UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended October 2, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-16172 COMPUTONE CORPORATION (Exact name of small business issuer as specified in its charter) Delaware 23-2472952 - ------------------------------- ------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1060 Windward Ridge Parkway, Suite 100, Alpharetta, GA 30005 ------------------------------------------------------------ (Address of principal executive offices) Issuer's telephone number, including area code: (770) 625-0000 N/A --- (Former name, former address and former fiscal year, if changed since last report) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Check whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15 (d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes No APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 7,698,444 shares of common stock on November 6, 1998. Transitional Small Business Disclosure Format (check one): Yes No X --- --- COMPUTONE CORPORATION INDEX PART I - FINANCIAL INFORMATION ITEM 1. Financial Statements: Balance Sheets as of October 2, 1998 and April 3, 1998 3 Statements of Operations for the three months ended October 2, 1998 and October 3, 1997 4 Statements of Operations for the six months ended October 2, 1998 and October 3, 1997 5 Statements of Cash Flows for the six months ended October 2, 1998 and October 3, 1997 6 Notes to Financial Statements 7 ITEM 2. Management's Discussion and Analysis or Plan of Operation 10 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings 13 ITEM 2. Changes in Securities 13 ITEM 3. Defaults Upon Senior Securities 13 ITEM 4. Submission of Matters to a Vote of Security Holders 13 ITEM 5. Other Information 13 ITEM 6. Exhibits and Reports on Form 8-K 14 SIGNATURES 15 2 PART I - FINANCIAL INFORMATION Item 1. Financial Statements Computone Corporation Balance Sheets (in thousands) October 2, 1998 April 3, 1998 --------------- ------------- (unaudited) ASSETS Current assets: Cash and cash equivalents $ 106 $ 146 Receivables, net of allowance for doubtful accounts of $694 at October 2, 1998 and $668 at April 3, 1998 1,529 2,540 Inventories, net 2,482 3,752 Prepaid expenses and other 119 102 -------- -------- Total current assets 4,236 6,540 Property, equipment and improvements, net 600 594 Intangible assets, net 459 506 Advance (See Note 7) 450 -- Other 25 27 -------- -------- Total assets $ 5,770 $ 7,667 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable, trade $ 2,362 $ 2,600 Accrued liabilities: Payroll 92 97 Deferred sales 484 523 Professional fees 32 153 Other 516 504 Line of credit 309 1,252 Notes payable to stockholders 450 460 Current maturities of long term debt 166 76 -------- -------- Total current liabilities 4,411 5,665 Notes payable to stockholders 420 120 Long term debt, less current maturities -- 6 -------- -------- Total liabilities 4,831 5,791 Stockholders' Equity Convertible redeemable preferred stock, $.01 par value; 10,000,000 shares authorized; no shares issued -- -- Common stock, $.01 par value; 25,000,000 shares authorized; 7,698,444 and 7,382,622 shares outstanding 77 74 Additional paid in capital 45,892 45,062 Accumulated deficit (45,030) (43,260) -------- -------- Total stockholders' equity 939 1,876 -------- -------- Total liabilities and stockholders' equity $ 5,770 $ 7,667 ======== ======== See accompanying notes to the financial statements. 3 PART I - FINANCIAL INFORMATION Item 1. Financial Statements Computone Corporation Statements of Operations (in thousands, except per share data) Three Months Ended -------------------------------------- October 2, 1998 October 3, 1997 --------------- ------------------ (unaudited) Revenues: Product sales $2,808 $3,511 ------ ------ Expenses: Cost of products sold 1,883 2,110 Selling, general and 1,196 1,079 administrative Product development 521 292 ------ ------ 3,600 3,481 ------ ------ Operating income (loss) (792) 30 Other income (expense): Other income (expense) 2 298 Interest expense - affiliates (18) (12) Interest expense - other (11) (36) ------ ------ Income (loss) before income taxes (819) 280 Provision for income taxes -- -- ------ ------ Net income (loss) $ (819) $ 280 ====== ====== Income (loss) per common share: Basic $(0.11) $ 0.04 ====== ====== Diluted $(0.11) $ 0.04 ====== ====== See accompanying notes to the financial statements. 4 PART I - FINANCIAL INFORMATION Item 1. Financial Statements Computone Corporation Statements of Operations (in thousands, except per share data) Six Months Ended ----------------------------------- October 2, 1998 October 3, 1997 --------------- --------------- (unaudited) Revenues: Product sales $ 5,652 $7,005 ------- ------ Expenses: Cost of products sold 3,881 4,231 Selling, general and administrative 2,525 2,038 Product development 957 568 ------- ------ 7,363 6,837 ------- ------ Operating income (loss) (1,711) 168 Other income (expense): Other income (expense) 2 296 Interest expense - affiliates (28) (24) Interest expense - other (32) (50) ------- ------ Income (loss) before income taxes (1,769) $ 390 Provision for income taxes -- -- ------- ------ Net income (loss) $(1,769) $ 390 ======= ====== Income (loss) per common share: Basic $ (0.23) $ 0.06 ======= ====== Diluted $ (0.23) $ 0.06 ======= ====== See accompanying notes to the financial statements. 