1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
--------------------
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, 2000
Commission File Number 0-11630
--------------------
TERAFORCE TECHNOLOGY CORPORATION
(FORMERLY INTELECT COMMUNICATIONS, INC.)
(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)
------------------------------------
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 [ ]
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 [ ]
The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $32,287,000 as of March 16, 2001 (based upon the
average of the highest bid and lowest asked prices on such date as reported on
the Nasdaq SmallCap Market). All directors, officers and 5% or greater
shareholders are presumed to be affiliates for purposes of this calculation.
There were 86,098,850 shares of Common Stock outstanding as of March 16, 2001.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be filed pursuant to
Regulation 14A under the Securities Exchange Act of 1934 not later than 120 days
after the end of the fiscal year (December 31, 2000) are incorporated by
reference in items 10, 11, 12 and 13 of PART III hereof.
2
PART I
ITEM 1 - BUSINESS
FORWARD LOOKING STATEMENT
This Annual Report on Form 10-K contains certain forward looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
These forward looking statements include information about possible or assumed
future results of our operations. Also, when we use any of the words "believes,"
"expects," "intends," "anticipates," or similar expressions, we are making
forward looking statements. Examples of types of forward looking statements
include statements on future levels of net revenue and cash flow, new product
development and strategic plans. The forward looking statements involve risks
and uncertainties that could cause actual results to differ materially from
those expressed in, or implied by, the forward looking statements. Factors that
might cause such a difference include, but are not limited to, those relating
to: general economic conditions in the markets in which the Company operates;
the ability of the Company to execute its change 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
execute management's margin improvement and cost control plans; 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 COMPANY
The name of the Company was changed to TeraForce Technology
Corporation ("the Company") 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, the principal effect of which was to change the domicile of Intelect
(Bermuda) so that it became a publicly traded, United States-domiciled, Delaware
corporation. The effect of the merger was that the shareholders of Intelect
(Bermuda) became shareholders of the Company with the Company becoming the
publicly traded company. In addition, the Company became the holding company for
Intelect (Bermuda) and replaced Intelect (Bermuda) as the holding company for
its subsidiaries. The merger was effected on December 4, 1997.
OVERVIEW
The change in the Company's name to TeraForce Technology Corporation
reflects a change in the Company's strategic direction and underlying business
model which was announced in November 2000. Under this new strategy the Company
intends to leverage its technological expertise in the convergence of
telecommunications and computing to develop and commercialize leading edge
technologies.
Key to this strategy is the Company's existing patent portfolio,
other intellectual property previously developed by the Company and the
Company's wholly-owned subsidiary, DNA Enterprises, Inc. ("DNA"). The Company
believes DNA is uniquely positioned to monitor and participate in the continuing
advancement of technology in telecommunications and computing.
2
3
DNA is a 20-year old engineering design services organization and is located in
Richardson, Texas, which contains one of the largest concentrations of
telecommunications equipment-related companies in the world. DNA provides
high-end engineering services to established companies and start-up
organizations, and has been involved in the development of many commercially
successful products in the areas of telecommunications and computing.
Concurrent with the launching of the new business strategy, the
Company has organized the digital signal processor ("DSP") products business
previously developed and conducted within DNA into a new wholly-owned
subsidiary, DNA Computing Solutions, Inc. ("DCS"). The nature and anticipated
growth of this business warrants the establishment of a dedicated organization
and infrastructure.
An integral aspect of the Company's business strategy is the
development of new technologies and products and the manner in which this will
be accomplished. The Company expects to identify new opportunities in the areas
of telecommunications and computing. Under its business model the Company
intends to provide management, seed capital, core technology, by development
resources and operational infrastructure in the initial stages of product
development, leveraging the experience and expertise found within DNA. Such
initiatives will be launched within special-purpose subsidiaries in order to
provide a "pure play" opportunity related to the product or technology under
development. At early stages of the development process the Company anticipates
attracting strategic investors into the opportunity. It is anticipated that
these investors will include early adopter customers, potential market channels,
technology partners as well as financial investors. The majority of development
costs would be funded by these strategic investors, in return for an equity
participation in the special purpose entity. It is also expected that portions
of the equity of these entities will be made available to help attract and
retain key employees and other important contributors. The ultimate goal of the
Company is to build equity value in the interest it retains in these projects
and realize that value through a spin-off, initial public offering, sale or
other exit transaction involving the subsidiary. The first initiative to be
launched under this model is the Aegean product line of optical networking
products.
The Company anticipates identifying and developing additional
products in the areas of telecommunications and computing. These new products
will likely leverage the Company's knowledge and expertise in areas such as
high-density computing and telecommunications systems.
The Company's optical networking products business has historically
been conducted by its wholly-owned subsidiary, Intelect Network Technologies
Company ("INT"), which manufactures and markets the OmniLynx product line.
Entering 2000 one of the primary target markets for OmniLynx was second, third
and fourth tier competitive local exchange carriers, or "CLEC." With the
dramatic changes which have occurred in the market place over the course of
2000, the Company reassessed this business and determined that the OmniLynx
product line's long-term strategic value was not as great as that of the
Company's other business opportunities. Accordingly, the Company determined to
sell INT or substantially all of its assets. In late 2000 and early 2001 the
Company substantially completed negotiations for the sale of substantially all
of the assets of INT related to the OmniLynx product line to EuroTelecom
Communications, Inc. ("EuroTelecom"), a company with the majority of its
operations in the United Kingdom. Due to financial difficulties which developed
within EuroTelecom, in February, 2001 the Company terminated further discussions
with EuroTelecom. Subsequent to the termination of the proposed transaction with
EuroTelecom the Company has significantly curtailed the operations of INT and
has notified the majority of INT's employees that their employment will
terminate on April 27, 2001. In the meantime the Company is seeking alternative
transactions for the operations or assets of INT. There can be no assurance,
however, that an alternative transaction can be arranged. Therefore the Company
has evaluated the net realizable value of the assets of INT assuming that no
alternative transaction is completed ( See Note 3 of the
3
4
Notes to Consolidated Financial Statements - included in Item 8. - "Financial
Statements and Supplementary Data.")
PRODUCTS, TECHNOLOGIES AND SERVICES
Engineering Design Services
The Company's engineering design services business is conducted
through DNA, which was founded in 1981 and acquired by the Company in 1996.
Through DNA the Company provides advanced product and system design and
development services for a variety of clients primarily in the
telecommunications industry. DNA is located in Richardson, Texas in an area
known as the Telecom Corridor(C), which has one of the highest concentrations of
telecommunications related companies in the world. DNA provides these services
to established companies as well as start-up organizations. Services are
generally provided on a time and material basis based on hourly or weekly rates,
with the customer retaining all rights to the developed intellectual property
("IP"). However, on occasion the Company may enter into arrangements whereby it
retains an interest in the related IP or in the resulting product.
DNA's staff of engineers possesses a broad range of skills and
experience across hardware, software, systems engineering and digital signal
processing. In addition to design services DNA also provides services related to
prototype development and initial production of new products, such as
procurement and manufacturing management.
Digital Signal Processing ("DSP") Products
The Company's DSP Products business was initially developed within
DNA beginning in 1996. Effective January 1, 2001 this business began operations
within DCS. DCS designs, produces and sells board-level products that deliver
high performance computing capabilities for embedded applications in the
military/aerospace, industrial and commercial market segments. Products include
multiprocessor VME and PCI boards based on Texas Instruments digital signal
processors and a new line of products launched in 2000. The new products line
includes single, dual and quad processor VME boards based on the Power PC(C)
line of RISC processors produced by Motorola and IBM. The Power PC(C) based
products are available in MPC and G4 versions. As of February 28, 2001 the
backlog of orders for DSP products was approximately $1,760,000; at February 28,
2000 the backlog was approximately $1,230,000.
Optical Networking Products
The Company has identified a new generation of optical networking
equipment, referred to as Aegean, which it anticipates developing under the new
business strategy discussed above. The Aegean product line is an advanced
optical networking solution targeted at the metropolitan area network and can be
generally described as a Multi-Service Delivery Platform or ("MSDP"). It is
designed to span the needs of both metro and access markets and is aimed at the
service delivery needs of incumbent local exchange carriers ("ILEC"),
interexchange carriers "IXC") and the new class of network operators emerging
from the energy industry and elsewhere.
The Company has performed market analysis, developed a detailed
systems architecture, put the initial development team in place and prepared
development schedules and budgets. The Company is now actively seeking
additional strategic contributors and investors in Aegean in order to commence
full scale development activities. Consistent with the Company's new business
strategy, the targeted investors include potential customers, market channels
and other technology companies, as well as financial investors. The Company
estimates it will require approximately $20 million of
4
5
outside investment to complete the first stage of the development process, which
includes production of a product prototype. The Company does not expect to
complete this stage, nor for Aegean to produce revenue, in 2001.
Historically the Company's optical networking business has been
conducted by INT, which was acquired by the Company in 1995. The INT product
line is marketed under the name OmniLynx. Earlier versions of this same product
line were marketed under the names SonetLynx(C) and FibreTrax(C). The OmniLynx
product line, in addition to providing add-drop multiplexing, provides the
functions of traditional networking equipment such as bridges, channel banks,
routers and video matrix switches. The product was originally designed and
optimized for deployment in purpose-built, or private networks. OmniLynx has
been widely deployed with over 4,000 nodes installed throughout the world in
intelligent transportation systems, pipeline projects and cellular telephone
networks.
Beginning in 1999 the Company undertook to modify and optimize the
product for application in public telecommunications networks and in January
2000 began to market OmniLynx for deployment in new public telecommunications
networks being built by CLECs. Although the product met with some early success
in this new market area, subsequently there was limited acceptance, due in part,
the Company believes, to the nature of the networks being built by the Company's
primary target customers, small to medium CLECs, and the financial instability
and uncertainty which developed for such businesses during the second half of
2000. Accordingly, the Company concluded late in 2000 to dispose of the OmniLynx
product line and focus its resources in other business areas.
As discussed above, the Company is significantly reducing the
operations of INT and is seeking transactions for the sale of all or a part of
assets related to the OmniLynx product line.
Other Products
During 1999 the Company completed early stage engineering and
development activities related to the CS4 Intelligent Services Platform, an
integrated enhanced network server for the telecommunications industry, and
completed a beta test of the product. Due to severe shortages of capital during
the last half of 1999 the Company ceased further development activities related
to the CS4. The Company has subsequently explored options for further
development of this product in cooperation with other entities. However, no such
arrangements have been reached to date.
During 1999 the Company made the decision to de-emphasize its
LANscape video conferencing product and in 2000 stopped offering the product.
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 15 of the Notes to
Consolidated Financial Statements for information regarding revenue and profits
by segment and geographic region.
MARKETS AND CUSTOMERS
Engineering Design Services
The Company's engineering services are employed by clients that span
the spectrum 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/services. The products the Company
develops range from compact circuit boards to multi-board systems that
5
6
address the consumer, commercial, industrial, and defense market sectors. DNA
provides expertise that the customer may not have internally or design capacity
beyond the customer's staffing levels. The Company markets its services directly
to prospects worldwide. Principal customers for the Company's services include
board manufacturers, telecommunications equipment vendors, semiconductor
suppliers, and communications service providers. During 2000 one customer
accounted for 18% of consolidated net revenue.
DSP Products
The Company's original line of DSP products is sold primarily
through channel partners. One such channel partner accounted for 13% of
consolidated net revenue during 2000. The Company's new line of PowerPC based
products is sold through a network of manufacturers representatives and a small
internal sales organization. All of these products are utilized for applications
in the military/aerospace commercial-off-the-shelf ("COTS") market by prime
contractors such as Raytheon, Texas Instruments and Lockheed-Martin. In
addition, they are deployed in telecommunications, instrumentation, industrial
control and imaging applications.
Optical Networking Products
The primary targeted markets for the Aegean product are ILECs, IXCs
and newer classes of network operators currently emerging. The Aegean product
has not produced any revenues to date.
The primary market for the OmniLynx product line has been
purpose-built networks such as highway control systems and pipeline networks.
Sales have been made by direct sales staff to network integrators, who design
and install networks. During 2000 one such customer accounted for 18% of
consolidated net revenue.
COMPETITION
The market for the Company's products and services is intensely
competitive and rapidly changing. The Company competes, or may in the future
compete, directly or indirectly for customers with companies such as Lucent
Technologies Corp., Northern Telecom, Ltd., Cisco Systems, and Alcatel. Some of
these competitors may also be customers of the Company from time to time.
The Company believes that the principal competitive factors
affecting the markets for its products and services include effectiveness, scope
of product offerings, technical features, ease of use, reliability, customer
service and support, distribution channels and price. Most competitors are
better capitalized and have greater design, engineering, sales and product
support resources than the Company and, accordingly, may have a competitive
advantage in product development and selling.
