-----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, Fdd2g6AlPFWovE2UNpXXUCoHN+TgAFVU2HtWwaT+woq3NvnveI1syysAfjHgtrN/ 3MTtT8ko2HUhF4+B1te8aw== /in/edgar/work/20000629/0000950148-00-001361/0000950148-00-001361.txt : 20000920 0000950148-00-001361.hdr.sgml : 20000920 ACCESSION NUMBER: 0000950148-00-001361 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 20000629 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COYOTE NETWORK SYSTEMS INC CENTRAL INDEX KEY: 0000057201 STANDARD INDUSTRIAL CLASSIFICATION: [3661 ] IRS NUMBER: 362448698 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 001-05486 FILM NUMBER: 665375 BUSINESS ADDRESS: STREET 1: 4360 PARK TERRACE DRIVE CITY: WESTLAKE VILLAGE STATE: CA ZIP: 91361 BUSINESS PHONE: 8187357600 MAIL ADDRESS: STREET 1: 4360 PARK TERRACE DRIVE CITY: WESTLAKE VILLAGE STATE: CA ZIP: 91361 FORMER COMPANY: FORMER CONFORMED NAME: DIANA CORP DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: FH INDUSTRIES CORP DATE OF NAME CHANGE: 19850814 FORMER COMPANY: FORMER CONFORMED NAME: SCOT LAD FOODS INC DATE OF NAME CHANGE: 19841202 10-K/A 1 e10-ka.txt FORM 10-K/A 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------- FORM 10-K/A AMENDMENT NO. 5 ------------------------- [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 31, 1999 [ ] 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 1-5486 COYOTE NETWORK SYSTEMS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 36-2448698 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 1640 SOUTH SEPULVEDA BOULEVARD, SUITE 320 LOS ANGELES, CALIFORNIA 90025 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (800) 935-8506 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $1.00 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] YES [ ] NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] On June 15, 2000, the aggregate market value of the voting stock of the Registrant held by stockholders who were not affiliates of the Registrant was $97,753,000 based on the closing sale price of $6.00 of the Registrant's common stock on The Nasdaq National Stock Market. At June 15, 2000, the Registrant had issued and outstanding an aggregate of 17,430,451 shares of its common stock. For purposes of this Report, the number of shares held by non-affiliates was determined by aggregating the number of shares held by Officers and Directors of Registrant, and by others who, to Registrant's knowledge, own more than 10% of Registrant's common stock, and subtracting those shares from the total number of shares outstanding. DOCUMENTS INCORPORATED BY REFERENCE -- NONE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I FORWARD-LOOKING STATEMENTS All statements other than historical statements contained in this Report on Form 10-K constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Without limitation, these forward looking statements include statements regarding new products to be introduced by us in the future, statements about our business strategy and plans, statements about the adequacy of our working capital and other financial resources, and in general statements herein that are not of a historical nature. Any Form 10-K, Annual Report to Shareholders, Form 10-Q, Form 8-K or press release of ours may include forward-looking statements. In addition, other written or oral statements which constitute forward-looking statements have been made or may in the future be made by us, including statements regarding future operating performance, short and long-term sales and earnings estimates, backlog, the status of litigation, the value of new contract signings, industry growth rates and our performance relative thereto. These forward-looking statements rely on a number of assumptions concerning future events, and are subject to a number of uncertainties and other factors, many of which are outside of our control, that could cause actual results to differ materially from such statements. These include, but are not limited to: risks associated with recent operating losses, no assurance of profitability, the need to increase sales, liquidity deficiency and the other risk factors set forth herein (see Item 7 -- Risk Factors). Except as required by law, including the federal securities laws, we do not undertake any obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. ITEM 1. BUSINESS GENERAL Coyote Network Systems, Inc. is engaged in the business of selling international long distance services. We sell competitively priced wholesale international long distance services, primarily to entrepreneurial carriers and we market retail international long distance services, primarily to affinity groups, i.e., groups that share a common characteristic such as language or culture. We were incorporated in 1961, and in November 1996, we made a strategic decision to dispose of all of our non-telecommunications equipment businesses. As a result, in 1997, we divested the Atlanta Provision Company, a meat and seafood provider, and C&L Communications, a distributor of telecom and datacom products. In 1998, we completed the restructuring by divesting Valley Communications, a network installation and service company. Accordingly, in 1997, we changed our name to Coyote Network Systems, Inc. In April 1998, we expanded the scope of our telecommunications business by acquiring substantially all of the assets of American Gateway Telecommunications, a provider of wholesale international long distance services. In September 1998, we completed the acquisition of INET Interactive Network System, a provider of international long distance services primarily to commercial and residential affinity groups. In November 1998, we formed TelecomAlliance, which was designed to enhance the growth and liquidity of entrepreneurial carriers by providing its member companies with wholesale long distance and Internet services. In January 1999, we formed Coyote Communications Services LLC, designed to provide network operations and support services to our customers and other new, entrepreneurial carriers. In September 1999 we sold substantially all of the assets of American Gateway. In May 2000, we made a strategic decision to discontinue the switch segment of our business, including the businesses of TelecomAlliance and Coyote Communications Services LLC. See "Our Discontinued Segments" and "Subsequent Events". In fiscal 1999 and 2000, we derived $6.8 million and $11.8 million, respectively, of revenue from the retail and wholesale international long distance service, our only continuing segment. In March 2000, we agreed to acquire Group Long Distance, Inc., or GLDI, a non-facilities-based reseller of long distance services to more than 15,000 small and medium-sized businesses and residential customers. On May 10, 2000, we entered into an Agreement and Plan of Merger, subsequently amended on May 26, 2000, under which we agreed to acquire Primary Knowledge, Inc., a California corporation in the process of changing its name to HomeAccess MicroWeb, Inc. HomeAccess is a developer of local community on-line 1 3 exchange services that are expected to enable customers to select, order and pay for products and services on-line from local merchants using personal computers or less expensive screen phones. The consummation of the transactions contemplated by the merger agreement are subject to certain contingencies, including approval of our stockholders. In May 2000, we agreed to acquire two additional telecommunications carriers, Ariana Telecommunications and Poly Link Development Ltd., which provide service in a variety of locations in the Middle East and eastern Asia, respectively. The acquisitions of GLDI, Ariana and Poly Link are subject to certain closing conditions which we expect will be satisfied later this year. Our principal executive offices are located at 1640 South Sepulveda Boulevard, Suite 320, Los Angeles, California 90025, and our telephone number is (800) 935-8506. INDUSTRY OVERVIEW Evolving technologies, pro-competitive legislation, deregulation and privatization of international telephone companies, the build-out of new networks in developing countries, the Internet, new carrier services and changing customer demands mark today's telecommunications industry. We believe these developments have created a new paradigm, an opportunity for new, emerging domestic and international carriers to compete with incumbent carriers and for established carriers to expand beyond their traditional markets. International Long Distance Market. The international long distance market is a large and growing segment of the telecommunications market. According to TeleGeography, a market research firm, the total market for international long distance services in 1997 was approximately $65.9 billion. International Data Corporation expects international long distance traffic to grow from 94.9 billion minutes in 1998 to 187.1 billion minutes in 2002. We believe that this growth will accelerate as countries around the world continue to deregulate their telecommunication markets. From the standpoint of U.S.-based long distance providers, the industry can be divided into two major segments: The U.S. international market, consisting of all international calls billed in the U.S., and the overseas market, consisting of all international calls billed in countries other than the U.S. The U.S. international market has experienced substantial growth in recent years, with gross revenues from international long distance services rising from approximately $8.0 billion in 1990 to approximately $19.3 billion in 1997, according to Federal Communications Commission data. The 1984 deregulation of the U.S. telecommunications industry enabled the emergence of a number of new long distance companies in the U.S. Currently, there are more than 500 U.S. long distance companies, most of which are small or medium-sized companies. To be successful, these small and medium-sized companies need to offer their customers a full range of services, including international long distance. However, most of these carriers do not have the critical mass to receive volume discounts on international traffic from the larger facilities-based carriers such as AT&T Corp., MCI Worldcom and Sprint Corporation. In addition, these small and medium-sized companies generally have only limited capital resources to invest. New international carriers emerged to take advantage of this demand for less expensive international bandwidth. These entrepreneurial carriers acted as aggregators of international traffic for smaller carriers, taking advantage of larger volumes to obtain volume discounts on international routes (resale traffic), or investing in facilities when volume on particular routes justified such investments. Over time, as these international carriers became established and created high quality networks, they began to carry overflow traffic from the larger long distance providers seeking lower rates on certain routes. Our wholesale international long distance business is designed, among other things, to obtain volume discounts and other economies by aggregating a number of emerging carriers. The highly competitive and rapidly changing international telecommunications market has created a significant opportunity for carriers that can offer high quality, low cost international long distance service. Deregulation, privatization, the expansion of the resale market and other trends influencing the international telecommunications market are driving decreased termination costs, a proliferation of routing options and increased competition. Successful companies among both the emerging and established international long distance companies will need to aggregate enough traffic to lower costs of both facilities-based or resale 2 4 opportunities, maintain systems which enable analysis of multiple routing options and provide a variety of services, invest in facilities and switches and remain flexible enough to locate and route traffic through the most advantageous routes. We seek to take advantage of these market conditions as a provider of retail and wholesale international long distance services. OUR RETAIL AND WHOLESALE DOMESTIC AND INTERNATIONAL LONG DISTANCE SERVICES We provide wholesale domestic and international long distance services, primarily to emerging and entrepreneurial carriers through a flexible network comprised of international gateway switches, leased transmission facilities and resale arrangements, operating agreement and termination arrangements with other long distance service providers, all of which enables us to complete telephone calls to more than 200 countries in Europe, Africa, Asia, the Pacific Rim, Australia, Canada, the Caribbean and Central and South America. Our INET Interactive Network System subsidiary is a full service, facilities-based telecommunications carrier that provides retail as well as wholesale long distance services to commercial customers as well as affinity groups, such as French and Japanese speaking people in the United States. As of March 31, 1999, INET had approximately 9,900 customers who purchased approximately 16.3 million minutes of traffic for the three months ended March 31, 1999. As of March 31, 2000, INET had approximately 23,600 customers who purchased approximately 23.4 million minutes of traffic for the three months ended March 31, 2000. INET's retail and wholesale services include call origination to and from anywhere in the U.S. to more than 200 countries worldwide. INET also provides back office services, such as billing administration and invoice reconciliation services and switch partitioning which maximizes switch resources and generates additional revenue by permitting the resale of excess switching capacity to other carriers. INET also provides retail services such as 1-800/888 services, calling card and pre-paid debit card services, billing services and language-centric and culture-sensitive customer support. Our former American Gateway Telecommunications subsidiary was a full service, facilities-based carrier offering wholesale services to telecom carriers and switchless resellers. AGT provided international long distance services to Asia, the Pacific Rim, Europe and the Americas. In fiscal 1999, American Gateway had nine wholesale customers who purchased an aggregate of 4.3 million minutes of traffic. In September 1999, we sold our interest in American Gateway by transferring all the assets and liabilities to PrinVest Corp., reporting a gain of $6.2 million. OUR DISCONTINUED SEGMENTS Our primary equipment products include telecommunications switches ("DSS Switches") and Internet Protocol gateways, or entrances and exits to a communications network ("Carrier IP Gateways"), designed to route voice traffic over public and private networks and the Internet. In fiscal 1999 and 2000, we generated revenues of approximately $32 million and $13 million, respectively, from the sale of switching and related original equipment manufacturer, or OEM, equipment. In May, 2000, we made the strategic decision to discontinue and dispose of this segment, including our DSS Switches and Carrier IP Gateways, and have substantially exited these business segments. Revenue from the sale of international long distance service constitutes our primary source of revenue. See "Subsequent Events". DSS Switch. We designed, developed, engineered and marketed flexible telecom switches that enable telecommunications carriers to provide voice and data services to retail and wholesale customers. DSS Switches enable telecom carriers to provide local, long distance and Internet access as well as value-added services like debit and credit card services, 800 number services, conferencing and operator services. The DSS Switch converts different signaling systems from international countries such that they are compatible with the signaling system used for domestic telephone calls, providing reliable, efficient, affordable international voice and data communications. 3 5 Carrier IP Gateway. The Carrier IP Gateway is a flexible Internet Protocol, or IP, solution designed to meet the needs of domestic and international long distance carriers, local service providers and Internet access providers. Internet Protocol describes software that is used on the Internet and data networks to track addresses, to route outgoing messages and to recognize incoming messages. The Carrier IP Gateway improves the efficiency of costly dedicated long distance telephone lines by compressing and packetizing the traffic and routing it between the public telephone network, private data networks and the Internet. The Carrier IP Gateway serves as a connection between the public telephone network, private voice and data networks and/or the Internet. The Carrier IP Gateway enables voice and fax calls to be routed over networks that use IP. Our equipment sales were targeted toward entrepreneurial carriers, such as competitive local exchange carriers, switchless resellers and international and domestic long distance providers. BUSINESS STRATEGY In addition to continuing to develop and grow our long distance carrier business through internal growth and acquisition, we plan to provide telephone communications services that will allow users to easily make retail purchases and bill payments using the Internet and provide other information services. In our view, the personal computer remains too complex and expensive to encourage high volumes of e-commerce transactions by the majority of the population. We believe that the market will move toward a much simpler electronic interaction between customer and seller, regardless of age, technological background, or location. We intend to build the "Model A" of Internet transaction-platforms based not on the computer with all its complexities but on the telephone with all its familiarities. We believe we can create a sustainable competitive advantage and increased valuation by providing our end-users customers with a low cost, high functionality communications package that includes easy-to-use Internet-based applications, local and long distance service and Internet access, all from a Web-enabled screen telephone. In most cases, we intend to sign agreements which call for vertical market partners, such as grocery chains, credit card issuers and utility companies, to purchase the requisite Web-enabled screen telephones for distribution in the partner's channels. Through these strategic relationships, we intend to generate transactional, e-commerce-based revenues through the tying together of a number of important consumer applications including long distance/local dial tone, Internet service, secure on-line shopping, bill payment and presentation, and smart card capability. In each case, a screen based telephone with a simple command and entry structure will be the primary interface, not the personal computer. We plan to receive revenues from e-commerce transactions, advertising and voice services as well as Internet access services. Each service and strategic partnership is intended to feed the others and drive a simple, yet comprehensive offering to our customers. The fulfillment of our strategy is subject to a number of contingencies, including obtaining adequate financing to complete acquisitions and to otherwise pursue our objectives. Target Markets. We plan to continue to acquire companies and form joint ventures to complement our carrier strategy and implementation of IP-based networks, both domestically and internationally, as well as acquiring cable rights to strategic countries. We are a licensed carrier in Japan and are pursuing carrier status in other countries. Sales and Marketing. To meet the needs of our customers, we market our services through the coordinated efforts of our direct sales force and independent agents. We primarily market our wholesale long distance services directly to U.S. based and foreign based international telecommunication carriers through our direct sales force. We primarily market our retail long 4 6 distance services through our agents and focused sales and marketing activities, e.g., advertising in local ethnic newspapers. Research and Development, Manufacturing and Supply. In fiscal 1999, we invested approximately $11.0 million in engineering, research and development efforts with the goal of providing new and enhanced features to our then existing DSS Switch and developing the Carrier IP Gateway, each of which are now discontinued segments of our business. See "Our Discontinued Segments" and "Subsequent Events". The purpose of these investments was to address the expanded customer and technical demands of the existing carrier marketplace while preparing us to successfully participate in the Internet Protocol based market. Our Switch Server Architecture, or SSA, is a scalable, open, standards-based platform that allows interworking of voice and data networks and the applications operating on these networks and is designed to meet the needs of entrepreneurial carriers. The SSA meets those needs by reducing network costs and enabling revenue generation through enhanced service applications. Carrier and service provider costs are reduced by routing voice and fax traffic over inexpensive IP networks. The SSA allows carrier and service providers to realize the cost reductions of next-generation IP-telephony networks while maintaining interoperability with the public telephone networks. The SSA employs internally-developed and OEM hardware and software components which enables us to quickly provide complete turnkey products and services to our customers. The SSA provides an industry-standard and open call-processing model which allows application developers to quickly develop and/or integrate third-party revenue-generating enhanced services. The research and development focus described above was conducted in accordance with detailed design specifications developed by us. We engaged contract engineers and independent laboratories to perform some of the research and development work. These efforts typically involved expertise in the following areas: automatic test systems, telecommunications and engineering processes, UNIX software, operation administration maintenance and provisioning, telecommunication signaling systems, telecommunications and data communications software and Internet software. In virtually all of these instances, we owned the results of the research and development performed. Where an application required the customization of existing contractor proprietary software, we typically entered into a license agreement with the contractor. Certain software and hardware for our DSS Switch and IP Gateway products were licensed or procured from other vendors under OEM arrangements, or were developed jointly with other vendors pursuant to research and development joint ventures, partnerships or similar arrangements. Other hardware and/or software components, such as subscriber and date line cards and core switch software, were developed by us or our contractors. General purpose hardware components were also used in the switches and IP gateways, which lowered costs and enabled us, if we chose, to acquire such components from more than one vendor. We performed certain system integration and test functions in house. In addition, we outsourced some of our manufacturing and procurement of raw materials used in manufacturing to outsourced vendors, including APW and I-PAC Manufacturing, Inc. Our outsource vendors have facilities to provide a turnkey product which includes the manufacturing or procurement of board, chassis, and system level assemblies. We conducted final assembly and testing of our products at our facility and then shipped the products directly to our end-user customer sites via a third-party transportation company. Certain software and hardware associated with adjunct and peripheral equipment to provide certain functions and features were licensed or procured under OEM arrangements from other vendors. 5 7 Proprietary Rights. We use a combination of trade secrets, industry know-how, confidentiality, non-compete agreements and tight control of our software to protect the services and features that we believe give us competitive advantages. Wholesale and Retail Facilities. We provide long distance service to and from international countries through a flexible network comprised of various foreign and domestic termination relationships, international gateway switches, leased facilities and resale arrangements with long distance providers. We plan to grow our revenues by capitalizing on the deregulation of international telecommunications markets. COMPETITION IN THE TELECOMMUNICATIONS INDUSTRY. Telecommunications markets are highly competitive. We compete with large communication carriers with financial resources significantly greater than ours. Some of these large carriers, such as AT&T, MCI Worldcom and Sprint, could initiate and support prolonged price competition to gain market share. The international telecommunications long distance market is intensely competitive and subject to rapid change. Our competitors in the international wholesale long distance market and the retail international long distance market include: - large, multinational corporations such as AT&T, MCI Worldcom and Sprint; - smaller service providers in the U.S. and overseas that have emerged as a result of deregulation, including providers such as Startec Global Communications Corp. and Primus Telecommunications Group, Inc., each of which focuses partly on affinity groups; - switchless and switch-based resellers of international long distance services; - international joint ventures and alliances; - dominant telecommunications operators that previously held various monopolies established by law over the telecommunications traffic in their countries; and - U.S. based and foreign long-distance providers that have the authority from the Federal Communications Commission, or FCC, to resell and terminate international telecommunications services. Many of these competitors have considerably greater financial and other resources and more extensive domestic and international communications networks than us. In addition, consolidation in the telecommunications industry could create even larger competitors with greater financial and other resources, and could also affect us by reducing the number of potential customers for our services. International competition also may increase as a result of the competitive opportunities created by a Basic Telecommunications Agreement concluded by members of the World Trade Organization, or WTO, in 1997. Under the terms of the WTO agreement, starting February 1998, the United States and more than 65 countries have committed to open their telecommunications markets to competition and foreign ownership and to adopt measures to protect against anti-competitive behavior. GOVERNMENT REGULATION. Our U.S. interstate and international telecommunications service offerings generally are subject to the regulatory jurisdiction of the Federal Communications Commission, or FCC. Our telecommunications service offerings outside the U.S. are generally done under contract to third-party carriers who deal with the international and in-country regulatory authorities. In addition, U.S. and foreign regulatory authorities may affect our international service offerings as a result of termination and/or transit arrangements. U.S. or international regulatory authorities may take action 6 8 or adopt regulatory requirements that could adversely affect us. Our business plan depends to a large degree on the deregulation of the telecommunications market which has enabled the emergence of many new services. United States Regulation We provide international telecommunications service to, from and through the United States and generally are subject to the terms of the Communications Act of 1934, the Telecommunications Act of 1996 and regulation by the FCC. Section 214 of the Communications Act requires us to make application to and receive authorization from the FCC prior to leasing international capacity, acquiring international facilities, purchasing switched minutes or providing international service to the public. In this regard, we offer telecommunications service pursuant to FCC authorization under Section 214. In addition, FCC rules require prior FCC approval before transferring control of or assigning FCC licenses and impose various reporting and filing requirements upon companies providing international services under a FCC authorization. We must file reports and contracts with the FCC and must pay regulatory fees that are subject to change. The long distance telecommunication services we offer in the U.S. also are subject to the jurisdiction of state regulatory authorities, commonly known as public utility commissions, or PUCs. Specifically, since we have facilities in California, New York, Georgia and Texas, we are subject to the regulations of the PUCs in those states. Regulatory action that may be taken in the future by the FCC may intensify competition, impose additional operating costs, disrupt transmission arrangements or otherwise require us to modify our operations. Although rule changes may provide us with more flexibility to respond more rapidly to changes in the global telecommunications market, they also will provide the same flexibility to our competitors. In addition, by its own actions or in response to a third-party's filing, the FCC could determine that our services, termination agreements, agreements with other carriers or reports do not or did not comply with FCC rules. If this were to occur, the FCC could order us to terminate non-compliant arrangements, fine us or revoke our FCC authorizations. We may also be indirectly adversely affected by the FCC on other actions that could affect our customers, potential customers, suppliers and the telecommunications industry in general. International Traffic. Under the World Trade Organization Basic Telecom Agreement, concluded in 1997, sixty-nine nations comprising 95% of the global market for basic telecommunications services agreed to permit competition from foreign carriers. In addition, fifty-nine of these countries have subscribed to specific pro-competitive regulatory principles. The WTO Agreement became effective in February 1998 and is expected to be implemented by the signatory countries by 2002. We believe the WTO Agreement will increase opportunities for us and for our competitors. However, the precise scope and timing of the implementation of the WTO Agreement remain uncertain and there can be no assurance that the WTO Agreement will result in beneficial regulatory liberalization. We have a "Special Type II Telecommunications Carrier" license that allows us to originate and terminate traffic in Japan. As such, we must comply with the provisions of the Japanese Telecommunications Business Law and the Japanese Ministry of Post and Telecommunications, or MPT, "Three Year program for the Promotion of Deregulation" and related laws on the "Rationalization of Regulatory Frameworks in the Telecommunications Field." A Special Type II license provides us with certain privileges and responsibilities, e.g., we must have two certified switch engineers in Japan and we must file periodic reports with the MPT. Environmental Regulation. Compliance with federal, state and local regulations relating to environmental protection has not had a material effect upon our capital expenditures, operating results or competitive position. 7 9 EMPLOYEES. As of June 19, 2000, we had 74 employees. In addition, we retain from time to time, on a contract basis, a number of people for specific projects. We believe that our future growth and success will depend in large part upon our ability to continue to attract and retain highly qualified people. We have no collective bargaining agreement with our employees. We believe that our relationships with our employees are good. Subsequent Event. In May 2000, we made the strategic decision to discontinue and dispose of the switch segment of our business and we have substantially exited that business segment. Our long distance services segment is now our only continuing segment. Our consolidated financial statements, Selected Financial Data and Management's Discussion and Analysis of Financial Condition and Results of Operations have been restated and revised to reflect the switch segment as discontinued operations. RISK FACTORS In addition to the other information included in this report, the following factors should be considered in evaluating our business and future prospects. OUR LIMITED OPERATING HISTORY IN OUR CURRENT BUSINESS SEGMENT MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS AND FUTURE PROSPECTS. In May 2000 we decided to discontinue and dispose of our switch business, which represented approximately 56% of our net sales for the year ended March 31, 2000. We did not enter the long distance services segment, which is currently our only business segment, until 1998. Accordingly, in our current business segment we have a limited operating history upon which you can evaluate our business and future prospects. In addition, we have recently entered into an agreement to acquire HomeAccess Microweb, Inc., a developer of local community on-line exchange services, a new business for us if this acquisition is consummated. You should consider the risks and uncertainties that companies in a relatively new business, like ours, may experience. Some of the risks and uncertainties we face as we continue to develop our experience in this market relate to our ability to: - sell our services; - generate significant revenues from our sale of long distance minutes; - integrate acquired businesses, technologies and services; and - respond to rapidly changing technologies and our competitors' development of similar services. If we are unable to address successfully some or all of these uncertainties, we may not be able to expand our business, compete effectively or achieve profitability. WE HAVE EXPERIENCED AND MAY CONTINUE TO EXPERIENCE OPERATING LOSSES AND NEGATIVE CASH FLOW FROM OPERATIONS, AND WE MAY BE UNABLE TO ACHIEVE PROFITABILITY. We have incurred substantial costs in developing and acquiring our businesses and technologies. For the last four fiscal years, we incurred losses from our operations. In addition, we experienced negative cash flow from operations of $17,859,000, $8,475,000, $6,125,000 and $15,673,000, in fiscal years 1997, 1998, 1999 and 2000, respectively. We may not be able to achieve profitability and positive cash flow from operations in the foreseeable future. To achieve profitability and positive cash flow, we must increase the sales of our services. If we are unable to increase our sales, we may not generate enough revenues to carry out our business plan and achieve profitability. Even if we do achieve profitability and positive cash flow, we may not be able to sustain or increase profitability and positive cash flow in the future. 