5 PART I - FINANCIAL INFORMATION Item 1. Financial Statements Computone Corporation Statements of Cash Flows (in thousands) Six Months Ended ---------------------------------- October 2, 1998 October 3, 1997 --------------- --------------- (unaudited) Cash flows from operating activities: Net income (loss) from operations $(1,769) $ 390 Adjustments to reconcile income (loss) from operations to net cash provided by (used in) operations: Depreciation and amortization 224 224 Provision for uncollectible accounts 26 (17) Provision for inventory reserve 60 (38) Changes in current assets and current liabilities: Accounts receivable 985 (934) Inventories 1,210 179 Prepaid expenses and other (16) (188) Accounts payable and accrued liabilities (392) (1,007) ------- ------- Net cash (used in) provided by operations 328 (1,391) ------- ------- Cash flows from investing activities: (Increase) decrease in other assets -- (11) Advance (See Note 7) (450) -- Capitalization of software costs (88) (143) Capital expenditures (94) (54) ------- ------- Net cash used in investing activities (632) (208) ------- ------- Cash flows from financing activities: Borrowings from affiliates 400 75 Repayment of debt - net (25) (500) Net borrowings under term loan -- 192 Net borrowings under lines of credit (943) 733 Exercise of common stock options and warrants 3 20 Issuance of common stock 829 1,320 ------- ------- Net cash provided by financing activities 264 1,840 ------- ------- Net increase in cash and cash equivalents (40) 241 Cash and cash equivalents, beginning of period 146 88 ------- ------- Cash and cash equivalents, end of period $ 106 $ 329 ======= ======= Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 60 $ 74 See accompanying notes to the financial statements. 6 COMPUTONE CORPORATION NOTES TO FINANCIAL STATEMENTS (UNAUDITED) All statements contained in this Form-10QSB Quarterly Report that are not historical facts are based on current expectations. Such statements are forward- looking (as defined in the Private Securities Litigation Reform Act of 1995) in nature and involve a number of risks and uncertainties. Actual results could vary materially. The factors that could cause actual results to vary materially include: the ability of the Company to obtain and maintain adequate working capital, the Company's need for substantial additional equity capital, the outcome of certain litigation pending against the Company, including an SEC investigation, the loss of the exemption pursuant to which the Company's Common Stock is currently traded on the Nasdaq SmallCap Market, general business and economic conditions in the market, the Company's ability to maintain its existing customers and other risks that may be described from time to time in reports the Company files with the SEC. Undue reliance should not be placed on any such forward-looking statements. 1. BASIS OF PRESENTATION --------------------- The financial statements included in this Form 10-QSB have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed, or omitted, pursuant to such rules and regulations. These financial statements should be read in conjunction with the financial statements and related notes included in the Company's Form 10-KSB Report for its fiscal year ended April 3, 1998. The financial statements presented herein as of October 2, 1998 reflect, in the opinion of management, all adjustments necessary for a fair presentation of financial position and the results of operations for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for the full year. 2. REVENUE RECOGNITION ------------------- Product sales are generally recognized, net of an allowance for estimated sales returns and allowances, when the related products are shipped; however beginning with the fourth quarter of the fiscal year ended April 3, 1998, the Company modified the application of its revenue recognition policy to defer recognition of revenue on sales to customers who are not end users of the Company's products until such time as the product has been sold through to the end user. The modification was implemented in response to management's determination that the estimated returns and allowances attributable to such sales cannot be accurately quantified and is considered a change in estimate under APB Opinion No. 20, "Accounting Changes". The effect of adopting this modification on the Company's financial statements for the six months ended October 2, 1998 was to increase revenue by approximately $80,000 and decrease operating loss by approximately $30,000. The effect of adopting this modification on the Company's financial statements for the three months ended October 2, 1998 was to increase revenue by approximately $30,000 and decrease operating loss by approximately $15,000. A warranty reserve of less than one percent of sales is accrued at the date of shipment. The Company generally provides a warranty of five years on all of its products sold. 7 COMPUTONE CORPORATION NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 3. INVENTORIES ----------- Inventories are valued at the lower of cost or market, with cost determined on the first-in, first-out method. Raw materials that have no planned production life or exceed 18 months of anticipated supply are deemed excess and are fully reserved. Reserves are also established, as management deems appropriate, for obsolete, excess and non- salable inventories, including finished goods inventories. Inventories are net of a reserve for obsolete, excess and non-salable items of $911,000 and $851,000 at October 2, 1998 and April 3, 1998, respectively. Inventories, net of a reserve for obsolete, excess and non-salable items, consisted of the following at October 2, 1998 and April 3, 1998 (in thousands): October 2, 1998 