of Matters to a Vote of Security Holders 17
ITEM 5 - Markets for Registrant's Common Equity and Related
Stockholder Matters 18
ITEM 6 - Selected Financial Data 19
ITEM 7 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 20
ITEM 7A - Quantitative and Qualitative Disclosures About Market Risk 29
ITEM 8 - Financial Statements and Supplementary Data 30
ITEM 9 - Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure 56
ITEM 10 - Directors and Executive Management of the Registrant 56
ITEM 11 - Executive Compensation 57
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management 62
ITEM 13 - Certain Relationships and Related Transactions 64
ITEM 14 - Controls and Procedures 65
ITEM 15 - Exhibits, Financial Statement Schedules and Reports on Form 8-K 65
2
PART I
ITEM 1 - BUSINESS
FORWARD-LOOKING STATEMENT
The statements in this Annual Report on Form 10K of TeraForce
Technology Corporation (the "Company") regarding future financial and operating
performance and results, and other statements that are not historical facts, are
forward-looking statements, as defined in Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. We use the words "may," "expect," "anticipate," "believe," "continue,"
"estimate," "project," "intend," "designed" or other similar expressions to
identify forward-looking statements. You should read statements that contain
such words carefully because they discuss future expectations, contain
projections of results of operations or of our financial condition, and/or state
other "forward-looking" information. These statements also involve risks and
uncertainties, including, but not limited to:
o events, conditions and financial trends that may affect the Company's
future plans and business strategy,
o results of expectations and estimates as to prospective events, and
o circumstances about which the Company can give no firm assurance.
Examples of types of forward-looking statements include statements on
future levels of net revenue and cash flow, new product development, strategic
plans and financing. These forward-looking statements involve risks and
uncertainties that could cause actual results to differ materially from those
projected or anticipated. Factors that might cause a difference include, but are
not limited to:
o general economic conditions in the markets the Company operates in;
o success in the development and market acceptance of new and existing
products;
o dependence on suppliers, third party manufacturers and channels of
distribution;
o customer and product concentration;
o fluctuations in customer demand;
o the ability to obtain and maintain access to external sources of
capital;
o the ability to control costs;
o overall management of the Company's expansion; and
o other risk factors detailed from time to time in the Company's filings
with the Securities and Exchange Commission.
We believe it is important to communicate our expectations of future
performance to our investors. However, events may occur in the future that we
are unable to accurately predict, or that we cannot control. Any forward-looking
statement speaks only as of the date the statement was made, and the Company
undertakes no obligation to update any forward-looking statement to reflect
events or circumstances after the date the statement was made. Because it is not
possible to predict every new factor that may emerge, forward-looking statements
should not be relied upon as a prediction of actual future financial condition
or results. When considering our forward-looking statements, keep in mind the
risk factors and other cautionary statements in this Annual Report on Form 10-K.
The risk factors noted in this section and other factors noted throughout this
prospectus provide examples of risks, uncertainties and events that may cause
our actual results to differ materially from those contained in any
forward-looking statement. If one or more of these risks or uncertainties
materialize, or if underlying assumptions prove incorrect, actual outcomes may
vary materially from those forward-looking statements included in this Annual
Report on Form 10-K. The terms "we," "our" and "us" and similar terms refer to
the Company and its consolidated subsidiaries, not to any individual or group of
individuals.
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OVERVIEW
TeraForce Technology Corporation, through its wholly-owned subsidiary,
DNA Computing Solutions, Inc. ("DNA-CS"), designs, develops, produces and sells
high-density, high-capacity embedded computing platforms and systems. Embedded
computing generally refers to the physical integration of computing nodes
(microprocessor and memory) into a host system or application. These nodes are
often deployed in arrays. Embedded computing platforms and systems are widely
applied in a number of industries including communications, medical imaging,
seismic processing, industrial control and defense electronics. Although we have
sold these products into a number of these industries, our primary focus is in
defense electronics; therefore, we refer to this as our Defense Electronics
Business. Prior to 2001 this business was referred to as the digital signal
processor ("DSP") business. In 2002, all of our net revenues related to the
defense electronics business.
Prior to 2002, we were also involved in providing design engineering
services through a wholly-owned subsidiary, DNA Enterprises, Inc. ("DNA"), and
in designing and producing telecommunications equipment through other
wholly-owned subsidiaries. (See Item 1- Business- Prior Operations.)
PRODUCTS
Embedded computing products, such as ours, are used for applications in
which there is a need for high-density and high-capacity computing, especially
in environments where limiting space, weight and power consumption are important
considerations. Examples of defense and intelligence gathering applications that
utilize embedded computing products include the following:
o Airborne radar o Ground based radar
o Signal intelligence o Image processing
o Unmanned aerial vehicles (UAV's) o Smart munitions
o Automated fire control o Battlefield control
o Airborne surveillance o Satellite communications
o Electronic countermeasures o Infrared search and tracking
o Ship based radar o Ship based sonar
o Submarine based sonar o Missile interception
Our products are organized in the following broad categories:
DSP Products - DSP products consist of single-board computers utilizing
digital signal processors produced by Texas Instruments Inc. These products are
produced in versions with one, two or four digital signal processors per board.
The boards include both VME and PCI versions, which are industry standard terms
and describe the manner in which electronic systems interconnect.
PowerPC Single Board Computers - PowerPC Single Board Computers
products are VME single board computers with one, two or four processors per
board. The microprocessors used in these products are the Motorola PowerPC(C)
line of reduced instruction set or "RISC" processors. We also sell "ruggedized"
versions of these products. "Ruggedized" products have been mechanically
modified to withstand harsh operating environments such as temperature, shock
and vibration.
Embedded Sub-Systems - Embedded Sub-Systems are products that comprise
an entire element of a larger system. These elements may include a number of
single board computers, deployed in arrays, as well as other system components
and enclosures. We have developed a new product that we call Eagle to be used as
an element in embedded sub-systems. Eagle is based on the Company's Matched
Heterogeneous Array Topology ("MHAT") technology. We anticipate that the Eagle
product will be available to customers in 2003.
WingSpan(TM) Software Suite - WingSpan is "midware" that we provide
with our products in order to enhance functionality and to facilitate the
customer's development process. WingSpan is a suite of software that includes
(a) a board support package to facilitate testing and integration into the
operating system, (b) a
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library of commonly used algorithms that have been optimized for our products
and (c) tools to facilitate the development of application software or the
porting of existing software to our products. We do not sell WingSpan separately
from our hardware products. We do not supply the application software to be
utilized on our products. The application software is generally designed to
operate under certain commercially available operating systems, most often VX
Works or Linux. Our products are generally offered in versions that will support
either of these two operating systems, as well as certain others.
As of March 31, 2003, our backlog of orders for defense electronic
products amounted to approximately $3,200,000, as compared to approximately
$500,000 at March 31, 2002. Included in backlog are orders for products for
which we have received a purchase order or similar commitment from the customer.
Generally, purchase orders are received for products that are to ship within a
relatively short period of time, usually 60 days or less. Of the backlog at
March 31, 2003, approximately $1,000,000 is not expected to ship during 2003 due
to the customer's required delivery schedule. We consider the backlog to be an
indicator, but not the sole predictor, of future revenue. A variety of
conditions, both specific to the individual customer and generally affecting the
customer's industry, may cause our customers to cancel, reduce or delay orders
that were previously made or anticipated. We cannot assure the timely
replacement of canceled, delayed or reduced orders. Significant or numerous
cancellations, reductions or delays in orders by a customer or group of
customers could materially adversely affect our business, financial condition
and results of operations. Our backlog alone should not be relied upon as
indicative of our revenues for any future period.
MARKETS AND CUSTOMERS
Our customers are generally large prime defense contractors and
subcontractors to the prime defense contractors. We also sell directly to
governmental agencies and to value added resellers who combine our products with
other system components for re-sale to the prime or subcontractors. Certain of
our DSP products are sold through an OEM arrangement with a reseller. Sales to
this reseller amounted to approximately 37% of consolidated net revenues for the
year ended December 31, 2002.
Our sales and marketing activities are directed by in-house sales
managers and we utilize a network of manufacturer's representatives in the
United States. Most international sales prospects are handled through a U.K.
based value added reseller. International sales have not been material to date.
The selection by a customer of our products for use in a particular
system or program is referred to as a "design win." The sales cycle leading to a
design win will often take a long time. We will usually provide a customer with
a demonstration unit that they may evaluate and test. After the evaluation
period ends, the customer will either return the unit or purchase it. If the
potential customer determines that the initial evaluation is satisfactory, the
customer will often purchase a limited number of units to use in the design,
development and testing of the customer's larger system.
Even after a customer has elected to purchase our product, the customer
will not usually purchase a significant number of units immediately. Although
the production phase of a particular program may last several years and
ultimately involve a significant number of units, the customer will usually only
purchase the units it will need for a short period of time. At this stage, there
are still a number of factors that will determine whether the customer purchases
a significant number of products, and when these products are purchased. These
factors include:
o the suitability of our products for a particular application,
including performance and cost issues;
o the technical performance of the final system;
o the customer's ability to fund the final system;
o the performance of the customer's other suppliers for the
final system; and
o the overall development and integration of the system by the
customer.
Sales are typically not made under long-term contracts, but instead are
made under purchase orders.
5
Historically, products similar to ours were often developed internally
by the large defense contractors. However, beginning about eight years ago the
Department of Defense implemented a program to force the contractors to utilize
commercial off the shelf ("COTS") components wherever possible. This has fueled
the growth in the Company's markets, and we anticipate that the growth will
continue. We expect the growth in the COTS market to continue as legacy systems
that were developed years ago are upgraded or replaced with systems with
significant COTS content.
COMPETITION
The market for our products is highly competitive and is characterized
by rapidly changing technology and frequent product performance improvements.
The market for our products in the defense electronics market is characterized
by a number of competitors. These include Mercury Computer Systems, Inc.,
Radstone Technology, PLC, CSPI Multi Computer Division of CSP Inc., and DY4
Systems, a Force Computer business unit. Our competitors also include in-house
design teams of large defense contractors. However, competition from in-house
design teams has diminished in recent years because of the increased use of COTS
products and the trend toward greater use of outsourcing. Despite this recent
change, there can be no assurance that in house developments will not return as
a major competitive force in the future. Increased use of in-house design teams
by defense contractors may have a material adverse effect on our business,
financial condition and results of operations.
All of the large defense contractors and majority of our other
competitors, have substantially greater research and development resources,
guaranteed long term supply capacity, marketing and financial resources,
manufacturing capability and customer support organizations than we have. We
believe our future ability to compete effectively will partially depend upon our
ability to continue to improve product and process technologies, to develop new
technologies that demonstrate performance advantages over our competitors, to
adapt products and processes to changes in technology, to identify and adopt
emerging industry standards and to adapt to our customer needs.
Most of our competitors have greater financial and other resources than
we have. We may be operating at a cost disadvantage compared to those
manufacturers who have greater direct buying power from component suppliers or
who have lower cost structures. There can be no assurance that we will be able
to compete successfully in the future with any of these competitors. In
addition, there can be no assurance that competitive pressures will not result
in price erosion, reduced margins, loss of market share or other factors that
could have a material adverse effect on our business, financial condition and
results of operations.
MANUFACTURING
We use third party electronic manufacturing service ("EMS") providers
to manufacture our products. Generally, we will acquire the components necessary
for the manufacture of the product and provide the components to the EMS
provider for assembly and initial testing. Completed units are normally then
delivered to our facility in Richardson, Texas for final testing and shipment.
Recently, we have shifted more of the product testing to the EMS providers. We
expect to rely more on the EMS provider for product testing. We expect that
moving the initial product testing to the EMS provider will allow us to use our
existing operations infrastructure to produce higher sales volumes. We also
expect that as production volumes increase and can be more accurately predicted,
the EMS providers will also buy many of the components required for our
products, which will allow us to use our resources in other ways.
We usually use a particular EMS provider for a specific product family.
A number of EMS providers are capable of producing our products; however,
switching from one provider to another involves significant costs and risks
related to product quality and timing.
Components are usually available from multiple sources. However, items
such as processors and memory chips may be available from limited or sole
sources. Historically, we have had to order some components a significant time
in advance of the date we plan to use the components. Sometimes components may
be discontinued by the manufacturer, requiring us to acquire a substantial
supply or to alter our product design. These design changes can result in the
obsolescence of other components in our inventory.
6
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
We believe we have a substantial base of intellectual property,
including software and hardware. We believe that factors such as technological
and creative skills of our personnel, new product developments, frequent product
enhancements, name recognition, and reliable product manufacturing are essential
to establishing and maintaining a technology leadership position.
We rely on a combination of patent, copyright, trademark and trade
secret laws to establish and protect our products' proprietary rights. In
addition, we currently require our employees and consultants to enter into
nondisclosure and assignment of invention agreements to limit the use of, access
to and distribution of, proprietary information. There can be no assurance that
our means of protecting our proprietary rights in the U.S. or abroad will be
adequate. The laws of some foreign countries may not protect our proprietary
rights as fully or in the same manner as do the laws of the U.S. Also, despite
the steps we take to protect our proprietary rights, it may be possible for
unauthorized third parties to copy or reverse engineer aspects of our products,
develop similar technology independently or otherwise obtain and use information
that we regard as proprietary. There can be no assurance that others will not
develop technologies similar or superior to our technology or design around the
proprietary rights we own.
Although we are not aware that our products infringe on the proprietary
rights of third parties, there can be no assurance that others will not assert
claims of infringement in the future or that, if made, such claims will not be
successful. We may seek to obtain a license under a third party's intellectual
property rights. There can be no assurance that a license will be available
under reasonable terms or that a license will be available at all.
Litigation to determine the validity of any claims against the Company,
whether or not such litigation is determined in favor of the Company, could
result in significant expense to us and divert the efforts of our technical and
management personnel from daily operations. In the event of any adverse ruling
in any litigation regarding intellectual property, we may be required to pay
substantial damages, discontinue the sale of infringing products, expend
significant resources to develop non-infringing technology or obtain licenses to
use infringing or substituted technology. The failure to develop, or license on
acceptable terms, a substitute technology could have a material adverse effect
on our business, financial condition and results of operations.
Litigation may also be necessary to enforce our patents and other
intellectual property rights, to protect our trade secrets, and to determine the
validity of and scope of the proprietary rights of others. Such litigation could
result in substantial costs and diversion of resources and could have a material
adverse effect on our business, financial condition or results of operations.
We currently hold 11 United States patents relating to
telecommunications and computing technology and have 18 currently pending
patents relating to telecommunications and computing technology. We seek to
protect our software, documentation and other written materials under trade
secret and copyright laws, which afford only limited protection. Patent
positions frequently are uncertain and involve complex and evolving legal and
factual questions. The coverage sought in a patent application may be denied or
significantly reduced before or after the patent is issued. There can be no
assurance that:
o any patents from pending patent applications or from any
future patent application will be issued,
o the scope of any patent protection will exclude competitors or
provide competitive advantages to us,
o any of our patents will be held valid if subsequently
challenged, or
o others will not claim rights in or ownership of the patents
and other proprietary rights held by us.
7
Because patent applications are confidential until patents are issued
in the United States or corresponding applications are published in other
countries, and because publication of discoveries in the scientific or patent
literature often lags behind actual discoveries, we cannot be certain that we
were the first to make the inventions covered by each of our pending patent
applications or that we were the first to file patent applications for such
inventions. In addition, there can be no assurance that competitors, many of
which have substantial resources and have made substantial investments in
competing technologies, will not seek to apply for and obtain patents that will
prevent, limit or interfere with our ability to make, use or sell our products
either in the United States or in international markets.
EMPLOYEES
As of March 31, 2003 we had 48 full-time employees, of which fifteen
were engaged in engineering and development, 11 were engaged in sales,
marketing, and customer support, 11 were engaged in manufacturing operations,
and 11 were engaged in administration and finance. None of our employees are
represented by a labor organization. We have experienced no material work
stoppages and believe we have a good relationship with our employees.
PRIOR OPERATIONS
Our name was changed to TeraForce Technology Corporation on January 30,
2001, upon approval by its stockholders, from Intelect Communications, Inc. The
Company was incorporated in Delaware on May 23, 1995. Its predecessor, Intelect
Communications Systems Limited ("Intelect (Bermuda)") was incorporated under the
laws of Bermuda in April 1980 and operated under the name Coastal International,
Ltd. until September 1985 and as Challenger International Ltd. until December
1995. On December 4, 1997, the shareholders of Intelect (Bermuda) approved a
merger proposal that reincorporated Intelect (Bermuda) to Delaware and resulted
in Intelect (Bermuda) becoming a publicly traded corporation. The merger was
effected on December 4, 1997.
Engineering Design Services
Our engineering design services business was conducted through DNA. a
20-year old engineering design services organization located in Richardson,
Texas that we acquired in 1996. Over its history DNA provided high-end
engineering design services to both established companies and start-up
organizations, primarily related to the telecommunications industry. During the
course of 2001, DNA experienced a significant decline in the demand for its
services. This was caused by the continued down-turn and uncertainty in the
telecommunications business and the financing difficulties experienced by many
start-up organizations. We determined that there was no longer adequate
justification to continue to fund the costs associated with maintaining the DNA
organization in light of the uncertainty in future demand for its services.
Therefore, as of December 31, 2001 we commenced a plan to dispose of this
business and on January 11, 2002 sold substantially all of the assets related to
the design services business to Flextronics International, Ltd. ("Flextronics").
The operations related to the engineering design services business are treated
as discontinued operations in the accompanying consolidated financial
statements. (See Note 4 of the Notes to Consolidated Financial Statements -
included in Item 8 - "Financial Statements and Supplementary Data.")
Effective with the sale of substantially all the assets of DNA to
Flextronics we no longer provide contract engineering design services. These
services had been provided on a time and material basis and the customer
retained all rights to the developed intellectual property.
A variety of clients utilized our engineering design services, ranging
from start-up ventures seeking to launch new products to large multi-national
corporations looking to access key know-how for extending current product lines
or introducing new products and services. The products we developed for these
clients
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ranged from compact circuit boards to multi-board systems. We marketed our
services directly to prospects worldwide. Principal customers for our services
included board manufacturers, telecommunications equipment vendors,
semiconductor suppliers, and communications service providers. During 2001,
three customers accounted for 65% of net revenue from engineering design
services.
Telecommunications Equipment
Prior to 2001, a major focus of our business was the development,
design, production and sale of optical networking equipment for application in
telecommunication networks. We had specifically focused on our OmniLynx product
line. The business related to OmniLynx, and predecessor products SonetLynx(C)
and FibreTrax(C), was conducted through a wholly-owned subsidiary, Intelect
Network Technologies Company ("INT"). During 2000, opportunities in the
telecommunications market began to decline dramatically. As a result of this, we
determined that the long-term strategic value of the OmniLynx product line was
not as promising as the Company's other businesses and implemented a plan to
materially curtail the operations of INT and to sell INT or substantially all of
the assets related to the OmniLynx product line. In February 2001, a potential
sale of the OmniLynx business to a company in the United Kingdom did not
materialize, and we terminated the majority of the employees of INT. In August
2001, we completed a sale of the OmniLynx product line and substantially all of
the related assets to a newly formed entity, Intelect Technologies, Inc.
("ITI"). ITI is a corporation initially owned 67% by Singapore Technology
Electronics, Ltd. ("STE") and 33% by the Company. In February, 2003 STE made an
additional investment in ITI increasing its ownership to approximately 78% and
decreasing our ownership to approximately 22%. ITI is continuing with the active
production and sale of the OmniLynx product line, primarily for use in
purpose-built network applications such as highway systems, rail systems,
airport communication systems and pipeline networks. We have minority board of
director representation in ITI and have no involvement in day-to-day operations.
We account for its investment in ITI using the equity method of accounting. (See
Note 5 of the Notes to Consolidated Financial Statements - included in Item 8 -
"Financial Statements and Supplementary Data.")
During 2001, we continued development activities on a new generation of
optical networking equipment through another wholly-owned subsidiary, Aegean
Networks, Incorporated ("Aegean"). We funded all development activities, but had
sought strategic investors to provide funding in order to allow full-scale
development. We had received indications of interest from a number of potential
strategic investors, but the uncertainties surrounding the recovery of markets
for telecommunications equipment and other economic factors resulted in no firm
commitments to provide funding for Aegean. In the fourth quarter 2001 we
curtailed development activities related to Aegean and in the second quarter of
2002 ceased all development activity related to Aegean.
During 2001, we launched development activities related to a line of
products to provide high-density, telecommunications-grade solutions to the
Internet server and storage markets. These activities were conducted through a
wholly-owned subsidiary, Centauri NetSystems Corporation ("Centauri"). Economic
and industry conditions made obtaining third party financing for this project
difficult and in March, 2002 we suspended all development activity related to
the Centauri project.
See Item 7 - "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for a discussion of research and
development expenditures over the past three years. See Note 16 of the Notes to
Consolidated Financial Statements - included in Item 8 - "Financial Statements
and Supplementary Data."- for information regarding revenue and profits by
segment and geographic region.
RISK FACTORS
In addition to the other information in this Annual Report on Form
10-K, the following are risk factors that should be considered in evaluating the
Company and an investment in our common stock. The trading price of the common
stock could decline due to any of these risks, and investors in our common stock
could lose all or part of their investment.
9
RISK FACTORS RELATED TO OUR BUSINESS
A Number of Factors Could Cause Operating Results to Fluctuate
Significantly.