8 10 IF WE ARE UNABLE TO OBTAIN SUBSTANTIAL ADDITIONAL FINANCING, WE MAY BE UNABLE TO SUPPORT OUR GROWTH, EXECUTE OUR BUSINESS STRATEGY OR RESPOND TO COMPETITIVE PRESSURES. As of March 31, 1999, we had negative working capital of $0.7 million and as of March 31, 2000, we had positive working capital of $2.5 million. Our current business plan contemplates growth through acquisitions, which would require substantial additional financing. The required additional financing may not be available to us on favorable terms or at all. Without additional financing on acceptable terms, we may have to reduce the scope of our planned expansion of operations. In particular, if we are unable to obtain adequate funds on acceptable terms or at all, we may be unable to: - take advantage of acquisition opportunities; - successfully integrate operations of acquired businesses into our own; - develop or enhance services; or - respond to competitive or business pressures. In addition, until we achieve higher sales and more favorable operating results, our ability to obtain funding from outside sources of capital could be restricted. THE MARKET PRICE OF OUR COMMON STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE, AND OUR INVESTORS MAY EXPERIENCE INVESTMENT LOSSES. The market price of our common stock has been and may continue to be volatile. As a result, investors may buy our stock at high prices only to see the price drop substantially a short time later. Our stock price may decline or fluctuate in response to a variety of factors, including: - actual or anticipated fluctuations in our operating results; - our announcement of potential acquisitions; - industry consolidation; - conditions and trends in the international telecommunications market; - adoption of new accounting standards affecting the telecommunications industry; - changes in estimates of our performance or recommendations by financial analysts; and - market conditions in the telecommunications industry and the market as a whole. The volatility of the market price of our stock could also result in securities class action litigation. Any litigation would result in substantial costs and divert our management's attention and resources. ANY FUTURE ACQUISITIONS OF COMPANIES MAY RESULT IN DISTRACTION OF OUR MANAGEMENT AND DISRUPTIONS TO OUR BUSINESS, AND WE MAY INCUR A VARIETY OF EXPENSES WITHOUT REALIZING THE ANTICIPATED BENEFITS. Our growth strategy is to expand through the acquisition of or investment in complementary businesses, technologies, services or products if appropriate opportunities arise. We may not be able to identify suitable acquisition or investment candidates in the future, or if we do identify suitable candidates, we may not be able to make such acquisitions or investments on commercially acceptable terms or at all. Our inability to make such acquisitions or investments and expand our range of services and products may have a negative impact on our growth strategy and our ability to compete in the long distance services segment of the telecommunications industry. If we acquire or invest in another company, we could have difficulty assimilating that company's personnel, operations, technology or products and service offerings. We may also experience risks associated with entering markets in which we have limited or no experience. In addition, the key personnel of the acquired company may decide not to work for us. These difficulties could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations. If we are unable to successfully integrate a newly acquired business into our existing operations, we may not be 9 11 able to recoup the cost of the acquisition. Furthermore, the accounting treatment for any acquisition transaction may result in significant goodwill, which, when amortized, will negatively affect our net income. Since April 1998, we have acquired two business, American Gateway Telecommunications and INET Interactive Network System, Inc., and we have entered into definitive agreements to acquire HomeAccess Microweb, Inc., Ariana Telecommunications and Poly Link Development Ltd. We disposed of our interests in American Gateway in October 1999 and we terminated a pending acquisition of Apollo Telecom, Inc. in April 1999 due to its inability to satisfy all of the closing conditions. In fiscal 2000 we also terminated a pending acquisition of additional interests in Systeam, S.p.A. because of our inability to timely raise the needed capital. We sold all of our interests in Systeam in February 2000. BECAUSE OUR BUSINESS IS NOT CURRENTLY DIVERSIFIED, A DECLINE IN OUR TELECOMMUNICATIONS BUSINESS WILL HARM OUR FINANCIAL PERFORMANCE AND MAY CAUSE THE PRICE OF OUR STOCK TO DECLINE. We have sold our non-telecommunications businesses and are discontinuing and disposing of our switch equipment segment to concentrate on developing our long distance services segment. For the year ended March 31, 2000, our switch segment represented approximately 56% of our total net sales. As a result of our decision to dispose of these segments of our business, we have become smaller and less diverse than in the past, with fewer fixed assets and a smaller revenue base. To reduce the effect of these business changes, we will have to develop and introduce new products or services on a timely basis. We may not be able to successfully develop, introduce and market new products and services, and any new products or services may not achieve market acceptance. If we are unable to develop new products or services and successfully market them, we may not be able to attain profitability. Any decrease in the sales of our services will no longer be offset by sales from our business segments that we discontinued and will therefore directly and adversely affect our financial condition, which may in turn cause the price of our stock to decline. OUR OPERATING RESULTS FLUCTUATE SIGNIFICANTLY FROM QUARTER TO QUARTER, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE AND MAKE IT DIFFICULT FOR US TO MANAGE OUR EXPENSES. Our operating results have fluctuated and may continue to fluctuate significantly from quarter to quarter due to a number of factors. In future quarters, our operating results may be below the expectations of public market analysts or investors, and the price of our common stock may decline. Some of the factors which cause fluctuations include: - fluctuations in the volume of calls, particularly in regions with relatively high per-minute rates; - the addition or loss of a major customer; - the loss of economically beneficial routing options for our traffic; - pricing pressure resulting from increased competition; - technical difficulties or failures with portions of our network; - fluctuations in the rates charged by carriers for our traffic and in other costs associated with obtaining rights to switching and other transmission facilities; - changes in the staffing levels of our sales, marketing and technical support and administrative personnel; and - market acceptance of new products. It is difficult for us to predict the occurrence of factors which may cause fluctuations. Because we base our expense levels in part on expectations regarding future sales, we may be unable to adjust spending in a timely manner to compensate for any unexpected shortfalls in sales. A significant shortfall in demand for our services relative to our expectations, or a material delay in customer orders, may cause us to be unable to meet our financial commitments. In recent periods, slower than expected closings of lease transactions and financings have adversely impacted our results and have had a negative effect on our cash flow and liquidity. 10 12 IF WE LOSE OUR KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN KEY PERSONNEL, WE MAY BE UNABLE TO PURSUE BUSINESS OPPORTUNITIES AND OUR REVENUES COULD DECLINE. We believe that our future success depends in large part upon our continued ability to recruit, hire, retain and motivate highly skilled technical, sales, marketing, network operations and managerial personnel. Competition for these employees is intense and may result in significant increases in our costs to hire and retain them, which could reduce our margins and profitability. We may not be successful in retaining key personnel, and the loss of any of our executive officers or other key employees, or the failure of any recently hired executive officers to integrate into our operations, could adversely affect our ability to execute our business strategy and compete in the telecommunications industry. If we are unable to attract additional qualified personnel in a timely manner and on reasonable terms, our revenues and profitability could decline. A PENDING NASDAQ INVESTIGATION MAY CAUSE THE PRICE OF OUR COMMON STOCK TO DECLINE, DISRUPT TRADING AND DISTRACT MANAGEMENT. In December 1998, we received publicity from several articles published by TheStreet.com, an Internet publication, which implied, among other things: - that one of our end-user customers, Crescent Communications, Inc., did not exist; and - that our sale of equipment to Crescent through a third party, Comdisco, Inc., was invalid. Following the publication of these articles, Nasdaq and the Securities and Exchange Commission commenced inquiries regarding our sale to Crescent Communications and other transactions. The SEC advised us in November 1999 that it had dropped its investigation. We do not know the status of the Nasdaq inquiry and Nasdaq has not contacted us regarding the matter since May 1999. If the Nasdaq inquiry continues it may divert the attention of our management from day-to-day operations which could have a material adverse effect on our business. If the Nasdaq inquiry results in a negative outcome, Nasdaq could impose a variety of sanctions against us, including possible de-listing. These sanctions could adversely affect the trading or registration of our common stock and cause the stock price to decline. IF WE DO NOT EFFECTIVELY MANAGE OUR GROWTH, OUR INFRASTRUCTURE MAY NOT BE ABLE TO SUPPORT IT AND WE MAY NOT BE ABLE TO MANAGE OUR BUSINESS. We have experienced growth in the number of our employees and the scope of our operations. This growth may strain our managerial and operational resources. To support our growth, our organizational infrastructure must grow accordingly. To manage potential future growth of our operations and personnel, we must improve our operational, financial and management information systems. If we fail to address these issues, our operational infrastructure may be insufficient to support our levels of business activity. In this event, we could experience disruptions in our business, delays in the development of new products and services or the enhancement of existing services, and declining revenues or profitability. ADDITIONAL FUNDING MAY BE DILUTIVE TO EXISTING STOCKHOLDERS OR MAY IMPOSE OPERATIONAL RESTRICTIONS. Any additional equity financing may be dilutive to our stockholders. Debt financing, if available, may involve restrictive covenants, which may limit our operating flexibility with respect to certain business matters, including limitations on our payment of dividends. If we raise additional funds by issuing equity securities, stockholders may experience dilution in net book value per share and any additional equity securities may have rights, preferences and privileges senior to those of the holders of our common stock. In February 2000, we sold shares equal to approximately 20% of our outstanding common stock in a private placement. Under NASD rules, we may not be able to obtain additional financing through another private placement in the near future without stockholder approval or a waiver from the NASD. 11 13 THE TELECOMMUNICATIONS INDUSTRY IS HIGHLY COMPETITIVE AND OUR INABILITY TO COMPETE SUCCESSFULLY COULD DECREASE THE DEMAND FOR OUR SERVICES AND ADVERSELY AFFECT OUR SALES AND REVENUES. Our competitors or potential competitors may have longer operating histories, greater name recognition, larger customer bases and greater financial, technical and marketing resources that we do. If we are unable to successfully compete in the marketplace, our revenues may decline. In addition, consolidation in the telecommunications industry could not only create even larger competitors with greater financial and other resources, but could also reduce the number of potential customers for our services. If we are unable to sell our services to the remaining potential customers, this could further impact our ability to attain a profitable level of sales. The international telecommunications industry is intensely competitive and subject to rapid change. Our competitors in the retail and wholesale international long distance market include: - multinational corporations; - service providers in the U.S. and overseas that have emerged as a result of deregulation; - switchless and switch-based resellers of international long distance services; - joint ventures and alliances among such companies; - dominant telecommunications operators that previously held various monopolies established by law over the telecommunications traffic in their countries; and - U.S. based and foreign long-distance providers that have the authority from the FCC to resell and terminate international telecommunications services. International competition also may increase as a result of the competitive opportunities created by the Basic Telecommunications Agreement concluded by members of the World Trade Organization in April 1997. Under the terms of such agreement, starting February 1998, the United States and more than 65 countries have committed to open their telecommunications markets to competition and foreign ownership and to adopt measures to protect against anti-competitive behavior. OUR INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS COULD HARM OUR COMPETITIVE POSITION AND OUR ABILITY TO MARKET AND SELL OUR SERVICES. We rely on a combination of trade secrets, confidentiality and non-compete agreements to protect our services and their specific features. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our services or to obtain and use information that we regard as proprietary. Competitors may also independently develop technologies that are substantially equivalent or superior to ours. Effective trademark, service mark, copyright and trade secret protection may not be available in every country in which we may market our services or products. Our failure to protect our intellectual property rights and proprietary information could enable others to offer services or products comparable or superior to ours which they could sell to our potential and existing customers. If this occurs, our customer base could be reduced and our sales could decline. Litigation may be necessary to enforce or protect our intellectual property rights or to defend against claims of infringement. Litigation for these purposes could be costly and could divert the attention of our management from day-to-day operations. An adverse outcome in intellectual property litigation could cost us our proprietary rights, subject us to significant liabilities, require us to seek licenses from third parties (which they may not be willing to grant) or prevent us from selling our services, all of which could have a material adverse affect on our ability to compete in the telecommunications industry and our overall business. We recently settled litigation involving a claim that our use of the name "Coyote" infringed on the rights of the plaintiff and agreed to change our name. 12 14 OUR PLANS FOR INTERNATIONAL EXPANSION MAY NOT SUCCEED, WHICH COULD HARM OUR REVENUES, PROFITABILITY AND OVERALL GROWTH. We plan to increase our expansion into international markets. Our expansion into international markets may not succeed for a number of reasons, including: - our inability to obtain necessary permits and operating licenses in foreign countries; - unexpected regulatory changes; - legal uncertainties inherent in transnational operations; - fluctuations in international currency exchange rates or imposition of currency exchange controls; - potentially adverse tax consequences; - changes in political and economic conditions; and - difficulties in staffing and managing international operations. Difficulties we may encounter in our international operations could divert management's attention from other day-to-day operations and negatively affect our financial performance. Managing operations in multiple countries could also strain our ability to manage our overall growth. Our inability to manage growth could delay our development of new products and services and our enhancement of existing services, which could negatively impact our ability to compete in the telecommunications industry and our business in general. OPTIONS, WARRANTS, CONVERTIBLE SECURITIES AND OTHER COMMITMENTS TO ISSUE COMMON STOCK MAY DILUTE THE VALUE OF THE COMMON STOCK. As of June 19, 2000, we had outstanding warrants and options to issue up to 10,330,540 shares of common stock, and convertible securities convertible into up to 3,364,561 shares of common stock. If the common stock underlying such options, warrants, convertible securities and commitments were issued, it would dilute the book value per share, earnings per share and voting power of our outstanding capital stock. THE TELECOMMUNICATIONS INDUSTRY IS HIGHLY REGULATED AND FUTURE REGULATIONS MAY ADVERSELY AFFECT OUR BUSINESS AND OPERATIONS. The federal government, through the FCC and other federal agencies, regulates and administers the telecommunications industry by passing laws and regulations that control prices, competition and the sale of long distance minutes. Foreign governments and agencies perform similar functions. The U.S. Congress, the FCC or foreign governments or agencies may adopt new laws, regulations and policies that may directly or indirectly affect us in the future. The adoption of new legislation or regulations which impact telecommunications businesses could adversely affect our business and operations. ITEM 2. PROPERTIES Our executive offices are located in approximately 15,000 square feet of office space in Los Angeles, California currently leased by us under a five-year lease expiring March 2004. We also lease 21,000 square feet of office space in Richardson, Texas to support our engineering requirements under a seven-year lease expiring April 2005. We also lease 5,100 square feet of office space in Norcross, Georgia under a five-year lease expiring October 2003. Additionally, we lease 23,000 square feet of office space in Westlake Village, California, the former location of our executive offices, under a five-year lease expiring February 2003. We are currently subletting the Westlake Village space and plan to reduce our Richardson obligation by 60% in the near future. 13 15 ITEM 3. LEGAL PROCEEDINGS Coyote Network Systems, Inc. (The Diana Corporation) Securities Litigation (Civ. No. 97-3186) We were a defendant in a consolidated class action, In re The Diana Corporation Securities Litigation, that was pending in the United States District Court for the Central District of California. The consolidated complaint asserted claims against us and others under Section 10(b) of the Securities Exchange Act of 1934, alleging essentially that we were engaged, together with others, in a scheme to inflate the price of our stock during the class period, December 6, 1994 through May 2, 1997, through false and misleading statements and manipulative transactions. On or about February 25, 1999, the parties executed and submitted to the court a formal Stipulation of Settlement, dated as of October 6, 1998. Under the terms of the settlement, all claims asserted or that could have been asserted by the class are to be dismissed and released in return for a cash payment of $8.0 million (of which $7.25 million was paid by our D&O insurance carrier on behalf of the individual defendants and $750,000 was paid by Concentric Network Corporation, an unrelated defendant) and the issuance of three-year warrants to acquire 2,225,000 shares of our common stock at prices per share increasing each year from $9 in the first year, to $10 in the second year and $11 in the third year. The cash portion of the settlement was previously paid into an escrow fund pending final court approval. Charges relating to the warrants were fully reserved by us in fiscal 1998. On June 9, 1999, the Court rendered its Final Judgment and Order approving the settlement set forth in the Stipulation of Settlement. No objections to the approval of the settlement were filed. We are also involved with other proceedings or threatened actions incident to the operation of our businesses. It is our opinion that none of these matters will have a material adverse effect on our financial position, results of operations or cash flows. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 14 16 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock was listed on The Nasdaq National Market under the symbol CYOE on November 5, 1998. Prior to such date, our common stock was included for quotation on the NASD OTC Bulletin Board under the symbol CYOE. The table below sets forth by quarter, the high and low sales prices of our common stock on The Nasdaq National Market, and the high and low bid prices per share for our common stock obtained from trading reports of The Nasdaq National Market subsequent to November 5, 1998. The sales prices have been adjusted to reflect the 5% stock dividend paid on November 4, 1998. Prices set forth below from prior to our November 5, 1998, listing on The Nasdaq National Market reflect inter-dealer prices without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
FISCAL 1999 FISCAL 1998 - ---------------------------------------- --------------------------------------- QUARTER HIGH LOW QUARTER HIGH LOW ------- ------- ------ ------- ------ ------ First................ $ 9.167 $3.720 First................ $5.580 $1.235 Second............... 10.119 4.533 Second............... 9.762 2.679 Third................ 16.500 6.071 Third................ 8.274 4.539 Fourth............... $ 9.125 $4.125 Fourth............... $6.429 $3.303
At June 16, 2000, we had 1,180 stockholders of record. We have not declared any cash dividends during the last three fiscal years. We have no plans to pay cash dividends on our common stock in the foreseeable future. Further, pursuant to our subordinated debentures, we cannot pay cash dividends on our common stock if our consolidated tangible net worth ($5,488,000 at March 31, 2000) would be less than the aggregate principal amount of the subordinated debentures ($1,254,000). SALES AND ISSUANCE OF UNREGISTERED SECURITIES In June 1999, in connection with lease financing provided to our end-user customers, we issued three year warrants to PrinVest Financial Corporation, a third-party leasing company, pursuant to the exemption provided by Section 4(2) of the Securities Act of 1933, as amended. Each of these warrants is to purchase 30,000 shares of common stock and may be exercised for three years from the date of issuance at $3.56, $5.56 and $7.56, per share, respectively. 15 17 ITEM 6. SELECTED FINANCIAL DATA COYOTE NETWORK SYSTEMS, INC. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
AS OF AND FOR THE YEARS ENDED -------------------------------------------------------- MARCH 31, MARCH 31, MARCH 31, MARCH 30, APRIL 1, 1999 1998 1997 1996 1995 --------- --------- --------- --------- -------- Net sales..................................... $ 6,756 $ -- $ -- $ -- $ -- ======== ======== ======== ======= ======= Earnings (loss) from: Continuing operations(1)(2)................. $ (9,628) $(17,278) $ (4,081) $(1,912) $(2,140) Discontinued operations(3)(4)............... (5,115) (16,877) (16,429) (1,453) 1,420 Extraordinary items......................... -- -- (508) -- -- -------- -------- -------- ------- ------- Net loss................................. $(14,743) $(34,155) $(21,018) $(3,365) $ (720) ======== ======== ======== ======= ======= Earnings (loss) per common share (basic and diluted): Continuing operations....................... $ (1.11) $ (2.33) $ (0.74) $ (0.41) $ (.48) Discontinued operations..................... (0.52) (2.27) (2.97) (0.31) .32 Extraordinary items......................... -- -- (.09) -- -- -------- -------- -------- ------- ------- Net earnings (loss) per common share........ $ (1.63) $ (4.60) $ (3.80) $ (.72) $ (.16) ======== ======== ======== ======= ======= Cash dividends per common share............... $ -- $ -- $ -- $ -- $ -- Total assets.................................. 34,151 19,860 20,120 28,591 24,205 Debt(5)....................................... 13,983 5,490 1,958 2,099 2,240 Working capital (deficit)..................... (659) 4,509 6,161 13,282 15,489 Shareholders' equity.......................... 6,057 8,060 16,834 24,686 19,729
- --------------- (1) Included in the fiscal 1999 loss is a charge of $2,000,000 in connection with provisions for losses on deposits made to two long distance telecom carriers to secure capacity on their networks. These provisions were made due to concerns related to the financial viability of these carriers and doubt regarding the ultimate realization of the deposits. (2) Included in the fiscal 1998 loss are the following: legal, accounting and other professional fees of $1,300,000; charges of $1,875,000 with respect to non-cash accounting charges associated with the issuance of our common stock upon conversion of notes issued June 1998; a charge of $2,200,000 in connection with failed acquisitions; and a non-cash expense of $8,000,000 relating to the issuance of warrants as part of the settlement of the securities litigation. (3) Included in the loss from discontinued operations in fiscal 1997 is a provision of $7,550,000 recorded for restructuring costs, severance and the estimated loss on disposal of assets of certain discontinued operations and, in fiscal 1999, is a provision of $900,000 for a reduction in the estimated market value of land and buildings which were part of a discontinued operation. (4) Included in the loss from discontinued operations in fiscal 1998 is a non-cash expense charge of $5,522,000 for the conversion into our common stock of certain Class A and B units owned by our directors and employees of our switch business segment. See Note 3 of Notes to Consolidated Financial Statements. (5) Includes current portion of long term debt, capital leases, notes payable and line of credit. 16 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL DISCONTINUANCE OF SWITCH SEGMENT In May 2000, we decided to discontinue and dispose of our switch business including the manufacture, development, sale and service of DSS Switches and IP Gateway equipment. Prior to the May 2000 decision, this segment was our largest segment in terms of revenues. The discontinuance of our switch segment includes the operations of TelecomAlliance, our joint venture with Profitec, and Coyote Communications Services, LLC, or Coyote Communications. Expected operating results relating to the discontinued operations from April 1, 2000 until the expected disposal date are included in the estimated loss on disposal and was recorded as a charge in the consolidated financial statements in the fourth quarter of fiscal 2000. The Company recorded a charge for estimated loss on disposal of the switch business of approximately $11.0 million in fiscal 2000, which includes an estimated $2.5 million of expected losses of the segment for the first two quarters of fiscal 2001. The Company expects to dispose of the segment near the end of the second quarter of fiscal 2001. As a result of the discontinuances, dispositions, acquisitions and other events described above, the comparison of year-to-year results may not be meaningful. DISCONTINUANCE OF ATLANTA PROVISION COMPANY, C&L COMMUNICATIONS, INC. AND VALLEY COMMUNICATIONS, INC. In November 1996, we made a strategic decision to dispose of all of our non-telecommunications switch business segments (the "Restructuring"). Subsequently, on February 3, 1997, our Board of Directors approved the sale of Atlanta Provision Company to Colorado Boxed Beef Company. On November 20, 1997, we completed the sale of our telecommunications equipment and distributor subsidiary, C&L Communications, Inc. to the management of C&L. In March 1998, we reached an agreement for the sale of our 80% owned wire installation and service subsidiary, Valley Communications, Inc., to Technology Services Corporation. As part of the Restructuring, our Board of Directors approved plans changing our name to Coyote Network Systems, Inc. and in November 1997, our shareholders approved the name change. Subsequently, the name of our telecommunications equipment subsidiary, Sattel Communications LLC, was changed to Coyote Technologies, LLC ("CTL"). Based in Richardson, Texas, CTL has granted subordinated equity participation interests, which amount to approximately a 20% effective ownership interest in CTL, to certain of our employees. These participation interests are convertible into shares of our common stock at the option of the holder. OUR LONG DISTANCE SERVICES SEGMENT In April 1998, our subsidiary, Coyote Gateway, LLC ("CGL"), acquired substantially all of the assets of privately held American Gateway Telecommunications, Inc. ("AGT"), a provider of wholesale international long distance services, primarily to entrepreneurial carriers. In consideration of the asset transfer, AGT received a 20% ownership interest in CGL. CGL continues to operate under the name of AGT. Effective September 1999, we sold our interest in AGT to PrinVest Corp, reporting a gain of $6.2 million. On September 30, 1998, we completed the acquisition of INET Interactive Network System, Inc. ("INET"), through the merger of INET into one of our wholly owned subsidiaries. INET is a full service, facilities-based telecommunications carrier that provides retail as well as wholesale long distance services to commercial customers and residential affinity groups, such as French and Japanese speaking people in the U.S. SEGMENTS Following our decision in May 2000 to discontinue the operations of the telecommunications switching business, our business is reported for as one continuing operating segment, that is the provider of long distance services. 17 19 Fiscal year 1999 and the comparative historical results of operations have been restated to reflect the operations of our DSS Switch business segment separately as discontinued operations. The following discussion relates to the continuing operations of the long distance services and our corporate administration offices. The long distance services business was comprised of two subsidiaries: AGT, which was acquired in April 1998 and sold effective September 1999, and INET, which was acquired in September 1998. RESULTS OF OPERATIONS -- FISCAL YEAR ENDED MARCH 31, 1999 VERSUS MARCH 31, 1998 Our continuing operations in fiscal 1999 consisted of the business of our two international long distance service subsidiaries that were acquired during fiscal 1999, INET and AGT. AGT was sold effective September 1999. Because these operations were acquired during fiscal 1999, they did not generate any sales, cost of sales or gross profit in fiscal 1998. The following table reflects selected results of operations data for each subsidiary and our total continuing operations in fiscal 1999:
FISCAL 1999 ---------------------------------------- COYOTE AGT INET TOTAL ------ ------- ------ -------- Net sales........................................ $ -- $ 2,779 $3,977 $ 6,756 Cost of sales.................................... -- 3,031 2,847 5,878 ------- ------- ------ -------- Gross profit (loss).............................. -- (252) 1,130 878 ------- ------- ------ -------- Selling, general and administrative expenses..... 5,139 2,880 1,679 9,698 ------- ------- ------ -------- Operating loss................................... $(5,139) $(3,132) $ (549) $ (8,820) ======= ======= ====== ========