April 3, 1998 --------------- ------------- Finished goods $ 526 $1,375 Work in progress 822 533 Raw materials 1,134 1,844 ------ ------ $2,482 $3,752 ====== ====== 4. INCOME (LOSS) PER SHARE ----------------------- In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share." SFAS No. 128 establishes standards for computing and presenting earnings per share ("EPS"). SFAS No. 128 requires the dual presentation of basic and diluted EPS on the face of the statement of operations. Basic EPS excludes dilution and is computed by dividing income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The Company adopted SFAS No. 128 during fiscal 1998 and has restated all prior period EPS data. For purposes of computing basic and diluted EPS, the net income (loss) for each period presented (the numerator) is divided by the weighted average number of common shares outstanding (the denominator) resulting in basic and diluted EPS of ($0.11) for the three months ended October 2, 1998 and $0.04 for the three months ended October 3, 1997. The basic and diluted EPS for the six months ended October 2, 1998 is ($0.23) and $0.06 for the six months ended October 3, 1997. For purposes of computing diluted EPS during the three and six month periods ended October 2, 1998, the Company excluded the effects of outstanding common stock options and warrants because they were anti-dilutive. 5. INCOME TAXES ------------ Income taxes are calculated using the liability method specified by SFAS 109, "Accounting for Income Taxes". The Company provides a valuation allowance against its deferred tax assets to the extent that management concludes that it is more likely than not that the Company will not benefit from the utilization of such deferred tax assets. The Company has available net operating and capital loss carryforwards amounting to approximately $53 million at April 3, 1998, including operating loss carryforwards which relate to a predecessor company, which expire in 2013. As a result of several ownership changes which have occurred since the losses started to accumulate, statutory provisions will substantially limit the Company's future use of the loss carryforwards. 8 COMPUTONE CORPORATION NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 6. DEBT ---- On June 20, 1997, the Company entered into a financing arrangement with a lender which provided for a term loan in the amount of $254,000 ($141,000 outstanding at October 2, 1998), at a rate of prime plus 1.50%, which is collateralized by the Company's inventory and is payable at $4,233 per month through June 2000. In addition, a line of credit agreement exists with the lender for up to $2,500,000 ($309,000 outstanding at October 2, 1998) and is based on the available borrowing base, at rate of prime plus 1.25% which is collateralized by the Company's accounts receivable. The financing arrangement contains various affirmative and negative covenants and, as of October 2, 1998, the Company was in violation of the minimum net worth covenant. On September 8, 1998, the Company received notice that the lender had accelerated all sums due under the financing agreement and made demand for payment of all outstanding balances. As such, the Company has reclassified the previously reported long-term loan balance to current maturities of long-term debt. The Company and its lender have also entered into a forbearance agreement that expires on November 16, 1998. Although the Company is engaged in negotiation with a new lender to provide working capital financing and repay all balances due to the Company's current lender, no assurance can be given that the Company will be able to consummate an agreement with a new lender and, if the Company cannot do so, that the expiration of the forbearance agreement would not have a material adverse effect on the Company's financial position and results of operations. 7. ADVANCE ------- On June 5, 1998, the Company entered into an Agreement and Plan of Reorganization (the "Agreement") with Ladia Communications Technologies, Inc., a newly formed subsidiary of the Company ("LCTI"), New Computone Corporation, a newly formed subsidiary of the Company ("Newco"), Ladia, L.L.C., a Massachusetts limited liability company ("Ladia") and the members of Ladia. A copy of the Agreement was included as Exhibit 1 to the Company's Form 8-K Report dated August 3, 1998 and reference is made to such exhibit for a full statement of the terms and conditions of the transactions contemplated by the Agreement. In summary, the Agreement provides that the current holders of the Company's Common Stock and the current members of Ladia will become shareholders of LCTI and the Company and Ladia will become subsidiaries of LCTI. The Agreement provides that the current members of Ladia and the holders of approximately $250,000 of debt owed by Ladia would initially receive approximately 430,000 shares of LCTI Common Stock and, subject to the satisfaction of certain specified criteria relating to Ladia financial performance through April 30, 1999, could receive up to 8.1 million shares of LCTI Common Stock. A copy of the Company's June 9, 1998 press release relating to the execution of the Agreement is included as Exhibit 2 to the Company's Form 8-K Report. The Company and Ladia are currently renegotiating certain terms of the Agreement. The Company cannot currently predict when the renegotiation of the Agreement will be completed or when the transactions contemplated by the Agreement will be consummated. The Agreement also contemplated that LCTI would use commercially reasonable efforts to raise additional equity financing of up to $5 million for Ladia. During the quarter ended October 2, 1998, the Company made available to Ladia $450,000 in proceeds from the private placement of Common Stock by the Company. The unwritten understanding between the Company and Ladia is that the funds advanced to Ladia by the Company would be converted in Common Stock of LCTI upon the consummation of the transactions contemplated by the Agreement and, if those transactions are not consummated, the amount of advances would constitute unsecured indebtedness of Ladia to the Company. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED OCTOBER 2, 1998 COMPARED TO THE THREE AND SIX MONTHS ENDED OCTOBER 3, 1997. RESULTS OF OPERATIONS - --------------------- FOR THE THREE MONTHS ENDED OCTOBER 2, 1998 - ------------------------------------------ The Company reported a loss from operations for the quarter ended October 2, 1998 of $792,000 compared to income from operations of $30,000 for the comparable quarter of the prior fiscal year. The Company's operating results for the three months ended October 2, 1998 were unfavorably affected by depressed sales volume, reduced margins on sales and increased general and administrative expenses. Sales volume during the quarter was unfavorably affected by internal delays in releasing new products into the market due to a reorganization of the Company's sales forces, and external delays in receiving product delivery from suppliers due to the Company's cash shortages. Margins were unfavorably affected by sales made to the Company's largest customer at reduced margins, and the write-off of previously capitalized manufacturing overhead costs. General and administrative expenses were unfavorably affected by increases the Company's compensation costs, legal costs, trade shows/advertising costs and bad debt expenses. Product sales revenue for the quarter ended October 2, 1998 totaled approximately $2,808,000 compared to $3,511,000 for the comparable quarter of the prior fiscal year, a decrease of $703,000, or 20%. This decrease in product sales revenue is attributable to the continued delay in the delivery of new products in conjunction with a reorganization of the Company's sales force to utilize more of the distribution channel and in the receipt of product from the Company's suppliers due to the Company's cash shortages. Cost of products sold for the quarter ended October 2, 1998 amounted to $1,883,000, or 67% of product sales revenues versus $2,110,000, or 60%, for the comparable quarter of the prior year. The increase in cost of products sold as a percentage of revenues is attributable to the high dollar volume of low margin sales to a major customer and a reduction in sales volumes and margins associated with the Company's I/O boards products. Selling, general and administrative expenses amounted to $1,196,000, or 43% of product sales revenue, for the three months ended October 2, 1998 versus $1,079,000, or 31%, for the comparable three months of the prior fiscal year. The increase in expenses during the quarter ended October 2, 1998 versus the same period of the prior fiscal year is attributable to increases in compensation costs, legal costs, trade shows/advertising costs and bad debt expenses. Product development expenses amounted to $521,000, or 19% of product sales revenue, for the three months ended October 2, 1998 versus $292,000, or 8%, for the comparable three month period of the prior fiscal year. This increase in product development costs is attributable to additional staffing and equipment rental expenses necessary to ensure the timely completion of the Company's new product release dates for the current fiscal year. RESULTS OF OPERATIONS - --------------------- FOR THE SIX MONTHS ENDED OCTOBER 2, 1998 - ---------------------------------------- The Company reported a loss from operations for the six month period ended October 2, 1998 of $1,711,000 compared to income from operations of $168,000 for the comparable period of the prior fiscal year. The Company's operating results for the six month period ended October 2, 1998 were unfavorably affected by depressed sales volume, reduced margins on sales and increased general and administrative expenses. Sales volume during the six months ended October 2, 1998 was unfavorably affected by internal delays in releasing new products into the market due to a reorganization of the company's sales force and external delays in receiving product delivery from suppliers due to the Company's cash shortages. Margins were unfavorably affected by sales made to the Company's largest customer at reduced margins, a change in sales mix reflecting an increase in low margin sales of third party 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED OCTOBER 2, 1998 COMPARED TO THE THREE AND SIX MONTHS ENDED OCTOBER 3, 1997. products that were bundled with the Company's remote access products, and the reduction of previously capitalized manufacturing overhead costs. General and administrative expenses were unfavorably affected by increases in the Company's compensation costs, legal costs, trade shows/advertising costs and bad debt expenses. Product sales revenue for the six month period ended October 2, 1998 totaled approximately $5,652,000 compared to $7,005,000 for the comparable period of the prior fiscal year, a decrease of $1,353,000, or 19%. This decrease in product sales revenue is attributable to the continued delay in the delivery of new products in conjunction with a reorganization of the Company's