Washington, DC 20549
AMENDMENT NO. 3
TO
FORM 10-K
ANNUAL REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Fiscal Year Ended Commission File Number
June 30, 2001 0-20706
DATA RACE, Inc.
(Exact name of registrant as specified in its charter)
Texas 74-2272363
(State of Incorporation) (I.R.S. Employer Identification No.)
6509 Windcrest Drive, Suite 120
Plano, Texas 75024
Telephone (972) 378-9677
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share
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 [_] NO [X]
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. [X]
On February 8, 2002, the aggregate market price of the voting stock held by
non-affiliates of the Company was approximately $1,770,000 (For purposes hereof,
directors, executive officers and 10% or greater shareholders have been deemed
affiliates.)
On January 31, 2002, there were 35,373,477 outstanding shares of Common Stock,
no par value.
DOCUMENTS INCORPORATED BY REFERENCE
None.
The registrant hereby files this report on Form 10-K/A to amend its Annual
Report on Form 10-K, as amended on February 15, 2002 and March 11,2002 for the
year ended June 30, 2001, to amend Part II, Item 8 "Management's Discussion and
Analysis of Financial Condition and Results of Operation". No other items in the
registrant's Annual Report on Form 10-K for the year ended June 30, 2001 are
amended.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements
PAGE
Independent Auditors' Report - Current..........................................................31
Independent Auditors' Report - Predecessor......................................................32
Financial Statements
Balance Sheets as of June 30, 2001 and 2000................................................33
Statements of Operations for the years ended June 30, 2001, 2000 and 1999..................34
Statements of Shareholders' Equity for the years ended June 30, 2001, 2000 and 1999........35
Statements of Cash Flows for the years ended June 30, 2001, 2000 and 1999..................41
Notes to Financial Statements..............................................................42
All schedules are omitted, because they are not required, are not applicable, or
the information is included in the financial statements and notes thereto.
2
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
DATA RACE, Inc.
Plano, Texas
We have audited the accompanying balance sheet of DATA RACE, Inc. as of
June 30, 2001, and the related statements of operations, shareholders' equity,
and cash flows for the year then ended. 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 audit.
We conducted our audit 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 audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of DATA RACE, Inc. as of June
30, 2001, and the results of its operations and its cash flows for the year then
ended, in conformity with accounting principles generally accepted in the United
States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As shown in the financial statements,
the Company incurred a net loss of $16,775,750 for the year ended June 30, 2001
and has incurred substantial losses for each of the preceding 2 years. At June
30, 2001, current liabilities exceed current assets by $1,274,179 and total
liabilities exceed total assets by $561,814. These factors and others discussed
in Note 3, raise substantial doubt about the Company's ability to continue as a
going concern. The financial statements do not include any adjustments relating
to the recoverability and classification of recorded assets, or the amounts and
classification of liabilities that might be necessary in the event the Company
cannot continue in existence.
LAZAR LEVINE & FELIX LLP
New York, New York
November 2, 2001
3
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
DATA RACE, Inc.:
We have audited the accompanying balance sheet of DATA RACE, Inc. as of
June 30, 2000, and the related statements of operations, shareholders' equity,
and cash flows for each of the years in the two-year period ended June 30, 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 generally accepted auditing
standards. 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 financial position of DATA RACE, Inc. as of June
30, 2000, and the results of its operations and its cash flows for each of the
years in the two-year period ended June 30, 2000, in conformity with generally
accepted accounting principles.
KPMG LLP
San Antonio, Texas
September 11, 2000
4
DATA RACE, Inc.
BALANCE SHEETS
As of June 30,
------------------------------
2001 2000
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ......................................... $ 9,334 $ 11,059,061
Accounts receivable, net .......................................... 2,026 6,401
Note receivable, current .......................................... -- 233,333
Inventory ......................................................... 2,876,506 249,876
Prepaid expenses and deposits ..................................... -- 206,001
------------ ------------
Total current assets .......................................... 2,887,866 11,754,672
Note receivable, non-current .......................................... -- 116,667
Property and equipment, net ........................................... 674,798 1,235,919
Other assets .......................................................... 84,630 84,630
------------ ------------
Total assets .................................................. $ 3,647,294 $ 13,191,888
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable .................................................. $ 2,327,133 $ 504,001
Accrued expenses .................................................. 638,167 960,346
Obligations under capital lease, current ......................... 125,078 --
Convertible debentures ........................................... 1,071,667 --
------------ ------------
Total current liabilities ..................................... 4,162,045 1,464,347
Non-current liabilities:
Obligations under capital lease, non-current ..................... 47,063 --
------------ ------------
4,209,108 1,464,347
------------ ------------
Commitments and contingencies
Shareholders' equity (deficit):
Common stock, no par value, 70,000,000 shares authorized
34,358,521 and 26,083,364 shares issued and outstanding at
June 30, 2001 and 2000, respectively ............................ 62,420,978 59,806,425
Additional paid-in capital ........................................ 9,545,152 7,673,310
Accumulated deficit ............................................... (72,527,944) (55,752,194)
------------ ------------
Total shareholders' equity (deficit) .......................... (561,814) 11,727,541
------------ ------------
Total liabilities and shareholders' equity ................... $ 3,647,294 $ 13,191,888
============ ============
See accompanying notes to financial statements
5
DATA RACE, Inc.
STATEMENTS OF OPERATIONS
Years Ended June 30,
--------------------------------------------------
2001 2000 1999
------------ ------------ ------------
Total revenue from continuing operations .............. $ 62,698 $ 316,212 $ 835,798
Cost of revenue ....................................... 1,344,506 761,759 1,532,733
------------ ------------ ------------
Gross profit (loss) ............................. (1,281,808) (445,547) (696,935)
------------ ------------ ------------
Operating expenses:
Engineering and product development ................. 4,995,226 3,293,231 2,384,787
Sales and marketing ................................. 4,757,711 2,618,432 1,927,894
General and administration .......................... 5,211,493 3,118,612 4,290,885
------------ ------------ ------------
Total operating expenses ........................ 14,964,430 9,030,275 8,603,566
------------ ------------ ------------
Operating loss .................................. (16,246,238) (9,475,822) (9,300,501)
Interest income ....................................... 239,301 395,078 129,624
Interest expense ...................................... (856,233) -- --
Other income .......................................... 87,420 45,372 5,565
------------ ------------ ------------
Loss from continuing operations ....................... (16,775,750) (9,035,372) (9,165,312)
Income from discontinued operations ................... -- 217,734 620,452
------------ ------------ ------------
Net loss ...................................... $(16,775,750) $ (8,817,638) $ (8,544,860)
============ ============ ============
Per share data:
Net loss ............................................ $(16,775,750) $ (8,817,638) $ (8,544,860)
Effect of beneficial conversion feature of
convertible preferred stock ....................... -- (235,718) (3,888,923)
------------ ------------ ------------
Net loss applicable to common
stock ............................................. $(16,775,750) $ (9,053,356) $(12,433,783)
============ ============ ============
Net basic and diluted loss from
continuing operations per common share ........... $ (0.60) $ (0.42) $ (0.81)
============ ============ ============
Net basic and diluted loss per common
share ........................................... $ (0.60) $ (0.41) $ (0.77)
============ ============ ============
Weighted average shares outstanding ................... 27,812,000 21,940,000 16,119,000
============ ============ ============
See accompanying notes to financial statements
6
DATA RACE, Inc.