In fiscal 1999, gross profit (loss) for AGT and INET as a percent of net sales was (9.1%) and 28.4%, respectively. Selling, general and administrative expenses of the continuing operations for fiscal 1999 were $9.7 million, compared to $7.1 million for fiscal 1998, an increase of $2.6 million, or 37.4%. This increase is primarily related to the selling, general and administrative expenses incurred by INET and AGT, which were acquired during fiscal 1999, and expansion of our corporate staff and related expenses. In fiscal 1999 these expenses also included a charge of $2.0 million in connection with provisions for losses on deposits made by AGT to two long distance telecom carriers to secure capacity on their networks. These provisions were made due to concerns related to the financial viability of these carriers and doubt regarding the ultimate realization of the deposits. We do not anticipate additional similar charges of this magnitude in the future. In fiscal 1998 selling, general and administrative expenses included a charge of $2.2 million related to losses in connection with failed acquisitions, including costs advanced, costs of due diligence expenses, consulting fees, legal expenses and other professional services. The operating loss for fiscal 1999 was $8.8 million, compared to $7.1 million for fiscal 1998, an increase of $1.7 million, or 25.0%. The increase is primarily due to the lack of net sales from our continuing operations in fiscal 1998, the higher selling, general and administrative expenses associated with INET and AGT and expansion of our operations in fiscal 1999. Non-operating expense for fiscal 1999 was $0.8 million, compared to $2.2 million for fiscal 1998, a decrease of $1.4 million, or 63.6%. The decrease is due to a $1.0 million increase in gains on sale of marketable securities and a $0.4 million decrease in interest expense. The 18.9% decrease in interest expense results primarily from a $1.9 million charge in fiscal 1998 related to the discount from market value (beneficial conversion feature) of the common stock issued upon conversion of our 8% convertible notes issued in an aggregate principal amount of $7.5 million in fiscal 1998. This decrease in interest expense was partially offset by increases in interest expense due to an increase of $8.2 million in notes payable for financing costs relating to INET and AGT, offset by decreases due to a decrease in long-term debt of $3.7 million as a result of the conversion of our 8% convertible notes into shares of common stock. The loss from continuing operations for fiscal 1999 was $9.6 million, compared to $17.3 million in fiscal 1998, a decrease of $7.7 million, or 44.3%, due primarily to securities litigation warrant expense of $8.0 million in fiscal 1998 resulting from our agreement to issue three-year warrants to acquire 2,225,000 shares of our 18 20 common stock in connection with our settlement of the securities class action lawsuit described in "Legal Proceedings," and the other reasons discussed above. The loss from discontinued operations in fiscal 1999 was $5.1 million, compared to a fiscal 1998 loss from discontinued operations of $16.9 million, a decrease of $11.8 million, or 69.7%. The decrease in the loss from fiscal 1998 to fiscal 1999 was primarily due to sales increases of $26.4 million in the switch business. The fiscal 1999 loss consisted of an operating loss of $4.2 million related to the switching business segment and a loss of $0.9 million related to the sale of land and buildings of the Atlanta Provisions Company operation which was discontinued in fiscal 1997. The loss from discontinued operations in fiscal 1998 included a non-cash expense of $5.5 million related to the conversion of Class A and B units of ownership in the switching business. Net loss in fiscal 1999 was $14.7 million, compared to $34.2 million in fiscal 1998, a decrease of $19.5 million, or 56.8%. The decrease in net loss resulted primarily from the $8.0 million expense in fiscal 1998 for warrants to be issued in connection with our settlement of class action securities litigation and the decrease in losses from operations, offset by a $0.9 million charge in fiscal 1999 for the estimated loss on disposal of discontinued operations. RESULTS OF OPERATIONS -- FISCAL YEAR ENDED MARCH 31, 1998 VERSUS MARCH 31, 1997 We acquired our long distance services business, which comprise our continuing operations, in fiscal 1999. These operations did not generate any sales, cost of sales or gross profit in fiscal 1998 or 1997. Selling, general and administrative expenses for fiscal 1998 were $7.1 million, compared to $3.4 million for fiscal 1997, an increase of $3.7 million, or 107.0%. This increase is primarily related to a charge of $2.2 million in fiscal 1998 related to losses in connection with failed acquisitions, including costs advanced, costs of due diligence expenses, consulting fees, legal expenses and other professional services. The operating loss for fiscal 1998 was $7.1 million, compared to $3.4 million for fiscal 1997, an increase of $3.7 million, or 107.0%. The increase is primarily due to the higher selling, general and administrative expenses in fiscal 1998. Non-operating expense for fiscal 1998 was $2.2 million, compared to $1.5 million for fiscal 1997, an increase of $0.7 million or 47.3%. The increase in non-operating expense is primarily due to a $2.3 million increase in interest expense that results primarily from a $1.9 million charge in fiscal 1998 related to the discount from market value (beneficial conversion feature) of the common stock issued upon conversion of our 8% convertible notes issued in an aggregate principal amount of $7.5 million in fiscal 1998, and net gains on sale of marketable securities of $0.2 million in fiscal 1998 compared to net losses on such sales of $0.7 million in fiscal 1997. In addition, in fiscal 1997, we had non-operating expense of $1.1 million due to our write-down of our preferred stock in Concentric Network. The loss from continuing operations for fiscal 1998 was $17.3 million, compared to $4.1 million in fiscal 1997, an increase of $13.2 million, or 323.4%, due primarily to securities litigation warrant expense of $8.0 million in fiscal 1998 resulting from our agreement to issue three-year warrants to acquire 2,225,000 shares of our common stock in connection with our settlement of the securities class action lawsuit described in "Legal Proceedings," an income tax credit in fiscal 1997 of $0.8 million, and the other reasons discussed above. The loss from discontinued operations in fiscal 1998 was $16.9 million, compared to a fiscal 1997 loss of $8.9 million, an increase of $8.0 million, or 90.1%. The increase in the loss from fiscal 1997 to fiscal 1998 was primarily due to a non-cash expense of $5.5 million in fiscal 1998 related to the conversion of Class A and B units of ownership in the switching business and decreases in net sales of $222.0 million. Net loss in fiscal 1998 was $34.2 million, compared to a net loss of $21.0 million in fiscal 1997, an increase of $13.2 million, or 62.5%. The increase in net loss resulted primarily from the $8.0 million expense in fiscal 1998 for warrants to be issued in connection with our settlement of class action securities litigation and the $3.7 million increase in operating loss, offset by a charge of $7.6 million in fiscal 1997 for the estimated loss on disposal of discontinued operations consisting of Atlantic Provision Company, C&L Communications 19 21 and Valley Communications and an extraordinary charge of $0.5 million in fiscal 1997 relating to expenses incurred in connection with Atlantic Provision Company's refinancing its line of credit in October 1996 and repayment of the line of credit in February 1997. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 1998, we had positive working capital of $4.5 million, and as of March 31, 1999, we had negative working capital of $0.7 million. We used cash from operating activities of $6.1 million during fiscal 1999 compared to using $8.5 million during fiscal 1998. This improvement in operating cash flow in fiscal 1999 is primarily due to the reduction in losses of the discontinued switch business. Our receivables increased from $0.2 million as of March 31, 1998 to $2.5 million at March 31, 1999, representing approximately four months of net sales due to poor collection follow-up. Through improved procedures and collection efforts, accounts receivable at March 31, 2000 were $3.6 million, representing approximately two months of net sales. We used cash for investing activities of $4.5 million during fiscal 1999 compared to $14,000 provided from investing activities in fiscal 1998. The increase in cash used for investing activities primarily results from capital expenditures for discontinued operations and acquisition investments. Capital expenditures on equipment purchases increased from $0.3 million in fiscal 1998 to $1.6 million in fiscal 1999. Equipment purchases primarily consisted of additional switching equipment required to support the international long distance services business. We received net proceeds of $2.9 million in fiscal 1998 from the sale of Atlantic Provision Company and C&L Communications and spent $1.3 million in fiscal 1999 in connection with our acquisitions of INET and our 19.9% interest in Crescent Communications, Inc. Proceeds from sales of marketable securities decreased from $1.8 million in fiscal 1998 to $0.9 million in fiscal 1999, and we purchased $0.7 million of marketable securities in fiscal 1998 and $0 in fiscal 1999. Investments in affiliates increased from $0 million in fiscal 1998 to $0.4 million in fiscal 1999. Capital expenditures for discontinued operations, comprising equipment and software, also increased, from $1.2 million in fiscal 1998 to $3.3 million in fiscal 1999. Financing activities provided net cash of $8.1 million in fiscal 1999, compared to $12.1 million in fiscal 1998. In fiscal 1999, net cash provided by financing activities included net cash proceeds of $6.3 million from the issuance of 700 shares of 5% Series A Convertible Preferred Stock and warrants, a portion of which we redeemed for $4.0 million and warrants in fiscal 2000, and increases in borrowings under our line of credit and in notes payable. Net cash provided by financing activities in fiscal 1998 included $3.4 million of net proceeds from a private placement of 1,880,750 shares of common stock in July 1997, $2.2 million of proceeds from the exercise of stock options, $2.2 million of net proceeds from a private placement of $2.5 million aggregate principal amount of 8% convertible notes in July 1997 and $4.6 million of net proceeds from a private placement of $5.0 million aggregate principal amount of 8% convertible notes in December 1997. In the third quarter of fiscal 2000, we completed and received funding under two demand loans. The first loan for a total amount of $600,000 was provided by Mr. James Fiedler, our former Chairman and Chief Executive Officer, in the amount of $175,000, by Mr. Daniel W. Latham, our President, Chief Operating Officer and director, in the amount of $75,000 and by Mr. Alan J. Andreini, a shareholder, in the amount of $350,000 in September and October 1999. This loan bore interest at bank's prime rate plus 1% per year (9.25% at December 31, 1999), was repayable on demand and was secured against our investment in Systeam, S.p.A. The second loan for a total amount of $1,225,000 was provided by Mr. Richard L. Haydon, a shareholder, in the amount of $500,000, by Mr. Andreini in the amount of $225,000 and by three other shareholders in a combined total amount of $500,000, in November 1999. This loan bore interest at the rate of 17.5% per year and was repayable, on demand by the lenders, no earlier than March 31, 2000. The maximum term of the loan was three years to November 2002. This loan was secured by shares of the common stock of INET. Under the terms of this loan, the lenders were granted, pro-rata, a combined total of 73,500 three-year warrants to purchase shares of our common stock at an exercise price of $4.50 per share. The warrants resulted in a non-cash interest expense charge of $0.3 million taken in the fourth quarter of fiscal 2000. 20 22 We repaid these loans and the accrued interest in February and April 2000. In January and February 2000, we completed a private placement with accredited investors and sold 3,157,895 shares of our 6% Series B Preferred Stock at $4.75 per share. The total cash we received was $13.9 million, net of fees and expenses associated with the placement. In February 2000, we completed the sale of our investment in Systeam, S.p.A. and received a cash payment of $1.2 million. A gain on the sale of this investment of approximately $0.4 million will be recorded in the fourth quarter of fiscal 2000. In March 2000, four of our customers completed third party lease contracts in respect of $14.2 million of switching equipment previously shipped under extended payment terms. In March and April 2000, we received payments of $10.0 million and $1.5 million, respectively. We expect to receive the remaining balance of $2.7 million when the lessees complete their payment obligations to the lessor. As of March 31, 1999, we had notes payable of $8.2 million. These notes were secured by certain of our assets and by 708,692 shares of our common stock and bore interest at the bank's prime rate plus 1/2% (8.25% at March 31, 1999). These notes were due on December 2001. Effective September 1999, these notes were assumed by the buyer of AGT. As of March 31, 1999 and 2000, we had capital lease obligations of $2.6 million and $2.8 million, respectively. Our cash and cash equivalents as of March 31, 1999 and 2000 were $1.2 million and $16.3 million, respectively. We also have a $2.2 million revolving line of credit secured against certain trade receivables. As of March 31, 1999 and 2000, $1.1 million and $1.7 million, respectively, had been drawn against the line, which bore interest at the bank's prime rate plus 3% (11% at March 31, 1999 and 12% at March 31, 2000). The line of credit expires on June 30, 2000. We have subordinated debentures in the aggregate principal amount of $1.3 million outstanding as of March 31, 2000. The debentures bear interest of 11.25% per year, payable semi-annually, and mature on January 1, 2002. We do not have any specific capital expenditure commitments at this time. Our specific plans and actions to fund debt obligations and ongoing operations include: - Refinancing of notes to improve short-term liquidity; - Collection of existing receivables related to the discontinued switching operations; and - Exercises of options and warrants and the possible sale of other equity instruments. We believe that our cash on hand on March 31, 2000 will fund our debt obligations and ongoing operations through the end of fiscal 2001. We believe that we will be able to continue to fund our operations and acquisitions by obtaining additional outside financing; however, we cannot assure you that we will be able to obtain the necessary financing when needed on acceptable terms or at all. THIRD PARTY LEASE FINANCING To facilitate the sale of our equipment in our discontinued switch segment, we often have third party lessors provide lease financing for the purchaser. Parties that provided the third party lease financing included Comdisco, PrinVest and First Venture Leasing. IMPACT OF INFLATION Inflation has not had a significant impact on net sales or loss from continuing operations for the three most recent fiscal years. 21 23 BACKLOG We do not maintain a backlog related to the long distance services business operations. We do not believe that such data is a meaningful indicator of future results of operations. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998 and June 1999, the AICPA issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and SFAS No. 137 which deferred the effective date of SFAS No. 133. We will adopt the standard in April 2001 and do not expect the adoption to have any material impact on our financial position or results of operations. ITEM 7A. QUALITATIVE AND QUANTITATIVE MARKET RISK DISCLOSURES Our primary market risk exposure is interest rate risk related to our borrowings on notes payable and under our revolving line of credit. INTEREST RATE SENSITIVITY MODEL The table below presents the principal (or notional) amounts and related interest of our borrowings by expected maturity dates. The table presents the borrowings that are sensitive to changes in interest rates and the effect on interest expense of future hypothetical changes in such rates.
YEAR ENDING MARCH 31, --------------------------------- 1999 2000 2001 2002 ------ ------ ------ ------ (U.S. DOLLARS -- THOUSANDS) Notes payable............................................... $8,183 $ 814 $ -- $ -- Interest expense (A)........................................ 675 67 -- -- Interest expense (B)........................................ -- 75 -- -- Interest expense (C)........................................ -- 59 -- -- Line of credit borrowings................................... 1,133 1,705 4,000 6,000 Interest expense (A)........................................ 133 140 330 495 Interest expense (B)........................................ -- 157 370 555 Interest expense (C)........................................ -- 123 290 435
- - The borrowings bear interest at the bank's prime rate plus 1/2% and 4% for the notes payable and line of credit, respectively. - - The interest expense shown for line (A) is based upon the actual bank's prime rate at March 31, 1999 of 7.75%. - - The interest expense shown for line (B) is based upon a hypothetical increase of one percentage point in the bank's prime rate to 8.75%. - - The interest expense shown for line (C) is based upon a hypothetical decrease of one percentage point in the bank's prime rate to 6.75%. 22 24 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES Report of Arthur Andersen LLP, Independent Public Accountants............................................... 24 Report of PricewaterhouseCoopers LLP, Independent Accountants............................................... 25 Consolidated Balance Sheets................................. 26 Consolidated Statements of Operations....................... 27 Consolidated Statements of Changes in Shareholders' Equity.................................................... 28 Consolidated Statements of Cash Flows....................... 29 Notes to Consolidated Financial Statements.................. 30
23 25 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of Coyote Network Systems, Inc. We have audited the accompanying consolidated balance sheets of Coyote Network Systems, Inc. (a Delaware corporation and formerly, The Diana Corporation) and subsidiaries as of March 31, 1999 and 1998, and the related consolidated statements of operations, shareholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 Coyote Network Systems, Inc. and its subsidiaries as of March 31, 1999 and 1998, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Los Angeles, California July 13, 1999, except as to Notes 1, 2 and 17, which are as of June 29, 2000 24 26 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of The Diana Corporation In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) of this report present fairly, in all material respects, the results of operations and cash flows of The Diana Corporation and its subsidiaries (the "Company") for the year ended March 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2, the Company initiated a restructuring plan during fiscal 1997 which resulted in Sattel Communications LLC ("Sattel") becoming the sole operating company comprising the Company's continuing operations. Sattel has a limited operating history and has not yet achieved significant sales of its products. The Company's other operating companies were sold or are held for sale as of March 31, 1997. As discussed in Note 15, management believes the Company will have sufficient cash resources, including proceeds from those net assets held for sale, to fund its operations for the fiscal year ending March 31, 1998. However, any material delay during fiscal 1998 in the timing of disposal and the ultimate receipt of cash proceeds by the Company with respect to the net assets held for sale could have a material adverse effect on the Company. In addition, the Company's viability is further dependent on Sattel achieving sales levels and operating results sufficient to fund the Company's operations. Finally, as discussed in Note 7, the Company is subject to uncertainties relating to class action litigation asserted against the Company and other potential claims by investors, the ultimate effects of which on the Company's financial position, results of operations and cash flows cannot presently be determined. /s/ PRICEWATERHOUSECOOPERS LLP PRICEWATERHOUSECOOPERS LLP Milwaukee, Wisconsin September 22, 1997, except as to the last paragraph of Note 8, which is as of November 4, 1998 and the "Discontinuance of Switch Business" section of Note 2, which is as of May 8, 2000. 25 27 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS) ASSETS
MARCH 31, MARCH 31, 1999 1998 --------- --------- Current assets: Cash and cash equivalents................................. $ 1,225 $ 3,746 Marketable securities..................................... -- 16 Receivables, net of allowance of $377 and $0 at March 31, 1999 and 1998, respectively............................ 2,502 150 Notes receivable -- current............................... 2,367 2,796 Deposits and other current assets......................... 4,321 1,411 Net current assets of discontinued operations............. 5,046 2,371 --------- -------- Total current assets.............................. 15,461 10,490 Property and equipment, net................................. 5,430 616 Intangible assets, net...................................... 2,303 -- Net long-term assets of discontinued operations............. 7,917 6,225 Notes receivable -- non-current............................. 871 1,170 Investments................................................. 1,550 750 Other assets................................................ 619 609 --------- -------- $ 34,151 $ 19,860 ========= ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Lines of credit........................................... $ 1,133 $ -- Accounts payable.......................................... 8,160 1,919 Accrued professional fees and litigation costs............ 676 805 Other accrued liabilities................................. 3,425 3,116 Deferred revenue and customer deposits.................... 1,410 -- Current portion of long-term debt and capital lease obligations............................................ 1,316 141 --------- -------- Total current liabilities......................... 16,120 5,981 Notes payable............................................... 8,183 -- Long-term debt.............................................. 1,534 5,349 Capital lease obligations................................... 1,817 -- Other liabilities........................................... 440 470 Commitments and contingencies (Note 7) Shareholders' equity: Preferred stock -- $.01 par value: authorized 5,000,000 shares, 700 issued, liquidation preference of $10,000 per share.............................................. 7,395 -- Common stock -- $1 par value: authorized 30,000,000 shares, issued 11,167,456 and 9,151,920 shares......... 11,167 9,152 Additional paid-in capital................................ 109,254 102,360 Accumulated deficit....................................... (116,002) (97,695) Treasury stock at cost.................................... (5,757) (5,757) --------- -------- Total shareholders' equity........................ 6,057 8,060 --------- -------- $ 34,151 $ 19,860 ========= ========
See notes to consolidated financial statements. 26 28 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FISCAL YEAR ENDED ----------------------------------- MARCH 31, MARCH 31, MARCH 31, 1999 1998 1997 --------- --------- --------- Net sales.................................................. $ 6,756 $ -- $ -- Cost of sales.............................................. 5,878 -- -- -------- -------- -------- Gross profit............................................... 878 -- -- -------- -------- -------- Selling, general and administrative expenses............... 9,698 7,058 3,410 -------- -------- -------- Operating loss............................................. (8,820) (7,058) (3,410) Securities litigation warrant expense...................... -- (8,000) -- Other non-operating income (expense): Interest expense......................................... (1,893) (2,334) (52) Net gains (losses) on sale of marketable securities...... 877 (155) (736) Write down of CNC preferred stock........................ -- -- (1,060) Interest and other income................................ 208 269 341 -------- -------- -------- (808) (2,220) (1,507) Income tax credit.......................................... -- -- 836 -------- -------- -------- Loss from continuing operations............................ (9,628) (17,278) (4,081) Loss from discontinued operations.......................... (4,215) (16,877) (8,879) Estimated loss on disposal of discontinued operations...... (900) -- (7,550) -------- -------- -------- Loss before extraordinary items............................ (14,743) (34,155) (20,510) Extraordinary items........................................ -- -- (508) -------- -------- -------- Net loss................................................... (14,743) (34,155) (21,018) ======== ======== ======== Preferred stock dividends.................................. (1,255) -- -- Net loss................................................... (14,743) (34,155) (21,018) -------- -------- -------- Loss applicable to common shareholders..................... $(15,998) $(34,155) $(21,018) ======== ======== ======== Loss per common share (basic & diluted): Continuing operations.................................... $ (1.11) $ (2.33) $ (0.74) Discontinued operations.................................. (0.52) (2.27) (2.97) Extraordinary items...................................... -- -- (.09) -------- -------- -------- Net loss per common share (basic & diluted).............. $ (1.63) $ (4.60) $ (3.80) ======== ======== ======== Weighted average number of common shares outstanding (basic & diluted)............................................... 9,814 7,423 5,535 ======== ======== ========
See notes to consolidated financial statements. 27 29 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS)
COMMON STOCK UNREALIZED TREASURY STOCK PREFERRED -------------------- ADDITIONAL LOSS ON ------------------- STOCK NUMBER OF PAR PAID-IN ACCUMULATED MARKETABLE NUMBER OF AMOUNT SHARES VALUE CAPITAL DEFICIT SECURITIES SHARES COST --------- ---------- ------- ---------- ----------- ---------- --------- ------- BALANCE AT MARCH 30, 1996.................... $ -- 5,526,282 $ 5,526 $ 59,456 $ (34,776) $(876) 877,692 $(4,644) Net loss................ -- -- -- -- (21,018) -- -- -- 5% stock dividend....... -- 250,893 251 7,474 (7,746) -- -- -- Realized loss on securities............ -- -- -- -- -- 876 -- -- Acquisition of Coyote Technologies, Inc. minority interest, net................... -- -- -- 385 -- -- 35,000 (2,203) Issuance of common stock................. -- 230,000 230 12,630 -- -- (200,000) 1,058 Other................... -- -- -- 179 -- -- (4,000) 32 ------ ---------- ------- -------- --------- ----- -------- ------- BALANCE AT MARCH 31, 1997.................... -- 6,007,175 6,007 80,124 (63,540) -- 708,692 (5,757) Net loss................ -- -- -- -- (34,155) -- -- -- Exercise of stock options............... -- 442,956 443 1,812 -- -- -- -- Amendment of A & B units Convertible to common stock................. -- -- -- 5,522 -- -- -- -- Issuance of common stock, net............ -- 1,880,750 1,881 1,481 -- -- -- -- Common stock issued on debt conversion....... -- 821,039 821 2,734 -- -- -- -- Non-cash expense........ -- -- -- 10,687 -- -- -- -- ------ ---------- ------- -------- --------- ----- -------- ------- BALANCE AT MARCH 31, 1998.................... -- 9,151,920 9,152 102,360 (97,695) -- 708,692 (5,757) Net loss................ -- -- -- -- (14,743) -- -- -- 5% stock dividend....... -- 497,623 497 2,859 (3,359) -- -- -- Exercise of stock options............... -- 105,713 106 352 -- -- -- -- B Unit conversions...... -- 73,500 73 (73) -- -- -- -- Common stock issued on debt conversion....... -- 1,068,750 1,069 2,337 -- -- -- -- Issuance of common stock, net............ -- 269,950 270 1,716 -- -- -- -- Issuance of 700 preference shares, net................... 6,345 -- -- -- -- -- -- -- Beneficial conversion feature -- preference shares................ 1,050 -- -- (1,050) -- -- -- -- Preferred stock cash dividend.............. -- -- -- -- (205) -- -- -- Non-cash warrant expense............... -- -- -- 753 -- -- -- -- ------ ---------- ------- -------- --------- ----- -------- ------- BALANCE AT MARCH 31, 1999.................... $7,395 11,167,456 $11,167 $109,254 $(116,002) $ -- 708,692 $(5,757) ====== ========== ======= ======== ========= ===== ======== ======= TOTAL SHAREHOLDERS' EQUITY ------------- BALANCE AT MARCH 30, 1996.................... $ 24,686 Net loss................ (21,018) 5% stock dividend....... (21) Realized loss on securities............ 876 Acquisition of Coyote Technologies, Inc. minority interest, net................... (1,818) Issuance of common stock................. 13,918 Other................... 211 -------- BALANCE AT MARCH 31, 1997.................... 16,834 Net loss................ (34,155) Exercise of stock options............... 2,255 Amendment of A & B units Convertible to common stock................. 5,522 Issuance of common stock, net............ 3,362 Common stock issued on debt conversion....... 3,555 Non-cash expense........ 10,687 -------- BALANCE AT MARCH 31, 1998.................... 8,060 Net loss................ (14,743) 5% stock dividend....... (3) Exercise of stock options............... 458 B Unit conversions...... -- Common stock issued on debt conversion....... 3,406 Issuance of common stock, net............ 1,986 Issuance of 700 preference shares, net................... 6,345 Beneficial conversion feature -- preference shares................ -- Preferred stock cash dividend.............. (205) Non-cash warrant expense............... 753 -------- BALANCE AT MARCH 31, 1999.................... $ 6,057 ========
See notes to consolidated financial statements 28 30 COYOTE NETWORK SYSTEMS, INC AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FISCAL YEAR ENDED ----------------------------------- MARCH 31, MARCH 31, MARCH 31, 1999 1998 1997 --------- --------- --------- OPERATING ACTIVITIES: Loss before extraordinary items............................. $(14,743) $(34,155) $(20,510) Adjustments to reconcile loss to net cash used in operating activities: Depreciation and amortization............................. 982 294 11 Loss (gain) on sales of marketable securities............. (877) 155 736 Gain on sale of land...................................... (20) -- -- Write down of CNC Preferred Stock......................... -- -- 1,060 Bad debt expense.......................................... 377 -- -- Provision for loss on discontinued operations............. 900 -- 7,550 Non-cash financing and warrant expense.................... 98 10,582 221 Net change in discontinued operations..................... (310) 7,040 (7,315) (Increase) decrease in: Receivables............................................ (4,874) 3,879 -- Deposits and other current assets...................... 6,071 (735) 96 Increase (decrease) in: Accounts payable....................................... 2,472 (640) 105 Other current liabilities.............................. 3,799 5,105 187 -------- -------- -------- Net cash used in operating activities....................... (6,125) (8,475) (17,859) -------- -------- -------- INVESTING ACTIVITIES: Purchases of property and equipment....................... (1,556) (254) (12) Purchases of marketable securities........................ -- (736) -- Proceeds from sale of marketable securities............... 893 1,777 1,353 Change in notes receivable................................ 1,050 (2,466) (5,000) Proceeds from sale of CNC preferred stock................. -- -- 2,500 Proceeds from sale of land................................ 67 -- 112 Cash payment on acquisition............................... (1,333) -- -- Increase in investments in affiliate...................... (400) -- -- Net proceeds from the sale of Atlantic Provision and C&L assets................................................. -- 2,861 640 Net change in discontinued operations..................... (3,265) (1,168) (2,716) -------- -------- -------- Net cash (used) provided by investing activities............ (4,544) 14 (3,123) -------- -------- -------- FINANCING ACTIVITIES: Increase in borrowings on line of credit.................. 1,133 -- -- Increase in notes payable................................. 262 -- -- Repayments of long-term debt.............................. (142) (141) (141) Convertible preferred stock issued, net of expenses....... 6,345 -- -- Common stock issued....................................... 758 5,617 13,918 Convertible debt issued................................... -- 6,870 -- Net change in discontinued operations..................... -- 275 3,314 Other items............................................... (208) (495) (508) -------- -------- -------- Net cash provided by financing activities................... 8,148 12,126 16,583 -------- -------- -------- Increase (decrease) in cash and cash equivalents............ (2,521) 3,665 (4,399) CASH AND CASH EQUIVALENTS: At beginning of year...................................... 3,746 81 4,480 -------- -------- -------- At end of year............................................ $ 1,225 $ 3,746 $ 81 ======== ======== ========
