ITEM 1. BUSINESS
GENERAL
Digital Transmission Systems, Inc. ("DTS") and subsidiaries (collectively termed the "Company") designs, manufactures, repairs and markets a broad range of products for the telecommunications ("telecom") industry. The Company's primary customers are long-distance carriers, domestic and international wireless service providers, including those offering cellular telephone services and Personal Communication Services ("PCS"), and domestic and international resellers/integrators who sell to and service end users with telecom equipment.
The Company's products of original design, consisting of proprietary software and hardware modules, facilitate the control, monitoring, and efficient transmission of high-speed digital information through public or private telecommunications networks. The Company's network access products enable telecommunications service providers to give their customers economical, high quality access to public and private networks and various telecommunications services. These services include voice and high speed data transmission, access to the Internet and video and desktop conferencing. Important product requirements in the market segments the Company serves include high feature density, modularity, quality performance and compactness. The Company's products meet these requirements and are suitable for both wireline and wireless service environments. Major customers of DTS include Nextel, Alltel Wireless and Alltel Supply.
The Company markets its products through a direct sales force employing inside and outside sales representatives and several reseller channels. Domestically, wireless service providers, including cellular, Specialized Mobile Radio ("SMR") and PCS service companies, are targeted as prospective customers directly by the Company's sales force. The Company also utilizes telecommunications equipment resellers and agents in the United States and other countries to market to private network customers.
In late fiscal 2001, the Company's Board of Directors approved a plan to divest of its de-installed telecommunications equipment business (Asurent Technologies, Inc. -- formerly Telcor Communications). The business, which includes a repair services unit, will continue to operate while the Company seeks and evaluates divestiture alternatives for Asurent Technologies. The financial statements have been reclassified to exclude the operating results of Asurent Technologies and account for them as discontinued operations (See Note 15 to the accompanying consolidated financial statements). The following discussion relates only to the Company's continuing operations. The decision for divestiture was based on a thorough strategic and financial review of the Company's operations and subsidiaries coupled with the consideration of the severe macroeconomic conditions in the telecommunications industry. The Company decided to only retain those segments that will potentially provide self-generated positive and profitable growth in the near-term as access to external financing has been difficult to obtain in recent periods.
BACKGROUND
Apart from a recent trend in consolidations and business combinations among service providers, the telecommunications industry is undergoing rapid and fundamental changes in the services being provided. Along with traditional voice services, customers are now being offered multimedia applications, Internet access, video and desktop conferencing, facsimile transmission, compressed voice communications and data communications between computers. The new services necessitate the increased use of high-speed digital or broadband transmissions. The increased demand for broadband capacity has led to significant network infrastructure growth and efforts to improve the efficiency of current telecommunications systems. For all participants in the telecommunications industry, including long distance carriers, telephone operating companies and wireless service providers, the need for efficient transmission of broadband signals, lower operating costs, seamless connectivity and the assurance of quality service between networks is of vital importance. Continued growth in traditional wireline and alternative services will increase the need for products like those offered by the Company which are designed to address these requirements.
The Company has focused on the equipment needs of the wireless service industry. Future needs will require the more efficient use of the frequency bands used by the wireless carriers in offering current or future services especially those requiring high speed or broadband digital data rates. The Company's association with Wi-LAN, Inc., a developer and licensor of high speed wireless technology in Calgary, Canada, has permitted the Company to potentially address such future equipment needs with W-OFDM technology from Wi-LAN. This patented technology allows the more efficient utilization of the limited bandwidth that wireless carriers are licensed to use. The Company believes the following trends are contributing and will continue to contribute to the growth in demand for its products and services:
Growth in Wireless Services. According to industry sources, the wireless market is currently estimated to include over 60 million cellular users in the US. Although many of these users initiated wireless service with analog cellular networks, many of these older networks are being upgraded to offer digital services in the frequency bands they have been authorized
to utilize. The growth and analog-to-digital migration of these legacy networks has created the need for highly integrated, multi-functional, high-speed network access products to speed deployment of new digital cellular services, ease the maintainability of networks, lower cell site costs and simplify the day-to-day operation of the associated network.
Deployment of PCS (Personal Communications Services). The Company believes that significant infrastructure investments will be made over the next few years as PCS licensees build new or upgrade their communications networks to third ("3G") and fourth generations ("4G") of wireless services. The establishment of a PCS network involves the construction of a significant infrastructure that must be reliably connected to existing wireline and cellular services. Each of these networks will require efficient equipment to control and monitor the flow of digital information without significant dependency on the local telephone company for links between cell sites or major switching centers.
Growth in Wireline Services. The Company believes the markets for traditional wireline service will continue to grow. Internet access is expanding and the Company believes the trend of increased level of mobile services and telecommuting is likely to continue because of: declining costs of telecommunications equipment and services, employer cost-cutting and desires to improve employee productivity, availability and convenience of improved technology and environmental concerns. The increasing number of public telecommunications services has created the need for broadband digital connection devices that give service providers the ability to economically expand their networks to provide new service offerings without drastic changes in technology and the associated infrastructure costs. The ability to quickly connect existing customers to these new broadband services without changing access technologies usually means lower costs to end users and simplification of network construction for the service provider.
Proliferation of Competitive Access Providers. Deregulation of the telecommunications industry has resulted in an increase in competitive alternatives for local access to network services. These Competitive Access Providers ("CAPs"), such as cable TV companies, utilities and long distance telephone service providers, have targeted major metropolitan markets in the United States to offer local telephone and broadband network services and are courting large corporate customers who have traditionally been serviced by the local Regional Bell Operating Companies ("RBOCs"). These CAPs have unique connection requirements for access to the public network that are creating opportunities for wireless digital transport equipment providers. Bridging two buildings separated by 100 yards or two locations 30 miles apart with wireless transport equipment allows companies to avoid the expense of leased lines from the local RBOC. The market for equipment that connects the various networks is one that the Company believes will continue to grow.
Growth of International Markets. Many countries throughout the world lag behind the United States in telecommunications infrastructure development. As customers in such countries begin to demand new or enhanced communications services, service providers will seek the ability to upgrade telecommunication networks quickly without sacrificing service quality. Service providers in developing countries are faced with the need to promptly connect high-speed digital lines to public networks, provide telecommunications to rural areas and provide extensions for thin route cellular services.
Growth in Usage of Internet Protocol (IP) Packet Systems. The proliferation of packet based data systems using the IP format has led to the advent of IP based telephone services. It is envisioned that future voice communications and data transmission through carrier networks will be increasingly accomplished through IP packet formatted systems. This trend will revolutionize the processing of voice calls and will lead to new services that many carriers are eager to offer.
All of these trends have created and will continue to create the need for cost-effective, quality broadband network control and network access products, such as those offered by the Company, that permit carriers to economically build and operate networks to address the service requirements of their customers.
THE DTS SOLUTION
DTS has developed an integrated, systems-based, high-speed network control and access solution for wireless and wireline networks that consists of the family of access devices -- FlexT1(R), FlexE1(TM), microFlex(TM) and the IP Processor. In fiscal 1998 the Company introduced microFlex, a DS-1 cross connect switch which addresses the need for high speed line concentration in wireless carrier networks and in wireline applications. In April 1999 the Company introduced the IP Processor, a device that allows connectivity to the internet from cell sites in a wireless carrier network. The Company believes that its products can be combined to offer whole product solutions that provide significant differentiation from competitive offerings in the marketplace with respect to size, price, feature density and reliability.
The FlexT1 and FlexEl network access products provide integrated access to public network services for both domestic ("T1") and international ("El") markets. The FlexT1 and FlexEl are provided in a compact physical package, are expandable and allow an end user to access many of the business services available from the public network. These products also enable the sharing of telecommunication facilities among the different services, such as voice, video, the Internet and facsimile, thus reducing the number of access lines the user must lease and potentially reducing overall telecommunications expenses. A companion product to the FlexT1/E1 family is microFlex(TM), a cross connect switch or "DACS" (Digital Access Cross Connect Switch). The microFlex offers non-blocking DS0 cross connect capability for up
to sixteen T1's or E1's in one RU (1.75in.) high package. This product has applications in hubbing or grooming environments involving many broadband lines such as those found when concentration of voice lines from several cell sites are necessary before transport to the central switching center.
COMPANY STRATEGY
The Company's goal is to become a leading worldwide supplier of network control and access products and services for both public and private high-speed telecommunications networks. In order to realize these goals the Company plans to:
Concentrate on the Domestic and International Expanding Cellular and PCS Markets. The Company has a sales force and support staff to further penetrate the growing domestic and international Cellular and PCS markets. The Company's network access products have numerous wireless applications and offer what the Company believes is a unique integrated solution to the wireless carriers' need to monitor and control transmission facilities to hundreds of remote cell sites.
Develop and Expand on Flexible and Modular Platforms. The Company continues to expand upon its modular Flex and microFlex and IP Processor line of network access products and plans to add various modules for feature enhancements, facilitating continued utilization of Flex products as new applications are developed.
The Company was certified in December 1994 and continues to be an ISO 9001 new equipment supplier, thus establishing its quality assurance credentials for the international arena.
PRODUCTS AND TECHNOLOGY
The Company's proprietary products facilitate network access, bandwidth management, network control and delivery of high-speed digital telecommunications services.
MICROFLEX PRODUCT
During fiscal 1998 the Company introduced microFlex which in conjunction with FlexT1/E1 allows more efficient use of high speed lines which a wireless carrier utilizes to connect voice and other traffic between cell sites and its switching center. In particular, microFlex offers cross connect functionality between segments of one high speed line (T1 or E1) with another in a total set of up to sixteen high speed lines.
FLEXT1 AND FLEXE1 PRODUCT FAMILY
The FlexTl family of products provides integrated access to public network telecommunications services. The FlexTl consists of single and multi-slot enclosures that are customized with various card sets to satisfy a wide range of network access applications. The FlexE1 provides much of the same functionality currently available in the FlexT1 for countries using the E1 (international) standard. Customer equipment needs include N x 56/64 Kbps and full T1 interfaces for data, voice and video applications.
FLEXT1/E1 SYSTEM ARCHITECTURE
The FlexT1/E1 bandwidth management features are derived from an advanced architecture with two independent Time Division Multiplexed ("TDM") busses available to each card position within a FlexT1/E1 enclosure. This architecture allows users to pay only for the functions and features needed for a particular application. Bandwidth managers connect directly to the service provider's network and user traffic is interfaced through card sets that connect directly to voice, data and video terminals. All card sets within the product family can be upgraded with software as new features become available.
IP PROCESSOR PRODUCTS
The IP Processor product from DTS provides wireless carriers a means for connecting cell sites in their network to the internet. This connectivity enhances the ability of the carrier to remotely access various pieces of equipment at the cell site for maintenance and network control purposes. This password protected access would be available from any personal computer connected to the internet. In addition, a craftsperson at the cell site would have access to the internet resources for accessing equipment user manual information.
INTERFLEX
InterFlex is the newest member of the Flex family of network access and connectivity products. InterFlex combines the functions of an STS-1/DS3/DS1/DS0 digital Cross-Connect Switch and a Voice & Data Access Multiplexer into a single compact unit. Wireless carriers can use InterFlex at cell sites to groom signals from base stations and ancillary equipment into one or more T1s or into a T3. At a Hub site, T1s from remote cell sites can be multiplexed into a T3 or STS-1 signal.
Partially full T1s can also be combined in the digital cross-connect switch to reduce the number of T1s and minimize transmission costs. The InterFlex has two chassis options: an 11 slot chassis occupying 10.15 inches (6 RUs) of vertical space and supporting up to 88 T1s, or a 4 slot horizontal model supporting 32 T1s in 5.25 inches (3 RUs) of vertical space. Application modules range from STS-1, T3, and T1 network cards, to a variety of router/hub, voice and data cards. An N+1 protection switch is also available to provide redundancy for the T3, STS-1, and octal T1 card sets.
The Company offers its complete set of products to wireless and wireline service providers through a direct sales force. A secondary channel to telecommunications service providers exists through selected reseller arrangements. Reseller agreements were signed with Alltel Supply and Somera Communications who distribute telecommunications equipment to telephone service providers and private network users.
COMPETITION
The market for telecommunications products is highly competitive and subject to rapid technological change, regulatory developments and emerging industry standards. The Company believes that the principal competitive factors in its markets are: support for multiple types of carrier services, conformance of products to multiple public carrier standards, reliability and safety, the development and rapid introduction of new product features, price, performance, and quality of customer support.
The Company's principal competition to date has come from major telecommunications equipment suppliers active in certain market segments. In the network access marketplace, ADC Kentrox (a subsidiary of ADC Telecommunications Inc.), Carrier Access Corporation, Paragon Networks, Inc., Adtran Inc. and Newbridge Networks, Inc. are competitors.
