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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10 - Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
Commission File Number 0-11630
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TERAFORCE TECHNOLOGY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 76-0471342
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1240 EAST CAMPBELL ROAD, RICHARDSON, TEXAS 75081
(Address of Principal Executive Offices) (Zip Code)
469-330-4960
(Registrant's Telephone Number, Including Area Code)
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Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
There were 118,532,185 shares of Common Stock outstanding as of July 31, 2003.
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TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
INDEX
PAGE
----
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
Consolidated Balance Sheets of the Company
at June 30, 2003 (unaudited) and December 31, 2002 2
Consolidated Statements of Operations of the Company
(unaudited) for the three months and six months ended June 30, 2003 and 2002 3
Consolidated Statements of Cash Flows of the Company
(unaudited) for the six months ended June 30, 2003 and 2002 4
Notes to Consolidated Financial Statements 5
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 10
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 13
ITEM 4 CONTROLS AND PROCEDURES 13
PART II OTHER INFORMATION
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 14
SIGNATURES 15
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
(Thousands of dollars, except share data)
June 30, December 31,
2003 2002
------------ ------------
(unaudited)
Assets
Current assets:
Cash and cash equivalents $ 1 $ 55
Temporary cash investments -- 457
Accounts receivable 580 573
Receivables from affiliate -- 699
Inventories 2,018 2,354
Prepaid services 26 193
Prepaid expenses and other current assets 456 587
------------ ------------
Total current assets 3,081 4,918
Property and equipment, net 460 573
Investment in and receivables from affiliate 1,032 702
Other assets 1,105 531
------------ ------------
$ 5,678 $ 6,724
============ ============
Liabilities and Stockholders' Deficit
Current liabilities:
Notes payable $ 4,547 $ 4,047
Accounts payable 2,423 1,919
Accrued liabilities 1,668 1,392
------------ ------------
Total current liabilities 8,638 7,358
Long-term notes payable 1,397 900
Other long-term liabilities 1,075 1,100
Stockholders' deficit:
Common Stock, $.01 par value; authorized 200,000,000 shares;
118,532,185 and 114,255,518 shares issued in 2003 and 2002,
respectively 1,185 1,143
Additional paid-in capital 186,191 184,953
Accumulated deficit (191,221) (187,143)
------------ ------------
(3,845) (1,047)
Less 400,474 shares of common stock in treasury at cost (1,587) (1,587)
------------ ------------
Total stockholders' deficit (5,432) (2,634)
------------ ------------
$ 5,678 $ 6,724
============ ============
See accompanying notes to consolidated condensed financial statements.
2
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Statements of Operations
(Thousands of dollars, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(unaudited)
Net revenues $ 1,385 $ 1,659 $ 2,338 $ 3,289
Cost of revenue 977 960 1,657 1,719
------------ ------------ ------------ ------------
Gross profit 408 699 681 1,570
------------ ------------ ------------ ------------
Expenses:
Engineering and development 696 903 1,481 1,940
Selling and administrative 1,147 1,777 2,351 2,962
------------ ------------ ------------ ------------
1,843 2,680 3,832 4,902
------------ ------------ ------------ ------------
Operating loss (1,435) (1,981) (3,151) (3,332)
------------ ------------ ------------ ------------
Other income (expense):
Litigation settlement -- -- -- 6,300
Litigation costs, net of
insurance reimbursement (48) 143 (125) 91
Share of income (loss) of unconsolidated
affiliate (152) (136) (369) (106)
Interest expense (252) (115) (368) (258)
Interest income and other -- 22 (65) 22
------------ ------------ ------------ ------------
(452) (86) (927) 6,049
------------ ------------ ------------ ------------
Net income (loss) $ (1,887) $ (2,067) $ (4,078) $ 2,717
============ ============ ============ ============
Basic and diluted income (loss) per share $ (.02) $ (.02) $ (.03) $ .03
============ ============ ============ ============
Weighted average number of common shares
outstanding - basic and diluted 118,080 88,469 116,575 87,583
============ ============ ============ ============
See accompanying notes to consolidated condensed financial statements.
