**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,DC   20549**

 

**FORM 10-Q**

 
| **ý** | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|------------|----------------------------------------------------------------------------------------------|
|       |                                                                                         |
|       | **For the quarterly period ended June  30, 2002**                                            |

 

**or**

 
| **o** | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**CommissionFile Number 0-12194**

 

**FORTEL INC.**

(Exact name of Registrantas specified in its charter)

 

| **California**                                                                     |   | **94-2566313**                        |
|------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)                   |   | (I.R.S. Employer  Identification No.) |
|                                                                               |   |                                  |
| **46832  Lakeview Blvd.  Fremont, California**                                     |   | **94538-6543**                        |
| (Address of principal  executive offices)                                          |   | (Zip Code)                            |
|                                                                               |   |                                  |
| Registrant’s telephone number, including area  code:  **(510) 440-9600** |

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or such shorter period that the Registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.    Yes  o   No  ý

 

The number of shares of the Registrant’s Common Stock outstanding as ofAugust 8, 2002 was 30,624,087.

 

 

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FORTEL INC. ANDSUBSIDIARIES

 

INDEX

 
| PART I.                                                                                                            | Financial Information                                                                       |
|--------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|
|                                                                                                               |                                                                                        |
| Item 1.                                                                                                            | Financial Statements                                                                        |
|                                                                                                               |                                                                                        |
| Condensed  Consolidated Balance Sheets (unaudited) - June 30, 2002 and September 30,  2001                         |
|                                                                                                               |                                                                                        |
| Condensed  Consolidated Statements of Operations (unaudited) - Three and Nine Months  Ended June 30, 2002 and 2001 |
|                                                                                                               |                                                                                        |
| Condensed  Consolidated Statements of Cash Flows (unaudited) - Nine Months Ended June  30, 2002 and 2001           |
|                                                                                                               |                                                                                        |
| Notes  to Condensed Consolidated Financial Statements (unaudited)                                                  |
|                                                                                                               |                                                                                        |
|                                                                                                               |                                                                                        |
| Item  2.                                                                                                           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                                                                                                               |                                                                                        |
|                                                                                                               |                                                                                        |
| Item  3.                                                                                                           | Quantitative  and Qualitative Disclosures about Market Risk                                 |
|                                                                                                               |                                                                                        |
| PART II.                                                                                                           | Other information                                                                           |
|                                                                                                               |                                                                                        |
| Item 6.                                                                                                            | Exhibits and  Reports on Form 8-K                                                           |

 

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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

FORTEL INC. ANDSUBSIDIARIES

CONDENSED CONSOLIDATEDBALANCE SHEETS (unaudited)

($000’s)

 
|                                              |   | **June 30,  2002** |   | **September  30,  2001** |   |
|---------------------------------------------------|--------|--------------------|--------|--------------------------|--------|
| Assets                                            |   |               |   |                     |   |
| Current assets:                                   |   |               |   |                     |   |
| Cash and cash  equivalents                        |   | $                  | 324    |                     | $      | 769 |   |
| Accounts  receivable, net                         |   | 4,264              |   | 2,031                    |   |
| Other current  assets                             |   | 387                |   | 778                      |   |
| Total current  assets                             |   | 4,975              |   | 3,578                    |   |
|                                              |   |               |   |                     |   |
| Fixed assets,  net                                |   | 289                |   | 515                      |   |
| Other assets,  net                                |   | 569                |   | 1,115                    |   |
| Total assets                                      |   | $                  | 5,833  |                     | $      | 5,208 |   |
|                                              |   |               |   |                     |   |
| Liabilities and  Shareholders’ Deficit       |   |               |   |                     |   |
| Current  liabilities:                             |   |               |   |                     |   |
| Accounts payable                                  |   | $                  | 3,779  |                     | $      | 3,657 |   |
| Accrued  liabilities                              |   | 6,973              |   | 5,022                    |   |
| Short-term debt                                   |   | 349                |   | 206                      |   |
| Deferred revenue                                  |   | 3,847              |   | 2,634                    |   |
| Total current  liabilities                        |   | 14,948             |   | 11,519                   |   |
|                                              |   |               |   |                     |   |
| Deferred revenue  - long-term                     |   | 801                |   | —                   |   |
| Total  liabilities                                |   | 15,749             |   | 11,519                   |   |
| Shareholders’  deficit:                      |   |               |   |                     |   |
| Common stock                                      |   | 79,565             |   | 79,544                   |   |
| Accumulated deficit                               |   | (89,481            | )      | (85,855                  | )      |
| Total  shareholders’ deficit                 |   | (9,916             | )      | (6,311                   | )      |
| Total  liabilities and shareholders’ deficit |   | $                  | 5,833  |                     | $      | 5,208 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

