10-Q 1 doc1.txt U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 2001 COMMISSION FILE NO. 1-13830 TELESOFT CORP. (Name of Registrant as specified in its charter) ARIZONA 86-0431009 (State of Incorporation) (IRS Employer Identification No.) 3443 NORTH CENTRAL AVENUE #1800 PHOENIX, ARIZONA 85012 (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (602) 308-2100 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 issuer was required to file such report), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) At October 5, 2001, the Registrant had outstanding 1,415,833 shares of common stock, no par value.

The Accompanying Notes are an Integral Part of the Consolidated Financial Statements. 3

The Accompanying Notes are an Integral Part of the Consolidated Financial Statements. 4

Supplemental disclosure of non-cash investing and financing activities: During the nine months ended August 31, 2001, the Company issued 130,000 shares of its common stock to Telesoft Recovery Corp. executives. This stock issuance was made in connection with their employment agreements in lieu of cash compensation in the amount of $145,031. The Accompanying Notes are an Integral Part of the Consolidated Financial Statements. 5

The Accompanying Notes are an Integral Part of the Consolidated Financial Statements. 6 TELESOFT CORP. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS For the nine month periods ended August 31, 2001 and 2000 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Basis of Presentation: The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for audited year-end financial statements. In the opinion of management, all adjustments consisting of recurring accruals considered necessary for a fair presentation have been included. Operating results for the three and nine months ended August 31, 2001 are not necessarily indicative of the results that may be expected for the year ending November 30, 2001. The unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company's Form 10-K for the year ended November 30, 2000. Principles of Consolidation The consolidated financial statements include the accounts of Telesoft Corp., together with its wholly owned subsidiaries, Telesoft Acquisition Corp and Telesoft Recovery Corp. All significant intercompany accounts and transactions have been eliminated. 2. INVESTMENT SECURITIES Amdocs Ltd. ("DOX") The Company accounted for its investment in DOX, which traded on the NYSE under the symbol DOX, as an available-for-sale equity security, which accordingly was carried at market value. During the nine months ended August 31, 2000, the Company sold all 7,434 DOX shares that it had held for $296,439. These shares were previously held as 20,000 shares of International Telecommunication Data Systems Inc. (ITDS). 3. STOCKHOLDERS' EQUITY Self-Tender Offer On February 3, 2000, the Company commenced an offer to repurchase up to 2.3 million shares of its common stock pursuant to a "Dutch auction" self-tender offer. On March 24, 2000, the tender expired. Pursuant to the tender offer the Company repurchased a total of 2.3 million shares of its common stock. The purchase price for the shares of common stock was $7.25 per share and the proration factor was 60.22 percent. The Company redeemed 1,938,816 common shares for $14,056,416 and 351,352 common stock options for $1,112,674. Included in the common shares redeemed were 1,031,663 shares of the Company's common stock redeemed from affiliates of the Company for an aggregate of approximately $7,480,000. Additionally, the Company repurchased all 293,750 shares of common stock owned by Joseph Zerbib for $2,129,688. As of August 31, 2001, affiliates of the Company owned 695,837 shares or 54.1% of the outstanding common stock of the Company. Expenses incurred related to the tender offer were $85,991. 7 TELESOFT CORP. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) For the nine month periods ended August 31, 2001 and 2000 3. STOCKHOLDERS' EQUITY (CONTINUED) Treasury Stock During the nine months ended August 31, 2001, the Company repurchased 90,995 shares of its common stock for $146,575. Common Stock During the nine months ended August 31, 2001, the Company issued 130,000 shares of its common stock to TRC executives. This stock issuance was made in connection with their employment agreements in lieu of cash compensation in the amount of $145,031. The Company has expensed the total amount of the stock issuance. Common Stock Options In February 2001, the Company granted 27,200 options to employees at an exercise price of $1.3125 per share, the fair market value of the underlying shares at the date of grant. 