Our revenues and operating results in any reporting period may
fluctuate significantly due to a variety of factors, including:
o changes in the price or availability of components for our
products;
o the mix of products sold to the defense electronics markets
and other markets;
o our ability to introduce new technologies and features ahead
of competitors;
o the timing and size of orders we receive from customers;
o fluctuations in demand for our products;
o delays in testing by customers;
o production delays due to quality problems with outsourced
components;
o changes in our pricing policies or the pricing policies of our
competitors;
o changes in customers' requirements, including changes or
cancellations of orders from customers;
o manufacturing and shipment delays and deferrals;
o our ability to efficiently produce and ship orders promptly on
a price-competitive basis;
o announcements or introductions of new products by our
competitors;
o changes in general economic conditions as well as those
specific to the defense electronics industry.
Current economic conditions have made it more difficult to make
reliable estimates of future revenues. Fluctuations in our revenue can lead to
greater fluctuations in our operating profits. In addition, we expect to incur
significant research and development expenses as we develop products to serve
our markets, all of which are subject to rapidly changing technology, frequent
product performance improvements and evolving industry standards. The ability to
deliver superior technological performance on a timely and cost effective basis
is a critical factor in securing design wins for future generations of defense
electronics systems. Significant research and development spending by the
Company does not ensure that our products will be designed into a customer's
system. Because future production orders are usually contingent upon securing a
design win, our operating results may fluctuate due to either obtaining or
failing to obtain design wins for significant customer systems.
We Have Incurred Significant Losses in the Past and Are Not Currently
Profitable.
We are not currently profitable. In 2002, 2001 and 2000 we have
incurred net losses of $4,350,000, $21,549,00 and, $29,572,000, respectively.
These losses have been funded from borrowings under credit facilities and sales
of common stock. It is not certain when we will become profitable. The ability
to become profitable will depend, in part, on our ability to increase net
revenue from sales of defense electronics products. Because of this we have
experienced a lack of liquidity from time to time, and therefore have not paid
our obligations in a timely manner in some cases. This in turn has impacted our
ability to operate our business. If our need for capital exceeds available
resources, there can be no assurance that additional capital will be available
through public or private equity or debt financing.
Debt Service Obligations May Adversely Affect Our Cash Flow and We May
Be Unable to Repay the Debt On Time.
We have approximately $4,900,000 of debt outstanding. Of this amount,
approximately $4,000,000 is due by December 31, 2003. It is unlikely that we
will be able to generate sufficient cash flow from operations to repay all of
this debt when it comes due. While we intend to restructure or refinance this
debt, there is no assurance that we will be able to do so in a timely manner.
Even if we are able to refinance or restructure this debt, we may still be
subject to substantial interest and principal repayment obligations.
10
Our Auditors Have Expressed Doubt as to Our Ability to Continue as a
Going Concern.
Our independent certified public accountants have added an explanatory
paragraph to their audit opinion issued in connection with our consolidated
financial statements. The opinion states that our ability to continue as a going
concern is uncertain due to the amount of debt that is due in 2003, the
uncertainty of refinancing or restructuring the debt and our history of
operating losses. Our consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty. These
adjustments might include changes in the possible future recoverability and
classification of assets or the amounts and classification of liabilities that
might result from the outcome of this uncertainty.
We May Not Be Able to Successfully Complete Development and Achieve
Customer Acceptance of New Defense Electronics Products.
We must continually enhance our products. Certain enhancements to our
products are in the development phase and are not yet ready for commercial
manufacturing or deployment. The successful development and deployment of these
products is subject to substantial risk. The development of these products, from
laboratory prototype to customer trial, and subsequently to general
availability, involves a number of steps including the following:
o completion of product development;
o the qualification and multiple sourcing of critical
components;
o validation of manufacturing methods and processes;
o extensive quality assurance and reliability testing, and
staffing of testing infrastructure;
o validation of embedded software; and
o establishment of systems integration and systems test
validation requirements.
Each of these steps in turn presents serious risks of failure, rework
or delay. Any one of these setbacks could decrease the speed and scope of
product introduction and marketplace acceptance of the product. In addition,
unexpected intellectual property disputes, failure of critical design elements,
and other setbacks may delay or even prevent the introduction of these products.
A lack of working capital may also negatively impact our ability to enhance our
products in a timely manner.
Additionally, the markets for our new products may be undeveloped. The
commercial acceptance of these types of products is uncertain. We cannot assure
you that our sales and marketing efforts for these products will be successful.
We are a Party to Lawsuits and May Be Subject to Other Contingent
Liabilities.
We are a named party in a lawsuit and may be subject to significant
other contingent liabilities. Defending these matters may require a substantial
amount of our resources, and any judgments may materially affect our financial
condition and results of operations. For more information see" Item 3 - Legal
Proceedings."
Our Failure to Quickly Adopt to Rapidly Changing Competitive and
Economic Conditions Could Have a Material Adverse Effect on Our Business and
Results of Operations.
We operate in a rapidly changing and competitive and economic
environment. Our future success will depend, in part, on our ability to enhance
our current products and to develop new products on a timely and cost-effective
basis that respond to technological developments and changing customer needs.
The markets for sophisticated technology are constantly undergoing rapid
competitive and economic changes. The full scope and nature of these changes are
difficult to predict. The defense electronics market, in particular, demands
constant technological improvements as a means of gaining military advantage. We
believe that technological change will continue to attract new entrants to our
market. Industry consolidation among competitors may increase their financial
resources, which may allow our competitors to reduce their prices. This would
require us to reduce the prices of our products or risk losing market share.
11
We Have a Limited Customer Base.
We are dependent on a small number of customers for a large portion of
our revenues. In fiscal 2002, three customers accounted for 65% of our revenues.
Customers in the defense electronics market purchase our products in connection
with government programs that may have limited duration, leading to fluctuating
sales to any particular customer in the defense electronics market from year to
year. A significant decrease in our sales to any of our major customers, or the
loss of any of our major customers, would have a material adverse effect on our
business, financial condition and results of operations. In addition, our
revenues are largely dependent upon the ability of our customers to develop and
sell products and systems that incorporate our products. There is no assurance
that our customers will not experience financial or other difficulties that
could adversely affect our operations and, in turn, our results of operations.
We May Not Be Successful if We Do Not Attract New Customers.
Our future success will depend on our attracting additional customers.
The growth of our customer base could be adversely affected by:
o customer unwillingness to implement our defense electronics
technology;
o any delays or difficulties that we may incur in completing the
development, introduction and production manufacturing of our
planned products or product enhancements;
o new product introductions by our competitors;
o any failure of our products to perform as expected;
o any difficulty we may incur in meeting customers' delivery,
installation or performance requirements; or
o customer concerns over our financial condition.
We Must Attract, Retain and Motivate Key Technical and Management
Personnel in a Competitive Market in Order to Sustain and Grow Our Business.
Our success depends to a significant extent upon key technical and
management employees. Competition for highly qualified employees can be intense
and the process of locating key technical and management personnel with the
required combination of skills and attributes can be lengthy and expensive.
There can be no assurance that we will be successful in retaining our existing
key personnel or in attracting and retaining the additional employees we may
require. We must continue to recruit, train, assimilate, motivate, and retain
qualified managers and employees to manage our operations effectively. If we do
not successfully recruit, hire and retain key employees, we may be unable to
execute our business plan effectively and our results of operations could be
significantly adversely affected.
We May Be Unable to Secure Necessary Components and Support Because We
Depend Upon a Limited Number of Third-Party Manufacturers and Support
Organizations.
We depend on a limited number of suppliers for components of our
products, as well as for equipment used to design and test our products. Certain
components used in our products are only available from a single source or
limited number of vendors. Some of the sole source and limited source vendors
are companies who, from time to time, allocate parts to equipment manufacturers
due to market demand for components and equipment. Many of our competitors are
much larger and may be able to obtain priority allocations from these shared
vendors, thereby limiting or making our sources of supply unreliable for these
components. Any delay in component availability for any of our products could
result in delays in deployment of these products and in our ability to recognize
revenues. Suppliers may be concerned regarding our financial condition and
therefore may be unwilling to sell components to us, or to grant trade credit to
us.
12
If we are unable to obtain a sufficient supply of components from
alternative sources, reduced supplies and higher prices of components will
significantly limit our ability to meet scheduled product deliveries to
customers. A delay in receiving certain components or the inability to receive
certain components could harm our customer relationships and our results of
operations.
Failures of components affect the reliability and performance of our
products, can reduce customer confidence in our products, and may adversely
affect our financial performance. From time to time, we have experienced delays
in receipt of components and have received components that do not perform
according to their specifications. Any future difficulty in obtaining sufficient
and timely delivery of components could result in delays or reductions in
product shipments that could harm our business. In addition, a consolidation
among suppliers of these components or adverse developments in their businesses
that affect their ability to meet our supply demands could adversely impact the
availability of components that we depend on. Delayed deliveries from these
sources could adversely affect our business.
Our defense electronics products are manufactured by a limited number
of third-party manufacturers. If we were required to find alternative
third-party manufacturers, we may be forced to incur significant costs and
risks. There is no assurance that the alternative manufacturers could produce
our products with quality or costs comparable to the existing manufacturers. In
addition, the transfer of the manufacturing process to an alternative provider
could result in significant delays that could cause us to miss deadlines imposed
by our customers.
Defense Electronics Products Business Is Subject to Special Risks.
We expect that the majority of our net revenues in the future will come
from the sale of our defense electronics products. We supply products to
sub-contractors and prime contractors whose ultimate customer is often an agency
of the United States government. Reductions in government spending on programs
that incorporate our products could have a material adverse effect on our
business, financial condition and results of operations. The contracts with the
United States government are subject to special risks including the following:
delays or cancellations of funding for programs; ability of the government to
unilaterally cancel the contract; reduction or modification as a result of
budgetary restraints or political changes; and other factors not under the
control of us or the prime contractor.
The Failure to Develop and Introduce New Products That Meet Changing
Customer Requirements and Address Technological Advances Would Limit Our Ability
to Sell Our Products and Services.
New product development often requires long-term forecasting of market
trends, and development and implementation of new technologies. If we fail or
are late to respond to new technological developments, market acceptance of our
products may be significantly reduced or delayed. The markets we participate in
are characterized by rapidly changing technology, evolving industry standards,
changes in end user requirements, and frequent new product introductions and
enhancements. The introduction of products embodying new technologies or the
emergence of new industry standards can render our existing products obsolete or
unmarketable. There can be no assurance that we will be able to develop and
introduce new products ahead of our competitors, or that our products will not
be rendered obsolete.
We May Not Be Able to Secure an Adequate Number of Design Wins.
Before buying our products, a customer will evaluate our products, and
those of our competitors, as a part of designing a larger system. When a product
is selected by a customer to be utilized in its system we refer to it as a
"design win." The design-win process is typically lengthy and expensive, and
there can be no assurance that we will be able to continue to meet the product
specifications of our customers in a timely and adequate manner. In the defense
electronics market, military planners have historically funded significantly
more design projects than actual deployments of new equipment. There can be no
assurance that we will secure an adequate number of design wins. Failure to
secure future design wins could have a material adverse effect on our business,
financial condition and results of operations.
13
Product Performance Problems Could Limit Sales Prospects.
The production of new products with high technology content involves
occasional problems as the technology and manufacturing methods mature. If
significant reliability, quality or network monitoring problems develop,
including those due to faulty components, a number of negative effects on our
business could result, including:
o costs associated with reworking the manufacturing processes;
o high service and warranty expenses;
o high inventory obsolescence expense;
o high levels of product returns;
o delays in collecting accounts receivable;
o reduced orders from existing customers; and
o declining interest from potential customers.
Although we maintain accruals for product warranties, actual costs
could exceed these amounts. From time to time, there will be interruptions or
delays in the activation of products at a customer's site. These interruptions
or delays may result from product performance problems or from aspects of the
installation and activation activities, some of which are outside our control.
If we experience significant interruptions or delays that cannot be promptly
resolved, confidence in our products could be undermined, which could have a
material adverse effect on operations.
Failure to Protect Our Intellectual Property Will Adversely Affect Our
Ability to Compete in the Industry and Our Profitability.
We rely on a combination of patents, copyright, trademark and trade
secret laws, and restrictions on disclosure to protect our intellectual
property. We also enter into confidentiality or license agreements with our
employees, consultants and corporate partners and control access to and
distribution of our software, documentation and other proprietary information.
These intellectual property protection measures may not be sufficient to prevent
wrongful misappropriation of our technology. In addition, these measures will
not prevent competitors from independently developing technologies that are
substantially equivalent or superior to our technology. The laws of many foreign
countries do not protect intellectual property rights to the same extent as the
laws of the United States. Failure to protect proprietary information could
result in, among other things, loss of competitive advantage, loss of customer
orders and decreased revenues. Monitoring the unauthorized use of our products
is difficult and we cannot be certain that the steps we have taken will prevent
unauthorized use of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as in the United States. If
competitors are able to use our technology, our ability to compete effectively
could be impaired. This litigation could result in substantial costs and
diversion of resources and may not ultimately be successful.
We May Be Subject to Intellectual Property Infringement Claims That Are
Costly to Defend and Could Limit Our Ability to Use Some Technologies in the
Future.
Like other participants in our industry, we expect that we will
continue to be subject to infringement claims and other intellectual property
disputes as competition in the marketplace continues to intensify. In the
future, we may be subject to litigation and may be required to defend against
claimed infringements of the rights of others or to determine the scope and
validity of the proprietary rights of others. Any such litigation could be
costly and divert management's attention from operations. In addition, adverse
determinations in such litigation could:
o result in the loss of our proprietary rights to use the
technology;
o subject us to significant liabilities;
o require us to seek licenses from third parties;
o require us to redesign the products that use the technology;
or
o prevent manufacturing or sale of our products that employ the
technology.
14
If we are forced to take any of the foregoing actions, our business may be
seriously harmed.
We May Be Unable to License Third-Party Technology at a Reasonable
Cost.
From time to time we may be required to license technology from third
parties to develop new products or product enhancements. We cannot ensure that
third-party licenses will be available to us on commercially reasonable terms.
The inability to obtain any third-party license required to develop new products
and product enhancements could require us to obtain substitute technology of
lower quality or performance standards, or to license such technology at a
greater cost. Both licensing inferior technology at a reasonable cost and
licensing necessary technology at a higher cost could seriously harm the
competitiveness of our products.
Our Products Are Subject to Government Regulation.
The export of our products and related technology may be subject at
times to regulation and restriction by the Department of Commerce. Because our
products are utilized in defense and intelligence gathering related
applications, in some cases the export of our products and related technology
may be subject to further regulation and restriction by the Department of State.
Sales to foreign countries have not been material to date, but the export
controls could limit our ability to sell our products outside the United States
or could delay such sales in the future. We also may be required to spend
substantial time and resources in order to comply with the regulations and
restrictions. We could be subject to fines if we fail to properly comply with
these regulations.
In addition, our business and operating results may also be adversely
affected by the imposition of certain tariffs, duties and other import
restrictions on components that we obtain from non-domestic suppliers or by the
imposition of export restrictions on products that we sell internationally. We
do not believe we have material exposure to environmental laws. Changes in
current or future laws or regulations, in the United States or elsewhere, could
materially and adversely affect our business and results of operations.
RISK FACTORS RELATED TO THE SECURITIES MARKET
Our Common Stock Is Subject to Price Volatility.
The price of our common stock is volatile. Fluctuations in operating
results, such as revenues or operating results being below the expectations of
public market analysts and investors, may cause additional volatility in the
price of the common stock. In such event, the market price of our common stock
could decline significantly. A significant decline in the market price of the
common stock could result in litigation that could also result in increased
costs and a diversion of management's attention and resources from operations.
There May Not Be a Liquid Market for our Common Stock.
Our common stock currently is traded on the OTC Bulletin Board operated
by Nasdaq. This market generally has less liquidity than the Nasdaq SmallCap
Market and certain institutional investors are precluded from buying stock in
this market. There can be no assurance that our investors will be able to sell
the Common Stock at prices and times that are desirable.
Additional Capital May Dilute Current Stockholders.
In order to provide capital for the operation of our business we may
enter into additional financing arrangements. These arrangements may involve the
issuance of new common stock, preferred stock that is convertible into common
stock, debt securities that are convertible into common stock or warrants for
the purchase of common stock. Any of these items could result in a material
increase in the number of shares of
15
common stock outstanding which would in turn result in a dilution of the
ownership interest of existing common shareholders. In addition these new
securities could contain provisions, such as priorities on distributions and
voting rights, which could affect the value of our existing common stock.
We May Propose a Reverse-Split of Our Common Stock.
In order to reduce the number of shares outstanding, increase the
trading price of our common stock and possibly attract additional groups of
investors we may at some time in the future propose a reverse-split of our
common stock. Such a proposal would require the approval of the majority of the
outstanding shares of voting stock to be implemented. There can be no assurance
that a reverse split would have the intended effect and therefore it could
dilute the value of our common stock.
ITEM 2 - PROPERTIES
All of our facilities are leased and are located in Richardson, Texas.
We lease approximately 50,000 square feet, and we currently utilize
approximately 25,000 feet. These facilities include production, engineering,
sales, marketing and administrative offices and we believe it to be suitable for
our current operations.
ITEM 3 - LEGAL PROCEEDINGS
We are involved in various legal proceedings and claims arising in the
ordinary course of business.
Shareholder Action. A shareholder class action lawsuit was filed in the
U. S. District Court for the Northern District of Texas in November 1999 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 monetary damages, interest, costs and expenses. In March 2001, our motion
to dismiss the case was denied. In December 2002, the Court denied the
plaintiffs' motion for class certification. The plaintiffs appealed this ruling
to the 5th Circuit Court of Appeals and in March 2003 the appellate court
refused to hear the appeal. Certain motions are now pending before the U. S.
District Court to determine the extent of individual plaintiffs' claims in this
matter.
United Pacific Insurance Company, an affiliate of Reliance Insurance
Company, the insurance carrier that provides the primary $2 million of insurance
coverage for this matter, has been ordered liquidated by the insurance
commissioner of the State of Pennsylvania. At this time we are unable to
determine what amounts, if any, may be available under this insurance coverage
and it could be some period of time before we can determine this. We received
$300,000 related to this claim from guarantee funds maintained by the insurance
commissioner of the State of Texas. If we don't receive the full benefit of this
coverage, there could be a material adverse impact on the Company.
Savage Matters. We are contingently liable for certain potential claims
that arise out of Savage Arms, Inc., a manufacturer of sporting bolt action
rifles ("Savage Arms"). We sold Savage Arms to the Savage Sports Corporation
("Savage Sports"), and pursuant to the Stock Purchase Agreement we executed on
October 3, 1995, we agreed to indemnify Savage Sports for certain product
liability claims, environmental clean-up costs and other contractual
liabilities, including certain asserted successor liability claims, that Savage
Sports incurred because of Savage Arms.
A firearms product liability lawsuit was filed in Alaska Superior Court
("the Taylor litigation"). Western Auto Supply Co. is a defendant in the Taylor
litigation, and has settled the claim for $5 million. Western Auto Supply Co.
asserted a third-party claim against Savage Sports seeking indemnification in
the amount of the settlement, plus attorneys' fees and related costs. During
2002 Savage reached a settlement on this matter pursuant to which it agreed to
pay a total of $1,000,000 over a period of four years. Savage then sought
indemnification from the Company for these amounts.
16
In October, 2002 we reached an agreement in principle with Savage
regarding this and indemnification matters, including the balance of amounts due
Savage pursuant to a settlement agreement reached in January, 2001. Under this
agreement we have agreed to pay Savage a total of $1,575,000, which includes the
remaining balance of the prior settlement, over a four year period. Savage has
agreed to fund the cost of insurance programs that are expected to respond to
any other such claim that may arise in the future. We are aware of no such
claims and Savage has advised us that they are not aware of any additional
claims. We recorded a charge of $1,520,000 related to this matter in the third
quarter of 2002.
SCI Action. In July 2002, the Company's wholly-owned subsidiary, DNA
Enterprises, Inc. ("DNA") filed suit against SCI Technology, Inc. and SCI
Systems, Inc. (collectively "SCI") for breach of contract and fraudulent
inducement. The suit alleges that SCI has failed to pay DNA royalties related to
a Licensing Agreement involving the joint development of certain circuit card
assembly ("CCA") boards. The suit is currently pending in United States District
Court for the Northern District of Texas. In August 2002, SCI filed a counter
claim against DNA alleging breach of contract, fraudulent inducement and
negligent misrepresentation. In April 2003, the Company and SCI reached a
settlement of these matters whereby all claims will be dismissed and SCI will
pay the Company an undisclosed amount. This settlement will not have a material
effect on the Company's financial condition or results of operations.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the quarter ended December 31, 2002, no matters were submitted
to a vote of our stockholders.
17
PART II
ITEM 5 - MARKETS FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the OTC Bulletin Board operated by Nasdaq
under the symbol "TERA." Prior to June 19, 2001, our common stock was traded on
the Nasdaq SmallCap Market. Our common stock was de-listed from the Nasdaq
SmallCap Market on June 19, 2001 for failure to maintain a minimum bid price of
$1.00. On January 30, 2001, we changed our trading symbol to "TERA" from "ICOM"
to reflect our name change to TeraForce Technology Corporation from Intelect
Communications, Inc.
