10-Q 1 form10q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended October 27, 2001 ---------------------------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transaction period from to ---------------- --------------------- Commission file number 0-17168 ----------------------- FASTCOMM COMMUNICATIONS CORPORATION ----------------------------------- (Exact name of registrant as specified in its charter) Virginia 54-1289115 --------------------------------- ---------------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation of Organization) Identification No.) 45472 Holiday Drive Dulles, Virginia 20166 -------------------------------------------------------------- (Address of principal executive offices, Zip code) (703) 318-7750 -------------------------------------------------------------- (Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No . --- --- As of December 7, 2001, there were 29,818,677 shares of the Common Stock, par value $.01 per share, of the registrant outstanding. No exhibits are filed with this report, which consists of 17 consecutively numbered pages. FASTCOMM COMMUNICATIONS CORPORATION FORM 10-Q TABLE OF CONTENTS PART I FINANCIAL INFORMATION Page No. -------- Item 1. Financial Statements Consolidated Statements of Operations Fiscal quarter and two fiscal quarters ended October 27, 2001 and October 28, 2000.........................................................3 Consolidated Balance Sheets October 27, 2001 and April 30, 2001...............................................................4 Consolidated Statements of Cash Flows Two fiscal quarters ended October 27, 2001 and October 28, 2000.............................................................5 Summary of Accounting Policies....................................................................6 Notes to Consolidated Financial Statements ....................................................7-9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................10-15 PART II OTHER INFORMATION Item 1. Legal Proceedings................................................................................16 SIGNATURES.........................................................................................................17

2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS FASTCOMM COMMUNICATIONS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) Fiscal quarter ended Two fiscal quarters ended ------------------------------- ------------------------------- October 27, October 28, October 27, October 28, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ Revenue $ 906,892 $ 4,200,675 $ 2,297,298 $ 7,848,608 Expenses Cost of sales 384,390 1,463,163 1,045,520 2,863,346 Selling, general and administrative 1,121,666 1,723,887 2,114,810 3,492,790 Research and development 673,904 1,493,615 1,331,020 2,805,038 Depreciation and amortization 958,346 1,019,171 1,916,729 1,955,828 Impairment of long-lived assets 5,600,000 -- 5,600,000 -- ------------ ------------ ------------ ------------ Loss from operations (7,831,414) (1,499,161) (9,710,781) (3,268,394) Other income (expense) Other income 19,698 100,263 19,698 101,896 Interest income -- 5,258 -- 12,038 Interest expense (185,986) (100,369) (352,877) (187,927) ------------ ------------ ------------ ------------ Net loss (7,997,702) (1,494,009) (10,043,960) $ (3,342,297) ------------ ------------ ------------ ------------ Dividend on prepaid warrants (46,482) (36,311) (92,957) (36,311) Net loss attributable to common shareholders $ (8,044,184) $ (1,530,320) $(10,136,917) $ (3,378,608) ============ ============ ============ ============ Basic and diluted loss per share $ (0.27) $ (0.06) $ (0.35) $ (0.13) Weighted average number of shares 29,647,690 26,416,001 29,375,663 26,221,596

See accompanying notes to unaudited consolidated financial statements 3 FASTCOMM COMMUNICATIONS CORPORATION CONSOLIDATED BALANCE SHEETS ASSETS October 27, April 30, 2001 2001 ------------ ------------ (unaudited) Current assets Cash and cash equivalents $ 2,326 $ 69,125 Accounts receivable, net 678,044 1,379,526 Inventories, net 2,231,122 2,759,284 Prepaid and other 369 13,628 ------------ ------------ 2,911,861 4,221,563 Property and equipment, net 735,329 1,147,594 Deferred investment advisory fee -- 120,172 Goodwill, net 1,610,988 8,714,070 Other assets 38,828 18,830 ------------ ------------ $ 5,297,006 $ 14,222,229 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Current portion of notes payable $ 1,000,000 $ 1,000,000 Accounts receivable financing loan 145,608 356,200 Current portion of capital lease obligations -- 1,519 Checks issued against future deposits -- 111,278 Accounts payable 2,299,756 3,074,381 Accrued compensation 287,043 978,011 Other current liabilities 1,513,165 1,556,283 ------------ ------------ 5,245,572 7,077,672 Convertible debentures 3,250,892 732,643 ------------ ------------ 8,496,464 7,810,315 ------------ ------------ Shareholders' equity Common stock, $.01 par value, 297,186 290,666 (50,000,000 shares authorized; 26,504,665 and 29,718,623 issued and outstanding) Additional paid in capital 49,238,676 48,812,608 Accumulated deficit (52,735,320) (42,691,360) ------------ ------------ Total shareholders' equity (3,199,458) 6,411,914 ------------ ------------ $ 5,297,006 $ 14,222,229 ============ ============