STATEMENTS OF SHAREHOLDERS' EQUITY
Series A Convertible Preferred Series C Convertible Series D Convertible
Stock Preferred Stock Preferred Stock
------------------------------------------------------------------------------------------------
Shares Amount Shares Amount Shares Amount
------------------------------------------------------------------------------------------------
Balances at June 30, 1998 175 $ 224,970 1,681 $ 1,380,001 -- $ --
Net loss -- -- -- -- -- --
Issuance of convertible
preferred stock, net of
offering cost of $248,820 -- -- -- -- 2,500 60,688
Redemption of preferred stock (124) (165,653) -- -- -- --
Issuance of restricted common
stock and warrants, net
offering costs of $552,475 -- -- -- -- -- --
Accretion of beneficial
conversion feature on
convertible preferred stock -- -- -- -- -- 2,478,655
Conversion of convertible
preferred stock to common
stock (51) (59,317) (1,681) (1,380,001) (2,500) (2,539,343)
Common stock issued for legal
and consulting services -- -- -- -- -- --
Exercise of stock options and
warrants -- -- -- -- -- --
Employee stock purchase plan -- -- -- -- -- --
------------------------------------------------------------------------------------------------
Balances at June 30, 1999 -- -- -- -- -- --
Net loss -- -- -- -- -- --
Issuance of common stock and
warrants, net of offering
costs of $300,000 -- -- -- -- -- --
Issuance of common stock and
warrants, net of offering
costs of $419,999 -- -- -- -- -- --
Accretion of beneficial
conversion feature on
convertible preferred stock -- -- -- -- -- --
Conversion of convertible
preferred stock to common
stock -- -- -- -- -- --
Common stock issued for legal
and consulting services -- -- -- -- -- --
Exercise of stock options and
warrants -- -- -- -- -- --
Employee stock purchase plan -- -- -- -- -- --
------------------------------------------------------------------------------------------------
Balances at June 30, 2000 -- -- -- -- -- --
Net loss -- -- -- -- -- --
Issuance of common stock in
exercise of warrants relating
to class A and B preferred
stock -- -- -- -- -- --
Issuance of common stock in
cashless exercise of warrants
related to November 1998
private placement -- -- -- -- -- --
Issuance of common stock and
warrants in connection with
March 2001 private placement
net of offering costs -- -- -- -- -- --
Modification of warrant terms
to acquire common stock in
connection with the sale of
common stock in the March 2001
private placement -- -- -- -- -- --
Stock option compensation -- -- -- -- -- --
Issuance of common stock in
connection with convertible
debt -- -- -- -- -- --
Exercise of warrants in
connection with June 2001
warrant agreement -- -- -- -- -- --
Exercise of stock options -- -- -- -- -- --
Employee stock purchase plan -- -- -- -- -- --
------------------------------------------------------------------------------------------------
Balance at June 30, 2001 -- $ -- -- $ -- -- $ --
================================================================================================
See accompanying notes to financial statements
7
DATA RACE, Inc.
STATEMENTS OF SHAREHOLDERS' EQUITY
Series E Convertible Series F Convertible
Preferred Stock Preferred Stock Common Stock
-----------------------------------------------------------------------------------------------
Shares Amount Shares Amount Shares Amount
-----------------------------------------------------------------------------------------------
Balances at June 30, 1998 -- $ -- $ -- 9,126,406 $33,334,779
Net loss -- -- -- -- -- --
Issuance of convertible
preferred stock, net of
offering cost of $248,820 750 473,425 750 491,113 -- --
Redemption of preferred stock -- -- -- -- -- --
Issuance of restricted common
stock and warrants, net of
offering costs of $552,475 -- -- -- -- 3,134,064 5,705,745
Accretion of beneficial
conversion feature on
convertible preferred stock -- 336,574 -- 159,444 -- --
Conversion of convertible
preferred stock to common
stock -- -- -- -- 4,499,567 3,978,661
Common stock issued for legal
and consulting services -- -- -- -- 2,325,300 2,318,938
Exercise of stock options and
warrants -- -- -- -- 1,080,895 1,126,998
Employee stock purchase plan -- -- -- -- 18,291 24,489
-----------------------------------------------------------------------------------------------
Balances at June 30, 1999 750 809,999 750 650,557 20,184,523 46,489,610
Net loss -- -- -- -- -- --
Issuance of common stock and
warrants, net of offering
costs of $300,000 -- -- -- -- 1,904,761 3,700,000
Issuance of common stock and
warrants, net of offering
costs of $419,999 -- -- -- -- 1,572,738 5,580,001
Accretion of beneficial
conversion feature on
convertible preferred stock -- 53,426 -- 182,292 -- --
Conversion of convertible
preferred stock to common
stock (750) (863,425) (750) (832,849) 1,094,447 1,696,274
Common stock issued for legal
and consulting services -- -- -- -- 190,000 520,088
Exercise of stock options and
warrants -- -- -- -- 1,131,602 1,807,517
Employee stock purchase plan 5,293 12,935
-----------------------------------------------------------------------------------------------
Balances at June 30, 2000 -- -- -- -- 26,083,364 59,806,425
Net loss -- -- -- -- -- --
Issuance of common stock in
exercise of warrants relating
to class A and B preferred
stock -- -- -- -- 210,222 472,999
Issuance of common stock in
cashless exercise of warrants
related to November 1998
private placement -- -- -- -- 297,313 --
Issuance of common stock and
warrants in connection with
March 2001 private placement
net of offering costs -- -- -- -- 3,047,620 1,147,888
Modification of warrant terms
to acquire common stock in
connection with the sale of
common stock in the March 2001
private placement -- -- -- -- -- --
Stock option compensation -- -- -- -- -- --
Issuance of common stock in
connection with convertible
debt -- -- -- -- 2,687,417 130,234
Exercise of warrants in
connection with June 2001
warrant agreement -- -- -- -- 1,673,343 200,000
Exercise of stock options -- -- -- -- 272,142 571,424
Employee stock purchase plan -- -- -- -- 87,100 92,008
-----------------------------------------------------------------------------------------------
Balance at June 30, 2001 -- -- -- -- 34,358,521 $62,420,978
===============================================================================================
See accompanying notes to financial statements
8
DATA RACE, Inc.
STATEMENTS OF SHAREHOLDERS' EQUITY
Additional Paid-In Accumulated Deficit Total Shareholders' Equity
Capital
-------------------------------------------------------------------------
Balances at June 30, 1998 $ 1,882,303 $(34,265,055) $ 2,556,998
Net loss -- (8,544,860) (8,544,860)
Issuance of convertible preferred stock,
net of offering cost of $248,820 2,725,954 -- 3,751,180
Redemption of preferred stock -- -- (165,653)
Issuance of restricted common stock and
warrants, net of offering costs of
$552,475 1,941,780 -- 7,647,525
Accretion of beneficial conversion
feature on convertible preferred stock 914,250 (3,888,923) --
Conversion of convertible preferred
stock to common stock -- -- --
Common stock issued for legal and
consulting services -- -- 2,318,938
Exercise of stock options and warrants -- -- 1,126,998
Employee stock purchase plan -- -- 24,489
-------------------------------------------------------------------------
Balances at June 30, 1999 7,464,287 (46,698,838) 8,715,615
Net loss -- (8,817,638) (8,817,638)
Issuance of common stock and warrants,
net of offering costs of $300,000 -- -- 3,700,000
Issuance of common stock and warrants,
net of offering costs of $419,999 -- -- 5,580,001
Accretion of beneficial conversion
feature on convertible preferred stock -- (235,718) --
Conversion of convertible preferred
stock to common stock -- -- --
Common stock issued for legal and
consulting services 209,023 -- 729,111
Exercise of stock options and warrants -- -- 1,807,517
Employee stock purchase plan -- 12,935
-------------------------------------------------------------------------
Balances at June 30, 2000 7,673,310 (55,752,194) 11,727,541
Net loss -- (16,775,750) (16,775,750)
Issuance of common stock in exercise of
warrants relating to class A and B
preferred stock -- -- 472,999
Issuance of common stock in cashless
exercise of warrants related to November
1998 private placement -- -- --
Issuance of common stock and warrants in
connection with March 2001 private
placement net of offering costs 164,718 -- 1,312,606
Modification of warrant terms to acquire
common stock in connection with the sale
of common stock in the March 2001
private placement 687,394 -- 687,394
Stock option compensation 176,873 -- 176,873
Issuance of common stock in connection
with convertible debt -- -- 130,234
Exercise of warrants in connection with
June 2001 warrant agreement -- -- 200,000
Accretion of beneficial conversion
feature on convertible debentures issued
in May 2001 685,074 -- 685,074
Accretion of beneficial conversion
feature on convertible debentures issued
pursuant to convertible debentures
purchase agreement executed in June 2001 157,783 -- 157,783
Exercise of stock options -- -- 571,424
Employee stock purchase plan -- -- 92,008
-------------------------------------------------------------------------
Balance at June 30, 2001 $ 9,545,152 $(72,527,944) $ (561,814)
=========================================================================
See accompanying notes to financial statements
9
DATA RACE, Inc.