The high and low bid prices for our common stock for each full quarter
of the last two fiscal years, as reported on the OTC Bulletin Board and Nasdaq,
are as follows (these prices are inter-dealer prices, without mark-up, mark-down
or commission included and may not necessarily represent actual transactions):
Quarter period ended High Low
-------------------- ---------- ----------
2002
March 31 0.240 0.080
June 30 0.360 0.090
September 30 0.240 0.100
December 31 0.260 0.100
2001
March 31 1.438 0.344
June 30 0.960 0.330
September 30 0.420 0.150
December 31 0.200 0.080
As of March 31, 2003, there were approximately 45,000 owners of record
of our common stock, including nominee holders such as banks and brokerage firms
who hold shares for the benefit of beneficial owners of our common stock.
The closing bid price of our common stock on the OTC Bulletin Board on
March 31, 2003 was $0.195.
DIVIDEND POLICY
No dividends were paid on any class of equity in 2002 or 2001. We do
not currently plan to pay any dividends on our common stock. Delaware law would
restrict our ability to pay any dividends on our common stock.
SECURITIES SOLD
From October, 2002 through March, 2003 we issued a total of 29,333,333
of our common stock in a series of private placements. We received proceeds
totaling $3,520,000 from these sales. We used $2,000,000 of this amount to repay
debt outstanding under a bank credit facility and the balance for working
capital.
These sales of common stock were exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933 (the Securities Act), as amended, and
pursuant to Rule 506 of Regulation D of the Securities Act. A Rule 506 exemption
was available for these sales because the Company sold only to accredited
investors; the Company did not solicit or advertise the sales; a registered
restrictive legend was placed on each certificate issued describing the
restrictions against resale; and a Form D was filed with the Securities and
Exchange Commission and in each state where the individual investors reside.
18
ITEM 6 - SELECTED FINANCIAL DATA
The following tables set forth certain historical consolidated
financial data for the Company.
Years ended December 31,
----------------------------------------------------------------------------
2002 2001* 2000* 1999* 1998*
------------ ------------ ------------ ------------ ------------
($ in thousands, except per share data)
STATEMENT OF OPERATIONS:
Net revenues $ 5,036 $ 6,822 $ 11,748 $ 12,103 $ 11,194
============ ============ ============ ============ ============
Operating loss $ (7,235) $ (16,724) $ (29,062) $ (23,241) $ (38,738)
============ ============ ============ ============ ============
Loss from continuing operations $ (2,830) $ (17,181) $ (28,790) $ (26,286) $ (42,686)
Loss from discontinued operations (1,520) (3,412) (782) (2,249) (49)
Loss on disposal of
discontinued operations -- (956) -- -- (403)
Extraordinary item - loss -- -- -- (1,054) --
------------ ------------ ------------ ------------ ------------
Net loss $ (4,350) $ (21,549) $ (29,572) $ (29,589) $ (43,138)
============ ============ ============ ============ ============
Loss allocable to common
stockholders $ (4,350) $ (21,549) $ (30,538) $ (34,517) $ (46,105)
============ ============ ============ ============ ============
Basic and diluted loss per share:
Continuing operations $ (0.03) $ (0.20) $ (0.36) $ (0.67) $ (1.76)
Extraordinary item -- -- -- (0.02) --
Discontinued operations (0.02) (0.05) (0.01) (0.05) (0.02)
------------ ------------ ------------ ------------ ------------
Net loss $ (0.05) $ (0.25) $ (0.37) $ (0.74) $ (1.78)
============ ============ ============ ============ ============
Weighted average shares (thousands) 93,581 86,354 83,229 46,762 25,939
BALANCE SHEET:
ASSETS:
Current assets $ 4,918 $ 8,105 $ 18,805 $ 11,861 $ 16,413
Excess of cost over assets of
companies acquired -- -- 3,354 4,115 4,787
Other long-term assets 1,806 2,091 1,845 8,366 11,270
------------ ------------ ------------ ------------ ------------
Total assets $ 6,724 $ 10,196 $ 24,004 $ 24,342 $ 32,470
============ ============ ============ ============ ============
LIABILITIES & STOCKHOLDERS' EQUITY:
Current liabilities including current
maturities of long-term debt $ 7,358 $ 11,807 $ 4,593 $ 8,674 $ 9,938
Long-term liabilities 2,000 -- -- 15,264 15,000
Stockholders' equity (deficit) (2,634) (1,611) 19,411 404 7,532
------------ ------------ ------------ ------------ ------------
$ 6,724 $ 10,196 $ 24,004 $ 24,342 $ 32,470
============ ============ ============ ============ ============
*Certain amounts have been reclassified to conform to current classifications.
19
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and their related notes found on pages 33
through 55 of this Form 10-K. Except for historical facts, all statements
included in the following discussion about our financial position, business
strategy, and plans of management for future operations are forward looking
statements. Forward-looking statements involve risks and uncertainties and
actual results could materially differ from those expressed in or implied by the
forward-looking statements.
RESULTS OF OPERATIONS
The following discussions of revenues, gross profit (loss), engineering
and development expenses, and selling and administrative expenses do not include
amounts related to our engineering design services business for any period
presented.
The following table shows the revenue and gross profit (loss) for our
products:
Years Ended December 31,
--------------------------------------
2002 2001 2000
---------- ---------- ----------
($ in Thousands)
NET REVENUE:
Defense electronic products $ 5,036 $ 4,195 $ 3,599
Optical networking equipment -- 2,368 6,994
Other -- 259 1,155
---------- ---------- ----------
$ 5,036 $ 6,822 $ 11,748
---------- ---------- ----------
GROSS PROFIT (LOSS):
Defense electronic products $ 1,702 $ (424) $ 375
Optical networking equipment -- -- (1,813)
Other -- (715) (67)
---------- ---------- ----------
$ 1,702 $ (1,139) $ (1,505)
---------- ---------- ----------
Net revenues
Net revenue from the sale of defense electronics products increased 20%
between 2001 and 2002 and 17% between 2000 and 2001. The increased product sales
reflect our continued penetration of the market for these products and customer
acceptance of our products. The majority of the increase in net revenues results
from sales of our PowerPC-based product line. We have sold these products into
an increasing number of programs; however, these programs have not yet reached
their full production phase. In the full production phase, orders tend to be
larger and more predictable. In the first quarter of 2003 we have received new
orders, or "bookings," for our products amounting to approximately $4,000,000.
We believe this is an indication of continuing increased demand for these
products.
While the majority of our defense electronics products are utilized in
defense and intelligence related applications, they have also been utilized in
commercial telecommunications applications. The severe downturn in the
telecommunications industry resulted in a sharp decline in demand for our
products in these applications. Therefore, revenues in 2001 from sales to the
telecommunications market were less than we had anticipated. Revenue from sales
of products for defense and intelligence related applications in 2001 was also
less than we had expected. Prior to September 11, 2001, funding for various
defense and intelligence related programs had been delayed pending the Bush
administration's assessment of the military and its priorities. This resulted in
delays in new orders throughout the industry. The events of September 11, 2001
compounded these delays.
20
Net revenue from optical networking equipment relates almost
exclusively to the OmniLynx product line. In August 2001, we sold essentially
all of the assets related to the OmniLynx product line to ITI, of which we
continue to own a portion. Prior to the completion of this transaction we had
significantly curtailed the OmniLynx operations. Accordingly, revenues from
optical networking equipment declined significantly in 2001. Subsequent to
August 2001, we had no revenues from optical networking equipment. The decision
to dispose of the OmniLynx related assets and operations was made in reaction to
rapidly changing market conditions that resulted in very significant declines in
the actual and expected demand for the OmniLynx product line. A significant
factor in our decision to curtail the OmniLynx operations was the decline in
demand from small to medium sized competitive local exchange carriers, which had
been one of our target markets.
Other revenues consist primarily of the voice and data switching
products used in air traffic control applications and video network products,
which we no longer sell.
Gross profit (loss)
Our gross profit from sales of defense electronics products increased
because of higher sales levels and certain fixed production costs. Furthermore,
this increase reflects higher sales of our PowerPC-based products that tend to
produce higher gross margins than our other products. In the fourth quarter of
2002 we recorded a charge of approximately $270,000 to adjust the carrying value
of component and finished goods inventories. This adjustment resulted primarily
from our on-going analysis of component obsolescence.
The gross loss related to defense electronics products for 2001
includes approximately $750,000 of charges related to the adjustment of the
carrying value of component and finished goods inventories. These charges
resulted from an evaluation of current component costs and the adjustment of
certain finished goods to net realizable value. Without the effect of these
charges, the gross profit related to defense electronic products in 2001
amounted to approximately $326,000, as compared to $375,000 in 2000. The decline
in gross profit, despite the increase in related net revenue between the
periods, reflects the costs of certain fixed infrastructure established to
handle higher production levels expected in the future, higher testing and
re-work costs in the early phases of PowerPC-based product production and higher
unit costs related to relatively low volume production runs during this early
phase.
As of December 31, 2000, our assets related to the OmniLynx product
line, including inventories, were reduced to estimated net realizable value.
Therefore, revenue from the sales of such OmniLynx products in 2001 produced no
gross profit or loss. The gross loss in 2001 represents manufacturing and
production overhead costs incurred in 2001. During 2000, gross loss from optical
networking equipment reflects the effect of relatively low production levels for
our manufacturing operations. The lower production levels resulted in unabsorbed
overhead of approximately $1,400,000 in 2000. The amortization of technology
costs and capitalized software development costs of approximately $1,300,000 in
2000 also affected the gross loss.
Engineering and development expenses
Engineering and development ("E&D") expense decreased to $3,065,000 in
2002 from $5,096,000 in 2001 and $5,258,000 in 2000. In 2000, certain amounts of
software development costs were capitalized. Including those capitalized
amounts, the total E&D expenditures were $6,153,000 in 2000. Total E&D expense
by product line were distributed as follows:
Years ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
($ in Thousands)
Defense electronic products $ 2,803 $ 2,286 $ 1,722
Optical networking products 84 1,336 3,504
Other 178 1,474 32
-------- -------- --------
$ 3,065 $ 5,096 $ 5,258
-------- -------- --------
21
E&D costs related to our defense electronics products have increased in
each of the past three years. This increase reflects our on-going product
development efforts. Activities in 2000 and 2001 primarily involved our PowerPC
products that were first introduced in late 2000. Activities in 2002 included
enhancements of these products, including the development of a "ruggedized"
version of these products. In addition, during 2001 and 2002 we expended
considerable effort in the development of our Eagle product line. Included in
E&D expenses for 2002 is approximately $800,000 related to engineering design
services provided by Flextronics pursuant to the arrangement entered into with
Flextronics concurrent with the sale of our engineering design services
business.
In 2000, we incurred E&D costs relating to optical networking equipment
primarily from enhancements and extensions of the OmniLynx product line. The E&D
costs in 2001 relate to the Aegean product line that we began developing in
2000. In the fourth quarter of 2001, we curtailed activity related to the Aegean
product line because we were unable to arrange outside funding for these
activities. We ceased all activities related to Aegean in the second quarter of
2002.
Other E&D costs in 2001 included approximately $670,000 related to the
engineering organization involved with the OmniLynx product line, which was
eliminated during 2001. The balance of other E&D costs in 2001 arose from
development activities on the Centauri product line. In the first quarter of
2002, we suspended all development activities related to the Centauri project.
Selling and administrative expenses
Selling and administrative expenses decreased $2,516,000, or 30%,
between 2001 and 2002 and decreased $4,660,000, or 36%, between 2000 and 2001.
These expenses decreased because of the curtailment and sale of the operations
related to the OmniLynx product line. The decrease was offset by increased
general and administrative expenses related to our defense electronics business.
We have reduced other selling and administrative costs, including headcount, in
response to the elimination of various business operations.
Asset write downs and costs related to sale of assets
In the fourth quarter of 2000, we determined that, due to changes in
certain target customer markets in telecommunications, our OmniLynx line of
optical networking products no longer fit within our long-term objectives and
began plans to sell the product line and related operations. A transaction for
the sale of the OmniLynx business failed in the first quarter of 2001 due to
business difficulties experienced by the potential purchaser. At that time, we
significantly curtailed the ongoing operations of the OmniLynx business and
began to pursue other methods of disposing of the business, including
liquidating the assets. As of December 31, 2000, the carrying values of the
assets related to the OmniLynx product line were adjusted to the lower of cost
and estimated net realizable value. A charge to operations was recorded as of
December 31, 2000 as follows:
22
($ in Thousands)
Reduction of inventory to net realizable value $ 5,642
Reduction of property and equipment
to net realizable value 2,199
Write-off of capitalized software development
costs and purchased intangibles 1,383
Other 27
----------
Asset writedown $ 9,251
==========
In August 2001 we sold substantially all of the OmniLynx assets to ITI.
We received a cash payment of $1,000,000 and are entitled to receive additional
amounts from ITI based upon the utilization of inventory acquired from us and
based on the financial position of ITI at specific points in time. The total
additional amount to be received cannot be determined at this time. 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.
In 2001, we recognized non-recurring costs in connection with the sale
of the OmniLynx assets that amounted to $2,101,000. These costs related to
maintaining the assets until the sale and the settlement of certain contractual
obligations related to those assets such as warranty obligations, employee
retention agreements and lease obligations.
Litigation settlement
In April 2002, we settled litigation that we had brought against
Cadence. See "Item 3 - Legal Proceedings." Pursuant to this settlement we
received $6,300,000, net of fees paid to our attorneys related to this matter.
Litigation costs
Litigation costs represent legal fees and expenses related to a
shareholder suit. See "Item 3 - Legal Proceedings." The allegations in the suit
relate to operations that have been sold or otherwise discontinued; therefore,
these costs are reflected as non-operating expenses. Amounts incurred by the
Company in excess of $200,000 are reimbursable under an insurance policy.
However, the insurance carrier that provides the first $2,000,000 of such
coverage is in receivership and has not paid any amounts to us. We have received
$300,000 from a guarantee fund maintained by the State of Texas. The costs for
2002 have been reduced by $300,000. We may be able to recover some amounts from
the estate of our insurance carrier, but the amount and timing of such recovery
is uncertain. Therefore, no estimate of any such recovery has been recorded.
Earnings (loss) of unconsolidated affiliate
Subsequent to the sale to ITI of substantially all of the assets
related to the OmniLynx product line, ITI has conducted all operations related
to the OmniLynx product. We have a 33% equity interest in ITI, which decreased
to 22% in February 2003, minority board of director representation, no funding
obligations and no involvement in day-to-day operations. We account for our
investment in ITI using the equity method of accounting. Earnings (loss) of
unconsolidated affiliate for the years ended December 31, 2002 and 2001
represent our proportionate share of the net earnings or loss of ITI for each
period.
Interest expense
Interest expense, including non-cash financing charges, consists of the
following:
23
Years ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
(in Thousands)
Interest on debt instruments $ 291 $ 151 $ 348
Non-cash financing costs 125 82 426
Other interest 92 29 24
-------- -------- --------
$ 508 $ 262 $ 798
-------- -------- --------
Interest on debt instruments in 2002 and 2001 relates to amounts
borrowed under bank credit agreements and short-term notes. In 2000, these
amounts were primarily attributable to amounts borrowed from St. James Capital
Corp., SJMB, L.P., and the Coastal Corporation Second Pension Trust.
Non-cash financing costs in 2002, 2001 and 2000 were the result of
warrants to purchase common stock issued in connection with various financings.
The reported expense amount is amortization of the value of the warrants
determined by using the Black-Scholes pricing model.
Interest income and other
Interest income and other includes interest on the temporary investment
of cash balances of approximately $47,000 in 2001 and $1,028,000 in 2000. The
year 2000 also includes approximately $1,070,000 from the settlement of a
dispute with a professional service provider offset by a charge of approximately
$875,000 related to the settlement of certain litigation.
Discontinued operations
The loss from discontinued operations of $1,520,000 in 2002 results
from a charge recorded in the third quarter of 2002 relating to the settlement
of certain indemnification obligations. These obligations arose from the sale of
certain operations to Savage Sports. See "Item 3 - Legal Proceedings."
Effective December 31, 2001 we commenced a plan to dispose of our
engineering design services business and on January 11, 2002 sold substantially
all of the assets related to this business for total consideration of
$2,800,000. Accordingly, this business segment has been accounted for as a
discontinued operation.
24
The loss on disposal of discontinued operations in 2001 is computed
based on the consideration received less the net book value of the assets
disposed of, including goodwill, and the operating loss of the business from
December 31, 2001 to the date of disposal, which amount includes severance costs
related to certain employees, and an estimate of the costs related to a real
estate lease utilized by the discontinued operation. The amount of the loss is
as follows:
($ in Thousands)
Proceeds $ 2,800
Net book value of assets sold (517)
Goodwill (2,682)
Operating loss through date of sale (308)
Estimated cost of real estate lease (249)
----------
Loss on disposal of discontinued operation $ 956
==========
The results of operations related to our engineering design services
business are reflected as loss from discontinued operations in 2001 and 2000.
Between 2000 and 2001, the loss related to the engineering design
services operations increased to $3,412,000 from $782,000, primarily as a result
of a decline in revenues from these operations to $3,405,000 in 2001 as compared
to $7,002,000 in 2000. This decline resulted from the drastic downturn in the
telecommunications industry over this same period of time. The majority of our
engineering design services were provided to companies involved in the
telecommunications industry. During the course of 2001, there was a significant
decline in demand for our services as customers reduced or eliminated product
development programs. This situation was also impacted by the inability of many
start-up organizations that utilized our services to obtain additional funding.
OUTLOOK FOR 2003 -
Net revenue from the sale of our defense electronic products has
increased in each of the last three years and we expect it to further increase
in 2003. Net revenue from these sales amounted to $5,036,000 in 2002. In the
first quarter of 2003 we received new orders for these products amounting to
approximately $4,000,000 and at March 31, 2003 our backlog of orders amounted to
approximately $3,200,000, as compared to approximately $500,000 at this same
time in 2002. Accordingly, we expect net revenues in 2003 to be significantly
higher than in 2002. We had expected net revenues in 2002 to be higher than they
were, primarily due to the anticipated commencement of full production in
certain programs that our products had been selected for. Our customers,
however, experienced delays in these programs and therefore delayed their orders
to us. We believe that certain of these delays have now been overcome and these
programs will contribute to our anticipated increase in net revenues in 2003.
However, there can be no assurance that this increase will occur or that there
will not be further delays in these and other programs.
Due to our increased working capital needs related to the increase in
orders and unexpected delays in completing financing arrangements in the first
quarter of 2003, we experienced delays in payments to some of our vendors. These
delays in payment temporarily affected our ability to complete orders. As a
result, revenues in the first quarter of 2003 are expected to be lower than we
had originally anticipated. Management believes that the financing arrangements
that have been concluded will alleviate the liquidity difficulties and that
revenues in the second quarter 2003 will increase significantly as compared to
the first quarter of 2003. However, if we are not successful in amending our
outstanding debt obligations in an acceptable manner, or if working capital
requirements increase further, the financing arranged to date may not be
sufficient for our needs.
Our ability to generate a profit from operations and to generate
positive cash flow from operations largely depends on the continued growth in
revenue from sales of defense electronics products. Our ability to achieve
higher levels of net revenue depends upon a number of factors, including
customer acceptance of
25
our products, including new and enhanced products, our ability to meet customer
demands as to product availability, price and performance, availability of
funding for programs in which our products will be deployed, the performance of
other companies who provide products or services to these programs and our
access to adequate working capital, as well as other factors that may not be
within our control (See Item 1 - Business - Risk Factors).
In order to execute our business plan we need access to capital. See
Liquidity and Capital Resources - Financing activities for a discussion of these
requirements and how we expect to meet them.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2002, we had cash and temporary investments of
$512,000, negative working capital of $2,440,000, funded debt of $4,947,000 and
other long-term liabilities of $1,100,000. For the year ended December 31, 2002,
cash flow used in operations amounted to $730,000.
Operating activities
Net cash applied in operations primarily reflects the operating loss of
$7,235,000, a gain of $6,300,000 from the settlement of litigation, net non-cash
charges of $2,785,000 and a decrease in working capital of $603,000. Significant
items contributing to these amounts are as follows:
o Inventory decreased $908,000.
o Accounts receivable decreased $415,000.
o Accounts payable and accrued liabilities decreased by $730,000
o Non-cash charges include the following:
o Utilization of prepaid services of $807,000
o Loss from unconsolidated affiliate of $582,000
o Accrued settlement obligation of $1,445,000
Investing activities
Cash flow from investing activities in 2002 includes $6,300,000 from
the settlement of the Cadence litigation and $1,243,000 of proceeds from the
sale of our engineering design services business.
Financing activities
During 2002 we raised $3,020,000 from the sale of common stock in
private placements. Of this amount, $2,000,000 was used to repay notes payable.
In addition, we reduced notes payable by an additional $1,355,000 from the
proceeds of the litigation settlement.
Subsequent to December 31, 2002, we have completed a series of
financing transactions and are seeking to complete other transactions and to
effect amendments to our credit agreements.
In January and March 2003, we completed private placement transactions
in which we issued a total of 4,166,667 shares of common stock and warrants for
the purchase of an additional 4,333,333 shares of common stock for aggregate
proceeds of $500,000. The warrants have an exercise price of $0.15 per share and
are exercisable at any time through March 31, 2007.