See accompanying notes to unaudited consolidated financial statements 4 FASTCOMM COMMUNICATIONS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Two fiscal quarters ended -------------------------------------- October 27, October 28, 2001 2000 ------------ ------------ Operating activities Net loss $(10,043,960) $ (3,342,297) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 1,916,729 1,955,828 Impairment of long-lived assets 5,600,000 -- Writeoffs of accounts receivable (1,007,287) (11,713) Provision for bad debt 164,657 -- Provision for inventory obsolescense 150,000 198,661 Non cash interest expense on convertible debentures 152,234 28,785 Amortization of deferred investment advisory fee 120,172 180,258 Changes in assets and liabilities Accounts receivable 1,544,112 (1,741,616) Inventories 378,162 (1,462,689) Prepaid and other current assets 13,259 (211,630) Other assets (19,998) (1,179) Accounts payable and accrued compensation (1,465,594) 647,657 Other current liabilities (244,514) (258,462) ------------ ------------ Net cash used in operating activities (2,742,028) (4,018,397) ------------ ------------ Investing activities Additions of property, plant and equipment (1,382) (127,892) Increase in acquisition costs -- (109,645) ------------ ------------ Net cash used in investing activities (1,382) (237,537) ------------ ------------ Financing activities Checks issued against future deposits (111,278) -- Net proceeds from the issuance of common stock -- 1,170,400 Net proceeds from the issuance of prepaid warrants -- 3,079,450 Net proceeds from issuance of convertible debenture 3,000,000 -- Net proceeds from exercise of warrants and options 361,521 Repayments on capital lease obligations (1,519) (9,847) Repayments of accounts receivable line of credit (210,592) (573,926) Increase in restricted cash -- (70,400) ------------ ------------ Net cash provided by financing activities 2,676,611 3,957,198 ------------ ------------ Net increase (decrease) in cash and cash equivalents (66,799) (298,736) Cash and cash equivalents, beginning of period 69,125 548,136 ------------ ------------ Cash and cash equivalents, end of period $ 2,326 $ 249,400 ============ ============

See accompanying notes to unaudited consolidated financial statements 5 FASTCOMM COMMUNICATIONS CORPORATION SUMMARY OF ACCOUNTING POLICIES USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain estimates used by management are particularly susceptible to significant changes in the economic environment. These include estimates of inventory obsolescence, valuation allowances for trade receivables and deferred tax assets and evaluation of the impairment of goodwill. Each of these estimates, as well as the related amounts reported in the financial statements, are sensitive to near term changes in the factors used to determine them. A significant change in any one of those factors could result in the determination of amounts different than those reported in the financial statements. Management believes that as of October 27, 2001, the estimates used in the financial statements are adequate based on the information currently available. REVENUE RECOGNITION Revenues from product sales are recognized at the time of product shipment. An allowance is provided for estimated sales returns and un-collectible accounts. Also, the Company establishes a reserve for estimated warranty claims at the time of product shipment. GOODWILL The Company has recorded goodwill based on the difference between the cost and the fair value of certain purchased assets and it is being amortized on a straight-line basis over the estimated period of benefit, which ranges from 4 to 7 years. The Company periodically evaluates the goodwill for possible impairment. The analysis consists of a comparison of future projected cash flows to the carrying value of the goodwill. Any excess goodwill would be written off due to impairment. ASSET IMPAIRMENT In accordance with Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be disposed of ("SFAS 121"), the Company periodically evaluates the carrying value of long-lived assets when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. RECENT ACCOUNTING PRONOUNCEMENT In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Accounting Standards No. 142, "Accounting for Goodwill" ("SFAS 142"). SFAS 142 establishes accounting standards for existing goodwill related to purchase business combinations. Under the Statement, the Company would discontinue the periodic amortization of goodwill effective with the adoption of the Statement. Also, the Company would have to test any remaining goodwill for possible impairment within the first six months of adopting the Statement based on new valuation criteria set forth in the Statement. Based on information available, the Company estimates that annual amortization expense will be reduced approximately $3,000,000 as the Company believes all goodwill will be written down or amortized to expense by April 30, 2002. The Statement becomes effective in fiscal 2003. 6 FASTCOMM COMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying interim consolidated financial statements of FastComm Communications Corporation (the "Company") have been prepared 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, although the Company believes that the disclosures made are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the consolidated financial statements and related footnotes included in the Company's latest Annual Report on Form 10-K. In the opinion of Management, the consolidated financial statements reflect all adjustments considered necessary for a fair presentation and all such adjustments are of a normal and recurring nature. The results of operations as presented in this report are not necessarily indicative of the results to be expected for the fiscal year ending April 30, 2002. The Company's fiscal year ends on April 30. For interim reporting purposes the interim fiscal quarters are closed on the first weekend following the calendar quarter end date, unless the quarter end date falls on a weekend, in which case such weekend is used as the interim fiscal quarter end. The fiscal quarters ended October 27, 2001 and October 28, 2000 each consisted of 91 calendar days. 2. EARNINGS (LOSS) PER SHARE Net income (loss) per common share is calculated using the weighted average number of shares of common stock outstanding and common share equivalents outstanding for the period. For the quarters presented, the earnings per share calculation does not include common share equivalents in that the inclusion of such equivalents would be antidilutive. 