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FORTEL INC. ANDSUBSIDIARIES

CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS

(unaudited)

(In thousands except pershare data)

 
|                                                                 |   | **Three  Months Ended  June 30,** |   | **Nine  Months Ended  June 30,** |   |
|----------------------------------------------------------------------|--------|-----------------------------------|--------|----------------------------------|--------|
|                                                                 |   | **2002**                          |   | **2001**                         |   | **2002** |   | **2001** |   |
|                                                                 |   |                              |   |                             |   |   |   |   |   |
| Net product  sales                                                   |   | $                                 | 2,689  |                             | $      | 1,631 |   | $ | 4,547 |   | $ | 5,907 |   |
| Services and  other                                                  |   | 1,429                             |   | 1,822                            |   | 4,949 |   | 6,063 |   |
| Net sales                                                            |   | 4,118                             |   | 3,453                            |   | 9,496 |   | 11,970 |   |
| Costs and  expenses:                                                 |   |                              |   |                             |   |   |   |   |   |
| Cost of products  sold                                               |   | 121                               |   | 125                              |   | 338 |   | 437 |   |
| Cost of services  and other                                          |   | 630                               |   | 789                              |   | 2,149 |   | 2,711 |   |
| Research and  development expenses                                   |   | 604                               |   | 840                              |   | 2,129 |   | 2,876 |   |
| Selling, general  and administrative expenses                        |   | 2,396                             |   | 3,309                            |   | 7,753 |   | 11,085 |   |
| Impairment of  goodwill                                              |   | —                            |   | 945                              |   | — |   | 945 |   |
| Operating income  (loss)                                             |   | 367                               |   | (2,555                           | )      | (2,873 | ) | (6,084 | ) |
|                                                                 |   |                              |   |                             |   |   |   |   |   |
| Other expense,  net                                                  |   | 205                               |   | 36                               |   | 638 |   | 129 |   |
| Income (loss)  before income taxes                                   |   | 162                               |   | (2,591                           | )      | (3,511 | ) | (6,213 | ) |
| Provision for  income taxes                                          |   | —                            |   | —                           |   | 115 |   | — |   |
| Net income  (loss)                                                   |   | $                                 | 162    |                             | $      | (2,591 | ) | $ | (3,626 | ) | $ | (6,213 | ) |
|                                                                 |   |                              |   |                             |   |   |   |   |   |
| Basic income  (loss) per share                                       |   | $                                 | .01    |                             | $      | (.09 | ) | $ | (.12 | ) | $ | (.21 | ) |
|                                                                 |   |                              |   |                             |   |   |   |   |   |
| Number of shares  used in basic income (loss) per share calculations |   | 30,624                            |   | 30,226                           |   | 30,603 |   | 29,791 |   |
|                                                                 |   |                              |   |                             |   |   |   |   |   |
| Diluted income  (loss) per share                                     |   | $                                 | .01    |                             | $      | (.09 | ) | $ | (.12 | ) | $ | (.21 | ) |
|                                                                 |   |                              |   |                             |   |   |   |   |   |
| Shares used in  diluted income (loss) per share calculation          |   | 31,054                            |   | 30,226                           |   | 30,603 |   | 29,791 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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FORTEL INC. ANDSUBSIDIARIES

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS

($000’s)

(unaudited)

 
|                                                                         |   | **Nine  Months EndedJune 30,** |   |
|------------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                         |   | **2002**                       |   | **2001** |   |
|                                                                         |   |                           |   |   |   |
| Cash flows from  operating activities:                                       |   |                           |   |   |   |
| Net loss                                                                     |   | $                              | (3,626 | ) | $ | (6,213 | )  |
| Adjustments to  reconcile net loss to net cash used in operating activities: |   |                           |   |   |   |
| Impairment of  goodwill                                                      |   | —                         |   | 945 |   |
| Depreciation and  amortization                                               |   | 885                            |   | 1,342 |   |
| Provision for  doubtful accounts                                             |   | 26                             |   | 131 |   |
| Stock-based  compensation to consultants                                     |   | 21                             |   | 13 |   |
| Change in  operating assets and liabilities:                                 |   |                           |   |   |   |
| Increase in  accounts receivable                                             |   | (2,259                         | )      | (73 | ) |
| Decrease in  refundable income taxes                                         |   | —                         |   | 119 |   |
| Decrease in  other current assets                                            |   | 300                            |   | 191 |   |
| Increase in  accounts payable                                                |   | 122                            |   | 1,451 |   |
| Increase  (decrease) in accrued liabilities                                  |   | 1,951                          |   | (29 | ) |
| Increase in  deferred revenue                                                |   | 2,014                          |   | 880 |   |
| Net cash used in  operating activities                                       |   | (566                           | )      | (1,243 | ) |
|                                                                         |   |                           |   |   |   |
| Cash flows from  investing activities:                                       |   |                           |   |   |   |
| Acquisition of  fixed assets                                                 |   | (22                            | )      | (37 | ) |
| Proceeds from  disposal of fixed assets                                      |   | —                         |   | 44 |   |
|                                                                         |   |                           |   |   |   |
| Net cash (used  in) provided by investing activities                         |   | (22                            | )      | 7 |   |
|                                                                              |        |                                |        |  |  |  |  |

