-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Iwy4B9Spr/KLZUkhqK390DWw7dZMYQkYgs/WNHh7wevndQ4Uggn4y6jPQLx2KQo2 uQ26PzHkipZrZB7d1NfThA== 0000950144-99-013329.txt : 19991117 0000950144-99-013329.hdr.sgml : 19991117 ACCESSION NUMBER: 0000950144-99-013329 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIGITAL LIGHTWAVE INC CENTRAL INDEX KEY: 0001016100 STANDARD INDUSTRIAL CLASSIFICATION: RADIO & TV BROADCASTING & COMMUNICATIONS EQUIPMENT [3663] IRS NUMBER: 954313013 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-21669 FILM NUMBER: 99756569 BUSINESS ADDRESS: STREET 1: 601 CLEVELAND STREET STREET 2: 5TH FLOOR CITY: CLEARWATER STATE: FL ZIP: 33775 BUSINESS PHONE: 8134426677 MAIL ADDRESS: STREET 1: 601 CLEVELAND STREET STREET 2: 5TH FLOOR CITY: CLEARWATER STATE: FL ZIP: 33775 10-Q 1 DIGITAL LIGHTWAVE, INC. 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 000-21669 DIGITAL LIGHTWAVE, INC. (Exact name of registrant as specified in its charter) --------------------- DELAWARE 95-4313013 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.)
15550 LIGHTWAVE DRIVE CLEARWATER, FLORIDA 33760 (727) 442-6677 (Address, including zip code, of principal executive offices and Registrant's telephone number, including area code) --------------------- Indicate by check mark whether Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such report (s)), and (2) has been subject to such filing requirements for the past 90 days. YES [ ] NO [ ] The number of shares outstanding of the Registrant's Common Stock as of November 11, 1999 was 27,018,319. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 DIGITAL LIGHTWAVE, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 1999 INDEX
PAGE ---- PART I FINANCIAL INFORMATION Item 1. Financial Statements: Consolidated Condensed Balance Sheets -- September 30, 1999 and December 31, 1998....................................... 1 Consolidated Condensed Statements of Operations -- Three Months Ended September 30, 1999 and September 30, 1998...... 2 Consolidated Condensed Statements of Operations -- Nine Months Ended September 30, 1999 and September 30, 1998...... 3 Consolidated Condensed Statements of Cash Flows -- Nine Months Ended September 30, 1999 and September 30, 1998...... 4 Notes to Consolidated Condensed Financial Statements........ 5 Management's Discussion and Analysis of Financial Condition Item 2. and Results of Operations................................... 9 PART II OTHER INFORMATION Item 1. Legal Proceedings........................................... 18 Item 6. Exhibits and Reports on Form 8-K............................ 19 SIGNATURES........................................................... 20
3 PART I FINANCIAL INFORMATION ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS DIGITAL LIGHTWAVE, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31, 1999 1998 ------------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $ 4,779 $ 3,848 Accounts receivable, net.................................. 11,533 7,152 Inventories............................................... 5,396 5,476 Prepaid expenses and other current assets................. 1,720 748 ------- ------- Total current assets.............................. 23,428 17,224 Property and equipment, net................................. 8,938 9,274 Other assets................................................ 925 1,060 ------- ------- Total assets...................................... $33,291 $27,558 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities.................. $ 8,506 $ 6,468 Notes payable, net of discount............................ 2,996 -- Interest payable.......................................... 132 -- Accrued settlement charges................................ 6,305 8,489 ------- ------- Total current liabilities......................... 17,939 14,957 Long-term liabilities....................................... 189 281 ------- ------- Total liabilities................................. 18,128 15,238 ------- ------- Stockholders' equity: Common stock.............................................. 3 3 Additional paid-in capital................................ 59,697 57,927 Accumulated deficit....................................... (44,537) (45,610) ------- ------- Total stockholders' equity........................ 15,163 12,320 ------- ------- Total liabilities and stockholders' equity........ $33,291 $27,558 ======= =======
The accompanying notes are an integral part of these consolidated condensed financial statements. 1 4 DIGITAL LIGHTWAVE, INC. CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE AND PER-SHARE DATA)
THREE MONTHS ENDED SEPTEMBER 30, -------------------------- 1999 1998 ----------- ----------- Sales....................................................... $ 14,162 $ 6,915 Cost of goods sold.......................................... 4,851 2,620 ----------- ----------- Gross profit.............................................. 9,311 4,295 Operating expenses: Engineering and development............................... 2,325 4,290 Sales and marketing....................................... 3,147 3,526 General and administrative................................ 1,187 1,096 ----------- ----------- Total operating expenses.......................... 6,659 8,912 ----------- ----------- Operating income (loss)..................................... 2,652 (4,617) Other income (expense)...................................... (11) 102 ----------- ----------- Income (loss) before income tax............................. 2,641 (4,515) Provision for income taxes.................................. -- -- ----------- ----------- Net income (loss).................................... $ 2,641 $ (4,515) =========== =========== Per share of common stock: Net income (loss) per share.......................... $ 0.10 $ (0.17) =========== =========== Diluted net income (loss) per share.................. $ 0.09 $ (0.17) =========== =========== Weighted average common shares outstanding.................. 26,863,115 26,484,670 =========== =========== Weighted average common and common equivalent shares outstanding............................................... 28,590,833 26,484,670 =========== ===========
The accompanying notes are an integral part of these consolidated condensed financial statements. 2 5 DIGITAL LIGHTWAVE, INC. CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE AND PER-SHARE DATA)
NINE MONTHS ENDED SEPTEMBER 30, -------------------------- 1999 1998 ----------- ----------- Sales....................................................... $ 33,002 $ 15,864 Cost of goods sold.......................................... 11,729 6,057 ----------- ----------- Gross profit.............................................. 21,273 9,807 Operating expenses: Engineering and development............................... 7,746 11,291 Sales and marketing....................................... 9,006 8,562 General and administrative................................ 3,511 4,639 Reorganization charges.................................... -- 1,018 Litigation settlement..................................... -- 8,500 ----------- ----------- Total operating expenses.......................... 20,263 34,010 ----------- ----------- Operating income (loss)..................................... 1,010 (24,203) Other income................................................ 63 547 ----------- ----------- Income (loss) before income tax............................. 1,073 (23,656) Provision for income taxes.................................. -- -- ----------- ----------- Net income (loss)...................................... $ 1,073 $ (23,656) =========== =========== Per share of common stock: Net income (loss) per share............................ $ 0.04 $ (0.89) =========== =========== Diluted net income (loss) per share.................... $ 0.04 $ (0.89) =========== =========== Weighted average common shares outstanding.................. 26,656,797 26,463,408 =========== =========== Weighted average common and common equivalent shares outstanding............................................... 27,517,832 26,463,408 =========== ===========