STATEMENTS OF CASH FLOWS
Years Ended June 30,
------------------------------------------------------
2001 2000 1999
------------ ------------ ------------
Cash flows from operating activities:
Net loss from continuing operations ......................... $(16,775,750) $ (9,035,372) $ (9,165,312)
Adjustments to reconcile net loss from continuing
operations to net cash (used in) operating
activities:
Depreciation and amortization ............................. 538,762 297,454 310,795
Non-cash consulting and legal fees ........................ -- 729,111 2,318,939
Non-cash beneficial conversion feature on
convertible debentures for May and June 2001
private placements ....................................... 842,857 -- --
Non-cash stock option compensation ........................ 176,873 -- --
Loss on impaired property and equipment ................... 1,180,978 -- --
Loss on sales of property and equipment ................... 35,598 3,773 --
Changes in assets and liabilities:
Accounts and notes receivable ........................... 354,375 48,667 22,703
Inventory ............................................... (2,626,630) (154,781) 309,210
Prepaid expenses, deposits and other assets ............. 206,001 (111,627) (153,615)
Accounts payable ........................................ 1,823,132 273,785 (65,778)
Accrued expenses ........................................ (322,179) 74,372 (568,936)
------------ ------------ ------------
Net cash used in operating activities ................. (14,565,983) (7,874,618) (6,991,994)
------------ ------------ ------------
Cash flows from investing activities:
Purchase of property and equipment .......................... (1,045,058) (339,351) (27,411)
Proceeds from sale of property and equipment ................ 4,146 -- 3,235
------------ ------------ ------------
Net cash used in investing activities ................... (1,040,912) (339,351) (24,176)
------------ ------------ ------------
Cash flows from financing activities:
Convertible notes ........................................... 1,071,667 -- --
Capital leases, net ......................................... 18,836
Redemption of Series A preferred stock ...................... -- -- (165,653)
Net proceeds from the issuance of preferred stock ........... -- -- 3,751,180
Net proceeds from issuance of common stock .................. 3,466,665 11,100,453 8,799,012
------------ ------------ ------------
Net cash provided by financing activities ............... 4,557,168 11,100,453 12,384,539
------------ ------------ ------------
Cash flows from discontinued operations ....................... -- 517,599 642,315
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents ......... (11,049,727) 3,404,083 6,010,684
Cash and cash equivalents at beginning of year ................ 11,059,061 7,654,978 1,644,294
------------ ------------ ------------
Cash and cash equivalents at end of year ...................... $ 9,334 $ 11,059,061 $ 7,654,978
============ ============ ============
Supplemental Disclosure:
Interest income (expense), net ........................... $ (616,932) $ 395,078 $ 129,624
Taxes paid ............................................... $ -- $ -- $ --
See accompanying notes to financial statements.
10
DATA RACE, Inc.
NOTES TO FINANCIAL STATEMENTS
June 30, 2001, 2000, and 1999
1) Description of Business and Summary of Significant Accounting Policies
Description of Business
DATA RACE, Inc. ("Data Race" or the "Company"), currently doing business as
IP AXESS, provides integrated IP based remote work solutions over multiple
access media. The Company's VocalWare(TM) IP client/server product line provides
users in remote locations with simultaneous access to critical corporate
resources including phone, fax, Internet, and E-mail over a single connection
via: DSL, cable modem, LAN, Frame Relay, ATM or high speed dial-up through VPN,
local ISP POP, or PSTN. The Company, after exiting the network multiplexer
business in January 2000, currently operates in one business segment.
Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
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.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents.
Accounts Receivable
Accounts receivable as shown is net of allowance for doubtful accounts of
approximately $2,000 and $500 at June 30, 2001 and 2000, respectively.
Inventory
Inventory is valued at the lower of cost (principally standard cost which
approximates first-in, first-out) or market (net realizable value). Costs
include materials, labor, overhead, and subcontract charges as applicable. If in
the ordinary course of business, management determines that the utility of its
inventory is no longer as great as its cost, due to obsolescence, physical
deterioration, changes in price levels, etc., the Company will recognize a
reduction in the value of its inventory and record a corresponding charge to
income.
Property and Equipment
Property and equipment are stated at cost. Equipment under capital leases
is stated at the present value of minimum lease payments. Major renewals and
betterments are charged to the property accounts while replacements,
maintenance, and repairs that do not improve or extend the lives of the
respective assets are expensed currently. Depreciation of property and equipment
is provided at amounts calculated to amortize the cost of the assets over their
useful economic lives using the straight-line method for financial reporting
purposes and accelerated methods for income tax purposes. Equipment held under
capital leases and leasehold improvements are amortized over the shorter of the
lease term or estimated useful life of the asset.
During fiscal year 2001, the Company invested approximately $434,000 in a
new e-business platform in which the Company was unifying its sales, customer
service, MRP and
11
accounting systems. Implementation of the system had to be abandoned during May
of 2001 due to the Company's financial difficulties and the loss of key
personnel responsible for implementation of the system. The Company recorded as
an asset impairment, approximately $403,000 relating to the e-business platform.
In addition the Company recorded approximately $778,000 in asset impairment on
non-amortized leasehold improvements in August 2001 pertaining to the early
termination of the San Antonio facilities. The Company anticipated this action
as it was consolidating its facilities prior to the close of the fiscal year
ending June 30, 2001. The Company believes its facilities are more than adequate
to meet the current and future needs during fiscal 2002 without modification or
further expense.
Convertible Preferred Securities
The beneficial conversion features of the Series A, C, D, E and F
Convertible Preferred Stock ("Preferred Stock") have been recognized by
allocating a portion of the proceeds to additional paid-in capital. The amount
allocated to additional paid-in capital consists of the conversion discount on
the Preferred Stock and the value attributed to the warrants. The conversion
discount is calculated as of the date of issuance as the difference between the
conversion price and the fair value of the common stock into which the security
is convertible. Because the security provides for more than one conversion rate,
the computation is made using the conversion terms most beneficial to the
investor, regardless of the actual discount applied upon conversion. The value
of the warrants is calculated using the Black-Scholes option pricing model and
may not correspond to a market value.
The calculated intrinsic value of the beneficial conversion features of the
Preferred Stock, the offering costs and the premium results in non-cash charges
to the loss available to common shareholders in the computation of loss per
common share over the conversion period. As a result, approximately $ 0,
$236,000, and $3,889,000 in non-cash charges are reflected in the loss per
common share for the years ended June 30, 2001, 2000, and 1999, respectively.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash and cash
equivalents, accounts receivable, accounts payable and notes payable. The book
value of cash and cash equivalents, accounts receivable, notes receivable,
accounts payable and notes payable are representative of their respective fair
values due to the short-term maturity of those instruments.