3. IMPAIRMENT OF LONG-LIVED ASSETS Net revenues generated by the Company's signaling product line declined from $5.6 million for the six months ended October 28, 2000 to $1.6 million for the six months ended October 27, 2001. Accordingly, the Company initiated a review for possible impairment of the related long-lived assets as required under generally accepted accounting principles. The Company evaluated the long-lived assets of its signaling product line, which consisted of goodwill associated with the acquisition of Cronus Technologies, for impairment in accordance with SFAS No, 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of." The review was based on future undiscounted cash flows. Based on this calculation, the Company recorded an impairment charge of $5,600,000 in the current fiscal quarter to reduce goodwill to its estimated net realizable value. 4. INVENTORIES Inventories are valued at the lower of cost or market and consist of the following: October 27, April 30, 2001 2001 -------------------------------- Production materials $ 1,499,534 $ 1,366,116 Work in process 360,430 487,209 Finished goods 371,158 905,959 ----------- ----------- $ 2,231,122 $ 2,759,284 =========== =========== 5. ACCOUNTS RECEIVABLE FINANCING AGREEMENT On February 6, 2001, the Company entered into an accounts receivable financing agreement with Alliance Financial Capital, Inc. Under the terms and conditions of this agreement, the Company can borrow up to the lesser of $3,000,000 or up to 85% of eligible accounts receivable, as defined in the agreement. The accounts receivable financing agreement bears interest at the prime rate plus 1.0% plus an additional 1.5% per invoice funded. The term of this agreement is for twelve months with a minimum average daily account balance of $750,000. 7 6. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF RISK The fiscal quarter ended October 27, 2001 includes sales of $236,000 to one unrelated third party that represented 26% of total revenues. The fiscal quarter ended October 28, 2000 includes sales of $1,142,000 and $518,000 representing 27% and 12% of total revenues to two unrelated third parties. 7. INCOME TAXES The Company has estimated its annual effective tax rate at 0% due to uncertainty over the level of earnings in fiscal 2002. Also, the Company has net operating loss carryforwards for income tax reporting purposes for which no income tax benefit has been recorded due to uncertainty over generation of future taxable income. 8. LONG TERM DEBT In May 2001, the Company raised $3,000,000 through the sale of a 10% senior secured convertible debenture to Wesley Clover Corporation. All or any portion of this Debenture may be converted into shares of common stock of the Company by dividing the aggregate principle amount converted together with all accrued but unpaid interest to the date of conversion by $0.446. The entire debenture plus accrued interest is due and payable in a single installment on June 8, 2006, unless sooner accelerated or converted into shares of common stock. In connection with this investment, the Company also issued warrants entitling Wesley Clover to purchase 3,363,229 shares of common stock of the Company for $0.5575 per share. The warrants expire on June 8, 2006 and may be called for redemption, by the Company, at such time as the bid price of the Company's shares of common stock remains above $1.12 for 30 (thirty) consecutive trading days. The Company valued the warrant component of this investment at $525,546 using the Black-Scholes valuation model, and accordingly, recorded this amount as a discount. This discount will be amortized into interest expense over the five year life of the warrants. Amortization charges to interest expense of $26,277 have been recorded in the current fiscal quarter. On a fiscal year to date basis, such charges total $43,795. 9. STOCK OPTIONS The Company has both qualified and non-qualified stock option plans (the "Plans") under which options to purchase up to 4,750,000 shares of common stock may be granted to officers, directors and other key employees of the Company. The exercise price of each option may not be less than 100% of the fair market value of the stock on the date of grant for incentive stock options or 85% of such fair market value for non-qualified stock options, as determined by the Board. Generally, options vest over a three year period and expire five years from the date of grant and, in most cases, upon termination of employment. The following table relates to options granted, exercised and cancelled during the six month period ended October 27, 2001: Number of Shares Price per share --------- --------------- Outstanding at April 30, 2001 3,783,765 $0.25 to $12.00 Granted during the period 432,000 $0.30 to $0.51 Cancelled during the period (595,634) $0.30 to $3.97 --------- Outstanding at October 27, 2001 3,620,131 $0.25 to $12.00 The Company has adopted the disclosure-only provisions of SFAS-No. 123 "Accounting for Stock Based Compensation", but applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock option plans. For SFAS No. 123 purposes, the weighted average fair value of each option granted during the quarter has been estimated as of the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: risk-free interest rate of 6.4%, expected volatility of 95%, expected option life of 5 years and dividend payout rate of zero. Using these assumptions, the weighted average fair value of the stock options granted is $0.28 for the quarter ended October 27, 2001. There were no adjustments made in calculating the fair value to account for vesting provisions or for non-transferability or risk of forfeiture. 8 If the Company had elected to recognize compensation cost based on the fair value at the grant dates for options issued under the plans described above, consistent with the method prescribed by SFAS No. 123, net loss applicable to common shareholders and loss per share would have been changed to the pro forma amounts indicated below: Six months ended Six months ended Net loss applicable to common shareholders: October 27, 2001 October 28, 2000 As reported $(10,136,917) $ (3,378,608) Proforma $(10,568,872) $ (4,169,072) Basic and diluted loss per share: As reported $ (0.35) $ (0.13) Proforma $ (0.36) $ (0.16)

As part of a program to retain its employees, the Company adopted a program to re-price the options of its current employees. The Company also re-priced the options issued to its board of directors and to its chairman of the board. Under the program, the exercise price of current stock options was changed to $0.51 per share. Although each employee could elect not to participate in this program, the exercise price of approximately 2.5 million options was changed to the lower price. Under applicable accounting rules, the Company will have to account for future variations in the price of its common stock above $0.51 per share as compensation expense until the re-priced options are either exercised, cancelled or expire. This calculation will be made each quarter based upon the performance of the Company's common stock in that quarter. Accordingly, operating results and earnings per share will be subjected to potentially significant fluctuations based upon changes in the market price of the Company's common stock. For the quarter and six months ended October 27, 2001, operating results and earnings per share were not impacted by this re-pricing because the price of the common stock at the end of both periods was below $0.51 per share. 10. RESTRUCTURING COSTS In fiscal year 2001, the Company commenced a broad restructuring aimed at achieving profitability and positive cash flow in its fiscal year 2002. Accordingly, in fiscal year 2001, the Company established a $618,000 liability for future cash expenditures associated with this restructuring. During the current fiscal year, the Company charged $195,000 against this liability. The Company anticipates that the remainder of this liability will be paid in the current fiscal year. 11. COMMITMENTS AND CONTINGENCIES A supplier of parts for the Company's integrated access device product line has filed an action against the Company. The Plaintiff seeks $96,581 for goods sold and delivered, $280,662 for goods allegedly manufactured but not yet delivered and $380,015 for parts allegedly ordered by Plaintiff to fulfill anticipated orders. The Company filed its answer to the complaint, is presently engaged in discovery and intends to vigorously defend this case. On January 29, 2001, two individuals holding subordinated senior notes totaling $1,000,000 commenced an action in the Circuit Court, Cook County, Illinois against the Company, Cronus, certain former principal shareholders of Cronus and a liquidating trust established by Cronus and its trustees seeking repayment of the notes, together with accrued interest. The Company settled the principal claims on November 30, 2001. The settlement will involve the liquidation of principal and interest over a six month period, which may be extended in certain circumstances and the issuance of warrants to purchase shares of the Company's common stock at a premium to current market price. Three remaining co-defendants in this lawsuit have filed cross-claims for indemnification against the Company. The Company has denied liability for indemnification in the circumstances of the lawsuit. The Company has filed answers, which include counterclaims, to each claim for indemnity. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FUTURE PROSPECTS RECENT FUNDING In May 2001, the Company raised $3,000,000 through the sale of a 10% senior secured convertible debenture ("Debenture") to Wesley Clover Corporation. All or any portion of this Debenture may be converted into shares of common stock of the Company by dividing the aggregate principle amount converted together with all accrued but unpaid interest to the date of conversion by $0.446. The entire debenture plus accrued interest is due and payable in a single installment on June 8, 2006, unless sooner accelerated or converted into shares of common stock of the Company. In connection with this investment, the Company also issued warrants entitling Wesley Clover to purchase 3,363,229 shares of common stock of the Company for $0.5575 per share. The warrants expire on June 8, 2006 and may be called for redemption, by the Company, at