U.S. SECURITIES AND EXCHANGE
COMMISSION Washington,
D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 2003
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from ____________ to ____________
Commission File No.: 0-13117
ION NETWORKS, INC.
(Exact Name of Small Business Issuer in Its Charter)
Delaware 22-2413505
-------- ----------
(State or Other Jurisdiction of (IRS Employer Identification Number)
Incorporation or Organization)
120 Corporate Boulevard, South Plainfield, NJ 07080
(Address of Principal Executive Offices)
(908) 546-3900
(Issuer's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the proceeding 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 .
There were 24,875,500 shares of Common Stock outstanding as of November 13,
2003.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT:
YES___ NO X
ION NETWORKS, INC. AND SUBSIDIARIES
FORM 10-QSB
FOR THE QUARTER ENDED SEPTEMBER 30, 2003
PART I. FINANCIAL INFORMATION
PAGE
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 2
Condensed Consolidated Balance Sheets as of September 30, 2003 (Unaudited) 3
Consolidated Statements of Operations for the Three and Nine Months ended September 30, 2003 and 2002 (Unaudited) 4
Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2003 (Unaudited) and 2002 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS 10
ITEM 3. CONTROLS AND PROCEDURES 14
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 15
ITEM 2. CHANGES IN SECURITIES 15
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 15
ITEM 5. OTHER INFORMATION 15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 16
SIGNATURES 17
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The condensed consolidated financial statements included herein have been
prepared by the registrant without audit pursuant to the rules and regulations
of the Securities and Exchange Commission. Although the registrant believes that
the disclosures are adequate to make the information presented not misleading,
certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
rules and regulations. It is suggested that these financial statements be read
in conjunction with the audited financial statements and the notes thereto
included in the registrant's Transition Report on Form 10-KSB for the nine
months ended December 31, 2002.
2
ION NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30,
2003
ASSETS (Unaudited)
------------
Current assets
Cash and cash equivalents $ 89,114
Accounts receivable, less allowance for doubtful accounts of $65,478 531,474
Inventory, net 856,684
Prepaid expenses and other current assets 136,317
------------
Total current assets 1,613,589
Restricted cash --
Property and equipment, net 90,749
Capitalized software, less accumulated amortization of $3,697,484 517,316
Other assets 19,709
------------
Total assets $ 2,241,363
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Current portion of capital leases $ 91,055
Current portion of long-term debt --
Accounts payable 558,848
Accrued expenses 468,539
Accrued payroll and related liabilities 62,844
Deferred income 197,094
Sales tax payable 71,147
Other current liabilities 59,865
------------
Total current liabilities
1,509,392
------------
Long term portion of capital leases 12,356
Long term debt, net of current portion --
Commitments and contingencies (Note 10)
Stockholders' Equity
Preferred stock - par value $.001 per share; authorized 1,000,000 shares
at
September 30, 2003; 200,000 shares designated Series A at September
30, 2003; 166,835 shares issued
and outstanding at September 30, 2003 167
Common stock - par value $.001 per share; authorized 50,000,000 shares at
September 30, 2003; 24,875,500 shares issued and
outstanding at September 30, 2003 24,876
Additional paid-in capital 44,585,740
Notes receivable from officers (486.535)
Accumulated deficit (43,390,459)
Accumulated other comprehensive loss (14,174)
------------
Total stockholders' equity 719,615
------------
Total liabilities and stockholders' equity $ 2,241,363
============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
ION NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Three Months Nine Months Nine Months,
Ended Ended Ended Ended
September September September 30, September 30,
30, 2003 30, 2002 2003 2002
------------ ------------ ------------ ------------
Net sales $ 888,324 $ 1,522,336 $ 2,527,643 $ 4,558,665
Cost of sales 214,535 557,564 689,374 1,875,153
------------ ------------ ------------ ------------
Gross Margin 673,789 964,772 1,838,269 2,683,512
------------ ------------ ------------ ------------
Research and development expenses 116,080 280,893 377,834 687,318
Selling, general and administrative expenses 454,509 1,614,473 1,937,370 5,465,600
Restructuring, asset impairment and other (213,071) 154,370
charges (405,402) 154,370
Depreciation and amortization expenses 163,597 281,596 604,025 1,002,863
------------ ------------ ------------ ------------
Total operating expense 521,115 2,331,332 2,513,827 7,310,151
------------ ------------ ------------ ------------
Income (Loss) from operations 152,674 (1,366,560) (675,558) (4,626,639)
Other income 3,465 -- 4,120 --
Interest income 4,308 15,663 15,633 48,121
Interest expense (1,681) (6,255) (11,708) (18,149)
------------ ------------ ------------ ------------
158,766 (1,357,152) (667,513) (4,596,667)
Income (Loss) before income taxes
Income tax expense -- -- -- 29,665
------------ ------------ ------------ ------------
Net Income (loss) $ 158,766 $ (1,357,152) $ (667,513) $ (4,626,332)
============ ============ ============ ============
Per share data
Net income (loss) per share
Basic $ 0.01 $ (0.06) $ (0.03) $ (0.20)
Diluted $ 0.01 $ (0.06) $ (0.03) $ (0.20)
Weighted average number of common shares
outstanding
Basic 23,900,500 22,608,272 23,900,500 22,978,336
Diluted 25,581,263 22,608,272 23,900,500 22,978,336
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
ION NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Nine For the Nine
Months Ended Months Ended
September 30, September 30,
2003 2002
------------------ -----------------
Cash flows from operating activities
Net loss $ (667,513) $(4,626,332)
Adjustments to reconcile net loss to net cash used in
operating activities:
Restructuring, asset impairments and other charges,