 

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|                                                  |   | **Nine  Months EndedJune 30,** |   |
|-------------------------------------------------------|--------|--------------------------------|--------|
|                                                  |   | **2002**                       |   | **2001** |   |
|                                                  |   |                           |   |   |   |
| Cash flows from  financing activities:                |   |                           |   |   |   |
| Proceeds from  borrowings under factor line of credit |   | $                              | 1,760  |   | $ | 3,996 |   |
| Repayment of  borrowings under factor line of credit  |   | (1,617                         | )      | (3,235 | ) |
| Issuance of  common stock                             |   | —                         |   | 63 |   |
| Net cash  provided by financing activities            |   | 143                            |   | 824 |   |
| Net decrease in  cash and cash equivalents            |   | (445                           | )      | (412 | ) |
| Cash and cash  equivalents, beginning of period       |   | 769                            |   | 889 |   |
|                                                  |   |                           |   |   |   |
| Cash and cash  equivalents, end of period             |   | $                              | 324    |   | $ | 477 |   |
|                                                  |   |                           |   |   |   |
| Supplemental  cash flow information:                  |   |                           |   |   |   |
| Interest paid                                         |   | $                              | 42     |   | $ | 125 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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FORTEL INC. ANDSUBSIDIARIES

 

NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

 

(unaudited)

(Amounts in thousandsexcept per share data)

 

1.             General

FORTEL Inc. (“FORTEL” orthe “Company”) is an information technology company specializing in computerand systems optimization, data correlation and search technology.  FORTEL acquires, develops and marketseBusiness performance management solutions. Product offerings include multi-platform performance analysis andautomatic correlation software used to optimize performance in eBusinessinfrastructure systems, and professional services for existing and newcustomers.  FORTEL’s SightLine andpredecessor ViewPoint suites of software have been sold to customers in financeand banking, defense management, manufacturing, retail services and government.

 

2.             Basis of Presentation

The accompanyingcondensed consolidated financial statements include the accounts of FORTEL Inc.and all wholly-owned domestic and foreign subsidiaries.  All material intercompany balances andtransactions have been eliminated.  Theinterim condensed consolidated financial statements have been prepared by theCompany, without audit, pursuant to the rules and regulations of the Securitiesand Exchange Commission (“SEC”) and should be read in conjunction with theaudited financial statements contained in the Company’s annual report on Form10-K/A for the fiscal year ended September 30, 2001.  Certain information and footnote disclosures, normally includedin financial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America, have been condensed oromitted although the Company believes the disclosures which are made areadequate to make the information presented not misleading.  Further, the condensed consolidated financialstatements reflect, in the opinion of management, all adjustments, consistingof normal recurring adjustments, necessary to present fairly the financialposition and results of operations as of and for the periods indicated.  The results of operations for the periodended June 30, 2002 are not necessarily indicative of the results expected forthe full year.

 

The Company’s condensedconsolidated financial statements have been prepared using accountingprinciples generally accepted in the United States of America applicable to agoing concern, which contemplates the realization of assets and liquidations of

 

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liabilities in the normal course of business.  The Company has incurred significant lossesfrom operations for at least the past five fiscal years.  The Company also has significantpayroll-related taxes that have not been paid to the appropriate taxauthorities (see Note 5).  The Companycontinues to experience negative cash flows from operations and has beendependent on credit facilities to sustain its activities.  These significant losses and the low levelof cash available do not currently enable the Company to satisfy all orsubstantially all of its obligations to third parties.  The Company is currently evaluating certainstrategic alternatives which include implementing a cost savings program,selling the Company, and reorganizing the Company and seeking protection underthe Federal Bankruptcy Code.  Thesefactors raise substantial doubt about the Company’s ability to continue as a goingconcern.  The consolidated financialstatements do not include any adjustment that might result from the outcome ofthis uncertainty.

 

Certain amounts whichwere presented in the financial statements as of September 30, 2001, werereclassified to conform with current fiscal year financial statementpresentation.