such time as the bid price of the Company's shares of common stock remains above $1.12 for 30 consecutive trading days. The Company valued the warrant component of this investment at $525,546 using the Black-Scholes valuation model, and accordingly, recorded this amount as a discount. This discount will be amortized into interest expense over the five year life of the warrants. Amortization charges to interest expense of $26,277 have been recorded in the current fiscal quarter. On a fiscal year to date basis, such charges total $43,795. When and if exercised, the unexercised warrants associated with this offering and other prior offerings and agreements would generate a maximum of $13,000,000 in additional cash for the Company. The Company can give no assurance as to whether any warrants will be exercised, nor to the amount of cash that will be generated, if any of these securities are exercised. SIGNALING OPPORTUNITIES In May 2001, FastComm announced the SignalPath Release 7 software which increases performance and system availability in its SignalPath Signaling Gateway product line. Release 7 software has more capacity and supports higher calling volumes which in turn means more revenues for carriers who use the Signaling Gateway product in their networks. This release lays the foundation for future products aimed at supporting large capacity switch vendors who are looking to replace entirely the circuit-switch technology used by incumbent telecom providers with packet networks. The potential market for such products is quite large, and worldwide revenues are expected to expand from approximately $700 million in 2001 to $7 billion in 2004 according to market research estimates. The competitive environment that exists in the telecommunications marketplace today dictates that the telecommunications carriers and Internet Service Providers must seek additional revenue sources. Voice over internet protocol (VoIP) offers unparalleled scalability, flexibility and economy. For this reason, telecommunications carriers are reselling carrier grade IP telephony services purchased from business to business outsource providers. A problem exists in that the VoIP vendors are often limited in terms of supporting traditional signaling protocols. The Company's SignalPath 230 Signaling Gateway resolves this issue by providing a new level of interoperability with global networks that employ protocols not directly supported by the VoIP network. Worldwide, VoIP networks carried less than 1% of the number of calls made during calendar year 2000, however it has been estimated that 40% of large corporations have some sort of VoIP testing underway. Based on this market data, the Company believes that VoIP will continue to offer revenue opportunities in the future. 10 PABX OPPORTUNITIES In June 2001, the Company introduced the R2 Adapter, a small low cost signaling appliance designed to enable PABX vendors to penetrate international markets where signaling conversion is required. Next generation IP based PABX's are software driven and far more flexible and cheaper to administer than traditional PABX's. According to an independent research report, the market for the IP based PABX's is significant and is expected to grow from $200 million today to $4 billion over the next four years. Currently, some PABX vendors, due to signaling incompatibilities, cannot sell IP based PABX's in parts of the world that employ an R2 signaling variant. The R2 Adapter resolves this incompatibility issue and opens large marketplaces that deploy R2, such as Latin America, the Middle East, Africa and parts of Southeast Asia, to these vendors. The IP/PABX vendors will generally sell one R2 Adapter for every IP based PABX sold. There is a very limited number of suppliers with competing products in the marketplace and accordingly, the Company anticipates future revenue from this product. RESTRUCTURING The Company commenced a broad restructuring aimed at achieving profitability and positive cash flow in its fiscal year 2002 by reducing costs and focusing on market opportunities which offer the greatest revenue potential. The Company has reduced its headcount from 103 to 50 fulltime employees and consolidated its two Virginia facilities into one. As a result of these and other cost saving activities, operating expenses have declined by more than $1 million per quarter. One time charges for these restructuring activities were reflected in the Company's operating results for its fourth fiscal quarter for the year ended April 30, 2001. The Company will require additional funding to meet future working capital needs and research and development expenses. It is anticipated that such funding will be generated by way of additional placements of convertible debt or equity, through investments made by strategic partners and through the exercise of in the money common stock warrants and options. The Company can give no assurance as to whether it will be able to conclude such financing arrangements, or that, if concluded, they will be on terms favorable to the Company. The Company has yet to achieve profitability or positive cash flow. There can be no assurance that the required increased sales and improved operating efficiencies necessary to return to profitability will materialize. As part of a program to retain its employees, the Company adopted a program to re-price the options of its current employees. The Company also re-priced the options issued to its board of directors and to its chairman of the board. Under the program, the exercise price of current stock