The accompanying notes are an integral part of these consolidated condensed financial statements. 3 6 DIGITAL LIGHTWAVE, INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------ 1999 1998 ------- -------- Cash flows from operating activities: Net income (loss)......................................... $ 1,073 $(23,656) Adjustments to reconcile net income (loss) due to cash used by operating activities: Depreciation and amortization.......................... 1,825 1,671 Loss on disposal of property........................... 13 -- Changes in operating assets and liabilities: (Increase) decrease in accounts receivable............. (4,776) 163 Decrease in inventories................................ 149 983 Increase in prepaid expenses and other current assets................................................ (837) (927) Increase (decrease) in accounts payable and accrued expenses.............................................. 1,970 (2,001) (Decrease) increase in accrued settlement charges...... (990) 8,454 ------- -------- Net cash used in operating activities................ (1,572) (15,313) ------- -------- Cash flows from investing activities: Purchase of property and equipment........................ (1,224) (2,878) ------- -------- Net cash used in investing activities................ (1,224) (2,878) ------- -------- Cash flows from financing activities: Proceeds from notes payable............................... 3,000 -- Proceeds from sale of common stock, net of expense........ 574 175 Payments received -- lease receivables.................... 395 48 Principal payments--capital lease obligations............. (242) (51) ------- -------- Net cash provided by financing activities............ 3,727 172 ------- -------- Net increase (decrease) in cash and cash equivalents........ 931 (18,019) Cash and cash equivalents at beginning of period............ 3,848 24,031 ------- -------- Cash and cash equivalents at end of period.................. $ 4,779 $ 6,012 ======= ======== Other supplemental disclosures: Cash paid for interest.................................... 39 21 Noncash investing and financing activities: Capital lease obligations incurred........................ $ 194 $ 287 Fixed asset additions included in accounts payable........ $ 155 $ 39 Accounts receivable related to capital leases............. $ 270 $ 297
The accompanying notes are an integral part of these consolidated condensed financial statements. 4 7 DIGITAL LIGHTWAVE, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying unaudited consolidated condensed financial statements of Digital Lightwave, Inc. ("the Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, these statements include all adjustments, consisting of normal and recurring adjustments, considered necessary for a fair presentation of results for such periods. The results of operations for the three and nine month periods ended September 30, 1999, are not necessarily indicative of results which may be achieved for the full fiscal year or for any future period. The unaudited interim financial statements should be read in conjunction with the financial statements and notes thereto contained in Digital Lightwave's Form 10-K for the period ended December 31, 1998, File No. 000- 21669. For comparative purposes, certain amounts previously disclosed in the financial statements have been reclassified to conform to the current presentation. These reclassifications had no effect on the results of operations for the periods presented. 2. INVENTORIES Inventories at September 30, 1999 and December 31, 1998 are summarized as follows:
SEPTEMBER 30, DECEMBER 31, 1999 1998 ------------- ------------ (IN THOUSANDS) Raw materials............................................... $3,235 $2,166 Work-in-process............................................. 1,787 1,443 Finished goods.............................................. 374 1,867 ------ ------ $5,396 $5,476 ====== ======
3. COMPUTATION OF NET LOSS PER SHARE Basic income (loss) per share is based on the weighted average number of common shares outstanding during the periods presented. For the quarter and the nine months ended September 30, 1998, diluted loss per share, which includes the effect of incremental shares from common stock equivalents using the treasury stock method, is not included in the calculation of net loss per share as the inclusion of such equivalents would be anti-dilutive. The table below shows the calculation of basic weighted average common shares outstanding and the incremental number of shares arising from common stock equivalents under the treasury stock method:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------- ----------------------- 1999 1998 1999 1998 ---------- ---------- ---------- ---------- Weighted average common stock outstanding....... 26,863,115 26,484,670 26,656,797 26,463,408 Weighted average common stock equivalents outstanding................................... 1,727,718 -- 861,035 -- ---------- ---------- ---------- ---------- Shares including effect of common stock equivalents outstanding....................... 28,590,833 26,484,670 27,517,832 26,463,408 ========== ========== ========== ==========
4. REORGANIZATION CHARGES The Company streamlined its management structure and eliminated 20 positions which resulted in a one-time charge of approximately $1.0 million during the nine months ended September 30, 1998. 5 8 DIGITAL LIGHTWAVE, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED) 5. LEGAL PROCEEDINGS As of April 9, 1998, 23 class action complaints (which were subsequently consolidated into a single action) for violations of the Federal Securities Laws during certain periods in 1997 and 1998 had been filed in the United States District Court for the Middle District of Florida (the "District Court"), on behalf of purchasers of the Company's Common Stock. The complaints named as defendants the Company, Bryan J. Zwan, the Company's then Chairman, Steven H. Grant, the Company's Executive Vice President, Finance, Chief Financial Officer and Secretary, and other former corporate officers. The complaints allege that the Company and certain officers during the relevant time period violated Sections 10(b) and 20(a) of the Securities Exchange Act by, among other things, issuing to the investing public false and misleading financial statements and press releases concerning the Company's revenues, income and earnings, which artificially inflated the price of the Company's Common Stock. On July 23, 1998, the Company entered into a memorandum of understanding for the settlement of these class action complaints. In late October 1998, a Stipulation of Settlement was filed with the court and on December 21, 1998, the court preliminarily approved the settlement. The settlement consists of $4.3 million in cash, to be paid to plaintiffs primarily by a claim on the Company's directors and officers liability insurance policy, and the issuance of up to 1.8 million shares of Common Stock. The Company recorded a one-time charge of $8.5 million during 1998 as a result of the settlement. On March 12, 1999, the court indicated that it would grant final approval of the settlement of the class action complaints and on April 30, 1999, the court entered a final judgment approving the settlement of the actions. The final order is subject to appeal. On July 21, 1999, the Company issued to plaintiffs' counsel 289,350 shares of Common Stock in partial satisfaction of the total shares required under this settlement. Those shares are not to be distributed, sold or hypothecated until after the appeal of the settlement, discussed below, is fully resolved. On May 20, 1999, Charles Chalmers, a lead plaintiff and class representative in the class action suit, filed a notice of appeal of the final judgment with the Eleventh Circuit Court of Appeals. Subsequently, plaintiffs filed a motion in the District Court to require Mr. Chalmers to post a bond to secure costs to be incurred in connection with the appeal. On August 9, 1999, the District Court granted plaintiff's motion mandating that Mr. Chalmers post a $12.5 million bond in support of his appeal. Mr. Chalmers did not post the bond and, on August 26, 1999, he filed a Notice of Appeal regarding the bond order with the Eleventh Circuit Court of Appeals. In addition, on August 9, 1999, the Securities and Exchange Commission filed an amicus brief in partial support of Mr. Chalmers' appeal of the settlement. On October 4, 1999, the Court of Appeals denied the Company's emergency motion for an expedited decision dismissing the appeal of the settlement. Briefing on the settlement appeal has been completed and the Court has ordered an expedited briefing schedule for the bond appeal. The Company intends to vigorously oppose the appeals. However, there can be no assurance as to the outcome of the appeals. If the appeal of the settlement is successful, the settlement of the class action could be set aside, and the Company again could be required to defend or attempt to settle the class action suit, which could have a negative effect on the Company and its results of operations and financial condition. On November 5, 1997, Hugh Brian Haney ("Plaintiff"), an early stage investor, commenced an action in the United States District Court for the Southern District of Ohio against Dr. Bryan J. Zwan, the Company's then Chairman of the Board and Chief Executive Officer, and the Company ("Defendants"). An amended complaint filed December 15, 1997 alleged violations of Section 10(b) of the Securities Exchange Act, violations of state corporation statutes, and various common law violations by Defendants in connection with Plaintiff's sale to the Company's predecessor in November 1995, pursuant to a previously