sales force to utilize more of the distribution channel and in the receipt of product from the Company's suppliers due to the Company's cash shortages. Cost of products sold for the six month period ended October 2, 1998 amounted to $3,881,000, or 69% of product sales revenues versus $4,231,000, or 60% of product sales revenues, for the comparable period of the prior year. The increase in cost of products sold as a percentage of product sales revenues is attributable to the high dollar volume of low margin sales to a major customer, the continued sales of third party manufacturers products in conjunction with the Company's products, and a reduction in sales volumes and margins associated with the Company's I/O boards products. Selling, general and administrative expenses amounted to $2,525,000, or 45% of product sales revenue, for the six month period ended October 2, 1998 versus $2,038,000, or 29%, for the comparable period of the prior fiscal year. The increase in expenses is attributable to increases in compensation costs, legal costs, trade shows/advertising costs and bad debt expenses. Product development expenses amounted to $957,000, or 17% of product sales revenues, for the six month period ended October 2, 1998 versus $568,000, or 8%, for the comparable period of the prior fiscal year. This increase in product development costs is attributable to additional staffing and equipment rental expenses necessary to ensure the timely completion of the Company's product release dates for the current fiscal year. LIQUIDITY - --------- In order to meet the Company's liquidity needs arising from the operating losses, the Company is endeavoring to raise approximately $2 million in equity capital by November 30,1998 by offering for sale, to accredited investors, up to 1,000,000 shares of the Company's common stock under Regulation D of the Securities Act of 1993. Management believes that these funds will be sufficient to fund the Company's operations during fiscal 1999. However, no assurances can be given that the Company will be successful in raising additional capital. Further, there can be no assurance, assuming the Company successfully raises additional funds that the Company will achieve profitability or positive cash flow. The Company's primary cash commitments in fiscal 1999 include payments under non-cancelable operating leases ($308,000), line of credit & current maturities of long-term debt ($925,000) and investments in research and development ($1,288,000 in fiscal 1998). Relationships with major vendors are satisfactory although the Company is on a "Cash On Delivery" status with several raw materials vendors. Of the $925,000 outstanding as of October 2, 1998, approximately $475,000 000 is due to related parties, the maturity of which the Company believes can be extended as needed. On June 20, 1997, the Company entered into a financing arrangement with a lender which provided for a term loan in the amount of $254,000 ($141,000 outstanding at October 2, 1998), at a rate of prime plus 1.50% which 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED OCTOBER 2, 1998 COMPARED TO THE THREE AND SIX MONTHS ENDED OCTOBER 3, 1997. collateralized by the Company's inventory and is payable at $4,233 per month through June 2000. In addition, a line of credit agreement exists with the lender for up to $2,500,000 ($309,000 outstanding at October 2, 1998) and is based on the available borrowing base, at a rate of prime plus 1.25% which is collateralized by the Company's accounts receivable. The financing arrangement contains various affirmative and negative covenants and, as of October 2, 1998, the Company was in violation of the minimum net worth covenant. On September 8, 1998, the Company received notice that the lender had accelerated all sums due under the financing agreement and made demand for payment of all outstanding balances. As such, the Company has reclassified the previously reported long-term loan balance to current maturities of long-term debt. The Company and its lender have also entered into a forbearance agreement that expires on November 16, 1998. Although the Company is engaged in negotiation with a new lender to provide working capital financing and repay all balances due to the Company's current lender, no assurance can be given that the Company will be able to consummate an agreement with a new lender and if the Company cannot do so, that the expiration of the forbearance agreement would not have a material adverse effect on the Company's financial position and results of operations. Cash provided by operations amounted to $328,000 for the six months ended October 2, 1998 compared to cash used in operations of $1,391,000 for the six months ended October 3, 1997. The increase in cash provided by operations compared to the prior year fiscal period primarily reflects the decrease in accounts receivable and inventories. Cash used in investing activities amounted to $632,000 for the six months ended October 2, 1998 compared with $208,000 used in financing activities for the six months ended October 3, 1997. This increase from the same period of the prior fiscal year is attributable to an advance (See Note 7 for further information). Cash provided by financing activities during the six months ended October 2, 1998 was $264,000 versus $1,840,000 for the six months ended October 3, 1997. This decrease is partially due to the Company's repayments on the June 20, 1997 financing arrangement during the six months ended October 2, 1998 versus borrowings under that arrangement during the