The Company expects increased competition from existing competitors as they develop and service products with functionality similar to that of the Company's products. In addition, the Company expects to compete with other new entrants to the telecommunications access equipment marketplace, including those targeting bandwidth on demand services and broadband integrated access products. To the extent that current or potential competitors can expand their current offerings to include monitoring and maintaining network facilities in an integrated product, the Company's business and operating results could be materially adversely affected.
MANUFACTURING
For its products of proprietary design, DTS currently outsources most subassembly, board assembly and testing to high quality suppliers which are ISO 9002 certified. For products designed by other manufacturers and sold as refurbished items with warranty, DTS does repair and testing of those products using its facilities and personnel with rare exception.
For several of the products and subassemblies of original design, finished circuit boards are brought to DTS headquarters for final assembly, system integration, testing and product burn-in. Defective subassemblies are returned to the contract manufacturers for root cause analysis and process problem resolution. System test development is jointly done by the Company's engineering and quality assurance personnel. Most DTS product board assemblies contain surface mount technology ("SMT") components so that only minor touch-up is possible by DTS manufacturing personnel.
High quality is demanded by all DTS' customers. The Company continues to strive for quality in the design and the manufacturing of products in order to attain a competitive advantage. All key procedures in the Company have been documented and Company policy requires that employees follow these procedures. It is the Company's belief that this policy promotes consistency in the delivery of value to the customer. This effort led to ISO 9001 certification for the Company in December 1994, and numerous successful follow-up compliance surveillance audits for products of original design.
PRODUCT DEVELOPMENT
The market value of the Company's diversified network access and control systems is based upon its core technologies in customer terminal interfaces for voice and high-speed data applications, T1 networking and microwave radio applications. Additionally, the Company has valuable experience in public, private and cellular T1 networking standards and control systems. The Company's product development efforts are currently concentrated in the T1 network access, transport and control areas.
The Company's resident core technologies resulting from the developments of the Flex and microFlex products include:
- T1/E1 multiplexing of voice and high speed data signals
- T1/E1 alarm reporting and trunk conditioning
- Network performance monitoring and testing
- TI ESF data link message transport
- SNMP protocol processing
- TCP/IP protocol message handling
- 10Base5 and 10BaseT Ethernet Media Access Control
- Microprocessor-based product design
- Real time processing of control and data signals
- Design of programmable logic device
The Company's product development efforts have also resulted in the development of a number of relevant technologies for products targeted toward the wireless infrastructure and CAP market segments. These technologies include hardware and software modules for high-speed digital modems, high data rate modulation algorithms, error correcting coding, automatic equalization methods utilizing digital signal processing, VLSI devices, RF filtering for microwave products, point-to-point and multipoint networking protocols, X.25 interfaces, voice compression, voice telephony interfaces and T1 digital cross connects.
The technologies listed above are being used by the Company's product development group to design wireless products and enhancements for the FlexT1/El platform. Future Company products will potentially exploit the bandwidth efficiencies offered with the use of the patented broadband wireless technology from Wi-LAN, Inc.
INTELLECTUAL PROPERTY
The Company's proprietary technology is protected in large measure by trade secret although it has several patents either granted or pending. Core technologies described in the "Product Development" section are incorporated in the Company's products through proprietary hardware and software modules that embed original algorithmic and device circuitry.
The Company currently owns the trademarks of "FlexT1," "FlexE1," and "microFlex." It has also filed federal trademark applications for FlexSentry, FlexCell, FlexE1 internationally, and these applications were published for opposition in the Trademark Office after examination. The applications for FlexCell and FlexE1 were formally opposed by Fujitsu Network Transmission Systems, Inc. Fujitsu has alleged that the trademark registrations should be denied because of their prior rights filed on a trademark application for FlexR, for certain access controllers. The Company and Fujitsu have reached an agreement whereby the DTS trademarks can be used with few restrictions.
The Company relies primarily upon trade secret protection for its confidential and proprietary product information. There can be no assurance that competitors or potential competitors of the Company will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's trade secrets or disclose such technology, or that the Company can meaningfully protect its trade secrets. Failure to obtain needed patents or licenses or proprietary information held by others could have a material adverse effect on the Company.
RESEARCH AND DEVELOPMENT COSTS
During fiscal years 2001 and 2000, the Company's expenditures in product development were $1,527,000 and $759,000, respectively. The increase in spending from 2000 to 2001 is primarily due to additional compensation costs as a result of the additional hiring of approximately 11 hardware and software engineers during early fiscal 2001. During fiscal 2001 and 2000, the Company capitalized approximately $105,000 and $174,000 in software development costs primarily for the continued development and enhancement of the Internet Protocol Processor card set.
During fiscal years 2000 and 1999, the Company's expenditures in product development were $759,000 and $1,353,000, respectively. The decrease in spending from 1999 to 2000 is primarily due to the divestiture of SouthTech, Inc., the Company's international subsidiary. During fiscal 2000, the Company capitalized approximately $174,000 in software development costs primarily for the continued development and enhancement of the Internet Protocol Processor card set. During fiscal 1999, the Company capitalized approximately $136,000 in software development costs primarily for the development of the Company's ELP (Enhanced Lightning Protection) Card set.
GOVERNMENT REGULATION
The FCC has regulated the design of telecommunications equipment for use in the United States by restricting radio frequency signal emissions and by licensing frequency usage. Compliance with electronic product safety regulations is also required for every new product design. It is possible that a government agency such as the FCC could issue regulations which would require the modification of DTS equipment in order to comply with the new regulations. A change in FCC rules may impact sales of DTS products should it occur. International standards for electronic product design in the areas
of safety and signal emissions are different in many cases from those issued by United States government agencies. Sales of telecommunications equipment in a foreign country are often restricted by equipment design standards and regulations adopted by a centralized governmental agency similar to the FCC. The Company has to date experienced no material difficulties in complying with the various laws and regulations affecting its business.
EMPLOYEES
As of June 30, 2001, the operating unit of the Company, apart from Asurent Technologies, had approximately 41 full-time employees, of whom 14 are technical personnel engaged in developing the Company's products, 11 are marketing and sales personnel, approximately 9 are quality assurance and operations personnel and 7 are involved in administration and finance. All of the Company's employees are full-time. The Company's employees are not unionized and the Company believes that its employee relations are good.
BACKGROUND OF THE COMPANY
A predecessor by merger to the Company was incorporated in Delaware in 1984. The Company was originally incorporated in Delaware in 1992 as Netra, Inc. and changed its name to Digital Transmission Systems, Inc. in 1995 in conjunction with the merger with its wholly-owned subsidiary Digital Transmission Systems, Inc., a California corporation. On March 4, 1996, the Company completed a public offering of 1,220,700 Units each consisting of one share of Common Stock and one warrant to purchase one share of Common Stock at a price of 120% of the unit offering price of $7.50. On February 18, 1997, trading of the Units was split into separate trading of the underlying Common Stock and Warrants. The Company stock was delisted from the NASDAQ small cap exchange on October 15, 1998 and is currently being traded as an OTC Bulletin Board issue.
ITEM 2.
ITEM 2. PROPERTIES
The Company's primary operations are located in an approximately 160,000 square foot facility in a modern business park in Duluth (in the greater Atlanta, Georgia area). The Company leases the Duluth facility under a five year lease with an irrevocable trust for the children of the former shareholders of Asurent Technologies (formerly Telcor Communications, Inc.) Base annual rent under this lease approximates $909,000 per year.
The Company believes its facilities are suitable and adequate for its current purposes but will seek facilities more appropriate for its operations after the divestiture of Asurent Technologies.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations, or liquidity. The Company is not a party to any material legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
On October 14, 1998, the Company was de-listed from NASDAQ due to noncompliance with a net worth requirement of $2,000,000 for continued listing. The Company's common stock, with symbol DTSX, continues to trade on the OTC Bulletin Board.
On March 4, 1996, the Company completed a public offering of 1,220,700 Units ("Units"), each consisting of one share of Common Stock ("Common Stock") and one Warrant ("Warrant") to purchase one share of Common Stock at an exercise price per share equal to 120% of the initial public offering price of the Units. The shares of Common Stock and Warrants were not detachable or separately transferable, and could only have been traded as part of a Unit until February 18, 1997 (the "Separation Date"), when each Unit was separated into one share of Common Stock and one Warrant. The Common Stock and Warrants had been listed on the NASDAQ SmallCap Market, the Company's principal market, under the symbols DTSX and DTSXW, respectively, and were listed on the Philadelphia Stock Exchange and the Boston Stock Exchange under the symbols DTS and DTS.W, respectively. The Units previously traded on the NASDAQ Market and the Philadelphia and Boston exchanges.
On February 18, 1997 the Common Stock and Warrants underlying the Units began trading separately and the Units ceased to trade. Both the Common Stock and Warrants traded on the NASDAQ Market and the Philadelphia and Boston exchanges. On October 14, 1998, the Company's securities ceased to be listed on NASDAQ and continue to trade on the OTC Bulletin Board. The Company's publicly traded warrants expired on March 5, 2001. The price per share of the Company's Common Stock in the table below represents the range of low and high closing sale prices as reported by the NASDAQ Stock Market or the OTC Bulletin Board for the quarters indicated:
The closing sale price of the Company's Common Stock as reported by the OTC Bulletin Board on June 30, 2001 was $0.51.
The total number of shareholders of record of the Company's common shares as of September 28, 2001 was approximately 83. Because a substantial portion of shares are held by brokers and other institutions on behalf of shareholders, the Company is unable to estimate the total number of shareholders beyond those represented by these record holders.
The Company has never paid cash dividends on its Common Stock. The Company currently intends to retain any earnings for use in the business and does not anticipate paying any cash dividends in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the Company's historical financial statements and related footnotes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" immediately following this section.
Amounts are in thousands, except per share data, and relate to the continuing operations of the Company.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND SELECTED FINANCIAL DATA
The following discussion of the results of operations and financial condition should be read in conjunction with the Company's audited consolidated financial statements and notes thereto.
OVERVIEW
During fiscal 2001, the Company created two subsidiaries -- Asurent Wireless, Inc. and Asurent Technologies, Inc. Asurent Wireless' operations encompass the design, manufacture and marketing of network access product lines of the Company (Flex products) while Asurent Technologies (formerly Telcor Communications) targets the de-installed telecommunications equipment market segment. The Asurent Technologies subsidiary was basically the result of a restructuring of Telcor Communications, a company purchased in March of 2000. During fiscal 2001 the Company engaged two different investment bankers to execute private placements of the Company's stock in order to increase cash reserves and provide additional working capital for its subsidiaries. The money raising activities by the two investment bankers did not provide the working capital required for the Company's growth in sales. With the advent of a severe downturn in telecommunications services domestically, the process of completing a private placement was abandoned. The Company has downsized in headcount and has implemented a number of expense reduction programs in order to preserve cash and prepare for any further downturn in telecommunications equipment sales. As a means to raise money for its remaining business, in late fiscal 2001 the Company's Board of Directors approved a plan to divest Asurent Technologies, Inc. The Company will seek and evaluate several divestiture alternatives. As a result of this Board approval, the financial statements have been reclassified to account for the operating results of Asurent Technologies as discontinued operations (See Note 15 to the accompanying consolidated financial statements). The following discussion relates only to the Company's continuing operations. The decision to exit the business was based on a thorough strategic and financial review of the Company's operations and subsidiaries coupled with the consideration of the severe macroeconomic conditions in the telecommunications industry. The Company decided to only retain those segments, addressed by the Asurent Wireless subsidiary, that will potentially provide self-generated profitable growth in the near-term, as access to external financing to provide working capital has been extremely difficult to obtain in recent periods. During fiscal 2001, Asurent Wireless' revenues grew 17% year over year and 57% since fiscal 1999. Earnings before interest, taxes, depreciation and amortization for Asurent Wireless totaled $140,000 during fiscal 2001.
COMPARISON OF YEARS ENDED JUNE 30, 2001 AND JUNE 30, 2000
The following table sets forth certain financial data derived from the Company's Statements of Operations (dollars in thousands):
NET SALES. Net sales increased by 17%, to $11,811,000 for the year ended June 30, 2001, from $10,085,000 for the year ended June 30, 2000. The sales mix, and the resulting percentage of total sales, is shown in the table below (dollars in thousands):
During the year ended June 30, 2001, two customers accounted for greater than 10% each of the Company's consolidated sales. Nextel Communications and Nextel Partners represented 66% of total sales and Alltel (a reseller/integrator of telecommunications products) accounted for approximately 31% of the Company's sales. Revenues from the Company's FlexT1/E1 product line increased 22% from $9,556,000 in the year ended June 30, 2000 to $11,622,000 in the year ended June 30, 2001. The increase was primarily due to increased customer demand for the Company's network access products. The microFlex product, introduced in fiscal 1998, realized $139,000 in sales for fiscal 2001 compared to $283,000 in sales in fiscal 2000, a decrease of 51% due to lower customer demand for the microFlex product line during fiscal 2001.