The benefical conversion features of the convertible debentures issued in
May and June 2001 have been recognized by recording additional paid in capital
and interest expense for the year ending June 30, 2001. The amount of the
benefical conversion and interest expense is calculated as of the date of
issuance as the difference between the conversion price and the fair value of
the common stock into which the note is convertible. The value of the benefical
conversion is calculate using the Black-Scholes option pricing model and may not
correspond to market value. The May 2001 benefical conversion feature using the
model assuming a risk free rate of return of 4.93% and a volatility of 152.96%
resulted in the company recording a one time charge to additional
paid-in-capital of $685,074 and a corresponding charge to interest expense in
May 2001. The June 2001 benefical conversion feature relating to the June 2001
private placement using the Black-Scholes model assuming a volatility of 166.17%
and risk free rate of return 4.35% resulted in the Company recording a one time
charge to additional paid-in-capital of $ 157.783 and a corresponding charge to
interest expense in June 2001.
12
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carry forwards. Deferred tax assets and
liabilities are measured using enacted tax rates 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.
Revenue Recognition
Revenue is generally recognized upon direct sale and shipment of products
to end-user customers or when contractual services have been provided to
end-user customers, title has passed to the end-user customer, the fee and terms
are fixed or determinable, and collectibility is reasonably assured. Such method
is in accordance with Staff Accounting Bulletin (SAB) No. 101, Revenue
Recognition in Financial Statements. Revenue is generally recognized upon
reseller (indirect) sale of products when title has passed to the reseller, a
reseller agreement exists, the fee and terms are fixed or determinable, and
collectibility is reasonably assured. The Company does have a reservation of
title on resellers where the products are delivered to reseller's location or
reseller's end-user location outside the United States. The Company reserves
title in the products until either: a) reseller pays in full for the products;
or b) reseller sells the product to a third party at which time title passes to
the third party. The Company, in most reseller agreements, has an inventory
balancing provision, which generally gives the reseller the opportunity to
balance its inventory by returning for credit up to 20% of the value of the
products shipped during a quarter. The Company will record a liability for up to
20% on sales by resellers for the inventory balancing provision. The Company
also has price protection for most resellers where products shipped to resellers
whose price have been decreased will be price protected if the resellers
products are unopened and shipped to reseller 180 days or less prior to the
effective date of price decrease. The reseller must submit a claim within 30
days of the effective date of the price decrease to receive credit in the amount
of the price decrease multiplied by the qualifying units.
Revenue from service obligations and licensing agreements are deferred and
recognized ratably over the period of the obligation or agreement. The Company
recognizes revenue and gross profit from evaluation units shipped only upon
receipt of payment or upon customer acceptance and reasonably assured
collection.
Comprehensive Income
The Financial Accounting Standards Board ("FASB") issued Statement No. 130,
"Reporting Comprehensive Income", in June of 1997. This statement established
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. For all periods
presented, no elements of comprehensive income exist other than loss from
operations.
Warranty Expense
The Company generally offers one or two year warranty coverage on the
majority of its products. Warranty costs are accrued and expensed when revenue
is recognized based upon the Company's experience with such costs. As of June
30, 2001, the Company had no accrual for warranty costs.
Research and Development
All engineering and product research and development expenditures are
charged against operations as incurred. Research and development costs charged
to continuing operations
13
aggregated approximately $5,000,000, $3,293,000 and $2,385,000 in fiscal 2001,
2000, and 1999, respectively.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to undiscounted future net cash flows expected to be generated by the asset. If
such assets are considered to be impaired on this basis, the impairment loss to
be recognized is measured by the amount by which the carrying amount of the
assets exceeds the fair value of the assets. Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs to sell.
Stock Based Compensation
The Company accounts for stock-based compensation using the intrinsic value
method described in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB No. 25") and related interpretations (including
FASB Interpretation No. 44). Accordingly, compensation cost for stock options is
measured as the excess, if any, of the quoted market price of the Company's
Common Stock at the date of the grant over the amount an employee must pay to
acquire the stock. The Company has adopted the disclosure requirements of SFAS
No. 123, "Accounting for Stock Based Compensation."
Equity instruments issued to non-employees that are fully vested and
non-forfeitable are measured at fair value at the issuance date and expensed in
the period over which the benefit is expected to be received. Equity instruments
issued to non-employees which are either unvested or forfeitable, for which
counter-party performance is required for the equity instrument to be earned,
are measured initially at fair value and subsequently adjusted for changes in
fair value until the earlier of: (1) the date at which a commitment for
performance is required for performance by the counter-party to earn the equity
instrument is reached, or (2) the date of which the counter-party's performance
is complete.
Earnings (Loss) Per Share
Net loss per share of common stock is presented in accordance with the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 128,
Earnings Per Share. Under SFAS No. 128, basic earnings/loss per share excludes
dilution for potentially dilutive securities and is computed by dividing income
or loss available to common stockholders by the weighted average number of
common shares outstanding during the period. Diluted earnings/loss per share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
Potentially dilutive securities are excluded from the computation of diluted
earnings/loss per share when their inclusion would be antidilutive. The Company
had approximately 3,434,000 and 2,734,000 options outstanding as of June 30,
2001 and 2000, respectively. The Company had no preferred stock outstanding as
of June 30, 2001 and 2000. As of June 30, 2001, the Company had warrants
outstanding to purchase 20,575,180 shares of common stock. As of June 30, 2000
the Company had warrants outstanding to purchase 2,808,139 shares of common
stock.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001. Under the new rules, the pooling of interest method of
accounting is no longer allowed for business combinations and goodwill and other
intangible assets deemed to have indefinite lives will no
14
longer be amortized but will be subject to annual impairment tests in accordance
with the Statements. Other intangible assets will continue to be amortized over
their useful lives.
In August 2001, the Financial Accounting Standards Board issued Statements
of Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, (FASB 144) which is effective for fiscal years
beginning after December 15, 2001. FASB 144 supercedes FASB 121 on the
impairment of long-lived assets and certain reporting provision of APB 30
dealing with the disposal of a business segment.
2) Discontinued Operations
The Board of Directors approved discontinuing the network multiplexer
product business segment in January 2000. Accordingly, the financial statements
for the years ended June 30, 2000 and 1999 reflect the operations of the
multiplexer product business as a discontinued operation. The Company sold its
network multiplexer business to HT Communications in March 2000 for $350,000.
The Company to date has received approximately $6,000 in principal payments and
$4,500 in royalty payments. The Company is in the process of filing suit against
HT Communications demanding payment on the past due balances. Due to defaults
upon the agreement between the Company and HT communications, the Company
removed the unrecognized portion of the deferred gain in the amount of $331,601
from its books along with the associated note receivable balance.
3) Going Concern Uncertainty
The accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America, which
contemplates continuation of the Company as a going concern. As shown in the
financial statements, the Company incurred a substantial loss of $16,775,750 for
the year ended June 30, 2001 and has incurred losses for each of the preceding 2
years. At June 30, 2001, current liabilities exceed current assets by
$1,274,179, total liabilities exceed total assets by $561,814 and the
accumulated deficit aggregated $72,527,944. In view of these matters,
realization of a major portion of the assets in the accompanying balance sheet
is dependent upon the Company's ability to meet its financing requirements, and
the success of its future operations. See ITEM 1 BUSINESS - Certain Business
Risks - We Will Need Additional Capital to Sustain Operations and footnote 10,
Shareholders' Equity - Equity Line of Credit.
In addition, effective July 11, 2001, the Company's common stock was
delisted by The Nasdaq National Market due to a failure to pay overdue annual
and additional listing fees in the amount of $44,125 and the inability to meet
the minimum bid price requirements for continued listing.
Operating losses have had and continue to have a substantial negative
effect on the Company's cash balance. The Company's goal of returning to
profitability and developing a more dependable revenue base relies on the
success of the VocalWare IP product line. To successfully penetrate the target
markets, the Company expects that significant additional resources will need to
be expended in order to expand its sales and marketing infrastructure and
operation systems, and to finance inventory and receivables.