4. RELATED PARTY DEBT: In April 2000, three of the Company's executive officers entered into an agreement with the Company, pursuant to which each of them agreed to make available to the Company up to $1,000,000 on the Company's request. In May 2000, each of their agreements was amended to increase the amount to $1,350,000. Draw downs were payable on May 31, 2001 and had an annual interest rate of 10%. Each loan is secured by the Company's assets. This financing was completed in order to satisfy the terms of the Company's self-tender offer of its common stock completed in fiscal 2000. Pursuant to a second amendment to their respective agreements in April 2001, each of the officers agreed to extend $350,000 of their respective loans until August 31, 2001. Pursuant to a third amendment to their respective agreements in July 2001, each of the officers has agreed to extend their respective loans until November 30, 2001. During the nine months ended August 31, 2001 and 2000, interest expense in connection with these notes was $36,169 and $69,900, respectively. As of August 31, 2001, borrowings outstanding on the line of credit were $300,000. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED AUGUST 31, 2001 AND 2000 Revenues decreased by 7.4% to $15,385,857 for the nine months ended August 31, 2001 compared to $16,622,940 for the nine months ended August 31, 2000. The Company's revenue is derived from four principal product lines and services: STS Outsourcing Programs (STS), System Sales and Maintenance, Customized Billing Outsourcing Services and Recovery Services. STS Program revenues were $8,249,437 for the nine months ended August 31, 2001 compared to $10,517,725 for the nine months ended August 31, 2000, a 21.6% decrease. This decrease was primarily due to market pressure from competing long-distance communications products including pre-paid cards, other calling cards, wireless services and the Internet. During fiscal 2000, the Company adjusted to these market pressures by lowering its retail rates and renegotiating its wholesale rates with its suppliers. The impact of these new rates began during the fourth fiscal quarter (September-November, 2000), which represents the first three months of the 2000-2001 academic year. Revenues for the fourth quarter of fiscal 2000 were 23.2% lower than the fourth quarter of fiscal 1999. Historically, the calling patterns during September through November are indicative of calling patterns for the balance of the academic year. Based on this decline in revenue, the Company has reduced selling, general and administrative expenses, including a reduction in staff to adjust to the reduction in subscribers, traffic, and revenues. We expect to have additional 9 pressure on revenue in the 2001-2002 academic year, based on decreased long distance usage, and a decrease in customer base. Revenues from System Sales and Maintenance were $ 4,606,961 for the nine months ended August 31, 2001 compared to $4,540,000 for the nine months ended August 31, 2000. TelMaster sales and maintenance related revenues increased by $1,048,739, or 37.8%, to $3,823,969 for the nine months ended August 31, 2001 compared to $2,775,230 for the nine months ended August 31, 2000. The DCS product revenues declined 16.6%, or $148,208, to $746,620, due to a decrease in demand for its text-based software. The Company expects this trend to continue. RATEX revenues declined 95.8%, or $833,190, to $36,372 for the nine months ended August 31, 2001 compared to $869,562 for the nine months ended August 31, 2000. In December 2000, the Company completed the sale of the RATEX division. For the nine months ended August 31, 2001 and 2000, revenues from Customized Billing Services were approximately $733,000 and $730,000, respectively. Revenues from Recovery Services, which are generated through the Company's wholly-owned subsidiary, Telesoft Recovery Corp., increased 115.2%, or $961,822, to $1,796,853 for the nine months ended August 31, 2001 from $835,031 for the nine months ended August 31, 2000.