See notes to consolidated financial statements. 29 31 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Principles of Consolidation Investments in 20 - 50% owned subsidiaries in which management has the ability to exercise significant influence are accounted for using the equity method of accounting. Accounts and transactions between members of the consolidated group are eliminated in the consolidated financial statements. Certain prior year balances have been reclassified in order to conform to current year presentation. The consolidated group (hereafter referred to as the "Company") included the following companies during the past three years: COYOTE NETWORK SYSTEMS, INC. ("Coyote"), formerly The Diana Corporation Coyote and its wholly owned non-operating subsidiaries are included in the consolidated group for all three fiscal years. Coyote's activities historically consisted primarily of corporate administrative and investing activities. COYOTE GATEWAY, LLC dba American Gateway Telecommunications ("American Gateway") On April 16, 1998, the Company established American Gateway, a Colorado limited liability company. The Company owns 80% of American Gateway, and American Gateway Telecom, Inc., a Texas corporation ("AGT") owns 16%. PrinVest Financial Corporation owns the remaining 4%. Its principal activities consist of the wholesaling of long distance services. This entity was disposed of in fiscal 2000. (See Note 17 -- Post July 13, 1999 Events) INET INTERACTIVE NETWORK SYSTEM, INC. ("INET") On September 30, 1998, the Company completed the acquisition of INET Interactive Network System, Inc. through the merger of INET into a wholly owned subsidiary of the Company. INET is a provider of international long distance services to commercial and residential "affinity" groups. INET markets international long distance services to primarily French and Japanese affinity groups. INET is the principal operating subsidiary of the Company. In May 2000, the Company made the strategic decision and adopted a formal plan to discontinue the following entities (see Note 17 -- Post July 13, 1999 Events): COYOTE TECHNOLOGIES, LLC ("Coyote Technologies, LLC"), formerly Sattel Communications, LLC Since fiscal 1997, Coyote has owned 100% of Coyote Technologies, Inc. (fka, Sattel Communications Corp.) (see Note 3). Coyote Technologies, Inc., through its subsidiary Coyote Technologies, LLC is a provider of telecommunication switches and IP gateways. Coyote Technologies, Inc. has an ownership interest in Coyote Technologies, LLC, a limited liability company, of approximately 97% and certain additional preferential rights (see Note 3). Its activities consist primarily of development, production and sale of scalable telecommunications switches and Internet protocol based gateway systems to telecommunications service providers. COYOTE COMMUNICATIONS SERVICES, LLC ("Coyote Communications") Formed in January 1999, Coyote Communications provides customer support and consulting services including network integration, network design, switch provisioning, outsourcing, on-site technical support, remote monitoring, 7 x 24 customer support, billing administration and help desk support. 30 32 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 TELECOMALLIANCE Formed in November 1998, TelecomAlliance is a joint venture between Coyote and Profitec. TelecomAlliance plans to offer its customers an alternative to traditional capital-intensive private network provisioning, with a national multi-service Internet-Protocol based platform that can be leased by a carrier to extend or supplement their current network, or to build a new network from scratch. As of March 31, 1999, TelecomAlliance was still in the organizational phase and had not commenced operations. Business Risk As discussed in Note 2 below, the Company has substantially completed a major restructuring that resulted in the disposition of several operations and in May 2000 decided to discontinue its business units that are involved in the production and sale of telecommunication switches and Internet Protocol based gateways to telecommunication service providers (see Note 17 -- Post July 13, 1999 Events). The Company's primary business is now the wholesaling and retailing of international long distance service. After the discontinuance and restructuring, the Company's operations are similar to those of an early-stage enterprise and are subject to all the risks associated therewith. These risks include, among others, uncertainty of markets, ability to develop, produce and sell profitably its products and services and the ability to finance operations. Management believes that it has made significant progress on its business plan in fiscal 1999 and fiscal 2000. Significant actions in this progress include commencing operations of INET, resolving the class action lawsuit (See Note 7) and raising additional equity (see Notes 8, 16 and 17 -- Subsequent Events). However, the Company remains constrained in its ability to access outside sources of capital until such time as the Company is able to demonstrate higher levels of sales and more favorable operating results. Management believes that it will be able to continue to make progress on its business plan and mitigate the risks associated with its business, industry and current lack of working capital. Financial Instruments The carrying values of cash and cash equivalents, marketable securities, receivables, accounts payable and borrowings at March 31, 1999, and March 31, 1998, approximate fair value. Marketable Securities The Company accounts for marketable securities in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Under SFAS No. 115, management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in non-operating income (expense). Marketable equity securities and debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value (based on published market values), with the unrealized gains and losses reported in a separate component of shareholders' equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in non-operating income (expense). Realized gains and losses, interest income and dividends are included in non-operating income (expense). For purposes of determining the gain or loss on a sale, the cost of securities sold is determined using the average cost of all shares of each such security held at the dates of sale. Gains on sales of available-for-sale securities totaled $877,000, $242,000 and $0 in fiscal 1999, 1998 and 1997, respectively; and losses totaled $0, $397,000 and $736,000 in fiscal 1999, 1998 and 1997, respectively. 31 33 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 Non-Marketable Securities Non-marketable securities are accounted for on a lower of cost or market basis. A write-down to market is recognized on the determination that a permanent impairment of value has occurred. Property and Equipment Property and equipment are stated at cost. Depreciation expense is computed on the straight-line method for financial reporting purposes over the estimated useful lives of the assets which range from three to eighteen years. Depreciation for income tax purposes is computed on accelerated cost recovery methods. Expenditures which substantially increase value or extend asset lives are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. Property and equipment consist of the following (in thousands):
MARCH 31, 1999 MARCH 31, 1998 -------------- -------------- Land............................................ $ -- $ 50 Fixtures and equipment.......................... 6,421 983 ------ ------ 6,421 1,033 ------ ------ Less accumulated depreciation................... (991) (417) ------ ------ $5,430 $ 616 ====== ======
Intangible Assets Intangible assets, net of amortization, consist of the following (in thousands):
MARCH 31, 1999 -------------- Goodwill....................................... $2,167 Other.......................................... 136 ------ $2,303 ======
The Company amortizes the goodwill created through the acquisition of INET in October 1998 over a five-year period on a straight-line basis. Accumulated amortization was $0.3 million at March 31, 1999. In fiscal 1997, the Company adopted the provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. The adoption of this standard did not have a material effect on the Company's consolidated results of operations or financial position. Pursuant to SFAS No. 121, long-lived assets and intangible assets are reviewed for impairment whenever events or circumstances provide evidence that suggest that the carrying amount of the asset may not be recoverable. Impairment is generally determined by using estimated undiscounted cash flows over the remaining amortization period. If the estimates of future undiscounted cash flows do not support recoverability of carrying value of the asset, a loss is recognized for the difference between the fair value and carrying value of the asset. 32 34 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 Revenue Recognition LONG DISTANCE SERVICES Revenue related to long-distance services is recognized at the time of usage. SWITCH SALES (DISCONTINUED) As described in Note 17 -- Post July 13, 1999 Events, the Company decided to discontinue its switch business in May 2000. All revenue and expenses related to the switch business are summarized in the line item "loss on discontinued operations" in the accompanying financial statements. Revenue from switching equipment sales based on a firm agreement and a fixed price, were recognized upon shipment to a credit-worthy customer. The Company also sells maintenance and other services to its customers. Revenue related to these services is recognized on a straight-line basis over the life of the contract. Since 1998, the Company has also been involved in transactions in which the end user of the switch equipment does not have established credit and will obtain a third party leasing company to purchase the equipment or assume the end user's payment obligation. At March 31, 1999, there were no unpaid transactions that had not been assumed by a credit-worthy leasing company. Generally, the Company recognizes revenue based on the type of sales transactions as follows: a) Shipments to credit-worthy customers with no portion of the collection dependent on any future event. Revenues are recorded at the time of shipment. b) Shipments to a customer without established credit. These transactions are primarily shipments to customers who are in the process of obtaining lease financing and to whom the Company has granted extended payment terms (generally three year notes requiring monthly payments and secured by the equipment sold). Revenues are deferred (not recognized) and no receivable is recorded until a credit-worthy leasing company has purchased the equipment from the end user and has assumed the payment obligation. Upon assumption by a leasing company, we receive a significant portion of the sales price in cash, and give up our security interest in the equipment in return for the forgiveness of the note from the end user. c) Shipments where a portion of the revenue is dependent upon some future event. These consist primarily of transactions involving third party leasing companies. Under these agreements, a portion of the sales price is contingent on the lessees completing their payment obligations to the lessor. Amounts related to this contingency ($4.2 million at March 31, 1999) are not recognized as revenue until the contingency is removed or payment is received. Also on certain transactions a portion of the payments are contingent on installation. At March 31, 1999, the Company had approximately $3.1 million subject to this contingency and therefore not recognized as revenue. Credit and Other Concentrations For the year ended March 31, 1999, third party lessors were involved in approximately 97% of net sales of our discontinued switching business (see Note 2). For the year ended March 31, 1998, a third party lessor was involved in approximately 40% of the revenue for the switch segment and revenue from Apollo Inc. accounted for approximately 19% of revenue of the switch segment (see Note 4). For the year ended March 31, 1997, Concentric Network Corporation accounted for almost all revenue of the switch segment. At March 31, 1999 and 1998, third-party lessors accounted for approximately 99% and 47%, respectively, of gross receivables of the discontinued segment. The Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral other than, in certain instances, a perfected security interest 33 35 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 in the related equipment. In addition, approximately 11% of inventory purchased during fiscal 1998 was supplied by Sattel Technologies, Inc. Research and Development Costs Engineering, research and development costs include all engineering charges related to new products and product improvements, and are charged to operations when incurred. These costs are included in loss from discontinued operations in the accompanying consolidated statements of operations. Software development costs are capitalized once technological feasibility is established and are included in the net long-term assets of discontinued operations in the accompanying consolidated balance sheets. Income Taxes The Company accounts for income taxes using the liability method in accordance with SFAS No. 109, "Accounting for Income Taxes". Loss Per Common Share The basic loss per common share is determined by using the weighted average number of shares of common stock outstanding during each period. Diluted loss per common share is equal to the basic loss per share. Because of the net losses in fiscal 1997, 1998 and 1999, the effect of options and warrants are antidilutive, and therefore are excluded from the calculations of diluted loss per common share. Loss per share amounts for the years ended March 31, 1997 and 1998 have been restated to reflect the effect of the Company's 5% stock dividend on November 4, 1998. The beneficial conversion feature ($1,050,000) discussed in Note 8 has been accounted for as a dividend to Series A Convertible Preferred shareholders. In computing net loss per share applicable to common stock shareholders for the year ended March 31, 1999, all dividends on preferred stock have been added to the net loss to arrive at the net loss applicable to common shares. At March 31, 1997, 1998 and 1999 the following convertible securities, outstanding options and warrants to purchase common stock were not included in the computation of diluted loss per common share as the effect would be antidilutive due to the net loss.
1999 1998 1997 --------- --------- --------- Options................................................... 1,315,118 503,974 838,360 Warrants and units........................................ 4,109,571 3,345,373 1,016,175 Warrants to be issued related to securities litigation settlement.............................................. 2,225,000 -- -- Convertible debt.......................................... -- 920,000 -- Convertible preferred stock............................... 1,500,000 -- -- --------- --------- --------- Total -- common stock........................... 9,149,689 4,769,347 1,854,535 ========= ========= =========
Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 34 36 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 Statement of Cash Flows For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments with a maturity of three months or less at the date of purchase to be cash equivalents. NOTE 2 -- DISCONTINUED OPERATIONS Discontinuance of Switch Business In May 2000, the Board of Directors of the Company approved a restructuring plan that provides for the discontinuance and sale of the DSS Switch segment of the business. As a result, the Company has reported the operations of the DSS Switch business for 1999, 1998 and 1997 separately as discontinued operations in the accompanying consolidated statement of operations. Also the assets and liabilities of this segment are presented separately and summarized in the accompanying 1999 and 1998 consolidated balance sheets as follows:
1999 1998 -------- -------- (DOLLARS IN THOUSANDS) Current assets and liabilities: Accounts receivable, net of reserves...................... $3,390 $ 564 Inventory................................................. 2,130 2,122 Accrued liabilities....................................... (474) (315) ------ ------ Net current assets of discontinued operations............... $5,046 $2,371 ====== ====== Non-current assets: Property and equipment, net............................... $2,763 $1,774 Capitalized software development and intellectual property rights................................................. 4,920 3,519 Other..................................................... -- 23 ------ ------ Net long-term assets of discontinued operations............. $7,683 $5,316 ====== ======
Expected operating results relating to the discontinued operations from April 1, 2000 until the expected disposal date will be included in the estimated loss on disposal and will be recorded as a charge in the consolidated financial statements in fiscal 2000. The Company expects to record a charge for estimated loss on disposal of the switch business of approximately $11.0 million in fiscal 2000, which includes an estimated $2.5 million of expected losses of the segment for the first two quarters of fiscal 2001. The Company expects to dispose of the segment near the end of the second quarter of fiscal 2001. A summary of the operations of the segment is as follows:
FISCAL YEAR ENDING MARCH 31, ------------------------------ 1999 1998 1997 ------- -------- ------- (DOLLARS IN THOUSANDS) Net sales................................................... $28,607 $ 5,264 $ 7,154 ======= ======== ======= Loss from discontinued operations........................... $(4,215) $(16,877) $(8,254) ======= ======== =======
Certain reclassifications have been made to the fiscal 1999 net sales shown above to reflect $7.3 million of deferred revenue (related to contingencies discussed in revenue recognition in Note 1), as reductions of sales rather than additions to cost of sales as previously presented. These reclassifications did not affect net income. 35 37 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 1996 - 1997 Restructuring In November 1996 (and revised in February 1997), the Board of Directors of Coyote approved a restructuring plan (the "Restructuring") to separate its telecom switching equipment business (the "Coyote Technologies Business") from the following businesses:
SEGMENT COMPANY ------- ------- Telecommunications equipment distribution........................... C&L Wire installation and service............ Valley Wholesale distribution of meat and seafood................................ Entree/Atlantic Provision Company
On February 3, 1997, the Board of Directors of Coyote approved the sale of a majority of the assets of Atlantic Provision Company to Colorado Boxed Beef Company. The sale closed on February 3, 1997. On November 20, 1997, the Company completed the sale of its telecommunications equipment distributor subsidiary, C&L Communications, Inc., to the management of C&L. In March 1998, the Company reached agreement on the sale of its 80% owned wire installation and service subsidiary, Valley Communications Inc., to Technology Services Corporation. The components of net long-term assets of discontinued operations include certain items from the discontinued meat and seafood segment as follows (in thousands):
1999 1998 ------- ------ Other assets.............................................. $ -- $ 7 Property and equipment, net............................... 2,572 2,572 Long term debt............................................ (688) (740) ------- ------ Net non-current assets of discontinued operations......... $ 1,884 $1,839 Reserve for loss on disposal............................ (1,650) (930) ------- ------ Net assets of discontinued operations................... $ 234 $ 909 ======= ======
The Company believes that the net assets of discontinued operations related to C&L, Valley and Entree/ Atlantic Provision are recorded at approximate net realizable value at March 31, 1999. The 1997 estimated loss on disposal of discontinued operations consists of the following (in thousands): Estimated operating losses for the disposal period and loss on disposal of C&L and Valley............................. $2,054 Operating losses for the disposal period and loss on the disposal of Atlantic Provision............................ 2,550 Investment banking fees, including the fair value of a warrant to purchase common stock.......................... 1,100 Professional fees incurred in connection with the spin-off.................................................. 854 Severance payments to Messrs. Fisher, Runge and Lilly (see Note 12).................................................. 508 Charge due to acceleration of deferred compensation payments to Messrs. Fisher and Runge (see Note 12)................. 137 Other....................................................... 347 ------ $7,550 ======
As of June 18, 1999, the Company had collected all cash related to the sale of discontinued operations of the meat and seafood segment except $410,000 due under a note and the only asset of discontinued operations was real estate related to the land and buildings of the discontinued Atlantic Provision operation. The real estate is listed for sale. Based upon an estimate of the current market value of the real estate, the Company 36 38 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 took an additional charge of $900,000 in the second quarter of fiscal 1999. The asset book value as of March 31, 1999 was $234,000, net of mortgages and reserves applicable to the property. Operating results, net of minority interest, relating to the following discontinued operations for fiscal year 1997 through the measurement date of November 20, 1996 are as follows (in thousands):
FISCAL YEAR ENDING MARCH 31, 1997 -------------------------------------------------------------------- TELECOMMUNICATIONS WIRE INSTALLATION MEAT AND SEAFOOD EQUIPMENT AND SERVICE TOTAL ---------------- ------------------ ----------------- -------- Net sales............................. $188,853 $19,750 $11,540 $220,143 ======== ======= ======= ======== Earnings (loss) from discontinued operations.......................... $ (584) $ (51) $ 10 $ (625) ======== ======= ======= ========
NOTE 3 -- CAPITAL STRUCTURE OF COYOTE TECHNOLOGIES On May 3, 1996, the Company and Sattel Technologies, Inc. ("STI") entered into a Supplemental Agreement by which the Company acquired an additional 15% ownership interest in Coyote Technologies, Inc. The acquisition occurred as part of a transaction in which the Company contributed an additional $10 million in cash to Coyote Technologies, Inc. In lieu of contributing its proportionate share of the additional funding to Coyote Technologies, Inc., and in exchange for a release from its obligation related to certain product development efforts, STI agreed to convey to the Company 15% of Coyote Technologies, Inc., together with 50,000 shares of the Coyote shares it had acquired pursuant to the Exchange Agreement. This transaction resulted in a net reduction of approximately $1,825,000 of intangible assets recorded at March 30, 1996. On October 14, 1996, the Company acquired from STI its remaining 5% ownership interest in Coyote Technologies, Inc. for 15,000 shares of the Company's common stock. At this time Coyote Technologies, Inc. became a wholly-owned subsidiary of the Company. During fiscal 1997, Coyote Technologies, LLC granted subordinated equity participation interests, which amount to approximately a 20% effective ownership interest (before consideration of the subordination provisions) in Coyote Technologies, LLC to certain employees of the Company. The Company's effective ownership of Coyote Technologies, LLC is approximately 80% as a result of these transactions. Coyote Technologies, LLC is a California limited liability company owned by members (the "Members") owning either of two classes of interests, the "Class A Units" and the "Class B Units" (collectively, the "Units"). Coyote Technologies, Inc. holds 8,000 Class A Units. Additional Class A Units are held by Charles Chandler, a former employee, and Sydney Lilly, a former director and former Executive Vice President of the Company. Mr. Chandler and Mr. Lilly hold 350 and 100 Class A Units, respectively. Aggregate capital contributed to Coyote Technologies, LLC related to these Class A Units totaled $242,000. Initially, 1,550 Class B Units were issued to employees of Coyote Technologies, LLC in connection with their continued employment, without capital contribution therefor. No compensation expense was recognized in fiscal 1997 upon the granting of the Class B Units to the employees. The estimated fair value of such units at the date of grant was considered immaterial to the financial statements based on the subordinated nature of the interests resulting from the priority distributions payable to holders of Class A Units. Compensation expense was to be recognized prospectively when it becomes probable that a conversion or other defined triggering event will occur. If the Company exercises its option to repurchase equity interests previously granted to employees, total compensation cost would be equal to the cash paid upon the repurchase. Prior to an amendment in September 1997, described in a succeeding paragraph of this note, the terms of a conversion were that if in the future Coyote Technologies, LLC achieves cumulative pre-tax profits of at least $15 million over the four most recent quarters, the members holding Class B Units not subject to the 37 39 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 Board of Directors' authorization discussed below would have the right and obligation (the "Conversion Rights") to convert their Class B Units into Company common stock on the basis of 500 shares of Company common stock for each Class B Unit, subject to adjustment for stock dividends, stock splits, merger, consolidation or stock exchange. The Conversion Rights are included in Class B Agreements amended in November 1996 in lieu of provisions of the April 1, 1996 agreement that provided members holding Class B Units might require Coyote Technologies, LLC to conduct an initial public offering, upon the achievement of the same cumulative pre-tax profit measure discussed above, in which the Class B holders would have the right to convert Class B Units into securities being offered, and would have the right to have those securities registered under the Securities Act of 1933 (the "Registration Rights"). If a majority of the Class B Units are redeemed or purchased by Coyote Technologies, LLC or an affiliate, or if a triggering event (including the conversion of a majority of the Class B Units) occurs, the individual Class A holders are entitled to have their Units redeemed, purchased or to participate on the same terms as the Class B Units, except with an upward adjustment in price to reflect the priority of distribution associated with the Class A Units. Pursuant to agreements regarding Class A Units, the holders of Class A Units other than Coyote Technologies, Inc. also have the right, but not the obligation, to require the Company to purchase all, but not less than all, of such holder's Class A Units at a price equal to the agreed-upon or appraised fair market value at any time after April 1, 1999. The Conversion Rights discussed above provided the Class B Unit holders with an approximately comparable ownership interest in the Company as they have in Coyote Technologies, LLC. In September 1997, the Board of Directors authorized an amendment to certain Class B Units owned by directors and employees of Coyote and Coyote Technologies, LLC at June 30, 1997, to provide for the elimination of the minimum pre-tax profits measure requirement discussed above and the conversion into Company common stock at the option of the holder. Consequently, there is a compensation charge of $4,016,000 recorded in the second quarter of fiscal 1998. This charge is based on the value at September 4, 1997 of 630,000 shares of Company common stock at $6.375 per share that will be issuable to Class B Unit Holders. Assuming that Class A Units, other than those held by Coyote Technologies, Inc., are convertible on the same basis as a result of the Board of Directors' authorization discussed above, an additional charge of $1,506,000 was also recorded in the second quarter of fiscal 1998 based on 236,250 shares of Company common stock and a per share price of $6.375. In fiscal 1999, certain Class B Unit holders converted a total of 138 Units into shares of Company common stock in accordance with the amended terms for conversion. Certain current and former employees of Coyote Technologies, LLC continue to collectively own 1,369 Class B Units, representing all of the Class B Units currently outstanding. The following table reflects the ownership of the Class B Units by the management of Coyote Technologies, LLC and others as of June 15, 1999:
NAME CLASS B UNITS ---- ------------- James J. Fiedler................................ 350 Daniel W. Latham................................ 212 David Held...................................... 250 Bruce Thomas.................................... 250 Others.......................................... 307 ----- 1,369 =====
38 40 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 NOTE 4 -- ACQUISITIONS NUKO In December 1997, the Company entered into a letter of intent regarding a merger with NUKO Information Systems, Inc. ("NUKO"). NUKO is a manufacturer of compression and transmission technology for a variety of video applications. The Company subsequently was unable to reach agreement with NUKO on the transaction and withdrew its offer in March 1998. During negotiations, and in accordance with the terms of the letter of intent, the Company advanced funds to support NUKO's ongoing activity. Including the interest, the total funding advanced to NUKO and now owed to the Company of $1.9 million is secured by a pledge to the Company of shares of stock owned by NUKO in iCompression, Inc. (fka, Internext Compression, Inc.). At the time this security was accepted by the Company, the iCompression stock had no published market value nor was there any reliable financial information available. In April 1998, NUKO filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code. In May 1999, the Company received an offer to purchase the collateral for a total price of $1.9 million. The Company has accepted this offer subject to NUKO's right of first offer to purchase the shares. This amount is included in notes receivable -- current in the accompanying balance sheet. (See Note 16 -- Subsequent Events regarding sale of iCompression stock). Systeam In fiscal 1998, the Company invested $750,000 in Systeam, S.p.A. Based in Rome, Italy, Systeam develops voice, data, video and Internet solutions. This investment represents an approximately 9% equity ownership of Systeam. In February 1999, the Company announced that it signed a definitive agreement to acquire controlling interest in Systeam by increasing its equity position to 60% from 9%, for approximately $5.0 million in cash, including $1.5 million for working capital and 880,000 unregistered shares of Company common stock. As part of the Systeam acquisition, the Company also will acquire an indirect controlling interest in Smartech, an information technology-consulting firm that provides software solutions for telecom, financial service and utility companies. Smartech is 51% owned by Systeam. In March 1999, the Company advanced to Systeam an additional $550,000 toward the option to achieve the planned 60% equity position. This amount is included in other assets in the accompanying balance sheet. The investment in Systeam is accounted for using the cost method. Subsequent to March 31, 1999, the Company sold all of its interests in Systeam, S.p.A., see Note 17 -- Post July 13, 1999 Events. Coyote Gateway On April 16, 1998, the Company established American Gateway (f/k/a Coyote Gateway, LLC), a Colorado limited liability company. The Company owns 80% of American Gateway, and AGT and PrinVest Financial Corporation own 20%. In consideration of its 20% ownership interest, AGT contributed assets to American Gateway, consisting of customer contracts for the transmission of international telephone minutes and vendor and carrier contracts to service those contracts. Subsequent to March 31, 1999, the Company sold all of its interest in American Gateway, see Note 17 -- Post July 13, 1999 Events. INET On September 30, 1998, the Company completed the acquisition of INET Interactive Network System, Inc. ("INET") through the merger of INET into a wholly owned subsidiary of the Company. Under the terms of the merger agreement, the Company made total cash payments of $1.0 million and issued a total of 198,300 shares of the Company's common stock as consideration for the outstanding shares of INET capital stock, the cancellation of certain warrants to purchase shares of INET common stock, the transfer of certain lines of credit and certain contractual releases. The Company also agreed to forgive and extinguish all loans and advances in the amount of $433,000 which had been made to INET prior to the merger, of which 39 41 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 $333,000 was advanced in fiscal 1999. As further consideration, the Company will issue earnout shares of the Company's common stock to the former INET shareholders in five installments based upon certain earning targets for the period from October 1, 1998 to March 31, 2001. As of March 31, 1999, the maximum amount payable under the earnout agreement is $1.25 million payable in Company common stock to be valued at certain average trading prices at the time any earnout is payable. Since the earnings targets have not yet been achieved and management considers the likelihood to be remote, no earnout stock has been provided as of March 31, 1999. In connection with the acquisition of INET, the Company recorded goodwill of $2.6 million. (See Note 1 -- Intangible Assets). Crescent In September 1998, the Company acquired a 19.9% equity position in Crescent Communications, Inc. ("Crescent"). Crescent is an early stage entity formed to provide primarily wholesale telecommunication services to select international markets. The Company acquired this minority interest for the sum of $1.3 million represented by a cash payment of $0.4 million to Crescent and $0.9 million in the form of a discount granted on switching equipment sold to Crescent (through a third-party lessor) in September 1998, this investment is accounted for using the cost method. As of March 31, 1999, Crescent was not yet running telecommunications traffic through its switching equipment and the Company recorded a $0.5 million realization reserve on this investment. Apollo In February 1999, the Company entered into an agreement, subject to certain conditions, to acquire Apollo Telecom, Inc. ("Apollo"). Apollo subsequently was unable to meet the stipulated conditions and the Company withdrew its offer in April 1999. During the negotiations and in connection with the proposed acquisition, the Company advanced funds to Apollo in part secured by a Class II Telecommunications License to originate and terminate traffic in Tokyo, Japan. The total funding advanced to Apollo as at March 31, 1999 was $1.1 million. In April 1999, subsequent to the withdrawal of the Company's acquisition offer, Apollo filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code. The Company subsequently obtained the Japanese license which has an estimated market value of $220,000. The Company recorded an expense charge of $0.9 million to fully provide for the loss in the fourth quarter of fiscal 1999. Provisions were made for expenses of $2.2 million in fiscal 1998 for losses in connection with failed acquisitions, including funds advanced, costs of professional services, due diligence expenses, financial consulting fees and losses. The Company has provided for this amount, by recording a $1.8 million reserve against notes receivable and has accrued $400,000 in other accrued liabilities for other costs in the accompanying Balance Sheet. In fiscal 1999, the Company incurred similar expenses related to the Crescent investment ($0.5 million) and the Apollo ($0.9 million) investment were offset by recoveries on prior year provisions. These provisions and recoveries are included in selling and administrative expenses in the accompanying financial statements. NOTE 5 -- DEPOSITS AND OTHER CURRENT ASSETS At March 31, 1999, the Company had deposits with long distance carriers of $5.2 million. In the fourth quarter of fiscal 1999, the Company recorded a reserve of $2.0 million related to various deposits made with long distance carriers for capacity on their systems. The financial viability of some of the carriers has raised concern regarding the ultimate realization of the deposits. This provision is included in selling, general and administrative expenses in the accompanying financial statements. 40 42 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 NOTE 6 -- DEBT Debt consists of the following (in thousands):