 

3.             RecentAccounting Pronouncements

In June 2002, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards (“SFAS”) No. 146,“Accounting for Exit or Disposal Activities’”. SFAS 146 addresses significant issues regarding the recognition,measurement, and reporting of costs that are associated with exit and disposalactivities, including restructuring activities that are currently accounted forunder Emerging Issues Task Force (“EITF”) No. 94-3, “Liability Recognition for Certain Employee Termination Benefits andOther Costs to Exit an Activity (including Certain Costs Incurred in aRestructuring).”  The scope of SFAS 146also includes costs related to terminating a contract that is not a capitallease and termination benefits that employees who are involuntarily terminatedreceive under the terms of a one-time benefit arrangement that is not anongoing benefit arrangement or an individual deferred-compensationcontract.  SFAS 146 will be effectivefor exit or disposal activities that are initiated after December 31, 2002 andearly application is encouraged. The Company will adopt SFAS 146 during the second fiscal quarter endingMarch 31, 2003.  The provisions of EITFNo. 94-3 shall continue to apply for an exit activity initiated under an exitplan that met the criteria of EITF No. 94-3 prior to the adoption of SFAS146.  The effect on adoption of SFAS 146will change on a prospective basis the timing of when restructuring charges arerecorded from a commitment date approach to when the liability is incurred.

 

InOctober 2001, the FASB issued SFAS No. 144, “Accounting for Impairment or Disposal of Long-LivedAssets”.  SFAS No. 144 

 

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supersedes SFAS No. 121,“Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assetsto Be Disposed Of”, and addresses financial accounting and reporting for theimpairment or disposal of long-lived assets. Additionally, SFAS No. 144 expands the scope of discontinued operationsto include all components of an entity with operations that (1) can bedistinguished from the rest of the entity and (2) will be eliminated from theongoing operations of the entity in a disposal transaction.  SFAS No. 144 is effective for financialstatements issued for fiscal years beginning after December 15, 2001 and itsprovisions are to be applied prospectively. The Company is currently assessing the impact of SFAS No. 144 on its consolidatedresults of operations and financial position.

 

In July 2001, the FASB issued SFAS No. 141,“Business Combinations”, and No. 142, “Goodwill and Other IntangibleAssets”.  SFAS No. 141 requires allbusiness combinations initiated after June 30, 2001 to be accounted for usingthe purchase method.  Under SFAS No.142, goodwill and intangible assets with indefinite lives are no longeramortized but are reviewed annually (or more frequently if impairment indicatorsarise) for impairment.  Separable intangibleassets that are not deemed to have indefinite lives will continue to beamortized over their useful lives (but with no maximum life).  The amortization provisions of SFAS No. 142apply to goodwill and intangible assets acquired after June 30, 2001.  With respect to goodwill and intangibleassets acquired prior to July 1, 2001, the Company is required to adopt SFASNo. 142 effective October 1, 2002.  TheCompany believes that the impact of SFAS No. 142 on the consolidated financialposition and results of operations will not be material.

 

4.             OtherAssets

Other assets consist ofthe following as of:

 
|                                    |   | **June 30,2002** |   | **September  30,2001** |   |
|-----------------------------------------|--------|------------------|--------|------------------------|--------|
| Purchased  technology                   |   | $                | 2,588  |                   | $      | 2,588 |   |
| Deferred  software implementation costs |   | 351              |   | 351                    |   |
| Purchased  software                     |   | 550              |   | 550                    |   |
| Capitalized  development projects       |   | 1,454            |   | 1,454                  |   |
| Other assets                            |   | 257              |   | 166                    |   |
| Less:  accumulated amortization         |   | (4,631           | )      | (3,994                 | )      |
|                                    |   | $                | 569    |                   | $      | 1,115 |   |

 

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5.             SignificantWithholding and Payroll Tax Liabilities

Prior to June 30, 2002,the Company has failed to file and pay certain required state and federalpayroll and withholding taxes of approximately $1,160 to the appropriate taxingauthorities.  Currently, the Company does not have sufficient funds to satisfy theseobligations.  The Company has estimatedapproximately $520 for penalties and interest on the unpaid payroll-relatedtaxes as of June 30, 2002, out of which $128 relates to penalties and interestfor the quarter ended June 30, 2002, resulting in an estimated total liabilityof $1,680 for payroll and withholding taxes and penalties and interest on theunpaid payroll-related taxes.  Inaddition, the Company, its officers, certain employees and directorsmight be subject to civil and criminal enforcement actions.  TheCompany intends to negotiate and establish a payment plan with the taxingauthorities and to pay such taxes, penalties and interests as soon as itreceives sufficient funds.  There can beno assurance that such a payment plan will be accepted by the taxingauthorities or that any plan proposed by the taxing authorities will befinancially feasible for the Company. Should the Company be unable to negotiate a feasible payment plan allowingthe Company to pay these liabilities, the Company would be unable to satisfysuch obligations, in which case the Company would cease as a going concern.  As of June 30, 2002, these significantpayroll-related tax liabilities were included in accrued liabilities.