six months ended October 3, 1997. In addition, issuance of common stock was $829,000 in the six months ended October 2, 1998 versus $1,320,000 in the six months ended October 3, 1997 (See Note 7). Working capital was a deficit of $175,000 at October 2, 1998 versus positive working capital of $875,000 at April 3, 1998, a decrease of $1,050,000. The ratio of current assets to current liabilities at October 2, 1998 was 0.96 to 1.00 compared to 1.15 to 1.00 at April 3, 1998. OUTLOOK FOR REMAINDER OF FISCAL YEAR 1999 - ----------------------------------------- Management believes that the release of the Company's TotalAccess DCS-5000, scheduled for the fourth quarter of fiscal 1999, will significantly enhance the Company's ability to increase its sales. The DCS-5000 combines the features of a high performance Ethernet digital remote access server with up to 12 DSP 24- channel modem cards. The DCS-5000 is intended for use by Internet Service Providers and medium to large companies that require high-density connectivity, allowing remote users and locations access to the Internet and corporate Intranets. The DCS-5000 will reduce the Company's dependence on third party products and management believes that it can be sold at a considerable margin. 12 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None, other than those matters described in Item 3 to the Company's Annual Report on Form 10-KSB for the year ended April 3, 1998. ITEM 2. CHANGES IN SECURITIES In July 1998, the Company sold 15,300 shares of Common Stock at a price of $3.75 per share to two accredited investors in a private placement. In September 1998, the Company sold 95,693 shares of Common Stock at a price of $2.09 per share to an accredited investor in the same private placement. The private placement is pursuant to Regulation D under the Securities Act of 1933. No underwriters were utilized in connection with such sales, nor were any underwriting discounts or commissions paid. The aggregate proceeds from such sales of Common Stock of $257,000 were used for working capital items and to partially fund the Company's loss from operations of $792,000 during the fiscal quarter ended October 2, 1998. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable. ITEM 5. OTHER INFORMATION On July 22, 1998, the Company was notified by the Nasdaq Stock Market, Inc. that effective July 29, 1998, the Company's Common Stock would be delisted from the Nasdaq SmallCap Market. On July 27, 1998, the Company filed an appeal with the Nasdaq Stock Market, Inc. On September 17, 1998, the Company's appeal was heard by a Nasdaq Listing Qualifications Panel (the "Panel"). On October 22, 1998, the Panel determined to continue the listing of the Company's Common Stock on the Nasdaq SmallCap Market subject to the condition that on or before November 30, 1998 the Company must make a public filing with the SEC and Nasdaq evidencing a minimum of $3,000,000 in net tangible assets. The determination of the Panel also indicated that the Company must be able to demonstrate compliance with all requirements for continued listing on The Nasdaq SmallCap Market. In the event the Company fails to meet any of the terms of the exception granted by the Panel, the Company's Common Stock will be delisted from The Nasdaq SmallCap Market. A copy of the October 22, 1998 determination by the Panel is included as Exhibit 99.1 to this Form 10-QSB Quarterly Report and reference is made to the text of the Panel's determination for a full statement of the terms and conditions of the exception granted. On October 27, 1998, the Company issued a press release reporting the exception granted by the Panel, a copy of which is included as Exhibit 99.2 to this Form 10-QSB Quarterly Report. 13 PART II - OTHER INFORMATION, continued. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit No. Description of Exhibit Reference ----------- ---------------------- --------- 27 Financial Data Schedule Filed Herewith (for SEC use only) 99.1 October 22, 1998 determination by Filed Herewith Nasdaq Listing Qualifications Panel 99.2 October 27, 1998 press release of Filed Herewith the Company relating to Nasdaq Determination (b) Reports on 8-K: No reports on Form 8-K were filed by the Company during the quarter ended October 2, 1998, except for a Form 8-K Report dated August 3, 1998 reporting certain information under Item 5. 14 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. COMPUTONE CORPORATION Date: November 16, 1998 By: /s/ Perry J. Pickerign ------------------------------------------- Perry J. Pickerign President and Chief Executive Officer (Principal Executive Officer) By: /s/ Greg B. Roseberry -------------------------------------------- Greg B. Roseberry Acting Chief Financial Officer (Principal Financial and Accounting Officer) 15 EXHIBIT INDEX ------------- Exhibit Number Description Reference - -------------- ----------- --------- 27 Financial Data Schedule File Herewith (for SEC use only) 99.1 October 22, 1998 determination by Filed Herewith Nasdaq Listing Qualifications Panel 99.2 October 27, 1998 press release of Filed Herewith the Company relating to Nasdaq Determination 16 NASDAQ Davie A. Donohoe, Jr. Counsel The Nasdaq Stock Market, Inc. 9801 Washingtonian Blvd. Gaithersburg, MD. 20878 202-496-2529 Fax 202-496-2688 Sent Via Facsimile and Federal Express - -------------------------------------- October 22, 1998 Fredrick W. Dreher, Esquire Duane, Morris & Heckscher, LLP One Liberty Place Philadelphia, PA. 19103 Re: Computone Corporation (Symbol: CMPTE) Nasdaq Listing Qualifications Panel