non-cash (528.912) (31,807)
Depreciation and amortization 604.025 1,002,863
Other charges - 9,052
Non-cash stock-based compensation (95,000) 62,893
Issuances of restricted stock - 539,000
Notes receivable from officers (13,130) (560,380)
Deferred compensation - 62,893
Changes in operating assets and liabilities:
Accounts receivable 30,288 545,553
Other receivables - (16,430)
Inventory 402,584 114,976
Prepaid expenses and other current assets 67,616 (12,444)
Other assets (4,831) -
Accounts payable and other accrued expenses (352,261) (102,775)
Accrued payroll and related liabilities (122,514) (378,526)
Deferred income 42,073 (3,089)
Sales tax payable (12,878) (23,062)
Other current liabilities (29,452) (51,982)
------------------ -----------------
Net cash used in operating activities (679,905) (3,469,597)
------------------ -----------------
Cash flows from investing activities
Acquisition of property and equipment - (4,493)
Capitalized software expenditures (184,671) (452,550)
Proceeds from sales of fixed assets 30,129 -
Related party notes receivable - 14,880
Restricted cash 125,700 249,300
------------------ -----------------
Net cash used in investing activities (28,842) (192,863)
------------------ -----------------
Cash flows from financing activities
Principal payments on debt and capital leases (66,918) (116,895)
Issuance of Preferred Stock - 285,303
Proceeds from sales of common stock/exercise of stock
options and warrants - 3,475,592
Exercises of options and warrants - 19,258
------------------ -----------------
Net cash (used in) provided by financing activities (66,918) 3,663,258
------------------ -----------------
Effect of exchange rates on cash (905) (23,831)
------------------ -----------------
Net decrease in cash and cash equivalents (776,570) (23,033)
Cash and cash equivalents - beginning of period 865,684 1,746,632
------------------ -----------------
Cash and cash equivalents - end of period $ 89,114 $ 1,723,599
================== =================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
ION NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
September 30, 2003
(Unaudited)
NOTE 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
ION Networks, Inc ("ION" or the "Company") designs, develops, manufactures and
sells infrastructure security and management products to corporations, service
providers and government agencies. The Company's hardware and software products
are designed to form a secure auditable portal to protect IT and network
infrastructure from internal and external security threats. ION's infrastructure
security solution operates in the IP, data center, and telephony environments
and is sold by a direct sales force and indirect channel partners mainly
throughout North America and Europe.
The condensed consolidated balance sheet as of September 30, 2003, the
consolidated statements of operations for the three month and nine month periods
ended September 30, 2003 and 2002 and the consolidated statements of cash flows
for the nine month period ended September 30, 2003 and 2002, have been prepared
by the Company without audit. In the opinion of management, all adjustments
(which include normal recurring adjustments) necessary to make the Company's
financial position, results of operations and cash flows at September 30, 2003
and 2002 not misleading have been made. The results of operation for the three
and nine months ended September 30, 2003 and 2002 are not indicative of a full
year or any other interim period
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United Sates of America have been condensed or omitted. It is suggested
that these consolidated financial statements be read in conjunction with the
audited consolidated financial statements and notes thereto included in the
transition report on Form 10-KSB for the nine months ended December 31, 2002.
The Company's consolidated financial statements have been prepared on the basis
that the Company will continue as a going concern. At September 30, 2003, the
Company had an accumulated deficit of $43,390,459 and positive working capital
of $104,197. The Company also realized a net loss of $667,513 for the nine
months ended September 30, 2003. We believe that our working capital as of
September 30, 2003 should be sufficient to fund the Company's operations beyond
December 2003, an improvement from the June 30, 2003 filing due to management
implemented cost savings measures and improved margins on sales, which has had
the effect of extending the Company's ability to meet its cash requirements
beyond December 31, 2003. The Company continues to experience a shortfall in the
cash necessary to grow inventory and further reduce indebtedness and expand
operations. Management and the board of directors are exploring various
alternatives to secure funding necessary to meet previously mentioned cash
requirements. Based on the Company's current financial position and future cash
requirements the Company will consider all viable options. Any future operations
are dependent upon the Company's ability to obtain additional debt or equity
financing, and its ability to generate revenues sufficient to fund its
operations. There can be no assurances that the Company will be successful in
it's attempts to generate positive cash flows or raise sufficient capital
essential to its survival. To the extent that the Company is unable to generate
or raise the necessary operating capital it may become necessary to curtail
operations. Additionally, even if the Company does raise operating capital,
there can be no assurances that the net proceeds will be sufficient enough to
enable it to develop its business to a level where it will generate profits and
positive cash flows. These matters raise substantial doubt about the Company's
ability to continue as a going concern. However, the accompanying financial
statements have been prepared on a going concern basis, which contemplates the
realization of assets and satisfaction of liabilities in the normal course of
business. The financial statements do not include any adjustments relating to
the recorded assets or the classification of the liabilities that might be
necessary should the Company be unable to continue as a going concern.