The Company has historically funded operations with the proceeds from the
sale of equity securities and has not generated positive cash flows from
operations for the past three years. The Company will need to raise more money
to continue to finance its operations and may not be able to obtain additional
financing on acceptable terms, or at all. Any failure to raise additional
financing will likely place the Company in significant financial jeopardy.
During July 2001 (subsequent to the balance sheet date) the Company
decreased its overhead through payroll reductions and related benefit costs
(reducing its workforce from 77 employees to 6 employees). Management is also
currently consolidating operations into one location thereby effecting savings
on rent and associated facility costs. The Company believes
15
that these cost reductions and the raising of additional financing will allow
them to continue in existence.
4) Accounts Receivable and Major Customers
During fiscal 2001 aggregate revenues from shipments to three customers
represented 85% of total revenues. Revenue from shipments to and fees from
Sabratek (a significant customer) represented 65.2% and 50% of revenue from
continuing operations for fiscal 2000 and 1999, respectively. Credit limits,
ongoing credit evaluation, and account-monitoring procedures are used by the
Company to minimize the risk of loss on accounts receivable. Generally,
collateral is not required. Export revenues were 4% of total revenue for fiscal
1999. Export revenues were not significant during fiscal 2001 or fiscal 2000.
5) Inventory
Inventory consists of the following:
June 30, 2001 June 30, 2000
------------- -------------
Finished goods ..................... $1,054,557 $ 138,014
Work in progress ................... 322,797 80,151
Raw materials ...................... 1,499,152 31,711
---------- ----------
Total net inventory ........... $2,876,506 $ 249,876
========== ==========
Inventory is valued at the lower of cost (principally standard cost which
approximates first-in, first-out) or market (net realizable value). Costs
include materials, labor, overhead, and subcontract charges as applicable. If in
the ordinary course of business, management determines that the utility of its
inventory is no longer as great as its cost, due to obsolescence, physical
deterioration, changes in price levels, etc., the Company will recognize a
reduction in the value of its inventory and record a corresponding charge to
income.
6) Property and Equipment
Property and equipment consists of the following:
Useful
June 30, 2001 June 30, 2000 Lives
------------- ------------- -----
Leasehold improvements ............... $ -- $ 1,560,385
Furniture, fixtures and equipment .... 3,103,959 2,345,925 2 - 5 yrs.
----------- -----------
3,103,959 3,906,310
Accumulated depreciation ............. (2,429,161) (2,670,391)
----------- -----------
Total property and equipment ..... $ 674,798 $ 1,235,919
=========== ===========
Because the Company terminated the lease for the San Antonio, Texas
facility after the close of its fiscal year 2001 (August, 2001), the Company
elected to record an asset impairment for the San Antonio leasehold improvements
resulting in a loss of $778,278. The Company also wrote off $402,700 in impaired
assets relating to its inability to further proceed with the implementation of
its new e-business integrated operating platform. The e-business platform was to
internally unify the Company's sales, customer service, material resources
planning (MRP) and accounting systems activities. The cost of this operating
platform consisted of the cost to acquire servers, associate server software,
applications software, initial training and external consultant implementation.
Implementation of the system had to be abandoned during May of 2001 due to
financial difficulties and the loss of key personnel responsible for
implementing this system. The total impairment loss of $1,180,978 is included in
General and Administration expenses.
16
7) Accrued Expenses
Accrued expenses consists of the following:
June 30, June 30,
2001 2000
-------- --------
Deferred gain ................................ $ -- $334,788
Payroll ...................................... 399,651 215,833
Accrued vacation ............................. 133,764 82,164
Other ........................................ 104,752 327,561
-------- --------
Total accrued expenses .................. $638,167 $960,346
======== ========
Due to defaults upon the agreement between the Company and HT
communications, the Company removed the unrecognized portion of the deferred
gain in the amount of $331,601 from its books along with the associated note
receivable (see Note 2).
8) Income Taxes
As a result of operating losses sustained, there was no income tax expense
(benefit) for the fiscal years ended June 30, 2001, 2000 and 1999. The tax
effects of temporary differences that give rise to significant portions of the
deferred tax assets and liabilities at June 30, 2001 and 2000 are presented
below:
June 30,
------------------------------
Deferred tax assets: 2001 2000
------------ ------------
Accounts receivable due to allowances for financial reporting
purposes ............................................................ $ 700 $ 192
Inventory, principally due to write-down for financial reporting
purposes ............................................................ 327,800 208,312
Property and equipment, due to difference in depreciation ................. 67,300 223,007
Accrued expenses .......................................................... 168,500 128,240
Net operating loss carryforwards .......................................... 24,396,100 19,514,286
Alternative minimum tax credit carryforwards .............................. 93,700 83,645
Research and experimentation credit carryforwards ......................... 881,600 678,176
Other, net ................................................................ -- 4,068
------------ ------------
Total gross deferred tax assets ....................................... 25,935,700 20,839,926
Less valuation allowance .............................................. (25,935,700) (20,839,926)
------------ ------------
Net deferred tax asset ................................................ $ -- $ --
============ ============
The valuation allowance related to deferred tax assets increased by
approximately $5,096,000 and $3,040,000 during the years ended June 30, 2001 and
2000, respectively.
In assessing the realization of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Based upon the level of
historical taxable income, management has provided a 100% valuation allowance
for the Company's deferred tax assets at June 30, 2001. The amount of the
deferred tax asset considered realizable, however, could fluctuate in the near
term if estimates of future taxable income during the carryforward period are
adjusted.
Reconciliation of the U.S. Federal statutory rate to the Company's
effective tax rate for each fiscal year is as follows:
2001 2000 1999
------- ------- -------
U. S. Federal statutory rate ............................... 34.0% 34.0% 34.0%
Increase (reduction) in income taxes resulting from:
Provision for valuation allowance .......................... (34.0) (34.0) (34.0)
------- ------- -------
Net effective tax rate ..................................... -- -- --
======= ======= =======
17
At June 30, 2001, the Company had net operating loss ("NOL") carryforwards
for federal and state income tax purposes of approximately $70,980,000, which
expire beginning in 2008. The Company also has research and experimentation
credit carryforwards for federal income tax purposes of approximately $678,000,
which began expiring in 2000, and alternative minimum tax credit carryforwards
of approximately $84,000. The Internal Revenue Code section 382 limits NOL and
tax credit carryforwards when an ownership change of more than fifty percent of
the value of stock in a loss corporation occurs within a three-year period. In
fiscal 1999, 1998 and 1997 the Company issued preferred stock that has since
been converted into common stock. Accordingly, the ability to utilize remaining
NOL and tax credit carryforwards may be significantly restricted.
9) Convertible Debentures
May 2001 Private Placement of Convertible Notes
In May 2001 the Company issued two 10% secured convertible promissory notes
with principal amounts, in the aggregate, of $700,000, and 1,166,667 common
stock purchase warrants. The notes mature one year from their date of issuance.
The notes and warrants were issued pursuant to Section 4(2) of the Securities
Act, as amended, in equal amounts to two accredited investors. The proceeds to
the Company from the sale of the notes was $700,000. The Company used the
proceeds from the private placement primarily for general corporate purposes.
The notes are convertible at any time at the holders option into common stock at
$0.30 per share. The warrants of which the total value are $110,179, are
exercisable at a price of $0.30 per share through May 2006.