options was changed to $0.51 per share. Although each employee could elect not to participate in this program, the exercise price of approximately 2.5 million options was changed to the lower price. Under applicable accounting rules, the Company will have to account for future variations in the price of its common stock above $0.51 per share as compensation expense until the re-priced options are either exercised, cancelled or expire. This calculation will be made each quarter based upon the performance of the Company's common stock in that quarter. Accordingly, operating results and earnings per share will be subjected to potentially significant fluctuations based upon changes in the market price of the Company's common stock. For the quarter and six months ended October 27, 2001, operating results and earnings per share were not impacted by this repricing because the price of the common stock at the end of both periods was below $0.51 per share. RESULTS OF OPERATIONS REVENUE Fiscal quarter ended Two fiscal quarters ended ---------------------------- ---------------------------- October 27, October 28, October 27, October 28, 2001 2000 2001 2000 ----------- ----------- ----------- ----------- $906,892 $4,200,675 $2,297,298 $7,848,608 Total revenues decreased $3,294,000 or 78%, compared with that of the corresponding quarter of the previous fiscal year and $5,551,000, or 71% on a fiscal year to date basis. This decrease is primarily attributable to a decline in unit sales of all of the Company's products associated with a global downturn in the demand for telecommunications equipment. 11 The fiscal quarter ended October 27, 2001 includes sales of $236,000 to one unrelated third party that represented 26% of total revenues. The fiscal quarter ended October 28, 2000 includes sales of $1,142,000 and $518,000 representing 27%, and 12% of total revenues to two unrelated third parties. A significant portion of the Company's sales are derived from products shipped against firm purchase orders received in each fiscal quarter and from products shipped against firm purchase orders released in that quarter. Unforeseen delays in product deliveries or the closing of sales, introduction of new products by the Company or its competitors, supply shortages, varying patterns of customer capital expenditures or other conditions affecting the digital access product industry or the economy during any fiscal quarter could cause quarterly revenue and net earnings to vary greatly. COST OF GOODS SOLD AND GROSS MARGIN Fiscal quarter ended Two fiscal quarters ended --------------------------- ---------------------------- October 27, October 28, October 27, October 28, 2001 2000 2001 2000 ----------- ------------ ----------- ----------- Cost of sales $ 384,390 $ 1,463,163 $ 1,045,520 $ 2,863,346 Gross margin 58% 65% 54% 64% Gross margin on product sales approximated 58% in the current fiscal quarter, compared to 65% recorded in the corresponding quarter of the previous fiscal year. On a fiscal year to date basis, gross margin on product sales approximated 54%. The Company increased its reserve for inventory obsolescence by $50,000 in the current fiscal quarter and by $150,000 on fiscal year to date basis. These reserve increases negatively impacted gross margins by 6% in the current fiscal quarter and by 7% on a fiscal year to date basis. The Company has a $750,000 reserve for inventory obsolescence, which management believes is adequate. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Fiscal quarter ended Two fiscal quarters ended --------------------------- ---------------------------- October 27, October 28, October 27, October 28, 2001 2000 2001 2000 ----------- ------------ ----------- ----------- $ 1,121,666 $ 1,723,887 $ 2,114,810 $ 3,492,790 Selling, general and administrative expenses decreased $602,000, or 35%, when compared with that of the corresponding quarter in the previous fiscal year and $1,378,000 or 39% on a fiscal year to date basis. In response to the downturn in demand for telecommunications equipment, the Company reduced headcount, cut back on travel and other discretionary expenses, and consolidated operating facilities. Accordingly, associated expenses declined significantly. RESEARCH AND DEVELOPMENT EXPENSES Fiscal quarter ended Two fiscal quarters ended --------------------------- ---------------------------- October 27, October 28, October 27, October 28, 2001 2000 2001 2000 ----------- ------------ ----------- ----------- $ 673,904 $ 1,493,615 $ 1,331,020 $ 2,805,038 Research and development expenditures consist primarily of hardware and software engineering personnel expenses, subcontracting costs, equipment, prototypes and facilities. These expenses decreased $820,000 or 55%, in the current quarter when compared with the corresponding quarter of the previous fiscal year and $1,474,000, or 53% on a fiscal year to date basis. This decrease in expenses is primarily attributable to the reductions in headcount, facility costs and discontinuance of the ChanlComm product line. 12 The markets for the Company's products are characterized by continuing technological change. The Company intends to continue to make substantial investments in product and technology development and believes that its future success depends significantly upon its ability to continue to enhance existing products and to develop or acquire new products that maintain the Company's technological competitiveness. Research and development project schedules for high technology products are inherently difficult to predict, and there can be no