During the quarter ending September 30, 2003, Kam Saifi, President and Chief
Executive Officer, and Cameron Saifi, Executive Vice President and Chief
Operating Officer, agreed to separate from the Company. The Company, Mr. Kam
Saifi and Mr. Cameron Saifi are continuing to negotiate the specific terms of
their separation and the termination of their employment agreements. In view of
the Company's financial condition, the Company have no plans to hire a Chief
Operating Officer at this time. On August 15, 2003 Mr. Norman E. Corn assumed
the duties of Chief Executive Officer, Mr. Stephen M. Deixler served as the
interim Chief Executive Officer in addition to his responsibilities as Chairman
of the Board of Directors and interim Chief Financial Officer. On July 7, 2003
Christopher Corrado resigned from the Board of Directors citing other
professional commitments.
On September 15, 2003 Patrick Delaney assumed the duties of Chief Financial
Officer, Mr. Stephen M. Deixler served as the interim Chief Financial Officer in
addition to his current responsibilities as Chairman of the Board of Directors.
6
NOTE 2. - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The accompanying condensed consolidated financial statements include the
accounts of ION Networks, Inc. and its subsidiaries (collectively, the
"Company") and have been prepared on the accrual basis of accounting. All
inter-company balances and transactions have been eliminated in consolidation.
Net Income (Loss) Per Share of Common Stock
Basic net loss per share excludes dilution for potentially dilutive securities
and is computed by dividing net income (loss) attributable to common
shareholders by the weighted average number of common shares outstanding during
the period. Diluted net loss per share reflects the potential dilution that
could occur if securities or other instruments to issue common stock were
exercised or converted into common stock. Potentially dilutive securities are
excluded from the computation of diluted net loss per share when their inclusion
would be antidilutive. A reconciliation between basic and diluted weighted
average shares outstanding is as follows:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
----------------- ----------------- ----------------- ----------------
Basic Weighted Average No. of 23,900,500 22,608,272 23,900,500 22,978,336
Shares Outstanding
Incremental Shares for Common Stock
Equivalents 1,680,763 467,240 1,676,673 827,628
----------------- ----------------- ----------------- ----------------
Total* 25,581,263 23,075,512 25,577,173 23,805,964
================= ================= ================= ================
* Since there was a loss attributable to common shareholders in the
three months ended September 30, 2002 and the nine months ended
September 30, 2003 and 2002 periods, the basic weighted average shares
outstanding were used in calculating diluted loss per share, as
inclusion of the incremental shares shown in this calculation would be
antidilutive. Potential common shares of 467,240 for the three months
ending September 30, 2002 and 1,676,673 and 827,628 for the nine months
ending September 30, 2003 and 2002 were excluded from the computation
of diluted earnings per share.
Stock Compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principals Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees", and comply with the disclosure
requirements of Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation" as amended by SFAS No. 148 "Accounting
for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB
Statement No. 123," issued in December 2002. Under APB Opinion No. 25,
compensation expense is based on the difference, if any, generally on the date
of grant, between the fair value of our stock and the exercise price of the
option. We account for equity instruments issued to non-employee vendors in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
("EITF") Issue No. 96-18, "Accounting for Equity Instruments That are Issued to
Other Than Employees from Acquiring, or in Conjunction with Selling, Goods and
Services". All transactions in which goods or services are the consideration
received for the issuance of equity instruments are accounted for based on the
fair value of the consideration received or the fair value of the equity
instrument issued, whichever is more reliably measurable. The measurement date
of the fair value of the equity instrument issued is the date on which the
counter party's performance is complete.
If the Company had elected to recognize compensation costs based on the fair
value at the date of grant for awards for the three and nine months ended
September 30, 2003 and 2002, consistent with the provisions of SFAS No. 123, the
Company's net income (loss) and basic and diluted net income (loss) per share
would have increased to the pro forma amounts indicated below:
Three months Three months Nine months Nine months
ended ended ended ended
September 30, September 30, September September 30,
2003 2002 30, 2003 2002
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Net income As reported $ 158,766 $ (1,357,152) $ (667,513) $ (4,626,332)
(loss)
Add back (Deduct): Stock based
employee compensation
determined under fair value
methods for all awards granted
since 1994 (inception) 41,746 (464,241) (135,761) (1,347,456)
------------------ ----------------- --------------- ----------------
Pro forma net $ 200,512 $ (1,357,152) $ (803,274) $ (5,973,788)
income (loss)
================== ================= =============== ================
Basic and diluted net income (loss) per share of
common stock
As reported $ 0.01 $ (0.06) $ (0.03) $ (0.20)
Pro forma $ 0.01 $ (0.06) $ (0.03) $ (0.26)
7
Foreign Currency Translation
The financial statements of the foreign subsidiaries were prepared in local
currency and translated into U.S. dollars based on the current exchange rate at
the end of the period for the balance sheet and a weighted-average rate for the
period on the statement of operations. Translation adjustments are reflected as
foreign currency translation adjustments in stockholders' equity and,
accordingly, have no effect on net loss. Transaction adjustments for the foreign
subsidiaries are included in income and are not material.
Income Taxes
Deferred income tax assets and liabilities are computed annually based on
enacted tax laws and rates for temporary differences between the financial
accounting and income tax bases of assets and liabilities. A valuation allowance
is established, when necessary, to reduce deferred income tax assets to the
amount that is more likely than not to be realized.