In March 2003, the Company and DNA-CS entered into a revolving line of
credit with a bank in order to provide working capital to DNA-CS. Under the
facility, DNA-CS may borrow up to $1,000,000. Outstanding amounts are due March
26, 2004; however, DNA-CS may extend the maturity date six months, provided
certain conditions are maintained. Interest is payable monthly at the greater of
prime plus 1% and 5.25%. At March 31, 2003 $600,000 was outstanding under this
facility. This working capital facility is secured by the accounts receivable
and inventory of DNA-CS, the guarantee of the Company and by limited guarantees
provided by certain private investors. As consideration for providing the
guarantees that secure
26
the Note the Company has entered into a Reimbursement Agreement with the
guarantors. The Reimbursement Agreement provides that the Company will reimburse
the investors for any amounts that may be required to reimburse the bank
pursuant to the guarantees. Pursuant to the Reimbursement Agreement and related
agreements, the investors have the right to purchase up to 8,333,333 shares of
the Company's common stock for $1,000,000 in cash, and the proceeds will be used
to repay amounts outstanding under the Note and provide for the release of the
guarantees. In addition, the investors have received warrants to purchase an
aggregate of 9,582,334 shares of the Company's common stock at a price of $0.15
per share. The warrants may be exercised at any time through March 31, 2007.
We also have had a series of discussions with potential financial and
strategic investors regarding additional financing activities. These activities
might include the repayment of all or a portion of our currently outstanding
debt, as well as providing us with additional working capital. These financing
activities might include the issuance of convertible preferred stock or
convertible debt securities. The discussions have not resulted in definitive
agreements or arrangements to date and there is no assurance that any additional
financing can be arranged on terms acceptable to all parties involved.
In connection with the financing activities described above, we have
been negotiating amendments to our credit agreements with Bank One NA ("Bank
One") and a private investor who has provided security to Bank One related to
these agreements. Currently, the Company has $1,500,000 outstanding under a Loan
Agreement with Bank One that is secured by the guarantee of the private
investor. These amounts were due January 31, 2003; however, Bank One has agreed
to extend the maturity to June 30, 2003. In addition, the Company has
outstanding $2,700,000 under a Credit Agreement with Bank One that is secured by
a letter of credit provided by this same private investor. Amounts outstanding
under this facility are due March 31, 2004, with periodic reductions beginning
April 30, 2003. The Company, Bank One and the private investor are currently
engaged in discussion to amend these agreements in order to extend the
maturities of these obligations. These discussions have not yet been concluded
and there is no assurance that the Company will be able to reach agreements
acceptable to all parties involved. If we are unable to reach agreements related
to our debt obligations and if we are unable to obtain required additional
working capital, it may have a material adverse effect on our operations.
Due to uncertainties regarding the restructuring or refinancing of our
outstanding debt and our access to other sources of capital, our auditors have
added an explanatory paragraph to their audit opinion that states there is
substantial doubt concerning our ability to continue as a going concern. Our
consolidated financial statements have been prepared on the basis that we are a
going concern and do not include any adjustments that might be necessary if this
were not the case. These adjustments include changes in the possible future
recoverability and classification of assets or the amount and classification of
liabilities.
27
As discussed above we are obligated under various contracts and
commercial commitments. The following table summarizes these obligations:
Period in which payments due (in thousands)
-------------------------------------------------
Nature of Obligation 2003 2004 2005 2006
---------- ---------- ---------- ----------
Notes payable $ 4,047 $ 900 $ -- $ --
Operating leases 490 300 88 --
Non-cancelable purchase
commitments -- -- -- --
Settlement payments 549 500 600 --
---------- ---------- ---------- ----------
Total $ 5,086 $ 1,700 $ 688 $ --
---------- ---------- ---------- ----------
Our estimate of capital needs is subject to a number of risks and
uncertainties that could result in additional capital needs that have not been
anticipated. An important aspect of our estimated capital requirements is our
ability to begin to generate positive cash flow from operations. As discussed
above, this in turn is dependent upon our ability to increase revenues from our
defense electronics business, to generate adequate gross profit from those sales
and to control other costs and expenses. Our capital needs could increase
materially if any of our contingent liabilities are resolved adversely to the
Company. In addition, we could require additional working capital if the defense
electronics business increases more rapidly than we currently anticipate.
Potential sources of additional capital include the sale of additional
debt or equity securities, other debt, such as bank debt, and the sale of
assets. A sale of additional securities could result in dilution to existing
common shareholders. There is no assurance that additional capital will be
available under terms which are acceptable.
Contingent liabilities
As discussed in Item 3 - "Legal Proceedings," we are exposed to certain
contingent liabilities which, if resolved adversely to us, could adversely
affect our liquidity, our results of operations, and/or our financial position.
CRITICAL ACCOUNTING POLICIES
We have identified the policies below as critical to our business
operations and the understanding of our results operations. The impact and any
associated risks related to these policies on our business operations is
discussed below. For a more detailed discussion on the application of these and
other accounting policies, see the Notes to the Consolidated Financial
Statements included in this Annual Report on Form 10-K. The preparation of
financial statements in accordance with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amount of assets, liabilities, revenue and expenses and the disclosure of
contingent assets and liabilities. There can be no assurance that the actual
results will not differ from those estimates.
28
Estimates
Management has made estimates regarding the following matter which
could have a material effect on our consolidated financial statements:
o The recoverability of amounts due from ITI and any potential
impairment to our investment in ITI.
Inventories
Our inventories consist primarily of electronic components that are
subject to obsolescence and variations in market prices. We have adjusted the
amount of excess and obsolete inventory based on current and expected sales
trends, the number of parts on hand, the current market value for those parts
and the viability and potential technical obsolescence of the components.
Revenue recognition
We generally recognize revenue when our products are shipped to the
customer. This is normally the point when all of the following factors have been
achieved:
o Persuasive evidence of a sales arrangement exists, such as a
contract or binding purchase order,
o The product has been delivered to the customer,
o The price is fixed or determinable, and
o Collection of the resulting receivable is reasonably assured.
In some cases the product is shipped to a customer for evaluation or
testing. In such cases, revenue is not recognized until the customer has
evidenced intent to purchase the product by issuing a non-cancelable purchase
order to us for the product.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have outstanding debt amounting to $4,200,000 that bears interest at
a variable interest rate. This interest rate is based on a widely used reference
interest rate known as LIBOR. An increase of 50 basis points in LIBOR would
result in an increase in our annual interest expense of $21,000.
29
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants ................. 31
Consolidated Balance Sheets ........................................ 32
Consolidated Statements of Operations .............................. 33
Consolidated Statements of Stockholders' Equity .................... 34
Consolidated Statements of Cash Flows .............................. 35
Notes to Consolidated Financial Statements ......................... 36
30
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
TeraForce Technology Corporation
We have audited the accompanying consolidated balance sheets of TeraForce
Technology Corporation and subsidiaries as of December 31, 2002 and 2001, and
the related consolidated statements of operations, stockholders' equity
(deficit), and cash flows for each of the three years in the period ended
December 31, 2002. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of TeraForce
Technology Corporation and subsidiaries as of December 31, 2002 and 2001, and
the consolidated results of their operations and their consolidated cash flows
for each of the three years in the period ended December 31, 2002 in conformity
with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 3 to the
financial statements, the Company has incurred significant operating losses in
2002, 2001 and 2000. As of December 31, 2002, notes payable in the amount of
$4,047,000 are due within one year. The Company's continued existence is
dependent on restructuring or refinancing these obligations and continued access
to external sources of capital, none of which is assured. These matters raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans with respect to these matters are also discussed in Note 3.
The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.
/s/ Grant Thornton LLP
Dallas, Texas
March 25, 2003
31
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2002 and 2001
(Thousands of dollars, except share data)
2002 2001
---------- ----------
Assets
Current assets:
Cash and cash equivalents $ 55 $ 1
Temporary cash investments 457 53
Accounts receivable, net of allowances of $1,658 in 2001 573 869
Receivables from affiliate 699 816
Inventories 2,354 3,262
Net current assets of discontinued operations -- 2,880
Prepaid expenses and other current assets 780 224
---------- ----------
Total current assets 4,918 8,105
Property and equipment, net 573 638
Investment in affiliate 702 1,284
Other assets 531 169
---------- ----------
$ 6,724 $ 10,196
========== ==========
Liabilities and Stockholders' Deficit
Current liabilities:
Notes payable $ 4,047 $ 7,554
Accounts payable 1,919 1,864
Accrued liabilities 1,392 2,389
---------- ----------
Total current liabilities 7,358 11,807
Long-term notes payable 900 --
Other long-term liabilities 1,100 --
Commitments and contingencies (Notes 10 and 15)
Stockholders' deficit:
Common Stock, $.01 par value. Authorized 200,000,000 shares,
114,255,518 and 87,088,850 shares issued in 2002 and 2001,
respectively 1,143 871
Additional paid-in capital 184,953 181,898
Accumulated deficit (187,143) (182,793)
---------- ----------
(1,047) (24)
Less 400,474 shares of common stock in treasury -at cost (1,587) (1,587)
---------- ----------
Total stockholders' deficit (2,634) (1,611)
---------- ----------
$ 6,724 $ 10,196
========== ==========
See accompanying notes to consolidated financial statements.
32
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
(Thousands of dollars, except share data)
Years ended December 31,
--------------------------------------
2002 2001 2000
---------- ---------- ----------
Net revenue $ 5,036 $ 6,822 $ 11,748
Cost of revenue 3,334 7,961 13,253
---------- ---------- ----------
Gross profit (loss) 1,702 (1,139) (1,505)
---------- ---------- ----------
Expenses:
Engineering and development 3,065 5,096 5,258
Selling and administrative 5,872 8,388 13,048
Asset writedowns -- -- 9,251
Costs related to sale of assets -- 2,101 --
---------- ---------- ----------
8,937 15,585 27,557
---------- ---------- ----------
Operating loss (7,235) (16,724) (29,062)
---------- ---------- ----------
Other income (expense):
Litigation settlement 6,300 -- --
Litigation costs (872) (282) (218)
Share of income (loss) of unconsolidated
affiliate (582) 34 --
Interest expense (508) (262) (798)
Interest income and other 67 53 1,288
---------- ---------- ----------
4,405 (457) 272
---------- ---------- ----------
Loss from continuing operations (2,830) (17,181) (28,790)
Loss from discontinued operations (1,520) (3,412) (782)
Loss on disposal of discontinued operations -- (956) --
---------- ---------- ----------
Net loss (4,350) (21,549) (29,572)
Dividends on preferred stock -- -- (966)
---------- ---------- ----------
Loss allocable to common stockholders $ (4,350) $ (21,549) $ (30,538)
========== ========== ==========
Basic and diluted loss per share:
Continuing operations $ (0.03) $ (0.20) $ (0.36)
Discontinued operations (0.02) (0.05) (0.01)
---------- ---------- ----------
Net loss per share $ (0.05) $ (0.25) $ (0.37)
========== ========== ==========
Weighted average number of common
shares outstanding (thousands) 93,581 86,354 83,229
========== ========== ==========
See accompanying notes to consolidated financial statements.
33
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity (Deficit)
Years ended December 31, 2002, 2001 and 2000
(Thousands of dollars, except share data)
Preferred Stock Common Stock Additional
---------------------------- ---------------------------- paid-in
Shares Par Shares Par capital
------------ ------------ ------------ ------------ ------------
Balances at January 1, 2000 3,719,409 $ 37 65,936,573 $ 659 $ 131,511
Net loss -- -- -- -- --
Private placements of common stock -- -- 11,801,666 118 42,523
Exercise of warrants -- -- 2,495,000 25 5,155
Exercise of employee stock options -- -- 418,795 5 886
Conversion of notes payable -- -- 4,705,749 47 8,003
Redemption of preferred stock (3,719,409) (37) -- -- (7,456)
Preferred dividends paid in cash -- -- -- -- --
Preferred dividends paid with stock -- -- 142,719 1 186
Settlement of royalty agreement -- -- 350,000 3 371
Directors' fees paid in stock -- -- 48,972 1 44
Preferred dividends accrued -- -- -- -- (187)
Interest expense paid with stock -- -- 184,376 2 311
Stock issued for services -- -- 15,000 -- 34
Stock received in legal settlement -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Balances at December 31, 2000 -- -- 86,098,850 $ 861 $ 181,381
Net loss -- -- -- -- --
Stock issued in settlement of
contractual obligations 990,000 10 377
Warrants issued with notes -- -- 140
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2001 -- -- 87,088,850 $ 871 $ 181,898
Net loss -- -- --
Warrants issued with notes -- -- 307
Stock issued in exchange of warrants 2,000,000 20 (20)
Private placements of common stock 25,166,668 252 2,768
------------ ------------ ------------ ------------ ------------
Balances at December 31, 2002 -- -- 114,255,518 1,143 $ 184,953
------------ ------------ ------------ ------------ ------------
Total
Accumu- Treasury Stock stock-
lated ---------------------------- holders'
deficit Shares Cost equity
------------ ------------ ------------ ------------
Balances at January 1, 2000 $ (130,706) 191,435 $ (1,097) $ 404
Net loss (29,572) -- -- (29,572)
Private placements of common stock -- -- -- 42,641
Exercise of warrants -- -- -- 5,180
Exercise of employee stock options -- -- -- 891
Conversion of notes payable -- -- -- 8,050
Redemption of preferred stock -- -- -- (7,493)
Preferred dividends paid in cash (966) -- -- (966)
Preferred dividends paid with stock -- -- -- 187
Settlement of royalty agreement -- -- -- 374
Directors' fees paid in stock -- -- -- 45
Preferred dividends accrued -- -- -- (187)
Interest expense paid with stock -- -- -- 313
Stock issued for services -- -- -- 34
Stock received in legal settlement -- 209,039 (490) (490)
------------ ------------ ------------ ------------
Balances at December 31, 2000 $ (161,244) 400,474 (1,587) $ 19,411
Net loss (21,549) -- -- (21,549)
Stock issued in settlement of
contractual obligations -- -- -- 387
Warrants issued with notes -- -- -- 140
------------ ------------ ------------ ------------
Balance at December 31, 2001 $ (182,793) 400,474 (1,587) $ (1,611)
Net loss (4,350) -- -- (4,350)
Warrants issued with notes -- -- -- 307
Stock issued in exchange of warrants -- -- -- --
Private placements of common stock -- -- -- 3,020
------------ ------------ ------------ ------------
Balances at December 31, 2002 $ (187,143) 400,474 (1,587) $ (2,634)
------------ ------------ ------------ ------------
See accompanying notes to consolidated financial statements.
34
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2002, 2001 and 2000
(Thousands of dollars)
Years ended December 31,
--------------------------------------
2002 2001 2000
---------- ---------- ----------
Cash flows from operating activities:
Net loss $ (4,350) $ (21,549) $ (29,572)
Adjustments to reconcile net loss to
net cash used in operating activities:
Accrued settlement obligation 1,445 -- --
Utilization of prepaid services 807 -- --
Depreciation and amortization 256 1,417 4,650
Asset writedowns -- -- 9,251
Share of loss (income) from
unconsolidated affiliate 582 (34) --
Other (305) 146 762
Change in operating assets and liabilities:
Accounts receivable 415 4,569 (242)
Inventories 908 (1,139) (5,506)
Assets held for sale -- 2,643 --
Accounts payable and accrued liabilities (730) 158 (1,785)
---------- ---------- ----------
Net cash used in operating activities (972) (13,789) (22,442)
---------- ---------- ----------
Cash flows from investing activities:
Capital expenditures (179) (325) (1,888)
Investment in temporary cash investments (404) -- --
Net proceeds from disposal of discontinued
operations 1,243 -- --
Proceeds from sale of assets -- 2,250 --
Investment in affiliate -- (1,250) --
Software development costs -- -- (896)
Investment and other 1 73 (235)
---------- ---------- ----------
Net cash provided by (used in)
investing activities 661 748 (3,019)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of notes payable 700 7,455 400
Proceeds from issuance of common stock 3,020 -- 42,641
Principal payments on notes payable (3,355) -- (9,654)
Redemption of preferred stock -- -- (7,493)
Proceeds from exercise of common stock warrants -- -- 5,180
Proceeds from exercise of employee stock options -- -- 891
Preferred stock dividends paid -- -- (966)
Other -- -- 49
---------- ---------- ----------
Net cash provided by
financing activities 365 7,455 31,048
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents 54 (5,586) 5,587
Cash and cash equivalents, beginning of year 1 5,587 --
---------- ---------- ----------
Cash and cash equivalents, end of year $ 55 $ 1 $ 5,587
========== ========== ==========
See accompanying notes to consolidated financial statements.
35
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Description of Business
The Company's defense electronics business designs, develops, produces
and sells high-capacity computing products which are used primarily in
defense related applications. Beginning in 2001 this business is
conducted through the Company's wholly-owned subsidiary, DNA Computing
Solutions, Inc. ("DNA-CS").
Prior to 2002 the Company operated, through various subsidiaries, in
three business segments, optical networking equipment, engineering design
services, and defense electronics products (formerly referred to as
digital signal processor or DSP). In addition, from 2001 through the
first quarter of 2002 the Company conducted limited development
activities regarding high-density computing systems.
Prior to 2001 the Company's optical networking equipment business was
conducted primarily through its wholly-owned subsidiary, Intelect Network
Technologies Company ("INT"). In August 2001 substantially all of the
assets of this company, which related to the OmniLynx product line, were
sold to a new entity, Intelect Technologies, Inc. ("ITI"). ITI is owned
67% by an unrelated third party and 33% by the Company at December 31,
2002. The Company also conducted limited development activities related
to a new generation of optical networking equipment through a
wholly-owned subsidiary, Aegean Networks, Incorporated from 2001 through
the second quarter of 2002.
The Company's engineering design services business, which was conducted
through its wholly-owned subsidiary, DNA Enterprises, Inc., historically
provided high-value product design and development services, primarily to
telecommunications and networking companies. As of December 31, 2001 the
Company commenced a plan to dispose of this business segment.
Accordingly, the operations related to the design services business have
been accounted for as discontinued operations. These operations were sold
in January 2002.
(2) Significant Accounting Policies and Practices
Estimates
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United
States of America. These principles require management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
Principles of Consolidation
The consolidated financial statements include the financial statements of
the Company and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in
consolidation. The Company's investment in ITI is accounted for using the
equity method of accounting.
36
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
Fair Value of Financial Instruments
Statement of Financial Accounting Standards (SFAS) No. 107, "Disclosures
about Fair Value of Financial Instruments," requires disclosure of the
fair value of certain financial instruments for which it is practicable
to estimate fair value. For purposes of the disclosure requirements, the
fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing
parties, other than in a forced sale or liquidation. The carrying values
of cash, accounts receivable, investments, notes payable and accounts
payable are reasonable estimates of fair value due to their maturities.
Revenue and Expense Recognition
Revenue from product sales is generally recognized upon shipment of
products. This is normally the point at which (a) there is persuasive
evidence of a sales arrangement, such as a contract or binding purchase
order; (b) the product has been delivered to the customer; (c) the price
is fixed or determinable; and (d) collection of the resulting receivable
is reasonably assured. In some cases product is shipped to a customer for
evaluation or testing. In such cases, revenue is not recognized until the
customer has evidenced intent to purchase the product by issuing a
non-cancelable purchase order. Sales returns are recorded in the same
accounting period as the related revenues.
Inventories
Inventories consist of raw materials, work in progress and finished
goods, and are stated at the lower of cost (determined on a first-in,
first-out basis) or market.
Property and Equipment
Property and equipment are generally stated at cost. Property and
equipment which in the opinion of management will no longer be utilized
in the Company's operations is valued at the lower of cost and fair value
less estimated costs of disposal.
Depreciation of equipment is calculated on a straight-line method over
the estimated useful lives of the assets. Equipment held under capital
leases and leasehold improvements are amortized on a straight-line basis
over the shorter of the lease term or estimated useful life of the assets
and included in depreciation expense. The estimated useful lives are as
follows:
Years
-----
Machinery and equipment 5 to 7
Computer equipment 3 to 5
Software 3
Furniture and fixtures 5 to 7
Leasehold improvements 5
37
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
Receivable From and Investment in Affiliate
In connection with the sale of the OmniLynx product line, the Company
recorded a receivable from ITI in an amount equal to the carrying value
of the assets sold. This amount was equal to the estimated net realizable
value of those assets. Amounts are payable by ITI to the Company based on
the utilization of those assets by ITI and on the financial condition of
ITI at certain points in time. See Note 6. The Company assesses the net
realizable value of the receivable from ITI based on the historical and
projected operating results of ITI and on periodic analysis provided to
the Company by ITI.
The Company's investment in ITI is accounted for using the equity method
of accounting. Accordingly, the Company recognizes its proportionate
share of ITI's net earnings or loss. The Company further assesses the
recoverability of its investment base on various factors, including the
operating results and financial condition of ITI.
Deferred Financing Costs
A portion of the proceeds from the issuance of convertible debt
securities with beneficial conversion features and/or detachable stock
purchase warrants is recognized as additional paid-in capital and as a
discount to its related debt instrument. The discount related to
beneficial conversion features, deferred financing costs in connection
with the issuance of debt, and the discount related to detachable stock
purchase warrants are amortized on the straight-line method which has
produced results similar to the effective interest method.
Engineering and Development and Software Development Costs
Engineering and development costs are expensed as incurred.