MANUFACTURING
The Company's OmniLynx product line is assembled and tested in the
Company's own manufacturing facility. Beginning in 2000 the Company began to
outsource a significant portion of the manufacturing process to third parties.
The Company's DSP products are manufactured by third parties and delivered to
the Company for testing and delivery to customers.
Raw materials are primarily electronic components available from
multiple sources. Certain sole source components, such as processors and memory
chips, are not generally considered a vulnerability because they are reliably
supplied by large companies. The Company has an ongoing program to reduce its
exposure to limited source components where possible.
6
7
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company believes it has a substantial base of intellectual
property, in the form of software and hardware, some of which is embodied in its
products and applied in its ongoing development programs. The Company believes
that factors such as technological and creative skills of its personnel, new
product developments, frequent product enhancements, name recognition, and
reliable product manufacturing are essential to establishing and maintaining a
technology leadership position.
The Company relies on a combination of patent, copyright, trademark
and trade secret laws, and confidentiality procedures to protect its proprietary
rights. The Company currently has six United States patents relating to
telecommunications technology and has 35 currently pending patents relating to
telecommunications and computing technology. The Company seeks to protect its
software, documentation and other written materials under trade secret and
copyright laws, which afford only limited protection.
Litigation may be necessary to enforce the Company's patents and
other intellectual property rights, to protect the Company's trade secrets, to
determine the validity of and scope of the proprietary rights of others, or to
defend against claims of infringement or invalidity. Such litigation could
result in substantial costs and diversion of resources and could have a material
adverse effect on the Company's business, financial condition or results of
operations.
In common with many companies in the telecommunications industry,
the Company has received notices that it may be infringing on certain
intellectual property rights of others. These claims have been defended with
advice of counsel and certain defenses are ongoing. In connection with such
claims or actions asserted against the Company, the Company may seek to obtain a
license under a third party's intellectual property rights, if necessary. There
can be no assurance, however, that a license will be available under reasonable
terms or at all. In addition, the Company could decide to litigate such claims,
which could be expensive and time consuming and which could have a material
adverse effect on the Company's business, financial condition or results of
operations.
EMPLOYEES
The Company had 194 full-time employees at December 31, 2000, of
which 70 were engaged in engineering and development, 37 were engaged in sales,
marketing, and customer support, 50 were engaged in manufacturing operations,
and 37 were engaged in administration and finance. None of the Company's
employees are represented by a labor union. The Company has experienced no
material work stoppages and believes its relations with its employees to be
good. In February 2001, the Company notified approximately 60 employees of INT
that their positions would be eliminated effective April 27, 2001.
GOVERNMENT REGULATION
The telecommunications industry, including many of the Company's
customers, is subject to regulation from federal and state agencies, including
the Federal Communications Commission ("FCC") and various state public utility
and service commissions. Similar regulatory structures exist in most countries
outside the United States. While such regulation does not affect the Company
directly, the effects of such regulations on the Company's customers may, in
turn, adversely impact the Company's business and results of operations. For
example, FCC regulatory policies, affecting the availability of services and
other terms on which telecommunications service providers ("Telcos") conduct
their business, may impede the Company's penetration of certain markets. Current
FCC regulations restrict Telcos' ability to charge their customers based on
access cost to local subscribers
7
8
and may affect the timing of Telcos' investment in the Company's technology.
These FCC regulations and policies are under continuous review by the federal
government and the courts and are subject to change. Although many FCC
restrictions on providing services in previously restricted markets have been
eliminated or modified, the failure to change, or a substantial delay in
changing, the existing restrictions on Telcos may materially adversely affect
their demand for products based upon the Company's technology.
The Telecommunications Act of 1996 removed certain restrictions
relating to the Regional Bell Operating Companies. The Company believes that
this has created and will continue to create increased competition in the
markets served by the Company's products.
In addition, the Company's business and operating results may also
be adversely affected by the imposition of certain tariffs, duties and other
import restrictions on components that the Company obtains from non-domestic
suppliers or by the imposition of export restrictions on products that the
Company sells internationally. The governments of many other countries actively
promote and create competition in the telecommunications industry. The Company
does not believe it has material exposure to environmental laws. Changes in
current or future laws or regulations, in the United States or elsewhere, could
materially and adversely affect the Company's business and results of
operations.
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 the Company's common stock (the "Common Stock").
The trading price of the Common Stock could decline due to any of these risks,
and investors in the Common Stock could lose all or part of their investment.
A Number of Factors Could Cause Operating Results to Fluctuate
Significantly.
The Company's operations have been, and will continue to be,
affected by a wide variety of factors, many of which are outside its control.
These factors include, but are not limited to, adequacy of supplies for key
components and assemblies, product feature component mix and the ability to
introduce new technologies and features ahead of competitors, the timing and
size of the orders received from customers, the Company's ability to efficiently
produce and ship orders promptly on a price-competitive basis, introductions or
announcements of new products by competitors, and the ability to implement the
new business strategy it has recently implemented.
The Common Stock Is Subject to Price Volatility and May Be De-listed
from the Nasdaq SmallCap Market.
The price of the 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 the Common Stock
could decline significantly. A significant decline in the market price of the
Common Stock could result in litigation which could also result in increased
costs and a diversion of management's attention and resources from operations.
The Common Stock currently has a bid price below $1.00 per share and
is therefore subject to de-listing from the Nasdaq SmallCap Market. If the
Common Stock is de-listed it may be eligible for inclusion in the OTC Bulletin
Board operating 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. Therefore, the price and average trading volume of
the Common Stock could decline. There can be no assurance that the Company's
investors will be able to sell the Common Stock at prices and times that are
desirable.
8
9
The Company Has Incurred Significant Losses in the Past and Is Not
Profitable.
The Company is not profitable. Over the past three years the Company
has incurred net losses of $29,572,000, $29,589,000 and $43,138,000,
respectively. These losses have been founded from borrowings under credit
facilities and sales of common and preferred stock. It is not certain when the
Company will become profitable. The ability to become profitable will depend, in
part on the Company's ability to increase net revenue from its design services
business and from sales of DSP products. In addition, it will depend on the
reduction or elimination of costs related to the OmniLynx product line. If cash
needs exceed available resources there can be no assurance that additional
capital will be available through public or private equity or debt financing.
The Company May Need Additional Financing for Its New Products and
Business Strategy Which It May Not Be Able to Attain.
The Company's ability to develop new products and pursue its new
business strategy is dependent on the availability of outside financing. The
Company intends to seek to obtain such financing by offering equity
participation in new product initiatives to strategic and financial investors.
This is a new method of financing for the Company and there can be no assurance
that it will be successful in attracting sufficient outside investment in new
product initiatives.
The Company May Not Be Able To Successfully Complete Development and
Achieve Commercial Acceptance of Its New Products.
The Company intends to continue the development of additional
products, such as the Aegean line of optical networking products, that are
consistent with its new business strategy. The development of these products,
from laboratory prototype to customer trials, and subsequently to general
availability involves a number of steps, including:
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;
o establishment of systems integration and systems test validation
requirements; and
o identification and qualification of component suppliers.
Each of these steps in turn presents serious risks of failure,
rework or delay, any one of which 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 a host
of other execution disks may delay or even prevent the introduction of these
products. If the Company does not develop and successfully introduce these
products in a timely manner, its business, financial condition and results of
operations would be harmed.
Additionally, the markets for the Company's new product lines may be
undeveloped. The commercial acceptance of these types of products may be
uncertain. The Company cannot assure you that the sales and marketing efforts
for these products will be successful. If the markets for these products do not
develop or the products are not accepted by the market, the Company's business,
financial condition and results of operations would suffer.
9
10
The Company Is a Party to Lawsuits and May Be Subject to Other
Contingent Liabilities.
The Company may be subject to significant contingent liabilities. In
connection with the sale of former operations, the Company agreed to indemnify
the purchaser of those operations for losses which may arise in connection with
product liability claims. During 2000 the Company settled one such claim
resulting in a cash payment by the Company of approximately $1,100,000 over a
period of two years. Another of these liabilities involves a fire arm product
liability lawsuit which one defendant settled for $5,000,000. That defendant has
asserted third party liability claims against the purchaser for the amount of
the settlement plus attorney's fees and related costs. The Company may be
responsible for any recovery against the purchaser in this proceeding. Based on
information available to date, it is impossible to predict the outcome of this
matter; however an adverse outcome could materially affect its financial
condition and results of operations.
The Company's Failure to Quickly Adopt to Rapidly Changing
Competitive and Economic Conditions Could Have a Material Adverse Effect on Its
Business and Results of Operations.
The Company operates in a rapidly changing competitive and economic
environment. The telecommunications and computing equipment market is constantly
undergoing rapid competitive and economic changes, the full scope and nature of
which is difficult to predict. Industry consolidation among competitors may
increase the number of competitors with greater financial resources, enabling
them to reduce their prices. his would require the Company to reduce the prices
of its products or risk losing market share. Moreover, the Company believes that
technological and regulatory change will continue to attract new entrants to the
market in which it competes.
The Company Has a Limited Customer Base.
The Company relies on a limited number of customers for a
substantial portion of its revenues. f one or more significant customers were
lost, or these customers' need for the Company's products and services were to
decrease, the Company's revenues and net income could decline.
The Company Must Attract, Retain and Motivate Key Technical and
Management Personnel in a Competitive Market in Order to Sustain and Grow Its
Business.
The Company's success depends to a significant extent upon key
technical and management employees. Competition for highly qualified employees
is intense and the process of locating key technical and management personnel
with the required combination of skills and attributes is often lengthy and
expensive. This competition is particularly intense in North Texas, where there
is a high concentration of established and emerging growth technology companies.
There can be no assurance that the Company will be successful in retaining its
existing key personnel or in attracting and retaining the additional employees
it may require. The Company must continue to recruit, train, assimilate,
motivate, and retain qualified managers and employees to manage its operations
effectively; otherwise its results of operations could be significantly
adversely affected.
The Company is Subject to Various Regulations and Industry
Standards.
The communications and computing industries are subject to numerous
and changing regulations and industry standards, including standards and
regulations imposed by the Federal Communications Commission and other
governmental authorities. If the Company's products do not meet these
regulations or are not compatible with these standards, its ability to sell
products and offer services could be seriously harmed.
10
11
The Company May Be Unable to Secure Necessary Components and Support
Because It Depends Upon a Limited Number of Third-Party Manufacturers and
Support Organizations.
Certain components used in the Company's 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
telecommunications and computing equipment manufacturers due to market demand
for components and equipment. Especially in recent times in a worldwide
telecommunications market expansion, many component suppliers have placed
critical components on worldwide allocation. Many of the Company's competitors
are much larger and may be able to obtain priority allocations from these shared
vendors, thereby limiting or making unreliable its sources of supply for these
components. If the Company is unable to obtain sufficient supply from
alternative sources, reduced supplies and higher prices of components will
significantly limit its ability to meet scheduled product deliveries to
customers, which would seriously harm its business and results of operations.
The Failure to Develop and Introduce New Products That Meet Changing
Customer Requirements and Address Technological Advances Would Limit the
Company's Ability to Sell Its Products and Services.
New product development often requires long-term forecasting of
market trends, and development and implementation of new technologies. If the
Company fails or is late to respond to new technological developments, market
acceptance of its products may be significantly reduced or delayed. The
telecommunications and computing equipment market is 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 existing products obsolete or unmarketable.
Product Performance Problems Could Limit Sales Prospects.
The production of new products and services 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 the Company's 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 the Company maintains 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 the control of the Company. If the Company experiences significant
interruptions or delays that cannot be promptly resolved, confidence in its
products could be undermined, which could have a material adverse effect on
operations.
11
12
The Company's Failure to Protect Its Intellectual Property Will
Adversely Affect Its Ability to Compete in the Industry and the Profitability of
Its Operations.
The Company attempts to protect its technology through a combination
of copyrights, trade secret laws, contractual obligations, and patents. These
intellectual property protection measures may not be sufficient to prevent
wrongful misappropriation of the Company's technology nor will they prevent
competitors from independently developing technologies that are substantially
equivalent or superior to its 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. Furthermore, policing the unauthorized use of the Company's
products is difficult. Litigation may be necessary in the future to enforce the
Company's intellectual property rights. This litigation could result in
substantial costs and diversion of resources and may not ultimately be
successful.
The Company May Be Subject to Intellectual Property Infringement
Claims That Are Costly to Defend and Could Limit Its Ability to Use Some
Technologies in the Future.
Like other participants in the industry, the Company expects that it
will continue to be subject to infringement claims and other intellectual
property disputes as competition in the marketplace continues to intensify. In
the future, the Company 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. Adverse
determinations in such litigation could result in the loss of the Company's
proprietary rights, subject the Company to significant liabilities, require the
Company to seek licenses from third parties, or prevent manufacturing or sale of
the Company's products. Furthermore, there can be no assurance that any
necessary licenses will be available on reasonable terms. Any one of these
results could seriously harm the Company's business and results of operations.