 

6.             CreditFacility

As of June 30, 2002, theCompany had a $3,000 accounts receivable revolving line of credit.  Borrowings are based on 80% of certaineligible receivables which are aged 90 days or less.  The interest rate approximates 18% per annum calculated on theaverage daily balance outstanding. Additionally, there is an administrative fee of 1/2 of one percent ofeach amount factored.  Advances againstthe revolving line of credit are subject to lender approval and arecollateralized by a security interest in all of the Company’s assets includingcopyrights, trademarks and intellectual property.  The credit facility has no maturity; however, either party mayterminate at any time.  The Company wasin violation of a covenant whereby the Company’s liabilities must not exceedits total assets.  There were nosanctions posed on the Company as result of this violation, however, as aresult of this violation, any and all future borrowings are subject toindividual approvals before any advances of funds.  During the nine months ended June 30, 2002, the Company hadborrowed approximately $1,760 and repaid approximately $1,617 under this creditfacility.  At June 30, 2002, there were$149 borrowings outstanding against the accounts receivable revolving line ofcredit.

 

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7.             CommonStock

Common stock activity forthe period from October 1, 2001 through June 30, 2002 is as follows:

 
|                                                         |   | **Common  StockShares** |   | **Common  StockAmount** |   |
|--------------------------------------------------------------|--------|-------------------------|--------|-------------------------|--------|
| Balance at  September 30, 2001                               |   | 30,387                  |   | $                       | 79,544 |   |
| Issuance of common  stock under repricing warrants agreement |   | 234                     |   | —                  |   |
| Exercise of  stock options                                   |   | 3                       |   | —                  |   |
| Stock-based  compensation                                    |   | —                  |   | 21                      |   |
| Balance at June  30, 2002                                    |   | 30,624                  |   | $                       | 79,565 |   |

 

In July 2000, theCompany, through a private placement, issued 2,192 shares of common stock totwo institutional investors, Deephaven Private Placement Trading Ltd. and HarpInvestors LLC (the “Investors”), in exchange for $5,000.  This private placement was pursuant to theSecurities Purchase Agreement, Registration Rights Agreement and RepricingWarrants (collectively the “Agreements”). Proceeds of $4,727, net of placement agency and professional fees of$273, were received.  Pursuant to theterms of the Agreements, the Investors have the right to demand additionalwarrants to purchase shares of common stock from the Company in the event themarket price of the Company’s stock falls below $2.28 per share.  During the nine-month period ended June 30,2002, the Company issued 234 shares of common stock in partial satisfaction ofthe repricing rights.  The Company hasregistered 5,341 shares of common stock of which 3,693 shares had been issuedas of June 30, 2002.

 

On November 6, 2000, theCompany entered into a letter agreement with the Investors to modify theAgreements to replace the redemption feature with specified liquidated damagesas a remedy for certain breaches of and defaults under the Agreements. Themodification of the Agreements gives the Investors the right to demandliquidating damages of up to $6,000 should certain events be breached by theCompany.  On July 25, 2001, the Companyreceived demand letters from the Investors demanding liquidated damages uponvarious defaults under the Agreements, all dated July 18, 2000 and as subsequentlyamended on November 6, 2000, in the aggregate amount of $1,400 due to (1) theCompany’s delisting from The Nasdaq SmallCap Market effective May 16, 2001, (2)its failure to register additional securities and (3) its failure to authorizeadditional securities.  To date, thedefaults have not been remedied, nor has the demand for payment been satisfiedby the Company, and as such, based on the provisions of the Agreements assubsequently amended, the liquidated damages, as demanded, have increased to$3,000 as of June 30, 2002.  In 

 

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addition, interest of approximately$521 has been accrued as of June 30, 2002 on the unpaid liquidateddamages.  The unpaid liquidated damagesand the related accrued interest thereon are recorded in accrued liabilities.  The Company does not currently have thecapabilities to satisfy these demands and, therefore, will continue to incurinterest charges at the rate of 18% per annum on the unpaid liquidated damages.

 

OnFebruary 12, 2002, the Company received election notices to exercise all 1,980fully vested warrants from the Investors with respect to the exercise ofRepricing Warrants for an aggregate of 65,062 shares of Common Stock.  Harp Investors LLC notified FORTEL of itsexercise notice and demanded the issuance of a stock certificate for 16,673shares of Common Stock in connection with their 507 fully vested andexercisable warrants.  Deephaven PrivatePlacement Trading, Ltd. notified FORTEL of its exercise notice and demanded theissuance of a stock certificate for 48,389 shares of Common Stock in connectionwith their 1,473 fully vested and exercisable warrants.  The total number of authorized shares ofCommon Stock is 40,000 as of June 30, 2002 and 30,624 shares of Common Stockare issued and outstanding.  The Companyis not in a position to fully satisfy these exercise requests as the number ofshares demanded exceeds the number of authorized and unissued shares of CommonStock, therefore the Company has not issued any shares of Common Stock pursuantof these exercise notices.  If issued,these shares would increase our outstanding common stock by over 300%.  The Investors have confirmed that thisrequest does not trigger any additional liquidating damages.