Capitalization of software development costs commences upon the
establishment of technological feasibility and ceases when the product is
generally available for sale. Both the establishment of technological
feasibility and the ongoing assessment of recoverability of capitalized
development costs involve judgments by management with respect to certain
external factors, including, but not limited to, anticipated future
revenues, estimated economic life and possible developments in software
and hardware technologies. During the year ended December 31, 2000, the
Company capitalized $896,000 of software development costs and charged
operations for $1,832,000 of amortization. In addition, in 2000 the
Company wrote off and charged operations for the remaining $1,156,000 of
unamortized capitalized software as a result of curtailment of operations
related to its OmniLynx product line (Note 6). Amortization is based on
the greater of estimated product revenues or two years.
Basic Earnings (Loss) Per Common Share
The Company uses the weighted average number of shares outstanding to
compute basic earnings (loss) per share. Diluted earnings (loss) per
share is computed using the weighted average number of common shares and
dilutive potential common shares outstanding. In 2002, 2001 and 2000 all
potential common shares were anti-dilutive.
38
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
Income Taxes
The Company accounts for income taxes under the liability method as
required by SFAS No. 109, "Accounting for Income Taxes." Under this
method, deferred tax assets and liabilities are determined based on
differences between the financial reporting and income tax bases of
assets and liabilities and are measured using the enacted tax rates and
laws expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. A
valuation allowance is provided unless realization of such assets is
deemed more likely than not.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash
equivalents include cash held in banks and time deposits having
maturities within three months of the date of purchase by the Company.
Goodwill
Goodwill, which represents the excess of purchase price over fair value
of net assets acquired, has been amortized on a straight-line basis over
10 to 15 years. As of December 31, 2000 the remaining goodwill related
entirely to the engineering design services business. This amount was
written off in connection with the disposal of the business (Note 4).
Stock Option Plan
The Company accounts for its stock option plan in accordance with the
provisions of Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
As such, compensation expense is recorded on the date of grant only if
the current market price of the underlying stock exceeded the exercise
price. SFAS No. 123, "Accounting for Stock-Based Compensation," requires
pro forma net income and pro forma earnings per share disclosures for
employee stock option grants as if the fair-value-based method defined in
SFAS No. 123 had been applied.
39
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
Had the Company determined compensation cost based on the fair value on
the grant date for its stock options under SFAS No. 123, the Company's
net losses would have been increased to pro forma amounts as follows:
Years ended December 31,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
$ (in Thousands)
Net loss allocable to
common shareholders:
As reported $ (4,350) $ (21,549) $ (30,538)
Pro forma $ (5,405) $ (22,751) $ (33,085)
Loss per share:
As reported $ (0.05) $ (0.25) $ (0.37)
Pro forma $ (0.06) $ (0.26) $ (0.40)
Reclassification
Certain prior period balances have been reclassified to conform to the
current year presentation.
(3) Liquidity Matters
The Company has incurred significant operating losses in 2002, 2001 and
2000; however, the amount of these losses has decreased in each of those
years. The Company's operating losses have been funded over the past
three years with the proceeds from the sale of debt and equity
securities, proceeds from borrowings, proceeds from the sale of assets
and, in 2002, with proceeds from the settlement of certain litigation. At
December 31, 2002 the Company had outstanding debt obligation amounting
to $4,947,000, of which $4,047,000 is due on demand or within one year
pursuant to the terms currently in effect.
The Company's continued existence is dependent on the Company's ability
to continue to fund any operating losses and on the restructuring or
refinancing of its debt obligations. Subsequent to December 31, 2002 the
Company has generated additional capital amounting to $1,500,000 from the
sale of equity securities and from the proceeds of new credit facilities
(See Note 5 - Subsequent Events). In addition, the Company is engaged in
continuing discussions regarding additional sources of capital, as well
as the restructuring of its outstanding debt obligations.
The decrease in operating losses is the result of the disposal of certain
operations, specifically those related to the telecommunications
industry, the reduction of other operating expenses and increases in net
revenues from the Company's defense electronics business. Net revenues
from the sale of defense electronic products have increased in each of
the last three years and Management expects net revenues to increase
further in 2003. Therefore, management believes that the Company's needs
for capital to fund operating losses will continue to decline.
The Company believes that it will be able to fund any further operating
losses and to refinance or otherwise restructure its outstanding debt
obligations through either the issuance of new equity securities, the
incurrence of new debt or the modification of the terms of its existing
debt obligations.
40
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
There can be no assurance that the Company can accomplish these matters,
or can do so under acceptable terms. These financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.
(4) Discontinued Operations
As of December 31, 2001 the Company had commenced a plan to dispose of
its engineering design services business. In January 2002 substantially
all of the assets related to this business were sold to Flextronics
International, Ltd. ("Flextronics"). Proceeds from the sale amounted to
$2,800,000 and consisted of $1,660,000 in cash at closing, a hold-back of
$140,000 which was paid six months after the closing and a hold-back of
$1,000,000 to be applied against amounts due to Flextronics pursuant to
the design services agreement discussed below. In conjunction with the
sale, the Company and Flextronics entered into a design services
agreement whereby the Company has agreed to purchase and Flextronics has
agreed to provide a specified number of hours of engineering design
services over the next year. Such services will be charged at agreed upon
rates and will aggregate approximately $1,000,000. As of December 31,
2002 the Company had utilized approximately $807,000 of such services and
the remaining balance of the hold-back amounted to $193,000.
The disposal of these operations has resulted in a loss of $956,000 which
has been recognized as of December 31, 2001. The loss includes the loss
from operations of the design services business from December 31, 2001 to
the date of disposal, certain costs associated with the disposal and
costs associated with a real estate lease related to those operations.
Approximately one year of lease costs, or $249,000 has been charged to
the discontinued operations. As of December 31, 2001 the net assets of
discontinued operations are comprised of the following (in thousands):
2001
----------
Accounts receivable $ 120
Inventories 53
Other current assets 14
Property and equipment, net 410
Goodwill, net 2,283
----------
$ 2,880
==========
In the third quarter of 2002 the Company reached an agreement in
principle regarding certain indemnification obligations to Savage Sports
Corporation ("Savage Sports")(See Note 15). Under the agreement, the
Company will pay Savage Sports a total of $1,575,000 over a four-year
period. Also under the agreement, Savage Sports will fund the cost of
insurance programs that are expected to respond to any other such claims
that may arise. The Company recorded a charge of $1,520,000 related to
this matter in the third quarter of 2002 as a loss from discontinued
operations. At December 31, 2002 $1,450,000 is payable under this
arrangement of which $1,100,000 is due after one year.
41
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
(5) Subsequent Events
Subsequent to December 31, 2002, the Company has completed a series of
financing transactions and is seeking to complete other such transactions
and to affect amendments to it credit agreements.
In January and March 2003, the Company completed private placement
transactions in which it issued a total of 4,166,667 shares of common
stock and warrants for the purchase of an additional 4,333,333 shares of
common stock for aggregate proceeds of $500,000. The warrants have an
exercise price of $0.15 per share and are exercisable at any time through
March 31, 2007.
In March 2003, the Company and DNA-CS entered into a revolving line of
credit with a bank in order to provide working capital to DNA-CS. Under
the facility, DNA-CS may borrow up to $1,000,000. Outstanding amounts are
due March 26, 2004; however, DNA-CS may extend such date six months,
provided certain conditions are maintained. Interest is payable monthly
at the greater of prime plus 1% and 5.25%. At March 31, 2003, $600,000
was outstanding under this facility.
This working capital facility is secured by the accounts receivable and
inventory of DNA-CS, the guarantee of the Company and by limited
guarantees provided by certain private investors. As consideration for
providing the guarantees that secure the Notes the Company has entered
into a Reimbursement Agreement with the guarantors. The Reimbursement
Agreement provides that the Company will reimburse the investors for any
amounts that they may be required to reimburse the bank pursuant to the
guarantees. Pursuant to the Reimbursement Agreement and related
agreements, the investors have the right to purchase up to 8,333,333
shares of the Company's common stock for $1,000,000 in cash, the proceeds
of which will be used to repay amounts outstanding under the Note and
provide for the release of the guarantees. In addition, the investors
have received warrants to purchase an aggregate of 9,582,334 shares of
the Company's common stock at a price of $0.15 per share. The warrants
may be exercised at any time through March 31, 2007.
(6) Investment in Affiliate
On August 30, 2001 the Company completed the sale of essentially all of
the assets related to the OmniLynx product line to ITI, which is a
corporation owned by Singapore Technologies Electronics Ltd. ("STE") and
the Company. Concurrent with the sale of the assets the Company
contributed $1,250,000 to ITI for its 33% equity interest. The Company
has minority board of director representation in ITI and exercises no
day-to-day control over the operations of ITI; therefore, the Company
accounts for its equity interest using the equity method of accounting.
In February 2003 STE purchased additional shares of ITI common stock for
$1,500,000. Subsequent to this transaction the Company owns approximately
22% of ITI's common stock.
42
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
Summary unaudited financial information for ITI is as follows (in thousands):
As of
December 31,
2002
------------
Current assets $ 5,624
Non-current assets 35
------------
$ 5,659
============
Current liabilities $ 3,235
Non-current liabilities --
Stockholders' equity 2,424
------------
$ 5,659
============
Twelve months
ended
December 1,
2002
-------------
Net sales $ 4,308
Cost of sales 1,968
Operating expenses 3,852
-------------
Operating loss (1,512)
Other income 4
-------------
Loss before taxes (1,508)
Income taxes 141
-------------
Net loss $ (1,367)
=============
The Company had, in the fourth quarter of 2000 determined that, due to changes
in certain target markets, its OmniLynx product line of optical networking
equipment no longer fit into its long-term objectives and began plans to sell
the product line and related operations. From that point until the ultimate
disposal of those assets to ITI the operations related to the OmniLynx product
line were significantly curtailed. As of December 31, 2000 the Company adjusted
the carrying value of these assets to their estimated net realizable value and
classified such assets as Assets Held for Sale. This resulted in a charge to
operations in the fourth quarter of 2000 as follows (in thousands):
Reduction of inventory to estimated net
realizable value $ 5,642
Reduction of property and equipment
to estimated net realizable value 2,199
Write-off of capitalized software development
costs and purchased intangibles 1,383
Other 27
----------
Asset writedown $ 9,251
==========
43
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
Pursuant to the sale of the OmniLynx assets to ITI, the Company received
a net cash payment of $1,000,000 and is entitled to receive additional
amounts from ITI based upon the utilization of inventory acquired from
the Company and based on the financial position of ITI at certain points
in time. The maximum additional amount that could be received from ITI is
approximately $2,700,000, although the Company estimates the actual
amount will be significantly less. Because of uncertainties regarding the
amount to be received, the Company has recognized no gain or loss on the
sale. This resulted in the receivable from ITI being initially recorded
at $780,000. The Company retained accounts receivable arising prior to
this transaction, as well as accounts payable and other liabilities, such
as warranty obligations, which arose prior to the sale. As a result of
exiting the OmniLynx business, the Company incurred certain non-recurring
expenses totaling $2,101,000 which have been classified as Costs Related
to Sale of Assets in the Statement of Operations.
(7) Inventories
The components of inventories are as follows (in thousands):
December 31,
-----------------------
2002 2001
---------- ----------
Raw materials $ 1,658 $ 2,615
Work in progress 408 493
Finished goods 288 154
---------- ----------
Total $ 2,354 $ 3,262
========== ==========
(8) Property and Equipment
Property and equipment are summarized as follows (in thousands):
December 31,
------------------------
2002 2001
---------- ----------
Machinery and equipment $ 1,048 $ 940
Computer equipment 297 288
Software 388 326
Furniture and fixtures 144 144
Leasehold improvements 101 101
---------- ----------
1,978 1,799
Less:
Accumulated depreciation and amortization (1,405) (1,161)
---------- ----------
Total $ 573 $ 638
========== ==========
44
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
(9) Notes payable
Notes payable consist of the following (in thousands):
December 31,
------------------------
2002 2001
---------- ----------
Guaranteed bank facilities (A) $ 4,200 $ 6,000
Short-term notes (B) 647 1,454
Other (C) 100 100
---------- ----------
Amount due within one year 4,947 7,554
Amount due after one year (4,047) (7,554)
---------- ----------
$ 900 $ --
========== ==========
(A) In June 2001 the Company entered into a loan agreement with Bank One,
N.A. ("Bank One") which provides for borrowings of up to $4,500,000 on a
non-revolving basis. In October 2002 the Company repaid $2,000,000 of
this facility with the proceeds from the sale of common stock in a
private placement. At this time the facility was amended to provide for
maximum borrowings of $2,700,000. All amounts outstanding under this
facility are due March 31, 2004 and the maximum amount outstanding is
reduced quarterly as follows: April 30, 2003 - $90,000; June 30, 2003 -
$810,000; September 30, 2003 - $450,000; December 31, 2003 - $450,000.
Interest is payable monthly at LIBOR plus 1.75% (3.19% at December 31,
2002). This facility is secured by a letter of credit provided by private
investors. At December 31, 2002 the letter of credit has an aggregate
face amount of $3,000,000 and has been supplied by a single private
investor. In connection with the repayment of amounts under the facility
in October of 2002, letters of credit aggregating $2,000,000 were
released and cancelled.
In October 2001 the Company entered into another loan agreement with Bank
One which provides for borrowings of up to $1,500,000 on a revolving
basis. This facility matured January 31, 2003; however, Bank One has
agreed to extend the maturity until June 30, 2003. Interest is payable
monthly at prime (4.25% at December 31, 2002). This facility is secured
by the guaranty of the private investor that provides the letter of
credit discussed above.
The Company, Bank One and the private investor are engaged in
negotiations regarding amendments to the credit facilities described
above in order to extend the maturities of the facilities. These
amendments may include repayment of certain outstanding amounts with a
portion of the proceeds from other financing activities (See Note 5 -
Subsequent Events). These negotiations have not been completed and
therefore no effect from any such amendments has been reflected in the
accompanying financial statements.
In connection with the letters of credit and guaranty of the above
facilities, the Company entered into reimbursement agreements with the
parties providing the security. The agreements provide that the Company
will reimburse the securing parties for any costs associated with the
letters of credit and guaranty, including any amounts which those parties
may be required to fund to the bank. The Company has agreed to grant
these parties a security interest in certain accounts receivable and
inventories in the event they must fund amounts to the bank. In addition,
the Company has agreed not to pledge certain of its assets or to incur
certain indebtedness in excess of $1,000,000 without the consent of the
securing parties. As consideration for providing this security the
Company has issued
45
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
warrants for the purchase of the Company's common stock to the securing
parties and has amended certain other warrants previously held by the
parties. The new and amended warrants provide for the purchase of up to
3,970,000 shares of the Company's common stock at a price of $0.15 per
share. The warrants generally expire in October, 2004. The fair value of
the new warrants and the amendment to the existing warrants is
approximately $200,000 using the Black-Scholes pricing model. This amount
is being amortized over the average term of the loans and is included in
interest expense.
(B) The private investor providing security for the loan agreements
described above, also has provided the Company with a series of cash
advances. These advances are pursuant to a series of short-term notes. As
of December 31, 2002 one note is outstanding with a maturity of September
15, 2003. The note provides for interest at 8% annually, payable upon
maturity of the note.
(C) Consists of $100,000 payable to an officer and director under a
demand note bearing interest of prime plus 3%. This note may be converted
into common stock at the option of the holder at the rate of $1.00 per
share.
(10) Commitments
Leases -
The Company leases office space and certain equipment under leases
expiring at various dates through 2005. Rental expense under operating
leases was approximately $791,000, $1,284,000, and $1,345,000 for the
years ended December 31, 2002, 2001 and 2000, respectively.
Future minimum commitments as of December 31, 2002 under operating leases
are as follows (in thousands).
Years ending December 31,
2003 $ 1,040
2004 800
2005 689
2006 --
----------
Total minimum lease payments $ 2,529
==========
(11) Employee Benefit Plans
The Company sponsors defined contribution 401(k) plans for substantially
all employees. Pursuant to the plans, employees may request the Company
to deduct and contribute amounts from their salary on a pre-tax basis.
Employee contributions are subject to certain limitations and the Company
may make matching contributions, at its discretion. The Company may also
make discretionary contributions in addition to matching contributions.
Company contributions vest ratably over periods of four to five years,
beginning in the second or first year of employment, respectively.
Company contributions to the plans were $136,000, $158,000 and $231,000
for the years ended December 31, 2002, 2001 and 2000, respectively.
46
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
(12) Income Taxes
The difference between the actual income tax benefit and the benefit
computed by applying the statutory corporate income tax rate of 34% to
pretax losses from continuing operations is attributable to the following
(in thousands):
Years ended December 31,
--------------------------------------
2002 2001 2000
---------- ---------- ----------
Computed expected tax benefit $ (1,479) $ (7,327) $ (10,054)
Increase in valuation allowance (168) 7,187 9,328
Non-deductible expenses 222 230 251
Other 1,425 (90) 475
---------- ---------- ----------
Tax expense $ -- $ -- $ --
========== ========== ==========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 2002 and 2001 are as follows (in thousands):
December 31,
------------------------
2002 2001
---------- ----------
Deferred tax assets:
Preacquisition net operating loss carryforwards $ 4,831 $ 4,831
Postacquisition net operating loss carryforwards 52,743 52,768
Accounts receivable -- 546
Inventories 261 176
Accrued liabilities 785 470
Alternative minimum tax and other credit
carryforwards 38 38
Other 3 --
---------- ----------
58,661 58,829
Less valuation allowance (58,616) (58,784)
---------- ----------
Deferred tax assets $ 45 $ 45
Deferred tax liabilities (45) (45)
---------- ----------
$ -- $ --
========== ==========
At December 31, 2002, the Company had federal operating loss carryforwards of
approximately $169,243,000. The future utilization of preacquisition net
operating losses of $14,210,000 will be limited under Internal Revenue Code
Sections 382 and 383.
47
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
Following is a summary of the carryforwards and the expiration dates as
of December 31, 2002 (in thousands):
Expiration
Amounts Dates
----------- -------------
Postacquisition net operating loss carryforwards $ 155,033 2010-2022
Preacquisition net operating loss carryforwards $ 14,210 2008-2009
(13) Warrant Issuances
The Company has issued various series of warrants in connection with debt
and equity financings, and as compensation for investment banking and
other services. As of December 31, 2002 there were outstanding warrants
to purchase 7,907,602 shares of the Company's common stock as follows:
Shares Subject to Warrants Exercise Price Expiration Date
----------------------------- ----------------------- ---------------------
199,400 $0.09 2004
3,970,000 $0.12 2003-2005
3,738,202 $2.00 and greater 2003-2004
All of the warrants outstanding above are exercisable. In February and
March of 2000, warrants for the purchase of 2,495,000 shares of common
stock were exercised, resulting in net proceeds to the Company of
approximately $5,180,000.
The issuance of warrants during the three year period ended December 31,
2002 is as follows:
2002
In April, 2002 warrants for the purchase of 26,017,308 shares of common
stock were returned to the Company and cancelled in exchange for the
issuance of 2,000,000 shares of common stock. These warrants had an
exercise price of $0.75 per share and stated expiration dates ranging
from 2002 to 2004.
In October, 2002 the Company issued warrants for the purchase of 400,000
shares of common stock at $0.12 per share exercisable through September,
2005 and amended certain other warrants for the purchase of an aggregate
of 780,000 shares of common stock to reduce the exercise price from $0.75
per share to $0.12 per share. The amended warrants expire in 2003 and
2004. These transactions were in connection with the sale of 16,666,668
shares of common stock in a private placement, the proceeds of which were
used to repay $2,000,000 in notes payable. See Note 9. The Company has
valued the warrants issued and the effect of the repricing at $307,000
using the Black-Scholes option pricing model. This amount has been
recorded as a deferred financing cost.
In connection with the restructuring and extension of certain notes
payable, the Company in December, 2002 issued warrants for the purchase
of 960,000 shares of common stock at $0.12 per share through October,
2004. In connection with this transaction the Company also amended
warrants for the purchase of an aggregate of 1,830,000 shares of common
stock to provide for an exercise price of $0.12 per share. These
warrants, which expire at various dates in 2003 and 2004 previously had
exercise prices of from $0.20 per share to $0.80 per share. See Note 9.
48
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
2001
In June, 2001 and October, 2001, the Company issued warrants for the
purchase of an aggregate of 2,160,000 shares of common stock in
connection with certain credit arrangements (Note 9).
2000
In January, 2000 the Company issued warrants for the purchase of
4,780,166 shares of common stock in connection with a private placement
of common stock.
In November, 2000 the Company issued warrants for the purchase of
19,500,000 shares of common stock in connection with the settlement with
St. James Capital Partners, L.P. and certain of its affiliates ("St.
James") involving the anti-dilution provisions of warrants previously
issued to St. James. In connection with this settlement St. James
returned to the Company, and the Company cancelled, warrants for the
purchase of 2,035,000 shares of common stock.
(14) Employee Stock Option Plan
In 1995, the Company adopted a stock option plan (the "Plan") pursuant to
which the Company's Board of Directors may grant stock options to
directors, officers and key employees. The Plan, as amended, authorizes
grants of options to purchase up to 15,500,000 shares of authorized
common stock. The exercise price for stock options granted may range from
75% to 110% of the fair market value of the shares on the date of grant.
All stock options have 10-year terms and vest and become fully
exercisable according to schedules determined by the Board of Directors,
generally one-third on each of the first three anniversaries of the date
of grant. At December 31, 2002, there were 2,734,407 shares available for
grant under the Plan. The Plan replaced a predecessor plan which
continues only to the extent that there are 140,000 unexercised options
outstanding at December 31, 2002.