ITEM 2 - PROPERTIES
All of the Company's facilities are leased. The facilities are in
Richardson, Texas. The Company's principal operations are serviced from three
leased facilities in Richardson, Texas, (comprising approximately 104,000 square
feet), which the Company believes to be suitable for its operations as currently
conducted. These facilities include manufacturing, engineering, sales,
marketing, and administrative offices. All of the Company's manufacturing
operations are located in a 28,000 square foot Richardson, Texas facility. With
the curtailment of the operations of INT, the Company believes that one facility
with approximately 25,000 square feet of space will not be required for ongoing
operations. The Company is currently seeking a sublease of this space which has
a remaining lease term through July 2, 2004.
ITEM 3 - LEGAL PROCEEDINGS
The Company is involved in various legal proceedings and claims
arising in the ordinary course of business.
Cadence Lawsuit. In July, 1999 the Company negotiated the sale of a
portion of its engineering design services operations conducted by DNA. The
agreement with Cadence Design Systems, Inc. ("Cadence") provided for a purchase
price of $15.0 million in cash. The Company believes Cadence and the Company
signed and delivered an asset purchase agreement to consummate the transaction.
The transaction was scheduled to close on July 23, 1999. Despite the Company
having, to the best of
12
13
its knowledge, met all conditions to closing, Cadence failed to close the
transaction. Therefore, the Company believes Cadence breached the agreement
which had been reached between the parties. The Company has filed suit in state
district court of Dallas County, Texas to recover damages, alleging breach of
contract, fraud, breach of fiduciary duty and negligent misrepresentation by
Cadence. The Company has amended its original complaint to indicate that, based
on the opinion of the Company's witness regarding damages, aggregate damages to
the Company and DNA exceed $100 million. The trial in this matter is currently
scheduled for October, 2001. The ultimate outcome of this matter cannot be
determined at this time.
Shareholder Class Action. A shareholders class action lawsuit was
filed in the U. S. District Court for the Northern District of Texas purported
to have been filed on behalf of all persons and entities who purchased the
Company's common stock during the period between February 24, 1998 and November
17, 1998. The named defendants include the Company and certain former and
present officers and directors of the Company. The complaint alleges that the
defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated thereunder by making false and misleading
statements concerning the Company's reported financial results during the
period, primarily relating to revenue recognition, asset impairment and
capitalization issues. The plaintiffs seek monetary damages, interest, costs and
expenses. The Company intends to defend the suit vigorously in all aspects. No
trial date has been set and discovery has not yet commenced for this matter.
St. James Lawsuits. In July 2000 the Company was served with a
lawsuit in a case styled St. James Capital Partners, L.P. and SJMB, L.P. v.
Intelect Communications, Inc. filed in state district court in Harris County,
Texas. The Company and St. James Capital Partners, L.P. ("SJCP") and SJMB, L.P.
("SJMB")(SJCP and SJMB collectively "St. James") were in disagreement as to the
operation of the anti-dilution provisions in warrants which the Company had
issued to St. James. The dispute in question relates to warrants originally
issued to St. James in April 1998 at an exercise price of $7.50 per share to
purchase an aggregate of 1.5 million shares, and an additional 535,000 shares
issued to them in January 1999 at an exercise price of $3.20 per share. St.
James petitioned the court for declaratory relief, among other claims, to
require the Company to acknowledge that St. James was entitled to a re-set of
the exercise price on each of the warrants to a price of $0.561 per share and
would be entitled to an aggregate of approximately 25 million shares to be
issued upon exercise of such warrants.
In September 2000 the Company filed suit against St. James in state
district court in Dallas County, Texas for breach of contract and seeking the
return of the stock of the Company's material subsidiaries which was being held
as collateral by St. James. Also in 2000 the Company filed suit against St.
James and certain individuals in U.S. District Court for the Northern District
of Texas seeking the disgorgement of short-swing profits pursuant to section
16(b) of the Securities Exchange Act of 1934.
The Company and St. James entered into an agreement, which fully
resolved the above disputes with St. James. Pursuant to the agreement St. James
and the Company released one another from all obligations and liabilities
related to financing previously entered into by the parties and St. James
delivered to the Company certain collateral and all warrants currently held by
it. The Company delivered to St. James redeemable warrants in recognition of the
anti-dilution provisions of the warrants currently held by St. James. Warrants
for 4,300,000 shares are exercisable immediately, have an exercise price of
$0.75 per share and expire June 30, 2002. Warrants for an additional 7,600,000
shares are exercisable beginning April 15, 2001, have an exercise price of $0.75
per share and expire September 30, 2002. Warrants for a further 7,600,000 shares
will be exercisable beginning October 15, 2001, have an exercise price of $0.75
per share and expire September 30, 2002. All of the warrants will be redeemable
by the Company at a price of $6.75 per share.
13
14
Savage Matters. The Company is contingently liable for certain
potential liabilities related to its discontinued operations. Specifically,
under a stock purchase agreement dated October 3, 1995 ("1995 Agreement"), the
Company agreed to indemnify Savage Sports Corporation, the purchaser of the
Company's subsidiary, Savage Arms, Inc. (a manufacturer of sporting bolt action
rifles) ("Savage"), for certain product liability, environmental clean-up costs
and other contractual liabilities, including certain asserted successor
liability claims. One of the liabilities assumed involves a firearms product
liability lawsuit filed in Alaska Superior Court (the "Taylor litigation"). The
Company is informed that a defendant in the Taylor litigation, Western Auto
Supply Co., settled the lawsuit for $5 million and, in turn, has asserted a
third-party claim against Savage for indemnification in the amount of the
settlement plus attorneys' fees and related costs. Savage has asserted defenses
to the claims and the Company believes additional defenses may be available.
Based on the information available to date, it is impossible to predict the
outcome of this litigation or to assess the probability of any verdict.
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 $1.1
million 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.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
14
15
PART II
ITEM 5 - MARKETS FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is traded on the Nasdaq SmallCap
Market under the symbol "TERA." On January 30, 2001, concurrent with the change
in its name to TeraForce Technology Corporation from Intelect Communications,
Inc., the Company's trading symbol changed to "TERA" from "ICOM." Prior to
January 30, 2001, the Company's stock traded under the "ICOM" symbol. The high
and low bid prices for the Company's common stock for each full quarter of the
last two fiscal years, as reported on 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
--------------------- ---------- ----------
March 31, 1999 2.469 1.000
June 30, 1999 1.906 0.719
September 30, 1999 1.969 0.750
December 31, 1999 1.938 0.625
March 31, 2000 10.438 1.375
June 30, 2000 5.563 1.750
September 30, 2000 2.656 1.125
December 31, 2000 1.719 0.313
In January 2001 the Company received notice from The Nasdaq Stock
Market, Inc. ("Nasdaq") that the Company's common stock failed to maintain a
minimum bid price of at least $1.00 over the prior 30 day period as required by
Nasdaq marketplace rules. Pursuant to the notice the Company has been provided
90 days, or until April 2, 2001, to regain compliance with this rule. If at any
time prior to April 2, 2001 the bid price for the Company's common stock is at
least $1.00 for ten consecutive trading days, the staff of Nasdaq will determine
if the Company complies with the rule. As of the date of the filing of this
Annual Report on Form 10-K, the Company does not anticipate demonstrating
compliance with this rule based on the trading price of its common stock over
the past 90 days. If the Company is unable to demonstrate compliance with the
rule by April 2, 2001, the Company's common stock will be subject to de-listing
from the Nasdaq SmallCap Market. Any such determination at that time may be
appealed by the Company to a Nasdaq Listing Qualifications Listing Panel. The
Company does intend to appeal any such determination of delisting; however,
there can be no assurance of the outcome of the appeal process. If the Company's
common stock is de-listed from the Nasdaq SmallCap Market, it may be eligible
for inclusion in the OTC Bulletin Board operated by the Nasdaq Stock Market.
Such market generally provides less liquidity and certain institutional
investors may not purchase stocks in this market.
As of March 16, 2001, the Company's outstanding shares of common
stock were held by approximately 5,800 owners of record (including nominee
holders such as banks and brokerage firms who hold shares for the benefit of
beneficial owners).
The closing bid price of the common stock on the Nasdaq Small Cap
Market on March 16, 2001 was $0.344.
DIVIDEND POLICY
In March 2000, the Company paid $966,000 of cash dividends with the
redemption of shares of its Series A Preferred Stock. No dividends have been
paid on any other class of equity in 2000. No cash dividends were paid by the
Company during 1998 and 1999. During 1999 and 1998 the Company issued common
stock in payment of preferred stock dividends of $830,000 and $1,309,000,
respectively. The Company does not currently plan to pay any dividends on common
stock in the foreseeable future.
15
16
ITEM 6 - SELECTED FINANCIAL DATA
The following tables set forth certain historical consolidated
financial data for the Company.
Years ended December 31,
----------------------------------------------------------
2000 1999 1998* 1997* 1996
-------- -------- -------- -------- --------
($ in thousands, except per share data)
STATEMENT OF OPERATIONS:
Net revenues $ 18,750 $ 16,699 $ 19,341 $ 37,777 $ 9,352
======== ======== ======== ======== ========
Operating loss $(30,062) $(25,498) $(38,787) $(17,642) $(33,638)
======== ======== ======== ======== ========
Loss from continuing operations $(29,572) $(28,535) $(42,735) $(19,743) $(42,983)
Loss on disposal of
discontinued operations -- -- (403) (498) (56)
Extraordinary item -- (1,054) -- -- --
-------- -------- -------- -------- --------
Net loss $(29,572) $(29,589) $(43,138) $(20,241) $(43,039)
======== ======== ======== ======== ========
Loss allocable to common
stockholders $(30,538) $(34,517) $(46,105) $(20,798) $(43,039)
======== ======== ======== ======== ========
Basic and diluted loss per share:
Continuing operations $ (0.37) $ (0.72) $ (1.76) $ (0.99) $ (3.32)
Discontinued operations -- -- (0.02) (0.02) (0.01)
Extraordinary item -- (0.02) -- -- --
-------- -------- -------- -------- --------
Loss for period $ (0.37) $ (0.74) $ (1.78) $ (1.01) $ (3.33)
======== ======== ======== ======== ========
Weighted average shares (thousands) 83,229 46,762 25,939 20,558 12,943
BALANCE SHEET:
ASSETS:
Current assets $ 18,805 $ 11,861 $ 16,413 $ 25,552 $ 11,594
Excess of cost over assets of
companies acquired 3,354 4,115 4,787 13,249 14,573
Other long-term assets 1,845 8,366 11,270 11,008 9,851
-------- -------- -------- -------- --------
Total assets $ 24,004 $ 24,342 $ 32,470 $ 49,809 $ 36,018
======== ======== ======== ======== ========
LIABILITIES & SHAREHOLDERS' EQUITY:
Current liabilities including current
maturities of long-term debt $ 4,593 $ 8,674 $ 9,938 $ 23,517 $ 9,810
Long-term liabilities -- 15,264 15,000 143 18,477
Stockholders' equity 19,411 404 7,532 26,149 7,731
-------- -------- -------- -------- --------
$ 24,004 $ 24,342 $ 32,470 $ 49,809 $ 36,018
======== ======== ======== ======== ========
* Certain amounts have been reclassified to conform to current classifications.
16
17
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 included later in this Form 10-K.
All statements other than historical facts included in the following discussion
about the Company's financial position, business strategy, and plans of
management for future operations are forward looking statements which could
prove to be wrong.
RESULTS OF OPERATIONS
The following table shows the revenue and gross profits (loss) for
the Company's products:
Years ended December 31,
--------------------------------------
2000 1999 1998
---------- ---------- ----------
($ in Thousands)
Revenue:
Optical networking equipment $ 6,994 $ 9,479 $ 6,410
Design services 7,002 4,596 8,147
Digital signal processors (DSP) 3,599 1,411 2,690
Other 1,155 1,213 2,094
---------- ---------- ----------
$ 18,750 $ 16,699 $ 19,341
---------- ---------- ----------
Gross profit (loss):
Optical networking equipment $ (1,813) $ (1,426) $ (1,399)
Design services 597 (544) 2,002
Digital signal processors (DSP) 375 245 1,390
Other (67) (13) (488)
---------- ---------- ----------
$ (908) $ (1,738) $ 1,505
---------- ---------- ----------
Revenues
During each of the three years ended December 31, 2000 the Company's
optical networking equipment sales related to the OmniLynx product line, which
prior to 2000, was marketed under the SonetLynx(C) and FiberTrax(C) names. Sales
of such equipment declined 26% in 2000 from 1999. In 2000 the Company
repositioned the OmniLynx product line for sale into public telecommunications
networks as opposed to purpose built, or private networks, which had been the
primary market for the product line. The public network market was perceived to
present a much larger opportunity for the product line. As a part of this
initiative sales and marketing efforts were concentrated towards public network
markets, especially small and medium sized competitive local exchange carriers
("CLECs"), with less emphasis on historical markets. Despite some early success
in the new markets, the Company had little success in marketing the OmniLynx
product line in public networks. Management believes this was due in large part
due to a dramatic downturn in the business environment for CLECs as well as the
nature of the public networks which were actually being deployed. These networks
had technical characteristics which did not emphasize the technical advantages
of the OmniLynx product line. Sales of optical networking equipment in 1999
increased 48% from 1998 levels, sales in both 1999 and 1998 reflect the
Company's refocusing on non-Far East markets which had previously been the
Company's primary market. In addition, the Company's financial condition
resulted in difficulties in obtaining necessary component parts and created
uncertainty as to the Company's ability to meet delivery requirements.