10 Total gross profit increased 3.9% or $319,502, to $8,453,146 for the nine months ended August 31, 2001 compared to $8,133,643 for the nine months ended August 31, 2000. Cost of goods sold was approximately 70.6% of STS revenues for the nine months ended August 31, 2001, compared with 72.6% for the nine months ended August 31, 2000. This decrease was primarily due to more favorable billing fee structures with the Company's university customers. The emphasis on more fixed fee structures positively contributed to the more moderate decrease in gross profits of 15.8% compared to the 21.6% decrease in revenues from this division. Cost of goods sold as a percentage of System Sales and Maintenance revenues were approximately 24% and 18% for the nine months ended August 31, 2001 and 2000, respectively. This increase was due to a higher proportion of professional services-related revenue. General and administrative expenses decreased by 13.3%, or $1,244,599, for the nine months ended August 31, 2001 to $8,140,523 from $9,385,122 for the nine months ended August 31, 2000. This decrease was primarily due to a human resources cost-cutting effort implemented by the Company during the last two fiscal quarters of 2000 and the first fiscal quarter of 2001. Also contributing to the decrease was the decrease in human resource costs resulting from the sale of the RATEX division. The gain on the sale of RATEX was largely offset by a charge taken for the issuance of common stock to the TRC executives in lieu of cash compensation under their employment agreements. RATEX related expenses for the first three-quarters of fiscal 2001 and 2000 were approximately $50,000 and $765,000, respectively. Recovery Services had operating expenses of $1,313,000 and $732,000 during the first three-quarters of fiscal 2001 and 2000, respectively. General and administrative expenses as a percentage of gross profit were 96.3% and 115.4% for the first three-quarters of fiscal 2001 and 2000, respectively. The Company expects general and administrative expenses as a percentage of gross profit to decrease over time as revenues for TelMaster systems and Recovery services increase. Other income and expense decreased to an expense of $5,005 for the first three-quarters of fiscal 2001 from income of $570,375 in the first three-quarters of fiscal 2000. This decrease was attributable to an approximate $306,000 decrease in pre-tax interest income in the first three-quarters of fiscal 2001 and a $145,189 pretax gain on the sale of investment securities in the first three-quarters of fiscal 2000. Interest expense for the nine months ended August 31, 2001 and 2000 was $38,786 and $82,378, respectively. Additionally, during the nine-months ended August 31, 2000, the Company realized a $168,782 return of premium on a key-person insurance policy. The provision for income taxes was $133,000 and a $282,700 benefit for the nine months ended August 31, 2001 and 2000, respectively. This represents 43.2% and 41.5% of income before provision for income taxes for 2001 and 2000, respectively. This percentage increase was partially attributable to decreased interest from tax-free investments as well as a lower percentage of tax-free interest included in pretax income. Net income increased to $174,568 for the first three-quarters of fiscal 2001 from a loss of $398,404 in the first three-quarters of fiscal 2000. This increase was attributable to an approximate $744,000 decrease in operating loss from the System Sales division, reflecting the impact of cost cutting measures, and improved results from the Recovery Services division, which had operating income of approximately $484,000 for the first three-quarters of fiscal 2001 compared to approximately $103,000 in the first three-quarters of fiscal 2000. These increases were offset by an approximate $575,000 decrease in other income from the first three-quarters of fiscal 2000 to the first three-quarters of fiscal 2001. 11

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED AUGUST 31, 2001 AND 2000 Revenues decreased by 8% to $2,867,114 for the three months ended August 31, 2001 compared to $3,115,844 for the three months ended August 31, 2000. The Company's revenue is derived from four principal product lines and services: STS Outsourcing Programs (STS), System Sales and Maintenance, Customized Billing Outsourcing Services and Recovery Services. STS Program revenues decreased 30.7% to $547,026 for the three months ended August 31, 2001 compared to $789,238 for the three months ended August 31, 2000. We expect this trend to continue throughout the balance of the 2001-2002 academic year. Revenues from System Sales and Maintenance were $1,404,814 for the three months ended August 31, 2001 compared to $1,677,177 for the three months ended August 31, 2000, a decrease of 16.2%. Revenues from TelMaster sales and maintenance were flat at $1,099,516 for the three months ended August 31, 2001 compared to $1,101,538 for the three months ended August 31, 2000. The change in TelMaster revenue mix from the third quarter of fiscal 2000 to the third quarter of fiscal 2001 included a $368,632 decrease in revenues from the development of a custom convergence billing, reporting and support system for Pacific Bell and MCI customer care services for the State of California's CALNET contract, which was terminated during the second quarter of 2001. 12 The DCS product revenues increased 7.7%, or $21,836, to $305,298. For the three months ended August 31, 2000, RATEX revenues were $292,177. In December 2000, the Company completed the sale of the RATEX division. For the three months ended August 31, 2001 and 2000, revenues from Customized Billing Services were approximately $285,000 and $246,000, respectively. Revenues from Recovery Services, which are generated through the Company's wholly-owned subsidiary, Telesoft Recovery Corp., increased 56.2%, or $226,725, to $630,015 for the three months ended August 31, 2001 from $403,290 for the three months ended August 31, 2000.