Warranty Costs
The Company estimates its warranty costs based on historical warranty claim
experience. Future costs for warranties applicable to sales recognized in the
current period are charged to cost of sales. The warranty accrual is reviewed
quarterly to reflect the remaining obligation. Adjustments are made when actual
warranty claim experience differs from estimates. The warranty accrual included
in other current liabilities as of September 30, 2003 and December 30, 2002
approximated $48,400.
NOTE 3 - RESTRICTED CASH:
The Company maintained a restricted cash balance in accordance with its Lease
Agreement for its former Piscataway, NJ facility. On March 17, 2003 the Lease
Agreement for the Piscataway, NJ facility was amended to apply $105,908 of the
remaining restricted cash balance of $125,700 towards the payment of the
outstanding rent obligations. The balance of $19,792 was added to the working
capital reducing the letter of credit to zero. On August 15, 2003 this lease was
terminated and the Company is not required under any agreements to maintain a
restricted cash balance.
NOTE 4 - INVENTORY:
Inventory, net of allowance for obsolescence of $326,981 and $720,772, at
September 30, 2003 and December 31, 2002, respectively, consists of the
following:
September 30, 2003 December 31, 2002
-------------------- -------------------
Raw materials 63,471 195,283
Work-in-progress 64,993 84,230
Finished goods 728,220 979,755
-------------------- -------------------
$ 856,684 $ 1,259,268
==================== ===================
NOTE 5 - COMPREHENSIVE INCOME:
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
130, "Reporting Comprehensive Income". The following table reflects the
reconciliation between net loss per the financial statements and comprehensive
loss.
Three Months Three Months Nine Months Ended Nine Months Ended
Ended September Ended September September 30, September 30, 2002
30, 2003 30, 2002 2003 (Unaudited)
(Unaudited) (Unaudited) (Unaudited)
------------------- ------------------ ------------------ --------------------
Net loss $ 158,766 $ (1,357,152) $ (667,513) $ (4,626,332)
Effect of foreign currency translation (796) (209) (905) (23,831)
------------------- ------------------ ------------------ --------------------
Comprehensive loss $ 157,970 $ (1,357,361) $ (668,418) $ (4,650,163)
=================== ================== ================== ====================
NOTE 6- NEW ACCOUNTING PRONOUNCEMENTS:
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation
of Variable Interest Entities," which addresses consolidation by business
enterprises of variable interest entities that either: (1) do not have
sufficient equity investment at risk to permit the entity to finance its
activities without additional subordinated financial support, or (2) the equity
investors lack an essential characteristic of a controlling financial interest.
FIN 46 requires disclosure of Variable Interest Entities (VIEs) in financial
statements issued after January 31, 2003, if it is reasonably possible that as
of the transition date: (1) the company will be the primary beneficiary of an
existing VIE that will require consolidation or, (2) the company will hold a
significant variable interest in, or have significant involvement with, an
existing VIE. The Company does not have any entities that require disclosure or
new consolidation as a result of adopting the provisions of FIN 46.
8
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity" ("SFAS No.
150"). SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. SFAS No. 150 requires that an issuer classify a financial instrument
that is within its scope as a liability (or an asset in some circumstances). The
requirements of this statement apply to issuers' classification and measurement
of freestanding financial instruments, including those that comprise more than
one option or forward contract. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The Company is in the process of assessing the impact of adopting SFAS No.
150 on its condensed consolidated results of operations, condensed consolidated
financial position or condensed consolidated cash flows. The adoption as SFAS
No. 150 did not have a material impact on the Company's financial statements.
NOTE 7 - RESTRUCTURING, ASSET IMPAIRMENTS AND OTHER CHARGES:
As a result of the Company being notified by the landlord to cancel its lease
effective August 15, 2003, the net book value of leasehold improvements
amounting to $28,955 were written-off. In addition, the Company was required to
sell property and equipment in order to move into its smaller newly leased
facility. At June 30, 2003 the Company recorded an impairment of $163,662 was
recorded which represents the difference between the cash proceeds of the August
2003 sale and carrying value prior to the impairment.
During the quarter ended June 30, 2003, the Company completed its liquidation of
its UK subsidiary. As a result of the liquidation, the Company reversed its
prior restructuring accrual of $508,458 related to the remaining long-term
lease, and other operating accruals of $294,704. These accruals were reflected
in the condensed consolidated statement of operations in the line items that
reflected the original charge.
During the quarter ended September 30,2003 the Company successfully negotiated a
settlement of a $243,071 open payable due to Xetel for a payment of $30,000 and
a forgiveness of debt in the amount of $213,071.