 

Repricing of Options

 

InOctober 2001, the Company’s Board of Directors authorized the repricing ofoptions to purchase 859 shares of common stock to $0.04 per share, whichrepresented the market value on the date of the repricing.  These options will be subject to variableplan accounting, as defined in FASB Interpretation No. 44 (FIN 44)"Accounting for Certain Transactions involving Stock Compensation aninterpretation of APB Opinion No. 25", and the Company will remeasure theintrinsic value of the repriced options (the excess of fair market value overthe exercise price), through the earlier of the date of exercise, cancellationor expiration, at each reporting date. As of June 30, 2002, the Company has recognized a compensation expenseof approximately $21 related to the repriced options.

 

8.             EarningsPer Share (“EPS”)

A reconciliation of thenumerator and denominator of basic and diluted EPS is provided as follows forthe three and nine months ended June 30, 2002 and 2001:

 

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|                               |   | **Three  Months Ended  June 30,** |   | **Nine  Months Ended  June 30,** |   |
|------------------------------------|--------|-----------------------------------|--------|----------------------------------|--------|
|                               |   | **2002**                          |   | **2001**                         |   | **2002** |   | **2001** |   |
|                               |   | **(unaudited)**                   |   | **(unaudited)**                  |   |
|                               |   |                              |   |                             |   |   |   |   |   |
| Numerator -  Basic and Diluted EPS |   |                              |   |                             |   |   |   |   |   |
| Net income  (loss)                 |   | $                                 | 162    |                             | $      | (2,591 | ) | $ | (3,626 | )  | $ | (6,213 | ) |
|                               |   |                              |   |                             |   |   |   |   |   |
| Denominator -  Basic EPS           |   |                              |   |                             |   |   |   |   |   |
| Common stock  outstanding          |   | 30,624                            |   | 30,226                           |   | 30,603 |   | 29,791 |   |
| Basic income  (loss) per share     |   | $                                 | .01    |                             | $      | (.09 | )  | $ | (.12 | )  | $ | (.21 | ) |
|                               |   |                              |   |                             |   |   |   |   |   |
| Denominator -  Diluted EPS         |   |                              |   |                             |   |   |   |   |   |
| Denominator -  Basic EPS           |   | 30,624                            |   | 30,226                           |   | 30,603 |   | 29,791 |   |
| Effect of  Dilutive Securities:    |   |                              |   |                             |   |   |   |   |   |
| Common stock  options              |   | 430                               |   | —                           |   | — |   | — |   |
|                               |   | 31,054                            |   | 30,226                           |   | 30,603 |   | 29,791 |   |
|                               |   |                              |   |                             |   |   |   |   |   |
| Diluted income  (loss) per share   |   | $                                 | .01    |                             | $      | (.09 | )  | $ | (.12 | )  | $ | (.21 | ) |

 

The EPS calculation does not include any effect of theexercise note received on February 12, 2002 (See Note 7 for furtherdiscussion).  Since the underlyingwarrants are now expired there is also no effect on the diluted EPS calculationfor the three months ended June 30, 2002.

 

For the three- andnine-month periods ended June 30, 2002, stock options to purchase 1,396 and1,666 shares of common stock, respectively, and warrants to purchase 225 and2,205 shares of common stock, respectively, were not included in thecomputation of diluted EPS because of the anti-dilutive effect of includingthese shares in the calculation for both periods.  For the three- and nine-month periods ended June 30, 2001, stockoptions to purchase 3,232 and 3,066 shares of common stock, respectively, andwarrants to purchase 2,210 and 2,210 shares of common stock, respectively, werenot included in the computation of diluted EPS because of the anti-dilutiveeffect of including these shares in the calculation for both periods.