Total gross profit increased 2%, or $40,540, to $2,101,288 for the three months ended August 31, 2001 compared to $2,060,748 for the three months ended August 31, 2000. Cost of goods sold was approximately 88% of STS revenues for both the three months ended August 31, 2001 and the three months ended August 31, 2000. Cost of goods sold as a percentage of System Sales and Maintenance revenues were approximately 19.8% and 20% for the three months ended August 31, 2001 and 2000, respectively. General and administrative expenses decreased by 15%, or $466,654, for the three months ended August 31, 2001 to $2,646,081 from $3,112,735, for the three months ended August 31, 2000. This decrease was primarily due to a human resources cost cutting effort implemented during the last two fiscal quarters of 2000 and the first fiscal quarter of 2001. Also contributing to the decrease was the decrease in human resource costs resulting from the sale of the RATEX division. RATEX related expenses for the third quarter of fiscal 2000 were $232,000. Recovery Services had operating expenses of $489,000 and $272,000 during the third quarter of fiscal 2001 and 2000, respectively. General and administrative expenses as a percentage of gross profit were 125.9% and 151.1% for the third quarter of fiscal 2001 and 2000, respectively. The Company expects general and administrative expenses as a percentage of gross profit to decrease over time as revenues for TelMaster systems and Recovery services increase. Other income decreased to $899 for the third quarter of fiscal 2001 from $131,230 in the third quarter of fiscal 2000. Interest expense for the three months ended August 31, 2001 and 2000 was $10,036 and $44,908, respectively. Additionally, during the three-months ended August 31, 2000, the Company realized a $168,782 return of premium on a key-person insurance policy. The provision for income taxes was a benefit of $229,500 and $368,200 for the three months ended August 31, 2001 and 2000, respectively. This represents 42% and 40% of income before provision for income taxes for 2001 and 2000, respectively. For the third quarter of fiscal 2001, the Company realized a $314,394 net loss compared to a $552,557 net loss in the third quarter of fiscal 2000. 13 MATERIAL CHANGES IN FINANCIAL POSITION Accounts receivable decreased to $4,938,852 as of August 31, 2001 from $8,160,650 as of November 30, 2000 ($4,341,738 and $7,737,213, net of allowance for uncollectibles as of August 31, 2001 and November 30, 2000, respectively). This decrease was primarily due to normal seasonal decline in STS revenues. STS revenues were approximately $547,000 and $5,473,000 for the third quarter of 2001 and the fourth quarter of 2000, respectively. Accounts payable and accrued liabilities decreased to $3,366,952 as of August 31, 2001 from $5,199,187 as of November 30, 2000. As of August 31, 2000, there was $2,413,929 in accounts payable and accrued liabilities. This increase from August 31, 2001 to August 31, 2000 was partially attributable to an increase in customer deposits on TelMaster system sales. LIQUIDITY AND CAPITAL RESOURCES At August 31, 2001, the Company had cash and cash equivalents of $ 743,052. In April 2000, three of the Company's executive officers entered into an agreement with the Company, pursuant to which each of them agreed to make available to the Company up to $1,000,000 at the Company's request. In May 2000, each of their agreements was amended to increase the amount to $1,350,000. Draw downs were payable on May 31, 2001 and had an annual interest rate of 10%. Pursuant to a second amendment to their respective agreements in April 2001, each of the officers has agreed to extend $350,000 of their respective loans until August 31, 2001. Pursuant to a third amendment to their respective agreements in July 2001, each of the officers has agreed to extend their respective loans until November 30, 2001. As of August 31, 2001, the outstanding balance on the loans aggregated $300,000. The Company believes that cash flows from its business will allow it to service the interest payments the Company will incur on these loans. However, there can be no assurance that the Company will not require additional funding within this time frame. The Company may be required to raise additional funds through public or private financing, strategic relationships, or other arrangements. There can be no assurance that such additional funding, if needed, will be available on terms attractive to the Company, or at all. Furthermore, any additional equity financing may be dilutive to existing stockholders. SEASONALITY The Company generally completes the sale of the majority of STS Program system installations in the university market during the spring and early summer months. The implementation and installation of these systems and services typically occurs during the summer months. Revenues derived from STS Programs begin in the fall and weaken during winter holiday and the summer months when students are on vacation. As a result, the Company's revenues have consistently been highest during the second and fourth quarters. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. At November 30, 2000 and August 31, 2001, the Company had no derivative financial instruments, other financial instruments, or long-term debt obligations. 14 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is not involved as a party to any legal proceedings other than various claims and lawsuits arising in the normal course of its business, none of which, in the opinion of the Company's management, are individually or collectively material to the Company's business. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS During the nine months ended August 31, 2001, the Company made the following sales of unregistered securities:

ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 18, 2001, the Company held its annual meeting of shareholders, at which the Company's shareholders considered the election of directors. Shareholders voted to elect Joseph W. Zerbib, Michael F. Zerbib, Thierry E. Zerbib, Brian H. Loeb, Cecile Silverman, Kalvan Swanky and Todd Belfer to serve as directors for the ensuing year and until their successors are elected and qualified. 771,892 shares were voted and 1,057 shares were withheld for each director. 15 ITEM 5. OTHER INFORMATION In April 2000, three of the Company's executive officers entered into an agreement with the Company, pursuant to which each of them agreed to make available to the Company up to $1,000,000 on the Company's request. In May 2000, each of their agreements was amended to increase the amount to $1,350,000. Draw downs were payable on May 31, 2001 and had an annual interest rate of 10%. Each loan is secured by the Company's assets. This financing was completed in order to satisfy the terms of the Company's self-tender offer of its common stock completed in fiscal 2000. Pursuant to a second amendment to their respective agreements in April 2001, each of the officers has agreed to extend $350,000 of their respective loans until August 31, 2001. Pursuant to a third amendment to their respective agreements in July 2001, each of the officers has agreed to extend their respective loans until November 30, 2001. As of August 31, 2001, the outstanding balance on the loans aggregated $300,000. 16 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) NO. DESCRIPTION REFERENCE --- ----------- --------- 10.12 Form of Promissory Note between the Company and (1) each of Michael Zerbib, Thierry Zerbib and Brian Loeb, dated April 3, 2000 10.13 Form of Amendment to the Promissory Note dated (1) April 3, 2000 between the Company and each of Michael Zerbib, Thierry Zerbib and Brian Loeb, dated May 24, 2000 10.14 Form of Second Amendment to the Promissory Note (1) dated April 3, 2000, as amended on May 24, 2000, between the Company and each Michael Zerbib, Thierry Zerbib and Brian Loeb, dated April 9, 2001 10.15 Form of Third Amendment to the Promissory Note Filed herewith dated April 3, 2000, as amended on May 24, 2000 and April 9, 2001, between the Company and each Michael Zerbib, Thierry Zerbib and Brian Loeb, dated July 23, 2001 11 Earnings per common and common equivalent shares Filed herewith (1) Filed with Form 10-Q for the quarter ended February 28, 2001 (b) There were no reports on Form 8-K filed during the quarter ended August 31, 2001. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Issuer has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TELESOFT CORP. BY: /s/ Michael F. Zerbib ---------------------------------------- Michael F. Zerbib Chief Financial Officer DATED: October 5, 2001 17

TELESOFT CORP 10-Q