Therefore, existing and potential customers became reluctant to place new orders
with the Company during these periods.
17
18
Net revenue from Design Services increased 52% in 2000 as compared
to 1999. This increase reflects the recovery of such business from the effects
of the proposed sale of certain of those operations to Cadence during 1999.
Revenues from design services declined 44% in 1999 as compared to 1998. During
the negotiation of the aborted sale with Cadence and preparation for closing the
transaction, the Company was limited in its ability to engage in new design
services projects. Therefore, as existing projects were completed, the Company
experienced a decline in revenues from such services.
In the fourth quarter of 2000 the Company began initial shipments of
its new line of DSP products based on PowerPC(C) line of RISC processors.
Initial orders for these products were primarily evaluation units for
prospective customers; therefor, the new product line did not contribute
materially to 2000 net revenue. The 155% increase in sales of the Company's
existing product line, based on Texas Instruments digital signal processors, in
2000 over 1999 reflects the increasing deployment of such products within
military / aerospace programs utilizing "commercial off the shelf", or "COTS"
components. Revenue from DSP products, primarily those based on Texas
Instruments components, decreased 47% in 1999 as compared to 1998.
Unavailability of components and customer uncertainty over future availability
were the primary causes of the 1999 decline in these revenues. The 1998 year
included the launch of development tools for the Texas Instruments components
and end products.
Other revenues consist primarily of the voice and data switching
products used in air traffic control applications and video network products,
which have declined in strategic significance to the Company and which are no
longer actively promoted or pursued.
Gross profit (loss)
Gross loss from optical networking equipment reflects the effect of
relatively low production levels for the Company's manufacturing operations. The
lower production levels resulted in unabsorbed overhead of approximately
$1,400,000 in 2000 and $1,700,000 in 1999. Also affecting the gross loss is
amortization of technology costs and capitalized software development costs of
approximately $1,300,000 in 2000 and $1,400,000 in 1999. In the fourth quarter
of 1999 the Company reduced the carrying value of its inventory by approximately
$1,600,000. This adjustment was based on cost variances and a periodic review of
the components of inventory in relation to anticipated sales and production and
product design changes, as well as current market prices for components and
completed products. In addition, 2000 and 1999 gross profit reflects the effect
of pricing concessions granted to certain customers due to significant past and
potential business with those customers.
As the Company has rebuilt the Design Services operation following
the failed Cadence transaction, it has added additional staff. In addition, the
highly competitive market for skilled telecommunications engineers has resulted
in higher turnover during 2000 and required additional efforts to maintain
staffing levels. These factors have increased the cost of hiring skilled
engineers and the relative high level of new staff has resulted in relatively
higher non-billable time. These factors have combined to result in lower gross
margins in 2000 than would normally be expected. Due to the Cadence transaction
discussed above, during 1999 the Company was required to maintain certain
minimum staffing levels within its Design Services operations, irrespective of
the amount of billable activity. Accordingly, certain costs were incurred
without the revenues normally associated with such costs. The failure of the
Cadence transaction to close also required the Company to reduce staffing levels
within the Design Services operation, which resulted in certain severance and
termination costs. Additionally, in order to stabilize and retain the remaining
staff, the Company was required to incur additional costs in the form of salary
adjustments and retention bonuses. Costs related to these items amounted to
approximately $254,000 during 1999.
18
19
Gross profit from DSP sales increased 53% between 1999 and 2000 in
absolute terms, but declined as percentage of net revenue. This relative decline
results in part from increased production infrastructure put in place during
2000 in order to support anticipated increased activity. In addition during
2000, the Company began to deliver initial versions of its new product line;
these deliveries consisted of small quantities of evaluation units. These small
production runs resulted in higher than normal component costs, due to small
volume purchases, and incremental charges to expedite certain time critical
deliveries. DSP products contributed positive gross profit for the first time in
1998 as revenues grew to a level which allowed for a characteristic margin. This
gross profit declined in 1999 as a result of lower sales levels.
Engineering & development (E&D) expenses
E&D expense decreased to $5,258,000 in 2000, as compared to
$10,040,000 in 1999 and $10,815,000 in 1998. In all three years, certain amounts
of software development costs were capitalized. Including those amounts, the
total E&D expenditures were $6,153,000, $10,647,000 and $12,713,000,
respectively, in the years 2000, 1999 and 1998. Total E&D expenditures by
product line were distributed as follows:
Years ended December 31,
------------------------------------------
2000 1999 1998
------------ ------------ ------------
($ in Thousands)
Optical networking products $ 3,504 $ 4,700 $ 4,580
CS4 -- 3,565 4,846
Digital signal processor (DSP) 1,722 886 1,002
Other 32 889 387
------------ ------------ ------------
$ 5,258 $ 10,040 $ 10,815
------------ ------------ ------------
Costs related to optical networking products relate primarily to
enhancements to the OmniLynx product line. Efforts related to this product line
have been materially reduced in late 2000 and early 2001. During 2000 the
Company began incurring costs related to the Aegean product initiative; however,
such costs have not been material to date. Engineering and development costs
related to DSP products increased during 2000 as a result of activities related
to the new line of products based on the Power PC(C) processor. During 1999 and
1998, the Company incurred significant engineering and development costs related
to its CS4 Intelligent Switching Platform. The Company has completed or
suspended all development activities related to this project and accordingly
does not currently have plans to incur further engineering and development costs
related to it. All E&D costs related to this project have been expensed.
Selling and administrative expenses
Selling and administrative expenses increased $925,000, or 7%
between 2000 and 1999 and decreased $4,676,000, or 26%, between 1999 and 1998.
The increase in 2000 costs reflects the Company's efforts to introduce the
OmniLynx product line into public network markets and increased marketing
efforts relating to DSP products. The reductions in 1999 are the result of lower
sales levels and the Company's efforts to reduce selling and administrative
expense, including the closing of certain offices and staff reductions. Such
expenses in 1999 include approximately $550,000 from an increase in the
allowance for doubtful accounts, estimated costs of $200,000 related to a
certain shareholder suit (see Item 3 - "Legal Proceedings"), legal costs of
approximately $200,000 related to the Cadence transaction and financing
transactions during the third quarter of 1999, and approximately $233,000
related to the adjustment of the carrying value of certain assets previously
utilized in the Company's video network products business. Selling and
administrative expenses in 1998 include $1,148,000 of warranty expense,
primarily the extra costs of start up and first year
19
20
operations of two major installations of the SonetLynx(C) product in Korea and
on the Alyeska pipeline. The Company estimates that the usual level of warranty
expenses would have been approximately $200,000 but for special startup
difficulties caused by distance, cultural differences and unusual technical
characteristics.
Asset write downs
In the fourth quarter of 2000 the Company determined that, due to
changes in certain target customer markets, its OmniLynx line of optical
networking products no longer fits within the Company's long-term objectives and
began plans to sell the product line and related operations. A transaction for
the sale of the OmniLynx business failed in the first quarter of 2001 due to
business difficulties experienced by the potential purchaser. The Company has
significantly curtailed the ongoing operations of the OmniLynx business and is
pursuing other methods of disposing of the business, including liquidating the
assets. Accordingly, as of December 31, 2000 the carrying values of the assets
related to the OmniLynx product line have adjusted to the lower of cost and
estimated net realizable value. A charge to operations has been recorded as of
December 31, 2000 as follows:
($ In Thousands)
Reduction of inventory to net realizable value $ 5,642
Reduction of property and equipment
to new realizable value 2,199
Write-off of capitalized software development
costs and purchased intangibles 1,383
Other 27
----------
Asset writedown $ 9,251
==========
In accordance with the evolving focus of the Company's primary
technologies, products and markets and forward growth plans, and in accordance
with the Company's accounting policies, including reviews of realizability of
its long-term assets, including goodwill, the Company wrote off the September
30, 1998 balance of $6,888,000 of goodwill from the acquisition in 1995 of
Intelect Inc., which at that time was primarily engaged in the supply of
communications systems for air traffic control and air defense installations.
The write-off decision was determined by the recent loss of three major
identified business opportunities, the absence of significant identified future
opportunities and business combinations which strengthened competitors, all
leading the Company to reassess the outlook for the air traffic control business
segment. The Company concluded that the outlook for future business would not
support a forecast of revenue and contribution margin adequate to liquidate
inventories and support amortization of the goodwill asset.
Accounts and notes receivable from the Company's Korean distributor,
and relating to the sales of the Company's products in Korea, totaled $4,696,000
at the end of September 1998, compared to $9,879,000 at December 31, 1997, from
which $6,731,000 was collected and to which $1,730,000 of shipments were added
during 1998. The Company was advised, at a meeting in October 1998, of the
distributor's illiquidity and inability to maintain any certain schedule of
payments of receivables. Accordingly, the Company determined that it would be
prudent and timely to write off or reserve substantially all the distributor's
receivables adjusted for a collection of $1,000,000 received in February 1999.
In connection with this collection, and contingent on certain future payments,
the Company agreed not to pursue any further collections of the receivable.
20
21
Interest expense
Interest expense, including non-cash financing charges, was
$798,000, $2,673,000, and $4,385,000 in the years ended December 31, 2000, 1999
and 1998 consisting of:
Years ended December 31,
---------------------------------
($ in Thousands)
2000 1999 1998
--------- --------- ---------
Interest on debt instruments $ 348 $ 1,603 $ 1,109
Non-cash financing costs 426 1,019 3,242
Other costs of financing -- 8 28
Other interest 24 43 6
--------- --------- ---------
$ 798 $ 2,673 $ 4,385
--------- --------- ---------
Interest on debt instruments in 2000, 1999 and 1998 was primarily
attributable to amounts borrowed from St. James Capital Corp., SJMB, L.P., and
the Coastal Trust.
Non-cash financing costs in all three years 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.
Other costs of financing consist primarily of legal and placement
fees.
Interest income and other
In 2000 interest income and other includes interest on the temporary
investment of cash balance of approximately $1,028,000 and approximately
$1,070,000 from the settlement of a dispute with a professional service
provider. These amounts are offset by a charge of approximately $875,000 related
to the settlement of certain litigation.
Loss on debt retirement
Pursuant to a restructuring of its debt obligations in August 1999,
the Company repaid $3,000,000 of note payable to St. James through the issuance
of 3,864,271 shares of common stock. This resulted in a loss on debt retirement
of $1,054,000.
Dividends on preferred stock
Dividends on preferred stock include the effect of beneficial
conversion features granted to the holders of the preferred stock in the amounts
of $3,910,000 for the year ended December 31, 1999 and $618,000 for the year
ended December 31, 1998.
Outlook for 2001 net revenue
Due to the decision to dispose of the OmniLynx product line and
related operations, the Company does not expect material revenues from this
product line in 2001. Furthermore, the Company does not expect the Aegean
product initiative to produce revenues in 2001.
The Company does expect further improvement in its Design Services
operations during 2001. Currently the Company expects net revenue from this
segment to be between $7 million and $9 million during 2001. Factors which could
affect these results include, but are not limited to, the
21
22
availability of experienced engineers and the Company's ability to attract and
retain them, and the demand for the Company's services.
The Company's DSP products operations are expected to grow
significantly during 2001. Currently the Company expects net revenue from this
segment to be between $8 million and $10 million during 2001. Factors which
could affect these results include, but are not limited to, customer acceptance
of the Company's new line of DSP products, the Company's ability to meet higher
production levels associated with higher net revenues, availability of component
parts, customer's belief that the Company has the financial resources necessary
to meet higher production demands, and the award of production contracts related
to programs utilizing the Company's DSP products.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2000 the Company had cash and temporary
investments of $5,697,000,working capital of $14,212,000 and no funded debt. For
the year ended December 31, 2000 cash flow used in operations amounted to
$22,442,000.
Approximately $16,500,000 of the cash flow used in operations during
2000 is associated with the operations related to the OmniLynx product line. As
a result of the Company's decision to dispose of this product line and its
associated operations, the demand on the Company's financial resources as a
result of these operations will be eliminated during the course of 2001. In
addition, as those operations are sold or otherwise disposed of the Company
expects to generate cash either from the sale of the operations or from the sale
of the related assets such as inventory and fixed assets.