MARCH 31, 1999 MARCH 31, 1998 -------------- -------------- Subordinated debentures due January 2002 and capitalized interest.................................................. $ 1,675 $1,817 8% Convertible loan due December 2000....................... -- 3,673 Note payable bearing interest at 10% payable in monthly installments through August 2000.......................... 436 -- Capital lease obligations................................... 2,556 -- ------- ------ 4,667 5,490 Less current portion........................................ (1,316) (141) ------- ------ $ 3,351 $5,349 ======= ======
The subordinated debentures consist of principal of $1,254,000 and capitalized interest of $421,000 at 11.25%. These debentures, which were issued in January 1992, are unsecured. The payment of cash dividends by the Company is restricted by the subordinated debentures which provide that the consolidated tangible net worth of the Company cannot be reduced to less than an amount equal to the aggregate principal amount of the subordinated debentures, or $1,254,000. Approximate annual amounts payable by the Company on debt and capital leases are as follows (in thousands):
CAPITAL DEBT LEASES TOTAL ------ ------- ------- 2000........................................................ $ 577 $ 845 $ 1,422 2001........................................................ 141 696 837 2002........................................................ 1,393 684 2,077 2003........................................................ -- 668 668 2004........................................................ -- 150 150 ------ ------ ------- 2,111 3,043 5,154 Less amount representing interest........................... -- (487) (487) ------ ------ ------- 2,111 2,556 4,667 Less current portion........................................ (577) (739) (1,316) ------ ------ ------- $1,534 $1,817 $ 3,351 ====== ====== =======
As of March 31, 1999, the Company has notes payable with PrinVest of $8.2 million secured by certain assets and by 708,692 shares of the Company's common stock and bearing interest at the bank's prime rate (7.75% at March 31, 1999) plus 1/2%. The notes were repayable on demand. (See Notes 12 and 15). In July 1999, the payment date was extended to December 2001. (See Note 17 -- Post July 13, 1999 Events). The Company also has a $2.2 million revolving line of credit secured against certain trade receivables, bearing interest at the bank's prime rate plus 4%. As of March 31, 1999, $1.1 million has been drawn against this line of credit. This line of credit is renewable annually on the first of March. NOTE 7 -- COMMITMENTS AND CONTINGENCIES The Company leases its facilities and various equipment under non-cancelable lease arrangements for varying periods. Leases that expire generally are expected to be renewed or replaced by other leases. Total 41 43 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 rental expense under operating leases in fiscal 1999, 1998 and 1997 was $931,000, $310,000, $279,000, respectively. Future minimum payments under non-cancelable operating leases with initial terms of one year or more for fiscal years subsequent to March 31, 1999 are as follows (in thousands): 2000................................................ $1,169 2001................................................ 1,097 2002................................................ 1,110 2003................................................ 1,053 2004................................................ 441 ------ $4,870 ======
Coyote Network Systems, Inc. (The Diana Corporation) Securities Litigation (Civ. No. 97-3186) The Company was a defendant in a consolidated class action, In re The Diana Corporation Securities Litigation, that was pending in the United States District Court for the Central District of California. The Consolidated Complaint asserted claims against the Company and others under Section 10(b) of the Securities Exchange Act of 1934, alleging essentially that the Company was engaged, together with others, in a scheme to inflate the price of the Company's stock during the class period, December 6, 1994 through May 2, 1997, through false and misleading statements and manipulative transactions. On or about February 25, 1999, the parties executed and submitted to the court a formal Stipulation of Settlement, dated as of October 6, 1998. Under the terms of the settlement, all claims asserted or that could have been asserted by the class are to be dismissed and released in return for a cash payment of $8.0 million (of which $7.25 million was paid by the Company's D&O insurance carrier on behalf of the individual defendants and $750,000 was paid by Concentric Network Corporation, an unrelated defendant) and the issuance of three-year warrants to acquire 2,225,000 shares of the Company's common stock at per share prices increasing from $9 in the first year, $10 in the second year and $11 in the third year. The cash portion of the settlement was previously paid into an escrow fund pending final court approval. The warrants were fully reserved by the Company in fiscal 1998. On June 9, 1999, the Court rendered its Final Judgment and Order approving the settlement set forth in the Stipulation of Settlement. No objections to the approval of the settlement were filed. The Company is also involved with other proceedings or threatened actions incident to the operation of its businesses. It is management's opinion that none of these matters will have a material adverse effect on the Company's financial position, results of operations or cash flows. Nasdaq and Securities Exchange Commission On December 9, 1998, TheStreet.com, an Internet publication, published articles questioning the Company's reported equipment sale through Comdisco, Inc. to Crescent Communications (see Notes 4 and 12). The articles implied that Crescent Communications, Inc. did not exist, leading to the conclusion that the sale was not valid. The article also discussed a Form S-3 Registration Statement, indicating that numerous insiders were "poised to sell huge chunks" of their holdings. Immediately following the publication of these articles, the trading volume in the Company's common stock reached approximately 2.2 million shares, a number significantly in excess of historical trading level, and the common stock price declined more than 50%. As a result of the articles and the significant trading in the Company's common stock, The Nasdaq National Market suspended trading in the Company's common stock on Thursday, December 10, 1998. After the Company issued two press releases responding to the articles and further clarifying the transaction with 42 44 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 Crescent Communications, The Nasdaq National Market resumed trading in the stock on Friday, December 11, 1998. Since the publication of the articles, The Nasdaq National Market and the Securities and Exchange Commission have asked the Company to provide documents and other material about the Crescent Communications transaction and other transactions. The Company is cooperating with both The Nasdaq National Market and the Commission in connection with these requests. However, because of the Commission's practice of keeping its investigations confidential, the Company does not know whether the Commission is in fact investigating the matter and, if so, the status of such matter. Investigations by the Commission and/or The Nasdaq National Market may cause disruption in the trading of the common stock and/or divert the attention of management. In addition, an adverse determination in any such investigation could have a material adverse effect on the Company. The Commission and The Nasdaq National Market could impose a variety of sanctions, including fines, consent decrees and possibly de-listing. See Note 17 -- Post July 13, 1999 Events regarding the Commission's notifying the Company in November 1999 that the Commission had dropped its investigation. 43 45 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 NOTE 8 -- SHAREHOLDERS' EQUITY Options and Warrants The Company has plans under which options to acquire up to 3,090,463 shares of the Company's common stock may be granted to directors, officers, key employees, consultants and non-employee directors of the Company and its subsidiaries. At March 31, 1999, options for 1,256,926 shares were available for grant under these plans. These plans are administered by the Company's Board of Directors, which is authorized, among other things, to determine which persons receive options under each plan, the number of shares for which an option may be granted, and the exercise price and expiration date for each option. The term of options granted shall not exceed 11 years from the date of grant of the option or from the date of any extension of the option term. The following table summarizes the transactions for the option plans as well as for warrants issued for the last three fiscal years:
OPTION PRICE WARRANT PRICE OPTIONS PER SHARE WARRANTS PER SHARE --------- -------------- --------- ------------- OUTSTANDING AT MARCH 30, 1996........... 971,158 $ 1.86 - 19.05 -- $ -- 5% stock dividend..................... 53,119 -- -- -- Granted............................... 135,024 5.00 - 27.00 -- -- Cancelled............................. (320,941) 19.05 -- -- --------- --------- ------------ OUTSTANDING AT MARCH 31, 1997........... 838,360 $ 1.86 - 27.00 -- $ -- Revalued -- cancelled................. (81,838) 19.05 - 27.00 -- -- Revalued -- granted................... 81,838 3.00 -- -- Granted............................... 284,250 3.00 - 7.72 2,329,198 $2.14 - 6.86 Exercised............................. (442,956) 1.95 - 5.55 -- -- Cancelled............................. (175,680) 5.53 - 27.00 -- -- --------- --------- ------------ OUTSTANDING AT MARCH 31, 1998........... 503,974 $ 1.86 - 19.05 2,329,198 2.14 - 6.86 5% stock dividend..................... 62,238 -- 149,045 -- Granted............................... 1,060,244 3.42 - 16.00 651,667 2.86 - 8.33 Exercised............................. (105,713) 2.86 - 9.00 -- -- Cancelled............................. (205,625) 2.86 - 19.05 -- -- --------- --------- ------------ OUTSTANDING AT MARCH 31, 1999........... 1,315,118 $ 1.86 - 16.00 3,129,910 $2.14 - 8.33 ========= ========= EXERCISABLE AT MARCH 31, 1999........... 305,997 3,129,910 ========= =========
WEIGHTED AVERAGE WEIGHTED REMAINING WEIGHTED OPTION AVERAGE CONTRACTUAL AVERAGE PRICE OUTSTANDING EXERCISE LIFE EXERCISABLE EXERCISE PER SHARE OPTIONS PRICE (YEARS) OPTIONS PRICE - ------------ ----------- -------- ----------- ----------- -------- $1.86 25,526 $1.86 2.76 25,526 $1.86 2.86 - 3.93 637,268 3.49 5.07 206,091 3.06 3.99 - 6.01 274,040 5.00 4.27 60,551 4.63 6.13 - 7.38 291,182 6.66 4.43 13,829 6.18 7.56 - 16.00 87,102 8.71 4.60 -- -- --------- ------- 1,315,118 $4.82 4.69 305,997 $3.41 ========= =======
44 46 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999
WEIGHTED AVERAGE WEIGHTED REMAINING WARRANT AVERAGE CONTRACTUAL PRICE OUTSTANDING EXERCISE LIFE PER SHARE WARRANTS PRICE (YEARS) --------- ----------- -------- ----------- $2.14 - 3.81 2,460,728 $2.78 3.28 3.99 - 6.86 142,431 5.68 2.26 8.01 - 8.33 526,751 8.08 3.92 --------- 3,129,910 $3.80 3.34 =========
The Company accounts for plans under APB Opinion No. 25, under which the total compensation expense recognized is equal to the difference between the option exercise price and the underlying market price of the stock at the measurement date. The Company has adopted SFAS No. 123, "Accounting for Stock-Based Compensation." The following pro forma net loss and net loss per common share information assumes that compensation cost was recognized for the vested portion of the awards granted in those years, based on the estimated fair value at the grant date consistent with the provisions of SFAS No. 123 (in thousand, except per share amounts):
1999 1998 1997 -------- -------- -------- Net loss -- as reported.................................... $(15,998) $(34,155) $(21,018) -- pro forma...................................... (16,716) (34,439) (21,500) Net loss per share -- as reported.......................... (1.63) (4.60) (3.80) -- pro forma........................... (1.70) (4.64) (3.88)
The fair value of each grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants in fiscal 1999, 1998 and 1997:
1999 1998 1997 ------------- ------------- --------- Expected stock price volatility................... 90% - 114.3% 130.90% 93.3% Risk free interest rate........................... 5.95% - 6.25% 5.95% - 6.25% 6.2% 2.0 - 5.0 Expected life..................................... years 5.0 years 4.8 years
The weighted average exercise prices per share for options outstanding and exercisable at March 31, 1999 are $4.82 and $3.41, respectively. The weighted average exercise prices per share for options outstanding and exercisable at March 31, 1998, are $5.00 and $6.06, respectively. The weighted average fair value of options granted during fiscal 1997, 1998 and 1999 is $17.65, $3.95 and $4.04 per share, respectively. The weighted average remaining contractual life for outstanding options at March 31, 1998 and March 31, 1999 is 3.65 years and 4.69 years, respectively. In February 1998, the Company's Board of Directors approved and adopted the establishment of a Non-Employee Director Stock Option Plan and to date has granted stock options to purchase 20,000 shares of the Company's common stock to each of the three non-employee directors. These options have a five-year term, are fully vested and have exercise prices of $3.42 and $4.39 per share. This plan is included in the above transaction table of options. In fiscal 1997, the Company recognized compensation expense of $125,000 in connection with the issuance of restricted stock and the amendment of certain previously issued stock options. In connection with the issuance of the convertible notes in July and December 1997, the Company issued 85,648 warrants (before adjustment for 5% stock dividend) at fair market value estimated using the Black-Scholes option-pricing 45 47 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 model of $384,000. These costs were originally capitalized in other assets and amortized over the term of the debt as non-cash interest expense. Upon conversion, the unamortized portion was credited to additional paid in capital. During fiscal 1997, the Company made a commitment to issue a warrant to an investment banker for services provided in connection with the Restructuring to purchase 100,000 shares of the Company's common stock at $22.63 per share (see Note 2). The warrant can be exercised at any time through February 2000. The Company recorded the fair value of the warrant within discontinued operations (see Note 2). The fair value of the warrant of $800,000 was estimated using the Black-Scholes option-pricing model. In fiscal 1998, the Company issued two warrants to an investment banker for services provided in connection with the Restructuring to purchase a total of 324,000 shares of the Company's common stock at $2.25 per share (before adjustment for 5% stock dividend). The Company recorded the fair value of the warrants of $503,000 as an expense in fiscal 1998. The fair value of the warrants of $503,000 was estimated using the Black-Scholes option-pricing model. In March 1998, the Company issued a warrant to a leasing company for services provided in connection with customer financing to purchase 38,800 shares of the Company's common stock at $4.00 per share (before adjustment for 5% stock dividend). The Company recorded a fair value of the warrants as a reduction in net sales in the fourth quarter ended March 31, 1998 of $123,000 using the Black-Scholes option-pricing model, this amount is included in loss on discontinued operations in the accompanying consolidated statement of operations. In fiscal 1999, the Company issued warrants to leasing companies for services provided in connection with customer financing to purchase 242,250 shares of the Company's common stock at prices ranging from $3.56 to $8.33 per share. The Company recorded a fair value of the warrants of $753,000 as a reduction in net sales in fiscal 1999, this amount is included in loss on discontinued operations in the accompanying consolidated statement of operations. The fair value was estimated using the Black-Scholes option-pricing model. Through June 19, 1999, none of the above warrants have been exercised. At March 31, 1999, the Company had 3,940,285 shares of common stock reserved and available for warrants and for the conversion of Class A and B Units as described in Note 12 -- Related Party Transactions. As described in Note 7 above, an agreement has been reached to settle the claims against the Company and its subsidiaries in The Diana Securities Litigation. Under the terms of the agreement, the Company anticipates that it will issue warrants for 2,225,000 shares of the Company common stock with an expected life of three years from date of issuance. Such warrants will have an exercise price of $9.00 per share if exercised during the first year from date of issue and an exercise price of $10.00 per share or $11.00 per share if exercised during the second year or third year, respectively. The Company recorded the fair value of the warrants of $8,000,000 as an expense in fiscal 1998. The fair value was estimated using the Black-Scholes option-pricing model. These warrants are not included in the above table. See Note 17 -- Post July 13, 1999 Events. Convertible Preferred Stock and Warrants In September 1998, the Company entered into a private placement agreement and issued 700 shares of 5% Series A Convertible Preferred Stock, par value $.01, with a liquidation value of $10,000 per share. The total cash received by the Company was $6,345,000 after payment of $655,000 for fees and expenses associated with the issue. The preferred stock has no voting rights and is convertible, subject to certain limitations and restrictions, into shares of common stock, after a minimum holding period of 120 days, based 46 48 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 upon a per share common stock price that will be the lesser of the initial conversion price as defined in the contract or 87% of the average of the three lowest per share market values during the ten trading day period prior to an applicable conversion date. This beneficial conversion feature has been valued at $1,050,000 and accounted for as a dividend to the preferred shareholders. The holders of Preferred Stock are entitled to receive 5% cumulative dividends per annum. No dividends can be paid or declared on any Common Stock unless full cash dividends, including past dividends declared, have been paid on the Preferred Stock. During fiscal 1999, the Company declared and paid cash dividends of $205,000 on the Preferred Stock. In conjunction with this agreement, the Company issued warrant rights to the investment participant to purchase 225,000 shares of common stock at a warrant exercise price of $8.43 per share. The term of the warrants is three years. In May 1999, in connection with a private placement, a partial redemption of the 5% Series A Convertible Preferred Stock was consummated and the terms for future conversion of the remaining balance into Company common stock were revised. (See Note 16 -- Subsequent Events). Common Stock and Convertible Notes In July 1997, the Company issued 1,880,750 shares of its common stock at $2.00 per share in a private placement. The Company received $3,362,000 from the private placement, net of fees of $400,000. In addition, the Company issued warrants to purchase 1,880,750 shares of the Company's common stock at $3.00 per share (before adjustment for 5% stock dividend). The warrants are exercisable immediately and expire five years from issuance. Mr. Fiedler, the Company's Chairman and Chief Executive Officer, participated in the private placement and purchased 175,000 shares of common stock and received warrants to purchase 175,000 shares of the Company's common stock. In addition, Mr. Stephen W. Portner, a director, and his daughter collectively participated in the private placement and purchased 11,250 shares of common stock and received warrants to purchase 11,250 shares of the Company's common stock. The common stock and common stock warrants issued in the private placement are subject to registration rights. In July 1997, the Company received $2,235,000 upon the issuance of $2,500,000 in 8% convertible notes. As of December 31, 1997, the full value of notes and accrued interest to the date of conversion had been converted into the Company's common stock. Common stock totaling 484,964 shares was issued in connection with conversions of $2,545,000 of convertible notes and accrued interest at a weighted average conversion price of $5.25 per share, which represented a conversion price of 80% of the average closing bid price on the conversion date in accordance with the terms of the notes. A finance charge of $625,000 was recorded in the fourth quarter of fiscal 1998 in respect of this discount value. In December 1997, the Company received $4,635,000 upon the issuance of $5,000,000 in 8% convertible notes. The initial conversion price is the lessor of $7.00 or 80% of the five-day average closing bid price on a conversion date with a conversion floor price (the "Conversion Floor Price") of $4.00 per share, provided that if the average closing bid price for any 20 consecutive trading days prior to a conversion date is less than $4.00 per share, the Conversion Floor Price will be adjusted to 80% of such 20 day average closing bid price. Effective April 7, 1998, in agreement with note holders, the conversion terms were modified so that the conversion price discount factors be determined with reference to the closing transaction price of the common stock for the 15 consecutive days prior to a conversion date and the applicable discount factor be applied to the 47 49 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 average closing transaction price of the stock for the five consecutive trading days prior to the conversion date in order to determine the conversion price. The applicable discount factors were agreed as follows:
15 DAY AVERAGE APPLICABLE CLOSING TRANSACTION PRICE DISCOUNT ------------------------- ---------- Below $3.00 ................................. 0% Between $3.00 - $3.75................................. 10% $3.75 - $4.25................................. 15% $4.25 - $4.85................................. 20% $4.85 - $6.00................................. 25% Amounts in excess of $6.00...................................... 20%
A finance charge of $1,250,000 was recorded in the fourth fiscal quarter ended March 31, 1998, in respect of the maximum beneficial value available to the investors based upon the estimated potential discount from market value upon conversion. The note can be converted equally beginning 45, 75 and 105 days following December 22, 1997. Interest is payable semi-annually in arrears in the form of Company common stock based on the above-described conversion price. As of June 9, 1998, the full value of notes and accrued interest to the date of conversion had been converted into Company common stock. Common stock totaling 1,404,825 shares was issued in connection with conversions of $5,133,000 of convertible notes and accrued interest. In October 1998, the Board of Directors approved the declaration of a 5% common stock dividend. Based upon an established record date of October 21, 1998, the Company issued 497,623 shares of common stock on November 4, 1998. Certain contractual anti-dilution provisions reduced conversion and warrant exercise prices by a minor amount. NOTE 9 -- INCOME TAXES A reconciliation of the provision (benefit) for income taxes and the amount computed by applying the statutory federal income tax rate (34%) to loss from continuing operations before extraordinary items, minority interest and income tax credit for the last three fiscal years is as follows (in thousands):
1999 1998 1997 ------- ------- ------- Federal income tax at statutory rate........................ $(3,277) $(5,875) $(1,388) State income tax, net of federal benefit.................... (578) (1,036) (245) Tax effect of net operating loss not benefited.............. 3,834 6,898 1,529 Refund of federal income taxes paid in a prior year......... -- -- (836) Other, net.................................................. 21 13 104 ------- ------- ------- Income tax credit........................................... $ -- $ -- $ (836) ======= ======= =======
48 50 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and income tax purposes. The components of the Company's deferred tax assets and liabilities of continuing operations are as follows (in thousands):
MARCH 31, 1999 MARCH 31, 1998 -------------- -------------- Federal net operating loss carryforwards.................... $ 21,576 $ 18,460 State net operating loss carryforwards...................... 729 1,367 Reserve for loss on discontinued operations................. 819 745 Reserves.................................................... 337 560 Capitalized interest in Coyote debentures................... 168 225 General business credits.................................... 490 145 All others.................................................. 314 261 -------- -------- Total deferred tax assets......................... 24,433 21,763 Valuation allowance for deferred tax assets................. (21,879) (19,396) -------- -------- Net deferred tax assets..................................... 2,554 2,367 Intangible assets (net)..................................... 1,407 1,407 All others.................................................. 1,147 960 -------- -------- Total deferred tax liabilities.................... 2,554 2,367 -------- -------- Net deferred taxes.......................................... $ -- $ -- ======== ========