The components of the restructuring, asset impairments and other charges are as
follows:
Asset Impairment Restructuring Other Charges Total
First Quarter
2003 charges $ - $ 123,510 $ - $ 123,510
Second Quarter
2003 charges $ 192,617 $ (508,458) $ - $ (315,841)
Third Quarter
2003 charges $ - $ - $ (213,071) $ (213,071)
=================== ================== =============== =====================
Total $ 192,617 $ (384,948) $ (213,071) $ (405,402)
=================== ================== =============== =====================
The movement of the reserve, which related to lease termination costs, during
2003 were as follows:
----------------------------------------------------------- ----------------------------------
Balance at December 31, 2002 $ 508,458
----------------------------------------------------------- ----------------------------------
First quarter 2003 provision 123,510
----------------------------------------------------------- ----------------------------------
First quarter 2003 payments -
----------------------------------------------------------- ----------------------------------
Second quarter 2003 adjustment (508,458)
----------------------------------------------------------- ----------------------------------
Second quarter 2003 payments -
----------------------------------------------------------- ----------------------------------
Third quarter 2003 adjustment -
----------------------------------------------------------- ----------------------------------
Third quarter 2003 payments -
----------------------------------------------------------- ----------------------------------
Total $ 123,510
----------------------------------------------------------- ----------------------------------
The Company is in negotiations with the landlord from the Fremont, California
location for the disposition of the reserved amount of $123,510. The Company has
not occupied the space since approximately March 2003 and the successful outcome
of the negotiations cannot be assured, however, the Company is confident that
the amount should not exceed the reserved amount of $123,510.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
ION Networks, Inc. (the "Company"), designs, develops, manufactures and sells
infrastructure security and management products to corporations, service
providers and government agencies. The Company's hardware and software products
are designed to form a secure auditable portal to protect IT and network
infrastructure from internal and external security threats. ION's products
operate in the IP, data center, telecommunications and transport, and telephony
environments and are sold by a direct sales force and indirect channel partners
mainly throughout North America and Europe.
The Company is a Delaware corporation founded in 1999 through the combination of
two companies - MicroFrame ("MicroFrame"), a New Jersey Corporation (the
predecessor entity to the Company, originally founded in 1982), and SolCom
Systems Limited ("SolCom"), a Scottish corporation located in Livingston,
Scotland (originally founded in 1994). From the time of the merger in 1999
through the quarter ended December 31, 2001, the Company's principal objective
was to address the need for security and network management and monitoring
solutions, primarily for the PBX-based telecommunications market, resulting in a
significant portion of our revenues being generated from sales to various
telecommunications companies. During the quarter ended December 31, 2001, a new
management team joined the Company and evaluated ION's revenue and expenditures,
existing product suite, present customer base and evolving addressable market.
As a result of this evaluation, the Company refocused its product line from that
of network management monitoring to that of infrastructure security, which was
the original focus of MicroFrame prior to the merger with Solcom. We also added
significant network features to the product to broaden the scope of the
potential customer base, emphasizing infrastructure security. We identified
additional enterprise markets that extend beyond the telecommunications industry
and believe that successfully penetrating these additional markets could
positively impact revenue, although there can be no assurance that these efforts
will be successful. Despite these efforts, during the last two years, the
telecommunications industry has endured a significant economic downturn.
Telecommunications service providers have generally reduced capital spending and
staff, and, in some cases, sought bankruptcy protection and/or ceased
operations. Consequently, the spending cutback of these organizations has
affected the Company through reduced product orders. The decline in product
orders negatively impacted our revenues, resulting in significant operating
losses and negative cash flows.
As a result, it is imperative for us to be successful in increasing our revenue,
reducing costs, and/or securing additional funding in the future in order to
continue operating as a going concern. If we are not successful in raising
additional capital, or significantly improving operating results to generate
sufficient cash flows to meet our obligations as they come due, our financial
condition will be materially and adversely affected and the Company will not be
able to continue to operate as a going concern.
RESULTS OF OPERATIONS
For the three months ended September 30, 2003 compared to the same period in
2002
Net sales for the three months ended September 30, 2003, was $888,324 compared
to net sales of $1,522,336 for the same period in 2002, a decrease of $634,012
or 41.6%. The decrease in sales is attributable mainly to the reduction in the
number of units sold in the three-month period ended September 30, 2003. The
impact of the overall downturn in the information technology and
telecommunications industries compounded by the Company's weak financial
condition contributed to the Company's decline in sales for the quarter ended
September 30, 2003 compared to the same period last year.
Cost of sales for the three months ended September 30, 2003 was $214,535
compared to $557,564 for the same period in 2002. Cost of sales as a percentage
of net sales for the three months ended September 30, 2003 decreased to 24.2%
from 36.6% for the same period in 2002, resulting therefore in gross margins
increasing to 75.8% from 63.4% as compared to the prior year. The decrease in
cost of sales and the increase in gross margin is mainly due to lowering the
costs associated with manufacturing of the appliances, increase in the sales mix
of high margin repair and maintenance revenue and fewer large volume higher
discount sales orders.
Research and development expense, net of capitalized software development, for
the three months ended September 30, 2003 was $116,080 compared to $280,893 for
the same period in 2002 or a decrease of $164,813. The decrease is primarily
contributable to reduction in salaries due to lower headcount and pay cuts.
Selling, general and administrative expenses ("SG&A") for the three months ended
September 30, 2003 were $454,509 compared to $1,614,473 for the same period in
2002, a decrease of $1,159,964. The reduction is due to management's
implementation of cost saving strategies primarily in the areas of salary
reductions, selling expenses and overhead.
Restructuring for the three months ended September 30, 2003 resulted in a
favorable credit of $213,071 compared to an unfavorable charge of $154,370 in
the same period in 2002, or a benefit of $367,441 compared to the prior year.