As discussed above, the Company expects its Design Services and DSP
products operations to expand during 2001 and therefore, expects them to
contribute positive cash flow from operations by the second half of 2001.
As outlined in its business strategy, the Company expects to fund
the majority of new product development costs with contributions from strategic
partners in those product initiatives. The Company has no material capital
expenditure commitments in 2001. There can be no assurance that the Company will
be successful in attracting such partners or that the amounts contributed will
be sufficient to commercially develop such products. In addition, the conditions
under which such potential partners are willing to participate in these projects
may be on terms which the Company finds unacceptable. If the Company is unable
to attract sufficient capital from potential partners, or if capital is
available only under terms the Company finds unacceptable, the Company may be
required to delay or curtail the planned development activities or to expend its
own capital.
Due to the factors discussed above management expects the Company to
generate positive cash flow from operations by the third quarter of 2001.
Management also believes that the Company's available financial resources and
those expected to be generated, as discussed above, are sufficient to fund the
Company's on-going operations. If the expected operational improvements or
realization of other assets does not materialize in the amounts or within the
time frames anticipated, the Company could be forced to seek other sources of
capital. These could include commercial banking facilities to provide working
capital, especially related to DSP products business, and the issuance of debt
or equity securities. There can be no assurance that these sources of financing
will be available to the Company when needed or under terms which the Company
finds acceptable. If the Company is unable to acquire such capital it could be
required to curtail certain operations or to sell assets.
22
23
Operating activities
Net cash applied in operations primarily reflects the $29,572,000
net loss offset by $14,794,000 of non-cash charges, and the $7,664,000 net
increase in working capital.
o Inventory increased $5,506,000, excluding writedowns.
o Accounts payable and accrued liabilities decreased $1,785,000.
o The non-cash charges consist primarily of $4,650,000 of
depreciation and amortization of intangible assets and $9,251,000,
related to asset writedowns.
Investing activities
Investments during 2000 were primarily $1,888,000 of fixed asset
additions and $896,000 of capitalized product enhancements and advancements
related to optical networking products, offset by proceeds from the sale of
marketable securities. The fixed asset additions were concentrated in computers,
software and test equipment to support engineering activities.
Financing activities
In the first half of 2000 the Company completed a series of
transactions which materially improved its liquidity and financial position. In
January, 2000 the Company completed a private placement of 7,200,000 million
shares of common stock and warrants to purchase an additional 3,600,000 shares
at an exercise price of $2.50 per share. Net proceeds to the Company, after
selling commissions and costs amounted to approximately $16.8 million.
In March 2000 the Company completed a private placement of 4,600,000
million shares of common stock. Net proceeds to the Company, after selling
commissions and costs, amounted to approximately $25.8 million. Of these
proceeds, approximately $9.6 million was used to repay indebtedness to the
Coastal Corporation Second Pension Trust ("Coastal") and approximately $7.5
million was used to redeem the Series A Preferred Stock, all of which was held
by Coastal.
Between December 31, 1999 and March 24, 2000, the Company issued
approximately 2,400,000 million shares of Common Stock pursuant to the exercise
of various warrants and employee stock options. Proceeds to the Company from
these transactions amounted to approximately $5.2 million.
During the course of 2000 the Company issued a total of 4,858,438
shares of common stock to St. James in payment of all principal and interest due
under the credit facility with St. James, which amount totaled approximately
$8,300,000.
Contingent liabilities
As discussed in "ITEM 3 - Legal Proceedings," the Company is exposed
to certain contingent liabilities which, if resolved adversely to the Company,
could adversely affect its liquidity, its results of operations, and/or its
financial position.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is not exposed to material market risk with regard to
financial instruments.
23
24
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TERAFORCE TECHNOLOGY CORPORATION. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants......................... 25
Consolidated Balance Sheets................................................ 26
Consolidated Statements of Operations...................................... 27
Consolidated Statements of Stockholders' Equity............................ 28
Consolidated Statements of Cash Flows...................................... 31
Notes to Consolidated Financial Statements................................. 32
24
25
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 (formerly Intelect Communications, Inc.), and
subsidiaries as of December 31, 2000 and 1999, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 2000. 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, 2000 and 1999, and
the consolidated results of their operations and their consolidated cash flows
for each of the three years in the period ended December 31, 2000 in conformity
with accounting principles generally accepted in the United States of America.
/s/ Grant Thornton LLP
Dallas, Texas
March 23, 2001
25
26
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2000 and 1999
(Thousands of dollars, except share data)
2000 1999
--------- ---------
Assets
Current assets:
Cash and cash equivalents $ 5,587 $ --
Investments 110 195
Accounts receivable net of allowances of $1,691 in 2000
and $1,228 in 1999 5,558 5,316
Assets held for sale 4,893 --
Inventories 2,175 5,972
Prepaid expenses 482 378
--------- ---------
Total current assets 18,805 11,861
Property and equipment, net 1,188 5,094
Goodwill, net 3,354 4,115
Software development costs, net -- 2,093
Other intangible assets, net -- 561
Other assets 657 618
--------- ---------
$ 24,004 $ 24,342
========= =========
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable $ 100 $ 2,340
Accounts payable 2,121 3,203
Accrued liabilities 2,372 3,131
--------- ---------
Total current liabilities 4,593 8,674
Notes payable -- 15,264
--------- ---------
4,593 23,938
Stockholders' equity:
$2.0145, 10% cumulative convertible preferred stock, Series A, $.01 par
value. Authorized 10,000,000 shares; 3,719,409 shares issued and
outstanding in 1999 -- 37
Common Stock, $.01 par value. Authorized 200,000,000 shares;
86,098,850 and 65,936,573 shares issued in 2000 and 1999,
respectively 861 659
Additional paid-in capital 181,381 131,511
Accumulated deficit (161,244) (130,706)
--------- ---------
20,998 1,501
Less 400,474 and 191,435 shares of common stock in treasury
in 2000 and 1999, respectively - at cost (1,587) (1,097)
--------- ---------
Total stockholders' equity 19,411 404
--------- ---------
$ 24,004 $ 24,342
========= =========
See accompanying notes to consolidated financial statements
26
27
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Years ended December 31, 2000, 1999 and 1998
Consolidated Statements of Operations
(Thousands of dollars, except share data)
Years ended December 31,
--------------------------------------
2000 1999 1998
---------- ---------- ----------
Net revenue $ 18,750 $ 16,699 $ 19,341
Cost of revenue 19,658 18,437 17,836
---------- ---------- ----------
Gross profit (loss) (908) (1,738) 1,505
---------- ---------- ----------
Expenses:
Engineering and development 5,258 10,040 10,815
Selling and administrative 13,973 13,048 17,724
Asset writedowns 9,251 -- 10,628
Amortization of goodwill 672 672 1,125
---------- ---------- ----------
29,154 23,760 40,292
---------- ---------- ----------
Operating loss (30,062) (25,498) (38,787)
---------- ---------- ----------
Other income (expense):
Interest expense (798) (2,673) (4,385)
Interest income and other, net 1,288 (364) 483
---------- ---------- ----------
490 (3,037) (3,902)
---------- ---------- ----------
Loss before income taxes (29,572) (28,535) (42,689)
Income tax benefit -- -- 46
---------- ---------- ----------
Loss from continuing operations (29,572) (28,535) (42,735)
Extraordinary items - loss on debt retirement -- 1,054 --
Loss on disposal of discontinued
operations, net of tax -- -- 403
---------- ---------- ----------
Net loss (29,572) (29,589) (43,138)
Dividends on preferred stock 966 4,928 2,967
---------- ---------- ----------
Loss allocable to common stockholders $ (30,538) $ (34,517) $ (46,105)
========== ========== ==========
Basic and diluted loss per share:
Continuing operations $ (0.37) $ (0.72) $ (1.76)
Extraordinary item -- (0.02) --
Discontinued operations -- -- (0.02)
---------- ---------- ----------
Net loss per share $ (0.37) $ (0.74) $ (1.78)
========== ========== ==========
Weighted average number of common \
shares outstanding (thousands) 83,229 46,762 25,939
========== ========== ==========
See accompanying notes to consolidated financial statements.
27
28
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years ended December 31, 2000, 1999 and 1998
(Thousands of dollars, except share data)
Preferred Stock
-------------------------------------------------------------------------------------------------
Series A Series B Series C Series D
---------------------- ----------------------- ----------------------- ----------------------
Shares Par Shares Par Shares Par Shares Par
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Balances at December 31, 1997 4,219,409 $ 42 914,286 $ 9 -- $ -- -- $ --
Comprehensive income:
Net loss -- -- -- -- -- -- -- --
Change in unrealized gain on
marketable securities -- -- -- -- -- -- -- --
Total -- -- -- -- -- -- -- --
Private placements:
Series C Preferred -- -- -- -- 10,000 1 -- --
Series D Preferred -- -- -- -- -- -- 10,000 1
Common Stock -- -- -- -- -- -- -- --
Conversion of notes payable -- -- -- -- -- -- -- --
Conversion of preferred stock -- -- (914,286) (9) (8,157) -- (1,750) --
Warrants issued with notes -- -- -- -- -- -- -- --
Warrants issued for services -- -- -- -- -- -- -- --
Exercise of warrants -- -- -- -- -- -- -- --
Exercise of employee stock
options -- -- -- -- -- -- -- --
Settlement of dispute -- -- -- -- -- -- -- --
Stock option compensation -- -- -- -- -- -- -- --
Preferred dividends paid
with stock -- -- -- -- -- -- -- --
Preferred dividends accrued -- -- -- -- -- -- -- --
Beneficial conversion features
of preferred stock issued -- -- -- -- -- -- -- --
Issue and subsequent acquisition
of common stock -- -- -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Balances at December 31, 1998 4,219,409 $ 42 -- $ -- 1,843 $ 1 8,250 $ 1
========== ========== ========== ========== ========== ========== ========== ==========
Accumu-
lated
Addi- other Total
Common Stock tional Accumu- compre- Treasury Stock stock-
---------------------- paid-in lated pensive ---------------------- holders
Shares Par capital deficit income Shares Cost equity
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Balances at December 31, 1997 23,954,978 $ 240 $ 75,940 $ (50,084) $ 2 -- $ -- $ 26,149
Comprehensive income:
Net loss -- -- -- (43,138) -- -- -- (43,138)
Change in unrealized gain on
marketable securities -- -- -- -- (2) -- -- (2)
----------
Total -- -- -- -- -- -- -- (43,140)
Private placements:
Series C Preferred -- -- 9,116 -- -- -- -- 9,117
Series D Preferred -- -- 9,443 -- -- -- -- 9,444
Common Stock 1,000,000 10 990 -- -- -- -- 1,000
Conversion of notes payable 10,600 -- 21 -- -- -- -- 21
Conversion of preferred stock 5,997,819 60 (51) -- -- -- -- --
Warrants issued with notes -- -- 2,980 -- -- -- -- 2,980
Warrants issued for services -- -- 155 -- -- -- -- 155
Exercise of warrants 600,000 6 1,194 -- -- -- -- 1,200
Exercise of employee stock
options 226,458 2 396 -- -- -- -- 398
Settlement of dispute 18,000 -- 101 -- -- -- -- 101
Stock option compensation -- -- 105 -- -- -- -- 105
Preferred dividends paid
with stock 333,795 3 1,306 (1,309) -- -- -- --
Preferred dividends accrued -- -- 1,040 (1,040) -- -- -- --
Beneficial conversion features
of preferred stock issued -- -- 618 (618) -- -- -- --
Issue and subsequent acquisition
of common stock 191,435 2 1,097 -- -- 191,435 (1,097) 2
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Balances at December 31, 1998 32,333,085 $ 323 $ 104,451 $ (96,189) $ -- 191,435 $ (1,097) $ 7,532
========== ========== ========== ========== ========== ========== ========== ==========
See accompanying notes to consolidated financial statements
28
29
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years ended December 31, 2000, 1999 and 1998
(Thousands of dollars, except share data)
Preferred Stock
-------------------------------------------------------------------------------------------------
Series A Series C Series D Series E
----------------------- ---------------------- ----------------------- -----------------------
Shares Par Shares Par Shares Par Shares Par
---------- ---------- --------- ---------- ---------- ---------- ---------- ----------
Balances at December 31, 1998 4,219,409 $ 42 1,843 $ 1 8,250 $ 1 -- $ --
Net Loss -- -- -- -- -- -- -- --
Warrants issued in connection
with debt retirement -- -- -- -- -- -- -- --
Private placements
Preferred, Series E -- -- -- -- -- -- 6,000 --
Common Stock -- -- -- -- -- -- -- --
Conversion of notes payable -- -- -- -- -- -- -- --
Conversion of preferred stock (500,000) (5) (1,843) (1) (8,250) (1) (6,000) --
Warrants issued with notes
and preferred stock -- -- -- -- -- -- -- --
Warrants issued for services -- -- -- -- -- -- -- --
Stock option compensation -- -- -- -- -- -- -- --
Preferred dividends paid
with stock -- -- -- -- -- -- -- --
Directors' fees paid in stock -- -- -- -- -- -- --
Preferred dividends accrued -- -- -- -- -- -- -- --
Amortization of beneficial
conversion features of
preferred stock -- -- -- -- -- -- -- --
---------- ---------- --------- ---------- ---------- ---------- ---------- ----------
Balances at December 31, 1999 3,719,409 $ 37 -- $ -- -- $ -- -- $ --
========== ========== ========= ========== ========== ========== ========== ==========