3
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Statements of Cash Flows
(Thousands of dollars)
Six Months Ended June 30,
------------------------------
2003 2002
------------ ------------
(unaudited)
Cash flows from operating activities:
Net income (loss) $ (4,078) $ 2,717
Adjustments to reconcile net loss to
net cash used in operating activities:
Litigation settlement -- (6,300)
Utilization of prepaid services 167 560
Depreciation and amortization 129 113
Share of loss from unconsolidated affiliate 369 106
Other 375 77
Changes in operating assets and liabilities:
Accounts receivable (7) (700)
Inventories 336 571
Accounts payable and accrued liabilities 780 (1,698)
------------ ------------
Net cash used in operating activities (1,929) (4,554)
------------ ------------
Cash flows from investing activities:
Proceeds from litigation settlement -- 6,300
Capital expenditures (7) (118)
Investment in temporary cash investments -- (867)
Net proceeds from disposal of discontinued operations -- 1,198
Software development costs (83) --
Temporary cash investments 457 --
Other -- 53
------------ ------------
Net cash used in investing activities 367 6,566
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of notes payable 997 500
Proceeds from issuance of common stock 511 --
Principal payments on notes payable -- (1,354)
------------ ------------
Net cash provided by (used in) investing activities 1,508 (854)
------------ ------------
Net increase (decrease) in cash and cash equivalents (54) 1,158
Cash and cash equivalents, beginning of period 55 1
------------ ------------
Cash and cash equivalents, end of period $ 1 $ 1,159
============ ============
See accompanying notes to consolidated condensed financial statements.
4
TERAFORCE TECHNOLOGY CORPORATION
Notes to Consolidated Condensed Financial Statements
(Unaudited)
June 30, 2003
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared
by the Company without audit in accordance with accounting principles generally
accepted in the United States of America for interim financial statements and
with instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion
of management, all adjustments (consisting only of normal recurring accruals)
considered necessary for a fair presentation have been included.
The accompanying consolidated financial statements do not include
certain footnotes and financial presentations normally required under accounting
principles generally accepted in the United States of America and, therefore,
should be read in conjunction with the audited financial statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2002.
The Company incurred an operating loss in the first six months of 2003
and has incurred significant operating losses in 2002, 2001 and 2000. These
losses were funded by proceeds from the issuance of equity securities and notes
payable, and as of June 30, 2003, notes payable due within one year amounted to
$4,547,000. 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. In the first six months of 2003 the Company
has generated additional capital amounting to approximately $1,500,000 from the
sale of equity securities and from the proceeds of new credit facilities. In
July and August 2003, the Company generated approximately $2,800,000 in capital
from the sale of convertible notes.
The Company's operating losses have declined over the three year period
ended December 31, 2002, primarily as a result of the disposal of certain
operations, specifically those related to the telecommunications industry, the
reduction of other operating expenses and increases in net revenues from the
Company's defense electronics business. Net revenues from the sale of defense
electronics products have increased in each of the last three years and
management expects net revenues to increase further in 2003. Therefore,
management believes that the Company's needs for capital to fund operating
losses will continue to decline.
The Company believes that it will be able to fund any further operating
losses and to refinance or otherwise restructure its outstanding debt
obligations through either the issuance of new equity securities, the incurrence
of new debt or the modification of the terms of its existing debt obligations.
There can be no assurance that the Company can accomplish these matters, or can
do so under acceptable terms. These financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
5
TERAFORCE TECHNOLOGY CORPORATION
Notes to Consolidated Condensed Financial Statements
(Unaudited)
June 30, 2003
INVENTORIES
The components of inventories are as follows:
June 30, December 31,
2003 2002
------------ ------------
($ Thousands)
Raw materials $ 1,403 $ 1,658
Work in process 265 408
Finished goods 350 288
------------ ------------
Total $ 2,018 $ 2,354
============ ============
SEGMENTS OF BUSINESS
In the three and six month periods ended June 30, 2003 and 2002, all of
the Company's net revenues were generated from its defense electronics business.
Segment-specific margins (gross profit less total engineering and
development costs, including capitalized software for the segment):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
($ Thousands)
Defense electronics $ (288) $ (97) $ (800) $ --
Optical networking equipment -- (94) -- (195)
Other -- (13) -- (175)
------------ ------------ ------------ ------------
Subtotal segment specific (288) (204) (800) (370)
All other expenses (1,147) (1,777) (2,351) (2,962)
------------ ------------ ------------ ------------
Operating loss $ (1,435) $ (1,981) $ (3,151) $ (3,332)
============ ============ ============ ============
At June 30, At December 31,
2003 2002
------------ ---------------
($ Thousands)
Defense electronics $ 3,452 $ 3,760
Optical networking equipment and other 1,082 1,501
Not allocable to a segment 1,144 1,463
------------ ------------
Total $ 5,678 $ 6,724
============ ============
INCOME TAXES
For the three and six month period ended June 30, 2002, the Company's
effective income tax rate differed from the federal statutory rate due to
current period tax expense offset by an offsetting change in the valuation
allowance for the same amount.