June 2001 Private Placement of Convertible Debentures
On June 12, 2001 the Company signed an agreement to place up to $1 million
in 6% convertible debentures and warrants to two accredited investors. The
parties amended the agreement on July 17, 2001 and October 18, 2001. The
convertible debentures have an interest rate of 6% per annum and mature 3 years
from their date of issuance. Under the terms of the convertible debentures, the
holders can elect at any time prior to maturity to convert the balance
outstanding on the debentures into shares of Company common stock at the lesser
of a fixed price that represents a 10% premium to the closing bid price of
common stock at the time the debentures were issued and 50% of the average of
the 5 lowest closing bid prices of Company common stock during the 25 business
days immediately preceding the conversion date. Under the agreements, as
amended, and pursuant to Section 4(2) of the Securities Act of 1933, as amended,
the Company issued to the investors $500,000 principal amount of convertible
debentures on June 18, 2001, $240,000 principal amount of convertible debentures
on July 30, 2001, $130,000 principal amount of convertible debentures on
September 6, 2001 and $277,499 principal amount of convertible debentures on
October 18, 2001. On June 18, 2001, the Company also issued to the investors
common stock purchase warrants to purchase up to 1,000,000 shares of common
stock at an exercise price of $0.14. On October 18, 2001 the parties amended the
agreement to increase the investment amount by $147,499 and the Company granted
to the investors a security interest in all of the assets of the Company
covering all prior and future indebtedness of the Company to the investors. We
have received proceeds from the sale of the convertible debentures equal to
$1,147,499 less $80,000 to Hadrian Investments Limited for placement agent fees,
or 8% of the proceeds received for the first $1,000,000 principal amount of
convertible debentures issued to the investors, and less $25,000 to cover the
legal expenses of the investors. We currently owe Hadrian Investments Limited an
additional $11,799.92 in connection with this financing, or 8% of the last
$147,499 convertible debentures issued to the investors. The Company used the
proceeds from the private placement primarily for general corporate purposes.
The Company is obligated to file a registration statement for the shares
issuable upon conversion of the convertible debentures and warrants with the
SEC. The Company was also obligated to cause the registration statement to be
declared effective by
18
October 2, 2001 and is currently accruing liquidated damages at the rate of 2%
of the outstanding principal amount of the convertible debentures per month.
These penalties may be paid in cash or, at the investors' option, in common
stock. In addition, if the Company issues additional shares of common stock,
then antidilution provisions contained in the convertible debentures may reduce
the conversion price of the shares issued to the investors so as to prevent
dilution of the their investment in the Company.
10) Shareholders' Equity
Equity Line of Credit
In July 2001, subsequent to the balance sheet date , the Company signed
what is sometimes termed an equity line of credit or an equity draw down
facility with an accredited investor, Grenville Finance Ltd. In general,
Grenville has committed up to $30 million to purchase our common stock over a 36
month period beginning after and during the period a resale registration
statement registering the shares purchased pursuant to the equity line of credit
is effective. During the periods the resale registration statement is effective,
the Company may request a draw of up to $1 million of that money, subject to a
formula based on average stock prices and average trading volumes, setting the
maximum amount of any request for any given draw. The amount of money that
Grenville will provide and the number of shares to be issued to Grenville in
return for that money is settled twice during a 22 day trading period following
the draw down request based on the formula in the stock purchase agreement.
Grenville receives a 17.5% discount to the market price of Company common stock
during the 22-day period and the Company receives the settled amount of the draw
down, less 8% of such amount to Hadrian Investments Limited for placement agent
fees. Additionally, we issued to Hadrian 500,000 shares in lieu of a cash
payment of $25,000 for services rendered to the Company by Hadrian. Also in July
2001, the Company issued a warrant to Grenville to purchase up to 16,366,612
shares of Company common stock at an exercise price of $0.07027 and paid
Grenville $20,000 for its legal fees and expenses incurred in connection with
the equity line of credit. The issuances of the securities to the accredited
investors are made pursuant to Section 4(2) of the Securities Act. The Company
will use the proceeds from the equity line for general corporate purposes.
March 2001 Private Placement
On March 2, 2001, the Company completed a Section 4(2) private placement of
3,047,620 shares of its common stock, and warrants to purchase 304,762 shares of
common stock to three accredited investors, Protius Overseas Limited, Keyway
Investments Ltd., and Lionhart Investments Ltd., for an aggregate price of
$2,000,000. The warrants are exercisable at a price of $0.9875 per share through
March 2, 2006. The Company used the proceeds from the private placement
primarily for general corporate purposes.
The Company has agreed to file a registration statement under the
Securities Act of 1933, covering the resale of the common shares and the shares
of common stock issuable upon exercise of the warrants. The Company has
incurred, and continues to incur, certain penalties since the registration
statement was not declared effective by May 31, 2001. These penalties may be
paid in cash or, at the investors' option, in common stock. In addition, if the
Company issues additional shares of common stock prior to the effective date of
the registration statement, then antidilution provisions contained in the
securities purchase agreement may require the Company to issue additional shares
of common stock to the investors so as to prevent dilution of the investors'
investment in the Company.
In connection with the private placement, (i) the Company granted to the
Investors a right of first refusal to purchase additional securities issued by
the Company (subject to certain exceptions) prior to August 29, 2001 and (ii)
agreed to reduce to $0.9875 the exercise price of warrants to purchase an
aggregate of 1,265,317 shares of the Company's Common Stock issued
19
in connection with the Company's June 1999 and December 1999 private placements
and to extend the term of these warrants for two years to December 10, 2003.
June 2000 Private Placement
On June 13, 2000, the Company completed a private placement of 1,572,738
shares of its common stock and warrants to purchase 471,822 shares of common
stock to six institutional investors including three investors from the
Company's June 1999 and December 1999 private placements for an aggregate price
of $6,000,000. Each warrant entitles the holder to purchase one share of common
stock at an exercise price of $5.45 at any time through June 12, 2002.
December 1999 Private Placement
On December 10, 1999, the Company completed a private placement of
1,904,761 shares of its common stock and warrants to purchase 571,429 shares of
common stock to three institutional investors for an aggregate price of
$4,000,000. Each warrant entitles the holder to purchase one share of common
stock at an exercise price of $3.00 through December 10, 2001.
June 1999 Private Placement
In June 1999, the Company completed a private placement of 2,132,955 shares
of its common stock, and warrants to purchase 693,888 shares of common stock to
three institutional investors for an aggregate price of $6,000,000. Each
investor purchased one-third of the securities issued in the private placement.
Each warrant entitles the holder to purchase one share of common stock at an
exercise price of $4.02 through June 2001.
November 1998 Private Placement
In November 1998, the Company obtained a binding commitment for a private
placement (the "November Private Placement") of its restricted common stock and
common stock purchase warrants to up to five accredited investors, for an
aggregate price of $2,200,000. The purchase price for one share of common stock
and one warrant was $2.25. Each warrant entitles the holder to purchase one
share of common stock at an exercise price of $2.25 per share, at any time on or
before the second anniversary of the closing date.
The investors included the Company's former President and CEO and Liviakis
Financial Communications Inc. ("LFC").
Series E & F Convertible Preferred Stock
In July 1998, the Company completed the first closing of a private
placement of its Series E Convertible Preferred Stock ("Series E Preferred
Stock") and related Common Stock Purchase Warrants ("Class B Warrants") to First
Capital Group of Texas L.P. (the "Class B Investor"), an investment firm managed
by the Company's Chairman of the Board, at an aggregate price of $750,000. In
January 1999, the Company completed the second closing of the private placement
of its Series F Convertible Preferred Stock (Series F Preferred Stock) and
related Class B Warrants to the Class B Investor for an aggregate price of
$750,000.
In June 2000 all of the 750 shares of Series E Preferred Stock and 750
shares of Series F Preferred Stock had been converted and all the Class B
Warrants were exercised.
Warrants
In June 2001, the Company issued 1,000,000 warrants in conjunction with the
6% convertible debentures totaling $1,000,000. The warrants are exercisable at a
price of $0.14 per share through June 2004.
In May 2001, the Company issued 1,166,667 warrants in conjunction with 10%
secured convertible promissory notes totaling $700,000. The warrants are
exercisable at a price of $0.30 per share through May 2006.
20
In March 2001, the Company issued 304,762 warrants at $0.9875 to acquire
its common stock in conjunction with its private placement.