 

9.             SegmentInformation

The Company currentlyoperates in one business segment.  Thetable below presents net sales by geographic area for the three- and nine-monthperiods ended June 30:

 
|   |   | **Three  Months Ended  June 30,** |   | **Nine  Months Ended  June 30,** |   |
|--------|--------|-----------------------------------|--------|----------------------------------|--------|
|   |   | **2002**                          |   | **2001**                         |   | **2002** |   | **2001** |   |
| U.S.   |   | $                                 | 1,848  |                             | $      | 1,733 |   | $ | 5,197 |   | $ | 6,669 |   |
| Europe |   | 2,205                             |   | 1,580                            |   | 4,003 |   | 5,051 |   |
| Other  |   | 65                                |   | 140                              |   | 296 |   | 250 |   |
| Total  |   | $                                 | 4,118  |                             | $      | 3,453 |   | $ | 9,496 |   | $ | 11,970 |   |

 

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The table below presentslong-lived asset information by geographic area:

 
|                |   | **June30,  2002** |   | **September  30,  2001** |   |
|---------------------|--------|-------------------|--------|--------------------------|--------|
| Long-lived  assets: |   |              |   |                     |   |
| U.S.                |   | $                 | 582    |                     | $      | 1,389 |   |
| International       |   | 276               |   | 241                      |   |
| Total               |   | $                 | 858    |                     | $      | 1,630 |   |

 

10.           Relatedparty transactions

During the fiscal yearended September 30, 2001, certain directors and officers of the Company madeloans to the Company.  These loans bearinterest at 18% per annum and are payable 90 days from receipt of thefunds.  These loans were recorded asshort-term debt.  To date, the Companyis in default as there has been no payments made on the principal nor on therelated interest.  As the note holdersare officers and directors of the Company and are aware of the Company’scurrent financial condition, they have not made any demands for payment of suchloans.  At June 30, 2002, included inshort-term debt is $200 in amounts owing to such directors and officers.  Accrued interest on these loans ofapproximately $36 is included in accrued liabilities.

 

11.           Comprehensiveincome (loss)

Comprehensive income(loss), as defined, includes all charges in equity (net assets) during a periodfrom non-owner sources.  There were nomaterial differences between comprehensive income (loss) and and net income(loss) as reported for each of the periods presented in these condensed financialstatements.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations

 

(Amounts in thousandsexcept per share data)

 

This report contains forward-looking statements that are not historicalfacts but rather are based on current expectations, estimates, projections,beliefs and assumptions about our industry, our company, our business andprospects.  Words such as “anticipates”,“expects”, “intends”, “plans”, “believes”, 

 

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“seeks”, “estimates” and variations of these words and similarexpressions are intended to identify forward-looking statements.  These statements are not guarantees offuture performance and are subject to certain risks, uncertainties and other factors,some of which are beyond our control, are difficult to predict and could causeactual results to differ materially from those expressed or forecasted in theforward-looking statements.  These risksand uncertainties include those described in “Risks Associated With FORTEL’sBusiness and Future Operating Results”, “Management’s Discussion and Analysisof Financial Condition and Results of Operations” and elsewhere in thisreport.  Readers are cautioned not to placeundue reliance on these forward-looking statements, which reflect ourmanagement’s view only as of the date of this report.  We undertake no obligation to update these statements or publiclyrelease the results of any revisions to the forward-looking statements that wemay make to reflect events or circumstances after the date of this report or toreflect the occurrence of unanticipated events.

 

References in this document to “FORTEL”, “we”, “our”, and “us” refer toFORTEL Inc., a California corporation, its predecessors, and each of its subsidiaries.

 

FORTEL and SightLine are trademarks of FORTEL Inc.  Zitel, Datametrics and ViewPoint areregistered trademarks of FORTEL Inc.  All other service marks, trademarksand registered trademarks are the property of their respective holders.

 

CriticalAccounting Policy

 

Inpreparing our consolidated financial statements, our critical accounting policyis revenue recognition.

 

We deriveour revenue from primarily two sources (i) software licenses and (ii) servicesand support revenue which includes software license maintenance, training andconsulting revenue.  As described below,significant management judgments and estimates must be made and used inconnection with the revenue recognized in any accounting period.  Material differences may result in theamount and timing of our revenue for any period if our management madedifferent judgments or utilized different estimates.

 

Wegenerally license our software products on a one-year time basis or on aperpetual basis.

 

We applythe provisions of Statement of Position 97-2 (“SOP 97-2”), “Software RevenueRecognition”, as amended by Statement of Position 98-9, “Modification of SOP97-2, Software Revenue 

 

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Recognition,With Respect to Certain Transactions” to all transactions involving the sale ofsoftware products.

 

Werecognize revenue from the sale of software licenses when persuasive evidenceof an arrangement exists, the product has been delivered, the fee is fixed anddeterminable and collection of the resulting receivable is reasonablyassured.  Delivery generally occurs whenproduct is delivered to a common carrier. In instances where delivery is electronic, the product is considereddelivered when the customer either takes possession by downloading the softwareor the access code to download the software has been provided to thecustomer.  Payments received in advanceof revenue recognition are recorded as deferred revenues.

 

At thetime of the transaction, we assess whether the fee associated with our revenuetransactions is fixed and determinable and whether or not collection isreasonably assured.  We assess whetherthe fee is fixed and determinable based on the payment terms associated withthe transaction.  If a significantportion of a fee is due after our normal payment terms, which are 30 to 45 daysfrom invoice date, we account for the fee as not being fixed anddeterminable.  In these cases, werecognize revenue as the fees become due.