6
TERAFORCE TECHNOLOGY CORPORATION
Notes to Consolidated Condensed Financial Statements
(Unaudited)
June 30, 2003
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. There was no
stock based compensation expense recorded for any period.
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
($ Thousands)
Net income (loss) allocable to
common shareholders:
As reported $ (1,887) $ (2,067) $ (4,078) $ 2,717
Pro forma $ (2,071) $ (2,321) $ (4,425) $ 2,324
Income (loss) per share:
As reported $ (.02) $ (.02) $ (.03) $ .03
Pro Forma $ (.02) $ (.03) $ (.04) $ .03
EARNINGS PER SHARE
Basic and diluted earnings or loss per share are the same for the three
and six month periods ended June 30, 2003 and 2002 because all potential common
shares were anti-dilutive for those periods.
NOTES PAYABLE
The Company has amended its credit agreements with Bank One, NA ("Bank
One"). Amounts outstanding under the Company's $1.5 million credit agreement
with Bank One have been combined with the Company's $2.7 million credit
agreement with Bank One and the $1.5 million agreement has been terminated.
Amounts outstanding under the amended $4.2 million agreement are due June 27,
2004, with no mandatory reductions prior to that time. Interest is payable
monthly at LIBOR plus 1.75% (2.86% at June 30, 2003). The facility is secured by
a letter of credit provided by a private investor.
The Company has agreed to utilize up to $400,000 of the available
proceeds from the issuance of convertible subordinated notes (See "Subsequent
Events") to repay accrued interest and outstanding principal under an
approximately $650,000 promissory note to the private investor that provides the
security for the Bank One credit agreement. The investor has agreed to extend
the maturity of this note to June 30, 2004. The note is unsecured and bears
interest at 8%, payable at maturity.
In March 2003, the Company and its wholly-owned subsidiary, DNA
Computing Solutions, Inc. ("DNA-CS"), entered into a revolving line of credit
with a bank in order to provide working
7
TERAFORCE TECHNOLOGY CORPORATION
Notes to Consolidated Condensed Financial Statements
(Unaudited)
June 30, 2003
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 June 30, 2003,
approximately $1,000,000 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, as of March 26, 2003 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, as of March 26, 2003 the investors received warrants to purchase an
aggregate of 9,583,333 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. The
Company has valued the warrants at approximately $360,000, using the
Black-Scholes pricing model. This amount and beneficial conversion feature in
the amount of approximately $408,000 related to the purchase rights have been
recorded as deferred financing costs.
STOCKHOLDERS' EQUITY
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.
SUBSEQUENT EVENTS
In July and August 2003, the Company has issued $3,010,000 principal
amount of 12% convertible subordinated notes in a private placement to qualified
investors. The purchasers of the notes have also received warrants to purchase
1,881,250 shares of the common stock at $0.16 per share. Net proceeds to the
Company, after paying commissions to the placement agent and legal costs,
amounted to approximately $2,809,000. The Company intends to use $400,000 of
this amount to pay accrued interest and outstanding principal related to a
promissory note and intends to use the balance for working capital. The Company
also issued warrants for the purchase of 1,881,250 shares of common stock to the
placement agent.
The Notes are subordinated unsecured obligations of the Company and are
subordinated to the rights of holders of all existing and future senior
indebtedness. The terms of the Note Agreement limit the ability of the Company
to incur additional senior indebtedness. Pursuant to the Note Agreement, the
Company shall not directly or indirectly create, incur or suffer to exist any
indebtedness senior to the Notes ("Senior Indebtedness") in an aggregate
principal amount exceeding at any time the sum of one million dollars
($1,000,000.00) without the prior written consent of at least 51% of the
aggregate principal amount of the Notes outstanding at the time the transaction
is authorized by the Company's board of directors. For purposes of calculating
the limitation on incurring Senior Indebtedness, the following indebtedness
shall not be included in calculating the
8
TERAFORCE TECHNOLOGY CORPORATION
Notes to Consolidated Condensed Financial Statements
(Unaudited)
June 30, 2003
aggregate amount of Senior Indebtedness: (a) Bank One, NA in the amount of $4.2
million, (b) a private investor in the amount of $650,000, (c) FirstCapital
Bank, SSB in the amount of $1,000,000, and (d) any restructuring or refinancing
of the Senior Indebtedness described in (a), (b) and (c).