The weighted-average fair value per share of stock options granted during
2002, 2001 and 2000 was $0.16, $0.43 and $1.77, respectively, on the
dates of grants. The fair value of each option grant is estimated on the
date of grant using the Black-Scholes option pricing model, with the
following weighted-average assumptions:
Years ended December 31,
-----------------------------------------------
2002 2001 2000
---------- ------- ---------------
Expected dividend yield 0% 0% 0%
Stock price volatility 130% 150% 130%
Risk free interest rate 1.67% to 4.8% to
3.5% 5.4% 6.2%
Expected option term 7 years 7 years 3 to 5 years
49
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
Stock option activity during the periods indicated was as follows:
Years ended December 31,
--------------------------------------
2002 2001 2000
---------- ---------- ----------
Number of options:
Outstanding, beginning of
period 6,268,468 5,530,305 4,372,197
Granted 5,621,500 1,917,000 2,458,000
Exercised -- -- (452,159)
Canceled (1,123,968) (1,178,837) (847,733)
---------- ---------- ----------
Outstanding, end of period 10,766,000 6,268,468 5,530,305
Weighted average exercise price:
Outstanding, beginning of
period $ 1.15 $ 1.50 $ 1.39
Granted $ 0.16 $ 0.44 $ 2.05
Exercised $ -- $ -- $ 2.61
Canceled $ 1.58 $ 1.62 $ 1.91
Outstanding, end of period $ 0.59 $ 1.15 $ 1.50
At December 31, 2002, 2001 and 2000, the number of options exercisable
was 7,537,222, 3,724,046 and 2,169,995, respectively, and the
weighted-average exercise price of those options was $0.95, $1.40 and
$1.92, respectively.
Additional information with respect to options outstanding at December
31, 2002 is as follows:
Options outstanding Options exercisable
------------------------------------------------ -------------------------------
Weighted
average Weighted Weighted
remaining Option average Option average
Exercise prices contractual shares exercise shares exercise
per share life outstanding price exercisable price
-------------------- -------------- -------------- -------------- -------------- --------------
$ 0.380-$1.000 8.79 years 9,201,000 $ 0.393 6,300,568 $ 0.4623
$ 1.010-$2.660 6.89 years 1,212,500 $ 1.372 968,324 $ 1.4130
$ 2.661-$3.156 5.45 years 352,500 $ 3.083 268,330 $ 3.0651
-------------- --------------
10,766,000 7,537,222
============== ==============
(15) Contingencies
A shareholder class action lawsuit was filed in the U. S. District Court
for the Northern District of Texas in November 1999 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
50
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
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 monetary
damages, interest, costs and expenses. In March 2001, the defendants'
motion to dismiss the case was denied. In December, 2002 the Court denied
the plaintiffs' motion for class certification. The plaintiffs appealed
this ruling to the 5th Circuit Court of Appeals which in March 2003
refused to hear the appeal. Certain motions are now pending before the U.
S. District court to determine the extent of individual plaintiffs'
claims in this matter.
United Pacific Insurance Company, an affiliate of Reliance Insurance
Company, the insurance carrier which provides the primary $2 million of
insurance coverage for this matter, 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
under this insurance coverage and it could be some period of time before
we can determine this. We received $300,000 related to this claim from
guarantee funds maintained by the insurance commissioner of the State of
Texas. If the Company doesn't receive the full benefit of this coverage,
there could be a material adverse impact on the Company.
The Company is contingently liable for certain potential claims that
arise out of Savage Arms, Inc., a manufacturer of sporting bolt action
rifles (Savage Arms). The Company sold Savage Arms to the Savage Sports
Corporation (Savage Sports), and pursuant to the Stock Purchase Agreement
executed on October 3, 1995, agreed to indemnify Savage Sports for
certain product liability claims, environmental clean-up costs and other
contractual liabilities, including certain asserted successor liability
claims, that Savage Sports incurred because of Savage Arms.
In June 2000 Savage filed suit against the Company in Superior Court in
Hampton County, Massachusetts seeking reimbursement from the Company of
various amounts related to a settlement of various product liability
claims between Savage and Emhart Industries, Inc. In January 2001, the
Company and Savage entered into a settlement agreement disposing of this
litigation. Pursuant to the agreement the Company agreed to pay Savage
approximately $1,200,000 over two years, including approximately $600,000
upon the signing of the agreement, and agreed to contribute towards the
annual cost of product liability insurance which covers any future
claims. A charge related to the settlement was recorded in the financial
statements as of December 31, 2000 and is included in the Consolidated
Statements of Operations under the caption Interest income and other,
net.
A firearms product liability lawsuit was filed in Alaska Superior Court
(the Taylor litigation). Western Auto Supply Co. is a defendant in the
Taylor litigation, and has settled the claim for $5 million. Western Auto
Supply Co. asserted a third-party claim against Savage Sports seeking
indemnification in the amount of the settlement, plus attorneys' fees and
related costs. During 2002 Savage reached a settlement on this matter
pursuant to which it agreed to pay a total of $1,000,000 over a period of
four years. Savage then sought indemnification from the Company for these
amounts.
51
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
In October, 2002 the Company reached an agreement in principle with
Savage regarding all indemnification matters, including the balance of
amounts due Savage pursuant to the settlement agreement reached in
January, 2001. Under this agreement the Company has agreed to pay Savage
a total of $1,575,000, which includes the remaining balance of the prior
settlement, over a four year period. Savage has agreed to fund the cost
of insurance programs that are expected to respond to any other such
claim that may arise in the future. The Company is aware of no such
claims and Savage has advised us that they are not aware of any
additional claims. The Company recorded a charge of $1,520,000 related to
this matter in the third quarter of 2002.
During 2000, the Company settled a dispute with a former professional
service provider which resulted in cash and non-cash proceeds to the
Company totaling approximately $1,070,000. This amount is included in the
Consolidated Statements of Operations under the caption Interest income
and other, net.
(16) Segments of Business and Geographic Areas
The Company's primary business segments consist of (a) optical networking
equipment in which the Company designs, develops, manufactures and
markets optical networking equipment used in the telecommunications
industry and (b) defense electronics (formerly referred to as digital
signal processor (or DSP) in which the Company provides state-of-the-art
digital processing products to product manufacturers and application
developers.
The accounting policies of the segments are the same as those described
in the significant accounting policies and practices (Note 2).
Sales to external customers (in thousands):
Years ended December 31,
------------------------------------
2002 2001 2000
---------- ---------- ----------
Defense electronics $ 5,036 $ 4,195 $ 3,599
Optical networking equipment -- 2,368 6,994
Other -- 259 1,155
---------- ---------- ----------
Total $ 5,036 $ 6,822 $ 11,748
========== ========== ==========
Included in the above were direct and indirect export sales of (in
thousands):
Total $ 183 $ 863 $ 1,732
========== ========== ==========
52
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
Segment-specific margins (gross profit less total engineering and
development costs, including capitalized software, and asset write downs
for the segment) (in thousands):
Years ended December 31,
--------------------------------------
2002 2001 2000
---------- ---------- ----------
Defense electronics $ (1,101) $ (2,710) $ (1,347)
Optical networking equipment (84) (1,336) (15,463)
Other (178) (2,189) 498
---------- ---------- ----------
Subtotal segment specific (1,363) (6,235) (16,312)
Capitalized software costs -- -- 896
All other expenses (5,872) (10,489) (13,646)
---------- ---------- ----------
Operating loss $ (7,235) $ (16,724) $ (29,062)
========== ========== ==========
Assets, capital expenditures and depreciation are identifiable only by
combined segments, as grouped below (in thousands):
At December 31,
------------------------------------
ASSETS 2002 2001 2000
---------- ---------- ----------
Defense electronics $ 3,760 $ 4,052 $ 8,450
Optical networking equipment
and other 1,501 2,625 8,902
Not allocable to a segment 1,463 3,519 6,652
---------- ---------- ----------
Total $ 6,724 $ 10,196 $ 24,004
========== ========== ==========
Years ended December 31,
------------------------------------
2002 2001 2000
---------- ---------- ----------
CAPITAL EXPENDITURES
Defense electronics $ 176 $ 83 $ 688
Optical networking equipment
and other -- -- 1,165
Not allocable to a segment 3 242 35
---------- ---------- ----------
Total $ 179 $ 325 $ 1,888
========== ========== ==========
DEPRECIATION
Defense electronics $ 138 $ 130 $ 531
Optical networking equipment
and other -- -- 1,509
Not allocable to a segment 106 528 16
---------- ---------- ----------
Total $ 244 $ 658 $ 2,056
========== ========== ==========
(17) Related Party Transactions
During the year ended December 31, 2000 the Company paid legal fees in
the amount of $379,000 for legal services from a law firm affiliated with
a former director.
53
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(continued)
(18) Significant Customers and Concentration of Credit Risk
In 2002 three defense electronics customers accounted for 37%, 17% and
11%, respectively, of consolidated net revenues. In 2001 one defense
electronics customer accounted for 37% of consolidated net revenues.
In 2000 one optical networking customer accounted for 28% and one defense
electronics customer accounted for 20% of consolidated net revenues.
The Company is subject to credit risk through trade receivables. The
Company's customers are generally large prime or subcontractors that are
involved in providing products and services to agencies of the United
States. Sales terms are normally 30 to 45 days from date of shipment.
(19) Supplemental Disclosure of Cash Flow Information
Years ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Cash paid during the period for:
Interest $ 341 $ 131 $ 665
Noncash Financing and Investment Transactions
During the years ended December 31, 2001 and 2000 the Company recorded
the following non-cash financing transactions:
2001:
o The Company issued common stock in settlement of approximately
$387,000 due to certain former employees pursuant to retention and
termination agreements.
2000:
o As of December 31, 1999 the Company had outstanding $8,000,000 in
notes payable to St. James. These notes were convertible into
common stock at the election of St. James at a rate per share
equal to the greater of $1.08 and 66 2/3% of the market price at
the time of the exchange. The granting of these conversion rights
resulted in a beneficial conversion feature in the amount of
$1,054,000 which amount has been reflected as a loss on retirement
of debt during the year ended December 31, 2000. During the course
of 2000 St. James converted the outstanding principal of
$8,000,000 and approximately $300,000 of accrued interest into an
aggregate of 4,858,438 shares of common stock. This equates to a
weighted average conversion rate of approximately $1.71 per share.
o Also during 2000, a note payable and related accrued interest
amounting to approximately $63,000 payable to an employee was
converted into 31,687 shares of common stock pursuant to the terms
of the note.
o In January 2000, the Company issued 7,200,000 shares of common
stock and warrants for the purchase of 3,600,000 shares of common
stock in a private placement. Net proceeds to the Company amounted
to approximately $16,800,000. The warrants provide for an exercise
price of $2.26 per share and are exercisable through January 2003.
54
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(concluded)
o In March 2000, the Company issued 4,600,000 shares of common stock
in a private placement. Net proceeds to the Company amounted to
approximately $25,800,000. The Company utilized approximately
$7,493,000 of these proceeds to redeem all outstanding Series A
Preferred Stock.
o During 2000, the Company issued 2,495,000 shares of common stock
upon the exercise of warrants, including a portion of the warrants
issued in connection with the January, 2000 private placement.
Proceeds to the Company from the exercise of these warrants
amounted to approximately $5,180,000.
(20) Valuation and Qualifying Accounts
Additions Additions
Balance at charged to charged to Balances
beginning costs and other at end
of period expenses accounts Deductions of period
---------- ---------- ---------- ---------- ----------
(In thousands)
Allowance for doubtful accounts:
For the year ended December 31, 2002 $ 1,606 $ 46 $ -- $ 1,652(a) $ --
For the year ended December 31, 2001 $ 1,460 $ 285 $ -- $ 139(a) $ 1,606
For the year ended December 31, 2000 $ 1,078 $ 1,168 $ -- $ 786(a) $ 1,460
Notes:
(a) Accounts written off
(21) Quarterly Information (Unaudited)
Quarter ended:
------------------------------------------------------------
March 31 June 30 September 30 December 31
------------ ------------ ------------ ------------
(In thousands, except per share amounts)
Year ended December 31, 2002:
Net revenue $ 1,630 $ 1,659 $ 718 $ 1,029
Gross profit $ 871 $ 699 $ 93 $ 39
Income (loss) from continuing
operations $ 4,784 $ (2,067) $ (2,554) $ (2,993)
Loss from discontinued -- -- (1,520) --
Net income (loss) $ 4,784 $ (2,067) $ (4,074) $ (2,993)
Net income (loss) per share 0.06 (0.02) (0.05) (0.03)
Year ended December 31, 2001:
Net revenue $ 3,054 $ 1,892 $ 925 $ 951
Gross loss $ (120) $ (61) $ (585) $ (373)
Net loss $ (4,905) $ (4,345) $ (6,747) $ (5,552)
Net loss per share $ (0.06) $ (0.05) $ (0.08) $ (0.06)
55
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Company's executive officers and directors is
set forth below. Directors serve one-year terms expiring at the next annual
meeting of stockholders. The executive officers of the Company are elected by
the Board of Directors.
Name Age Office and Employment During Last Five Years
---- --- --------------------------------------------
Herman M. Frietsch 63 Chairman of the Board since 1989, Chief Executive Officer
since February 1997, Director since 1988, Executive Chairman
from October 1995 to February 1997.
Robert P. Capps 49 Executive Vice President, Chief Financial Officer, Treasurer and
Secretary of the Company since August 1999. Prior to
joining the Company, Mr. Capps was Executive Vice President
and Chief Financial Officer of Dynamex, Inc. from 1996 to
1999 and Executive Vice President and Chief Financial
Officer of Hadson Corporation from 1986 until 1996.
Dr. R. Eugene Helms 52 Executive Vice President and Corporate Development Officer
of the Company and President of DNA Computing Solutions,
Inc., Vice President and Chief Technology Officer since June
1996. President and Chief Executive Officer of DNA
Enterprises, Inc. (a subsidiary of the Company) from April
1996 to September 1999. President and Owner of
TeleSolutions Inc., a consulting firm, from January 1990 to
1996. Vice President, Engineering of Mizar, Inc., a DSP
products manufacturer, from March 1994 to October 1995.
Robert E. Garrison II 61 Director of the Company. Mr. Garrison has been President
and Chief Executive Officer of Sanders Morris Harris Group,
Inc., a publicly traded financial services company, since
January 1999. Mr. Garrison served as Executive Vice
President of Investment Banking with Harris, Webb &
Garrison, a regional investment banking and brokerage firm,
from June 1994 to January 1999. Mr. Garrison is a director
of Sanders Morris Harris Group, Inc. He has been a Director
of the Company since July 1997 and is Chairman of the Audit
Committee and a member of the Stock Option Committee.
Anton von Liechtenstein 62 Director of the Company. Mr. Liechtenstein is a private
investor and has not been employed by another company during
the past five years. He has been a Director since 1980 and is
Chairman of the Stock Option Committee and a member of the
Audit Committee.
56
David H. Yedwab 56 Director of the Company. Mr. Yedwab has been Executive Vice
President of the Eastern Management Group, a
management-consulting firm, since 1987. He has been a
Director since July 2000 and is a member of the Audit
Committee and the Compensation Committee.
Number of securities
remaining available for
Number of securities to be Weighted-average exercise future issuance under
issued upon exercise of price of outstanding equity compensation plans
outstanding options, options, warrants and (excluding securities
warrants and rights rights reflected in column a)
Plan Category (a) (b) (c)
----------------------------- ----------------------------- --------------------------- -----------------------------
Equity compensation plans
approved by security holders
7,500,407 $0.78 none
----------------------------- ----------------------------- --------------------------- -----------------------------
Equity compensation plans
not approved by security
holders(1) 3,265,593 $0.16 2,734,407
----------------------------- ----------------------------- --------------------------- -----------------------------
Total 10,766,000 $0.59 2,734,407
----------------------------- ----------------------------- --------------------------- -----------------------------
(1) In August 2002 our Board of Directors approved an amendment to the Company's
Amended and Restated Stock Incentive Plan (the "Incentive Plan"), increasing the
number of shares of common stock authorized to be issued under the plan to
15,500,000 from 9,500,000. The Incentive Plan has been previously approved by
our shareholders. However, the amendment that increased the authorized shares to
be issued under the Plan to 15,500,000 has not yet been approved by our
shareholders.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Messrs. Capps, Frietsch, Helms, Garrison, Yedwab and Liechtenstein
failed to file their Forms 5 with respect to calendar year 2002. A total of six
reports were filed late and seven transactions were reported late.
ITEM 11 - EXECUTIVE COMPENSATION
COMPENSATION OF DIRECTORS
Currently, employee directors receive no cash compensation for their
services as directors. Each non-employee, outside director is entitled to
receive a cash fee of $1,000 per month for service as a director. Members of the
Audit, Compensation, and the Stock Option Committees each are entitled to
receive a cash fee of $1,000 per month for each committee on which the director
serves. At the election of each director at the beginning of each year, all fees
are payable in cash or in Common Stock pursuant to the Directors' Stock Plan.
Directors can elect to defer receipt of the stock issued in payment of such fees
to a future fiscal year. With respect to fiscal year 2002, all members of the
Board elected to receive their fee in cash. Directors also may receive grants of
stock options at the discretion of the Board.
For a discussion of certain transactions between the Company and
certain directors and their affiliates, see "Item 13 - Certain Relationships and
Related Transactions."
57
COMPENSATION OF EXECUTIVE OFFICERS
Summary Compensation Table
The following table summarizes annual and long-term compensation for
each of the last three fiscal years to Herman M. Frietsch, Chief Executive
Officer of the Company, and the other two most highly compensated executive
officers of the Company who were serving at December 31, 2002 and who received
more than $100,000 in salary and bonus during the last fiscal year ended
December 31, 2002 (Named Executive Officers).
SUMMARY COMPENSATION TABLE
Annual Compensation
Long-Term Compensation Awards(1)
------------------------------------------------------------------------------------------------------------------------------
Securities
Other Underly-
Annual ing All other
Name and Principal Fiscal Compen- Options/ Compen-
Positions Year Salary ($) Bonus ($) sation ($) SARS (#) sation $(2)
------------------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Herman M. Frietsch 2002 290,000 -- -- 1,500,000 9,555
Chairman and Chief Executive 2001 278,850 -- -- 200,000 11,566
Officer 2000 275,255 -- -- 200,000 8,161
Robert P. Capps 2002 205,000 -- --
Executive Vice President, Chief 2001 197,125 -- -- 650,000 9,318
Financial Officer, Treasurer and 2000 150,278 10,000 -- 100,000 12,238
Secretary 165,000 2,624
R. Eugene Helms 2002 225,000 -- -- 800,000 12,906
Executive Vice President and 2001 225,000 -- -- 100,000 15,302
Corporate Development Officer 2000 210,000 -- -- 165,000 14,029
----------
(1) The Company has made no Restricted Stock Awards or Long Term
Incentive Plan payments.
(2) Consists of matching contributions to 401(k) defined contribution plan and
insurance premium for life, health and dental insurance.
58
The following table sets forth stock options granted in 2002 to each of
the named executive officers. The table also sets forth the hypothetical gains
that would exist for the options at the end of their ten-year terms at assumed
compound annual rates of stock price appreciation of 5% and 10%. The actual
future value of the options will depend on the market value of the Company's
common stock as the options are vested and exercisable.
OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
-------------------------------------------
Potential Realizable
Number of % of Total Value at Assumed Annual
Securities Options/ Rates of Stock Price
Underlying Granted to Exercise Appreciation for Option
Options Employees in Price Expiration Terms(1)
Name Granted (#) 2002 ($/Share) Date 5% ($) 10% ($)
----------------------------- -------------- --------------- ------------ -------------- ---------------------------
Herman M. Frietsch 1,500,000(2) 34% 0.16 08/19/12 150,900 382,500
Robert P. Capps 650,000(2) 15% 0.16 08/19/12 65,400 165,750
R. Eugene Helms 800,000(2) 18% 0.16 08/19/12 80,500 204,000
----------
(1) The amount shown on this table represents hypothetical gains that could be
achieved for the respective options, if exercised at the end of the option term.
These gains are based on assumed rates of stock price appreciation of 5% and 10%
compounded annually from the date the respective options were granted to their
expiration date. The gains shown are net of the option exercise price, but do
not include deductions for taxes or other expenses associated with the exercise.
Actual gains, if any, on stock option exercises will depend on the future
performance of the Common Stock, the option holder's continued employment
through the option period, and the date on which the options are exercised.
These amounts are not intended to forecast possible future appreciation, if any,
of the Company's stock price.
(2) Options granted August 19, 2002. Options have a two-year vesting schedule,
vesting 50% on December 31, 2002, 25% on the first anniversary of grant and 25%
on the second anniversary of the grant, except for such earlier vesting
permitted under the terms of the Amended and Restated Stock Incentive Plan.
59
The following table sets forth the number of shares acquired on
exercise of stock options and the aggregate gains realized on exercise in 2002
by the Named Executive Officers. The table also sets forth the number of shares
covered by exercisable and unexercisable options held by such executives on
December 31, 2002 and the aggregate gains that would have been realized had
these options been exercised on December 31, 2002, even though these options
were not exercised, and the unexercisable options could not have been exercised,
on December 31, 2002.