assurance that the Company will achieve its expected initial shipment dates of products in development. The timely availability of new and enhanced products is critical to the success of the Company. Delays in availability of these new products, or lack of market acceptance of such products, could adversely affect the Company. DEPRECIATION AND AMORTIZATION Fiscal quarter ended Two fiscal quarters ended --------------------------- ---------------------------- October 27, October 28, October 27, October 28, 2001 2000 2001 2000 ----------- ------------ ----------- ----------- $ 958,346 $ 1,019,171 $ 1,916,729 $ 1,955,828 Depreciation and amortization expenses are comparable on both a quarterly and fiscal year to date basis. IMPAIRMENT OF LONG-LIVED ASSETS Net revenues generated by the Company's signaling product line declined from $5.6 million for the six months ended October 28, 2000 to $1.6 million for the six months ended October 27, 2001. Accordingly, the Company initiated a review for possible impairment of the related long-lived assets as required under generally accepted accounting principles. The Company evaluated the long-lived assets of its signaling product line, which consisted of goodwill associated with the acquisition of Cronus Technologies, for impairment in accordance with SFAS No, 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of." The review was based on future undiscounted cash flows. Based on this calculation, the Company recorded an impairment charge of $5,600,000 in the current fiscal quarter to reduce goodwill to its estimated net realizable value. LIQUIDITY AND CAPITAL RESOURCES At October 27, 2001, the Company had a cash balance of $2,326. During the current fiscal quarter, working capital deficit increased from $820,000 at July 28, 2001 to $2.3 million at October 27, 2001. At October 27, 2001, the Company had a current ratio of 0.56 to one. As of the date of this report, the Company has $10,000 in cash and $150,000 in accounts receivable. The Company is in various stages of negotiation with several large potential customers as well as potential sources of financing. The Company can offer no assurance as to the outcome of these negotiations. MAY PRIVATE PLACEMENT In May 2001, the Company raised $3,000,000 through the sale of a 10% senior secured convertible debenture ("Debenture") to Wesley Clover Corporation. All or any portion of this Debenture may be converted into shares of common stock of the Company by dividing the aggregate principle amount converted together with all accrued but unpaid interest to the date of conversion by $0.446. The entire debenture plus accrued interest is due and payable in a single installment on June 8, 2006, unless sooner accelerated or converted into shares of common stock of the Company. In connection with this investment, the Company also issued warrants entitling Wesley Clover to purchase 3,363,229 shares of common stock of the Company for $0.5575 per share. The warrants expire on June 8, 2006 and may be called for redemption, by the Company, at such time as the bid price of the Company's shares of common stock remains above $1.12 for 30 consecutive trading days. The Company valued the warrant component of this investment at $525,546 using the Black-Scholes valuation model, and accordingly, recorded this amount as a discount. This discount will be amortized into interest expense over the five year life of the warrants. Amortization charges to interest expense of $26,277 have been recorded in the current fiscal quarter. On a fiscal year to date basis, such charges total $43,795. 13 UNEXERCISED WARRANTS When and if exercised, the unexercised warrants associated with this offering and other prior offerings and agreements would generate a maximum of $13,000,000 in additional cash for the Company. The Company can give no assurance as to whether any warrants will be exercised, nor to the amount of cash that will be generated, if any of these securities are exercised. ACCOUNTS RECEIVABLE FINANCING AGREEMENT On February 6, 2001, the Company entered into an accounts receivable financing agreement with Alliance Financial Capital, Inc. Under the terms and conditions of this agreement, the Company can borrow up to the lesser of $3,000,000 or 85% of eligible accounts receivable, as defined in the agreement. The accounts receivable financing agreement bears interest at prime rate plus 1.0% plus an additional 1.5% per invoice funded. The term of this agreement is for twelve months with a minimum average daily account balance of $750,000. In connection with the acquisition of Cronus, the Company assumed $1,000,000 in debt to two individuals, which is subordinated in priority and payment to all senior debt referenced above. This debt matured on December 10, 2000. The Company is currently in default on the repayment of this debt and the individuals have commenced a lawsuit against the Company. The Company is actively working to settle this matter. The Company will require additional funding to meet future expansion and research and development expenses. It is anticipated that such funding will be generated by way of additional placements of equity, through research and development arrangements funded by third parties, by investments by strategic partners and through the exercise of in the money common stock warrants and options. The Company can give no assurance as to whether it will be able to conclude such financing arrangements, or that, if concluded, they will be on terms favorable to the Company SIX MONTHS OF FISCAL 2002 COMPARED TO SIX MONTHS OF FISCAL 2001 