granted option exercisable by Dr. Zwan and/or the Company's predecessor, of 4,900 shares of stock in the Company's predecessor, an amount equivalent to 19,215,686 shares of the Company's common stock. The amended complaint sought, among other things, (1) rescission of the sale of the shares transferred by Plaintiff and 6 9 DIGITAL LIGHTWAVE, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED) (2) damages of $235 million, together with interest. On October 20, 1998, the Company and Dr. Zwan entered into an agreement with Plaintiff to settle the action. The settlement agreement provided, among other things, for dismissal of the action with prejudice, for a $500,000 payment by the Company to Plaintiff for his attorneys' fees and granted Plaintiff an option, for 10 years, to purchase for $1 per share 2 million shares of Dr. Zwan's stock in the Company. Pursuant to that agreement, the action was dismissed with prejudice on November 13, 1998. The Company recorded a $3.0 million charge to earnings consisting of the cash payment and the valuation of the options upon settlement. On April 21, 1999, Plaintiff filed an action in the United States District Court for the Southern District of Ohio against the Defendants alleging that the terms of the settlement agreement entered into between the parties had been breached and requesting that the settlement agreement be specifically enforced and that damages in excess of $75,000 be awarded, or, alternatively, that the settlement agreement be set aside. The Company believes that it has fulfilled its obligations under the settlement agreement and that the claims made by Plaintiff against the Company in this action are without merit. Accordingly, in response to this action, the Company filed a motion to dismiss for failure to state a claim against the Company, which is pending before the Court. However, there can be no assurance that the Company's motion will be granted, or if the motion is denied, that the Company will succeed in defending or settling this action. Additionally, there can be no assurance that the action will not have a material adverse effect on the Company. The Company from time to time is involved in lawsuits arising in the ordinary course of business. With respect to these matters, management believes that it has adequate legal defenses and/or provided adequate accruals for related costs. The Company is not aware of any additional lawsuits that were pending that could have a material adverse effect on the Company's business, financial condition and results of operations. 6. FINANCING TRANSACTIONS The Company entered into an accounts receivable agreement dated December 28, 1998 with EAB Leasing Corp. ("EAB") providing for the sale of the Company's accounts receivable to EAB. The aggregate maximum amount the Company can borrow at one time under this agreement was $2.9 million through July 12, 1999, with a maximum of $2.0 million available on a monthly basis. In connection with this agreement, the Company has granted EAB a security interest in its accounts, accounts receivables, contract rights, equipment, chattel paper, general intangibles, instruments, inventory and all proceeds of the foregoing. The annual interest rate equivalent charged to the Company under this agreement is the prime rate plus 1.5%. The agreement also provides that the Company pay a minimum monthly service fee in the amount of $10,000. On July 12, 1999, the accounts receivable agreement with EAB automatically renewed for a six month period ending January 12, 2000 under the same terms and conditions as the previous agreement except the $2.0 million maximum available on a monthly basis was waived. The agreement is still subject to the aggregate maximum amount the Company can borrow at one time of $2.9 million. As of September 30, 1999, there were no borrowings outstanding under this agreement. On March 31, 1999, the Company entered into a financing agreement with certain investors pursuant to which the Company agreed to issue $3.0 million of 9% Secured Bridge Notes due January 17, 2000. These notes were issued on April 6, 1999. They are collateralized by all of the Company's assets and are subordinated to the accounts receivable agreement with EAB and the proposed line of credit agreement with Emergent Business Capital described in the following paragraph. In connection with the financing agreement, the Company issued warrants to purchase an aggregate of 550,000 shares of the Company's common stock at an exercise price of $2.75 per share, the market price of the stock on the date prior to the issuance of the warrants. The warrants have a term of five years from the date of issuance. The Company has agreed to register the warrants and the common stock issuable upon exercise thereof under the Securities Act of 1933. The Company expects to complete this registration during the fourth quarter of 1999. 7 10 DIGITAL LIGHTWAVE, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED) On March 31, 1999, the Company entered into a Letter of Commitment with Emergent Business Capital pursuant to which Emergent Business Capital would provide the Company with a $5.0 million line of credit (the "Emergent Line of Credit"). Under the Emergent Line of Credit, the Company would be entitled to borrow up to $5.0 million, subject to certain borrowing limitations based on amounts of the Company's accounts receivable and other assets. The Emergent Line of Credit would have a term of two years. All indebtedness outstanding under the Emergent Line of Credit Agreement would be collateralized by substantially all of the Company's assets. On April 19, 1999, the Company filed a registration statement with the Securities and Exchange Commission relating to a public offering of $20.0 million of Convertible Subordinated Notes. The Convertible Subordinated Notes would be convertible into shares of the Company's common stock. The Company would grant the underwriter a 30-day option to purchase up to an additional $3.0 million of Convertible Subordinated Notes for the purpose of covering over-allotments. C.E. Unterberg, Towbin is the underwriter of this offering. 7. COMMITMENTS In May 1999, the Company signed an original equipment manufacturer contract to provide integrated performance monitoring and diagnostic capabilities for a product marketed by Lucent Technologies, Inc. Lucent's placement of orders for product is conditional upon the Company achieving certain milestone events defined in the contract. 8. SUBSEQUENT EVENTS On October 14, 1999, the Company and Dr. Bryan J. Zwan, the Company's majority stockholder and a director, entered into an agreement which provides that (i) the size of the Board of Directors ("Board") will be increased from four to five members, (ii) two new outside directors will be appointed to the Board upon the approval of Dr. Zwan and a majority of the current Board and one current outside director will step down, (iii) the newly formed Board will stay in place at least until the Company's annual meeting in 2001 and (iv) the Company will enter into agreements containing provisions with respect to change of control, severance and non-compete with current senior management. In November 1999, the Board decided not to proceed with the registration statement with the Securities and Exchange Commission relating to a public offering of $20.0 million of Convertible Subordinated Notes described in Note 6 -- Financing Transactions. The Company may record a charge related to costs deferred in anticipation of the issuance of this debt during the fourth quarter. The total of these costs at September 30, 1999 was $608,623. The Company continues to consider various financing alternatives, including the existing accounts receivable agreement with EAB, the Emergent Line of Credit, and other asset based lending facilities. There can be no assurance that the Company will be successful in obtaining alternative financing on a timely basis or, if available, on terms acceptable to the Company. 