The Company has approximately $50,000,000 in both federal and state net operating loss carryforwards. These carryforwards expire at various dates through fiscal 2019. The Tax Reform Act of 1986 imposed substantial restrictions on the utilization of net operating losses in the event of an "ownership change" as defined in Section 382 of the Internal Revenue Code of 1986. Subsequent to March 31, 1999, due to the Company's continuing financing efforts, there may be ownership changes which would significantly limit the Company's ability to immediately utilize its net operation loss carryforwards. NOTE 10 -- NON-OPERATING INCOME (EXPENSE) AND UNUSUAL ITEMS In June 1996, Concentric Network Corporation executed a Promissory Note for $5.0 million in favor of the Company for a bridge loan. Concentric Network granted to the Company a warrant to purchase a split adjusted 36,765 shares of Concentric Network Series D Preferred Stock ("CNC Preferred Stock") at a split adjusted exercise price of $20.40 per share (equal to the par value of such shares) as additional consideration for the bridge loan to Concentric Network. In August 1996, the Promissory Note and accrued interest receivable were converted into 3,729,110 shares of CNC Preferred Stock. In September 1996, the Company sold to StreamLogic Corporation 1,838,234 shares, or 49% of its CNC Preferred Stock for $2.5 million. No gain or loss was recognized in connection with this sale. In August 1997, Concentric Network completed its Initial Public Offering at an offering price of $12.00 per share. The CNC Preferred Stock owned by the Company was automatically converted into Concentric Network common stock immediately prior to the closing of the IPO. The value of the Company's investment in CNC Preferred Stock was approximately $1,512,000. The Company deemed this value to be the maximum fair market value of its holding on an if-converted basis at March 31, 1997 and in addition, concluded the value of that investment was permanently impaired. Consequently, the Company recorded a non-operating loss of $1,060,000 in fiscal 1997 related to the impairment of its investment. The Company was prohibited from selling 75% of its Concentric Network common stock for six months following Concentric Network's IPO. The Company sold 25% of its Concentric Network common stock in August 1997 at $12.00 per share and received $396,000 and sold the remaining 75% in the fourth quarter of fiscal 1998 receiving $1,358,000 and recorded a gain on these sales of $242,000 in fiscal 1998. In March 1999, in connection with a 49 51 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 public offering made by Concentric Network, the Company exercised and sold the Concentric Network common stock represented by the warrant and recorded a non-operating gain of $877,000. In September 1997, the Board of Directors authorized an amendment to certain Class B Units owned by directors and employees of the Company at June 30, 1997, to provide for the elimination of the minimum pre-tax profits measure requirement and the conversion into Company common stock at the option of the holder. An accrued expense charge of approximately $5,522,000 was recorded in the second quarter of fiscal 1998 and is included in the loss from discontinued operations in the accompanying consolidated financial statements, since all of these related to Coyote Technologies, LLC the provider of the discontinued switches. This charge is based on the value at September 4, 1997, of 866,250 shares of Company common stock at $6.375 per share that will be issuable to the Class A and Class B Unit Holders. NOTE 11 -- EXTRAORDINARY ITEMS On October 4, 1996, Atlantic Provision refinanced its revolving line of credit with a new lender. In connection with the refinancing, Atlantic Provision incurred expenses of $227,000, which are reflected in the fiscal 1997 Consolidated Statement of Operations as an extraordinary item. In February 1997, Atlantic Provision sold a majority of its assets and used part of the proceeds to repay its revolving line of credit (see Note 2). Atlantic Provision incurred expenses of $281,000 in connection with the early repayment which are reflected in the fiscal 1997 Consolidated Statement of Operations as an extraordinary item. NOTE 12 -- RELATED PARTY TRANSACTIONS On November 11, 1996, the Company loaned $300,000 each to James J. Fiedler and Daniel W. Latham. Mr. Fiedler is the Company's Chairman and Chief Executive Officer and Mr. Latham is the Company's President and Chief Operating Officer. Messrs. Fiedler and Latham both executed unsecured Promissory Notes due November 1, 1999 which provide interest at 6.07% per annum compounded on the anniversary date and payable on November 1, 1999. In addition, each person agreed to surrender previously awarded options they each held to purchase 150,000 shares of the Company's common stock. The Promissory Notes provide for full repayment prior to November 1, 1999 in the event of the following: (a) upon any transfer of Messrs. Fiedler's or Latham's Class B Units in Coyote Technologies, LLC (other than to a Permitted Transferee, as defined in the Agreement Regarding Award of Class B Units (the "Award Agreement")), or by any such Permitted Transferee (including without limitation certain transfers contemplated by the Award Agreement) or (b) upon any exchange or conversion of Class B Units for or into securities registered under the Securities Exchange Act of 1934, as amended, in accordance with the Award Agreement. In connection with the employment agreements with Messrs. Fiedler and Latham entered into on September 4, 1997, the Company's Board of Directors agreed to forgive the notes. Under the employment agreements, equal one third portions of the notes were forgiven at September 4, 1997 and, if their respective employment terms are renewed, will be forgiven at each of the next two anniversaries of the date of the employment agreements, provided that each individual remains as an employee of the Company at each such forgiveness date. Messrs. Fiedler and Latham used the proceeds of the loan to each purchase 100 non-forfeitable Class B Units of Coyote Technologies, LLC from Mark Jacques, a former officer of Coyote Technologies, LLC for an aggregate purchase price of $600,000. On November 12, 1996, Coyote Technologies, LLC entered into a settlement agreement with Mr. Jacques whereby Mr. Jacques (i) agreed to the assignment to the Company of the employment agreement between him and Coyote Technologies, LLC and (ii) retained his remaining 250 Class B Units of Coyote Technologies, LLC. Mr. Jacques was terminated as an employee of the Company in January 1997. The Company has accounted for the loans to Messrs. Fiedler and Latham and their purchase of 50 52 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 Class B Units from Mr. Jacques as a settlement with Mr. Jacques and recorded an expense of $600,000 during the third quarter of fiscal 1997. The Company entered into Separation Agreements, dated November 20, 1996 (the "Separation Agreements"), with each of Richard Y. Fisher, Sydney B. Lilly and Donald E. Runge (the "Departing Officers") that provide for termination of employment and resignation from all offices and directorships in the Company and its subsidiaries by the Departing Officers, except for Mr. Lilly's directorship of the Company. The Separation Agreements provide for payment by the Company, as of November 29, 1996, of $186,000 and $749,000, respectively, to Mr. Runge and Mr. Fisher, in settlement of deferred compensation previously earned and payments of $343,000 to Mr. Fisher and $83,000 to each of Mr. Runge and Mr. Lilly as severance settlements resulting in total payments to the Departing Officers of $1,444,000. In accordance with provisions of the Amended and Restated Employment Agreements entered into by the Company and each of the Departing Officers on April 2, 1995, each Departing Officer shall be entitled to have all medical, dental, hospital, optometrical, nursing, nursing home and drug expenses for themselves and their spouses paid by the Company for life, or in the case of Mr. Lilly, until March 31, 2000. The Separation Agreement for Mr. Fisher provides that he shall repay in full a promissory note dated April 11, 1988, in the amount of $42,469. The Separation Agreements further provided that all stock options of the Departing Officers shall remain exercisable until December 31, 1997 (April 2, 2000 with respect to 82,688 options granted to Mr. Lilly on April 2, 1995) and amends existing Stock Option Agreements with Messrs. Fisher, Lilly and Runge to provide for, among other things, the Company to maintain the effectiveness of the Form S-8 Registration Statement currently in effect covering the exercise of the stock options. The Company has made all required payments under the Separation Agreements. Certain of the Company's non-employee directors have provided services to the Company and/or its subsidiaries for which they were compensated. Amounts accrued or paid to all directors for these services during fiscal 1999, 1998 and 1997 are $0, $50,000 and $4,000, respectively. In February 1997, Atlantic Provision conveyed its 50% ownership interest in Fieldstone Meats of Alabama, Inc. to a former officer and director of Atlantic Provision in consideration for past services as a director and officer of Atlantic Provision for his assistance in the sale of the Atlantic Provision business. Mr. Fiedler, the Company's Chairman and Chief Executive Officer, loaned the Company $250,000 in June 1997. The principal amount of the loan was converted to common stock in conjunction with Mr. Fiedler's purchase of Company common stock in a private placement in July 1997. Mr. Latham, the Company's President and Chief Operating officer, loaned the Company $98,000 subsequent to March 31, 1997. This loan was repaid in July 1997. Mr. Portner, a director, purchased Company common stock pursuant to the Regulation D private placement. Mr. Fiedler advanced the Company $220,000 in March 1999, which was repaid in March 1999. On September 4, 1997, the Board of Directors authorized an amendment to certain Class B Units owned by directors and employees of Coyote and Coyote Technologies, LLC, at June 30, 1997. (See Note 3). In January 1998, the Board of Directors of the Company approved an interest-free loan to Daniel W. Latham for a maximum amount of $500,000 to be used solely for the purpose of providing partial down payment monies on his purchase of a residence in California. The funding is to be secured by the residential property and is for a five-year term unless specifically extended by the Board of Directors. Earlier repayment of the loan will be demanded in the event of either (1) sale or refinancing of the property; (2) termination of Mr. Latham's employment either voluntarily or for cause; or (3) sale by Mr. Latham of all, or substantially all, of his stock in Coyote Network Systems, Inc. As of March 31, 1999, $421,000 was funded under this agreement. In October 1998, the Company amended the terms of the loan and in agreement with Mr. Latham 51 53 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 established an annual interest rate of 6.5% to be applied to the loans and payable at the completion of the term. In September 1998, the Company sold approximately $13.0 million of switch equipment to Crescent Communications, Inc. ("Crescent") through a third party leasing arrangement. In addition to the cash proceeds, the Company received an approximately 20% ownership interest represented by 1,990 shares of common stock in Crescent and the Company entered into a maintenance and service agreement with Crescent. The Company did not recognize approximately $2.5 million of revenue on this sale related to its equity interest in the buyer and amounts reserved for payment contingencies. The entire cash proceeds related to the sale were collected prior to September 30, 1998. On September 30, 1998, the Board of Directors of the Company accepted the tendered resignation of Mr. Lilly as a director of the Company and approved Mr. Lilly's Amended Separation Agreement ("Amendment"). The Amendment provides for payments to Mr. Lilly of $50,000 per year for five years to be paid in sixty monthly installments commencing on October 1, 1999. As of March 31, 1999, Mr. Lilly had been paid $25,000. The Amendment also extended the time period during which the Company is required to pay all medical expenses for Mr. Lilly and his spouse under the Separation Agreement for an additional ten years until March 31, 2010. Comdisco, Inc., a technology services and finance company, is the beneficial owner of approximately 6% of the Company's common stock including 515,400 shares purchased by Comdisco on the open market and 192,990 warrants issued in connection with lease financing provided by Comdisco to the Company's end-user customers. During fiscal 1998 and fiscal 1999, Comdisco has provided financing in a total amount of $24.0 million to four of the Company's customers. In fiscal 1999, the Company sold 71,650 shares of common stock for $300,000 to Systeam. (See Note 4). PrinVest Financial Corporation, a financing and leasing corporation, owns a minority interest of approximately 4% of the Company's subsidiary Coyote Gateway, LLC (dba AGT), and 90,000 warrants to purchase shares of the Company's common stock. During fiscal 1999, PrinVest has provided financing to AGT ($8.2 million at March 31, 1999) in connection with deposits required to be made by AGT to other long distance telecommunications carriers and for working capital. The Company has pledged 708,692 shares of common stock as collateral on the notes payable to PrinVest. As of March 31, 1999, PrinVest was the purchaser/lessor on approximately $15.0 million of equipment that it is leasing to end-users. See Note 17 -- Post July 13, 1999 Events. In November 1997, the Company completed the sale of C&L Communications, Inc. to the management of C&L (See Note 2). During the years ended March 31, 1998 and 1999, the Company had the following transactions with C&L:
1999 1998 ---------- -------- Purchases from C&L (1)...................................... $9,498,000 $ -- Sales to C&L (1)............................................ $ -- $304,000 Redemption of Preferred Stock by C&L........................ $1,500,000 $ --
- --------------- (1) Included in discontinued operations The purchases from C&L consist primarily of compression equipment manufactured by Newbridge Networks. C&L is a Newbridge dealer and the Company is not. See Note 17 -- Subsequent Events. 52 54 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 NOTE 13 -- BUSINESS SEGMENT INFORMATION After the decision to discontinue the switch business, the Company will be operating in only one segment, long distance services. NOTE 14 -- STATEMENTS OF CASH FLOWS Supplemental cash flow information relating to continuing operations for the last three fiscal years is as follows (in thousands):
1999 1998 1997 ------- ------ ------ Cash paid for interest...................................... 1,808 444 42 Cash paid for taxes......................................... 6 6 5 Non-cash transactions, continuing operations: Convertible debt expense associated with conversion to common stock below market price........................ $ (382) $1,875 $ -- Acquisitions purchased with common stock.................. 1,686 -- 1,818 Conversion of promissory note and accrued interest into CNC preferred stock.................................... -- -- 5,072 Conversion of debt to common stock........................ 3,789 -- -- Securities litigation warrant expense..................... -- 8,000 -- Dividend paid in common stock............................. 3,359 -- 7,725 Beneficial conversion feature on preferred shares......... 1,050 -- -- Amounts paid directly by lender........................... (7,921) -- -- Non-cash transactions, discontinued operations: Expense charge on conversion of A & B units............... $ -- $5,522 $ -- Sales discount granted for investment in affiliate........ (900) -- --
NOTE 15 -- LIQUIDITY AND CAPITAL RESOURCES Fiscal 1999 -- Year Ended March 31, 1999 After the restructuring and discontinuance, the Company's operations are similar to those of an early-stage enterprise and are subject to all the risks associated therewith. These risks include, among others, uncertainty of markets, ability to develop, produce and sell profitably its products and services and the ability to finance operations. Management believes that it has made significant progress on its business plan in fiscal 1999 and to date in fiscal 2000. Significant actions in this progress include commencing operations of INET, resolving the class action lawsuit (See Note 7) and recently raising additional equity investment (see Notes 8, 16 and 17). However, the Company remains constrained in its ability to access outside sources of capital until such time as the Company is able to demonstrate higher levels of sales and more favorable operating results. Management believes that it will be able to continue to make progress on its business plan and mitigate the risks associated with its business, industry and current lack of working capital. In fiscal 1999, the Company raised $6.3 million, net of fees, from the issuance of 700 shares of 5% Series A Convertible Preferred Stock (see Note 8). These funds, together with operating cash on hand at the end of the prior fiscal year and increases in short-term borrowings, were sufficient to finance the Company's growth in operating activities experienced during fiscal 1999. However, the increases in short-term debt and other current liabilities required to support the operations resulted in a deficiency in current working capital as at March 31, 1999 of $0.7 million. 53 55 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 Subsequent to year-end, the Company continues to be constrained in its ability to access outside capital, however, management has taken certain actions that they believe will allow the Company to continue to fund operations at least until March 2000. These actions include: - Received $10.2 million proceeds from a private placement in May 1999 (See Note 16 -- Subsequent Events); - Received an offer for a commitment for a stand-by credit facility of $3.5 million (See Note 16 -- Subsequent Events); - In July 1999, the Company entered into an agreement to sell its shares of iCompression, Inc. (See Note 4) for $1.9 million (See Note 17 -- Post July 13, 1999 Events); and - Extended the maturity date of the $8.2 million note payable with PrinVest to December 2001 (See Notes 12 and 17 -- Subsequent Events). In order to fund the current and future operating and investment activities, the Company will need to continue to generate cash from its present operations and, in addition, will require and is seeking further outside investment. Fiscal 1998 -- Year Ended March 31, 1998 As discussed below, the Company encountered a liquidity deficiency during the end of fiscal 1997 and in early fiscal 1998, primarily because (i) certain customers of Coyote Technologies were past due on receivables, (ii) Coyote Technologies granted certain customers extended payments terms, (iii) Coyote Technologies' revenue growth has been lower than expected and (iv) the Company made payments of $2,349,000 in connection with the Restructuring. As a result of the liquidity deficiency, the Company had become delinquent on certain of its working capital obligations. In July and December 1997, the Company raised $5,597,000 and $4,635,000 respectively, through equity and debt financing (see Note 8). With completion of the equity and debt financing and the collection of $4,400,000 of previously delinquent customer receivables and the receipt of $2,254,000 from the exercise of Company Employee Stock Options, the Company had more than sufficient funds to finance its operating activities in fiscal 1998 and ended the fiscal year with an operating cash balance of $3,700,000. The Company has now divested the majority of its discontinued operations (Atlantic Provision, C&L, Valley) and is actively seeking buyers for the remaining land and building which were formerly part of the Atlantic Provision operations in Atlanta. In order to fund the current and future operating, acquisition and investment activities, the Company will need to generate cash from its present and recently acquired operations and, in addition, will require and is currently seeking further outside investment. As of July 1, 1998, the Company had an operating cash balance of approximately $5,000,000. Fiscal 1997 -- Year Ended March 31, 1997 The Company encountered a liquidity deficiency in fiscal 1997 and subsequently, primarily because (i) certain customers of Coyote Technologies, LLC were past due on receivables, (ii) Coyote Technologies, LLC has granted certain customers extended payment terms, (iii) Coyote Technologies', LLC revenue growth has been lower than expected and (iv) the Company made payments of $2,349,000 in connection with the Restructuring. As a result of the liquidity deficiency, the Company had become delinquent on certain of its working capital obligations. In July 1997, the Company raised $5,597,000 through equity and debt. After completion of 54 56 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 the equity and debt financings, collection of $4.4 million from Concentric Network, pursuant to the final court agreement secured by Coyote Technologies, LLC against this customer, and the anticipated sales of C&L, Valley and Atlantic Provision's real estate discussed further below, management believes that it will have sufficient resources to provide adequate liquidity to meet the Company's planned capital and operating requirements through March 31, 1998. Thereafter, the Company's operations will need to be funded either with funds generated through operations or with additional debt or equity financing. If the Company's operations do not provide funds sufficient to fund its operations and the Company seeks outside financing, there can be no assurance that the Company will be able to obtain such financing when needed, on acceptable terms or at all. The Company is seeking buyers for C&L and Valley. It is anticipated that the proceeds of the sales of these businesses and assets will be used to fund a portion of the Company's capital and operating requirements in fiscal 1998. Restrictions in the revolving lines of credit of C&L and Valley prevent the Company from presently accessing funds from these subsidiaries. Such restrictions in C&L's revolving line of credit may also initially limit the Company's access to the total proceeds from a sale of Valley prior to any ultimate sale of C&L given the existing ownership structure of Valley. NOTE 16 -- SUBSEQUENT EVENTS On May 27, 1999, the Company sold, pursuant to Rule 506 under Regulation D, 1,767,000 shares of common stock at $6.00 per share in a private placement with new and existing domestic and international institutional investors. The placement agent received cash commissions of $352,000 and commissions in the form of common stock aggregating 131,148 shares and five-year warrants to purchase 176,700 shares at $6.00 per share. The net proceeds of approximately $10.2 million are to be used for working capital and to redeem $4 million of the outstanding Convertible Preferred Stock. In connection with this redemption, the conversion price of the remaining $6 million of Convertible Preferred Stock was fixed at $6.00 per share and the Company issued the holder of the Convertible Preferred Stock 18-month warrants to purchase 325,000 shares of common stock at $6.00 per share. These warrants may be exercised at any time until December 30, 2000. The Company has agreed to use its best efforts to file a registration statement as to the common stock issued in the private placement and underlying the warrants and Convertible Preferred Stock referred to above. In July 1999, the Company received an offer for a commitment for a stand-by credit facility from certain shareholders that would provide a funding commitment to the Company of $3.5 million. This facility would be secured by the stock of INET, bear 12.5% interest on the outstanding principal balance and be repayable on March 31, 2000. In July 1999, the Company sold its shares of iCompression, Inc. (See Note 4) for $1.9 million. NOTE 17 -- POST JULY 13, 1999 EVENTS Since July 13, 1999, several significant events have occurred. They are summarized as follows: 1. In September 1999, the Company sold its interest in American Gateway by transferring all assets and liabilities to PrinVest Corp., reporting a gain of $6.2 million. In connection with this sale, PrinVest cancelled the $8.2 million outstanding principal amount of Notes of American Gateway owed to PrinVest. 2. In November 1999, the Commission advised the Company that it had dropped its investigation regarding its sales to Crescent Communications, described in Note 7. The Company does not know 55 57 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 1999 the status of the Nasdaq inquiry and Nasdaq has not contacted the Company regarding the matter since May 1999. 3. In February 2000, the Company sold its interest in Systeam, S.p.A. for $1.2 million. 4. In January and February 2000, the Company raised additional equity of $13.9 million (net of expenses) by the sale of approximately 3.2 million shares of 6% Series B Convertible Preferred Stock. 5. In January 2000, the Company restructured its management team and business strategy. In connection therewith, the Company issued 2,000,000 shares of common stock to a consulting firm and issued options to purchase 750,000 shares of common stock at $5.00 per share to James R. McCullough, the Company's new Chief Executive Officer. 6. In March 2000, four of our customers completed third party lease contracts in respect of $14.2 million of switching equipment previously shipped under extended payment terms. We received payments of $10.0 million and $1.5 million in March 2000 and April 2000, respectively. 7. In May 2000, the Company approved a plan that included the discontinuance of the Company's switch business. The financial statements have been restated to present the operations of the switch business as discontinued operations (see Note 2). 56 58 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE (a) Previous independent accountants (i) On October 15, 1997, after completion of the March 31, 1997 fiscal year audit, Price Waterhouse LLP, our former independent accountants, in a letter addressed to our Chairman and CEO with a copy to the Chief Accountant at the SEC, confirmed that the client -- auditor relationship between Coyote Network Systems, Inc. (formerly The Diana Corporation) and Price Waterhouse LLP had ceased upon the resignation of Price Waterhouse LLP. During the third quarter of fiscal 1997, ending on January 4, 1997, we announced a restructuring plan to concentrate our resources on one line of business (communication switching) via our holdings in Coyote Technologies, LLC (formerly Sattel Communications LLC), and to discontinue, from an accounting standpoint, and to divest our other holdings. Our largest subsidiary, Atlanta Provision Company, Inc., was sold in February 1997. We subsequently moved our headquarters to Calabasas, California from Milwaukee, Wisconsin. The change in both scope and size of annual revenues (from over $200,000,000 to approximately $10,000,000) going forward as well as the change in management and locations (now the former Sattel management in California) led to the cessation of our client -- auditor relationship with Price Waterhouse LLP. (ii) The reports of Price Waterhouse LLP on the financial statements for the prior two fiscal years contained no adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principle, except as to the uncertainties noted in the Report of Independent Accountants filed with our Form 10-K dated September 22, 1997. The uncertainties noted relate to our liquidity and viability, and class action litigation and other potential claims by investors. (iii) The Company's audit committee was not involved by Price Waterhouse LLP regarding its decision to end our client -- auditor relationship. (iv) Except as mentioned below, in connection with its audits for the two most recent fiscal years and through October 15, 1997, there have been no disagreements with Price Waterhouse LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which disagreements if not resolved to the satisfaction of Price Waterhouse LLP would have caused them to make reference thereto in their report on the financial statements for such years. During the audit of the fiscal 1997 financial statements a difference of opinion arose relating to the audit procedures necessary with respect to certain customer sales, including Concentric Network Corporation. The difference of opinion was with respect to the timing and manner of further Price Waterhouse LLP direct contact in addition to written receivable confirmation requests with our customers and management's concern regarding both pending legal proceedings with customers and/or potential adverse effect on our customer relationships. After further discussion, the manner of the customer contact was mutually agreed upon and the initial disagreement thus promptly (within 1 day) resolved. No disagreements in accounting related to these sales arose. The Audit Committee discussed the subject matter of this disagreement with Price Waterhouse LLP. We have authorized Price Waterhouse LLP to respond fully to the inquiries of its successor auditors concerning the subject matter of this disagreement. (v) During the two most recent fiscal years and through October 15, 1997, our management believes that there have been no reportable events (as defined in Regulations S-K Item 304 (a)(1)(v) ) except as follows: (1) During the year-end audit of the accounts for fiscal 1997, the following weaknesses in internal control were identified: (1.1) Errors, including instances of failure to properly consider, with respect to our policy, the effect of non-standard contract provisions on revenue recognition. (1.2) Need for a more structured approach by which to thoroughly complete and document a review of relevant terms and conditions for all contracts consistent with our revenue recognition policy/procedure and required revenue recognition criteria. 57 59 Upon further review by us it was determined that certain sales transactions at our Sattel Communications ("Sattel") operation were not consistent with the Sattel policy and procedure and the criteria required to support revenue recognition in accordance with generally accepted accounting principles. These errors resulted in revisions to previously reported unaudited financial information with respect to the second and third quarters of fiscal 1997. These revisions, which were included and reported in Note 16 Quarterly Results of Operations (Unaudited) of Form 10-K filed in respect of the fiscal year 1997, were as follows: FISCAL YEAR ENDED MARCH 31, 1997 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
12 WEEKS ENDED ---------------------------------------------- OCTOBER 12, 1996 JANUARY 4, 1997 --------------------- --------------------- ORIGINALLY ORIGINALLY REPORTED REVISED REPORTED REVISED ---------- ------- ---------- ------- Net sales.......................................... $ 4,046 $ 3,666 $ 4,337 $ 2,552 Gross profit (loss)................................ 3,034 2,775 3,057 1,842 Net loss........................................... $(4,598) $(4,737) $(4,001) $(5,936) Net loss per common share.......................... $ (.87) $ (.90) $ (.76) $ (1.12)
The per share amounts presented above do not reflect our November 4, 1998 stock dividend. (2) In addition to the matter reported in (v)(1) above, it was also noted that internal control weaknesses existed, which did not result in revisions to previously reported financial information, relative to insufficient identification and control surrounding Sattel's maintenance of detailed historical cost and accumulated depreciation information by individual asset, and that the timeliness and quality of account reconciliations and supporting analysis requires improvement in order to ensure that procedures are in place to support expected increases in transaction volumes anticipated by us. The following actions are being taken by our management to correct the identified weaknesses: - Strengthening of our financial organization to increase the number of personnel qualified to address revenue recognition issues and to improve the timeliness and quality of account reconciliations and analysis. - Implementation of a more timely and diligent review and resolution by management of all non-standard contract terms and conditions. - Development and implementation of a comprehensive system to identify and properly address relevant revenue recognition considerations. - Implementation of an enhanced fixed assets accounting and control system. (b) New independent accountants We engaged Arthur Andersen LLP as our new independent accountants as of December 9, 1997. During the two most recent fiscal years prior to fiscal 1998 and through December 9, 1997 we (or someone on our behalf) did not consult with Arthur Andersen LLP regarding (1) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on our financial statements or (2) any matter that was either the subject matter of a disagreement or a reportable event. 58 60 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY Identification of Directors Our board of directors is divided into three classes of directors, consisting of one class of two members and two classes of one member each, or four members in the aggregate. The term of each class is three years. The board of directors currently consists of four members, James R. McCullough, Daniel W. Latham, John M. Eger and J. Thomas Markley. The following table sets forth certain information with respect to each person who is currently a director of us, and the individual nominated and recommended to be elected to our board of directors and is based on our records and information furnished to us by such persons. Reference is made to "Security Ownership of Certain Beneficial Owners and Management" for information pertaining to stock ownership by each of our directors and executive officers.
NAME AGE POSITION ---- --- -------- John M. Eger............................... 60 Director Daniel W. Latham........................... 51 President, Chief Operating Officer and Director J. Thomas Markley.......................... 67 Director James R. McCullough........................ 32 Chief Executive Officer and Director
NOMINEE FOR ELECTION AS A DIRECTOR WITH TERM EXPIRING IN 2002 DANIEL W. LATHAM, age 51, has served as our director since November 1996. He has served as our President and Chief Operating Officer since November 1996 and President of Coyote Technologies, LLC ("CTL") since September 1995. Prior to his association with CTL, Mr. Latham was the President of Frontier Communications Long Distance Company. DIRECTORS WITH TERMS EXPIRING IN 2001 J. THOMAS MARKLEY, age 67, has served as our director since September 1999, and previously served as an advisor to our board of directors. Mr. Markley has served as President of JTM, Inc., a consulting firm specializing in senior management consulting for telecommunications, data communications and electric utilities, since July 1989. Previously, Mr. Markley was Senior Vice President, Telecommunications Operations and Planning for SALIENT(3) Communications, Inc., a telecommunications company that designs, manufactures and markets equipment for communications network operators worldwide. Mr. Markley also held senior management positions with Raytheon, a leading diversified technology company, as Corporate Vice President, President of Raytheon Data Systems and President of Raytheon Worldwide. Prior to Raytheon, Mr. Markley was Deputy Program Manager of NASA's Apollo Program. Mr. Markley has served on the President's Science Advisory Council, as a member of the Space Defense Initiative Committee and as an examiner for the Malcolm Baldridge National Quality Award. JAMES R. MCCULLOUGH, age 32, has served as our director and as our Chief Executive Officer since February 2000. Mr. McCullough's principal occupation prior to joining us was as a Co-President of Renwick Corporate Finance, Inc., a consulting company, from 1996 to the present. From 1994 to 1997, Mr. McCullough was the general partner of an investment fund focusing on early stage technology companies. DIRECTOR WITH TERM EXPIRING IN 2000 JOHN M. EGER, age 60, has served as our director since February 2000. As a telecommunications lawyer, Mr. Eger is a professor at San Diego State University where he serves as the Lionel Van Deerlin Endowed Chair of Communications and Public Policy and Executive Director of the University's International Center 59 61 for Communications. Earlier, Mr. Eger established CBS Broadcast International and was Senior Vice President of the CBS Broadcast group. From 1971 - 1973, he was legal assistant to the chairman of the Federal Communications Commission, and from 1974 - 1976, served as Telecommunications Advisor to Presidents Nixon and Ford and Head of the White House Office of Telecommunications Policy. Mr. Eger also serves as a director of GTC Telecom Corp. Identification of Executive Officers Information is set forth below regarding each of our executive officers who do not also serve as directors, including their age, principal occupation during the last five years and the date each first became an executive officer.