Total
Common Stock Additional Treasury Stock stock
---------------------- paid-in Accumulated ---------------------- holders'
Shares Par capital deficit Shares Cost equity
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balances at December 31, 1998 32,333,085 $ 323 $ 104,451 $ (96,189) 191,435 $ (1,097) $ 7,532
Net Loss -- -- -- (29,589) -- -- (29,589)
Warrants issued in connection
with debt retirement -- -- 1,054 -- -- -- 1,054
Private placements
Preferred, Series E -- -- 5,690 -- -- -- 5,690
Common Stock 3,860,659 39 3,270 -- -- -- 3,309
Conversion of notes payable 11,642,049 116 10,884 -- -- -- 11,000
Conversion of preferred stock 17,001,757 170 (163) -- -- -- --
Warrants issued with notes
and preferred stock -- -- 1,692 (636) -- -- 1,056
Warrants issued for services -- -- 73 -- -- -- 73
Stock option compensation -- -- 51 -- -- -- 51
Preferred dividends paid
with stock 933,204 9 821 (830) -- -- --
Directors' fees paid in stock 165,819 2 226 -- -- -- 228
Preferred dividends accrued -- -- 187 (187) -- -- --
Amortization of beneficial
conversion features of
preferred stock -- -- 3,275 (3,275) -- -- --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balances at December 31, 1999 65,936,573 $ 659 $ 131,511 $ (130,706) 191,435 $ (1,097) $ 404
========== ========== ========== ========== ========== ========== ==========
See accompanying notes to consolidated financial statements
29
30
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years ended December 31, 2000, 1999 and 1998
(Thousands of dollars, except share data)
Preferred Stock
Series A Common Stock Additional Accumu-
----------------------- ---------------------- paid-in lated
Shares Par Shares Par capital deficit
---------- ---------- ---------- ---------- ---------- ----------
Balances at December 31, 1999 3,719,409 $ 37 65,936,573 $ 659 $ 131,511 $ (130,706)
Net Loss -- _ - -- -- -- (29,572)
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 -- -- -- -- -- (966)
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 $ (161,244)
========== ========== ========== ========== ========== ==========
Total
Treasury Stock stock-
---------------------- holders'
Shares Cost equity
---------- ---------- ----------
Balances at December 31, 1999 191,435 $ (1,097) $ 404
Net Loss -- -- (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)
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 400,474 $ (1,587) $ 19,411
========== ========== ==========
See accompanying notes to consolidated financial statements
30
31
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2000, 1999 and 1998
(Thousands of dollars)
Years ended December 31,
--------------------------------------
2000 1999 1998
---------- ---------- ----------
Cash flows from operating activities:
Net loss $ (29,572) $ (29,589) $ (43,138)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 4,650 4,721 4,357
Amortization of loan discount 426 1,013 3,242
Asset writedowns 9,251 -- 10,628
Loss on debt retirement -- 1,054 --
Other 467 306 571
Change in operating assets and liabilities:
Accounts receivable (242) 1,780 4,597
Inventories (5,506) 882 (565)
Other assets (131) 446 599
Accounts payable and accrued liabilities (1,785) 242 (3,220)
---------- ---------- ----------
Net cash used in operating activities (22,442) (19,145) (22,929)
---------- ---------- ----------
Cash flows from investing activities:
Capital expenditures (1,888) (1,045) (2,035)
Software development costs (896) (607) (1,898)
Investment and other (235) 356 (211)
---------- ---------- ----------
Net cash used in investing activities (3,019) (1,296) (4,144)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of notes payable 400 11,300 19,657
Proceeds from issuance of common shares 42,641 3,309 1,000
Proceeds from issuance of preferred shares -- 5,690 18,815
Principal payments on notes payable (9,654) (738) (14,831)
Redemption of preferred stock (7,493) -- --
Proceeds from exercise of common stock warrants 5,180 -- 1,200
Proceeds from exercise of employee stock options 891 -- 309
Preferred stock dividends paid (966) -- --
Other 49 (111) (180)
---------- ---------- ----------
Net cash provided by financing
activities 31,048 19,450 25,970
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents 5,587 (991) (1,103)
Cash and cash equivalents, beginning of year -- 991 2,094
---------- ---------- ----------
Cash and cash equivalents, end of year $ 5,587 $ -- $ 991
========== ========== ==========
See accompanying notes to consolidated financial statements.
31
32
TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Description of Business
The Company, through various subsidiaries, designs, develops, produces
and sells digital signal processing ("DSP") products and optical
networking equipment, and also provides high-value product design and
development services to telecommunications and networking companies.
(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 subsidiaries, all of which are wholly owned,
since their dates of acquisition. All significant intercompany balances
and transactions have been eliminated in consolidation.
Fair Value of Financial Instruments
Statement of Financial Accounting Standards 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, marketable securities, notes
payable and accounts payable are reasonable estimates of their fair
value due to the short-term maturity of underlying financial
instruments. It is not practical to estimate the fair value of the
Company's long-term debt because quoted market prices do not exist and
comparable securities were not available.
Revenue and Expense Recognition
Revenue from product sales is recognized upon shipment of products.
Reserves for estimated sales returns and allowances are recorded in the
same accounting period as the related revenues.
Revenue from engineering services is recognized as the services are
provided to the customers.
32
33
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
estimated net realizable value.
Depreciation on equipment is calculated on the 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 and software 3 to 5
Furniture and fixtures 5 to 7
Motor vehicles 3
Deferred Financing Costs
Deferred financing costs in connection with the issuance of debt are
amortized to interest expense using the effective interest method over
the term of the related debt instrument (note 8). 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 is amortized to interest expense ratably from the
date of issuance to the date the related debt first becomes
convertible. The discount related to detachable stock purchase warrants
is amortized on the straight-line method over the term of the debt.
Other costs in connection with the issuance of the same securities are
also deferred and amortized in the same manner.
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 years
ended December 31, 2000, 1999 and 1998, the Company capitalized
$896,000, $607,000 and $1,988,000 of software development costs and
charged operations for $1,832,000, $1,646,000 and $1,083,000 of
amortization, respectively. 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 3). Amortization prior to 1998 is
based on estimated product revenues over the next five years or
straight line, whichever is greater. After 1997, amortization is based
on the greater of estimated product revenues or two years.
33
34
Earnings (Loss) Per Common Share
The Company uses the weighted average number of shares outstanding to
compute basic loss per share. Diluted loss per share is computed using
the weighted average number of common shares and dilutive potential
common shares outstanding. In 2000, 1999 and 1998 all potential common
shares were anti-dilutive.
Income Taxes
The Company accounts for income taxes under the liability method as
required by Statement of Financial Accounting Standards (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.
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, is amortized on a straight-line basis over 10
to 15 years. As of December 31, 1998, the goodwill associated with
acquisitions, excluding the acquisition of DNA Enterprises, Inc., was
either fully amortized or written off. The remaining accumulated
amortization at December 31, 2000 and 1999 was $3,388,000 and
$2,716,000, respectively.
The Company assesses the recoverability of goodwill by determining
whether the amortization of the goodwill balance over its remaining
life can be recovered through undiscounted future operating cash flows
of the acquired operation. The amount of the goodwill impairment, if
any, is measured based on projected discounted future operating cash
flows using a discount rate reflecting the Company's average cost of
funds. The assessment of the recoverability of goodwill will be
impacted if estimated future operating cash flows are not achieved.
During the year ended December 31, 1998, the Company charged $6,888,000
to operations for the writedown of goodwill in connection with the 1995
acquisition of Intelect Network Technology Company (INT). The goodwill
was considered impaired due to the loss of three significant bids for
air traffic control (ATC) projects, the absence of any significant
future prospects for the ATC products of INT, and the industry trend
toward consolidation, all combining to diminish the outlook for the ATC
business.
The aforementioned writedowns were measured in accordance with the
policy described above. At December 31, 2000, the Company believes that
no significant impairment of the remaining goodwill has occurred and
that no reduction of the estimated useful lives is warranted.
34
35
Other Intangible Assets
Other intangible assets consist of purchased product technology.
Product technology assets are being amortized by the straight-line
method over periods ranging from three to five years. The
recoverability of these costs is evaluated in a manner similar to that
of goodwill.
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 made in 1995 and future years as if the
fair-value-based method defined in SFAS No. 123 had been applied.
Warranty Reserve
The Company accrues a reserve for warranty expense based on estimated
future costs.
Reclassification
Certain prior period balances have been reclassified to conform to the
current year presentation.
(3) Asset writedowns
In the fourth quarter of 2000 the Company determined that, due to
changes in certain target customer markets, its OmniLynx line of
optical networking products no longer fits within its 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. The Company has significantly curtailed
the ongoing operations of the OmniLynx business and is pursuing other
methods of disposing of the business, including liquidating the assets.
Accordingly, as of December 31, 2000 the carrying values of the assets
related to the OmniLynx product line have been adjusted to the lower of
cost and estimated net realizable value and have been classified as
Assets Held for Sale in the accompanying balance sheet as of December
31, 2000. A charge to operations has been recorded as of December 31,
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
===============
Assets held for sale as of December 31, 2000 consist of the following
(in thousands):
Inventory $ 3,661
Property and equipment 1,232
---------------
$ 4,893
===============
35
36
(4) Investments
Equity securities are considered available-for-sale and are stated at
fair value. Unrealized holding gains and losses, net of the related tax
effect, on available-for-sale securities are excluded from earnings and
are reported as a separate component of shareholders' equity until
realized. Realized gains and losses from the sale of such securities
are determined on a specific identification basis. Holdings of equity
securities were sold in 1998. Certificates of deposit are
interest-bearing and are pledged in the course of contractual
performance and for the purpose of obtaining operating leases.
(5) Inventories
The components of inventories are as follows (in thousands):
December 31,
-----------------------
2000 1999
---------- ----------
Raw materials $ 1,859 $ 2,896
Work in progress 289 1,010
Finished goods 27 2,066
---------- ----------
Total $ 2,175 $ 5,972
========== ==========
In the fourth quarter of 1999, the Company wrote inventories down by
$1,600,000 to provide for obsolete items.
(6) Property and Equipment
Property and equipment are summarized as follows (in thousands):
December 31,
------------------------
2000 1999
---------- ----------
Machinery and equipment $ 3,262 $ 7,396
Computer equipment and software 383 2,341
Furniture and fixtures 48 662
Leasehold improvements 47 295
---------- ----------
3,740 10,694
Less:
Accumulated depreciation and amortization (2,552) (5,600)
---------- ----------
Total $ 1,188 $ 5,094
========== ==========
(7) Other Intangible Assets
Other intangible assets are summarized as follows (in thousands):
December 31,
------------------------
2000 1999
---------- ----------
Investment in technology associated with
optical networking products $ 1,407 $ 1,407
Other intellectual property 105 105
---------- ----------
1,512 1,512
Less accumulated amortization (1,512) (951)
---------- ----------
$ -- $ 561
========== ==========
36
37
(8) Notes Payable
Notes payable consist of the following (in thousands):
December 31,
-------------------------------------------------
2000 1999
----------------------- -----------------------
Current Long Term Current Long Term
---------- ---------- ---------- ----------
Payable to The Coastal Corporation Second Pension
Trust ("Coastal") (A) $ -- $ -- $ -- $ 9,214
Payable to St. James Capital Partners, L.P. and SJMB,
L.P. (collectively "St. James") (B)
-- -- 2,000 6,000
Other (C) 100 -- 340 50
---------- ---------- ---------- ----------
$ 100 $ -- $ 2,340 $ 15,264
========== ========== ========== ==========
(A) Payable under a series of notes and credit agreements, due July 31,
2000. In August 1999 all amounts were combined under an Amended and
Restated Revolving Credit Facility. This facility provided for
borrowings of up to $12.0 million, subject to a borrowing base, as
defined, and subject to the discretion of Coastal, with interest
payable quarterly at prime plus 3.5%. The facility was secured by a
first lien on the Company's accounts receivable, inventory and related
assets and a pledge of the stock of the Company's subsidiaries, subject
to an inter-creditor agreement with St. James. Amounts outstanding
under the facility were due July 31, 2000; however, in March, 2000 all
amounts outstanding were repaid from the proceeds from the sale of
common stock.