8 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report contains certain statements of a forward-looking nature relating to future events or the future performance of the Company. Prospective and current investors are cautioned that such statements are only predictions and that actual events or results may differ materially. In evaluating such statements as well as the future prospects of the Company generally, such investors should specifically consider various factors identified in the Company's Annual Report on Form 10-K for the period ended December 31, 1998, including the matters set forth therein under the caption "Factors That May Affect Operating Results," which could cause actual results to differ materially from those indicated by such forward-looking statements. Factors that may affect the Company's results of operations include but are not limited to the Company's limited operating history and cumulative losses, control by a majority shareholder, dependence on a limited number of products, uncertain market acceptance of planned products, rapid technological changes, dependence on new product introductions, ability to compete effectively with other companies, dependence on contract manufacturing and limited source suppliers, delays in product development and delivery schedules, success of the original equipment manufacturer ("OEM") agreement with Lucent Technologies, dependence on key personnel, ability to manage our growth, ability to enter into strategic relationships, quarterly fluctuations in operating results, dependence on proprietary technology, dependence on a limited number of major customers, product certifications, factors inhibiting takeover, shares eligible for future sale, possible volatility of stock price, success in defending significant litigation, liquidity risks and future capital needs, general business conditions, potential year 2000 problems and government regulations. The Company participates in a highly concentrated industry, and has limited visibility with regard to customer orders and the timing of such orders. The Company may also encounter difficulty obtaining sufficient supplies to staff and meet production schedules. As a result, quarter-to-quarter and year-to-year financial performance is highly dependent upon the timely receipt of orders from its customers during fiscal periods. The Company disclaims any obligation to update any such factors or announce publicly revisions to such statements to reflect events or developments. OVERVIEW The Company designs, develops, markets and supports network analysis equipment for monitoring, maintaining and managing fiber optic networks. The Company's products provide telecommunications service providers and equipment manufacturers with capabilities to cost-effectively deploy and manage fiber optic networks to address the rapidly increasing demand for bandwidth. From inception in 1990 through 1996, the Company focused its primary activities on developing the necessary technology and infrastructure required to launch its first product, the Network Information Computer. In 1998, the Company commenced limited sales of the Network Access Agent. The Company's sales are generated from sales of its products, less an estimate for customer returns. Sales are recognized when products are shipped to a customer. The Company expects that the average selling price ("ASP") of its Network Information Computers will fluctuate based on a variety of factors, including product configuration, potential volume discounts to customers, the timing of new product introductions and enhancements and the introduction of competitive products. Fluctuations in the ASP may have a material adverse effect on the Company's results of operations. The Company sells its products through a direct sales force to telecommunications service providers and equipment manufacturers. The sales cycle for new customers tends to be long. In addition, the telecommunications industry historically has had a limited number of competitors. Given long sales cycles and few industry participants, sales of the Company's products have tended to be concentrated, and the Company expects that sales will continue to be concentrated in the future. To date, the Company has not entered into long-term agreements or blanket purchase orders for the sale of its products, but generally obtains purchase orders for immediate shipment and other cancelable purchase commitments. As a result, the Company does not expect to carry substantial quarterly backlog from quarter to quarter in the future. The Company's sales during a particular quarter are, therefore, highly dependent upon orders placed by customers during the quarter. Consequently, sales may fluctuate significantly from quarter- 9 12 to-quarter and year-to-year due to the timing and amount of orders from customers, among other factors. Because most of our expenses, particularly employee compensation and rent, are relatively fixed and cannot be reduced in response to decreased revenues, quarterly fluctuations in sales have a significant effect on net income. Since inception the Company has incurred substantial net operating losses as a result of significant investment in research and development, sales and marketing and administrative expenses. The Company intends to continue to build its organization in anticipation of growth and believes that its operating expenses will continue to increase accordingly due to a variety of factors including: (1) increased research and development expenses associated with the completion of the products in development and the continued enhancement of existing products; and (2) increased selling, general and administrative expenses associated with continued expansion of sales and marketing capabilities, product advertising and promotion. The quarter ended September 30, 1999 marked the second consecutive quarter of profitability for the Company rendering 1999 profitable on a year-to-date basis. There can be no assurance that profitability will be sustained. RESULTS OF OPERATIONS The following is a discussion of significant changes in the results of operations of the Company which occurred in the quarter and nine months ended September 30, 1999 compared to the quarter and nine months ended September 30, 1998. The following tables summarize the approximate changes in selected operating items and include dollar changes, percentage changes and percent of net sales to facilitate the discussions that follow.
QUARTER ENDED PERCENT OF ----------------------------- AMOUNT PERCENT NET CHANGE CHANGE SALES SEPTEMBER 30, SEPTEMBER 30, FAV/ FAV/ ----------- 1999 1998 (UNFAV) (UNFAV) 1999 1998 ------------- ------------- ------- ------- ---- ---- (IN MILLIONS, EXCEPT %) Net sales.................................. $14.2 $ 6.9 $7.3 105% 100% 100% Cost of goods sold......................... (4.9) (2.6) (2.3) (87) 34 38 ----- ----- ---- --- --- Gross profit............................... 9.3 4.3 5.0 117 66 62 Engineering and development expenses....... (2.3) (4.3) 2.0 46 17 62 Sales and marketing expenses............... (3.2) (3.5) 0.3 7 22 51 General and administrative expenses........ (1.2) (1.1) (0.1) (8) 8 16 ----- ----- ---- --- --- Total operating expenses......... (6.7) (8.9) 2.2 25 47 129 Operating income (loss).................... 2.6 (4.6) 7.2 155 19 (67) Other income, net.......................... -- 0.1 (0.1) (111) -- 1 ----- ----- ---- --- --- Pre-tax income (loss)...................... 2.6 (4.5) 7.1 159 19 (66) Income taxes............................... -- -- -- -- -- -- ----- ----- ---- --- --- Net income (loss).......................... $ 2.6 $(4.5) $7.1 159% 19% (66)% ===== ===== ==== === ===
10 13
NINE MONTHS ENDED PERCENT OF ----------------------------- AMOUNT PERCENT NET CHANGE CHANGE SALES SEPTEMBER 30, SEPTEMBER 30, FAV/ FAV/ ----------- 1999 1998 (UNFAV) (UNFAV) 1999 1998 ------------- ------------- ------- ------- ---- ---- (IN MILLIONS, EXCEPT %) Net sales................................. $33.0 $ 15.9 $17.1 108% 100% 100% Cost of goods sold........................ (11.7) (6.1) (5.6) (92) 36 38 ----- ------ ----- --- ---- Gross profit.............................. 21.3 9.8 11.5 117 64 62 Engineering and development expenses...... (7.8) (11.3) 3.5 31 23 71 Sales and marketing expenses.............. (9.0) (8.6) (0.4) (5) 27 54 General and administrative expenses....... (3.5) (4.6) 1.1 24 11 29 Reorganization charges.................... -- (1.0) 1.0 100 -- 6 Litigation settlement..................... -- (8.5) 8.5 100 -- 54 ----- ------ ----- --- ---- Total operating expenses........ (20.3) (34.0) 13.7 40 61 214 Operating income (loss)................... 1.0 (24.2) 25.2 104 3 (152) Other income, net......................... 0.1 0.5 (0.4) (87) -- 3 ----- ------ ----- --- ---- Pre-tax income (loss)..................... 1.1 (23.7) 24.8 105 3 (149) Income taxes.............................. -- -- -- -- -- -- ----- ------ ----- --- ---- Net income (loss)......................... $ 1.1 $(23.7) $24.8 105% 3% (149)% ===== ====== ===== === ====