Also, in connection with the private placement of common stock and warrants
to acquire common stock for proceeds of $2 million in March 2001, the Company
agreed to modify the terms of pre-existing warrants to acquire an aggregate of
1,265,317 shares of the Company's common stock. The Company reduced the strike
price of these warrants from a weighted-average amount of $3.56 to $0.98 per
share, and extended the expiration date of the warrants from December 2001 to
December 2003. The change in the fair value of these warrants as a result of the
modifications is $687,394, which has been recorded as a cost of the issuance of
the common stock and related warrants.
In September 2000, the Company issued 210,222 shares of its common stock in
conjunction with the exercise of 210,222 warrants from the November 1998 private
placement. In a cashless exercise, the Company issued 297,313 shares of its
common stock as result of the exercise of 690,333 warrants. The remaining 56,110
warrants balance of the November 1998 private placement expired in November
2000. In November 2000, the remaining balance of Series C Warrants expired.
In July 2000, remaining warrants for the class A and B first and second
close expired.
The following table shows the outstanding warrants for each of the fiscal
years ending June 30, 2001, 2000 and 1999 respectively. Each warrant in the
table is convertible to one share of the Company's common stock for the
indicated price.
Warrants outstanding as of June 30, 2001 2000 1999 Price Expiration
----------------------------------- ---- ---- ---- ----- ----------
June 2001 6% convertible debentures 1,000,000 -- -- $ 0.14 Jun. 2004
May 2001 10% convertible notes 1,166,667 -- -- 0.30 May 2006
March 2001 private placement 304,762 -- -- 0.9875 Mar. 2006
June 2000 private placement 471,822 471,822 -- 5.45 Jun. 2002
December 1999 private placement 571,429 571,429 -- 0.9875 Dec. 2003
June 1999 private placement 693,888 693,888 693,888 0.9875 Dec. 2003
November 1998 private placement -- 956,655 1,001,109 2.25 Nov. 2000
Series C Warrants -- 53,977 53,977 6.435 Nov. 2000
Class A and B second close -- 24,968 249,383 0.6625 Jul. 2000
Class A and B first close -- 35,400 35,400 0.6625 Jul. 2000
Class A and B first and second close -- -- 281,250 0.80 Jul. 2000
Series A warrants -- -- 25,274 16.375 Jan. 2000
--------- --------- ---------
Total warrants outstanding 4,208,568 2,808,139 2,340,281
========= ========= =========
Stock Option Plans
Under the Company's existing stock option plans (the "Plans"), stock
options to purchase up to 4,680,842 shares of common stock were originally
authorized to be granted to employees, directors, and certain other persons. As
of June 30, 2001, 3,434,057 stock options covering shares of common stock were
outstanding under the Plans and 1,246,785 shares were available for issuance
upon exercise of options, which may be granted in the future under the Plans.
21
Options under the Plans may either be incentive stock options or
non-qualified stock options (except in the case of the Company's non-qualified
stock option plan which permits only the issuance of non-qualified stock
options). Options under the Plans may be granted for a term not to exceed ten
years (five years with respect to incentive stock options granted to any person
having 10% or more voting power of the Company) and are not transferable other
than by will or the laws of descent and distribution. Incentive stock options
may be exercised within 90 days after the optionee's termination of employment
(to the extent exercisable prior to such termination), and one year after the
optionee's disability. The exercise price of the options under the Plans must be
at least equal to the fair market value of the common stock on the date of
grant, or 110% of such value for incentive stock options granted to any person
having 10% or more of the voting power of the Company. The aggregate fair market
value of the common stock for which any employee may be granted incentive stock
options that first become exercisable in any one calendar year may not exceed
$100,000. Options may be exercised by payment of cash or by tender of shares of
common stock (valued at their then current market value). The Compensation
Committee of the Board of Directors administers the Plans.
On December 10, 1998, the Compensation Committee and the Board of Directors
authorized and granted the Board of Directors and the Chief Executive Officer of
the Company the right to exchange up to 100% of their outstanding options, both
vested and unvested, for replacement options at a rate of three replacement
options for every four options surrendered. These replacement options are
exercisable at a price of $3.625 per share (the fair market value at the date of
repricing). A total of 609,500 options were exchanged for 442,125 replacement
options. The replacement options vest in two equal installments on June 10, 1999
and December 10, 1999.
On September 12, 2000, the Company's Board of Directors adopted the Stock
Option Plan, authorizing the grant of 1,250,000 incentive stock options and
non-qualified stock options to employees, directors and certain other persons.
On November 11, 2000, the shareholders approved the 2000 Stock option plan
authorizing 1,250,000 options for future grants.
On April 21, 1998, the Board of Directors authorized and granted the
non-officer employees of the Company, the right to exchange up to 100% of their
outstanding options, both vested and unvested, for replacement options at a rate
of one replacement option for each option surrendered. These replacement options
are exercisable at a price of $1.7813 per share (the fair market value at the
date of repricing). A total of 341,604 options were exchanged. Officers, other
than the Chief Executive Officer, were authorized and granted the right to
exchange up to 100% of their outstanding options; both vested and unvested, for
replacement options at a rate of two replacement options for every three options
surrendered. These replacement options are exercisable at a price of $1.7813 per
share (the fair market value at the date of repricing). A total of 294,750
options were exchanged for 196,499 replacement options. The replacement options
vest in two equal installments on October 21, 1998 and April 21, 1999.
A summary of option activity under the Plans for the fiscal years ended
June 30, 2001, 2000 and 1999 is as follows:
2001 2000 1999
----------------------- ----------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- --------- --------- --------- --------- ---------
Outstanding at
beginning of year .............. 2,733,708 $ 3.77 1,689,516 $ 3.21 1,494,898 $ 5.00
Granted ........................ 1,555,748 3.86 2,147,650 3.63 1,292,380 3.50
Exercised ...................... 272,142 2.10 565,132 2.28 292,233 2.02
Expired ........................ 583,257 4.88 538,326 2.99 805,529 7.86
--------- --------- --------- --------- --------- ---------
Outstanding at year
End ............................ 3,434,057 $ 3.75 2,733,708 $ 3.77 1,689,516 $ 3.21
========= ========= =========
Options exercisable at
year end ....................... 2,143,142 $ 3.47 1,373,145 $ 3.51 911,498 $ 2.68
Shares available for
future grant ................... 1,246,785 -- 697,784 -- 574,758 --
22
The following summarizes information regarding the Company's stock options
outstanding at June 30, 2001:
Weighted Average
Range of Remaining Weighted Number Weighted
Exercise Number Contractual Life Average Exercisable at Average
Price Outstanding Years Exercise Price June 30, 2001 Exercise Price
------------------ ----------- ---------------- -------------- -------------- --------------
$ .01 - $ 1.13 412,046 9.7 $ .62 197,646 $ .14
1.63 - 2.06 427,070 6.7 1.70 364,568 1.71
2.50 - 2.94 150,650 8.5 2.69 126,900 2.63
3.37 - 3.97 694,000 8.0 3.61 647,666 3.59
4.13 8.88 1,735,291 8.8 5.08 791,362 4.95
13.00 - 14.50 15,000 4.5 14.00 15,000 14.00
-------- ------- ----------- ---------------- -------------- -------------- --------------
$ 1.63 - $ 14.50 3,434,057 8.5 $ 3.75 2,143,142 $ 3.47
======== ======= =========== ================ ============== ============== ==============
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its stock option and stock purchase plans. Had compensation cost
been recognized consistent with SFAS No. 123, the Company's net loss and loss
per share would have been increased to pro forma amounts indicated below for the
years ended June 30, 2001, 2000 and 1999
2001 2000 1999
-------------- -------------- --------------
Net loss applicable to
common stock As Reported $ (16,775,750) $ (9,053,356) $ (12,433,783)
Pro Forma (17,519,425) (11,699,109) (13,415,803)
Net diluted loss per
share As Reported $ (0.60) $ (0.41) $ (0.77)
Pro Forma (0.63) (0.53) (0.83)
The per share weighted average value of stock options issued by the Company
during fiscal 2001, 2000 and 1999 was $4.34, $5.81 and $2.80 respectively, on
the date of grant using the Black-Scholes option-pricing model. The Company used
the following weighted-average assumptions to determine the fair value of stock
options granted for the fiscal years ended June 30, 2001, 2000 and 1999:
Stock Employee Stock
Option Plans Purchase Plan
2001 2000 1999 2001 2000 1999
------ ------ ------ ------ ------ ------
Dividend yield 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Expected volatility 208.7% 137.3% 142.0% 92.3% 92.3% 92.3%
Risk-free rate of return 4.67% 5.23% 4.7% 4.67% 5.23% 4.7%
Average expected option life 3.6yrs 3.6yrs 3.6yrs 0.5yrs 0.5yrs 0.5yrs
23
Consultant and Advisor Stock Plan
In April of 1999, the Company established a Consultant and Advisor Stock
Plan (the "Consultant and Advisor Stock Plan") for the purpose of providing
incentives to and compensating consultants and advisors for their contributions
to the Company. In June 2001 the Company amended the plan by increasing the
number of shares issuable under the plan from 500,000 shares to 1,000,000 shares
of the Company's common stock.