NAME AGE POSITION ---- --- -------- Timothy G. Atkinson....................... 43 Vice President of Business Development and General Counsel and Secretary Cheryl Johnson............................ 40 Controller and Principal Finance and Accounting Officer
TIMOTHY G. ATKINSON, age 43, has served as our Vice President of Business Development and General Counsel since April 2000 and as our Secretary since May 2000. Prior to joining us, Mr. Atkinson was in private practice as a shareholder and Managing Partner of the Denver office of Reinhart, Boerner, Van Deuren, Norris & Rieselbach from April 1991 to May 2000. CHERYL JOHNSON, age 40, has served as our Controller and Principal Finance and Accounting Officer since June 2000 and has served as the Chief Financial Officer of our wholly owned subsidiary, INET Interactive Network Systems, Inc. since March 2000. From January 1998 to January 2000, Ms. Johnson served as the Chief Financial Officer of G&H Technology, Inc. Before joining G&H Technology, Inc., Ms. Johnson was a Senior Manager with Ernst & Young, LLP from March 1995 to January 1998. Ms. Johnson is a certified public accountant with 16 years of accounting, financial and business management experience working with public and privately held companies. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our directors and executive officers, and persons who beneficially own more than ten percent of a registered class of our equity securities, to file with the Securities and Exchange Commission (the "Commission") initial reports of ownership and reports of changes in ownership of our common stock and our other equity securities. Officers, directors, and persons who beneficially own more than ten percent of a registered class of our equity securities are required by the regulations of the Commission to furnish us with copies of all Section 16(a) forms they file. To our knowledge, based solely on review of the copies of such reports furnished to us, during the fiscal years ended March 31, 1999 and 2000, all Section 16(a) filing requirements applicable to our officers, directors, and greater than ten percent beneficial owners were complied with, except that transactions that should have been reported on Forms 5 for the fiscal years ended March 31, 1997 and/or March 31, 1998 were reported on Forms 5 for the fiscal year ended March 31, 1999 for each of Stephen W. Portner, Sydney B. Lilly, Jack E. Donnelly, Brian A. Robson and James J. Fiedler, and transactions that should have been reported on Forms 3 and 4 during the fiscal years ended March 31, 1997 and March 31, 1998 for Alan J. Andreini were reported on Form 5 for the fiscal year ended March 31, 1999. In addition, the Form 3 that should have been filed by Alan J. Andreini during the fiscal year ended March 31, 1997 was filed on April 5, 1999. 60 62 ITEM 11. EXECUTIVE COMPENSATION All shares and per share numbers included herein have been retroactively adjusted to give effect to a 5% stock dividend which was paid on November 4, 1998 to holders of record as of October 21, 1998. The following table sets forth, for the three fiscal years ended March 31, 1999, the total annual compensation paid to, or accrued by us for the account of, James J. Fiedler, Daniel W. Latham and Brian A. Robson (the "Named Executives") serving as such at March 31, 1999 and one former executive officer: SUMMARY COMPENSATION TABLE
LONG-TERM ANNUAL COMPENSATION COMPENSATION ------------------------------------ ------------------ NAME AND OTHER ANNUAL SECURITIES ALL OTHER PRINCIPAL POSITION(1) YEAR SALARY BONUS COMPENSATION(6) UNDERLYING OPTIONS COMPENSATION --------------------- ---- -------- ------- --------------- ------------------ ------------ James J. Fiedler(2).......... 1999 $300,000 $ 9,335 $20,000 94,500(7) $ 7,200(9) Former Chairman, CEO 1998 $200,000 $19,746 $15,000 -- $ 7,200(9) and Director 1997 $200,000 -- $ 3,720 -- -- Daniel W. Latham(3).......... 1999 $300,000 $ 9,335 $20,000 94,500(7) $ 7,200(9) President, COO and Director 1998 $175,000 $19,746 $15,000 -- $ 7,200(9) 1997 $175,000 -- $ 3,750 -- $170,197(10) Brian A. Robson(4)........... 1999 $152,487 $12,875 -- 98,125(8) -- Former Executive Vice 1998 $139,907 -- -- 13,125 $ 21,921(11) President, CFO and Secretary 1997 $ 56,250 -- -- $ 13,041(11) Edward Beeman(5)............. 1999 $ 79,526 -- -- -- $ 53,548(12) Former Executive Vice 1998 -- -- -- -- -- President, CFO and Secretary 1997 -- -- -- -- --
- --------------- (1) As a result of the changes in our management in January 2000, there will be significant differences in the executive compensation for our fiscal year ending March 31, 2000. As described in our Current Report on Form 8-K, dated as of January 25, 2000, Mr. Fiedler was succeeded as Chief Executive Officer by Mr. James R. McCullough. (2) On November 29, 1996, Mr. Fiedler was appointed as our Chairman and Chief Executive Officer. Mr. Fiedler also remained as Chairman and Chief Executive Officer of CTL. Effective as of January 26, 2000, Mr. Fielder resigned as Chief Executive Officer and effective as of February 29, 2000 he resigned as Chairman of the Board and as a director. (See "Employment Agreements"). (3) On November 29, 1996, Mr. Latham was appointed as our President and Chief Operating Officer. Mr. Latham also remained as President of CTL (See "Employment Agreements"). (4) On October 31, 1996, Mr. Robson was appointed as our Vice President and Controller. On December 15, 1998, Mr. Robson was appointed as our Executive Vice President, Chief Financial Officer and Secretary. On June 15, 2000, Mr. Robson resigned as our Executive Vice President, Chief Financial Officer and Secretary. (5) On June 1, 1998, Mr. Beeman was appointed as our Executive Vice President, Chief Financial Officer and Secretary. In November 1998, Mr. Beeman's employment with us was terminated. (6) Compensation for serving on the board of directors. (7) Pursuant to their respective employment agreements, Messrs. Fiedler and Latham are entitled to receive ten year stock options to purchase a total of 450,000 shares of our common stock over a period of five years, to be granted in increments of 90,000 shares annually, at various exercise prices for each 90,000 share increment. As adjusted for the stock dividend, each 90,000 share increment has been adjusted to a 94,500 share increment, and the exercise price of each of the five 94,500 share increments is $3.81, $7.62, $11.43, $15.24 and $19.05, respectively. Effective as of January 24, 2000, by action of our board of directors, the terms of Messrs. Fiedler's and Latham's employment agreements were modified to provide for immediate acceleration of the award of 378,000 options and repricing of 94,500 options which were awarded on April 1, 1999 at an exercise price of $7.62 per share. All of such options are currently exercisable at an exercise price of $5.00 per share. 61 63 (8) Stock options to purchase 13,125 shares of common stock were granted on June 1, 1997 at $2.86 per share. Stock options to purchase 13,125 shares of common stock were granted on June 1, 1998 at $3.90 per share. Stock options to purchase 85,000 shares of common stock were granted on December 11, 1998 at $6.56 per share. (9) Represents automobile allowance. (10) Represents relocation assistance and $98,000 paid to Mr. Latham to cover his loss on a personal residence and related real estate commissions and selling expenses. (11) Represents relocation assistance paid by us. (12) Represents automobile allowance and relocation assistance paid by us. The table below provides information regarding stock options granted during the fiscal year ended March 31, 1999 to the Named Executives: OPTIONS GRANTED IN LAST FISCAL YEAR(1)
INDIVIDUAL GRANTS ------------------------------------------------------------------------------------- POTENTIAL REALIZABLE VALUE AT ASSUMED % OF ANNUAL RATE OF TOTAL OPTIONS STOCK PRICE APPRECIATION NUMBER OF GRANTED TO FOR OPTION TERM(2) SHARES UNDERLYING EMPLOYEES IN EXERCISE EXPIRATION ------------------------- OPTIONS GRANTED FISCAL YEAR PRICE DATE 5% 10% ----------------- ------------- -------- ---------- ----------- ----------- James J. Fiedler........ 94,500(3) 9.3% $3.81 04/01/08 $226,430 $573,819 Daniel W. Latham........ 94,500(3) 9.3% $3.81 04/01/08 $226,430 $573,819 Brian A. Robson......... 13,125(4) 1.3% $3.90 06/01/03 $ 14,142 $ 31,250 85,000(5) 8.3% $6.56 12/11/03 $154,055 $340,420
- --------------- (1) As a result of the changes in our management in January 2000, there will be significant differences in the options granted for our fiscal year ending March 31, 2000. As described in our Current Report on Form 8-K, dated as of January 25, 2000, Mr. Fiedler was succeeded as Chief Executive Officer by Mr. James R. McCullough. In addition, Mr. Robson resigned as our Executive Vice President, Chief Financial Officer and Secretary effective June 15, 2000. (2) The dollar amounts under these columns are the results of calculations at the 5% and 10% rates set by the Securities and Exchange Commission. The potential realizable values are not intended to forecast possible future appreciation, if any, in the market price of the common stock. (3) Effective as of January 24, 2000, by action of our Board of Directors, the terms of Messrs. Fiedler's and Latham's employment agreements were both modified to provide for immediate acceleration of the award of 378,000 options, including the repricing of 94,500 options which were originally awarded on April 1, 1999 at an exercise price of $7.62 per share. All of these options are currently exercisable at an exercise price of $5.00 per share. Assuming the $5.00 per share exercise price, the Potential Realizable Value at Assumed Annual Rate of Stock Price Appreciation for Option Term would be $1,188,610 and $3,012,173 for 5% and 10%, respectively. (4) These options vest annually in one-third increments commencing June 1, 1999. (5) These options vest annually in one-third increments commencing December 11, 1999. AGGREGATED OPTION EXERCISES DURING THE FISCAL YEAR ENDED MARCH 31, 1999 AND FISCAL YEAR END OPTION VALUES The table below provides information regarding the value of the in-the-money stock options held by the Named Executives at March 31, 1999. The Named Executives did not exercise any stock options during the fiscal year. As a result of the changes in our management in January 2000, there will be significant differences in the options granted for our fiscal year ending March 31, 2000. As described in our Current Report on Form 8-K, dated as of January 25, 2000, Mr. Fiedler was succeeded as Chief Executive Officer by Mr. James 62 64 R. McCullough. In addition, Mr. Robson resigned as our Executive Vice President, Chief Financial Officer and Secretary on June 15, 2000.
VALUE OF UNEXERCISED NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS OPTIONS AT MARCH 31, 1999 AT MARCH 31, 1999(1) ---------------------------- ---------------------------- EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ----------- ------------- ----------- ------------- James J. Fiedler........................... -- 94,500 -- $195,615 Daniel W. Latham........................... -- 94,500 -- $195,615 Brian A. Robson............................ 4,375 106,875 $13,212 $ 52,412
- --------------- (1) Value based on the closing price of $5.88 of the common stock on The Nasdaq National Market on March 31, 1999, less the option exercise price. Does not include, as to Messrs. Fiedler and Latham, an aggregate of 378,000 options each, which vested in January 2000 pursuant to a modification of their respective employment agreements. If such options were added, the value of such unexercisable in-the-money options for Messrs. Fiedler and Latham would increase to $582,255 for each, as the exercise prices of such grants were repriced at $5.00 per share. Stock Option Plans On December 11, 1986, the board of directors adopted our 1986 Non-Qualified Stock Option Plan (the "1986 Plan"). The 1986 Plan, as amended, provides for the grant of options to purchase up to 832,963 shares of common stock to our executive officers, key officers, employees, directors and consultants and those of our subsidiaries. In February 1998, the board of directors adopted our Non-Employee Director Stock Option Plan (the "Director Plan"). The Director Plan provides for the grant of options to purchase up to 157,500 shares of common stock to our non-employee directors. In March 1996, the board of directors adopted the Employees Non-Qualified Stock Option Plan of CTL (the "CTL Plan"). The CTL Plan provides for the grant of options to purchase up to 2,100,000 shares of common stock to our executive officers, key employees, directors, consultants and advisors, those of our affiliates and subsidiaries. On March 8, 2000, the board of directors adopted, and at the annual meeting of stockholders, the stockholders will be asked to approve, our 2000 Equity Incentive Plan (the "Equity Plan"). The Equity Plan provides for the grant of options to purchase up to 4,000,000 shares of common stock to our directors, officers, key employees and consultants and those of our subsidiaries. As of June 19, 2000, options to purchase 592,463, 157,500 and 2,100,000 shares of common stock have been granted under the 1986 Plan, the Director Plan and the CTL Plan, respectively. As of June 19, 2000, 442,956, 0 and 1,291,160 shares of common stock have been issued pursuant to the exercise of options under the 1986 Plan, the Director Plan and the CTL Plan, respectively. As of June 13, 2000, subject to stockholder approval, options to purchase 911,500 shares of common stock have been granted under the Equity Plan. No shares have been issued pursuant to the exercise of options under the Equity Plan. Any unexercised options that expire in accordance with their terms or terminate upon a director's resignation or an employee's ceasing to be employed by us, our affiliates or subsidiaries become available again for issuance under the 1986 Plan, the Director Plan, the CTL Plan or the Equity Plan, as the case may be. In April 1998, stock options to purchase 10,500 shares of our common stock were granted to each of the non-employee members of the board of directors pursuant to the Director Plan. These options have an exercise price of $3.42 per share. In September 1999, stock options to purchase 21,000 shares of our common stock were granted to J. Thomas Markley pursuant to the CTL Plan. These options have an exercise price of $4.40 per share. In January 2000, stock options to purchase 750,000 shares of our common stock were granted to James R. McCullough. Of such options, 300,000 vested immediately and the balance vest in three installments of 100,000, 150,000 and 200,000 on January 14, 2001, 2002 and 2003, respectively. These options have an exercise price of $5.00 per share. 63 65 In January 2000, stock options to purchase 50,000 shares of our common stock were granted, subject to stockholder approval, to one of our independent directors, J. Thomas Markley, and to former directors Stephen W. Portner and Jack E. Donnelly, pursuant to the Equity Plan and the Director Plan. These options are fully vested and have an exercise price of $5.00 per share. In February 2000, stock options to purchase 50,000 shares of our common stock were granted, subject to stockholder approval, to one of our independent directors, John M. Eger, pursuant to the Equity Plan. Such options are fully vested and have an exercise price of $5.50 per share. Employment Agreements On April 1, 1998, we entered into employment agreements, expiring on March 31, 2003, with Mr. Fiedler and Mr. Latham (the "Executives"). Pursuant to their employment agreements, the Executives will receive a guaranteed minimum annual salary of $300,000 or an amount based on a percentage of our pre-tax income, whichever is greater, with a maximum salary of $4.5 million. The Executives shall also receive deferred compensation for five years following each Executive's five-year employment term (the "Employment Term") based on a percentage of our pre-tax income during each year of the Employment Term; however, deferred compensation shall not exceed $600,000 per year. The employment agreements also provide that the Executives will not compete with us for one year following the termination of their respective employment. By action of our board of directors on January 24, 2000, certain terms of the employment agreements were modified to provide for the following: (i) 94,500 unvested options previously awarded to each of the Executives pursuant to the employment agreements were repriced at an exercise price of $5.00 per share and became immediately exercisable, (ii) immediate award of their remaining entitlement of 283,500 options as currently exercisable at $5.00 per share; (iii) medical benefits were extended to June 30, 2006, and (iv) payment of a cash incentive of $150,000 to each Executive if they remain with us through July 24, 2000, or if they are terminated. Mr. Fiedler relinquished his duties as our Chief Executive Officer and retired from our board of directors, effective as of January 26, 2000 and February 29, 2000, respectively. In accordance with the terms of Mr. Fiedler's employment agreement and the separation agreement entered into between us and Mr. Fiedler on February 16, 2000, we will pay Mr. Fiedler severance payments through March 31, 2003 at his present salary. In addition, in lieu of the $150,000 incentive payment referenced above, we will grant to Mr. Fiedler 200,000 immediately vested options to purchase common stock at an exercise price of $5.00 per share. On January 26, 2000, we appointed James R. McCullough as our Chief Executive Officer to succeed Mr. Fiedler. Also on January 26, 2000, we entered into an employment agreement with Mr. McCullough pursuant to which he will receive a salary of $160,000 per annum and options to purchase up to 750,000 shares of common stock at $5.00 per share. Of such options, 300,000 vested immediately and the balance vest in three installments of 100,000, 150,000 and 200,000 on January 14, 2001, 2002 and 2003, respectively. The options will immediately vest upon a change in control and the vesting will be accelerated if certain common stock price targets are met and sustained. If Mr. McCullough is terminated by us without cause or Mr. McCullough terminates the agreement for good cause, he is entitled to receive his base salary for a period of six months and the vesting schedule for the options will remain in effect. If Mr. McCullough voluntarily terminates the agreement or is terminated by us for cause, he is not entitled to any additional compensation after the termination date and all unvested options will terminate. The agreement also provides that Mr. McCullough will meet with the Audit Committee no later than six months after the execution of the agreement to discuss adjusting Mr. McCullough's compensation. In June 2000, Mr. McCullough met with the Audit Committee and the Board of Directors approved the Audit Committee's recommendation to award Mr. McCullough additional compensation based on Mr. McCullough's performance over the preceding five months. Specifically, Mr. McCullough was granted an option to purchase 750,000 shares of Common Stock at an exercise price of $7.00 per share. The option was in three equal blocks of 250,000 each when the closing bid price of the Common Stock for 20 consecutive trading days exceeds $12.00, $16.00 and $20.00 per share, respectively. In addition, the vesting provisions will be accelerated if Mr. McCullough is terminated without cause or there is a change in control of the Company. 64 66 On April 15, 2000, we entered into an employment agreement with Mr. Atkinson pursuant to which he will receive a salary of $180,000 per annum and options to purchase 150,000 shares of common stock at $9.00 per share and options to purchase 100,000 shares of common stock at $7.00 per share. These options vest and become exercisable in three equal installments on October 15, 2000, April 15, 2001 and October 15, 2001. The options will immediately vest upon a change in control. If Mr. Atkinson is terminated by us without cause or Mr. Atkinson terminates the agreement for good cause, he is entitled to receive his base salary for a period of six months and the vesting schedule for the options will remain in effect. If Mr. Atkinson voluntarily terminates the agreement or is terminated by us for cause, he is not entitled to any additional compensation after the termination date and all unvested options will terminate. Mr. Atkinson also received, as a signing bonus, $50,000 and 25,000 shares of common stock. Effective June 15, 2000, we entered into a separation agreement with Mr. Robson. Under the agreement, Mr. Robson resigned as our Executive Vice President, Chief Financial Officer and Secretary effective June 15, 2000. Under the terms of the agreement, Mr. Robson is entitled to receive $15,000 per month through October 31, 2000 and medical, dental and life insurance benefits through August 31, 2001. In addition, all unvested options became fully vested and Mr. Robson received a fully-vested option to purchase 50,000 shares of common stock at an exercise price of $5.00 per share. Mr. Robson has also agreed to provide us with consulting services with respect to the preparation of our Securities and Exchange Commission filings. Compensation of Directors Directors receive an annual fee of $15,000, paid on a monthly basis. Directors are also reimbursed for travel expenses. In addition, directors receive up to $1,250 per day for each meeting attended (board or committee). Non-employee directors (including retired directors as determined by the board of directors) receive supplemental medical reimbursement to pay all medical expenses for them and their immediate families (spouses and unemancipated children) up to a limit of $25,000 per year. In addition, effective as of February 2, 2000 and subject to stockholder approval, we have granted immediately exercisable options to purchase 50,000 shares of the common stock to each of our non-employee directors at an exercise price of $5.00 per share. Compensation Committee Interlocks and Insider Participation The board of directors does not have a compensation committee because executive compensation decisions are made by the full board. Recommendations on executive compensation with regard to Messrs. Fiedler and Latham are made by the outside non-employee directors when requested to do so by the full board. All directors participate in the deliberations. From November 1996 until January 26, 2000, when he was succeeded by Mr. McCullough, Mr. Fiedler served as our Chairman and Chief Executive Officer. Mr. Latham is the Company's President and Chief Operating Officer. Messrs. Fiedler's and Latham's fiscal 1999 compensation and employment contracts are described above. 65 67 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information as of June 19, 2000 regarding the beneficial ownership of our common stock by (a) each person known by us to own beneficially more than 5% of our common stock, (b) each of our directors and the Named Executives, and (c) all our directors and executive officers as a group. Except as otherwise indicated and subject to community property laws where applicable, the persons named in the table below have sole voting and dispositive power with respect to the shares of common stock shown as beneficially owned by them. Information as to Alan J. Andreini and Kiskiminetas Springs School was derived from the Schedules 13D and 13G filed by each such stockholder. Information as to Richard L. Haydon was derived from the Schedule 13D filed by Mr. Haydon on March 20, 2000, as well as information provided to us by Mr. Haydon. Except for the percentage of ownership, the information set forth below reflects the information contained in the Schedule 13G and/or 13D as of the date such Schedule 13G or 13D was filed, where applicable.