GROSS PROFIT. Gross profit for the year ended June 30, 2001 increased 35% to $5,046,000 from $3,752,000 for the year ended June 30, 2000. As a percentage of sales, gross profit increased from 37% for the year ended June 30, 2000 to 43% for the year ended June 30, 2001. The increase reflects increased efficiencies in operations expense of the Company (a component of cost of sales) coupled with sales price increases across the major Flex product lines.
PRODUCT DEVELOPMENT. Product development expenses increased from $759,000 for the year ended June 30, 2000 to $1,527,000 for the year ended June 30, 2001. The increase in overall spending from 2000 to 2001 is primarily due to additional compensation costs as a result of the addition of a team of hardware and software engineers during early fiscal 2001.
Approximately $105,000 of software development costs related to new products were capitalized during the fiscal 2001 year, as compared to $174,000 during the year ended June 30, 2000. As a percentage of sales, total product development costs increased from 8% for the year ended June 30, 2000 to 13% for the year ended June 30, 2001. The increase, as a percentage of sales, is attributable to increased product development spending during the year ended June 30, 2001 as compared to the year ended June 30, 2000.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses of the Company decreased 9%, from $3,698,000 for the year ended June 30, 2000 to $3,379,000 for the year ended June 30, 2001.
Selling expenses increased by 23% from $1,380,000 for the year ended June 30, 2000 to $1,700,000 for the year ended June 30, 2001. The increase is primarily a result of the associated 17% increase in revenue and an increase in overall headcount of sales personnel during fiscal 2001. Selling expenses as a percentage of product sales remained consistent at 14% for the years ended June 30, 2001 and 2000.
General and administrative expenses for the Company decreased from $2,318,000 for the year ended June 30, 2000 to $1,679,000 for the year ended June 30, 2001. The decrease is primarily attributable to certain non-recurring charges of approximately $1,200,000 relating to an executive severance settlement and consolidation expenses borne by the Company during fiscal 2000. No such expenses were recorded during fiscal 2001. Offsetting the absence of the one-time charges in fiscal 2001 is an increase in overall headcount of the Company from 32 full-time employees at June 30, 2000 to 41 full-time employees at June 30, 2001.
NET LOSS. The net loss for the year increased from $3,815,000 for the year ended June 30, 2000 to a loss of $38,077,000 for the year ended June 30, 2001. Significant components of the current year loss include (1) a non-cash charge of $527,000 which represents depreciation and amortization, (2) write-downs to fair market value of certain assets of the Company's discontinued subsidiary and losses from the discontinued subsidiary's operations of approximately $37,224,000 and (3) interest and other expense of $466,000. The net loss from continuing operations decreased 50% from $1,700,000 for the year ended June 30, 2000 to $853,000 for the year ended June 30, 2001.
COMPARISON OF YEARS ENDED JUNE 30, 2000 AND JUNE 30, 1999
The following table sets forth certain financial data derived from the Company's Statements of Operations (dollars in thousands):
NET SALES. Net sales increased by 34%, to $10,085,000 for the year ended June 30, 2000, from $7,538,000 for the year ended June 30, 1999. The sales mix, and the resulting percentage of total sales, is shown in the table below (dollars in thousands):
During the year ended June 30, 2000, two customers accounted for greater than 10% each of the Company's consolidated sales. Nextel represented 60% of total sales and Alltel (a reseller/integrator of telecommunications products) accounted for approximately 35% of the Company's sales. Revenues from the Company's FlexT1/E1 product line increased over 70% from $5,623,000 in the year ended June 30, 1999 to $9,556,000 in the year ended June 30, 2000. The increase was primarily due to increased access to working capital as a result of the Wi-LAN investment on January 7, 2000. Such an investment enabled DTS to more effectively manage inventory levels and supplier relationships which in turn resulted in DTS's ability to more adequately serve its customers. Revenues from SKYPLEX (both international and domestic customers) decreased by 100% from $1,402,000 in the year ended June 30, 1999 to $0 in the year ended June 30, 2000. The decrease is due to the sale of the Company's international subsidiary (and the corresponding SKYPLEX product line) during FY1999. The microFlex product, introduced in fiscal 1998, realized $283,000 in sales for fiscal 2000 compared to $459,000 in sales in fiscal 1999, a decrease of 38%. The decrease is attributable to the sale of the Company's international subsidiary during fiscal 1999. Prior to the sale of the international subsidiary, the Company sold its microFlex product to certain international customers. Such international sales were eliminated after the sale of the subsidiary as the Company focused its operations on only servicing domestic customers.
GROSS PROFIT. Gross profit for the year ended June 30, 2000 increased 35% to $3,752,000 from $2,774,000 for the year ended June 30, 1999. As a percentage of sales, gross profit remained consistent at 37% for both the years ended June 30, 2000 and 1999. For the years ended June 30, 2000 and 1999, sales of the Company's FlexT1 and microFlex products represented approximately 98% and 81%, respectively, of total sales recorded for each respective fiscal year.
PRODUCT DEVELOPMENT. Product development expenses decreased from $1,353,000 for the year ended June 30, 1999 to $759,000 for the year ended June 30, 2000. Approximately $174,000 of software development costs related to new products were capitalized during the fiscal 2000 year, as compared to $136,000 during the year ended June 30, 1999. The decrease in product development costs is due to the sale of the Company's international subsidiary during fiscal 1999. Prior to the sale, the Company was developing international products (SKYPLEX) in addition to its domestic product offerings. As the international subsidiary was sold during fiscal 1999, no such international product development expense was incurred during the period ended June 30, 2000 thereby accounting for a majority of the decrease. As a percentage of sales, total product development costs decreased from 18% for the year ended June 30, 1999 to 8% for the year ended June 30, 2000. The decrease, as a percentage of sales, is attributable to lower product development spending and significantly higher revenues recorded during the year ended June 30, 2000 as compared to the year ended June 30, 1999.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses of the Company increased 71%, from $2,161,000 for the year ended June 30, 1999 to $3,698,000 for the year ended June 30, 2000. Selling expenses of the Company increased by 18% from $1,173,000 for the year ended June 30, 1999 to $1,380,000 for the year ended June 30, 2000. The increase is a result of increased selling costs due to the increase in revenue noted during fiscal 2000 as compared to fiscal 1999 coupled with an increase in additional marketing, travel and compensation expenses during fiscal 2000. Selling expenses as a percentage of sales decreased from 16% for the year ended June 30, 1999 to 14% for the year ended June 30, 2000.
General and administrative expenses for the Company increased from $988,000 for the year ended June 30, 1999 to $2,318,000 for the year ended June 30, 2000. The increase is primarily attributable to non-recurring charges of approximately $1,200,000 relating to an executive severance settlement and consolidation expenses recorded by the Company during fiscal 2000. Also contributing to the increase is an overall increase in headcount from approximately 27 employees at the end of fiscal 1999 to approximately 32 employees at the end of fiscal 2000.
NET LOSS. The net loss for the year increased from $424,000 for the year ended June 30, 1999 to a loss of $3,815,000 for the year ended June 30, 2000. Significant components of the fiscal 2000 loss include (1) non-cash charges of $421,000
which represents depreciation and amortization, (2) non-cash charges related to certain one-time severance and consolidation expenses mentioned above of approximately $1,200,000 and (3) losses from discontinued operations of approximately $2,115,000. For the year ended June 30, 1999, significant components of the net loss included depreciation and amortization charges of $853,000 and interest expense of $651,000 for a total of $1,504,000.
SALE OF DTS STOCK BY SIGNIFICANT SHAREHOLDER -- PEREGRINE VENTURES -- FISCAL
On December 31, 1998 an option to purchase 1,738,159 common shares of DTS stock was granted to MicroTel International ("MicroTel") by Peregrine Ventures, a California based limited partnership and shareholder of DTS, in consideration for a certain amount of MicroTel common stock. On the same date, the two DTS Board members representing Peregrine Ventures interests, tendered their resignations effective immediately. The option, due to expire on January 31, 1999, was exercised by MicroTel and thus Microtel became DTS' largest single shareholder, holding approximately 40% of the then outstanding stock of DTS. Two MicroTel representatives were subsequently elected to the DTS Board of Directors at the DTS Shareholders Meeting held on April 13, 1999. MicroTel is a Delaware corporation whose stock is publicly traded on the OTC Bulletin Board under the ticker symbol MCTL. In addition to various subsidiaries whose principal business is to manufacture and market power supplies, keypads, video displays, circuit boards and other electronic assemblies to a variety of aerospace and communications clients, MicroTel also owns two CXR subsidiaries -- CXR Telcom and CXR S.A. -- which manufacture and market telecommunications products to telecommunications and private network users.
ACQUISITION OF DTS STOCK BY WI-LAN, INC. -- FISCAL 2000
On December 29, 1999, the Company entered into an agreement with Wi-LAN Inc. ("Wi-LAN"), a leading provider of wireless data communications technology and products, to sell Wi-LAN $1.5 million in convertible debentures (the "1999 debentures"). The debentures, convertible into the Company's common stock at any time by the holder, have a four-year term with a 10% interest rate with principal and interest due at maturity. The Company has no buy-back provision, and the conversion rate is one share per $1 in debentures, which approximated the fair value of the Company's common stock on the date the Company entered into the agreement. On January 7, 2000, a closing on the Wi-LAN debentures was held whereby the Company received the proceeds from the first tranche of the debentures of $400,000. The remaining $1,100,000 in proceeds from the issuance of debentures was received prior to March 31, 2000. In connection with various transactions subsequent to the sale of the $1.5 million in debentures and through June 30, 2001, Wi-LAN has converted $1,278,900 of the 1999 debentures into 1,278,900 shares of the Company's common stock. The outstanding amount of these 1999 debentures as of June 30, 2001 is $221,100. In connection with the agreement, Wi-LAN also received an option to purchase additional debentures of $1.5 million with similar terms but at a conversion rate to be determined by the market price of the Company's common stock at the time the option is exercised. The expiration on the option to purchase additional debentures of $1.5 million is January 7, 2002.
Apart from the transactions described above, in January 2000, Wi-LAN purchased 1,738,159 shares of the Company's common stock from MicroTel, another DTS shareholder, and the outstanding $2 million in debentures (the "1997 debentures") with outstanding warrants from Finova Mezzanine Capital, a DTS lender. By converting $1,310,000 of the 1997 debentures, Wi-LAN received 1,310,000 shares of the Company's common stock and gained over 50% of the outstanding common stock of the Company. Through the transaction with Finova, Wi-LAN also received outstanding warrants for 702,615 shares of common stock at an exercise price of $1 per share which expire in March 2004. All 702,615 warrants remain outstanding and exercisable as of June 30, 2001.
Additionally, Wi-LAN converted another $190,000 of the 1997 debentures into 190,000 shares of the Company's common stock through June 30, 2001. The outstanding amount of the 1997 debentures as of June 30, 2001 is $500,000.
On March 31, 2000, Wi-LAN purchased 454,737 shares of the Company's Series B preferred stock for $3 million in cash to be used in connection with the acquisition of Telcor Communications. The Company's Series B Preferred Stock is convertible into common shares at $7.125 per share, the market closing price of the Company's common stock on March 30, 2000.
In June 2000, the Company announced that Wi-LAN Inc. entered into a purchase and assignment agreement with the two former shareholders of Telcor to acquire the right to receive approximately 31% of the merger consideration still due to the former Telcor shareholders. According to the agreement, Wi-LAN acquired $6,100,000 of the original $20 million acquisition payable for $500,000 in cash and $5,600,000 by issuing the former Telcor shareholders a right to receive $5,600,000 of Wi-LAN common shares based on the market value of Wi-LAN shares on July 17, 2000, subject to a specified maximum number of shares. Wi-LAN may redeem all or part of the right for cash. In addition, Wi-LAN granted the former Telcor shareholders an option exercisable by August 31, 2000, to sell between $2,000,000 and $4,000,000 of additional merger consideration to Wi-LAN for the issuance of a right to receive Wi-LAN shares of equivalent value, based on the market value of Wi-LAN shares at October 30, 2000, subject to a specified maximum number of shares. On
August 31, 2000, the former shareholders of Telcor exercised the aforementioned option and sold $4,000,000 of merger consideration to Wi-LAN in exchange for Wi-LAN shares as discussed above.
ACQUISITION OF TELCOR COMMUNICATIONS, INC.
TRANSACTION SUMMARY
On March 31, 2000 the Company consummated the merger of Telcor Communications, Inc. ("Telcor"), a leading reseller of new and used wireless and wireline telecom equipment based in Duluth, Georgia, into a wholly-owned subsidiary of the Company. The merger consideration payable to the shareholders of Telcor was $25 million in a combination of the Company's common stock and cash. The amount of $5 million of the consideration was paid at closing with $2.5 million in cash and $2.5 million in common stock valued at $7.375 per share (the closing price of DTS common stock a few days before and after the announcement date). A total of 338,983 shares of DTS common stock were paid in connection with the closing on March 31, 2000. The remaining consideration of $20 million was due and payable on or before October 30, 2000.