(B) Payable pursuant to a credit facility due July 31, 2000, with
interest payable at maturity at a fixed rate of 7%. Borrowings were
secured by a second lien on the Company's accounts receivable,
inventory and related assets and by a pledge of the stock of the
Company's subsidiaries, subject to an inter-creditor agreement with
Coastal. In August, 1999 this facility was amended and $3,000,000 of
the then outstanding balance was repaid by the issuance of 3,864,271
shares of common stock. In addition, St. James was granted the right to
exchange any or all remaining balance for common stock at a rate per
share equal to the greater of $1.08 and 66 2/3% of the market price of
the Company's common stock at the time of the exchange. This amendment
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 in the
accompanying statements of operations. In January, 2000 St. James
converted $6,000,000 outstanding under the Facility into 3,645,182
shares of common stock, pursuant to the terms of the amended agreement.
In April, 2000 St. James converted $1,500,000 of debt into 767,573
shares of common stock and in June, 2000 converted the remaining
balance of approximately $800,000 into 445,683 shares of common stock.
(C) Includes $100,000 payable to an officer and director under a demand
note bearing interest of prime plus 3% and which may be converted into
common stock at the option of the holders at the rate of $1.00 per
share.
(9) Lease Commitments
The Company leases office space and certain equipment under leases
expiring at various dates through 2005. Rental expense under operating
leases was approximately $1,284,000, $1,345,000 and $1,607,000 for the
years ended December 31, 2000, 1999 and 1998, respectively.
37
38
Future minimum commitments as of December 31, 2000 under operating
leases are as follows (in thousands):
Years ending December 31,
2001 $ 933
2002 822
2003 718
2004 412
2005 85
-----------------
Total minimum lease payments $ 2,970
=================
(10) 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 $231,000, $326,000 and $406,000 for the years ended December 31,
2000, 1999 and 1998, respectively.
(11) Income Taxes
Significant components of the provision for income taxes attributable
to continuing operations for the years ended December 31, 2000, 1999
and 1998 are as follows (in thousands):
2000 1999 1998
---------- ---------- ----------
Current
Federal $ -- $ -- $ --
State -- -- 94
---------- ---------- ----------
Total current 94
---------- ---------- ----------
Deferred:
Federal -- -- (48)
State --
---------- ---------- ----------
Total deferred -- -- (48)
---------- ---------- ----------
Total current and deferred $ -- $ -- $ 46
========== ========== ==========
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,
--------------------------------
2000 1999 1998
-------- -------- --------
Computed expected tax benefit $(10,054) $(10,060) $(14,667)
Increase in valuation allowance 9,328 9,837 11,349
Permanent items 251 394 315
Writeoff of goodwill -- -- 2,494
Other 475 (171) 555
-------- -------- --------
Tax expense (benefit) $ -- $ -- $ 46
======== ======== ========
38
39
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 2000 and 1999 are as follows (in thousands):
December 31,
----------------------
2000 1999
-------- ----------
Deferred tax assets:
Preacquisition net operating loss carryforwards $ 4,831 $ 4,831
Postacquisition net operating loss carryforwards 42,287 34,988
Accounts receivable 575 372
Inventories 2,026 1,152
Property and equipment 748 --
Software development costs 393 --
Accrued liabilities 666 657
Alternative minimum tax and other credit
carryforwards 38 298
Other 78 16
-------- ----------
51,642 42,314
Less valuation allowance (51,597) (42,269)
-------- ----------
Deferred tax assets 45 45
Deferred tax liabilities (45) (45)
-------- ----------
$ -- $ --
======== ==========
At December 31, 2000, the Company had federal operating loss
carryforwards of approximately $138,582,000 and tax credit
carryforwards of $38,000. The future utilization of $14,210,000
of the preacquisition net operating losses and the credit carryforwards
related to the acquisition of companies will be limited under Internal
Revenue Code Sections 382 and 383. The tax benefits from the
utilization of the preacquisition operating loss carryforwards and the
tax credits will be credited to goodwill when realized.
Following is a summary of the carryforwards and the expiration dates as
of December 31, 2000 (in thousands):
Expiration
Amounts Dates
------------ ----------
Postacquisition net operating loss carryforwards $124,372 2012-2020
Preacquisition net operating loss carryforwards 14,210 2008-2009
Alternative minimum tax credit 38 --
(12) 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, 2000 there are outstanding
warrants to purchase 31,700,573 shares of the Company's common stock as
follows:
Shares Subject to Warrants Exercise Price Expiration Date
------------------------------ ------------------ -------------------
26,017,308 $0.75 6-30-02 to 8-12-04
1,100,000 $1.00 to $2.00 2-12-01 to 1-27-05
3,545,000 $2.01 to $3.00 2-12-01 to 12-31-03
1,038,265 Greater than $3.00 6-7-01 to 5-20-03
39
40
All of the warrants outstanding above are exercisable except for
7,600,000 which may not be exercised until April 15, 2001 and 7,600,000
which may not be exercised until October 15, 2001. Warrants for
19,500,000 common shares may be redeemed by the Company any time at a
price of $6.75 per share. 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, 2000 is as follows:
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 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.
1999
In August, 1999 and December, 1999 the Company issued to Coastal
warrants for the purchase of 1,067,308 and 5,000,000 shares of common
stock , respectively. These warrants were issued in connection with
restructuring of the Company's capital structure and the purchase of
the Company's common stock. As a part of the December, 1999 transaction
the August warrants and warrants for the purchase of 450,000 shares of
common stock previously issued to Coastal were amended to adjust the
exercise price to $0.75. The value of the warrants issued in August,
which was attributable to the refinancing of debt of approximately
$707,000 based on a Black-Scholes pricing model has been treated as
deferred financing costs and is being amortized over the remaining term
of the debt.
In February, 1999 in connection with the issuance of Series E preferred
stock the Company issued warrants for the purchase of an aggregate of
600,000 shares of common stock . In connection with the issuance of
common stock in January of 1999 the Company issued warrants for the
purchase of 690,000 shares of common stock. The value of those warrants
was approximately $636,000 using a Black Scholes pricing model.
In January, 1999 in connection with the extension of debt obligations
to St. James, the Company issued warrants for the purchase of 535,000
shares of common stock. The value of these warrants, approximately
$349,000 using a Black-Scholes pricing model, has been treated as
deferred financing costs and is being amortized over the term of the
remaining debt.
In December, 1999 the Company issued warrants for the purchase of
250,000 shares of common stock for investment banking services related
to the private placement of common stock which was completed in
January, 2000.
1998
During 1998 the Company issued warrants for the purchase of 963,036
shares of common stock in connection with the private placement of
equity securities.
In April and May of 1998 the Company issued warrants for the purchase
of 1,500,000 shares of common stock in connection with the arrangement
of a credit agreement with a private lender. The
40
41
value of these warrants, approximately $2,980,000 using a Black-Scholes
pricing model, has been treated as deferred financing costs and is
being amortized over the term of the related debt.
(13) 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 by the
shareholders in June 2000, authorizes grants of options to purchase up
to 8,000,000 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, 2000, there were 2,469,695 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, 2000.
The per share weighted-average fair value of stock options granted
during 2000, 1999 and 1998 was $1.77, $0.64 and $1.91, 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,
--------------------------------------------------
2000 1999 1998
------------ --------------- ------------
Expected dividend yield 0% 0% 0%
Stock price volatility 130% 100% 75%
Risk free interest rate 6.2% 4.6% 5.7%
Expected option term 3 to 5 years 3 years 3 years
The Company applies APB Opinion No. 25 in accounting for its Plan and,
accordingly, has recognized compensation expense with respect to
certain options granted at exercise prices less than the stock's market
value on the date of grant. During the year ended December 31, 1998,
the Company recognized compensation expense of $101,000.
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,
-------------------------------------
2000 1999 1998
---------- ---------- ----------
$ (in Thousands)
Net loss allocable to common shareholders:
As reported $ (30,538) $ (34,517) $ (46,105)
Pro forma $ (33,085) $ (37,693) $ (52,107)
Loss per share:
As reported $ (0.37) $ (0.74) $ (1.78)
Pro forma $ (0.40) $ (0.81) $ (2.01)
41
42
Stock option activity during the periods indicated was as follows:
Years ended December 31,
-----------------------------------------------
2000 1999 1998
------------- ------------- -------------
Number of options:
Outstanding, beginning of
period 4,372,197 4,031,044 3,271,000
Granted 2,458,000 1,913,000 3,488,000
Exercised (452,159) -- (226,450)
Canceled (847,733) (1,571,847) (2,501,506)
------------- ------------- -------------
Outstanding, end of period 5,530,305 4,372,197 4,031,044
Weighted average exercise price:
Outstanding, beginning of
period $ 1.39 $ 2.23 $ 3.93
Granted 2.05 1.13 2.98
Exercised 2.61 -- 1.76
Canceled 1.91 2.14 5.54
Outstanding, end of period $ 1.50 $ 1.39 $ 2.23
In October 1999 the exercise price of 1,535,000 options was reduced to
$1.00 per share from approximately $2.00 per share.
At December 31, 2000, 1999 and 1998, the number of options exercisable
was 2,169,995, 2,066,675, and 1,316,341, respectively, and the
weighted-average exercise price of those options was $1.40, $1.92, and
$2.49, respectively.
At December 31, 2000, the weighted-average remaining contractual life
of outstanding options was 8.75 years and the range of exercise prices
is shown in the following table:
Options outstanding Options exercisable
------------------------------------------------------ -----------------------------------
Weighted Weighted Weighted
average average average
Exercise prices remaining Option shares exercise Option shares exercise
per share contractual life outstanding price exercisable price
--------------- ---------------- ------------ ---------------- ------------- ----------------
$1.000-1.500 9.10 years 4,056,667 $1.038 1,565,364 $1.016
$1.688-2.660 8.00 533,638 $2.188 454,631 $2.213
$3.000-3.156 8.60 940,000 $3.113 150,000 $3.000
(14) Contingencies
The Company is contingently liable for certain potential liabilities
related to its discontinued operations. Specifically, under a stock
purchase agreement dated October 3, 1995 ("1995 Agreement"), the
Company agreed to indemnify Savage Sports Corporation, the purchaser of
Savage Arms, Inc. (a manufacturer of firearms), for certain product
liability, environmental clean-up costs and other contractual
liabilities, including certain asserted successor liability claims. One
of the liabilities assumed involves a firearms product liability
lawsuit filed in Alaska Superior Court (the "Taylor litigation"). The
Company is informed that a defendant in the Taylor litigation, Western
Auto Supply Co., settled the lawsuit for $5 million and, in turn, has
asserted a third-party claim against Savage Arms, Inc. for
indemnification in the amount of the settlement plus attorneys'
42
43
fees and related costs. Savage Arms has asserted defenses to the claims
and the Company believes additional defenses may be available. Based on
the information available to date, it is impossible to predict the
outcome of this litigation or to assess the probability of any verdict.
A shareholders class action lawsuit was filed in the U. S. District
Court for the Northern District of Texas purported to have been filed
on behalf of all persons and entities who purchased Intelect 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 Intelect'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. The Company
intends to defend the suit vigorously in all aspects.
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. The settlement was recorded in the financial statements
as of December 31, 2000.
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.
(15) 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; (b) design services in which the Company
provides advanced product and system design services to other companies
in the telecommunications industry; and (c) digital signal processor
(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,
------------------------------------
2000 1999 1998
---------- ---------- ----------
Optical networking equipment $ 6,994 $ 9,479 $ 6,410
Design services 7,002 4,596 8,147
Digital signal processor (DSP) 3,599 1,411 2,690
Other 1,155 1,213 2,094
---------- ---------- ----------
Worldwide total $ 18,750 $ 16,699 $ 19,341
========== ========== ==========
Included in the above were direct and indirect export sales of (in
thousands):
---------- ---------- ----------
Worldwide total $ 2,025 $ 748 $ 4,068
========== ========== ==========
43
44
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,
--------------------------------------
2000 1999 1998
---------- ---------- ----------
Optical networking equipment $ (15,463) $ (6,734) $ (10,792)
Design services 597 (544) 2,002
Digital signal processor (DSP) (1,347) (641) 402
Other (99) (4,465) (13,418)
---------- ---------- ----------
Subtotal segment specific (16,312) (12,384) (21,806)
Capitalized software 896 606 1,988
All other expenses (14,646) (13,720) (18,969)
---------- ---------- ----------
Operating loss $ (30,062) $ (25,498) $ (38,787)
========== ========== ==========
Assets, capital expenditures and depreciation are identifiable only by
combined segments, as grouped below (in thousands):
At December 31,
--------------------------------------
ASSETS 2000 1999 1998
---------- ---------- ----------
Optical networking equipment
and other $ 8,902 $ 15,638 $ 20,906
Design services and DSP 8,450 6,790 8,200
Not allocable to a segment 6,652 1,914 3,364
---------- ---------- ----------
Worldwide total $ 24,004 $ 24,342 $ 32,470
========== ========== ==========
Years ended December 31,
--------------------------------------
2000 1999 1998
---------- ---------- ----------
CAPITAL EXPENDITURES
Optical networking equipment
and other $ 1,165 $ 876 $ 1,662
Design services and DSP 688 99 354
Not allocable to a segment 35 70 19
---------- ---------- ----------
Worldwide total $ 1,888 $ 1,045 $ 2,035
========== ========== ==========
DEPRECIATION
Optical networking equipment
and other $ 1,509 $ 1,545 $ 1,161
Design services and DSP 531 471 396
Not allocable to a segment 16 31 145
---------- ---------- ----------
Worldwide total $ 2,056 $ 2,047 $ 1,702
========== ========== ==========
(16) Related Party Transactions
During the years ended December 31, 2000, 1999 and 1998 the Company
paid legal fees in the amounts of $379,000, $1,503,000 and $869,000
respectively for legal services from a law firm affiliated with a
former director.