PERCENT OF NAME AND ADDRESS NUMBER OF SHARES OUTSTANDING OF BENEFICIAL OWNER BENEFICIALLY OWNED SHARES ------------------- ------------------ ----------- James R. McCullough(1)................................ 578,278(2) 3.3% James J. Fiedler(1)................................... 1,020,288(3) 5.7% Daniel W. Latham(1)................................... 610,313(4) 3.4% J. Thomas Markley(1).................................. 60,000(5) * John M. Eger(1)....................................... 50,000(6) * Brian A. Robson(1).................................... 161,251(7) * Alan J. Andreini(8)................................... 1,467,645(9) 8.4% Richard L. Haydon(10)................................. 1,517,230(11) 8.4% Kiskiminetas Springs School(12)....................... 969,710(13) 5.6% Omega Capital Advisers(14)............................ 2,052,632(15) 11.8% All directors and executive officers of the Company as a group (6 persons)................................. 1,423,591(2)(4)(5)(6)(16) 7.7%
- --------------- * Less than 1%. (1) The address of the stockholder is: c/o Coyote Network Systems, Inc., 1640 S. Sepulveda Blvd., Suite 320, Los Angeles, CA 90025. (2) Includes 300,000 shares of common stock issuable upon the exercise of stock options which are currently exercisable at $5.00 per share. Does not include 450,000 share of common stock issuable at $5.00 per share upon the exercise of options which vest over a period of three years, subject to acceleration if certain common stock price targets are met and sustained. In addition, includes 277,778 of the 833,344 shares of common stock held by KRJ, LLC, an entity in which Mr. McCullough owns a one-third equity interest. Mr. McCullough disclaims any beneficial ownership interest in the shares of common stock held by KRJ, LLC. (3) Includes 472,500 shares of common stock issuable upon exercise of stock options which are currently exercisable, subject to, in the case of options to purchase 378,000 shares, stockholder approval. Also includes 108,675 shares of common stock issuable upon exercise of warrants which are currently exercisable. Includes 192,938 shares of common stock received by the stockholder upon conversion of Class B Units of Coyote Technologies, LLC ("CTL") on June 24, 1999 and 75,075 shares received by the stockholder upon exercise of warrants on September 8, 1999. (4) Includes 472,500 shares of common stock issuable upon exercise of stock options which are currently exercisable, subject to, in the case of options to purchase 378,000 shares, stockholder approval. Includes 137,813 shares of common stock received by the stockholder upon conversion of Class B Units of CTL on July 7, 1999 and September 2, 1999. (5) Includes 60,000 shares of common stock issuable upon exercise of stock options which are currently exercisable, subject to, in the case of options to purchase 50,000 shares, stockholder approval. 66 68 (6) Includes 50,000 shares of common stock issuable upon exercise of stock options which are currently exercisable, subject to, in the case of all such options, stockholder approval. (7) Includes 161,251 shares of common stock issuable upon exercise of stock options which are currently exercisable, subject to, in the case of options to purchase 50,000 shares, stockholder approval. (8) The address of Alan J. Andreini is: 395 Hudson Street, New York, NY 10014. (9) Includes 1,101,010 shares of common stock held by Mr. Andreini for his own account. Includes 145,700 shares held in the account of Kiskiminetas Springs School (the "School"), 24,950 shares held in the account of John D. Andreini (who is deceased) and Blanche M. Andreini (the "Parents"), 95,650 shares held in the account of The Andreini Foundation (the "Foundation") and 2,625 shares held for the benefit of Alan J. Andreini, Jr. (the "Son"), of which Mr. Andreini may be deemed to be the beneficial owner. Mr. Andreini disclaims beneficial ownership of all shares of common stock except those shares held by him for his own account and for the benefit of the Son. Mr. Andreini has sole voting and dispositive power over 1,199,285 shares of common stock (includes 1,101,010 shares held by Mr. Andreini for his own account, 95,650 shares held in the account of the Foundation and 2,625 shares held in the account of the Son). Mr. Andreini has shared voting and dispositive power over 170,650 shares of common stock (includes 145,700 shares held in the account of the School and 24,950 shares held in the account of the Parents). (10) The address of Richard L. Haydon is: 1114 Avenue of the Americas, New York, NY 10036. (11) Includes 830,980 shares of common stock held in various managed discretionary accounts of which Mr. Haydon may be deemed to be the beneficial owner. Includes 686,250 shares of common stock issuable upon exercise of warrants which are currently exercisable, held by various discretionary accounts, of which Mr. Haydon may be deemed to be the beneficial owner. Based upon information supplied by this stockholder (in addition to the information derived from Mr. Haydon's Schedule 13D, filed on March 20, 2000), Mr. Haydon has sole voting and dispositive power over 1,517,230 shares of common stock. (12) The address of Kiskiminetas Springs School is: 1888 Brett Lane, Saltsburg, PA 15681. (13) According to the Schedule 13D filed on February 10, 2000, by Kiskiminetas Spring School, the School beneficially owns 969,710 shares of common stock. (14) The address of Omega Capital Advisers is 88 Pine Street, 31st Floor, New York, New York 10005. (15) Includes 1,052,632 shares of common stock purchased by the Stockholder in a private placement in January 2000. (16) Includes 1,007,500 shares of common stock issuable upon exercise of stock options and shares of common stock granted but not outstanding as of June 19, 2000. Of such shares, 478,000 are subject to stockholder approval. Does not include 800,000 shares of common stock issuable upon exercise of stock options not currently exercisable. Of such shares, none are subject to stockholder approval. Does not include shares of common stock or options held by Messrs. Fielder and Robson, who are no longer executive officers of us, but includes shares of common stock and options to purchase common stock held by Mr. Atkinson and Ms. Johnson. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In January 1998, our Board of Directors approved an interest-free loan to Daniel W. Latham, our President and Chief Operating Officer and director, for a maximum amount of $500,000 to be used solely for the purpose of providing partial down payments on his purchase of a residence in California. The funding is to be secured by the residential property and is for a five-year term unless specifically extended by the Board of Directors. Earlier repayment of the loan will be demanded in the event of either (1) sale or refinancing of the property; (2) termination of Mr. Latham's employment by us either voluntarily or for cause; or (3) sale by Mr. Latham of all, or substantially all, of his shares of our common stock. As of March 31, 1999 and 2000, $421,000 was funded to Mr. Latham under this agreement. In October 1998, we amended the terms of the loan, and in agreement with Mr. Latham established an annual interest rate of 6.5% to be applied to the loan and which is payable at the completion of the term. 67 69 Comdisco, Inc., a technology services and finance company, was the beneficial owner of approximately 6% of our common stock including 515,400 shares purchased by Comdisco on the open market and 192,990 warrants issued in connection with lease financing provided by Comdisco to our end-user customers. During fiscal 1998 and fiscal 1999, Comdisco has provided lease financing in a total amount of $24.0 million to four of our customers. In August 1999, Comdisco filed a Schedule 13G disclosing that its beneficial ownership as of August 23, 1999 consisted solely of the 192,990 warrants and that Comdisco had ceased to be a beneficial owner of more than 5% of our common stock. In the third quarter of fiscal 1999, we completed and received funding under two demand loans. The first loan for a total amount of $600,000 was provided by Mr. James Fiedler, our former Chairman and Chief Executive Officer, in the amount of $175,000, by Mr. Latham in the amount of $75,000 and by Mr. Alan J. Andreini, a stockholder who was deemed to beneficially own approximately 8.4% of our outstanding common stock as of June 19, 2000, in the amount of $350,000, in September and October 1999. This loan bore interest at the bank's prime rate plus 1% per year, was repayable on demand and was secured against our investment in Systeam, S.p.A. The second loan for a total amount of $1,225,000 was provided by Mr. Richard L. Haydon, a stockholder who was deemed to beneficially own approximately 8.4% of our outstanding common stock as of June 19, 2000, in the amount of $500,000, by Mr. Andreini in the amount of $225,000 and by three other stockholders in a combined total amount of $500,000, in November 1999. This loan bore interest at the rate of 17.5% per year and was repayable, on demand by the lenders, no earlier than March 31, 2000. The maximum term of the loan was three years to November 2002. This loan was secured by shares of the common stock of INET. Under the terms of this loan, the lenders were granted, pro-rata, a combined total of 73,500 three-year warrants to purchase shares of our common stock at an exercise price of $4.50 per share. The warrants will result in a non-cash interest expense charge of $0.3 million taken in the fourth quarter of fiscal 2000. We repaid these loans and the accrued interest in February and April 2000. On January 26, 2000, we entered into a Consulting Agreement with KRJ, LLC ("KRJ"), pursuant to which KRJ will provide assistance in identifying strategic partners and business opportunities, making introductions to IP Telephony customers, introducing new management, restructuring vendor finance programs, investor relations, and identifying credit facilities. Mr. McCullough has an approximately one-third interest in KRJ and the balance of KRJ is owned by affiliates of First Venture Leasing, LLC ("First Venture"). As compensation for KRJ's services, we issued KRJ 2,000,000 shares of common stock. Of such shares, 1,250,000 were placed in escrow to be released to KRJ in three equal annual installments, subject to acceleration if certain Common Stock price targets are met and sustained. In March 2000, 416,000 shares held in escrow were released to KRJ as certain Common Stock price targets were met. The agreement also provides that KRJ will meet with the Audit Committee no later than six months after the execution of the agreement to discuss providing additional compensation to KRJ based upon the services it has provided as of the date of the meeting. The terms of the Consulting Agreement were the result of an arms' length negotiation in which Mr. McCullough did not participate. In June 2000 in consideration of additional services provided under the consulting agreement with KRJ, our Board of Directors resolved to present for shareholder approval the issuance of 2,500,000 shares of common stock and the grant of warrants to purchase 2,400,000 shares of common stock at an exercise price per share of $7.00. The vesting of the shares and the exercisability of the warrants would be dependent on the average bid price of our common stock exceeding certain amounts that range from $12 to $30 per share. On March 31, 2000, we entered into a Financial Services Agreement with First Venture, pursuant to which a limited liability company, Coyote Leasing, LLC ("Coyote Leasing") was formed by First Venture to offer certain leasing and credit packages to our customers. First Venture is an entity in which Mr. McCullough, our Chief Executive Officer, had a 25% equity interest, which he relinquished effective upon his election to our Board of Directors on February 2, 2000. As partial consideration for Coyote Leasing's commitment to fund at least $50,000,000 in leases for our customers during the 2000 calendar year and the purchase of $14.27 million of accounts receivable of CTL, we granted to First Venture warrants to purchase 620,000 and 261,600 shares of our common stock, at an exercise price of $5.00 and $7.35 per share, 68 70 respectively. Each warrant is exercisable for a period of three years. First Venture initially paid us $11.5 million for the receivables with the remaining balance of $2.77 million due and payable based upon the performance of the leases to which the receivables relate. The terms of the agreement with First Venture were the result of an arms' length negotiation in which Mr. McCullough did not participate. Also on March 31, 2000, we entered into a Remarketing Agreement and two separate License Agreements with Coyote Leasing, pursuant to which Coyote Leasing will act as our agent in remarketing equipment leased to third parties upon the termination of such leases and shall have the right to use certain trademarks, service marks, trade names and other designations in connection with the services to be provided by Coyote Leasing. PART IV ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
FORM 10-K PAGE NUMBER ----------- (A) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES (1) The following consolidated financial statements of Coyote Network Systems, Inc. (formerly The Diana Corporation) and its subsidiaries are included in Item 8: Report of Arthur Andersen LLP, Independent Public Accountants................................................. 24 Report of PricewaterhouseCoopers LLP, Independent Accountants................................................. 25 Consolidated Balance Sheets -- March 31, 1999 and March 31, 1998........................................................ 27 Consolidated Statements of Operations -- Fiscal Years Ended March 31, 1999, March 31, 1998 and March 31, 1997........... 28 Consolidated Statements of Shareholders' Equity -- Fiscal Years Ended March 31, 1999, March 31, 1998 and March 31, 1997........................................................ 29 Consolidated Statements of Cash Flows -- Fiscal Years Ended March 31, 1999, March 31, 1998 and March 31, 1997........... 30 Notes to Consolidated Financial Statements.................. 31 (2) The following consolidated financial statement schedule of Coyote Network Systems, Inc. is included in Item 14(d): Schedule I -- Condensed Financial Information of Registrant.................................................. 75 Schedule II -- Valuation and Qualifying Accounts............ 80 All other schedules are omitted because the required information is not applicable or is not present in amounts sufficient to require submission of the schedules or because the information required is included in the consolidated financial statements or the notes thereto. (B) REPORTS ON FORM 8-K: The Company did not file any reports on Form 8-K during the fourth quarter of fiscal 1999.
69 71 (C) EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 2.1 Stock Acquisition by Merger Agreement, dated as of September 30, 1998, among Coyote Network Systems, Inc., INET Acquisition, Inc., INET Interactive Network System, Inc., Claude Buchert, Helene Legendre and First Rock Trustees, Limited, a Gibraltar corporation, trustee of the Guimauve Trust, a Gibraltar trust dated September 1, 1994 (incorporated herein by reference to Exhibit 2.1 of Registrant's Form 8-K dated September 30, 1998 filed on October 15, 1998). 3.1 Restated Certificate of Incorporation (incorporated herein by reference to Exhibit 3.01 of Registrant's Form 10-Q for the quarter ended September 30, 1998 filed on November 16, 1998). 3.2 By-Laws of Registrant, as amended March 7, 1997 (incorporated herein by reference to Exhibit 3.2 of Registrant's Form 10-K for the fiscal year ended March 31, 1997). 3.3 Certificate of Designations, Preferences and Rights of Series B Preferred Stock (incorporated herein by reference to Exhibit 4.2 of Registrant's Form 8-K dated January 31, 2000 filed on February 14, 2000). 4.1 Loan and Security Agreement between C&L Communications, Inc. and Sanwa Business Credit dated January 2, 1996 (incorporated herein by reference to Exhibit 10.1 of Registrant's Registration Statement on Form S-3 Reg. No. 333-1055). 4.2 First Amendment to Loan and Security Agreement and Waiver Agreement between C&L Communications, Inc. and Sanwa Business Credit Corporation dated June 27, 1996 (incorporated herein by reference to Exhibit 4.2 of Registrant's Form 10-K/A for the year ended March 30, 1996). 4.3 Loan and Security Agreement by and between Valley Communications, Inc. and Sanwa Business Credit Corporation dated March 14, 1996 (incorporated herein by reference to Exhibit 4.1 of Registrant's Form 10-Q for the period ended July 20, 1996). 4.4 Certain other long-term debt as described in Note 6 of Notes to Consolidated Financial Statements which do not exceed 10% of the Registrant's total assets on a consolidated basis. The Registrant agrees to furnish to the Commission, upon request, copies of any instruments defining the rights of holders of any such long-term debt. 4.5 Second Amendment to Loan and Security Agreement and Waiver Agreement between C&L Communications, Inc. and Sanwa Business Credit Corporation dated July 10, 1997 (incorporated herein by reference to Exhibit 4.5 of Registrant's Form 10-K for the fiscal year ended March 31, 1997 filed on September 23, 1977). 4.6 First Amendment to Loan and Security Agreement by and between Valley Communications, Inc. and Sanwa Business Credit Corporation dated May 29, 1997 (incorporated herein by reference to Exhibit 4.6 of Registrant's Form 10-K for the fiscal year ended March 31, 1997 filed on September 23, 1977). 4.7 Form of Subscription Agreement (incorporated herein by reference to Exhibit 4.1 of Registrant's Form 8-K filed on July 31, 1997). 4.8 Form of Note (incorporated herein by reference to Exhibit 4.2 of Registrant's Form 8-K filed on July 31, 1997). 4.9 Form of Registration Rights Agreement relating to common stock issuable upon conversion of 8% Convertible Notes (incorporated herein by reference to Exhibit 4.3 of Registrant's Form 8-K dated December 22, 1997 filed on January 5, 1998). 4.10 Form of Offshore Warrant Subscription Agreement (incorporated herein by reference to Exhibit 4.4 of Registrant's Form 8-K filed on July 31, 1997).
70 72
EXHIBIT NUMBER DESCRIPTION ------- ----------- 4.11 Waiver of Events of Default for Sanwa Business Credit Corporation to C&L Communications, Inc. dated September 1, 1997 (incorporated herein by reference to Exhibit 4.11 of Registrant's Form 10-K for the fiscal year ended March 31, 1997 filed on September 23, 1977). 4.12 Second Amendment to Loan and Security Agreement by and between Valley Communications, Inc. and Sanwa Business Credit Corporation dated September 16, 1997 (incorporated herein by reference to Exhibit 4.12 of Registrant's Form 10-K for the fiscal year ended March 31, 1997 filed on September 23, 1977). 4.13 Stock and Warrant Purchase Agreement dated June 6, 1997 by and between Coyote Network Systems, Inc. and James J. Fiedler (incorporated herein by reference to Exhibit 4.13 of Registrant's Form 10-K for the fiscal year ended March 31, 1997 filed on September 23, 1977). 4.14 Warrant issued to James J. Fiedler dated June 6, 1997 to purchase shares of common stock of Coyote Network Systems, Inc. (incorporated herein by reference to Exhibit 4.14 of Registrant's Form 10-K for the fiscal year ended March 31, 1997 filed on September 23, 1977). 4.15 Registration Rights Agreement dated June 6, 1997 by and among The Diana Corporation and James J. Fiedler (incorporated herein by reference to Exhibit 4.15 of Registrant's Form 10-K for the fiscal year ended March 31, 1997 filed on September 23, 1977). 4.16 Form of Subscription Agreement for shares of common stock (incorporated herein by reference to Exhibit 4.1 of Registrant's Form 8-K dated May 27, 1999 filed on June 3, 1999). 4.17 Share Purchase Warrant Agreement to purchase 325,000 shares of common stock issued to JNC Opportunity Fund, Ltd. (incorporated herein by reference to Exhibit 4.2 of Registrant's Form 8-K/A dated May 27, 1999 filed on June 22, 1999). 4.18 Cross Receipt and Agreement between Coyote Network Systems, Inc. and JNC Opportunity Fund, Ltd. (incorporated herein by reference to Exhibit 4.3 of Registrant's Form 8-K dated May 27, 1999 filed on June 3, 1999). 4.19 Registration Rights Agreement dated as of August 31, 1998 between Coyote Network Systems, Inc. and JNC Opportunity Fund Ltd. (incorporated herein by reference to Exhibit B of Exhibit 10.03 of Registrant's Form 10-Q for the quarter ended September 30, 1998 filed November 16, 1998). 4.20 Warrant dated August 31, 1998 to purchase 225,000 shares of common stock issued to JNC Opportunity Fund Ltd. (incorporated herein by reference to Exhibit D of Exhibit 10.03 of Registrant's Form 10-Q for the quarter ended September 30, 1998 filed November 16, 1998). 10.1 1986 Nonqualified Stock Option Plan of The Diana Corporation as amended (incorporated herein by reference to Exhibit 10.13 of Registrant's Form 10-K for the year ended April 3, 1993). 10.2 1996 Sattel Communications LLC Employees Nonqualified Stock Option Plan (incorporated herein by reference to Exhibit 10.13 of Registrant's Form 10-K for the year ended March 30, 1996). 10.3 Operating Agreement of Sattel Communications, LLC (incorporated herein by reference to Exhibit 10.17 of Registrant's Form 10-K/A for the year ended March 30, 1996). 10.4 Amendment to the Operating Agreement of Sattel Communications LLC (incorporated herein by reference to Exhibit 10.18 of Registrant's Form 10-K/A for the year ended March 30, 1996).
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EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.5 Second Amendment to the Operating Agreement of Sattel Communications LLC (incorporated herein by reference to Exhibit 10.19 of Registrant's Form 10-K/A for the year ended March 30, 1996). 10.6 Agreement Regarding Class A Units dated October 2, 1996 by and between Sydney B. Lilly and Sattel Communications LLC (incorporated herein by reference to Exhibit 10.2 of Registrant's Form 8-K filed March 3, 1997). 10.7 Amended and Restated Agreement Regarding Award of Class B Units dated November 11, 1996 by and between James J. Fiedler and CTL Communications LLC (incorporated herein by reference to Exhibit 10.3 of Registrant's Form 8-K filed March 3, 1997). 10.8 Amended and Restated Agreement Regarding Award of Class B Units dated November 11, 1996 by and between Daniel W. Latham and Sattel Communications LLC (incorporated herein by reference to Exhibit 10.4 of Registrant's Form 8-K filed March 3, 1997). 10.9 Amendment to Stock Option Agreements dated November 20, 1996 by and between Coyote Network Systems, Inc. and Richard Y. Fisher (incorporated herein by reference to Exhibit 10.5 of Registrant's Form 8-K filed March 3, 1997). 10.10 Separation Agreement dated November 20, 1996 by and between The Diana Corporation and Richard Y. Fisher (incorporated herein by reference to Exhibit 10.6 of Registrant's Form 8-K filed March 3, 1997). 10.11 Amendment to Stock Option Agreements dated November 20, 1996 by and between Coyote Network Systems, Inc. and Sydney B. Lilly (incorporated herein by reference to Exhibit 10.7 of Registrant's Form 8-K filed March 3, 1997). 10.12 Separation Agreement dated November 20, 1996 by and between The Diana Corporation and Sydney B. Lilly (incorporated herein by reference to Exhibit 10.8 of Registrant's Form 8-K filed March 3, 1997). 10.13 Amendment to Stock Option Agreements dated November 20, 1996 by and between Coyote Network Systems, Inc. and Donald E. Runge (incorporated herein by reference to Exhibit 10.9 of Registrant's Form 8-K filed March 3, 1997). 10.14 Separation Agreement dated November 20, 1996 by and between The Diana Corporation and Donald E. Runge (incorporated herein by reference to Exhibit 10.10 of Registrant's Form 8-K filed March 3, 1997). 10.15 Form of Indemnification Agreement dated November 26, 1996 or November 27, 1996 between Coyote Network Systems, Inc. and (i) Bruce C. Borchardt, (ii) Jack E. Donnelly, (iii) James J. Fiedler, (iv) Jay M. Lieberman and (v) R. Scott Miswald (incorporated herein by reference to Exhibit 10.12 of Registrant's Form 8-K filed March 3, 1997). 10.16 Loan Agreement and Promissory Note dated November 11, 1996 by and between Coyote Network Systems, Inc. and James J. Fiedler (incorporated herein by reference to Exhibit 10.13 of Registrant's Form 8-K filed March 3, 1997). 10.17 Loan Agreement and Promissory Note dated November 11, 1996 by and between Coyote Network Systems, Inc. and Daniel W. Latham (incorporated herein by reference to Exhibit 10.14 of Registrant's Form 8-K filed March 3, 1997). 10.18 Employment Agreement dated September 4, 1997 by and between Coyote Network Systems, Inc. and James J. Fiedler. (incorporated herein by reference to Exhibit 10.29 of Registrant's Form 10-K filed September 23, 1997). 10.19 Employment Agreement dated September 4, 1997 by and between Coyote Network Systems, Inc. and Daniel W. Latham (incorporated herein by reference to Exhibit 10.30 of Registrant's Form 10-K filed September 23, 1997).
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EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.20 Stockholder Protection Rights Agreement dated as of September 10, 1996 between Coyote Network Systems, Inc. and ChaseMellon Shareholder Services, L.L.C. as Rights Agent (incorporated herein by reference to Exhibit 1 of Registrant's Form 8-A filed September 11, 1996). 10.21 1998 Non-Employee Director Stock Option Plan dated February 19, 1998 (incorporated herein by reference to Exhibit 10.34 of Registrant's Form 10-K filed July 14, 1998). 10.22 Merger Agreement dated November 19, 1997, by and among Coyote Network Systems, Inc.; Soncainol, Inc.; and Michael N. Sonaco, James G. Olson and William H. Cain (incorporated herein by reference to Exhibit 10.1 of Registrant's Form 8-K filed December 5, 1997). 10.23 Stock Purchase Agreement dated March 31, 1998, between C&L Acquisitions, Inc. and Technology Services Corporation (incorporated herein by reference to Exhibit 99.1 of Registrant's Form 8-K dated April 16, 1998 filed June 19, 1998). 10.24 Employment Agreement effectively dated April 1, 1998, by and between Coyote Network Systems, Inc. and James J. Fiedler (incorporated herein by reference to Exhibit 10.1 of Registrant's Form 10-Q filed August 14, 1998). 10.25 Employment Agreement effectively dated April 1, 1998, by and between Coyote Network Systems, Inc. and Daniel W. Latham (incorporated herein by reference to Exhibit 10.2 of Registrant's Form 10-Q filed August 14, 1998). 10.26 Non-Compete Agreement between C&L Acquisitions, Inc. and Technology Services Corporation, dated March 31, 1998 (incorporated herein by reference to Exhibit 99.2 of Registrant's Form 8-K dated April 16, 1998 filed June 19, 1998). 10.27 Convertible Preferred Stock Purchase Agreement between Coyote Network Systems, Inc. and JNC Opportunity Fund Ltd., dated August 31, 1998 and Registration Rights Agreement dated as of August 31, 1998 between Coyote Network Systems, Inc. and JNC Opportunity Fund Ltd. (incorporated herein by reference to Exhibit 10.3 of Registrant's Form 10-Q filed November 16, 1998). 10.28 Amendment to Separation Agreement between the Company and Sydney B. Lilly effective September 30, 1998 (incorporated herein by reference to Exhibit 10.41 of Registrant's Form 10-K for the fiscal year ended March 31, 1999 filed July 14, 1999). 16.1 Letter dated November 5, 1997 from Price Waterhouse LLP, (incorporated herein by reference to Form 8-K/A (Amendment No. 2) filed on November 5, 1997). The disclosures included in Item 9(a) of this Annual Report on Form 10-K/A (Amendment No. 2) were derived from Item 4(a) of the Company's October 15, 1997 Form 8-K/A (Amendment No. 2) as referenced in the letter dated November 5, 1997 from Price Waterhouse LLP. 21 Subsidiaries of Registrant 23.1 Consent of Arthur Andersen LLP 23.2 Consent of PricewaterhouseCoopers LLP 27 Financial Data Schedule
73 75 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FISCAL YEAR ENDED MARCH 31, 1997 ----------------- Administrative expenses..................................... $ (3,410) Interest expense............................................ (52) Non-operating expense....................................... (1,386) Income tax credit........................................... 836 -------- Loss from continuing operations............................. (4,012) Loss from discontinued operations........................... (16,498) -------- Loss before extraordinary items............................. (20,510) Extraordinary items......................................... (508) -------- Net loss.................................................... $(21,018) ======== Loss per common share (basic & diluted): Continuing operations..................................... $ (.72) Discontinued operations................................... (2.99) Extraordinary items....................................... (.09) -------- Net loss per common share................................. $ (3.80) ======== Weighted average number of common shares outstanding...... 5,535 ========
See notes to condensed financial information and notes to consolidated financial statements. 74 76 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FISCAL YEAR ENDED MARCH 31, 1997 ----------------- Operating activities: Loss before extraordinary items........................... $(20,510) Adjustments to reconcile loss to net cash used by operating activities: Equity in loss of unconsolidated subsidiaries............. 17,558 Other..................................................... (595) Changes in current assets and liabilities................. 1,231 -------- Net cash used by operating activities....................... (2,316) -------- Investing activities: Proceeds from sales of marketable securities.............. 1,353 Changes in investments in and advances to unconsolidated subsidiaries........................................... (15,945) Other..................................................... 100 -------- Net cash used by investing activities....................... (14,492) -------- Financing activities: Repayments of long-term debt.............................. (141) Common stock funding...................................... 13,918 Extraordinary items....................................... (508) -------- Net cash provided by financing activities................... 13,269 -------- Decrease in cash............................................ (3,539) Cash at the beginning of the year........................... 3,567 -------- Cash at the end of the year................................. $ 28 ======== Non-cash transactions: Purchase of minority interest with common stock........... 1,818
See notes to condensed financial information and notes to consolidated financial statements. 75 77 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) NOTES TO CONDENSED FINANCIAL INFORMATION NOTE 1 -- BASIS OF PRESENTATION The condensed financial information includes the accounts of the parent company. Substantially all investments in and advances to unconsolidated subsidiaries are eliminated in the consolidated financial statements. In fiscal 1997, other income includes interest income of $69,000 that is eliminated in the consolidated financial statements. Intercompany profits between related parties are eliminated in these financial statements. 76 78 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of Coyote Network Systems, Inc. and Subsidiaries: We have audited in accordance with auditing standards generally accepted in the United States the consolidated financial statements of Coyote Network Systems, Inc. included in this Form 10-K, and have issued our report thereon dated July 13, 1999, except as to Notes 2 and 17, which is as of May 16, 2000. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The Schedule of Valuation and Qualifying Accounts is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commissions rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Los Angeles, California July 13, 1999 77 79 COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
BALANCE AT BALANCE AT BEGINNING OF END OF PERIOD ACQUISITION PROVISION WRITE-OFF PERIOD ------------ ----------- --------- --------- ---------- Allowance for doubtful accounts: Year ended March 31, 1997.......... $ -- $ -- $ -- $ -- $ -- Year ended March 31, 1998.......... $ -- $ -- $ -- $ -- $ -- Year ended March 31, 1999.......... $ -- $ -- $377 $ -- $377
78 80 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 this 29th day of June, 2000. COYOTE NETWORK SYSTEMS, INC. By: /s/ JAMES R. MCCULLOUGH ------------------------------------ James R. McCullough Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of and the in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ JAMES R. MCCULLOUGH Chief Executive Officer and June 29, 2000 - ----------------------------------------------------- Director (Principal Executive James R. McCullough Officer) /s/ DANIEL W. LATHAM President, Chief Operating June 29, 2000 - ----------------------------------------------------- Officer and Director Daniel W. Latham /s/ CHERYL JOHNSON Controller (Principal Financial June 29, 2000 - ----------------------------------------------------- and Accounting Officer) Cheryl Johnson /s/ JOHN M. EGER Director June 29, 2000 - ----------------------------------------------------- John M. Eger /s/ J. THOMAS MARKLEY Director June 29, 2000 - ----------------------------------------------------- J. Thomas Markley
79 EX-21 2 ex21.txt EXHIBIT 21 1 EXHIBIT 21 LIST OF SUBSIDIARIES COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES SUBSIDIARIES OF THE REGISTRANT All significant subsidiaries of the Registrant have been listed. Indentations indicate indirectly owned subsidiaries which are owned by the named subsidiary. State of Subsidiaries of the Registrant Incorporation - ------------------------------ ------------- Coyote Communications Services, LLC Colorado Coyote Gateway, LLC Colorado Coyote Technologies, Inc. Nevada Coyote Technologies, LLC California INET Interactive Network System, Inc. California EX-23.1 3 ex23-1.txt EXHIBIT 23.1 1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference of our reports dated July 13, 1999, except as to Notes 2 and 17, which is as of May 16, 2000, included in the Form 10-K/A Amendment No. 5 of Coyote Network Systems, Inc. for the year ended March 31, 1999 into (i) Registration Statement on Form S-3 (File No. 33-88392), (ii) Registration Statement on Form S-8 (File No. 33-57188) and (iii) Registration Statement on Form S-3 (File No. 333-1055). ARTHUR ANDERSEN LLP Los Angeles, California June 29, 2000 80 EX-23.2 4 ex23-2.txt EXHIBIT 23.2 1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 and in the Registration Statements on Form S-8 listed below of Coyote Network Systems, Inc., formerly The Diana Corporation, of our report dated September 22, 1997, except as to the last paragraph of Note 8, which is as of November 4, 1998 and the "Discontinuance of Switch Business" section of Note 2, which is as of May 8, 2000, relating to the financial statements and financial statement schedule of The Diana Corporation, which appears in this Annual Report on Form 10-K/A (Amendment No. 5). 1. Registration Statement on Form S-3 (Registration No. 33-88392) 2. Registration Statement on Form S-8 (Registration No. 33-67188) 3. Registration Statement on Form S-3 (Registration No. 33-1055) 4. Registration Statement on Form S-8 (Registration No. 33-63011) 5. Registration Statement on Form S-8 (Registration No. 33-63013) 6. Registration Statement on Form S-8 (Registration No. 33-63017) /s/ PRICEWATERHOUSECOOPERS LLP PricewaterhouseCoopers LLP Milwaukee, Wisconsin June 29, 2000 81 EX-27 5 ex27.txt FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS OF COYOTE NETWORK SYSTEMS, INC. AS OF AND FOR THE YEAR ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 US YEAR MAR-31-1999 APR-01-1998 MAR-31-1999 1 1,225 0 2,502 (377) 0 15,461 6,422 (992) 34,151 16,120 1,534 0 7,395 11,167 (12,505) 34,151 6,756 6,756 5,878 5,878 9,698 0 1,893 (9,628) 0 (9,628) (5,115) 0 0 (14,743) (1.63) (1.63)
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