Under the Consultant and Advisor Stock Plan, the Company may issue up to an
aggregate of 1,000,000 shares of Common Stock to consultants and advisors whom
are natural persons providing bona fide services to the Company. Shares may not
be issued under the Consultant and Advisor Stock Plan to directors or officers
of the Company, or for services rendered in promoting or maintaining a market in
the Company's securities.
The Company recognizes as expense the market value of shares on the day of
issuance for such consulting services as the recipients generally sold the
shares upon issuance. The Company does not amortize additional compensation
expense for this plan. For the years ended June 30, 2000 and 1999, the Company
issued approximately 190,000 and 100,000 shares of common stock with a value of
approximately $520,000 and $428,000 respectively. The company did not issue any
other shares in conjunction with this plan for the year ending June 30, 2001.
11) Commitments
The Company's facilities consisted of three buildings of approximately
21,000, 29,000 and 10,000 square feet, which are subject to ten, seven and five
year operating leases, respectively. The total net rent expense charged to
operations was approximately $290,000, $282,000, and $286,000, in fiscal 2001,
2000, and 1999 respectively.
In September 2000, the company sublet 29,000 square feet of its San
Antonio, Texas facilities to Teftec, Inc. a nonaffiliated company with the
approval of Crow Holdings Company, the company's landlord. In fiscal 2001, the
company received $125,000 in rents from Teftec resulting in net rent expense of
$290,000 for fiscal 2001, for all leased facilities.
The following is a schedule of future minimum lease payments under
non-cancelable operating leases as of June 30, for each fiscal year shown below:
Operating
Fiscal year ending June 30, Leases
----------------------------------------------- -----------
2002......................................... $ 387,000
2003......................................... 347,000
2004......................................... 229,000
2005......................................... 229,000
Thereafter................................... 148,000
-----------
$ 1,340,000
===========
During fiscal year 2001, the company entered into three capital leases for
capital equipment. A summary is presented below for all capital leases including
provisions for interest. Each lease may be bought out at the end of its term for
$1.00
Capital
Fiscal year ending June 30, Leases
----------------------------------------------- -----------
2002......................................... $ 141,000
2003......................................... 42,000
2004......................................... 21,000
-----------
Total future payments for capital leased 204,000
Less interest under capital lease obligations (32,000)
-----------
Net present value of capital leases $ 172,000
===========
24
Each leased asset is depreciated over the life of the lease. The maximum
lease term is 36 months. Prior to June 30, 2001 the Company recorded asset
impairment for these leases since completing the original lease obligation will
be dependent upon additional cash being generated by the Company. The company is
also responsible for all property taxes that may be assessed from time to time
per the agreement.
12) Related Party Transactions
Certain outside directors also receive consulting fees for services
rendered from time to time to the Company. In fiscal 1999, no such person
received in excess of $60,000 for such services. In fiscal 2001 and fiscal 2000,
First Capital Group of Texas II, L.P., an investment firm managed by Jeffery P.
Blanchard, the Company's Chairman of the Board, respectively received $74,000
and $71,000 in consulting fees. In February 2001, the Company received a 30-day
loan from First Capital Group of Texas II, L.P in the amount of $150,000 that
the Company repaid in March including a nominal amount of interest. In May 2001
First Capital Group of Texas II, L.P., as part of the Company's May private
placement, invested $350,000 in the form of a convertible promissory note (see
Note 9.)
In July 1998, and January 1999, the Company completed the first and second
closings respectively, of a Private Placement (see Note 9) involving, among
other things, the sale of its Series E and F Preferred Stock and related Common
Stock Purchase Warrants to First Capital Group of Texas II, L.P., an investment
firm managed by Jeffery P. Blanchard, the Company's Chairman of the Board, at an
aggregate amount of $750,000 for each closing.
In fiscal 2000, two officers resigned their positions with the Company. The
total severance and retirement package was approximately $480,000 and was
recorded as an expense in fiscal 2000.
13) Employee Benefit Plans
Effective March 1, 1992, the Company adopted the DATA RACE, Inc. 401(k)
Plan under section 401(k) of the Internal Revenue Code of 1986, as amended.
Under the Plan, substantially all employees eligible to participate may elect to
contribute up to the lesser of 15% of their salary or the maximum allowed under
the Code. All full time employees with at least one year of continuous service
and who have completed 1,000 work hours are eligible for the Plan. The Company
may elect to make contributions to the Plan at the discretion of the Board of
Directors. The Company made contributions of approximately $76,000 in fiscal
2001, $65,000 in fiscal 2000, and $68,000 in fiscal 1999. Subsequent to the
close of its fiscal year on June 30, 2001, the Company terminated its 401k plan
through board of director resolution on July 13, 2001. For the quarter ending
June 30, 2001, the company opted not to match employee contributions.
In December 1993, the Company adopted the DATA RACE, Inc. Employee Stock
Purchase Plan ("ESPP") pursuant to which eligible employees may purchase up to
an aggregate of 200,000 shares of the Company's common stock at 85% of the fair
market value of the common stock through payroll deductions. In 1997, the ESPP
was amended to offer two consecutive six-month plan periods, beginning February
1 and August 1, respectively. Of the 200,000 shares available in this Plan,
approximately 194,000 shares have been purchased as of June 30, 2001.
25
14) Legal Matters
On May 18, 2001, the Company, executive officers, Michael McDonnell,
previously the President and Chief Executive Officer (resigned in July 2001),
James Scogin, Acting President and Chief Financial Officer, and John Liviakis,
one of our significant shareholders, were sued in the United States District
Court for the Northern District of Illinois, Eastern Division, by Robert
Plotkin, a Chicago-based attorney, and several of Mr. Plotkin's relatives and
family trusts, who are all shareholders of the Company. The amount of the
monetary damages being sought is $20,000,000. The complaint alleges that the
plaintiffs were induced to purchase shares of our common stock based upon
alleged misrepresentations and omissions of material fact. The proceeding has
been moved to the United States District Court for the Eastern District of
Texas, Sherman Division in October 11, 2001. Discovery has not commenced, but we
believe the lawsuit is without merit and intend to vigorously defend the Company
against these allegations.
The Company is not aware of any other legal matters.
26
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended the Registrant has duly caused this report to
be signed on behalf of the undersigned, thereunto duly authorized.
DATA RACE, INC., DBA IP AXESS
By: /s/ JAMES G. SCOGIN
--------------------------------------
James G. Scogin
President, Chief Financial Officer and
Principal Accounting Officer
Date: April 3, 2002
27