Sales Sales include total revenues from customer purchases of Network Information Computers (NIC) and Network Access Agents (NAA), net of accrual for product returns. Net sales for the quarter increased $7.3 million to $14.2 million from $6.9 million in the year ago quarter. Sales to existing customers during the quarter represented 93% of sales, or $13.3 million as compared to 83% of sales, or $5.7 million in the year ago quarter. During the quarter, the Company shipped 299 units in varying configurations of the NIC and 4 NAA units to a total of 49 customers (including 17 new customers) at an ASP of $46,740 as compared to 251 NIC units to a total of 36 customers (including 14 new customers) at an ASP of $27,550 in the year ago quarter. Sales for the nine months ended September 30, 1999, increased $17.1 million to $33.0 million from $15.9 million in the year ago period. Sales to existing customers for the period represented 89% of sales, or $29.5 million as compared to 71% of sales, or $11.3 million for the same period last year. During the period, the Company shipped 800 units in varying configurations of the NIC and 10 NAA at an ASP of $40,744 as compared to 539 NIC units at an ASP of $29,432 in the year ago period. Sales to existing customers continue to represent a large portion of the Company's net sales. The Company believes repeat sales to an existing customer are an important measure of growing product acceptance in the highly concentrated telecommunications industry. While this longer-term trend may not continue, management believes that new product offerings including upgrades of existing products offer the Company's existing customers an opportunity to continue to extend the life of their initial investment in the Company's products. The increase in ASP for the quarter and nine months ended September 30, 1999 as compared to the year ago periods is primarily due to the higher selling price associated with the Company's higher speed optical configuration, OC-48, which was not available until September of 1998. Cost of Goods Sold Costs of goods sold principally includes inventory, labor and overhead, management costs, facility rental and depreciation of equipment. Cost of goods sold for the quarter increased by $2.3 million to $4.9 million from $2.6 million in the year ago quarter. Cost of goods sold for the nine months ended September 30, 1999 increased by $5.6 million to $11.7 million from $6.1 million in the year ago period. 11 14 The primary reason for the increase in cost of goods sold is the increase in the volume of units sold. Gross Profit Gross profit for the quarter increased by $5.0 million to $9.3 million from $4.3 million in the year ago quarter. As a percentage of sales, gross margin for the quarter ended September 30, 1999 increased to 65.7% from 62.1%. Gross profit for the nine months ended September 30, 1999 increased by $11.5 million to $21.3 million from $9.8 million in the year ago period. As a percentage of sales, gross margin for the nine months ended September, 30, 1999 increased to 64.5% from 61.8%. The increase in gross profit is directly related to the increase in sales for the quarter and nine months ended September 30, 1999. Along with the increase in sales, gross margin percentages have also increased. The primary reasons for this were increased margins on higher speed optical configured units at OC12 and above, particularly OC-48 which has significantly impacted margins in 1999 on both a quarterly and year to date basis. Engineering and Development Engineering and development expenses principally include compensation attributable to engineering and development personnel, depreciation of fixed assets, outside consulting fees and other development expenses. Engineering and development expenses for the quarter decreased by $2.0 million to $2.3 million from $4.3 million in the year ago quarter. Engineering and development expenses for the nine months ended September 30, 1999 decreased by $3.5 million to $7.8 million from $11.3 million in the year ago period. The decrease for both the quarter and the nine months is primarily due to the Company's efforts to lower overhead costs and streamline its operating structure by eliminating certain full time and consultant positions. This resulted in a savings of $1.0 and $3.1 million in salaries and related benefits for the quarter and nine months, respectively, over the same periods last year. In addition, engineering and development for the quarter were lower in 1999 as a greater portion of overhead expenses were capitalized as part of inventory costs due to higher production activity. Also, product development spending in the 1998 quarter was higher as the development of the OC-48 product was completed and the product was brought to market in September of 1998. Sales and Marketing Sales and marketing expenses principally include salaries and commissions paid on sales of products, travel expenses, tradeshow costs, and costs of promotional materials and customer incentives. Sales and marketing expenses for the quarter decreased $0.3 million to $3.2 million from $3.5 million in the year ago quarter. This decrease is the result of the elimination of the International Sales organization and normal attrition for which replacements were not sought. In addition, in 3rd quarter 1998, customer incentives were granted in the form of free customer upgrades resulting in a $0.3 million expense. These items were partially offset by higher commissions resulting from the increased sales activity. Sales and marketing expenses for the nine months ending September 30, 1999 increased $0.4 million to $9.0 million compared to $8.6 million in the year ago period. The increase is directly related to higher commissions resulting from the increased sales activity partially offset by the salary and benefits savings previously discussed. General and Administrative General and administrative expenses principally include professional fees, facility rentals, compensation, and information systems related to general management functions. General and administrative expenses for the quarter increased by $0.1 million to $1.2 million from $1.1 million in the year ago quarter. 12 15 General and administrative expenses for the nine months ended September 30, 1999 decreased by $1.1 million to $3.5 million from $4.6 million in the year ago period. The decrease for the year-to-date period primarily reflects higher professional fees related to legal costs in 1998. Reorganization Charges During the nine months ended September 30, 1998, the Company streamlined its management structure and eliminated 20 positions which resulted in a one-time charge of $1.0 million. Litigation Settlement During the nine months ended September 30, 1998, the Company signed a memorandum of understanding for the settlement of class action complaints filed against it in U.S. District Court for alleged violations of federal securities laws. The settlement resulted in a one-time charge of $8.5 million. Other Income or Expense Other expense for the quarter ended September 30, 1999, represents a unfavorable change of $0.1 million to $0.0 million in expense from $0.1 million in income in the same quarter last year. Other income for the nine months ended September 30, 1999 decreased by $0.4 million to $0.1 million from $0.5 million in the same period last year. The change in both the quarter and the nine months is the result of the utilization of cash reserves to fund the Company's operations which caused a decrease in interest earned on invested cash balances This change is also a result of increased interest expense related to the Company's debt issued in the 2nd quarter of 1999. Net Income or Loss Net income for the quarter increased by $7.1 million to $2.6 million or $.09 per share (diluted), from a net loss of $4.5 million or $.17 per share in the year ago quarter. Net income for the nine months ended September 30, 1999 increased by $24.8 million to $1.1 million or $.04 per share (diluted), from a net loss of $23.7 million or $.89 per share in the year ago period. The net loss for the nine months ended September 30, 1998 was adversely impacted by the one-time charges of $8.5 million to record the settlement of outstanding securities litigation and $1.0 million to record the reorganization. Without these charges, the net loss would been $14.1 million or a loss of $.53 per share. LIQUIDITY AND CAPITAL RESOURCES From its inception through December 31, 1998, the Company has financed its operations primarily through private sales of its Common Stock, cash from operations and the initial public offering of 3,658,860 shares of its Common Stock. The Company completed its IPO in February 1997, resulting in net proceeds to the Company of $39.6 million. During 1997, the Company used the net proceeds to fund the repayment of notes payable for approximately $0.8 million, to purchase computer equipment, software, test equipment and other assets for approximately $6.0 million and to fund product research and development for approximately $5.3 million. In addition, approximately $3.5 million was used to fund the Company's expansion in the form of additional manufacturing and administrative space and a significant increase in engineering, production and financial management personnel to support the Company's growth. Cash and cash equivalents at September 30, 1999 were approximately $4.8 million as compared to approximately $3.8 million at December 31, 1998. As of September 30, 1999, the Company's working capital was approximately $5.5 million as compared to $2.3 million at December 31, 1998. The increase was primarily the result of the growth in trade accounts receivable caused by record sales in 1999. For the nine months ended September 