The acquisition was accounted for by the purchase method of accounting, and accordingly, the purchase price was allocated to assets acquired and liabilities assumed based on their fair value at the date of acquisition.
In June 2000, the Company announced that Wi-LAN Inc. entered into a purchase and assignment agreement with the two former shareholders of Telcor to acquire the right to receive approximately 31% of the merger consideration still due to the former Telcor shareholders. According to the agreement, Wi-LAN acquired $6,100,000 of the original $20 million acquisition payable for $500,000 in cash and $5,600,000 by issuing the former Telcor shareholders a right to receive $5,600,000 of Wi-LAN common shares based on the market value of Wi-LAN shares on July 17, 2000, subject to a specified maximum number of shares. Wi-LAN may redeem all or part of the right for cash. In addition, Wi-LAN granted the former Telcor shareholders an option exercisable by August 31, 2000, to sell between $2,000,000 and $4,000,000 of additional merger consideration to Wi-LAN for the issuance of a right to receive Wi-LAN shares of equivalent value, based on the market value of Wi-LAN shares at October 30, 2000, subject to a specified maximum number of shares. On August 31, 2000, the former shareholders of Telcor exercised the aforementioned option and sold $4,000,000 of merger consideration to Wi-LAN in exchange for Wi-LAN shares as discussed above.
On November 30, 2000, the Company paid down the entire remaining acquisition payable balance of $7,655,400 (as of November 30, 2000) through the issuance of common and Preferred stock. The Company issued 638,273 shares of its common stock valued at $2.064 per share and remitted a cash payment of $117,605 to the former shareholders of Telcor as final consideration owed to the former Telcor shareholders under the amended merger agreement. The value of $2.064 per share represents the share value calculated by the parties pursuant to the terms of the merger agreement as executed on March 31, 2000. Further, the Company issued 683,543 common shares valued at $2.064 per share and 2,330,217 shares of Series C Preferred Stock convertible into the Company's common stock at $2.064 per share to Wi-LAN, Inc. also reflecting final payment of all remaining merger consideration then payable. The total consideration paid under the above transactions was $7,655,400 and represented the final payments for all amounts owed under the merger agreement, as amended, to the former shareholders of Telcor and to Wi-LAN, Inc.
SUMMARY OF TRANSACTION CONSIDERATION
NAME CHANGE
Telcor Communications, Inc. was renamed Asurent Technologies, Inc. during March 2001.
DISCONTINUANCE OF ACQUIRED BUSINESS UNIT
In late fiscal 2001, the Company's Board of Directors approved a plan to divest Asurent Technologies, Inc. -- formerly Telcor Communications -- from DTS. Asurent Technologies will continue to operate while the Board seeks and evaluates several divestiture alternatives. The financial statements have been reclassified to account for the operating results of Asurent Technologies as discontinued operations (See Note 15 to the accompanying consolidated financial statements). The following discussion relates only to the Company's continuing operations. The decision for divestiture was based on a thorough strategic and financial review of the Company's operations and subsidiaries coupled with the consideration of the severe macroeconomic conditions in the telecommunications industry. The Company decided to only retain those segments that will potentially provide self-generated profitable growth in the near-term, as access to external financing to provide working capital has been extremely difficult to obtain in recent periods.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW. The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements during the years ended June 30, 2001 and 2000, the Company's continuing operations incurred losses of $853,000 and $1,700,000, respectively. Although a significant portion of the current year loss from operations is attributable to non-cash depreciation and amortization charges, the Company continues to require additional capital to properly service its indebtedness and fund future product development initiatives. Additional equity may be required during fiscal year 2002 and the Company is actively pursuing various financing alternatives. The Company attempted to raise capital throughout fiscal 2001 and was unable to secure adequate financing to assure the long term growth and profitability of the entire organization given the severity of the current downturn in the telecommunications industry. As such, the Board of Directors of the Company decided to approve a plan to divest of Asurent Technologies. Following the discontinuance, the Company will focus on the continued growth and profitability of its network access product division (Asurent Wireless) and continue to explore financing alternatives for working capital and product development initiatives throughout fiscal 2002.
The financial statements do not include any adjustments relating to the recoverability and classification of assets and liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms of its financing agreements, to obtain additional financing or refinancing as may be required, and ultimately to attain profitability. The Company is actively pursuing additional equity or debt financing through discussions with potential lenders and investors.
Potential additional sources of cash for use in future periods may include, but are not limited to, private or public placements of the Company's securities and securing additional financing with certain financial institutions. In the event the Company is able to raise additional capital, the Company intends on using such proceeds to accelerate product development initiatives, add additional personnel as may be required and to pay down existing and any additional indebtedness.
EQUITY. On October 14, 1998, NASDAQ delisted the Company because the Company did not meet the listing requirement of minimum net assets. The Company's securities are currently traded on the OTC Bulletin Board. The delisting action has hampered the Company's efforts to raise capital through a private placement of its stock with qualified investors. However, the Company employed several programs in an effort to help the Company preserve cash which, in the
first and second fiscal quarters of 1999, was used to fund severance costs of terminated employees, to fund payroll and essential expenses and the purchase of supplies from critical vendors. First, a group of employees and affiliates volunteered to forego or delay salary, commission and other compensation payments through a restricted stock for cash program offered by Board resolution on August 10, 1998. Under that program a total of approximately 395,612 common shares were approved by the Board to compensate those employees and affiliates in return for cancellation of salary or other compensation payments totaling $52,320 and a delay of payment of another $62,206. These shares could not be pledged, sold or traded until November 30, 1999 at which time, under Rule 144, the restricted legend was removed from the certificates and the certificates are now freely tradable. Secondly, another program to preserve cash has been to work out extended payment terms with certain key material suppliers for overdue amounts payable. The Company completed formal negotiations with three critical suppliers and established extended payment terms (over a 12 month period) for overdue amounts payable. Third, non-critical suppliers have been offered settlements in the form of uniform terms and reduced but immediate cash payments for cancellation of long standing past due amounts. A total of $402,000 of amounts payable have been settled for a reduced amount under these conditions. The Company has recorded an extraordinary gain of $359,000 to reflect the settlement transactions closed during the third quarter of fiscal 1999 which is included in the accompanying financial statements.
On December 29, 1999, the Company entered into an agreement with Wi-LAN Inc. ("Wi-LAN"), a leading provider of wireless data communications technology and products, to sell Wi-LAN $1.5 million in convertible debentures (the "1999 debentures"). The debentures, convertible into the Company's common stock at any time by the holder, have a four-year term with a 10% interest rate with principal and interest due at maturity. The Company has no buy-back provision, and the conversion rate is one share per $1 in debentures, which approximated the fair value of the Company's common stock on the date the Company entered into the agreement. On January 7, 2000, a closing on the Wi-LAN debentures was held whereby the Company received the proceeds from the first tranche of the debentures of $400,000. The remaining $1,100,000 in proceeds from the issuance of debentures was received prior to March 31, 2000. In connection with various transactions subsequent to the sale of the $1.5 million in debentures and through June 30, 2001, Wi-LAN has converted $1,278,900 of the 1999 debentures into 1,278,900 shares of the Company's common stock. The outstanding amount of these 1999 debentures as of June 30, 2001 is $221,100. In connection with the agreement, Wi-LAN also received an option to purchase additional debentures of $1.5 million with similar terms but at a conversion rate to be determined by the market price of the Company's common stock at the time the option is exercised. The expiration on the option to purchase additional debentures of $1.5 million is January 7, 2002.
Apart from the transactions described above, in January 2000, Wi-LAN purchased 1,738,159 shares of the Company's common stock from MicroTel, another DTS shareholder, and the outstanding $2 million in debentures (the "1997 debentures") with outstanding warrants from Finova Mezzanine Capital, a DTS lender. By converting $1,310,000 of the 1997 debentures, Wi-LAN received 1,310,000 shares of the Company's common stock and gained over 50% of the outstanding common stock of the Company. Through the transaction with Finova, Wi-LAN also received outstanding warrants for 702,615 shares of common stock at an exercise price of $1 per share which expire in March 2004. All 702,615 warrants remain outstanding and exercisable as of June 30, 2001.
Additionally, Wi-LAN converted another $190,000 of the 1997 debentures into 190,000 shares of the Company's common stock through June 30, 2001. The outstanding amount of the 1997 debentures as of June 30, 2001 is $500,000.
On March 31, 2000, Wi-LAN purchased 454,737 shares of the Company's Series B preferred stock for $3 million in cash. The Company's Series B Preferred Stock is convertible into common shares at $7.125 per share, the market closing price of the Company's common stock on March 30, 2000.
In June 2000, the Company announced that Wi-LAN Inc. entered into a purchase and assignment agreement with the two former shareholders of Telcor to acquire the right to receive approximately 31% of the merger consideration still due to the former Telcor shareholders. According to the agreement, Wi-LAN acquired $6,100,000 of the original $20 million acquisition payable for $500,000 in cash and $5,600,000 by issuing the former Telcor shareholders a right to receive $5,600,000 of Wi-LAN common shares based on the market value of Wi-LAN shares on July 17, 2000, subject to a specified maximum number of shares. Wi-LAN may redeem all or part of the right for cash. In addition, Wi-LAN granted the former Telcor shareholders an option exercisable by August 31, 2000, to sell between $2,000,000 and $4,000,000 of additional merger consideration to Wi-LAN for the issuance of a right to receive Wi-LAN shares of equivalent value, based on the market value of Wi-LAN shares at October 30, 2000, subject to a specified maximum number of shares. On August 31, 2000, the former shareholders of Telcor exercised the aforementioned option and sold $4,000,000 of merger consideration to Wi-LAN in exchange for Wi-LAN shares as discussed above.
On November 30, 2000, the Company paid down the entire remaining acquisition payable balance of $7,655,400 through the issuance of common and Preferred stock. The Company issued 638,273 shares of its common stock valued at $2.064 per share and remitted a cash payment of $117,605 to the former shareholders of Telcor as final consideration owed to the former Telcor shareholders under the amended merger agreement. The value of $2.064 per share represents the share
value calculated by the parties pursuant to the terms of the merger agreement as executed on March 31, 2000. Further, the Company issued 683,543 common shares valued at $2.064 per share and 2,330,217 shares of Series C Preferred Stock convertible into the Company's common stock at $2.064 per share to Wi-LAN, Inc. also reflecting final payment of all remaining merger consideration then payable. The total consideration paid under the above transactions was $7,655,400 and represented the final payments for all amounts owed under the merger agreement, as amended, to the former shareholders of Telcor and to Wi-LAN, Inc.
On January 25, 2000, the Board of Directors of the Company approved a plan whereby certain compensation obligations of the Company to employees and Board members could be satisfied through the issuance of restricted common stock at the option of the holder. Approximately 30,000 shares of the Company's common stock were issued to satisfy such obligations. The shares were issued at $3.56 per share (a 25% discount from the market closing price on January 25, 2000) and were restricted as to trade, pledge, or sale until January 25, 2001. The Company has recorded $143,000 in compensation expense to reflect the satisfaction of these obligations which represented the fair market value of the shares issued.
LINE OF CREDIT ARRANGEMENTS. On April 10, 1997, DTS established a bank line of credit agreement with Silicon Valley Bank which makes available $2,500,000 in borrowings with availability based on DTS's accounts receivable. The loan was amended on March 18, 1998 to increase the maximum eligible borrowing to the lesser of $4,000,000 or 80% of eligible receivables plus 30% of eligible inventory, as defined, through the maturity date of April 10, 2000. The loan is secured by DTS's assets and bears interest at the rate of prime plus 2.25%. A net worth covenant was amended on March 16, 1998, requiring DTS to maintain a net worth of $1,000,000. In September 1998, DTS agreed to a UCC filing whereby all assets of DTS became collateral under the Agreement. The loan requires a monthly monitoring fee of $1,000 and a commitment fee of 0.125% due monthly on the unused portion of the facility. The agreement term is two years with an automatic renewal each year unless written notice of termination is given by one of the parties. DTS issued 60,000 two year warrants to Silicon Valley Bank at a strike price of $5.25 each as consideration for the amended agreement. On February 25, 1999, DTS signed an amendment to the loan agreement with Silicon Valley Bank which modified previous loan covenants and revised the maximum borrowing amount to $1,500,000. The revised covenants are primarily based upon minimum monthly and quarterly revenue levels. As consideration for the amended agreement, DTS issued 250,000 two year warrants for common stock of the Company at $0.119 per share which represents the market price of the Company's common stock at the close of business on December 2, 1998 when the new agreement was reached.
On February 24, 2000, DTS signed an additional amendment to the loan agreement with Silicon Valley Bank which modified previous terms. Under the modified terms, the revised loan agreement had a maturity date of April 10, 2001. Additionally, the revised and amended agreement increased the maximum borrowing to $2,500,000 with interest at prime plus 2.25% (9.00% at June 30, 2001). Covenants under the agreement were further revised to require certain minimum quarterly revenue and monthly income requirements.