The Company will pay all outstanding principal balances on the Notes at
maturity, which is June 30, 2005. Interest on the Notes will accrue at a rate of
12% per annum, computed on the basis of a 360-day year of twelve 30-day months.
Interest will be due annually on June 15 and at maturity on June 30, 2005. The
Company may redeem all or any portion of the outstanding Notes at any time
beginning 120 days after the final closing of this offering. Each Note to be so
redeemed shall be redeemed against payment of an amount in cash equal to: 110%
of the outstanding principal balance of the Note, plus accrued interest, if
redeemed after June 15, 2003 but on or before June 1, 2004, and 105% of the
outstanding principal balance of the Note, plus accrued interest, if redeemed
after June 1, 2004.
A Noteholder may convert at any time following August 4, 2003 any or
all of the principal and accrued interest of his Notes into shares of Common
Stock. The number of shares of Common Stock issuable upon conversion shall be
determined by dividing the outstanding indebtedness and accrued interest to be
converted by the conversion price in effect at the time of conversion. The
initial conversion price of the Notes is $0.16 per share. The conversion price
will be subject to anti-dilution provisions and therefore may be adjusted from
time to time upon the occurrence of certain events.
The number of shares to be issued upon exercise of the Warrants to the
purchasers of the Notes and the placement agent will be subject to anti-dilution
provisions and therefore may be adjusted from time to time. The exercise price
of the Warrants was equal to the conversion price of the Notes upon the closing
of this offering or $0.16 per share. The exercise price will be subject to
anti-dilution provisions and therefore may be adjusted from time to time upon
the occurrence of certain events. The Warrants may be exercised at the option of
the holder at any time prior to their expiration. The Warrants will expire four
years after their issuance.
The Company entered into a registration rights agreement with each
Noteholder, and has agreed to file a registration statement with the SEC under
the Securities Act of 1933, as amended (the "Securities Act"), registering the
shares of Common Stock underlying the Notes and the Warrants within 90 days of
the final closing of the Offering. The Company will use its best efforts to have
the registration statement declared effective by the SEC as soon as practicable
thereafter. The Company and Noteholders each agreed with the other to indemnify
the other for certain liabilities arising under the Securities Act.
9
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE PERIOD ENDED JUNE 30, 2003
Forward Looking Statements
This Quarterly Report on Form 10-Q contains certain forward looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In
this report, as well as in oral statements made by the Company, statements that
are prefaced with the words "may," "will," "expect," "anticipate," "believe,"
"continue," "estimate," "project," "intend," "designed" and similar expressions
are intended to identify forward looking statements regarding events, conditions
and financial trends that may affect the Company's future plans, business
strategy, results of operations, financing activities and financial position.
These statements are based on the Company's current expectations and estimates
as to prospective events and circumstances about which the Company can give no
firm assurance. Further, 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. 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 such a difference include, but are not limited to: general
economic conditions in the markets the Company operates in; the ability of the
Company to execute its plan in strategic direction; success in the development
and market acceptance of new and existing products; dependence on suppliers,
third party manufacturers and channels of distribution; customer and product
concentration; fluctuations in customer demand; the ability to obtain and
maintain access to external sources of capital; the ability to control costs;
overall management of the Company's expansion; and other risk factors detailed
from time to time in the Company's filings with the Securities and Exchange
Commission. 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.
--------------------------------------------------------------------------------
COMPARISON OF THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2003 TO
THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2002
--------------------------------------------------------------------------------
NET REVENUE
For the first six months of 2003 and 2002 all of our net revenues were
generated by our defense electronics business. Net revenue from defense
electronics decreased 17% in the second quarter of 2003 as compared to the
second quarter of 2002 and declined 29% in the first six months of 2003 as
compared to the same period in 2002. However, in the first quarter of 2003 the
Company's bookings of new orders amounted to approximately $4,000,000 and the
Company's backlog of orders amounted to approximately $2,446,000 at June 30,
2003, compared to a backlog of approximately $394,000 at June 30, 2002. The
decline in net revenues in the first and second quarters of 2003 is due, in
part, to the timing of shipments based on customer requirements. 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 temporarily
affected our ability to complete orders. Management believes that the financing
arrangements that have been completed will alleviate the liquidity difficulties.