AGGREGATED OPTION/ EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options at
Shares Options at Fiscal Year-End (#) Fiscal Year-End(1)($)
Acquired Value
on Exercise Realized
Name (#) ($) Exercisable Unexercisable Exercisable Unexercisable
--------------------------- -------------- ----------- ---------------- --------------- ------------ -------------------
Herman M. Frietsch -- -- 2,056,667 833,333 -- --
Robert P. Capps -- -- 805,000 380,000 -- --
R. Eugene Helms -- -- 1,020,000 455,000 -- --
(1) Market value of shares covered by in-the-money options on December 31,
2002, less the option exercise price. Options are in-the-money if the
market value of the shares greater than the option exercise price.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of the Board of Directors of the Company
consists of two members, the Committee's Chairman Mr. Frietsch and Mr. Yedwab.
Mr. Frietsch serves as the Chairman of the Board and Chief Executive Officer of
the Company. Mr. Yedwab is an independent director.
EMPLOYEE AGREEMENTS
Herman M. Frietsch
The Company has had a contractual employment relationship with Mr.
Frietsch since 1995. This arrangement was recently revised, incorporated in, and
reformatted by an Employment Agreement effective as of January 1, 2001. Mr.
Frietsch has agreed to continue to serve as Chairman and Chief Executive Officer
of the Company. His employment agreement provides for a term, that ends on
December 31st following the third anniversary of the date that the Board of
Directors notifies Mr. Frietsch that the automatic daily extension of his
agreement will be discontinued. Mr. Frietsch receives a base salary of $290,000
per year, subject to increase at the determination of the Board of Directors,
and may receive a discretionary bonus subject to determination by the Board of
Directors. Mr. Frietsch is also entitled to receive options to purchase Common
Stock pursuant to the Company's Stock Incentive Plan. In the event of a
termination of Mr. Frietsch's employment (other than if Mr. Frietsch is
terminated for "cause" or if he terminates "without good reason"), all unvested
stock options issued and outstanding shall vest upon such termination.
In the event of a termination by the Company for "cause" (as defined in
the agreement) or by Mr. Frietsch "without good reason," then the Company's
obligation to pay compensation and benefits shall terminate as of that date,
other than for salary and benefits already accrued. In the event of termination
of
60
the agreement by the Company "without cause" or by Mr. Frietsch for "good
reason" (e.g., a material breach of the employment agreement by the Company, a
material change in the nature or scope of his authority and duties, his salary
is reduced, bonus eligibility is denied or required compensation payments are
not made), then the Company shall pay Mr. Frietsch as severance pay, at Mr.
Frietsch's option, in accordance with the general payroll practices of the
Company or in a lump sum payment, the greater of (i) $1,000,000 or (ii) the sum
of three years of his base salary as of the date of termination. If Mr. Frietsch
is terminated upon or following within twelve months of a "change in control,"
the Company shall pay as severance pay and as liquidated damages, at Mr.
Frietsch's option the greater of (i) the sum of three years of his base salary
and (ii) $1,000,000. In the event of termination for disability or death, then
Mr. Frietsch or his estate, as the case may be, is entitled to receive payments
equal to three years of his base salary at the time of termination. All payments
shall either be made in accordance with the Company's general payroll practices
or in a lump sum payment. Mr. Frietsch is entitled to a gross-up payment to
compensate for any excise taxes imposed.
R. Eugene Helms
Dr. Helms is party to an Employment Agreement with the Company dated
January 1, 2001, which provides for his continued employment as Executive Vice
President and Corporate Development Officer. Pursuant to the arrangement, Dr.
Helms is to receive a base salary of $225,000 per year. The term of the
arrangement extends through January 1, 2004 and is automatically renewed for
subsequent one-year terms, unless either party provides notice of termination in
accordance with the provisions of the agreement. The Company may terminate Dr.
Helms for disability, cause, without cause, and for death or disability, and Dr.
Helms may terminate the agreement for good reason and without good reason ( as
defined in the agreement). In the event of Dr. Helms' disability, as defined,
the Company has no obligation to pay further benefits under the Agreement. In
the event of termination for cause by the Company or without good reason by Dr.
Helms, the Company's obligation to pay compensation and benefits shall also
terminate. If the Company terminates Dr. Helms without cause or he terminates
the arrangement for good reason, then the Company shall pay severance pay an
amount equivalent to Dr. Helms' base salary for the greater of (i) two years
following the date of termination or (ii) the remainder of the term of the
agreement. Finally, in the event Dr. Helms is terminated due to a change in
control, then he is to receive as severance pay and liquidated damages, an
amount equal to $100 less than three times his "annualized includable
compensation for the base period" (as defined in Section 280G of the Internal
Revenue Code). All payments shall either be made in accordance with the
Company's general payroll practices or in a lump sum payment. Dr. Helms
continues to be eligible for bonuses and stock options at the Company's
discretion. Further, in accordance with the terms of the Stock Incentive Plan,
Dr. Helms' options vest in the event of a change in control (as defined in the
agreement). Dr. Helms is entitled to gross-up payments to compensate for any
excise tax imposed. In the event of Dr. Helms' death prior to the expiration of
the agreement, his employment and obligations to the Company shall automatically
terminate and his compensation shall terminate as of the end of the month of his
death. However, for the balance of the term of the agreement after his death,
his beneficiaries will be entitled to receive their Company benefits payable
under a life insurance policy provided by the Company and other amounts
reimbursable to Dr. Helms by the Company.
61
Robert P. Capps
Mr. Capps is party to an Employment Agreement with the Company dated
January 1, 2001, which provides for his continued employment as Executive Vice
President and Chief Financial Officer. Pursuant to the arrangement, Mr. Capps is
to receive a base salary of $205,000 per year. The term of the arrangement
extends through January 1, 2004 and is automatically renewed for subsequent
one-year terms, unless either party provides notice of termination in accordance
with the provisions of the agreement. The Company may terminate Mr. Capps for
disability, cause, without cause, and for death or disability, and Mr. Capps may
terminate the agreement for good reason and without good reason ( as defined in
the agreement). In the event of Mr. Capps' disability, as defined, the Company
has no obligation to pay further benefits under the Agreement. In the event of
termination for cause by the Company or without good reason by Mr. Capps, the
Company's obligation to pay compensation and benefits shall also terminate. If
the Company terminates Mr. Capps without cause or he terminates the arrangement
for good reason, then the Company shall pay severance pay an amount equivalent
to Mr. Capps' base salary for the greater of (i) two years following the date of
termination or (ii) the remainder of the term of the agreement. Finally, in the
event Mr. Capps is terminated due to a change in control, then he is to receive
as severance pay and liquidated damages, an amount equal to $100 less than three
times his "annualized includable compensation for the base period" (as defined
in Section 280G of the Internal Revenue Code). All payments shall either be made
in accordance with the Company's general payroll practices or in a lump sum
payment. Mr. Capps continues to be eligible for bonuses and stock options at the
Company's discretion. Further, in accordance with the terms of the Stock
Incentive Plan, Mr. Capps' options vest in the event of a change in control (as
defined in the agreement). Mr. Capps is entitled to gross-up payments to
compensate for any excise tax imposed. In the event of Mr. Capps' death prior to
the expiration of the agreement, his employment and obligations to the Company
shall automatically terminate and his compensation shall terminate as of the end
of the month of his death. However, for the balance of the term of the agreement
after his death, his beneficiaries will be entitled to receive their Company
benefits payable under a life insurance policy provided by the Company and other
amounts reimbursable to Mr. Capps by the Company.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of March 31,
2003, unless otherwise noted, with respect to the beneficial ownership of the
Company's Common Stock by (i) each person known by the Company to own
beneficially more than 5% of the outstanding Common Stock; (ii) each director
and nominee for director; (iii) each executive officer named in the Summary
Compensation Table under the heading "Executive Compensation" below; and (iv)
all directors and executive officers of the Company as a group. Unless otherwise
indicated, the information included below is based upon the Company's stock
transfer records as maintained by the Company's stock transfer agent.
The number of shares of Common Stock beneficially owned by each
director or executive officer is determined pursuant to the rules of the
Securities and Exchange Commission (the SEC), and the information is not
necessarily indicative of beneficial ownership for any other purpose. Under the
SEC's rules, an individual beneficially owns any shares as to which the
individual has sole or shared voting power or investment power and any shares,
which the individual has the right to acquire through the exercise of any stock
option or other right within the next 60 days. Unless otherwise indicated, each
person has sole investment and voting power (or shares such power with his or
her spouse) with respect to the shares set forth in the following table. The
inclusion herein of any shares deemed beneficially owned does not constitute
admission of beneficial ownership of those shares.
62
Name and Address Amount and Nature of
of Beneficial Owner Beneficial Ownership Percent of Class
------------------------------------------ ----------------------- ------------------
The Coastal Corporation Second
Pension Trust(11) 9,896,251 8.39%
SSJ Enterprises, LLC(12) 9,766,666(1) 7.98%
Morton A. Cohn(13) 9,123,334(2) 7.69%
Fayez Sarofim(14) 8,923,334(3) 7.52%
Herman M. Frietsch 2,623,479(4) 2.18%
Robert P. Capps 826,666(5) *
R. Eugene Helms 1,066,666(6) *
Robert H. Garrison 4,089,080(7) 3.35%
Anton von Liechtenstein 1,038,382(8) *
David H. Yedwab 500,000(9) *
All Directors and Executive Officers
as a group (6 persons) 10,144,273(10) 7.98%
(1) Includes 4,333,333 shares issuable upon the exercise of warrants.
(2) Includes 590,000 shares issuable upon the exercise of warrants.
(3) Includes 590,000 shares issuable upon the exercise of warrants.
(4) Includes 1,966,666 shares issuable upon the exercise of options that are
currently exercisable or become exercisable by June 15, 2003. Includes 154,813
shares, that assume conversion at a price of $1.00 per dollar of outstanding
principal, and interest of a loan made by Mr. Frietsch to the Company in
December 1997. Includes 6,000 shares owned beneficially by Mr. Frietsch's spouse
as to which he disclaims beneficial ownership.
(5) Represents 826,666 shares issuable upon exercise of options that are
currently exercisable or become exercisable by June 15, 2003.
(6) Includes 1,041,666 shares issuable upon the exercise of options that are
currently exercisable or become exercisable by June 15, 2003.
(7) Includes 1,000,000 shares issuable upon the exercise of options that are
currently exercisable or become exercisable by June 15, 2003, 1,666,667 shares
issuable upon the exercise of warrants and 1,250,000 shares issuable upon the
exercise of conversion rights associated with a credit facility.
(8) Includes 750,000 shares issuable upon the exercise of options that are
currently exercisable or become exercisable by June 15, 2003.
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(9)Represents 500,000 shares issuable upon the exercise of options that are
currently exercisable or become exercisable by June 15, 2003.
(10)Includes 6,084,998 shares issuable upon the exercise of options that are
currently exercisable or become exercisable by June 15, 2003, 1,666,667 shares
issuable upon the exercise of warrants, and 154,813 shares issuable upon the
exercise of conversion rights related to certain debt. Includes 6,000 shares
owned beneficially by Mr. Frietsch's spouse as to which he disclaims beneficial
ownership.
(11)The principal address of The Coastal Corporation Second Pension Trust is
1001 Louisiana Street, Houston, Texas 77002. The share information is provided
solely upon information provided by the holder to the SEC on said holder's
Schedule 13D.
(12)The principal address of SSJ Enterprises, LLC is 992 East Seventh Street,
Brooklyn, New York 11230. The share information is provided solely upon
information provided by the holder to the SEC on said holder's Schedule 13D.
(13)The principal address of Morton A. Cohn is 800 Bering Street, Houston, Texas
77057. The share information is provided solely upon information provided by the
holder to the SEC on said holder's Schedule 13D.
(14)The principal address of Fayez Sarofim is Two Houston Center, Suite 2907,
Houston, Texas 77010. The share information is provided solely upon information
provided by the holder to the SEC on said holder's Schedule 13D.
* Represents less than 1%
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On April 11, 2002, we issued 1,000,000 shares of Common Stock to The
Coastal Corporation Second Pension Trust ("Coastal") in exchange for the return
and cancellation of warrants for the purchase of 6,517,308 shares of Common
Stock that Coastal held. The 1,000,000 shares of Common Stock are deemed
restricted under federal securities laws; however, we have agreed to register
these shares with the SEC so Coastal may resell them without restriction.
On April 11, 2002 we issued 1,000,000 shares of Common Stock to St.
James Capital Partners, L.P. and SJMP, L.P. (collectively "St. James") in
exchange for the return and cancellation of warrants for the purchase of
19,500,000 shares of Common Stock. . These shares are deemed restricted under
federal securities laws; however, we have agreed to register these shares with
the SEC so St. James may resell them without restriction.
64
The Company is obligated to Mr. Frietsch under a demand note with a
principal amount of $100,000. The note bears interest at prime plus 3%. Accrued
and unpaid interest amounted to approximately $54,000 as of December 31, 2002.
The note and accrued interest is convertible into Common Stock at the option of
Mr. Frietsch at a rate of $1.00 per share.
In March 2003 the Company entered into a Reimbursement Agreement with
Robert E. Garrison II, a director of the Company, and certain other private
investors. Pursuant to the Reimbursement Agreement Mr. Garrison and the other
investors provided limited guarantees amounting to $1,375,000 to secure a
revolving credit agreement between the Company's wholly-owned subsidiary, DNA
Computing Solutions, Inc. and a bank. The limited guarantee provided by Mr.
Garrison amounted to $202,500. As consideration for providing the guarantee Mr.
Garrison received the right to purchase 1,250,000 shares of the Company's common
stock at a price of $0.12 per share, provided that any proceeds are utilized to
repay amounts outstanding under the revolving credit agreement and that the
limited guarantee is released by the bank. In addition, Mr. Garrison received
warrants for the purchase of 1,666,667 shares of common stock. The warrants have
an exercise price of $0.15 per share and are exercisable at any time through
March 31, 2007.
ITEM 14 - CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. The term
"disclosure controls and procedures" is defined in Rule 13a-14(c) of the
Securities Exchange Act of 1934, or the Exchange Act. This term refers to the
controls and procedures of a company that are designed to ensure that
information required to be disclosed by a company in the reports that it files
under the Exchange Act is recorded, processed, summarized and reported within
require time periods. Our Chief Executive Officer and our Chief financial
Officer have evaluated the effectiveness of our disclosure controls and
procedures as of a date within 90 days before the filing of this annual report,
and they have concluded that as of that date, our disclosure controls and
procedures were effective at ensuring that required information will be
disclosed on a timely basis in our reports filed under the Exchange Act.
(b) Changes in Internal Controls. We maintain a system of internal
controls that are designed to provide reasonable assurance that our books and
records accurately reflect in all material respects our transactions and that
our established policies and procedures are followed. There were no significant
changes in our internal controls or in other factors that could significantly
affect our internal controls subsequent to the date of their evaluation by our
Chief Executive Officer and our Chief financial Officer, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
PART IV
ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
A. The Financial Statements filed as part of this report are listed and
indexed on Page 32. Schedules other than those listed in the index have been
omitted because they are not applicable or the required information has been
included elsewhere in this report.
65
B. Listed below are all Exhibits filed as part of this report. Certain
Exhibits are incorporated by reference to documents previously filed by the
Registrant with the Securities and Exchange Commission pursuant to Rule 12b-32
under the Securities Exchange Act of 1934, as amended. Exhibits which are
incorporated by reference are indicated by the information in the parenthetical
following such exhibit.
Exhibit Description of Exhibit
------- ----------------------
3.1 Amended and Restated Certificate of Incorporation of the Company,
filed as an exhibit to the Company's Form 8-K filed on February 1,
2001 and incorporated by reference herein.
3.2* Amended and Restated By-Laws of the Company.
4.1 Warrant issued to Hambrecht & Quist LLC exercisable to purchase up
to 33,036 shares of Common Stock at an exercise price of $10.292 per
share, expiring May 20, 2003 filed as an exhibit to the Company's
Form 10-Q filed on August 14, 1998 and incorporated by reference
herein.
4.2 Form of Registration Rights Agreement between the Company and the
Buyers, dated as of December 22, 1998 filed as an exhibit to the
Company's Form 8-K filed on March 2, 1999 and incorporated by
reference herein.
4.3 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc. at an exercise price of $2.998 filed as an exhibit to the
Company's Form 8-K filed on March 2, 1999 and incorporated by
reference herein.
4.4 Registration Rights Agreement between the Company and Coastal filed
as an exhibit to the Company's Form 8-K filed on August 18, 1999 and
incorporated by reference herein.
4.5 Registration Rights Agreement among the Company and the Buyers,
dated February 24, 1999, relating to the Series E Convertible
Preferred Stock and warrants filed as an exhibit to the Company's
Form 8-K filed on March 2, 1999 and incorporated by reference
herein.
4.6 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc., relating to the Series E Preferred Stock filed as an exhibit
to the Company's Form 8-K filed on March 2, 1999 and incorporated by
reference herein.
4.7 Form of Warrant issued to Stonegate and the Investors to purchase
common stock of Intelect Communications, Inc. at $2.50 per share,
subject to adjustment filed as an exhibit to the Company's Form 8-K
filed on February 8, 2000 and incorporated by reference herein.
4.8 Warrant issued to Stonegate to purchase 250,000 shares of common
stock of Intelect Communications, Inc. at $1.00 per share filed as
an exhibit to the Company's Form 8-K filed on February 8, 2000 and
incorporated by reference herein.
4.9 Form of Registration Rights Agreement dated January 27, 2000 between
Intelect Communications, Inc., the Investors names therein, and
Stonegate filed as an exhibit to the Company's Form 8-K filed on
February 8, 2000 and incorporated by reference herein.
4.10 Form of Warrant issued to Stonegate affiliates to purchase common
stock of Intelect Communications, Inc. at $6.00 per share, subject
to adjustment filed as an exhibit to the Company's Form 8-K filed on
March 21, 2000 and incorporated by reference herein.
4.11 Form of Registration Rights Agreement dated March 14, 2000 between
Intelect Communications, Inc., the Investors named therein, and
Stonegate filed as an exhibit to the Company's Form 8-K filed on
March 21, 2000 and incorporated by reference herein.
4.12 Form of Amended and Restated Promissory Notes held by officer,
convertible into Common Stock of the Company at a rate of $1.00 per
share filed as an exhibit to the Company's Form 10-K filed on March
30, 2000 and incorporated by reference herein.
4.13 Securities Purchase Agreement dated September 30, 2002 between the
Company and Morton A. Cohn and Fayez Sarofim, filed as an exhibit to
the Company's Form 8-K filed October 21, 2002 and incorporated by
reference herein.
66
Exhibit Description of Exhibit
------- ----------------------
4.14 Registration Rights Agreement dated September 30, 2002 between the
Company and Morton A. Cohn and Fayez Sarofim, filed as an exhibit to
the Company's Form 8-K filed October 21, 2002 and incorporated by
reference herein.
4.15 Form of Amended and Restated Warrant expiring May 31, 2004 with an
exercise price of $0.12 per share, filed as an exhibit to the
Company's Form 8-K filed October 21, 2002 and incorporated by
reference herein.
4.16 Form of Warrant expiring October 31, 2004 with an exercise price of
$0.12 per share, filed as an exhibit to the Company's Form 8-K filed
October 21, 2002 and incorporated by reference herein.
4.17 Form of Amended and Restated Warrant expiring December 31, 2003 with
an exercise price of $0.12 per share, filed as an exhibit to the
Company's Form 8-K filed October 21, 2002 and incorporated by
reference herein.
4.18 Warrant expiring October 31, 2004 with an exercise price of $0.12
per share, filed as an exhibit to the Company's Form 8-K/A filed
January 15, 2003 and incorporated by reference herein.
4.19 Amended and Restated Warrant expiring October 31, 2004 with an
exercise price of $0.12 per share, filed as an exhibit to the
Company's Form 8-K/A filed January 15, 2003 and incorporated by
reference herein.
4.20 Amended and Restated Warrant expiring October 31, 2004 with an
exercise price of $0.12 per share, filed as an exhibit to the
Company's Form 8-K/A filed January 15, 2003 and incorporated by
reference herein.
4.21 Amended and Restated Warrant expiring December 31, 2003 with an
exercise price of $0.12 per share, filed as an exhibit to the
Company's Form 8-K/A filed January 15, 2003 and incorporated by
reference herein.
4.22 Amended and Restated Warrant expiring May 31, 2004 with an exercise
price of $0.12 per share, filed as an exhibit to the Company's Form
8-K/A filed January 15, 2003 and incorporated by reference herein.
4.23 Form of Registration Rights Agreement between the Company and
certain private investors, filed as an exhibit to the Company's Form
8-K/A filed January 15, 2003 and incorporated by reference herein.
4.24 Exchange Agreement dated April 11, 2002 between the Company and
Coastal, filed as an exhibit to the Company's Form 10Q filed May 10,
2002 and incorporated herein by reference.
4.25 Exchange Agreement dated April 11, 2002 between the Company and St.
James, filed as an exhibit to the Company's Form 10Q filed May 10,
2002 and incorporated herein by reference.
4.26 Registration Rights Agreement dated April 11, 2002 between the
Company and St. James, filed as an exhibit to the Company's Form 10Q
filed May 10, 2002 and incorporated herein by reference.
4.27 Form of Securities Purchase Agreement dated September 30, 2002
between the Company and certain private investors, filed as an
exhibit to the Company's Form 8-K/A filed November 13, 2002 and
incorporated by reference herein.