On February 16, 2001, DTS signed an additional amendment to the loan agreement with Silicon Valley Bank which modified previous terms. Under the modified terms, covenants imposed by the agreement were revised. All revenue and income covenants previously enforced were removed and replaced with a single covenant requiring a minimum level of net tangible equity on a monthly basis. After the recording of numerous significant asset write-downs taken in late fiscal 2001 due to the planned divestiture of Asurent Technologies, the Company was subsequently not in compliance with the consolidated monthly minimum net tangible equity requirement imposed by Silicon Valley Bank. As the line of credit provided by Silicon Valley Bank is used primarily in the operations of Asurent Wireless, the Company will seek to have its covenants under the aforementioned line of credit agreement revised so that only the financial results of DTS excluding Asurent Technologies are subject to calculation in the revised covenants. The Company plans on obtaining a waiver for non-compliance at June 30, 2001 from Silicon Valley Bank and, in addition, the Company intends on securing an amendment to the loan agreement with respect to revised covenants in October 2001.
On April 10, 2001, DTS signed an additional amendment to the loan agreement with Silicon Valley Bank that extended the maturity date of the loan agreement to April 10, 2002. No other terms of the agreement were changed.
CASH. As of June 30, 2001, the Company had approximately $146,000 in cash and cash equivalents. For the year ended June 30, 2001, $1,084,000 was used in continuing operating activities as compared to cash provided by continuing operations of $300,000 for the year ended June 30, 2000. The loss from continuing operations for the period ended June 30, 2001 of $853,000 includes non-cash charges relating to depreciation and amortization of $527,000. Exclusive of the fiscal 2001 non-cash charges, cash was used in operations primarily through an increase in accounts receivable and inventory of $217,000 and $324,000, respectively, and a decrease in accounts payable and accrued liabilities of $699,000.
Heretofore, the Company has been able to satisfy its immediate short-term cash requirements through increasing product sales and accelerating collections coupled with managing vendor accounts and relationships.
The Company purchased $320,000 and $88,000 of property, plant and equipment during the years ended June 30, 2001 and 2000, respectively. In addition, the Company capitalized certain software development costs paid to outside
contractors. During the year ended June 30, 2001, the Company capitalized $105,000 of such costs as compared to capitalized costs of $174,000 for the year ended June 30, 2000.
MANAGEMENT AND EMPLOYMENT AGREEMENTS
By agreement of the Board of Directors of the Company, Wi-LAN has a services agreement with the Company's Chief Executive Officer ("CEO") which provides for the CEO to provide services to Wi-LAN. Wi-LAN has accrued or paid the Company's CEO $80,833 and $65,439 during the years ended June 30, 2001 and 2000, respectively. The Company is also reimbursed by Wi-LAN for payments made by the Company to certain Wi-LAN United States-based sales personnel who provide services to Wi-LAN. The Company has recorded a receivable from Wi-LAN for these amounts of $25,000 and $161,000 at June 30, 2001 and 2000, respectively. Additionally, the Company has accrued or paid $61,000 and $251,000 in interest expense to Wi-LAN related to convertible debentures held by Wi-LAN during the years ended June 30, 2001 and 2000, respectively.
SEASONALITY
The Company's sales have been subject to quarterly fluctuations mainly due to the purchasing cycle of the Company's major customers. Other fluctuations occur due to increased build-out of the telecommunications infrastructure during certain months of the year. The Company's business plan is to continue the diversification of its product offerings, further develop its distribution channels and further expand its customer base. The Company believes that the implementation of this plan will decrease the seasonality of its sales. The Company operates with a moderate level of backlog for each product line due to advance purchase commitments and production lead times. At June 30, 2001, the Company's order backlog totaled $2,018,000.
LEGAL PROCEEDINGS
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations, or liquidity.
NEW ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements. SAB 101 summarizes existing guidance on revenue recognition. The implementation date of SAB 101 for the Company was for the quarter ended June 30, 2001. The implementation of SAB 101 did not have a material impact on the Company's financial statements.
In March 2000, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 44 (FIN 44), Accounting for Certain Transactions involving Stock Compensation -- an Interpretation of APB Opinion No. 25. FIN 44 provides guidance for certain issues that arose in applying APB Opinion No. 25. The provisions of FIN 44 were effective for the Company on July 1, 2000. Adoption of FIN 44 did not materially affect the Company's financial results.
In June 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also provides that intangible assets acquired in a purchase method business combination must meet certain specified criteria in order to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately.
Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 will also require that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
The Company is required to adopt the provisions of Statement 141 immediately, and Statement 142 effective July 1, 2002. Furthermore, goodwill and intangible assets determined to have an indefinite useful life acquired in a purchase business combination completed after June 30, 2001, but before Statement 142 is adopted in full will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-Statement 142 accounting literature. The Company does not expect Statement 141 or 142 to have a significant impact on its financial statements.
Also, in June 2001, the FASB issued Statement No. 143, Accounting for Asset Retirement Obligations. Statement 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred.
When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. Statement 143 is effective for the Company beginning July 1, 2002. The Company does not expect Statement 143 to have a significant impact on its financial statements.
IMPORTANT CONSIDERATIONS RELATED TO FORWARD-LOOKING STATEMENTS
It should be noted that this discussion contains forward-looking statements which are subject to substantial known and unknown risks and uncertainties. There are a number of factors which could cause actual results to differ materially from those anticipated in statements made herein. Such factors include, but are not limited to, changes in general economic conditions, the growth rate of the market for the Company's products and services, the effect of competitive products and pricing, and the irregular pattern of revenues, as well as a number of other risk factors which could affect the future performance of the Company.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Please see pages through.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required herein will be included in the Company's Proxy Statement for the Annual Meeting of Shareholders to be filed with the Commission in October 2001 under the captions "Election of Directors" and "Executive Officers" and is incorporated by reference herein.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required herein will be included in the Company's Proxy Statement for the Annual Meeting of Shareholders to be filed with the Commission in October 2001 under the captions "Election of Directors" and "Executive Officers" and is incorporated by reference herein.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required herein will be included in the Company's Proxy Statement for the Annual Meeting of Shareholders to be filed with the Commission in October 2001 under the captions "Election of Directors" and "Executive Officers" and is incorporated by reference herein.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required herein will be included in the Company's Proxy Statement for the Annual Meeting of Shareholders to be filed with the Commission in October 2001 under the captions "Election of Directors" and "Executive Officers" and is incorporated by reference herein.
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Supplemental schedules
Schedule I -- Valuation and Qualifying Accounts
(b) Reports on Form 8-K.
None.
INDEPENDENT AUDITORS' REPORT
The Board of Directors Digital Transmission Systems, Inc.
Under date of August 31, 2001, we reported on the consolidated balance sheets of Digital Transmission Systems, Inc. and subsidiaries as of June 30, 2001 and 2000, and the related consolidated statements of operations, shareholders' equity (deficit) and cash flows for each of the years in the three-year period ended June 30, 2001, as contained in the annual report on Form 10-K for the year 2001. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
Our report dated August 31, 2001, contains an explanatory paragraph that states that the Company has suffered recurring losses from operations, which raise substantial doubt about its ability to continue as a going concern. The consolidated financial statements and financial statement schedule do not include any adjustments that might result from the outcome of that uncertainty.
/s/ KPMG LLP
Atlanta, Georgia August 31, 2001
DIGITAL TRANSMISSION SYSTEMS, INC.
SCHEDULE I -- VALUATION AND QUALIFYING ACCOUNTS (000'S OMITTED)
(1) Inventory and accounts receivable deductions of reserve consist of write-offs of previously reserved amounts. Deductions of warranty reserve is based on satisfaction of respective warranty liability.
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES
INDEPENDENT AUDITORS' REPORT
The Board of Directors Digital Transmission Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Digital Transmission Systems, Inc. and subsidiaries as of June 30, 2001 and 2000, and the related consolidated statements of operations, shareholders' equity (deficit), and cash flows for each of the years in the three-year period ended June 30, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Digital Transmission Systems, Inc. and subsidiaries as of June 30, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 2001 in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in note 1(b) to the financial statements, the Company has suffered recurring losses from operations, which raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in note 1(b). The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ KPMG LLP
Atlanta, Georgia August 31, 2001
DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES Consolidated Balance Sheets June 30, 2001 and 2000 (in thousands, except share and per share data)
See accompanying notes to consolidated financial statements.
DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended June 30, 2001, 2000, and 1999 (in thousands, except per share data)
See accompanying notes to consolidated financial statements.
DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity (Deficit) Years ended June 30, 2001, 2000, and 1999 (in thousands)
See accompanying notes to consolidated financial statements.
DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended June 30, 2001, 2000, and 1999 (in thousands)
See accompanying notes to consolidated financial statements.
DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001 AND 2000
(1) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Digital Transmission Systems, Inc. and subsidiaries (the "Company" or "DTS") designs, manufactures, repairs, refurbishes, and markets a broad range of products for the telecommunications ("telecom") industry. The Company's primary customers are long-distance carriers, domestic wireless service providers, including those offering cellular telephone services and Personal Communication Services ("PCS"), and domestic and international resellers/integrators who sell to and service end users with telecom equipment.
The Company's products of original design, consisting of proprietary software and hardware modules, facilitate the control, monitoring, and efficient transmission of high-speed digital information through public or private telecommunications networks. The Company's network access products enable telecommunications service providers to give their customers economical, high quality access to public and private networks and various telecommunications services. These services include voice and high speed data transmission, access to the Internet and video and desktop conferencing.
In July 2001, the Company's Board of Directors approved a plan to discontinue operations of the Company's wholly-owned subsidiary, Asurent Technologies, Inc. (formerly Telcor Communications, Inc.) -- (see note 15). Asurent Technologies, Inc. acquires and markets de-installed and refurbished telecom equipment originally designed and manufactured by leading telecom equipment suppliers.
The consolidated financial statements include accounts of DTS and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported periods to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ from those estimates.
The markets for the Company's telecom products are characterized by significant risk as a result of rapid changes in technology, competitors with significant financial resources, frequent new product and service introductions, and mergers and acquisition activity in the telecom industry. Furthermore, the Company's business is also subject to additional significant risks such as availability of capital, history of operating losses, concentrations with major customers, inability to integrate acquired companies, dependency on major suppliers, protection of intellectual property rights, dependence on key personnel, and new laws or regulations affecting the telecom industry. As a result, negative developments in the Company's markets or in managing these additional risks could have an adverse effect on the Company's financial position, results of operations and liquidity.
(B) GOING CONCERN MATTERS
The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, during the years ended June 30, 2001, 2000, and 1999, the Company incurred losses from continuing operations of $853,000, $1,700,000, and $424,000, respectively, and has an accumulated deficit of $57,310,000 as of June 30, 2001. These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern for a reasonable period of time.
The financial statements do not include any adjustments relating to the recoverability and classification of assets and liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms of its financing agreements, to obtain additional financing or refinancing as may be required, and ultimately to attain profitability. The Company is actively pursuing additional equity or debt financing through discussions with potential lenders and investors.
(C) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on deposit in demand or money market accounts with commercial banks. All cash and cash equivalents are carried at cost which approximates market. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.
(D) INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined using average cost which approximates the first-in, first-out (FIFO) method. The Company has established a valuation allowance for inventories based on a review of the composition, quantity, and expected future usage or sales of inventories including expected sales prices.
(E) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization on property and equipment are provided using the straight-line method over the estimated useful lives of the assets as follows:
Leasehold improvements are amortized using the straight-line method over the estimated useful life of the improvements or the lease term, whichever is shorter. Amortization of assets held under capital lease arrangements is included in depreciation and amortization.
(F) INTANGIBLE ASSETS
Intangible assets consist of capitalized software development costs. The Company capitalizes software development costs from the time technological feasibility of the product is established until the product is available for sale to customers. Substantially all of the Company's software development costs have been paid to third party contractors. Software development costs are amortized using the greater of (1) the straight-line method over the estimated useful life of the product (not to exceed three years) or (2) the ratio of current revenues to total current and anticipated revenues for each product. The carrying value of software development costs is reviewed for impairment by the Company by comparing the carrying values to the future undiscounted net operating cash flows expected to be derived from the underlying products. If such a review indicates impairment, the Company uses fair value in determining the amount that should be written off.
(G) PRODUCT DEVELOPMENT
Product development costs consist principally of compensation and benefits paid to the Company's employees and are expensed as incurred.
(H) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company reviews long-lived assets 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 future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment 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.
(I) FINANCIAL INSTRUMENTS
Financial instruments which potentially subject the Company to concentrations of credit risk are primarily cash, cash equivalents, and accounts receivable. The Company's cash equivalents are held on deposit in demand or money market accounts with commercial banks.