Decision 2400C-98 Dear Mr. Dreher: This is to inform you that, pursuant to the September 17, 1998 hearing before a Nasdaq Listing Qualifications Panel (the "Panel"), a determination has been made in the matter of Computone Corporation (the "Company") and its request for continued inclusion on The Nasdaq Small Cap Market pursuant to an exception to the filing and net tangible assets/market capitalization/net income requirement, as set forth in NASD Marketplace Rules 4310(c)(14) and 4310 (c)(2). After careful review of the record, the Company's submissions and its oral representation, the Panel made the following findings. The Company designs, manufactures and markets hardware and software communications connectivity products for business and industrial systems, using personal computers, servers and workstations. The Form 10-Q for the quarterly period ended July 3, 1998, reported $6,224,000 in total assets and $1,500,000 in net tangible assets/1/. Net income for the three months ended July 3, 1998 and the fiscal year ended April 3, 1998 was $(950,000) and $(3,466,000), respectively. The Company reported 7,553,777 total shares outstanding, of which approximately 4,035,379 shares in the public float. The closing bid price on October 21, 1998 was $1.75 per share; consequently, the market capitalization and market value of public float were $13,219,109, and $7,061,913, respectively. _______________________ /1/ Based on the Company's historical monthly burn rate of $316,666 and proceeds of $250,000 received from two related private placements, net tangible assets are currently estimated to be $1,116,668. As of the date of the hearing, the Company estimated net tangible assets of approximately $1,300,00. The estimate is based upon a $250,000 increase from certain private placements, and losses of $(400,000) since the end of the July 3, 1998 quarter. The Company discussed: the status of its delinquent filings; the status of the Securities and Exchange Commission (the "SEC") investigation relating to certain revenue recognition issues, which the SEC alleged are contrary to generally accepted accounting principles; recent changes in the Company's management; its plans for continuing merger discussions with Ladia Communications Technologies, Inc.") ("Ladia"); and in its plans to achieve and sustain compliance with all applicable maintenance criteria. The Form 10-Q for the quarter ended July 3, 1998 was filed with the SEC on September 11, 1998. In correspondence dated September 16, 1998, the Company stated that the delay in filing result4ed from its proactive response to the SEC's ongoing investigation. Though discussions are continuing, the Company's counsel is confident that a settlement may be reached by year-end, and does not anticipate that any fine or other monetary penalty will be imposed. In response to the SEC's investigation, the Company represented that the Board has approved substantial changes to its revenue recognition policy/2/. To allay any future concerns, the Company has implemented new conservative revenue recognition policies and is instituting further internal accounting controls. In addition, the Company stated that it is in the final stages of recovering from a number of unusual and non-recurring difficulties. It has replaced its Former Chief Executive Officer with Mr. Perry Pickerign, and appointed an interim Chief Financial Officer. It plans to fill that position by year-end. The Company represented that Mr. Pickerign has a well-defined turnaround plan to increase sales and gross margins and intends to implement those changes immediately. Mr. Pickerign stated that the Company will break-even in the third quarter and report profitability of between $300,000 and $400,000 in the fourth quarter of fiscal 1998. As reported in the Company's Form 8-K dated August 4, 1998, the Company is renegotiating the Ladia merger agreement. Because of a reduction in the valuation of Ladia, the Company stated that it has no intention of proceeding with the transaction on the terms contemplated in the original agreement. It further stated that the principal terms, which are the subject of the renegotiation, relate to the percentage interest that would be issuable to members of Ladia. The Company believes that the percentage issuance will not exceed 20% of the outstanding shares. Although discussions are continuing, there is no definitive schedule for completion of the transaction in the near term. The Company represented that it will consider the applicability of NASD Marketplace Rule 4330(f) with respect to the Ladia transaction. The Company stated that it plans to increase its net tangible assets by completing a private placement of equity to sophisticated existing clients of Pennsylvania Merchant Group Ltd. The Company expects proceeds of approximately $1,000,000 to $1,500,000. It expected to begin marketing efforts on or about October 20, 1998, and contemplates completion of the placement by November 15, 1998. The Panel was of the opinion that the company has regained compliance with the filing requirement. The Panel was further of the opinion that the Company presented a plan which will enable it to comply with the net tangible assets requirement within a reasonable period of time and to sustain compliance with all requirements for continued listing on The Nasdaq SmallCap Market over the long term, so long as the ________________ /2/ The Company has agreed that it will recognize revenue until the products are sold to the ultimate end users. Company is able to consummate the proposed private