The Company successfully negotiated a settlement of a $243,071 due to a vendor
for a payment of $30,000 and a forgiveness of debt in the amount of $213,071.
During the quarter ended September 30, 2002, the Company incurred restructuring
charges for severance and other related expenses in the amount of $154,370.
Depreciation and amortization expenses - amortization of capitalized software,
goodwill and other acquisition related intangibles, and depreciation of property
and equipment was $163,597 for the three months ended September 30, 2003
compared to $281,596 in the same period in 2002. The decrease was due to a
reduction of capitalized software and amortized goodwill and other intangibles
subject to amortization in the period as compared to the prior quarter.
Net income for the three months ended September 30, 2003 was $158,766 (loss from
operations of $54,305 offset by Xetel settlement of $213,071) compared to the
prior year loss of $1,357,152 (loss from operation of $1,212,190 increased by
restructuring charge of $154,370) for the same prior year period. This is
primarily due to the reduction of operating expenses and improved gross margin.
The improvement in net income was due primarily by the reduction of operating
expenses, improved gross margin and impact of restructuring charges offset in
part by decline in net sales.
For the nine months ended September 30, 2003 compared to the same period in 2002
Net sales for the nine months ended September 30, 2003, was $2,527,643 compared
to $4,558,665 for the same period in 2002, a decrease of $2,031,022 or 44.6%.
The decrease in sales is attributable mainly to the reduction in the number of
units sold in the nine month period ended September 30, 2003. The impact of the
overall downturn in the information technology and telecommunications industries
compounded by the Company's weak financial condition contributed to the
Company's decline in sales for the nine months ended September 30, 2003 compared
to the same period last year.
Cost of sales for the nine months ended September 30, 2003 was $689,374 compared
to $1,875,153 for the same period in 2002. Cost of sales as a percentage of net
sales for the nine months ended September 30, 2003 decreased to 27.3% from 41.1%
for the same period in 2002, and therefore gross margin increased to 72.7% from
58.9% as compared to the prior year. The decrease in cost of sales and the
increase in gross margin is mainly due to lowering the costs associated with
manufacturing of the appliances, increase in the sales mix of high margin repair
and maintenance revenue and fewer large volume higher discount sales orders.
Research and development expense, net of capitalized software development, for
the nine months ended September 30, 2003 was $377,834 compared to $687,318 for
the same period in 2002 or a decrease of $309,484 as compared to the comparable
period of the prior year. The decrease is primarily contributable to reduction
in salaries due to lower headcount and pay cuts.
Selling, general and administrative expenses ("SG&A") for the nine months ended
September 30, 2003 were $1,937,370 compared to $5,465,600 for the same period in
2002, a decrease of $3,528,230. The reduction is due to management's
implementation of cost saving strategies primarily in the areas of work force
reduction, pay cuts, selling expenses and other overhead items. SG&A expenses
for the nine months ended September 30, 2003 were favorably impacted by the
charging in 2002 and then subsequently reversing in 2003 of $294,704 related to
the liquidation of a foreign subsidiary.
Restructuring for the nine months ended September 30, 2003 was a credit of
$405,402 compared to a charge of $154,370 in the same period in 2002. During the
nine months ended September 30, 2003 the Company realized credits of $508,548
and $213,071 for benefits related to liquidation of foreign subsidiary and Xetel
accounts payable reduction, respectively. These credits were offset in part by
charges related to terminating a lease in California of $123,510 and impairment
of leasehold improvements for the Companies prior headquarter locations of
$192,617. During the same period last year the Company had charges totaling
$154,370 for severance and other related expenses.
Depreciation and amortization expenses - amortization of capitalized software,
goodwill and other acquisition related intangibles, and depreciation of property
and equipment - was $604,025 for the nine months ended September 30, 2003
compared to $1,002,863 in the same period in 2002. The decrease was due to a
reduction of capitalized software and amortized goodwill and other intangibles
subject to amortization in the period as compared to the prior year impacted by
reduction in headcount and pay cuts.
Net loss for the nine months ended September 30, 2003 was $667,513 ($1,683,746
less credit from liquidation of foreign subsidiary above in the amount of
$803,162 and $213,071) compared to a loss of $4,626,332 for the same period in
2002. The improvement in net income was due primarily by the reduction of
operating expenses, improved gross margin and impact of restructuring charges
offset in part by decline in net sales.
9
FINANCIAL CONDITION AND CAPITAL RESOURCES
Our condensed consolidated financial statements have been prepared on the basis
that we will continue as a going concern. At September 30, 2003, we had an
accumulated deficit of $43,390,459 and positive working capital of $104,197. We
also realized a net loss of $667,513 for the nine months ended September 30,
2003. We believe that our working capital as of September 30, 2003 should be
sufficient to fund the Company's operations beyond December 2003, an improvement
from the June 30, 2003 filing due to management implemented cost savings
measures and improved margins on sales, which has had the effect of extending
the Company's ability to meet its cash requirements beyond December 31, 2003.
The Company continues to experience a shortfall in the cash necessary to grow
inventory and further reduce indebtedness and expand operations. Management and
the board of directors are exploring various alternatives to secure funding
necessary to meet previously mentioned cash requirements. Based on the Company's
current financial position and future cash requirements, the Company will
consider all viable options. Any future operations are dependent upon the
Company's ability to obtain additional debt or equity financing, and its ability
to generate revenues sufficient to fund its operations. There can be no
assurances that the Company will be successful in it's attempts to generate
positive cash flows or raise sufficient capital essential to its survival. To
the extent that the Company is unable to generate or raise the necessary
operating capital it will become necessary to cease all operations.