Accounts receivable arise from sales of products to long-distance carriers, wireless service providers, and resellers/integrators in the telecommunications industry, domestically and internationally. Generally, the Company requires no collateral on trade receivables, but believes that credit risks are substantially mitigated by its credit evaluation process. The Company maintains an allowance for returns and doubtful accounts, but
historically has not experienced significant losses related to doubtful accounts. The amount of losses on doubtful accounts could differ materially from the allowance recorded in these consolidated financial statements.
(J) REVENUE RECOGNITION
Revenue from the sale of products is recognized at the time of shipment. The Company estimates and records provisions for sales returns and warranty obligations in the period the sale is reported, based on historical experience and other relevant factors.
Certain of the Company's contractual arrangements allow for limited rights of return. Management of the Company has provided an allowance for expected sales returns related to these customers based on historical return rates and expected future returns on sales to these customers. The amount of sales returns could differ materially from the allowance recorded in these consolidated financial statements.
(K) WARRANTY ACCRUAL
The Company warrants its products against defects in design, materials, and workmanship for periods ranging from two to five years. A provision for estimated future costs relating to warranty obligations is recorded when the products are shipped based on historical experience.
Certain of the Company's product lines have been recently introduced to the market and, therefore, limited historical data is available against which to base estimates of future warranty obligations. Management of the Company has provided for warranty expense related to these new products based on the historical repair costs of established product lines, as well as recent and expected repair costs of these new products. The amount of warranty expense could differ materially from the accrual recorded in these consolidated financial statements.
(L) INCOME TAXES
Income taxes are accounted for under the asset and liability method. Deferred income 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 carryforwards. Deferred income 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 income tax assets and liabilities of a change in tax rates is recognized in the consolidated statement of operations in the period that includes the enactment date.
(M) STOCK OPTION PLANS
The Company accounts for its stock option plans in accordance with Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), which encourages entities to recognize as compensation expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows entities to continue to apply the provisions of Accounting Principles Board ("APB") Opinion No. 25 and provide pro forma disclosures for employee stock-based awards as if the fair-value based method of SFAS No. 123 had been applied. As such, compensation expense would be recorded only if the current market price of the underlying stock as of the date of grant exceeded the exercise price. The Company has elected to continue applying the provisions of APB Opinion No. 25 and include the pro forma disclosures required under SFAS No. 123.
(N) EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share ("EPS") is calculated as income (loss) available to common shareholders divided by the weighted-average number of common shares outstanding during each period. Diluted EPS is calculated as income (loss) available to common shareholders divided by the weighted-average number of common shares outstanding during each period plus the effect of any potential dilutive common shares, such as those attributable to convertible debt, convertible preferred stock, warrants, or stock options.
A total of 1,304,000 common shares related to the potential conversion of warrants, options and convertible Series B and Series C preferred stock were excluded from the computation of diluted net loss per share in the year ended June 30, 2001, because the exercise price of these securities was greater than the average market price of the Company's common stock. In addition, the Company excluded all remaining convertible preferred stock, warrants, outstanding stock options and convertible debentures from the calculations of diluted net loss per share as all such securities are anti-dilutive for all periods presented. The total number of shares excluded was 5,598,000, 3,140,000, and 256,000 for the years ended June 30, 2001, 2000, and 1999, respectively.
(O) COMPREHENSIVE INCOME (LOSS)
No statements of comprehensive income (loss) have been included in the accompanying consolidated financial statements since comprehensive loss and net loss presented in the accompanying consolidated statements of operations would be the same.
(P) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, trade accounts receivable, accounts receivable from related party, notes payable to banks, accounts payable, accrued liabilities, and accrued payroll and benefits approximate fair value because of the short maturity of these instruments.
The carrying amount of the $3 million in notes payable to related parties approximates fair value because of the short maturity of these notes.
The fair value of $721,000 in notes payable to related parties is estimated by discounting the future cash flows of these instruments at rates currently offered to the Company for similar debt instruments of comparable maturities by the Company's bankers. The fair value of these notes payable approximates the carrying value.
(Q) RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements. SAB 101 summarizes existing guidance on revenue recognition. The implementation date of SAB 101 for the Company was for the quarter ended June 30, 2001. The implementation of SAB 101 did not have a material impact on the Company's financial statements.
In March 2000, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 44 (FIN 44), Accounting for Certain Transactions involving Stock Compensation -- an Interpretation of APB Opinion No. 25. FIN 44 provides guidance for certain issues that arose in applying APB Opinion No. 25. The provisions of FIN 44 were effective for the Company on July 1, 2000. Adoption of FIN 44 did not materially affect the Company's financial results.
In June 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also provides that intangible assets acquired in a purchase method business combination must meet certain specified criteria in order to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately.
Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 will also require that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
The Company is required to adopt the provisions of Statement 141 immediately, and Statement 142 effective July 1, 2002. Furthermore, goodwill and intangible assets determined to have an indefinite useful life acquired in a purchase business combination completed after June 30, 2001, but before Statement 142 is adopted in full will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-Statement 142 accounting literature. The Company does not expect Statement 141 or 142 to have a significant impact on its financial statements.
Also, in June 2001, the FASB issued Statement No. 143, Accounting for Asset Retirement Obligations. Statement 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. Statement 143 is effective for the Company beginning July 1, 2002. The Company does not expect Statement 143 to have a significant impact on its financial statements.
(R) RECLASSIFICATIONS
Reclassifications were made to certain amounts in the 2000 and 1999 financial statements to conform with the presentation in the 2001 consolidated financial statements.
(2) ACQUISITION OF ASURENT TECHNOLOGIES, INC.
On March 31, 2000, a wholly-owned subsidiary of the Company consummated a merger with Asurent Technologies, Inc. and subsidiaries ("Asurent Technologies") -- (formerly Telcor Communications, Inc.), a leading reseller of new and refurbished wireless and wireline telecom equipment based in Duluth, Georgia. The merger consideration payable to the shareholders of Asurent Technologies was $25 million in a combination of the Company's common stock, cash, and an acquisition payable. The amount of $5 million of consideration was paid at closing consisting of $2.5 million in cash and $2.5 million in common stock (338,983 shares with a value of $7.375 per share representing the closing price of DTS common stock a few days before and after the announcement date). The remaining consideration of $20 million was due and payable in cash or the Company's common stock (at fair value at the date of issuance), at the Company's option, on or before October 30, 2000. The acquisition payable was unsecured and non-interest bearing. Subsequent to the closing of the acquisition, the former Asurent Technologies shareholders became DTS shareholders and loaned the Company $3 million.
The acquisition was accounted for using the purchase method of accounting, and accordingly, the purchase price was allocated to assets acquired and liabilities assumed based on their fair values on March 31, 2000. A summary of the acquisition is as follows (in thousands):
See note 15 for discussion of discontinued operation of Asurent Technologies.
(3) RELATED PARTY TRANSACTIONS
(A) WI-LAN, INC.
On December 29, 1999, the Company entered into an agreement with Wi-LAN Inc. ("Wi-LAN"), a leading provider of wireless data communications technology and products, to sell Wi-LAN $1.5 million in convertible debentures (the "1999 debentures"). The debentures, convertible into the Company's common stock at any time by the holder, have a four-year term with a 10% interest rate with principal and interest due at maturity. The Company has no buy-back provision, and the conversion rate is one share per $1 in debentures, which approximated the fair value of the Company's common stock on the date the Company entered into the agreement. On January 7, 2000, a closing on the Wi-LAN debentures was held whereby the Company received the proceeds from the first tranche of the debentures of $400,000. The remaining $1,100,000 in proceeds from the issuance of debentures was received prior to March 31, 2000. In connection with various transactions subsequent to the sale of the $1.5 million in debentures and through June 30, 2000, Wi-LAN converted $1,278,900 of the 1999 debentures into 1,278,900 shares of the Company's common stock. The outstanding amount of these 1999 debentures as of June 30, 2001 is $221,100. In connection with the agreement, Wi-LAN also received an option to purchase additional debentures of $1.5 million with similar terms but at a conversion rate to be determined by the market price of the Company's common stock at the time the option is exercised. The expiration on the option to purchase additional debentures of $1.5 million is January 7, 2002.
Apart from the transactions described above, in January 2000, Wi-LAN purchased 1,738,159 shares of the Company's common stock from MicroTel, another DTS shareholder, and the outstanding $2 million in debentures (the "1997 debentures") with outstanding warrants from Finova Mezzanine Capital, a DTS lender. By converting $1,310,000 of the 1997 debentures, Wi-LAN received 1,310,000 shares of the Company's common stock and gained over 50% of the outstanding common stock of the Company. Through the transaction with Finova, Wi-LAN also received outstanding warrants for 702,615 shares of common stock at an exercise price of $1 per share which expire in March 2004. All 702,615 warrants remain outstanding and exercisable as of June 30, 2001.
Additionally, Wi-LAN converted another $190,000 of the 1997 debentures into 190,000 shares of the Company's common stock through June 30, 2000. The outstanding amount of the 1997 debentures as of June 30, 2001 is $500,000.
On March 31, 2000, Wi-LAN purchased 454,737 shares of the Company's Series B preferred stock for $3 million in cash. The Company's Series B Preferred Stock is convertible into common shares at $7.125 per share, the market closing price of the Company's common stock on March 30, 2000.
In June 2000, DTS announced that Wi-LAN entered into a purchase and assignment agreement with the two former shareholders of Asurent Technologies to acquire the right to receive approximately 31% of the merger consideration still due to the former Asurent Technologies shareholders. According to the agreement, Wi-LAN acquired $6,100,000 of the original $20 million acquisition payable for $500,000 in cash and $5,600,000 by issuing the former Asurent Technologies shareholders a right to receive $5,600,000 of Wi-LAN common shares based on the market value of Wi-LAN shares on July 17, 2000, subject to a specified maximum number of shares. Wi-LAN may redeem all or part of the right for cash. In addition, Wi-LAN granted the former Asurent Technologies shareholders an option which was exercisable by August 31, 2000, to sell between $2,000,000 and $4,000,000 of additional merger consideration to Wi-LAN for the issuance of a right to receive Wi-LAN shares of equivalent value, based on the market value of Wi-LAN shares at October 30, 2000, subject to a specified maximum number of shares. On August 31, 2000, the former shareholders of Telcor exercised the aforementioned option and sold $4,000,000 of merger consideration to Wi-LAN in exchange for Wi-LAN shares as discussed above.
On November 30, 2000, the Company issued 2,330,217 shares of the Company's Series C preferred stock to Wi-LAN for a $4.8 million reduction of the acquisition payable. The Company's Series C preferred stock is convertible into common shares at $2.58 per share.
Also on November 30, 2000, the Company issued 638,273 shares of common stock to the former Asurent Technologies shareholders for a reduction in the outstanding acquisition payable of $1,317,395.
In addition, on November 30, 2000, the Company issued 683,543 shares of common stock to Wi-LAN for a $1,410,832 reduction of the acquisition payable.
Wi-LAN also has a services agreement with the Company's Chief Executive Officer ("CEO") which provides for the CEO to provide services to Wi-LAN. Wi-LAN has accrued or paid the Company's CEO $80,833 and $65,439 during the years ended June 30, 2001 and 2000, respectively, which has not been reflected in the Company's consolidated financial statements. The Company is also reimbursed by Wi-LAN for payments made by the Company to certain Wi-LAN United States-based sales personnel who provide services to Wi-LAN. The Company has recorded a receivable from Wi-LAN for these amounts of $25,000 and $161,000 at June 30, 2001 and 2000, respectively, in the accompanying consolidated balance sheets. Additionally, the Company has accrued or paid $61,000 and $251,000 in interest expense to Wi-LAN related to convertible debentures held by Wi-LAN during the years ended June 30, 2001 and 2000, respectively.
(B) EMPLOYEES AND BOARD OF DIRECTORS
On January 25, 2000, the Board of Directors of the Company approved a plan whereby certain compensation obligations of the Company to employees and Board members could be satisfied through the issuance of restricted common stock at the option of the holder. Approximately 30,000 shares of the Company's common stock were issued during the year ended June 30, 2000 to satisfy such obligations. The shares were issued at $3.56 per share (a 25% discount from the market closing price on January 25, 2000) and were restricted as to trade, pledge, or sale until January 25, 2001. The Company has recorded $143,000 in compensation expense to reflect the satisfaction of these obligations which represented the fair market value of the shares issued.
In November 2000, the Company offered 800,000 shares of its common stock to be purchased by employees. As of June 30, 2001, a total of 62,422 shares were issued to employees under this offer for cash of $98,780 and notes receivable of $18,825, which were subsequently forgiven and expensed.
(4) INVENTORIES
Inventories consist of the following at June 30, 2001 and 2000 (in thousands):
(5) PROPERTY AND EQUIPMENT
Property and equipment consists of the following at June 30, 2001 and 2000 (in thousands):
Depreciation and amortization relating to property and equipment for the years ended June 30, 2001, 2000, and 1999 was approximately $419,000, $209,000, and $497,000, respectively.