During the year ended December 31, 1998, the following related party
transactions were also recorded:
44
45
(a) Renewed a loan to an officer in the amount of $171,000, including
accrued interest and additional advances, which was outstanding
at December 31, 1998. The 5% note is secured by a stock pledge
agreement.
(b) Repaid a loan of $200,000 from an officer, including interest of
$4,000.
(17) Significant Customers and Concentration of Credit Risk
In 2000 three customers accounted for 18%, 18% and 13%, respectively,
of consolidated net revenues.
In 1999 three customers accounted for 19%, 14% and11%, respectively, of
consolidated net revenue.
In 1998, no customer accounted for more than 10% of consolidated net
revenues.
The Company is subject to credit risk through trade receivables. At
December 31, 1997, the distributor responsible for all revenue from
Korea accounted for $9,879,000 (63%) of the accounts receivable. In
October 1998, the Company was advised of the illiquidity of the
distributor and wrote off or reserved substantially all of the
$4,696,000 receivables remaining unpaid at the end of September 1998,
adjusted, effective in December 1998, for a payment of $1,000,000 in
February 1999.
(18) Supplemental Disclosure of Cash Flow Information
Years ended December 31,
----------------------------------------
2000 1999 1998
------- ------- --------
(in thousands)
Cash paid during the period for:
Interest $ 665 $ 622 $ 1,126
Noncash Financing and Investment Transactions
During the year ended December 31, 2000 the Company recorded the
following non-cash financing transaction:
o Issued common stock in repayment of approximately $8,300,000 of
interest and principal on a note payable
During the year ended December 31, 1999 the Company recorded the
following non cash financing transactions:
o Issued common stock in repayment of $11,000,000 of interest and
principal on notes payable
o Issued common stock in exchange for all outstanding Series C, D
and E Preferred Stock
o Issued common stock in payment of preferred stock dividends of
$830,000.
o Issued common stock in payment of directors' fees of $228,000.
45
46
During the year ended December 31, 1998, the Company recorded the
following noncash financing transactions:
o Converted notes payable into common stock -$21,000.
o Converted 914,286 shares of Series B preferred stock and 8,157
shares of Series C preferred stock and 1,750 shares of Series D
preferred stock into 5,997,819 shares of common stock.
o Issued common stock in payment of preferred stock dividends -
$1,309,000
o Issued common stock warrants in conjunction with notes payable
-$2,980,000.
o Issued common stock warrants in conjunction with an advisory
services agreement -$155,000.
(19) Valuation and Qualifying Accounts
Additions Additions
Balance at charged to charged to Balances at
beginning costs and other end
of period expenses accounts Deductions of period
--------------- ------------- ---------- ------------ -------------
(in thousands)
Allowance for doubtful accounts:
For the year ended December 31, 2000 $ 1,228 $ 1,322 $ -- $ 859(a) $ 1,691
For the year ended December 31, 1999 $ 870 $ 810 $ -- $ 452(a) $ 1,228
For the year ended December 31, 1998 $ 541 $ 4,206 $ -- $ 3,877(a) $ 870
Notes:
(a) Accounts written off
(20) Quarterly Information (Unaudited)
Quarter ended:
-----------------------------------------------------
March 31 June 30 September 30 December 31
-------- -------- ------------ -----------
(In thousands, except per share amounts)
Year ended December 31, 2000:
Net revenue $ 4,584 $ 5,030 $ 4,162 $ 4,974
Gross profit (loss) $ 350 $ (325) $ (34) $ (899)
Net income (loss) $(4,552) $(4,690) $(4,627) $(15,703)
Net income (loss) per share $ (0.77) $ (0.06) $ (0.05) $ (0.18)
Year ended December 31, 1999:
Net revenue $ 3,123 $ 7,193 $ 1,662 $ 4,721
Gross profit (loss) $ (606) $ 1,846 $(1,468) $ (1,510)
Income (loss) before
extraordinary item $(7,904) $(4,687) $(8,197) $ (7,747)
Net income (loss) $(7,904) $(4,687) $(9,251) $ (7,747)
Income (loss) per share
before extraordinary item $ (0.24) $ (0.16) $ (0.21) $ (0.13)
Net income (loss) per share $ (0.24) $ (0.16) $ (0.23) $ (0.13)
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
46
47
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company will file with the Securities and Exchange Commission a
definitive Proxy Statement no later than 120 days after the close of its fiscal
year ended December 31, 2000 (the "Proxy Statement"). The information required
by this Item is incorporated by reference from the Proxy Statement.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference
from the Proxy Statement.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference
from the Proxy Statement.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference
from the Proxy Statement.
PART IV
ITEM 14 - 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 21. 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.
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,
as currently in effect (2)
3.3 Amended and Restated By-Laws of the Company (1)
4.2 Warrant to Purchase Common Stock of the Company Expiring February
26, 2002 (9)
4.7 Warrant to Purchase Common Stock of the Company Expiring March 27,
2002 (9)
4.9 Registration Rights Agreement dated as of May 8, 1997 between the
Company and The Coastal Corporation Second Pension Trust (11)
4.21 Registration Rights Agreement dated June 19, 1998 between the
Company and Lifeline Industries, Inc. (4)
4.22 Warrant issued to Lifeline Industries, Inc. dated June 29, 1998,
exercisable as to 30,000 shares of Common Stock (4)
4.23 Amended and Restated Warrant issued to Lifeline Industries, Inc.
exercisable to purchase up to 30,000 shares of Common Stock (14)
47
48
Exhibit Description of Exhibit
------- ----------------------
4.24 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 (12)
4.25 Amended and Restated Warrant issued to AJC, Inc. exercisable to
purchase up to 300,000 shares of Common Stock (14)
4.26 Form of Registration Rights Agreement between the Company and the
Buyers, dated as of December 22, 1998 (7)
4.27 Form of Warrant to Purchase Common Stock of Intelect
Communications, Inc. at an exercise price of $2.998 (7)
4.28 Form of Warrant to Purchase Common Stock of Intelect
Communications, Inc., issued as of December 2, 1998 (7)
4.29 Form of Warrant issued to Grayson and Associates to purchase 70,063
shares of Common Stock (29)
4.31 Form of Warrant to Purchase Common Stock of Intelect
Communications, Inc. issued to St. James Parties dated November 30,
2000 (7)
4.32 Registration Rights Agreement between the Company and Coastal (15)
4.34 Registration Rights Agreement among the Company and the Buyers,
dated February 24, 1999, relating to the Series E Convertible
Preferred Stock and warrants (7)
4.35 Form of Warrant to Purchase Common Stock of Intelect
Communications, Inc., relating to the Series E Preferred Stock (7)
4.36 Form of Registration Rights Agreement between Intelect
Communications, Inc. and the Buyers, dated as of June 30, 1999 (16)
4.38 Warrant issued to Coastal to purchase 5,000,000 shares of common
stock of Intelect at $0.75 per share (17)
4.39 Warrant issued to Coastal to purchase 450,000 shares of common
stock of Intelect at $0.75 per share (17)
4.40 Warrant issued to Coastal to purchase 1,067,308 shares of common
stock of Intelect at $0.75 per share (17)
4.41 Registration Rights Agreement dated December 21, 1999 between
Intelect and Coastal (17)
4.42 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 (18)
4.43 Warrant issued to Stonegate to purchase 250,000 shares of common
stock of Intelect Communications, Inc. at $1.00 per share (18)
4.44 Form of Registration Rights Agreement dated January 27, 2000
between Intelect Communications, Inc., the Investors names therein,
and Stonegate (18)
4.45 Warrant issued to Alpine Capital Partners, Inc. to purchase 250,000
shares of common stock of Intelect Communications, Inc. at $7.50
per share (19)
4.46 Warrant issued to Peter Ianace by Intelect Communications, Inc.
dated February 10, 2000 exercisable as to 115,000 shares of Common
Stock (19)
4.47 Form of Warrant issued to Stonegate affiliates to purchase common
stock of Intelect Communications, Inc. at $6.00 per share, subject
to adjustment (20)
4.48 Form of Registration Rights Agreement dated March 14, 2000 between
Intelect Communications, Inc., the Investors named therein, and
Stonegate (20)
4.49 Form of Amended and Restated Promissory Notes held by affiliates,
convertible into Common Stock of the Company at a rate of $1.00 per
share (30)
10.1 Employment Agreement between the Company and Herman Frietsch and
Amendment thereto* (30)
10.2 Stock Purchase Agreement dated October 3, 1995 by and among
Intelect (Bermuda), Savage Corporation and Savage Sports
Corporation (21)
48
49
Exhibit Description of Exhibit
------- ----------------------
10.3 Employment Agreement dated as of April 1, 1996 between the Company
and Eugene Helms*(22)
10.5 Lease Agreement between TCIT Dallas Industrial and Intelect Network
Technologies, dated February 25, 1997 (24)
10.6 Lease Agreement between Campbell Place One Joint Venture and DNA
Enterprises, dated February 1, 1997 (24)
10.7 Settlement Agreement and Mutual Release dated November 30, 2000
among the Company and the St. James Parties (29)
10.33 Subscription Agreement for Common Stock Units dated December 17,
1999 between Intelect and Coastal (17)
10.34 Settlement Agreement and Mutual Release dated February 2, 2000
between Intelect Communications, Inc., Intelect Network
Technologies Company, Intelect Communications, Inc. and Richard
Dzanski (18)
10.35 Amended and Restated Stock Incentive Plan *(31)
21.1 Subsidiaries of the Company
23.1 Consent of Grant Thornton LLP
---------
* Management contract or other compensatory plan or arrangement.
(1) Incorporated herein by reference to the Company's Form S-4 filed
October 30, 1997
(2) Incorporated herein by reference to the Company's Form 8-K filed on
February 1, 2001
(4) Incorporated herein by reference to the Company's Form S-3 filed on
August 10, 1998
(7) Incorporated herein by reference to the Company's Form 8-K filed on
March 2, 1999
(9) Incorporated herein by reference to the Company's Form 10-K filed
April 15, 1997
(11) Incorporated herein by reference to the Company's Form 10-Q filed
August 14, 1997
(12) Incorporated herein by reference to the Company's Form 10-Q filed
on August 14, 1998
(13) Incorporated herein by reference to the Company's Form 8-K filed on
June 29, 1998
(14) Incorporated herein by reference to the Company's Form 10-Q filed
on November 16, 1998
(15) Incorporated herein by reference to the Company's Form 8-K filed on
August 18, 1999
(16) Incorporated herein by reference to the Company's Form S-3 filed on
August 27, 1999
(17) Incorporated herein by reference to the Company's Form 8-K filed on
December 22, 1999
(18) Incorporated herein by reference to the Company's Form 8-K filed on
February 8, 2000
(19) Incorporated herein by reference to the Company's Form S-3 filed on
February 11, 2000
(20) Incorporated herein by reference to the Company's Form 8-K filed on
March 21, 2000
(21) Incorporated herein by reference to the Company's Form 8-K dated
November 10, 1995
(22) Incorporated herein by reference to the Company's Form 10-Q filed
November 13, 1996
(24) Incorporated herein by reference to the Company's Form 10-Q filed
May 15, 1997
(25) Incorporated herein by reference to the Company's Form 10-Q filed
November 13, 1997
(29) Incorporated herein by reference to the Company's Form 8-K filed on
December 4, 2000
(30) Incorporated herein by reference to the Company's Form 10-K filed
on March 30, 2000
(31) Incorporated herein by reference to the Company's Definitive Proxy
Statement filed on April 30, 1999
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:
Form 8-K filed on December 4, 2000 - Item 5 "Other Events."
49
50
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: March 30, 2001 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 March 30, 2001.
/s/ HERMAN M. FRIETSCH /s/ ANTON VON AND ZU LIECHTENSTEIN
----------------------------------------------- -------------------------------------------
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
----------------------------------------------- -------------------------------------------
Robert P. Capps Robert E. Garrison, II, Director
Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ DAVID YEDWAB
-------------------------------------------
David Yedwab, Director
50
51
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
21.1 Subsidiaries of the Company
23.1 Consent of Grant Thornton LLP