11
Additionally, even if the Company does raise operating capital, there can be no
assurances that the net proceeds will be sufficient enough to enable it to
develop its business to a level where it will generate profits and positive cash
flows. These matters raise substantial doubt about the Company's ability to
continue as a going concern. However, the accompanying financial statements have
been prepared on a going concern basis, which contemplates the realization of
assets and satisfaction of liabilities in the normal course of business. The
financial statements do not include any adjustments relating to the recorded
assets or the classification of the liabilities that might be necessary should
the Company be unable to continue as a going concern.
Net cash used in operating activities during the nine months ended September 30,
2003 was $679,905 compared to net cash used during the same period in 2002 of
$3,469,597. The decrease in net cash used during the nine months ended September
30, 2003 compared to the same period in 2002, was primarily due to the reduction
in operating expenses and improved gross margins.
Net cash used in investing activities during the nine months ended September 30,
2003 was $28,842 compared to net cash used in during the same period in 2002 of
$192,863. This decrease was primarily due to a reduction in capitalized software
expenditures and restricted cash.
Net cash used from financing activities during the nine months ended September
30, 2003 was $66,918 compared to net cash generated during the same period in
2002 of $3,663,258,which included $3,475,592 for the proceeds from sales of
common stock.
Operating Lease commitments
The Company entered into a lease on July 21, 2003 for approximately 7,000 square
feet for its principal executive offices at 120 Corporate Blvd., South
Plainfield, New Jersey 07080. The Company moved its offices to this location on
August 6, 2003. The terms of the lease require payment of $162,180 in monthly
installments of $4,505 from October 1, 2003 to July 31, 2006. The Company is
also obligated to make additional payments to the landlord relating to certain
taxes and operating expenses.
Capital Leases
The Company leases certain equipment under agreements, which are classified as
capital leases. Each of the capital lease agreements expires within five years
and has purchase options at the end of the lease term. Future capital lease
payments as of September 30, 2003 are approximately $103,411.
SIGNIFICANT ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of operations
are based upon our condensed consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amount of assets and
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities at the date of our financial statements. Actual results may
differ from these estimates under different assumptions or conditions.
Significant accounting policies are defined as those that are reflective of
significant judgments and uncertainties, and potentially result in materially
different results under different assumptions and conditions. We believe that
our critical accounting policies are limited to those described below.
Revenue Recognition - The Company recognizes revenue from product sales to end
users, value-added resellers (VARs) and original equipment manufacturers (OEMs)
upon shipment if no significant vendor obligations exist and collectibility is
probable. We do not offer our customers the right to return products, however
the Company records warranty costs at the time revenue is recognized. Management
estimates the anticipated warranty costs but actual results could differ from
those estimates. Maintenance contracts are sold separately and maintenance
revenue is recognized on a straight-line basis over the period the service is
provided, generally one year.
Allowance for Doubtful Accounts Receivable - Accounts receivable are reduced by
an allowance to estimate the amount that will actually be collected from our
customers. Many of our customers have been adversely affected by economic
downturn in the telecommunications industry. If the financial condition of our
customers were to materially deteriorate, resulting in an impairment of their
ability to make payments, additional allowances could be required.
Inventory Obsolescence Reserves - Inventories are stated at the lower of cost
(average cost) or market. Reserves for slow moving and obsolete inventories are
provided based on historical experience and current product demand. If our
estimate of future demand is not correct or if our customers place significant
order cancellations, inventory reserves could increase from our estimate. We may
also receive orders for inventory that has been fully or partially reserved. To
the extent that the sale of reserved inventory has a material impact on our
financial results, we will appropriately disclose such effects. Our inventory
carrying costs are not material; thus we may not physically dispose of reserved
inventory immediately.
Impairment of Software Development and Purchased Software Costs - The Company
capitalizes computer software development costs in accordance with the
provisions of Statement of Financial Accounting Standards No. 86, "Accounting
for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed"
12
("SFAS 86"). SFAS 86 requires that the Company capitalize computer software
development costs upon the establishment of the technological feasibility of a
product, to the extent that such costs are expected to be recovered through
future sales of the product. Management is required to use professional judgment
in determining whether development costs meet the criteria for immediate expense
or capitalization. These costs are amortized by the greater of the amount
computed using (i) the ratio that current gross revenues from the sales of
software bear to the total of current and anticipated future gross revenues from
the sales of that software, or (ii) the straight-line method over the estimated
useful life of the product. As a result, the carrying amount of the capitalized
software costs may be reduced materially in the near term.
We record impairment losses on capitalized software and other long-lived assets
used in operations when events and circumstances indicate that the assets might
be impaired and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amount of those items. Our cash flow estimates
are based on historical results adjusted to reflect our best estimate of future
market and operating conditions. The net carrying value of assets not
recoverable is reduced to fair value. While we believe that our estimates of
future cash flows are reasonable, different assumptions regarding such cash
flows could materially affect our estimates.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation
of Variable Interest Entities," which addresses consolidation by business
enterprises of variable interest entities that either: (1) do not have
sufficient equity investment at risk to permit the entity to finance its
activities without additional subordinated financial support, or (2) the equity
investors lack an essential characteristic of a controlling financial interest.