placement. The Panel noted that the Company expects to return to profitability by the fiscal year end. In addition, the Panel was of the opinion that the Company diligently responded to the SEC's inquiries, and expressed confidence that it has taken the necessary steps to avoid any recurrence in the future. Finally, the Panel raised concerns that NASD Marketplace Rule 4330(f) may apply to the Ladia transaction; however, the Panel noted that the Company's representation that the transaction has been postponed. Accordingly, the Panel determined to continue the listing of the Company's securities on The Nasdaq SmallCap Market pursuant to the following exception. On or before, November 30, 1998, the Company must make a public filing with the SEC and NASDAQ evidencing a minimum of $3,000,000 in net tangible assets. The filing must contain a balance sheet, no older than 45 days, including pro forma adjustments for any significant events or transactions occurring on or before the filing date. In order to fully comply with the terms of this exception, the Company must be able to demonstrate compliance with all requirements for continued listing on The Nasdaq SmallCap Market. In the event the Company fails to meet any of the terms of this exception, the Company's securities will be delisted from The Nasdaq Stock Market. All companies operating under exceptions are required to issue a press release (see sample attached) announcing the conditional listing on The Nasdaq SmallCap Market and are identified by a fifth character "C" appended to the Company's symbol. Accordingly, effective October 27, 1998, the trading symbol of the Company's securities will be changed from CMPTE to CMPTC. The "C" will be removed from the symbol when the Panel has confirmed compliance with the terms of the exception and all other criteria necessary for continued listing. It is a requirement during the exception period that the Company must provide prompt notification of any significant events, which occur during this time. Should there be a material change in the Company's financial or operational character, the Panel reserves the right to reconsider the terms of this exception. In addition, any compliance document will be subject to review by the Panel, which may at its discretion request additional information before approving the Company's compliance. The Company should be aware that the Nasdaq Listing and Review Council ("Review Council") may, on its own motion, determine to review any Panel decision within ---- 45 calendar days after issuance of the written decision. If the Review Council determines to review this decision it may affirm, modify, reverse, dismiss, or remand the decision to a Panel. You will be notified immediately in the event the Review Council determines that this matter will be called for review. The Company may also request that Review Council to review this decision. This request for review must be made in writing within 15 days from the date of this ------------------------------------------------------------ decision to: Sara Bloom, Office of General Counsel, The Nasdaq Stock market, - ------------ 1801 K Street, NW, Washington, DC 20006, (202)728-8478 and facsimile (202) 728- 8321. Please be advised that the institution of a review, whether by way of your request or on the initiative of the Review Council, will not operate as a ---- stay of this decision. If you have any questions, please do not hesitate to contact me at (202) 496- 2529. Sincerely, /s/ David A. Donohoe, Jr. - --------------------------- David A. Donohoe, Jr. Counsel Listing Qualifications Hearing [LOGO OF COMPUTONE APPEARS HERE] PRESS RELEASE Computone President & CEO: Perry Pickerign FOR IMMEDIATE RELEASE (770) 625-0000, FAX: (770) 625-0011 OCTOBER 27, 1998 Computone Investor Relations: Dianne Will (214) 954-9300, FAX: (214) 954-9333 NEW STOCK SYMBOL FOR COMPUTONE -------------------------- ALPHARETTA, GA-- Computone Corporation (NASDAQ-CMPTC) today announced that its Common Stock will continue to be listed on The Nasdaq SmallCap Market via an exception from the net tangible asset requirement. While Computone Corporation failed to meet this requirement as of the end of its fiscal year ended April 4, 1998, Computone Corporation was granted a temporary exception from this standard subject to Computone Corporation meeting certain conditions. This exception will expire on November 30, 1998. In the event Computone Corporation is deemed to have met the terms of the exception, its Common Stock shall continue to be listed on The Nasdaq SmallCap Market. Computone Corporation believes that it can meet these conditions; however, there can be no assurance it will do so. If at some future time, Computone Corporation's Common Stock should cease to be listed on The Nasdaq SmallCap Market, the Common Stock may continue to be listed on the OTC-Bulletin Board. For the duration of the exception, the Nasdaq symbol for Computone Corporation's Common Stock will be CMPTC. Established in 1984, Computone offers an extensive line of Ethernet, remote access/Internet communications servers, multi-port solutions for PCI, ISA, EISA, and MicroChannel computer systems; and UNIX-to-SNA/X.25 connectivity solutions. Computone was awarded Arthur Andersen's prestigious "Fast Tech 50" award for four consecutive years. Computone is located at 1060 Windward Ridge Parkway, Alpharetta, GA 30005. To reach Computone Sales: Call (800) 241-3946 or (770) 625-0000, Facsimile: (770) 664-0013, E-mail: sales@ computone.com or visit our Web site - http://www.computone.com. # # #