Additionally, we noted a decline in customer purchasing activity during the
second quarter of 2003. We understand that this situation was encountered by
others in our industry as well. We believe that this decline in activity was
temporary and was in reaction to funding issues arising from the war in Iraq.
Subsequent to June
10
30, 2003 we have noted a resumption of activity from certain customers. While
this temporary decline may impact the timing of certain orders and shipments to
customers, we believe that net revenues in the last half of 2003 will exceed the
first half of 2003.
GROSS PROFIT
Gross profit from defense electronics decreased in the second quarter
and first six months of 2003 as compared to the comparable periods of 2002 due
to the decline in net revenues between these periods.
ENGINEERING AND DEVELOPMENT EXPENSE
Engineering and development expense decreased 23% to $696,000 in the
second quarter of 2003 from $903,000 in the same period in 2002. Costs by
product line are as follows:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
($ Thousands)
Defense electronics $ 696 $ 796 $ 1,481 $ 1,570
Optical networking products -- 94 -- 195
Other -- 13 -- 175
------------ ------------ ------------ ------------
$ 696 $ 903 $ 1,481 $ 1,940
============ ============ ============ ============
Engineering and development expenses related to defense electronics in
the second quarter and first six months of 2003 reflect on-going enhancements of
the VQG4 product line and our new Eagle product that was introduced at the end
of the first quarter of 2003. All development activities, other than those
related to our defense electronics products, were terminated in 2002. Included
in engineering and development expenses during the second quarter and first six
months of 2003 is approximately $48,000 and $167,000, respectively, related to
design services provided by Flextronics International, Ltd. During the second
quarter and first six months of 2002 such amounts were $260,000 and $560,000,
respectively. These non-cash services were provided under the engineering design
services agreements we entered into when we sold our engineering design services
business in January 2002.
SELLING AND ADMINISTRATIVE EXPENSE
Selling and administrative expenses decreased approximately 35% in the
second quarter of 2003 as compared to the second quarter of 2002 and 21% in the
first six months of 2003 as compared to that same period in 2002. These declines
result from lower sales commissions and reduced administrative expenses.
LITIGATION SETTLEMENT
In March 2002 we settled our outstanding litigation against Cadence
Design Systems, Inc. We received $6,300,000, net of attorney fees, from this
settlement.
LITIGATION COSTS
Litigation costs represent legal fees and expenses related to the
shareholder action. These amounts are net of approximately $300,000 of insurance
reimbursement that was received in the second quarter of 2002.
11
INTEREST EXPENSE
Interest expense for the second quarter and first six months of 2003
includes approximately $181,000 and $285,000, respectively, from the
amortization of the value of warrants issued in connection with various debt
transactions. The warrants were valued when they were issued using the
Black-Scholes option pricing model. Without the effect of this amortization,
interest expense declined in the 2003 periods as compared to 2002 due to lower
outstanding debt balances and lower interest rates.
--------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
--------------------------------------------------------------------------------
As of June 30 2003, our working capital deficit was $5,557,000, which
included $4,547,000 of notes payable due within one year. As of June 30 2003,
our Notes Payable total $5,900,000. Of this amount $4,200,000 is due on June 27,
2003, approximately $650,000 is due on June 30, 2004 and $1,000,000 is due
September 26, 2004. Of the debt due on June 30, 2004, $400,000 has been repaid
with the proceeds of long-term debt subsequent to June 30, 2003. Accordingly,
$400,000 of this amount has been classified as non-current as of June 30, 2003.
OPERATING ACTIVITIES
Net cash used in operations for the six months ended June 30, 2003
amounted to $1,929,000. This amount arose primarily from the net loss of
$4,078,000, offset by non-cash charges of $167,000 from the utilization of
prepaid services, and $369,000 related to our share of the loss from our
unconsolidated affiliate.
INVESTING ACTIVITIES
For the three months ended March 31, 2003, investing activities
provided cash in the amount of $457,000, primarily from the liquidation of
temporary cash investments.