FIN 46 requires disclosure of Variable Interest Entities (VIEs) in financial
statements issued after January 31, 2003, if it is reasonably possible that as
of the transition date: (1) the company will be the primary beneficiary of an
existing VIE that will require consolidation or, (2) the company will hold a
significant variable interest in, or have significant involvement with, an
existing VIE. The Company does not have any entities that require disclosure or
new consolidation as a result of adopting the provisions of FIN 46.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity" ("SFAS No.
150"). SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. SFAS No. 150 requires that an issuer classify a financial instrument
that is within its scope as a liability (or an asset in some circumstances). The
requirements of this statement apply to issuers' classification and measurement
of freestanding financial instruments, including those that comprise more than
one option or forward contract. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The adoption as SFAS No. 150 did not have a material impact on the
Company's financial statements.
13
ITEM 3. CONTROLS AND PROCEDURES.
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our Chief
Executive Officer and our Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on this
evaluation, our Chief Executive Officer and our Chief Financial Officer
concluded that our disclosure controls and procedures are effective in timely
alerting them to material information required to be included in this report.
There has been no change in our internal control over financial reporting that
occurred during our most recent fiscal quarter that has materially affected or
is reasonably likely to materially affect our internal control over financial
reporting.
14
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
MR. NORMAN E. CORN JOINED THE COMPANY ON AUGUST 16, 2003 AND ON SEPTEMBER 8,
2003 EXECUTED THE AMENDED AND RESTATED EMPLOYMENT AGREEMENT TO PERFORM THE
DUTIES OF CHIEF EXECUTIVE OFFICER.
MR. PATRICK E. DELANEY JOINED THE COMPANY ON SEPTEMBER 15, 2003 AND EXECUTED THE
EMPLOYMENT AGREEMENT TO PERFORM THE DUTIES OF CHIEF FINANCIAL OFFICER.
BOTH AGREEMENTS MAYBE TERMINATED WITHOUT NOTICE AND WITHOUT SEVERANCE
COMPENSATION AT THE DISCRETION OF EITHER PARTY.
15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
Exhibit
No. Description
------- -----------
10.20 Amended and Restated Employment Agreement dated September 8,
2003 by and between the Company and Norman E. Corn.*
10.21 Employment Agreement dated September 15, 2003 by and between
the Company and Patrick Delaney.*
31.1 Section 302 Certification of the Chief Executive Officer.*
31.2 Section 302 Certification of the Chief Financial Officer.*
32.1 Section 906 Certification of the Chief Executive Officer.*
32.2 Section 906 Certification of the Chief Financial Officer.*
* Filed herewith
(b) Reports on Form 8-K:
On May 16, 2003, the Company filed a report on Form 8-K reporting the issuance
of two press releases announcing the Company's financial results for the three
months ended March 31, 2003 and a transcript of the conference call hosted on
May 12, 2003 discussing such financial results.
On August 14, 2003, the Company filed a report on Form 8-k as follows: ION
Networks, Inc. is unable to complete and timely file its Form 10-QSB for the
quarterly period ended June 30, 2003 without unreasonable effort or expense. The
reasons for this delay include the recent departure of the Registrant's
President and Chief Executive Officer, and the departure of the Registrant's
Chief Operating Officer, both of which have increased the workload on existing
staff and disrupted the preparation of the financial statements and other
information necessary to completely and accurately prepare the Form 10-QSB.
On October 15, 2003, the Company filed a report on Form 8-k reporting effective
October 6, 2003, Deloitte and Touche, LLP ("D&T") and the Company agreed that D
& T would not continue as its principal accountants. On October 7, 2003, the
Company appointed Marcum & Kliegman, LLP as the Corporation's new principal
accountants for the fiscal year 2003 subject to their normal new client
acceptance procedures. Prior to its appointment, the Registrant did not consult
with Marcum & Kliegman, LLP regarding matters or events set forth in Items
(a)(2)(i) and (ii) of Regulation S-B of the Securities Exchange Act of 1934.
On November 3, 2003 the Company filed a report on Form 8-K/A amending the
October 15, 2003 Form 8-K filing for technical corrections, in response to SEC
comments. There was no substantive changes to the October 15, 2003 Form 8-k
filing.
16
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.
Date: November 14, 2003
ION NETWORKS, INC.
/s/ Norman E. Corn
------------------------------------------
Norman E. Corn, Chief Executive Officer
/s/ Patrick E. Delaney
------------------------------------------
Patrick E. Delaney, Chief Financial Officer
17
EXHIBIT INDEX
10.
Exhibit
No. Description
------- -----------
10.20 Amended and Restated Employment Agreement dated September 8,
2003 by and between the Company and Norman E. Corn.*
10.21 Employment Agreement dated September 15, 2003 by and between
the Company and Patrick Delaney.*
21.1 16.
31.1 Section 302 Certification of the Chief Executive Officer.*
31.2 Section 302 Certification of the Chief Financial Officer.*
32.1 Section 906 Certification of the Chief Executive Officer.*
32.2 Section 906 Certification of the Chief Financial Officer.*
* Filed herewith