(6) INTANGIBLE ASSETS
The Company capitalized software development costs of $105,000, $174,000, and $136,000 during the years ended June 30, 2001, 2000, and 1999, respectively. Amortization expense relating to these assets was $108,000, $212,000, and $356,000, for the years ended June 30, 2001, 2000, and 1999, respectively.
(7) NOTES PAYABLE TO BANKS
(A) DTS CREDIT FACILITY
The Company maintains a revolving credit facility with a commercial bank whereby it may borrow the lesser of $2,500,000 or 80% of eligible receivables, as defined.
Amounts outstanding under the facility were $1,646,000 and $1,172,000 at June 30, 2001 and 2000, respectively. The amount available for additional borrowings under this facility was $21,000 as of June 30, 2001. Advances accrue interest at the prime rate plus 2.25% (9.00% and 11.75% at June 30, 2001 and 2000, respectively) are payable monthly, and are secured by accounts receivable, inventory, and certain other assets, as defined. The credit facility expires on April 10, 2002. A commitment fee of .125% of the unused portion of the line and a $1,000 collateral fee are payable monthly.
In connection with a March 1998 amendment to the credit facility, the Company issued warrants to the lender enabling the lender to purchase 60,000 shares of the Company's common stock at $5.50 per share. The warrants are exercisable at any time and expire in March 2003. All 60,000 warrants remain outstanding and exercisable as of June 30, 2001.
In consideration of an amendment to the credit facility executed in December 1998, the Company issued warrants to the lender to purchase 250,000 shares of the Company's common stock at $0.119 per share which expire in December 2003. The fair market value of the warrants was insignificant. All 250,000 warrants remain outstanding and exercisable as of June 30, 2001.
Covenants under the facility include a minimum level of net tangible equity on a monthly basis and restrict the Company from paying dividends. The Company was not in compliance with all covenants as of June 30, 2001, and has not yet obtained a waiver from the bank.
(B) ASURENT TECHNOLOGIES CREDIT FACILITY
The Company's wholly-owned subsidiary, Asurent Technologies, maintains a revolving credit facility with a commercial bank whereby it may borrow the lesser of 85% of eligible accounts receivable and 50% of eligible inventory (limited to $7 million in borrowings), as defined, or $11 million. Advances under the facility bear interest at LIBOR plus 2.5% or prime, whichever Asurent Technologies selects at the date of the advance, payable monthly.
Amounts outstanding under the facility were $6,002,581 at June 30, 2001 and are included in net liabilities of discontinued operations in the consolidated balance sheet. The amount available for borrowing under this facility was $344,058 as of June 30, 2001. The facility is secured by Asurent Technologies' trade accounts receivable, inventories, and all other assets and expires on May 11, 2002.
Under the terms of the facility, Asurent Technologies is required to comply with certain covenants which include, but are not limited to, dividend restrictions, maintaining minimum requirements for debt to equity, net worth, cash flows, and capital expenditures. At June 30, 2001, Asurent Technologies was not in compliance with certain of these covenants and had not obtained a waiver for those covenants for which it was not in compliance.
In connection with approvals needed for the merger with Asurent Technologies, the Company issued warrants to the lender to purchase 60,000 shares of the Company's common stock at $7.375 per share. The warrants are exercisable at any time and expire in May 2003. The Company recorded the fair value of the warrants of $286,000, which was estimated using the Black Scholes option pricing model, as financing costs and additional paid-in capital. All 60,000 warrants remain outstanding and exercisable as of June 30, 2001.
(8) NOTES PAYABLE TO RELATED PARTIES AND LONG-TERM DEBT
Notes payable to related parties and long-term debt consists of the following at June 30, 2001 and 2000 (in thousands):
As of June 30, 2001, the future maturities of notes payable to related parties are as follows (in thousands):
On September 25, 1997, the Company issued $4 million of 11.5% subordinated convertible debentures due September 25, 2002 (the "1997 debentures"). The Debenture Purchase Agreement (the "Debenture Agreement") contained numerous rights, privileges, and conditions in favor of the lenders. The 1997 debentures are convertible at any time by the lenders into common stock of the Company at a conversion price of $10.25 per share, subject to adjustment in certain events. The 1997 debentures are redeemable by the Company after September 1999 provided that (a) the Company pays the lender additional interest such that the lender would receive an effective compounded 20% interest rate from inception of the debenture or (b) the 20-day average bid price for the Company's stock exceeds $15.00 per share.
The 1997 debentures may be put to the Company for redemption at the option of the lender at any time prior to maturity if (a) there is a change in control, as defined in the Debenture Agreement, (b) the Company's common stock is delisted from NASDAQ, or (c) the Company's common stock ceases to be publicly traded at the sum of the principal amount of the debentures tendered for redemption, plus unpaid interest outstanding related to the debentures, plus 15% interest on outstanding principal and interest amounts due, plus any expenses and costs owed to the lender as set forth in the Debenture Agreement. The Debenture Agreement also imposed certain covenants, as defined.
On February 5, 1999, the 1997 debentures were restructured as part of the sale of the Company's subsidiary, SouthTech, Inc. As part of the restructuring, $1,000,000 in principal of the debentures were assumed by the acquiring company. In addition, $1,000,000 in principal was converted along with accrued but unpaid interest of $314,333 into 1,314,333 shares of Series A preferred stock which bear no dividends and are convertible into common stock at a ratio of one for one at any time.
The remaining $2,000,000 in 1997 debentures were restructured in February 1999 to convert into one share of common stock per $1 in debentures and bear interest at 10% per annum. Interest was payable after February 5, 2000, (i) on each June 1, September 1, and February 1 until and including February 1, 2002 (ii) on the first day of each month commencing March 1, 2002 and (iii) on the final maturity date of February 5, 2004. Monthly interest payments shall be accompanied by payments of principal on the first day of each month (i) beginning on February 1, 2002, in the amount of $55,555 each, and (ii) beginning on February 1, 2003 in the amount of $111,111 each, and (iii) all remaining principal shall become due on February 5, 2004.
On January 7, 2000, Wi-LAN purchased the remaining $2,000,000 in 1997 debentures from Finova Mezzanine Capital, a DTS lender. Wi-LAN converted $1,500,000 of the 1997 debentures into 1,500,000 shares of the Company's common stock during the year ended June 30, 2000. The outstanding amount of the 1997 debentures as of June 30, 2001 is $500,000, which is due beginning September 2003 through January 2004.
On December 29, 1999, the Company entered into an agreement to sell $1.5 million in subordinated convertible debentures (the "1999 debentures") due February 5, 2004 to Wi-LAN to raise additional working capital. The new debentures have a four-year term with a 10% interest rate with principal and interest due at maturity. Wi-LAN converted $1,278,900 of the 1999 debentures into 1,278,900 shares of the Company's common stock during the year ended June 30, 2000.
(9) INCOME TAXES
A reconciliation of the expected income tax benefit (at the Federal statutory income tax rate of 34%) to the actual income tax benefit reported in the consolidated statements of operations is as follows (in thousands):
The income tax effects of the temporary differences that give rise to significant portions of the Company's deferred income tax assets and liabilities at June 30, 2001 and 2000 are presented below (in thousands):
The valuation allowance for deferred income tax assets as of June 30, 2001 and 2000 was $15,810,000 and $7,272,000, respectively. The net increase in the total valuation allowance for the years ended June 30, 2001, 2000, and 1999 was approximately $8,538,000, $148,000, and $180,000, respectively. In assessing the realizability of deferred income tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which the temporary differences resulting in the deferred tax assets become deductible. Management considers the scheduled reversal of deferred income tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. In order to fully realize the deferred income tax assets, the Company will need to generate future taxable income of approximately $38,000,000 prior to the expiration of the net operating loss carryforwards beginning in 2005. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred income tax assets are deductible, management believes it is more likely than not the Company will not realize the benefits of these deductible differences.
At June 30, 2001, the Company has net operating loss carryforwards for federal income tax purposes of approximately $38,000,000 which are available to offset future federal taxable income, if any, through 2021. In addition, the Company has product development tax credit carryforwards of approximately $441,000 which are available to reduce future federal regular income taxes, if any, and have expiration dates beginning in 2005.
On January 7, 2000, the Company experienced an ownership change as defined in Internal Revenue Code Section 382. Net operating loss carryforwards and product development tax credit carryforwards of $19,887,000 and $441,000, respectively, are subject to an annual limitation of $639,561.
(10) SHAREHOLDERS' EQUITY (DEFICIT)
(A) SERIES A PREFERRED STOCK
On February 5, 1999, the Company completed the restructuring of the 1997 debentures. In connection with this restructuring, the Company issued 1,314,333 shares of Series A preferred stock ("Series A preferred stock") to the lender at $1.00 per share in exchange for $1 million of the 1997 debentures and accrued interest of $314,333.
The holder of the Series A preferred stock is not entitled to receive dividends. The holder of the Series A preferred stock shall have the right to convert any or all of such shares into the Company's common stock as is determined by dividing $1.00 for each share of Series A preferred stock by the conversion price of $1.00 per share. The holder of the Series A preferred stock is not entitled to any voting rights as stockholder.
In the event of any voluntary or involuntary sale of all or a substantial portion of the Company's capital stock, a substantial portion of the assets, or any merger or consolidation of the Company with another entity, or any liquidation or dissolution of the Company, the holder of the Series A preferred stock shall be entitled to receive, prior to the receipt of any assets by holders of all other equity securities of the Company, a cash amount equal to $1.00 for each share of Series A preferred stock.
The Company may, at the option of the Board of Directions, redeem all shares of the Series A preferred stock by paying, in cash, an amount equal to the redemption price, which is equal to $1.00 for each share of Series A preferred stock adjusted for any stock dividends, combinations, or splits with respect to such shares.
(B) SERIES B PREFERRED STOCK
In connection with the acquisition of Asurent Technologies on March 31, 2000, the Company issued 454,737 shares of Series B preferred stock ("Series B preferred stock") to Wi-LAN at $7.125 per share for net proceeds totaling $3,000,000.
The holder of the Series B preferred stock is entitled to a 5% dividend, payable annually in arrears in common stock at the market price of the common stock on the due date of dividend payment. The dividend payable as of June 30, 2001 of approximately $162,000 has been reflected as common stock subscribed in the accompanying consolidated balance sheet. The holder of the Series B preferred stock may convert any or all of such shares into a number of shares of common stock determined by dividing $7.125 by the conversion price of $7.125. The holder of the Series B preferred stock is not entitled to any voting rights as stockholder of the Company prior to conversion.
In the event of any voluntary or involuntary sale of all or a substantial portion of the Company's capital stock, a substantial portion of the Company's assets, any merger or consolidation of the Company with another entity, or any liquidation or dissolution of the Company, voluntary or involuntary, the holder of the Series B preferred stock shall be entitled to receive, prior to the receipt of any assets by holders of all other equity securities of the Company (other than the holder of the Company's Series A preferred stock who shall receive a preferential distribution of $1.00 per share ahead of the Series B preferred stock), a cash amount equal to $7.125 for each share of Series B preferred stock adjusted for any stock dividends, combinations or splits with respect to such shares.
The Company may, at the option of the Board of Directors, redeem all shares of the Series B preferred stock by paying in cash an amount equal to 110% of the redemption price. The redemption price is equal to $7.125 for each share adjusted for any stock dividends, combinations, or splits with respect to such shares. Written notice of this redemption must be provided at least 60 days prior to redemption, but no more than 75 days prior to the date on which the Company desires to redeem shares of Series B preferred stock.
(C) SERIES C PREFERRED STOCK
In connection with a pay down of the acquisition payable, the Company issued 2,330,217 shares of Series C preferred stock ("Series C preferred stock") to Wi-LAN at $2.064 per share for a total reduction of the acquisition payable of $4,810,000.
The holder of the Series C preferred stock is entitled to a 5% dividend, payable annually in arrears in common stock at the market price of the common stock on the due date of dividend payment. The dividend payable as of June 30, 2001 of approximately $140,000 has been reflected as common stock subscribed in the accompanying consolidated balance sheet. The holder of the Series C preferred stock may convert any or all of such shares into a number of shares of common stock determined by dividing $2.58 for each share of Series C preferred stock by the conversion price of $2.58 per share. The holder of Series C preferred stock is not entitled to any voting rights as stockholder of the Company prior to conversion.
In the event of any voluntary or involuntary sale of all or a substantial portion of the Company's capital stock, a substantial portion of the Company's assets, any merger or consolidation of the Company with another entity, or any liquidation or dissolution of the Company, voluntary or involuntary, the holder of the Series C preferred stock shall be entitled to receive, prior to the receipt of any assets by holders of all other equity securities of the Company (other than the holder of the Company's Series A preferred stock who shall receive a preferential distribution of $1.00 per share and the holder of the Company's Series B preferred stock who shall receive a preferential distribution of $7.125 per share), a cash amount equal to $2.58 for each share of Series C preferred stock adjusted for any stock dividends, combinations, or splits with respect to such shares.