30, 1999, capital expenditures were approximately $1.2 million. Future capital expenditures 13 16 will depend on several factors including timing of introductions of new products and enhancements to existing products as well as continued product development efforts. The Company entered into an accounts receivable agreement dated December 28, 1998 with EAB Leasing Corp. ("EAB") providing for the sale of the Company's accounts receivable to EAB. The aggregate maximum amount the Company can borrow at one time under this agreement is $2.9 million through July 12, 1999 with a maximum of $2.0 million available on a monthly basis. In connection with this agreement, the Company has granted EAB a security interest in its accounts, accounts receivable, contract rights, equipment, chattel paper, general intangibles, instruments, inventory and all proceeds of the foregoing. The annual interest rate equivalent charged to the Company under this agreement is the prime rate plus 1.5%. The agreement also provides that the Company pay a minimum monthly service fee in the amount of $10,000. On July 12, 1999, the accounts receivable agreement with EAB automatically renewed for a six month period ending January 12, 2000 under the same terms and conditions as the previous agreement except the $2.0 million maximum available on a monthly basis was waived. The agreement is still subject to the aggregate maximum amount the Company can borrow at one time of $2.9 million. As of September 30, 1999, there were no borrowings outstanding under this agreement. On March 31, 1999, the Company entered into a financing agreement with certain investors pursuant to which the Company agreed to issue $3.0 million of 9% Secured Bridge Notes due January 17, 2000. These notes were issued on April 6, 1999. They are collateralized by all of the Company's assets and are subordinated to the accounts receivable agreement with EAB and the proposed line of credit agreement with Emergent Business Capital described in the following paragraph. In connection with the financing agreement, the Company issued warrants to purchase an aggregate of 550,000 shares of the Company's common stock at an exercise price of $2.75 per share, the market price of the stock on the date prior to the issuance of the warrants. The warrants have a term of five years from the date of issuance. The Company has agreed to register the warrants and the common stock issuable upon exercise thereof under the Securities Act of 1933. The Company expects to complete this registration during the fourth quarter of 1999. On March 31, 1999, the Company entered into a Letter of Commitment with Emergent Business Capital pursuant to which Emergent Business Capital would provide the Company with a $5.0 million line of credit (the "Emergent Line of Credit"). Under the Emergent Line of Credit, the Company would be entitled to borrow up to $5.0 million, subject to certain borrowing limitations based on amounts of the Company's accounts receivable and other assets. The Emergent Line of Credit would have a term of two years. All indebtedness outstanding under the Emergent Line of Credit Agreement would be collateralized by substantially all of the Company's assets. On April 19, 1999, the Company filed a registration statement with the Securities and Exchange Commission relating to a public offering of $20.0 million of Convertible Subordinated Notes. The Convertible Subordinated Notes would be convertible into shares of the Company's common stock. The Company would grant the underwriter a 30-day option to purchase up to an additional $3.0 million of Convertible Subordinated Notes for the purpose of covering over-allotments. C.E. Unterberg, Towbin is the underwriter of this offering. In November 1999, the Board decided not to proceed with the registration statement with the Securities and Exchange Commission relating to a public offering of $20.0 million of Convertible Subordinated Notes. The Company may record a charge related to costs deferred in anticipation of the issuance of this debt during the fourth quarter. The total of these costs at September 30, 1999 was $608,623. The Company continues to consider various financing alternatives, including the existing accounts receivable agreement with EAB, the Emergent Line of Credit, and other asset based lending facilities (the "Financing Sources"). The Company anticipates that its existing cash and cash equivalents and anticipated cash flow from operations together with funds provided from the Financing Sources will be sufficient to fund the Company's working capital and capital expenditure requirements for at least the next 12 months. The anticipated cash flow from operations assumes the Company achieves a level of sales that is significantly higher than those of earlier quarters. In the event that these sales levels are not attained, the Company will be required to supplement its working capital with additional funding in order to meet shorter or longer term 14 17 liquidity needs. There can be no assurance, however, that the Company will achieve the assumed or increased sales levels or that adequate additional financing will be available when needed or, if available, on terms acceptable to the Company. YEAR 2000 READINESS DISCLOSURE Year 2000 Issues and State of Readiness The Company is aware of the issues associated with existing computer-controlled systems properly recognizing and processing information relating to dates in and after the Year 2000. Systems that cannot adequately process dates beyond the year 1999 could generate erroneous data or cause a system to fail. The problem may affect internal information technology ("IT") systems used by the Company for product development, accounting, distribution and planning. The problem may also affect non-IT embedded systems such as building security systems, machine controllers, and other equipment. The Company has made an assessment of its Year 2000 readiness for its operations relating to (1) the Company's software products, (2) the Company's internal IT and non-IT systems and (3) third party customers, vendors and others with whom the Company does business. The Company believes that the current versions of its products (ASA 312 Network Information Computer software versions 3.500 and later and Network Access Agents) are Year 2000 compliant. The Company's products use time and dates only as a "time stamp" for data-logging events, for file dates, for display of elapsed time, and setting the test duration. The products' internal system calendar years are entered as a 2-digit number in the range of "95" (for 1995) through "94" (for 2094). Since there is never a reason for "back dating," this provides an unambiguous means of entry for the year. The date is displayed in a 4-digit year format (e.g., 01-Jan-1998) to enhance understandability. Based on the foregoing, it is not expected that the Company's current products will be adversely affected by date changes in the Year 2000. Certain customers of the Company may be running earlier versions of the Company's products that are not Year 2000 compliant. These earlier software versions, like the compliant versions, rely on time and dates only as a "time stamp" for data-logging events, for file dates, for display of elapsed time, and setting the test duration and do not prohibit function of the equipment. The Company has made its policy statement regarding its product line available on the Internet as well as providing written copies at customer request. This alerts customers to the noncompliance of earlier versions of the ASA 312 software. Of these earlier versions, 3.100 through prior to 3.500 partially comply, although if allowed to run past 1999 and into January 1, 2000, the date after power-down will be incorrectly set to 1980. Instructions regarding correcting this are provided both on the Internet and via customer inquiry. This leaves only versions lower than 3.100 which are truly non-compliant. The suggested solution for these products is an upgrade to a more recent, compliant version of the software at the cost of the Company. The Company has evaluated the number of customers still operating with these non-compliant versions. Of these customers, it is estimated that approximately half have already received the desired upgrades. The cost to upgrade the remaining units is estimated to total $36,000 which would not have a material adverse impact on the Company's business, operating results or financial condition. With respect to IT systems, the Company has inventoried its internal software and electronic hardware devices currently in use to determine which of these devices rely on a valid date in order to function. Of these, certain operating, accounting, and telephony systems were identified as critical. Resources required to make these systems Year 2000 compliant were evaluated based on availability and cost of the related upgrade. In general, the Company has obtained Year 2000 compliant versions from third party software vendors and modified these systems. A portion of the telephony system still requires such upgrade and the Company expects to complete this during November 1999. Total costs of the remaining remediation, when complete, are estimated at approximately $15,000. Non-IT embedded systems, consisting primarily of security systems, the emergency power generator, HVAC controls and elevators have also been reviewed. These systems were found to be year 2000 compliant. The Company also has certain key relationships with suppliers and subcontractors. We have contacted certain third-party suppliers of key components or services regarding their Year 2000 readiness. We have 15 18 received confirmation of their Year 2000 readiness and/or documentation concerning their efforts to achieve compliance. Risks Associated with Year 2000 and Contingency Plan Based on information currently available to the Company, the Company believes that the most reasonably likely worst case Year 2000 scenarios with respect to the Company relate to the potential failure of third party suppliers, subcontractors and customers to become Year 2000 compliant. The inability of suppliers and subcontractors to complete their Year 2000 remediation processes in a timely fashion could result in delays in introducing new products, reduced sales of new or existing products and disruptions in any future strategic relationships. The failure of these entities to become Year 2000 compliant could in turn have a material and adverse effect on the Company's results of operations and financial condition. The effect of non-compliance by suppliers, subcontractors and customers is not reasonably quantifiable. The Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues. Many companies are expending significant resources to correct or upgrade their current systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase testing products such as those offered by the Company. This could have a material adverse effect upon the Company's business, operating results and financial condition. The Company anticipates that generally throughout the computer industry substantial litigation may be brought against software vendors of non-compliant operating environments. The Company believes that any such claims against the Company, with or without merit, could have a material adverse effect on the Company's business, operating results and financial condition. The most significant aspect of a Year 2000 contingency plan would involve the ability of the Company to identify alternative vendors if the need arose. As an element of the Company's normal business planning and analysis, multiple sources for key components and services are continually being evaluated. Therefore, the Company believes it has that ability. The Company is not aware of any Year 2000 compliance problems relating to its current products or its IT or non-IT systems that would have a material adverse effect on the Company's business, results of operations and financial condition. However, the Company may discover Year 2000 problems in its products that will require substantial revisions. In addition, third-party software or hardware incorporated into the Company's products and material IT and non-IT systems may need to be revised or replaced, all of which could be time consuming and expensive. If material Year 2000 problems are discovered, the failure of the Company to fix its products or fix or replace third-party software, third party software incorporated into its products and in its IT systems could result in lost revenues, increased operating costs, the loss of customers and other business interruptions, any of which could have a material adverse effect on the Company's business, results of operations and financial conditions. 16 19 Expenses Related to Year 2000 Compliance The total cost of the Year 2000 preparedness effort is funded through operating cash flows and the Company is expensing these costs. The Company has not established any specific reserves for these costs. The Company has not incurred significant expense in becoming Year 2000 compliant as both the majority of our product software and the infrastructure of our internal systems were developed after the Year 2000 risks were realized. Future costs related to Year 2000 compliance are not expected to have a material adverse effect on the Company's results of operations or financial condition. However, the Company may experience serious unanticipated negative consequences and/or material costs caused by undetected errors or defects in the technology used in its internal systems, which are composed predominantly of third party software and hardware technology with embedded software, and the Company's own products. 17 20 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS As of April 9, 1998, 23 class action complaints (which were subsequently consolidated into a single action) for violations of the Federal Securities Laws during certain periods in 1997 and 1998 had been filed in the United States District Court for the Middle District of Florida, on behalf of purchasers of the Company's Common Stock. The complaints named as defendants the Company, Bryan J. Zwan, the Company's then Chairman, Steven H. Grant, the Company's Executive Vice President, Finance, Chief Financial Officer and Secretary, and other former corporate officers. The complaints allege that the Company and certain officers during the relevant time period violated Sections 10(b) and 20(a) of the Securities Exchange Act by, among other things, issuing to the investing public false and misleading financial statements and press releases concerning the Company's revenues, income and earnings, which artificially inflated the price of the Company's Common Stock. On July 23, 1998, the Company entered into a memorandum of understanding for the settlement of these class action complaints. In late October 1998, a Stipulation of Settlement was filed with the court and on December 21, 1998, the court preliminarily approved the settlement. The settlement consists of $4.3 million in cash, to be paid to plaintiffs primarily by a claim on the Company's directors and officers liability insurance policy, and the issuance of up to 1.8 million shares of Common Stock. The Company recorded a one-time charge of $8.5 million during 1998 as a result of the settlement. On March 12, 1999, the court indicated that it would grant final approval of the settlement of the class action complaints and on April 30, 1999, the court entered a final judgment approving the settlement of the actions. The final order is subject to appeal. On July 21, 1999, the Company issued to plaintiffs' counsel 289,350 shares of Common Stock in partial satisfaction of the total shares required under this settlement. Those shares are not to be distributed, sold or hypothecated until after the appeal of the settlement, discussed below, is fully resolved. On May 20, 1999, Charles Chalmers, a lead plaintiff and class representative in the class action suit, filed a notice of appeal of the final judgment with the Eleventh Circuit Court of Appeals. Subsequently, plaintiffs filed a motion in the District Court to require Mr. Chalmers to post a bond to secure costs to be incurred in connection with the appeal. On August 9, 1999, the District Court granted plaintiff's motion mandating that Mr. Chalmers post a $12.5 million bond in support of his appeal. Mr. Chalmers did not post the bond and, on August 26, 1999, he filed a Notice of Appeal regarding the bond order with the Eleventh Circuit Court of Appeals. In addition, on August 9, 1999, the Securities and Exchange Commission filed an amicus brief in partial support of Mr. Chalmers' appeal of the settlement. On October 4, 1999, the Court of Appeals denied the Company's emergency motion for an expedited decision dismissing the appeal of the settlement. Briefing on the settlement appeal has been completed and the Court has ordered an expedited briefing schedule for the bond appeal. The Company intends to vigorously oppose the appeals. However, there can be no assurance as to the outcome of the appeals. If the appeal of the settlement is successful, the settlement of the class action could be set aside, and the Company again could be required to defend or attempt to settle the class action suit, which could have a negative effect on the Company and its results of operations and financial condition. On August 5, 1999, as a complete settlement of an investigation of the Company being conducted by the U.S. Securities and Exchange Commission relating to the circumstances underlying the restatement of its financial results, the Company agreed to voluntarily consent to the entry of a permanent injunction enjoining it from violations of Sections 10(b), 13(a) and 13(b)(2) of the Securities Exchange Act of 1934, and Rules 10b-5, 12b-20 and 13a-13 thereunder. The settlement is subject to approval by the Commission and the United States District Court. There can be no assurance that the settlement will be approved or if it is not approved, that the Company will succeed in defending or settling any subsequent action that might be brought against it by the Commission. In addition, it is the Company's understanding that several current and former officers and directors of the Company are also the subjects of this investigation, which is ongoing. 