4.28 Form of Registration Rights Agreement dated September 30, 2002
between the Company and certain private investors, filed as an
exhibit to the Company's Form 8-K/A filed November 13, 2002 and
incorporated by reference herein.
4.29* Form of warrant expiring March 31, 2007 with an exercise price of
$0.15 per share.
10.1** Employment Agreement between the Company and Herman Frietsch and
Amendment thereto filed as an exhibit to the Company's Form 10-K
filed on March 30, 2000 and incorporated by reference herein.
67
Exhibit Description of Exhibit
------- ----------------------
10.2** Employment Agreement dated as of January 1, 2001 between the Company
and Eugene Helms filed as an exhibit to the Company's Form 10-K
filed April 15, 2002 and incorporated by reference herein.
10.3* Lease Agreement between Campbell Place One Joint Venture and DNA
Enterprises, dated February 1, 1997.
10.4 Agreement to Form Joint Venture dated August 17, 2001 between the
Company and Singapore Technologies Electronics Limited filed as an
exhibit to the Company's Form 8-K filed September 7, 2001 and
incorporated by reference herein.
10.5 Sharing Agreement dated August 30, 2001 among the Company, Intelect
Network Technologies Company and Intelect Technologies Inc. filed as
an exhibit to the Company's Form 8-K filed September 7, 2001 and
incorporated by reference herein.
10.6 Stockholders Agreement dated August 30, 2001 among the Company,
Intelect Technologies Inc. and Singapore Technologies Electronics
Limited filed as an exhibit to the Company's Form 8-K filed
September 7, 2001 and incorporated by reference herein.
10.7 Transition Services Agreement dated August 30, 2001 between the
Company and Intelect Technologies Inc. filed as an exhibit to the
Company's Form 8-K filed September 7, 2001 and incorporated by
reference herein.
10.8 Asset Purchase Agreement dated January 11, 2002 among the Company,
Flextronics Design S.D., Inc. and DNA Enterprises, Inc. filed as an
exhibit to the Company's Form 8-K filed January 15, 2002 and
incorporated by reference herein.
10.9 Design / Engineering Services Agreement dated January 11, 2002
between the Company and Flextronics Design S.D. filed as an exhibit
to the Company's Form 8-K filed January 15, 2002 and incorporated by
reference herein.
10.10 Form of Promissory Note dated June 1, 2001 in favor of Bank One,
N.A. filed as an exhibit to the Company's Form 10-Q filed August 14,
2001 and incorporated by reference herein.
10.11 Business Loan Agreement dated June 1, 2001 between the Company and
Bank One, N.A. filed as an exhibit to the Company's Form 10-Q filed
August 14, 2001 and incorporated by reference herein.
10.12 Reimbursement Agreement dated June 1, 2001 among the Company and
Oscar S. Wyatt, Jr., Fayez Sarofim and Morton Cohn filed as an
exhibit to the Company's Form 10-Q filed August 14, 2001 and
incorporated by reference herein.
10.13 Form of Promissory Note dated October 12, 2001 in favor of Bank One,
N.A. filed as an exhibit to the Company's Form 10-Q filed November
14, 2001 and incorporated by reference herein.
10.14 Loan Agreement dated October 12, 2001 between the Company and Bank
One, N.A. filed as an exhibit to the Company's Form 10-Q filed
November 14, 2001 and incorporated by reference herein.
10.15 Reimbursement Agreement dated October 12, 2001 between the Company
and Oscar S. Wyatt, Jr. filed as an exhibit to the Company's Form
10-Q filed November 14, 2001 and incorporated by reference herein.
10.16 Promissory Note dated October 5, 2001 filed as an exhibit to the
Company's Form 10-Q filed November 14, 2001 and incorporated by
reference herein.
10.17 Promissory Note dated October 12, 2001 filed as an exhibit to the
Company's Form 10-Q filed November 14, 2001 and incorporated by
reference herein.
10.18 Promissory Note dated September 29, 2001 filed as an exhibit to the
Company's Form 10-K filed April 15, 2002 and incorporated by
reference herein.
10.19 Promissory Note dated November 30, 2001 filed as an exhibit to the
Company's Form 10-K filed April 15, 2002 and incorporated by
reference herein.
10.20 Promissory Note dated December 14, 2001 filed as an exhibit to the
Company's Form 10-K filed April 15, 2002 and incorporated by
reference herein.
68
Exhibit Description of Exhibit
------- ----------------------
10.21 Promissory Note dated February 11, 2001 filed as an exhibit to the
Company's Form 10-K filed April 15, 2002 and incorporated by
reference herein.
10.22** Employment Agreement dated January 1, 2001 between the Company and
Robert P. Capps filed as an exhibit to the Company's Form 10-K filed
April 15, 2002 and incorporated by reference herein.
10.23 Release and Settlement Agreement dated January 19, 2001 between the
Company and Savage Arms, Inc. filed as an exhibit to the Company's
Form 10-K filed April 15, 2002 and incorporated by reference herein.
10.24 Settlement and Release Agreement dated March 4, 2002 among the
Company, DNA Enterprises, Inc. and Cadence Design Systems, Inc.
filed as an exhibit to the Company's Form 10-K filed April 15, 2002
and incorporated by reference herein.
10.25** Amended and Restated Stock Incentive Plan filed as an exhibit to the
Company's Definitive Proxy Statement filed on April 30, 2001 and
incorporated by reference herein.
10.26 Amendment to Credit Agreement dated October 3, 2002 between the
Company and Bank One, NA, filed as an exhibit to the Company's Form
8-K filed October 21, 2002 and incorporated by reference herein.
10.27 Reimbursement Agreement by and between the Company and O.S. Wyatt,
Jr. dated as of December 30, 2002, filed as an exhibit to the
Company's Form 8-K/A filed January 15, 2003 and incorporated by
reference herein.
10.28 Promissory Note dated October 1, 2002, filed as an exhibit to the
Company's Form 8-K/A filed January 15, 2003 and incorporated by
reference herein.
10.29 Reimbursement Agreement dated March 26, 2003, filed as an exhibit to
the Company's Form 8-K dated March 26, 2003 and incorporated by
reference herein.
10.30* Loan Agreement dated March 26, 2003 between DNA Computing Solutions,
Inc. and FirstCapital Bank, SSB.
10.31* Note Modification Agreement dated March 31, 2003 between the Company
and Bank One, NA.
21.1* Subsidiaries of the Company
23.1* Consent of Grant Thornton, LLP
99.1* Certification of Herman M. Frietsch, Chief Executive Officer of
TeraForce Technology Corporation, dated April 15, 2003, relating to
TeraForce's Annual Report on Form 10-K for the year ended December
31, 2002.
99.2* Certification of Robert P. Capps, Chief Financial Officer of
TeraForce Technology Corporation, dated April 15, 2003, relating to
TeraForce Annual Report on Form 10-K for the year ended December
31,2002.
--------------------
* Filed herewith.
** Management contract or other compensatory plan or arrangement.
C. The Registrant has not filed any reports on Form 8-K during the last
quarter of the period covered by this Report, except as follows:
On October 21, 2002, we filed a Current Report on Form 8-K dated
October 3, 2002, reporting events under Item 5 and filing exhibits under Item 7,
as amended by the Current Report on Form 8-K/A we filed on November 12, 2002.
On November 15, 2002, we filed a Current Report on Form 8-K dated
November 14, 2002, disclosing information under Item 9 and filing exhibits under
Item 7, as amended by the Current Report on Form 8-K/A we filed on January 15,
2003 and the Current Report on Form 8-K/A we filed on March 25, 2003.
69
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
TERAFORCE TECHNOLOGY CORPORATION
(Registrant)
Date: April 15, 2003 By: /s/ HERMAN M. FRIETSCH
----------------------------- -----------------------------------
Herman M. Frietsch
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated on April 12, 2002.
/s/ HERMAN M. FRIETSCH /s/ ANTON VON AND ZU LIECHTENSTEIN
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Herman M. Frietsch Anton von and zu Liechtenstein, Director
Chief Executive Officer and Director
(Principal Executive Officer)
/s/ ROBERT P. CAPPS /s/ ROBERT E. GARRISON II
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Robert P. Capps Robert E. Garrison II, Director
Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ DAVID H. YEDWAB
--------------------------------------------
David H. Yedwab, Director
70
CERTIFICATIONS
I, Herman M. Frietsch certify that:
1. I have reviewed this annual report on Form 10-K of TeraForce Technology
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 15, 2003
/s/ Herman M. Frietsch
-------------------------------------
Herman M. Frietsch
Chief Executive Officer
71
I, Robert P. Capps certify that:
1. I have reviewed this annual report on Form 10-K of TeraForce Technology
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 15, 2003
/s/ Robert P. Capps
------------------------------
Robert P. Capps
Chief Financial Officer
72
INDEX TO EXHIBITS
EXHIBIT DESCRIPTION OF EXHIBIT
NO. ----------------------
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3.1 Amended and Restated Certificate of Incorporation of the Company,
filed as an exhibit to the Company's Form 8-K filed on February 1,
2001 and incorporated by reference herein.
3.2* Amended and Restated By-Laws of the Company.
4.1 Warrant issued to Hambrecht & Quist LLC exercisable to purchase up
to 33,036 shares of Common Stock at an exercise price of $10.292 per
share, expiring May 20, 2003 filed as an exhibit to the Company's
Form 10-Q filed on August 14, 1998 and incorporated by reference
herein.
4.2 Form of Registration Rights Agreement between the Company and the
Buyers, dated as of December 22, 1998 filed as an exhibit to the
Company's Form 8-K filed on March 2, 1999 and incorporated by
reference herein.
4.3 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc. at an exercise price of $2.998 filed as an exhibit to the
Company's Form 8-K filed on March 2, 1999 and incorporated by
reference herein.
4.4 Registration Rights Agreement between the Company and Coastal filed
as an exhibit to the Company's Form 8-K filed on August 18, 1999 and
incorporated by reference herein.
4.5 Registration Rights Agreement among the Company and the Buyers,
dated February 24, 1999, relating to the Series E Convertible
Preferred Stock and warrants filed as an exhibit to the Company's
Form 8-K filed on March 2, 1999 and incorporated by reference
herein.
4.6 Form of Warrant to Purchase Common Stock of Intelect Communications,
Inc., relating to the Series E Preferred Stock filed as an exhibit
to the Company's Form 8-K filed on March 2, 1999 and incorporated by
reference herein.
4.7 Form of Warrant issued to Stonegate and the Investors to purchase
common stock of Intelect Communications, Inc. at $2.50 per share,
subject to adjustment filed as an exhibit to the Company's Form 8-K
filed on February 8, 2000 and incorporated by reference herein.
4.8 Warrant issued to Stonegate to purchase 250,000 shares of common
stock of Intelect Communications, Inc. at $1.00 per share filed as
an exhibit to the Company's Form 8-K filed on February 8, 2000 and
incorporated by reference herein.
4.9 Form of Registration Rights Agreement dated January 27, 2000 between
Intelect Communications, Inc., the Investors names therein, and
Stonegate filed as an exhibit to the Company's Form 8-K filed on
February 8, 2000 and incorporated by reference herein.
4.10 Form of Warrant issued to Stonegate affiliates to purchase common
stock of Intelect Communications, Inc. at $6.00 per share, subject
to adjustment filed as an exhibit to the Company's Form 8-K filed on
March 21, 2000 and incorporated by reference herein.
4.11 Form of Registration Rights Agreement dated March 14, 2000 between
Intelect Communications, Inc., the Investors named therein, and
Stonegate filed as an exhibit to the Company's Form 8-K filed on
March 21, 2000 and incorporated by reference herein.
4.12 Form of Amended and Restated Promissory Notes held by officer,
convertible into Common Stock of the Company at a rate of $1.00 per
share filed as an exhibit to the Company's Form 10-K filed on March
30, 2000 and incorporated by reference herein.
4.13 Securities Purchase Agreement dated September 30, 2002 between the
Company and Morton A. Cohn and Fayez Sarofim, filed as an exhibit to
the Company's Form 8-K filed October 21, 2002 and incorporated by
reference herein.
4.14 Registration Rights Agreement dated September 30, 2002 between the
Company and Morton A. Cohn and Fayez Sarofim, filed as an exhibit to
the Company's Form 8-K filed October 21, 2002 and incorporated by
reference herein.
4.15 Form of Amended and Restated Warrant expiring May 31, 2004 with an
exercise price of $0.12 per share, filed as an exhibit to the
Company's Form 8-K filed October 21, 2002 and incorporated by
reference herein.
4.16 Form of Warrant expiring October 31, 2004 with an exercise price of
$0.12 per share, filed as an exhibit to the Company's Form 8-K filed
October 21, 2002 and incorporated by reference herein.
4.17 Form of Amended and Restated Warrant expiring December 31, 2003 with
an exercise price of $0.12 per share, filed as an exhibit to the
Company's Form 8-K filed October 21, 2002 and incorporated by
reference herein.
4.18 Warrant expiring October 31, 2004 with an exercise price of $0.12
per share, filed as an exhibit to the Company's Form 8-K/A filed
January 15, 2003 and incorporated by reference herein.
4.19 Amended and Restated Warrant expiring October 31, 2004 with an
exercise price of $0.12 per share, filed as an exhibit to the
Company's Form 8-K/A filed January 15, 2003 and incorporated by
reference herein.
4.20 Amended and Restated Warrant expiring October 31, 2004 with an
exercise price of $0.12 per share, filed as an exhibit to the
Company's Form 8-K/A filed January 15, 2003 and incorporated by
reference herein.
4.21 Amended and Restated Warrant expiring December 31, 2003 with an
exercise price of $0.12 per share, filed as an exhibit to the
Company's Form 8-K/A filed January 15, 2003 and incorporated by
reference herein.
4.22 Amended and Restated Warrant expiring May 31, 2004 with an exercise
price of $0.12 per share, filed as an exhibit to the Company's Form
8-K/A filed January 15, 2003 and incorporated by reference herein.
4.23 Form of Registration Rights Agreement between the Company and
certain private investors, filed as an exhibit to the Company's Form
8-K/A filed January 15, 2003 and incorporated by reference herein.
4.24 Exchange Agreement dated April 11, 2002 between the Company and
Coastal, filed as an exhibit to the Company's Form 10Q filed May 10,
2002 and incorporated herein by reference.
4.25 Exchange Agreement dated April 11, 2002 between the Company and St.
James, filed as an exhibit to the Company's Form 10Q filed May 10,
2002 and incorporated herein by reference.
4.26 Registration Rights Agreement dated April 11, 2002 between the
Company and St. James, filed as an exhibit to the Company's Form 10Q
filed May 10, 2002 and incorporated herein by reference.
4.27 Form of Securities Purchase Agreement dated September 30, 2002
between the Company and certain private investors, filed as an
exhibit to the Company's Form 8-K/A filed November 13, 2002 and
incorporated by reference herein.
4.28 Form of Registration Rights Agreement dated September 30, 2002
between the Company and certain private investors, filed as an
exhibit to the Company's Form 8-K/A filed November 13, 2002 and
incorporated by reference herein.
4.29* Form of warrant expiring March 31, 2007 with an exercise price of
$0.15 per share.
10.1** Employment Agreement between the Company and Herman Frietsch and
Amendment thereto filed as an exhibit to the Company's Form 10-K
filed on March 30, 2000 and incorporated by reference herein.
10.2** Employment Agreement dated as of January 1, 2001 between the Company
and Eugene Helms filed as an exhibit to the Company's Form 10-K
filed April 15, 2002 and incorporated by reference herein.
10.3* Lease Agreement between Campbell Place One Joint Venture and DNA
Enterprises, dated February 1, 1997.
10.4 Agreement to Form Joint Venture dated August 17, 2001 between the
Company and Singapore Technologies Electronics Limited filed as an
exhibit to the Company's Form 8-K filed September 7, 2001 and
incorporated by reference herein.
10.5 Sharing Agreement dated August 30, 2001 among the Company, Intelect
Network Technologies Company and Intelect Technologies Inc. filed as
an exhibit to the Company's Form 8-K filed September 7, 2001 and
incorporated by reference herein.
10.6 Stockholders Agreement dated August 30, 2001 among the Company,
Intelect Technologies Inc. and Singapore Technologies Electronics
Limited filed as an exhibit to the Company's Form 8-K filed
September 7, 2001 and incorporated by reference herein.
10.7 Transition Services Agreement dated August 30, 2001 between the
Company and Intelect Technologies Inc. filed as an exhibit to the
Company's Form 8-K filed September 7, 2001 and incorporated by
reference herein.
10.8 Asset Purchase Agreement dated January 11, 2002 among the Company,
Flextronics Design S.D., Inc. and DNA Enterprises, Inc. filed as an
exhibit to the Company's Form 8-K filed January 15, 2002 and
incorporated by reference herein.
10.9 Design / Engineering Services Agreement dated January 11, 2002
between the Company and Flextronics Design S.D. filed as an exhibit
to the Company's Form 8-K filed January 15, 2002 and incorporated by
reference herein.
10.10 Form of Promissory Note dated June 1, 2001 in favor of Bank One,
N.A. filed as an exhibit to the Company's Form 10-Q filed August 14,
2001 and incorporated by reference herein.
10.11 Business Loan Agreement dated June 1, 2001 between the Company and
Bank One, N.A. filed as an exhibit to the Company's Form 10-Q filed
August 14, 2001 and incorporated by reference herein.
10.12 Reimbursement Agreement dated June 1, 2001 among the Company and
Oscar S. Wyatt, Jr., Fayez Sarofim and Morton Cohn filed as an
exhibit to the Company's Form 10-Q filed August 14, 2001 and
incorporated by reference herein.
10.13 Form of Promissory Note dated October 12, 2001 in favor of Bank One,
N.A. filed as an exhibit to the Company's Form 10-Q filed November
14, 2001 and incorporated by reference herein.
10.14 Loan Agreement dated October 12, 2001 between the Company and Bank
One, N.A. filed as an exhibit to the Company's Form 10-Q filed
November 14, 2001 and incorporated by reference herein.
10.15 Reimbursement Agreement dated October 12, 2001 between the Company
and Oscar S. Wyatt, Jr. filed as an exhibit to the Company's Form
10-Q filed November 14, 2001 and incorporated by reference herein.
10.16 Promissory Note dated October 5, 2001 filed as an exhibit to the
Company's Form 10-Q filed November 14, 2001 and incorporated by
reference herein.
10.17 Promissory Note dated October 12, 2001 filed as an exhibit to the
Company's Form 10-Q filed November 14, 2001 and incorporated by
reference herein.
10.18 Promissory Note dated September 29, 2001 filed as an exhibit to the
Company's Form 10-K filed April 15, 2002 and incorporated by
reference herein.
10.19 Promissory Note dated November 30, 2001 filed as an exhibit to the
Company's Form 10-K filed April 15, 2002 and incorporated by
reference herein.
10.20 Promissory Note dated December 14, 2001 filed as an exhibit to the
Company's Form 10-K filed April 15, 2002 and incorporated by
reference herein.
10.21 Promissory Note dated February 11, 2001 filed as an exhibit to the
Company's Form 10-K filed April 15, 2002 and incorporated by
reference herein.
10.22** Employment Agreement dated January 1, 2001 between the Company and
Robert P. Capps filed as an exhibit to the Company's Form 10-K filed
April 15, 2002 and incorporated by reference herein.
10.23 Release and Settlement Agreement dated January 19, 2001 between the
Company and Savage Arms, Inc. filed as an exhibit to the Company's
Form 10-K filed April 15, 2002 and incorporated by reference herein.
10.24 Settlement and Release Agreement dated March 4, 2002 among the
Company, DNA Enterprises, Inc. and Cadence Design Systems, Inc.
filed as an exhibit to the Company's Form 10-K filed April 15, 2002
and incorporated by reference herein.
10.25** Amended and Restated Stock Incentive Plan filed as an exhibit to the
Company's Definitive Proxy Statement filed on April 30, 2001 and
incorporated by reference herein.
10.26 Amendment to Credit Agreement dated October 3, 2002 between the
Company and Bank One, NA, filed as an exhibit to the Company's Form
8-K filed October 21, 2002 and incorporated by reference herein.
10.27 Reimbursement Agreement by and between the Company and O.S. Wyatt,
Jr. dated as of December 30, 2002, filed as an exhibit to the
Company's Form 8-K/A filed January 15, 2003 and incorporated by
reference herein.
10.28 Promissory Note dated October 1, 2002, filed as an exhibit to the
Company's Form 8-K/A filed January 15, 2003 and incorporated by
reference herein.
10.29 Reimbursement Agreement dated March 26, 2003, filed as an exhibit to
the Company's Form 8-K dated March 26, 2003 and incorporated by
reference herein.
10.30* Loan Agreement dated March 26, 2003 between DNA Computing Solutions,
Inc. and FirstCapital Bank, SSB.
10.31* Note Modification Agreement dated March 31, 2003 between the Company
and Bank One, NA.
21.1* Subsidiaries of the Company
23.1* Consent of Grant Thornton, LLP
99.1* Certification of Herman M. Frietsch, Chief Executive Officer of
TeraForce Technology Corporation, dated April 15, 2003, relating to
TeraForce's Annual Report on Form 10-K for the year ended December
31, 2002.
99.2* Certification of Robert P. Capps, Chief Financial Officer of
TeraForce Technology Corporation, dated April 15, 2003, relating to
TeraForce Annual Report on Form 10-K for the year ended December
31, 2002.
--------------------
* Filed herewith.
** Management contract or other compensatory plan or arrangement.