The Company may, at the option of the Board of Directors, redeem all shares of the Series C preferred stock by paying in cash an amount equal to 110% of the redemption price. The redemption price is equal to $2.58 per share adjusted for any stock dividends, combinations, or splits with respect to such shares. Written notice of this redemption must be provided at least 60 days prior to redemption, but no more than 75 days prior to the date on which the Company desires to redeem shares of Series C preferred stock.
(D) WARRANTS
In connection with a March 1998 amendment to the Company's revolving credit facility, the Company issued warrants to a commercial bank enabling the bank to purchase 60,000 shares of the Company's common stock at $5.50 per share. The warrants are exercisable at any time and expire in March 2003. All 60,000 warrants remain outstanding and exercisable as of June 30, 2001.
In connection with a December 1998 amendment to the Company's revolving credit facility, the Company issued warrants to a commercial bank enabling the bank to purchase 250,000 shares of the Company's common stock at an exercise price of $0.119 per share. The warrants are exercisable at any time and expire in December 2003. The fair market value of the warrants at the date of issuance was insignificant. All 250,000 warrants remain outstanding and exercisable as of June 30, 2001.
In connection with a February 1999 restructuring to the Company's 1997 debentures, the Company issued warrants to the holders which enables them to purchase 702,615 shares of the Company's common stock at $1.00 per share. The warrants are exercisable at any time and expire in March 2004. The Company recorded the fair value of the warrants of $188,000, which was estimated using the Black Scholes option pricing model, as financing costs and additional paid-in capital. All 702,615 warrants remain outstanding and exercisable as of June 30, 2001.
In connection with approvals needed for the merger with Asurent Technologies in March 2000, the Company issued warrants to a commercial bank to purchase 60,000 shares of the Company's common stock at $7.375 per share. The warrants are exercisable at any time and expire in May 2003. The Company recorded the fair value of the warrants of $286,000, which was estimated using the Black-Scholes option pricing model, as financing costs and additional paid-in capital. All 60,000 warrants remain outstanding and exercisable as of June 30, 2001.
(E) STOCK OPTION PLANS
Effective October 1992, the Board of Directors adopted the 1992 Stock Incentive Plan (the "1992 Plan") which provides for the grant of stock options for up to 840,946 shares of common stock. The 1992 Plan also permits the Board of Directors to grant stock appreciation rights, stock bonuses, and restricted stock awards in accordance with the provisions of the Plan. The Plan remains in effect until October 2002 unless sooner terminated by the Board of Directors.
Effective January 1996, the Board of Directors adopted the 1996 Stock Incentive Plan (the "1996 Plan") which provided for the grant of stock options for up to 200,000 shares of common stock. Through various amendments, shareholders of the Company have voted to increase the number of shares of common stock authorized under the 1996 Plan to 2,000,000 shares. The 1996 Plan also permits the Board of Directors to grant stock appreciation rights, stock bonuses, and restricted stock awards in accordance with the provisions of the Plan. The Plan remains in effect until January 2006 unless sooner terminated by the Board of Directors.
Options granted under the 1992 and 1996 Plans may be incentive stock options or nonqualified stock options, as determined by the Board of Directors at the time of grant. Incentive stock options are granted at a price not less than the fair market value of the stock on the grant date, and nonqualified options are granted at a price to be determined by the Board of Directors provided that such exercise price is not less than 85% of the fair market value of the stock on the grant date. Option vesting terms are established by the Board of
Directors at the time of grant, and presently range from three to five years. The expiration date of options granted under the 1992 and 1996 Plans are determined at the time of grant and may not exceed ten years from the date of the grant.
As of June 30, 2001, there were no options available for grant under the 1992 Plan, and there were 881,009 options available for grant under the 1996 Plan.
The Company also issues options to members of the Board of Directors as compensation for board representation and attendance. Options are issued at the fair market value at the date of grant and vest at the conclusion of each fiscal year. As of June 30, 2001, 12,000 of these options were outstanding of which 12,000 were exercisable.
On August 10, 1998, the Board of Directors approved a reissuance of employee options whereby all optionholders under the 1992 and 1996 Plans could forfeit their outstanding options and receive instead new options at an exercise price of $0.75, the fair market value of the Company's stock on the approval date. The reissued options vest quarterly over three years, but none could be exercised prior to February 10, 1999. Options for 305,894 shares were cancelled and reissued under the terms of this arrangement.
The per share weighted-average fair value of all stock options granted during the years ended June 30, 2001, 2000 and 1999 was $1.88, $3.25, and $0.33, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: 2001 -- expected dividend yield 0%, expected volatility 100%, risk-free interest rate of 5.0% and an expected life of five years; 2000 -- expected dividend yield 0%, expected volatility 100%, risk-free interest rate of 5.38%, and an expected life of five years; 1999 -- expected dividend yield 0%, expected volatility 50%, risk-free interest rate of 5.8%, and an expected life of five years.
The Company applies APB Opinion No. 25 in accounting for its stock option plans and, accordingly, no compensation cost has been recognized in the consolidated financial statements for stock options issued with exercise prices at fair value. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net loss would have been adjusted to the pro forma amounts indicated below (in thousands, except per share data):
Pro forma net loss reflects only options granted during the years ended June 30, 1996 through 2001. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma loss amounts presented above because compensation cost is reflected over the options' vesting periods ranging from one to five years, and compensation cost for options granted prior to July 1, 1995 is not considered.
The following summarizes stock option activity for the years ended June 30, 2001, 2000, and 1999:
The following table summarizes information about stock options outstanding and exercisable as of June 30, 2001:
At June 30, 2001, the weighted-average remaining contractual life of outstanding options was 8.75 years. At June 30, 2001, 2000, and 1999, the number of options exercisable was 428,367, 264,908, and 310,565, respectively, and the weighted-average exercise price of those options was $1.81, $.82, and $.71, respectively.
(E) NOTES RECEIVABLE FROM STOCK SALES
Notes receivable from stock sales resulted from the exercise of stock options for full recourse promissory notes during the year ended June 30, 1998 and the purchase of common stock by employees during the year ended June 30, 2001. These notes were forgiven and expensed during the year ended June 30, 2001.
(F) STOCK COMPENSATION EXPENSE
Unearned compensation expense of $269,000 was recorded as a reduction of shareholders' equity for the fiscal year ended June 30, 1996 for 62,089 options issued at an exercise price less than fair market value. Compensation expense of approximately $56,000 was recorded in the consolidated statements of operations during the year ended June 30, 1999 for the options that vested during that year.
(G) STOCK OPTION MODIFICATION
In June 2000, the Company modified the terms of the outstanding stock options held by the Company's former president in connection with a severance agreement. These modifications included an acceleration of vesting of all unvested options that would have vested through June 30, 2001. Additionally, the Company remitted $110,999 to the former President to be used to exercise all vested options. As a result, the Company has reflected $835,000 in compensation expense in the accompanying 2000 consolidated statement of operations to reflect the fair value of the shares issued under this arrangement.
(11) MAJOR CUSTOMERS, SUPPLIERS, AND INTERNATIONAL SALES
Sales to customers who individually accounted for more than 10% of the Company's sales during the years ended June 30, 2001, 2000, and 1999, were as follows (in thousands, except percentages):
Purchases from any individual supplier or sales to international customers did not exceed 10% during any of the years included in the accompanying consolidated financial statements.
(12) COMMITMENTS AND CONTINGENCIES
(A) LEASES
The Company leases office and warehouse facilities from an irrevocable trust for the benefit of the children of the former Asurent Technologies shareholders. The lease is for a five-year period with a monthly rental of $76,000. Rental expense paid to the trust for the years ended June 30, 2001 and 2000 was approximately $932,000 and $229,000, respectively.
Rental expense under all lease agreements for the years ended June 30, 2001, 2000, and 1999, was approximately $1,761,000, $694,000, and $356,000, respectively.
Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of June 30, 2001 are as follows (in thousands):
(B) 401(K) PLAN
The Company sponsors a Digital Transmission Systems 401(k) Savings Plan ("DTS Plan") for the benefit of eligible employees and their beneficiaries. Under the DTS Plan, employees may elect to contribute from 1% to 20% of their gross compensation to the plan. The Company matches 25% of employee contributions up to 6% of their eligible compensation. The Company can also make an additional annual discretionary contribution that is allocated to employees based upon relative levels of compensation. The Company recorded expense of approximately $21,000, $52,000, and $27,000 for matching contributions to the DTS Plan for the years ended June 30, 2001, 2000, and 1999, respectively. The Company did not make any discretionary contributions to the DTS Plan during the years ended June 30, 2001, 2000, and 1999.
(C) LEGAL MATTERS
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, based in part upon the advice of counsel, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations, or liquidity.
(13) BUSINESS SEGMENT INFORMATION
The Company operates in one reportable segment: developer of proprietary equipment for telecommunication companies. Asurent Technologies was treated as a separate reportable segment prior to the decision to dispose of this operation (see note 15).
(14) CREATION AND SALE OF SOUTHTECH, INC.
At its April 1998 meeting, the DTS Board of Directors approved the creation of a wholly owned subsidiary -- SouthTech, Inc. ("SouthTech") whose business purpose was the administration and growth of the Company's international business. The subsidiary was legally created as a Georgia corporation in July 1998. The SKYPLEX and DIV product lines and associated intellectual property together with the payables and receivables pertaining to the sales realized from those product lines form the assets and liabilities transferred. Since its creation, investment capital had been sought for the subsidiary in order to fund its operating losses which had been substantial. Cash resources of the Company had been used for the purposes of developing the SKYPLEX product line, a set of microwave radio products utilizing spread spectrum technology, and developing sales distribution channels in Latin America, Asia Pacific, and the Mid-East global sectors.
The Company entertained an offer from a private group of investors to buy SouthTech in the latter part of 1998, but the offer was later withdrawn on November 10, 1998. In late November 1998, Chapala Communications, Inc. ("Chapala"), a Georgia based company, offered to purchase the stock of SouthTech. The sale involved the transfer of certain assets and liabilities of SouthTech to Chapala. The transaction resulted in approximately $981,000 of assets and $2,442,000 of liabilities being transferred to Chapala which resulted in a net gain of $1,461,000 which has been recorded in the accompanying fiscal 1999 financial statements. In accordance with Statement of Financial Accounting Standards No. 125 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, the Company derecognized the liabilities that were transferred to SouthTech upon obtaining formal, legally binding releases of such liabilities from the respective creditors.
As additional consideration for the sale, the Company received 19.5% of Chapala voting stock ownership in the form of 1,000,000 shares of $0.001 par value Series A voting Preferred Stock. Each share of Series A Preferred Stock shall be convertible into the number of fully paid and nonassessable shares of Common Stock obtained by dividing (a) the aggregate Series A Preferred Stock Liquidation Preference of the shares to be converted, by (b) the conversion price. The initial conversion price is $0.484 per share subject to adjustment, as defined. Any conversion of Series A Preferred Stock into Common Stock in accordance with the above conversion formula is limited with respect to total ownership after conversion. Such a limitation is 19.5% of outstanding common stock after conversion. Conversion of the Series A Preferred Stock to common stock is at the option of the holder and is not redeemable by Chapala.
SouthTech was later merged into Chapala and the resulting entity was named LinkaNet Labs, Inc. ("LinkaNet"). The Company has valued its investment in Chapala using the equity method. The Company has assigned zero value to its interest in LinkaNet within the accompanying financial statements and has no obligations to fund LinkaNet's future operations or present liabilities. Since inception, LinkaNet has incurred significant losses from operations. In the event that the operations of LinkaNet ultimately attain profitability, the Company will appropriately adjust its interest in LinkaNet. It is not anticipated that such an adjustment will have a material impact on the Company's results of operations in future periods.
In connection with the sale of SouthTech, the Company received a note from SouthTech in the amount of $127,000 at June 30, 1999. The note represents a portion of the vendor liability that was not assumed by Chapala. The Company also deferred $127,000 of the gain associated with the sale as of June 30, 1999. As a result of additional negotiations with Chapala during fiscal 2000, the Company deemed the remaining $127,000 note receivable from Chapala as uncollectible and appropriately reversed the note balance against the remaining deferred revenue balance. Accordingly, as of June 30, 2001 and 2000, there are no amounts outstanding with respect to the sale of the international subsidiary.
The SouthTech purchase and sale transaction was closed on February 5, 1999.
(15) DISPOSITION OF BUSINESS
In July 2001, the Board of Directors of the Company approved a plan to dispose of the operations of the Company's wholly owned subsidiary, Asurent Technologies. Asurent Technologies was acquired by the Company in March 2000. The accompanying financial statements have been restated to reflect Asurent Technologies as a discontinued operation for all periods presented.
The operating results of discontinued operations are as follows: