September 24, 1998
INNOVACOM INC (MPEG)
Quarterly Report (SEC form 10QSB)
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
With the exception of historical facts stated herein, the matters discussed in this report are "forward looking" statements that involve risks and uncertainties that could cause actual results to differ materially from projected results. Such "forward looking" statements include, but are not necessarily limited to, statements regarding anticipated levels of future revenues and earnings from operations of the Company. Factors that could cause actual results to differ materially include, in addition to other factors identified in this report, lack of revenues, substantial losses, need for additional capital and limited operating history, and other risks factors detailed in the Company's Securities and Exchange Commission ("SEC") filings including the risk factors set forth in the Company's Registration Statement on Form SB-2, SEC File No. 333-45875 and "Certain Consideration" section in the Company's Form 10-KSB for the year ended December 31, 1997. Readers of this report are cautioned not to put undue reliance on "forward looking" statements which are, by their nature, uncertain as reliable indicators of future performance. The Company disclaims any intent or obligation to publicly update these "forward looking" statements, whether as a result of new information, future events, or otherwise.
As discussed in "Item 5. Other Information," in June 1998, the Company reevaluated its business and decided to focus the Company in the development of video compression technology in the areas of digital television, communications, and digital video disks. As a result of this emphasis, the Company has decided to discontinue its ASIC design project, cancel a number of projects and reduce personnel. See "Liquidity and Capital Resources - Management Plans." Therefore, the results for the three months ended March 31, 1998, will not be indicative of future operations.
Three Months Ended March 31, 1998, Compared to March 31, 1997.
Revenues
Revenues decreased to approximately $45,000 for the first quarter ended March 31, 1998, from approximately $75,000 for the first quarter ended March 31, 1997. In the first quarter of 1997 three developer kits were sold to customers who were considering purchase of the Company's single chip encoder product. There were no developer kit sales in the same period of 1998, but sales of pre-production system and board products partially offset this decline.
Cost of goods sold
Cost of goods sold was approximately $22,000 or 49% of revenue for the first quarter ended March 31, 1998, compared to approximately $21,000 or 28% of revenue for the first quarter ended March 31, 1997. This reflects the difference in the cost structure of the developer kits sold in 1997 relative to the pre-production products sold in 1998. Neither percentage is necessarily representative of the cost of sales percentage that might be experienced at such time, if any, that finished products begin to be shipped.
Research and development
Research and development was approximately $1,210,000 for the first quarter in 1997 as opposed to approximately $1,423,000 for the first quarter of 1998. Expense in the first quarter of 1997 included $500,000 for the purchase of certain technology, an expense that was not repeated in the same period in 1998, but this was more than offset by expenditures in many areas but principally for supplies and materials, consultants, and payroll that were higher in the first quarter of 1998 than in 1997.
Selling, general and administrative
Selling, general and administrative expenses were approximately $2,015,000 for the quarter ended March 31, 1998, compared to approximately $841,000 for the quarter ended March 31, 1997. In the first quarter of 1998, the Company experienced increased expenses required by public companies for SEC and public reporting, legal expenses related to the Company's ongoing litigation, and costs due to additional administrative personnel relative to the first quarter of 1997. In the first quarter of 1998, the Company' was preparing for the release of new products, but was not doing so in the same period in 1997. This caused an increase in marketing and sales expenses in the quarter ended March 31, 1998 relative to the same quarter in 1997.
Interest Income
Interest income was approximately $10,000 in the first quarter of 1998 as compared to approximately $1,000 for the same quarter in 1997. Both amounts reflect interest earned on short term investment of surplus cash. The Company had more surplus cash in the first quarter of 1998 and earned correspondingly more interest income.
Interest expense
Interest expense in the three months ended March 31, 1998 was approximately $987,000 as compared to approximately $4,000 for the same period in 1997. At December 31, 1997, and during the three months ended March 31, 1998, the Company had a note payable and convertible debentures outstanding with a balance in total in excess of $8,000,000. There were no corresponding liabilities at December 31, 1996, or in the three months ended March 31, 1997. The stated interest on these two items for the three months ended March 31, 1998 was approximately $173,000. Amortization of the original discount of the convertible debentures generated an additional interest expense in the first quarter of 1998 of approximately $777,000. These expenses were not present in the three months ended March 31, 1997.
Loss from Continuing Operations Before Income Tax Expense and Discontinued Operations
Loss from continuing operations before income tax expense and discontinued operations increased from approximately $2,002,000 in the three months ended March 31, 1997, to approximately $4,391,000 for the same period in 1998. This increase reflects the substantial increases in expenses from 1997 to 1998.
Income Tax Expense
Income tax expense reflects the minimum state tax provision for the Company.
Liquidity and Capital Resources
Through March 31, 1998, the Company funded its operations primarily through the sale of stock and placement of short and long term debt. On March 31, 1998, the Company had a cash balance of approximately $795,000 and a working capital deficit of approximately $5,623,000. This compares with cash of approximately $4,148,000 and a working capital deficit of approximately $1,454,000 at December 31, 1997. The decrease in both cash and working capital is primarily due to the operating losses of the Company, net of non-cash expenses, and to purchases of fixed assets in the three month period ended March 31, 1998. Cash used by operating activities from continuing operations for the Company totaled approximately $2,318,000 and $1,006,000 for the three months ended March 31, 1998 and 1997, respectively. Cash used in investing activities consisted of expenditures for the purchase of property and equipment. Such expenditures increased to approximately $824,000 during the three months ended March 31, 1998, from approximately $216,000 during the prior year period. During the three months ended March 31, 1997, cash provided by financing activities included proceeds of $665,000 from the sale of common stock, and proceeds from notes payable borrowings of $565,000
In May 1998, Micro Technologies converted $4,181,422 of its line of credit to the Company in exchange for 1,742,362 shares of Common Stock.
To provide for working capital, in June 1998, the Company issued 7% Convertible Debentures in the aggregate principal amount of $2 million (the "Debentures"). The Debentures accrue interest at the rate of 7% per annum and are convertible into shares of the Company's Common Stock at a conversion price equal to $0.35 per share. The Debentures have a term of five years, expiring June 29, 2003 (the "Due Date"), and are secured by all of the assets of the Company. As part of the issuance of the Debentures, the Company issued to the Debenture holders five year warrants to purchase up to 500,000 shares of Common Stock at $.50 per share. In conjunction with the issuance of the Debentures, Micro Technologies subordinated its lien on the Company's assets to the Debenture holders.
On June 26, 1998, Micro Technologies converted its remaining balance on the credit facility of $317,358 into 1,220,608 shares of common stock and terminated the credit facility.
The Company continued to experience losses in the quarter ended June 30, 1998, which forced the Company to expend essentially all its cash on hand at March 31, 1998, to borrow additional amounts from a number of lenders, and to carry an increased level of accounts payable. In June of 1998, the Company reduced headcount substantially, closed or curtailed a number of operations and projects, suspended essentially all new purchases or commitments for capital assets, and began to identify and sell surplus assets with the goal of reducing its monthly cash usage rate by more than 50%. Management determined to concentrate on those projects and
products that it anticipated would generate short-term revenue and cash flow, and minimize future requirements for additional debt or equity placements.
To provide for additional working capital, on or about August 28, 1998, the Company issued additional Debentures in the aggregate principal amount of $500,000, with the right to issue up to $1 million more Debentures in September and/or October 1998 under the same terms. The Debentures accrue interest at the rate of 7% per annum and are convertible into shares of the Company's Common Stock at a conversion price equal to the lesser of (i) 125% of the five-day average share price at the time of issuance and (ii) 80% for conversions prior to 120 days after issuance, 77.5% for conversions 120-150 days after issuance, and 75% thereafter. The Debentures have a term of five years, expiring August 28, 2003, and are secured by all of the assets of the Company. As part of the issuance of the Debentures, the Company issued to the Debenture holders five year warrants to purchase up to 75,000 shares of Common Stock at $.50 per share.
In the event the company is unable to generate revenue, the Company will require additional funding to finance its operations. There can be no assurance that the Company will be successful in its efforts to internally generate the cash that will be required to fund the Company's operations and to pay off the liabilities incurred in prior periods. Traditionally, the Company has financed its operations through the issuance of convertible debentures. However, no assurance can be given that the Company will be able to secure additional financing or, if it can, that it will be available on terms favorable to the Company.
Impact of the Year 2000 Issue
The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's, or its suppliers' and customers' computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations causing disruptions of operations including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
The majority of the Company's operations are based on PC application and the Company believes that its software is year 2000 compliant. The Company has not yet identified any year 2000 problem but will continue to monitor the issues. No assurances can be given that the year 2000 problem will not occur with respect to the Company's computer systems.
Neither the Company nor its subsidiary have initiated formal communications with significant suppliers and large customers to determine the extent to which those third parties' failure to remedy their own Year 2000 Issues would materially effect the Company and its subsidiaries. The Company has not received any indication from its suppliers and large customers that the Year 2000 Issue may materially effect their ability to conduct business and the Company has no current plans to formally undertake such an ass |