The Company used $2,742,000 in cash from operations during the six months ended October 27, 2001 compared to $4,018,000 in cash used in operations during the corresponding period of the previous fiscal year. This $1,276,000 decrease is primarily attributable to an increase in funds generated from accounts receivable and reduced inventory purchases offset by an increase in the net loss for the period. Cash provided by financing activities is primarily attributable to the sale of a $3,000,000, 10% senior secured convertible debenture to Wesley Clover Corporation. RESTRUCTURING COSTS In fiscal year 2001, the Company commenced a broad restructuring aimed at achieving profitability and positive cash flow in its fiscal year 2002. Accordingly, in fiscal year 2001, the Company established a $618,000 liability for future cash expenditures associated with this restructuring. During the current fiscal year, the Company charged $195,000 against this liability. The Company anticipates that the remainder of this liability will be paid in the current fiscal year. INCOME TAXES The Company has estimated its annual effective tax rate at 0% due to uncertainty over the level of earnings in fiscal year 2002. Also, the Company has net operating loss carry-forwards for income tax reporting purposes for which no income tax benefit has been recorded due to uncertainty over generation of future taxable income. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Accounting Standards No. 142, "Accounting for Goodwill" ("SFAS 142"). SFAS 142 establishes accounting standards for existing goodwill related to purchase business combinations. Under the Statement, the Company would discontinue the periodic amortization of goodwill effective with the adoption of the Statement. Also, the Company would have to test any remaining goodwill for possible impairment within the first six months of adopting the Statement based on new valuation criteria set forth in the Statement. Based on information available, the Company estimates that annual amortization expense will be reduced approximately $3,000,000 as the Company believes all goodwill will be written down or amortized to expense by April 30, 2002. The Statement becomes effective in fiscal 2003. OTHER FACTORS THESE FINANCIAL STATEMENTS SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND RELATED FOOTNOTES INCLUDED IN THE COMPANY'S LATEST ANNUAL REPORT ON FORM 10-K. 14 THE COMPANY CONTINUES TO EXPERIENCE SEVERE CASH FLOW PROBLEMS RESULTING FROM REDUCED SALES AND SLOW COLLECTIONS. FURTHER, THE COMPANY'S INDEPENDENT AUDITORS HAVE INCLUDED A PARAGRAPH IN THEIR OPINION WHICH INDICATES THAT, BASED ON RECENT OPERATING LOSSES, ALONG WITH EXISTING WORKING CAPITAL AND ACCUMULATED DEFICITS, THERE IS SUBSTANTIAL DOUBT ABOUT THE COMPANY'S ABILITY TO CONTINUE AS A GOING CONCERN. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" IN THE COMPANY'S LATEST ANNUAL REPORT ON FORM 10-K CERTAIN PARTS OF THE FOREGOING DISCUSSION AND ANALYSIS MAY INCLUDE FORWARD-LOOKING STATEMENTS THAT INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES. AS A CONSEQUENCE, ACTUAL RESULTS MIGHT DIFFER MATERIALLY FROM RESULTS FORECAST OR SUGGESTED IN ANY FORWARD-LOOKING STATEMENTS. SEE "MARKETS FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS -- CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION" IN THE COMPANY'S LATEST ANNUAL REPORT ON FORM 10-K. 15 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS A supplier of parts for the Company's integrated access device product line has filed an action against the Company. The Plaintiff seeks $96,581 for goods sold and delivered, $280,662 for goods allegedly manufactured but not yet delivered and $380,015 for parts allegedly ordered by Plaintiff to fulfill anticipated orders. The Company filed its answer to the complaint, is presently engaged in discovery and intends to vigorously defend this case. On January 29, 2001, two individuals holding subordinated senior notes totaling $1,000,000 commenced an action in the Circuit Court, Cook County, Illinois against the Company, Cronus, certain former principal shareholders of Cronus and a liquidating trust established by Cronus and its trustees seeking repayment of the notes, together with accrued interest. The Company settled the principal claims on November 30, 2001. The settlement will involve the liquidation of principal and interest over a six month period, which may be extended in certain circumstances and the issuance of warrants to purchase shares of the Company's common stock at a premium to current market price. Three remaining co-defendants in this lawsuit have filed cross-claims for indemnification against the Company. The Company has denied liability for indemnification in the circumstances of the lawsuit. The Company has filed answers, which include counterclaims, to each claim for indemnity. No other material legal proceeding to which the Company is party or to which the Company is subject is pending and no such proceeding is known by the Company to be contemplated. 16 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed by the undersigned thereunto duly authorized. FASTCOMM COMMUNICATIONS CORPORATION (Registrant) Date: December 11, 2001 By: /s/ Peter C. Madsen Peter C. Madsen ---------------------- President, Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer) Date: December 11, 2001 By: /s/ Mark H. Rafferty Mark H. Rafferty ---------------------- Vice President, Chief Financial Officer Treasurer, Secretary and Director (Principal Financial and Accounting Officer) 17

FASTCOMM COMMUNICATIONS CORP 10-Q