FINANCING ACTIVITIES
In July 2003, we completed a private placement of $3,010,000 principal
amount of convertible subordinated notes. We received net proceeds of
approximately $2,809,000, after paying sales commissions and legal costs related
to the offering. We intend to use $400,000 of these proceeds to reduce
outstanding debt and intend to use the balance for working capital. The notes
are due June 30, 2005 and bear interest at 12%, payable annually. The holders of
the notes may convert outstanding principal and accrued interest on the notes
into our common stock at the rate of $0.16 per share. We may redeem the notes at
any time beginning in November of 2003. To redeem the notes before June 1, 2004
we must pay the holders 110% of the outstanding principal amount and all accrued
interest. If we redeem the notes after June 1, 2004 we must pay 105% of the
outstanding principal amount and all accrued interest. We also issued warrants
to purchase an aggregate of 1,881,250 shares of our common stock to the
purchasers of the notes. The warrants have a four-year term and an exercise
price of $0.16 per share.
Also in July 2003 we restructured some of our outstanding debt. We
amended our $1.5 million and $2.7 million credit agreements with Bank One to
combine them into a single $4.2 million credit agreement. The maturity of the
amended agreement was extended to June 27, 2004, with no mandatory reductions
prior to that date. The amended credit agreement is secured by a letter of
credit provided by a private investor. We also reached an agreement with this
private investor to extend the maturity date of an approximately $650,000 note
payable to June 30, 2004. We expect to use $400,000
12
of the proceeds from the private placement of convertible notes to repay accrued
interest and principal related to this note.
As a result of the financing activity in July and August 2003, none of
our debt obligations are due before June 27, 2004 and we have reduced our
working capital deficit by approximately $2,800,000.
LIQUIDITY OUTLOOK
We have satisfied our needs for capital during 2003 with proceeds from
sales of equity and convertible debt securities and from the proceeds of credit
arrangements. We have restructured our debt obligations such that there are no
principal payments required before June 2004. We expect our need for capital to
decline as a result of improved operating results in the last half of 2003. This
belief is based on our backlog of orders and from other orders that we expect to
receive in the second six months of 2003 and beyond. We also have been engaged
in discussions with potential strategic partners. These arrangements, if
concluded, could have a positive effect on our business and could also result in
additional liquidity being available to us.
While we believe we will have adequate liquidity to operate our
business, 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 and other debt, such as bank debt. 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 that
are acceptable to us.
CONTINGENT LIABILITIES
As discussed in "ITEM 3 - Legal Proceedings" in the Company's Annual
Report on Form 10-K, the Company is exposed to certain contingent liabilities
which, if resolved adversely to the Company, would adversely affect its
liquidity, its results of operations, and/or its financial position.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have outstanding debt at June 30, 2003 amounting to approximately
$5,900,000 that bears interest at a variable interest rate and subjects us to
interest rate risk. This interest is based on widely used reference interest
rates known as prime and LIBOR. An increase of 50 basis points in these rates
would result in an increase in our annual interest expense of $29,500.
ITEM 4 - CONTROLS AND PROCEDURES
The term "disclosure controls and procedures" is defined in Rules
13a-15(e) and 15(d)-(e) 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
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within the time periods specified by the Securities and Exchange Commission. Our
management, including our Chief Executive Officer and our Chief Financial
Officer, has evaluated the effectiveness of our disclosure controls and
procedures as of the end of the period covered by this quarterly report. Based
upon that evaluation, our Chief Executive Officer and Chief Financial Officer
have concluded that our disclosure controls and procedures were effective as of
the end of the period covered by this quarterly report.
There were no changes to our internal control over financial reporting
during our last fiscal quarter that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
A. Listed below are all Exhibits filed as part of this report.
Exhibit Description of Exhibit
------- ----------------------
31.1 302 Certificate
31.2 302 Certificate
32.1 906 Certificate
32.2 906 Certificate
B. The Company has not filed any report on Form 8-K during the period
covered by this Report, except as follows:
On May 21, 2003 we filed a Current Report on Form 8-K dated May 16,
2003, disclosing information under Item 12 and filing exhibits under Item 7.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
TERAFORCE TECHNOLOGY CORPORATION.
(Registrant)
Date: August 14, 2003 /s/ ROBERT P. CAPPS
------------------------- --------------------------------------------
Robert P. Capps
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: August 14, 2003 /s/ HERMAN M. FRIETSCH
------------------------- --------------------------------------------
Herman M. Frietsch
Chief Executive Officer and Director
(Principal Executive Officer)
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