18 21 On November 5, 1997, Hugh Brian Haney ("Plaintiff"), an early stage investor, commenced an action in the United States District Court for the Southern District of Ohio against Dr. Bryan J. Zwan, the Company's then Chairman of the Board and Chief Executive Officer, and the Company ("Defendants"). An amended complaint filed December 15, 1997 alleged violations of Section 10(b) of the Securities Exchange Act, violations of state corporation statutes, and various common law violations by Defendants in connection with Plaintiff's sale to the Company's predecessor in November 1995, pursuant to a previously granted option exercisable by Dr. Zwan and/or the Company's predecessor, of 4,900 shares of stock in the Company's predecessor, an amount equivalent to 19,215,686 shares of the Company's common stock. The amended complaint sought, among other things, (1) rescission of the sale of the shares transferred by Plaintiff and (2) damages of $235 million, together with interest. On October 20, 1998, the Company and Dr. Zwan entered into an agreement with Plaintiff to settle the action. The settlement agreement provided, among other things, for dismissal of the action with prejudice, for a $500,000 payment by the Company to Plaintiff for his attorneys' fees and granted Plaintiff an option, for 10 years, to purchase for $1 per share 2 million shares of Dr. Zwan's stock in the Company. Pursuant to that agreement, the action was dismissed with prejudice on November 13, 1998. The Company recorded a $3.0 million charge to earnings consisting of the cash payment and the valuation of the options upon settlement. On April 21, 1999, Plaintiff filed an action in the United States District Court for the Southern District of Ohio against the Defendants alleging that the terms of the settlement agreement entered into between the parties had been breached and requesting that the settlement agreement be specifically enforced and that damages in excess of $75,000 be awarded, or, alternatively, that the settlement agreement be set aside. The Company believes that it has fulfilled its obligations under the settlement agreement and that the claims made by Plaintiff against the Company in this action are without merit. Accordingly, in response to this action, the Company filed a motion to dismiss for failure to state a claim against the Company, which is pending before the Court. However, there can be no assurance that the Company's motion will be granted, or if the motion is denied, that the Company will succeed in defending or settling this action. Additionally, there can be no assurance that the action will not have a material adverse effect on the Company. ITEM 6. EXHIBIT AND REPORTS ON FORM 8-K (a) Exhibit EXHIBIT DESCRIPTION 10.1 -- Memorandum of Understanding between the Company and Dr. Bryan J. Zwan dated October 14, 1999. 27 -- Financial Data Schedule (for SEC use only). (b) Reports on Form 8-K. No reports on Form 8-K were filed during the period covered by this Report. 19 22 SIGNATURES 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 and in the capacities and on the dates indicated. Digital Lightwave, Inc. By: /s/ GERRY CHASTELET ------------------------------------ Gerry Chastelet Chairman, Chief Executive Officer And President (Principal Executive Officer) Date: November 15, 1999 By: /s/ STEVEN H. GRANT ------------------------------------ Steven H. Grant Executive Vice President -- Finance, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer) Date: November 15, 1999 20 EX-10.1 2 MEMORANDUM OF UNDERSTANDING DATED OCTOBER 14, 1999 1 EXHIBIT 10.01 DIGITAL LIGHTWAVE, INC. MEMORANDUM OF UNDERSTANDING October 14, 1999 This memorandum of understanding ("Memorandum") is binding and sets forth the agreement between Digital Lightwave, Inc. (the "Company") and Dr. Bryan Zwan, the majority stockholder of the Company ("BJZ"). Upon execution of this Memorandum, the parties agree to immediately proceed to prepare and execute additional agreements regarding the terms of this Memorandum; provided however that if the parties hereto do not ever finalize such additional agreements, this Memorandum shall be binding and control with respect to the matters contained herein. 1) RETRACTION OF LETTERS TO THE OUTSIDE DIRECTORS OF THE COMPANY BJZ hereby retracts, and agrees to execute a formal notice retracting, the statements contained in his letters dated September 16, 1999 and September 20, 1999. 2) AGREEMENT NOT TO TAKE ADDITIONAL ACTION For so long as he is a director of the Company, BJZ shall not take any action in his capacity as a stockholder of the Company to (a) remove current senior management of the Company (Messrs. Chastelet, Grant, Haider and Matz); it being understood that BJZ may, in his capacity as a director, remove senior management in accordance with paragraph 4(c) below or (b) remove Messrs. Hamilton, Chastelet or Zwan from the Board from the date hereof up to and including the date of the annual meeting in the year 2000. 3) AGREEMENT WITH RESPECT TO THE BOARD a) BJZ and the Company shall enter into an agreement which provides that: i) The size of the Company's board of directors (the "Board") shall be increased from four members to five members and two new, outside directors ("New Directors") shall be appointed to the Board. ii) William Seifert shall resign from the Board upon the later to occur of (i) the appointment of the New Directors to the Board and (ii) the conclusion of his assignments on the two special committees of the Board on which he serves. iii) The New Directors shall be nominated for appointment to the Board by any member of the current Board (Messrs. Hamilton, Seifert, Zwan and Chastelet). iv) BJZ agrees to vote his shares of common stock at the Company's annual meeting in the year 2000 in favor of the election to the Board of Messrs. Hamilton, Chastelet 2 and Zwan and, if appointed to the Board prior to the annual meeting in the year 2000, the New Directors. v) The New Directors shall be appointed to the Board only with the vote or consent of a majority of the directors serving as of the date hereof; provided however that no director shall serve without the affirmative vote or consent of BJZ in the Board action to appoint the New Directors. 4) EMPLOYMENT AGREEMENTS a) Upon the vote of a majority of the members of the Board serving as of the date hereof and eligible to vote, the Company shall enter into an agreement with respect to change of control, severance and non-compete with Messrs. Chastelet, Grant, Haider and Matz. b) The agreements referred to in paragraph 4(a) above shall be in the form negotiated, in good faith and in accordance with current negotiations, between counsel to the Company and counsel to BJZ. c) The agreements referred to in paragraph 4(a) above shall contain a provision providing for removal of Messrs. Chastelet, Grant, Haider and Matz, as applicable, in accordance with the terms of their respective agreements, upon the vote of a majority of the members of the Board. 5) UNTERBERG PUBLIC OFFERING a) The Company and BJZ agree to decide by November 1, 1999 whether to proceed immediately on such date with the public offering of common stock by the Company and, if BJZ so elects, BJZ, by converting the proposed underwritten offering by C.E. Unterberg Towbin ("Unterberg") on file with the Securities and Exchange Commission as of the date hereof, into an equity offering. b) The terms and conditions of the public offering of common stock, including the pricing, and other terms, shall be finally determined by the Pricing Committee established by the Board for this purpose, which is comprised of BJZ, Dr. William Hamilton and Mr. William Seifert. 3 c) In connection with the offering, BJZ will agree to a standard six month lock-up agreement with the Company and Unterberg with respect to any public sale (including a sale under Rule 144) of his shares of common stock, other than shares currently under option. Executed on October 14, 1999. DIGITAL LIGHTWAVE, INC. By: /s/ Gerry Chastelet /s/ Dr. Bryan J. Zwan ------------------------------ ----------------------------------- Gerry Chastelet Dr. Bryan J. Zwan President and CEO EX-27 3 FINANCIAL DATA SCHEDULE (FOR SEC USE ONLY)
5 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 4,779 0 11,533 0 5,396 23,428 13,578 4,640 33,291 17,939 0 0 0 3 15,160 33,291 33,002 33,002 11,729 11,729 20,263 0 171 1,073 0 1,073 0 0 0 1,073 (0.04) (0.04)
-----END PRIVACY-ENHANCED MESSAGE-----