 

We assesscollection based on a number of factors, including past transaction historywith the customer and the credit-worthiness of the customer.  We do not request collateral from ourcustomers.  If we determine thatcollection of a fee is not reasonably assured, we defer the fee and recognizerevenue at the time collection becomes reasonably assured, which is generallyupon receipt of cash.

 

For allsales, we use either a binding purchase order or signed license agreement asevidence of an arrangement.  Salesthrough our distributors are evidenced by a master agreement governing therelationship together with binding purchase orders on a transaction bytransaction basis.

 

Forarrangements with multiple obligations (for example, undelivered maintenanceand support), we allocate revenue to each component of the arrangement usingthe residual value method based on the fair value of the undelivered elements,which is specific to FORTEL.  This meansthat we defer revenue from the arrangement fee equivalent to the fair value ofthe undelivered elements.  Fair values forthe ongoing maintenance and support obligations are based upon separate salesof renewals to other customers or upon renewal rates quoted in thecontracts.  Fair value of services, suchas training or consulting, is based upon separate sales by us of these servicesto other customers.

 

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Ourarrangements do not generally include acceptance clauses.  However, if an arrangement includes anacceptance provision, acceptance occurs upon the earlier of receipt of awritten customer acceptance or expiration of the acceptance period.

 

We recognize revenue for maintenance services ratably over the contractterm.  Our training and consultingservices are billed based on hourly rates, and we generally recognize revenueas these services are performed. However, at the time of entering into a transaction, we assess whetheror not any services included within the arrangement require us to performsignificant work either to alter the underlying software or to build additionalcomplex interfaces so that the software performs as the customer requests.  If these services are included as part of anarrangement, we recognize the entire fee using the percentage of completionmethod.  We estimate the percentage ofcompletion based on our estimate of the total costs estimated to complete theproject as a percentage of the costs incurred to date and the estimated coststo complete.

 

Results of Operations

 

The Company recorded net income of $162 ($0.01 per share) for thefiscal 2002 third quarter, compared with a net loss of $2,591 ($0.09 per share)for the same quarter of the prior year. For the nine-month period ended June 30, 2002, net loss was $3,626 ($.12per share) compared with a net loss of $6,213 ($0.21 per share) for the sameperiod a year earlier.

 

Total net sales for the current quarter were $4,118 versus total netsales of $3,453 for the same period a year earlier, an increase of $665 due toan increase in license sales.  For thenine-month period ended June 30, 2002, total net sales were $9,496 compared tototal net sales of $11,970 for the same period a year earlier.  The decrease in net sales is primarilyattributable to a decrease in license sales and a decrease in maintenancerevenues.

 

Gross margin for the quarter endedJune 30, 2002 was 82%of net sales compared to 74%of net sales for the same quarter of the prior year.  The increase in gross margin percentage is a result of higherlicense sales, which have higher gross margins.  For the nine months ended June 30, 2002 and June 30, 2001, grossmargin was 74% of netsales.  The Company does not believethat the gross margins reported for the current quarter just ended arenecessarily indicative of the gross margins to be expected in future quarters.  Gross margins may be affected by severalfactors, including the mix of products sold and price competition.

 

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Research and development expensesfor the quarter ended June 30, 2002 were 15% of net sales compared to 24% for the same quarter of the prioryear.  For the nine months ended June30, 2002, research and development expenses were 22% of net sales compared to 24% of net sales for the same period ayear earlier.  Actual spending decreased$236 and $747 for the quarter and nine-monthperiod, respectively, from prior year periods. The result is primarily attributable to a decrease in headcount andrelated expenses.

 

Selling, general and administrative(“SG&A”) expenses for the quarter ended June 30, 2002 were 58% of net salesversus 96% ofnet sales for the same period a year earlier. Actual spending decreased $913 from the prior year period. For the nine months ended June 30, 2002, SG&A expenses were 82% of net sales compared to 93% of net sales for the same period ayear earlier.  Actual spending decreased$3,332 from the prioryear period.  The decreased spending inboth periods is primarily attributable to a reduction in marketing and salespersonnel.  In addition, in the quarterended June 30, 2001, included in SG&A was a charge of approximately $220related to the reduction in workforce.

 

Other expense was $205 for the quarter just ended versus $36 in the same quarter of the prioryear.  For the nine-month period endedJune 30, 2002, other expense were $638 versus $129for the same period a year earlier. Other expense consisted primarily of interest expense.  The increase in other expense in bothperiods is primarily attributable to the interest accrued on the unpaidliquidated damages to the private placement investors.

 

# **Liquidity and Capital Resources**

 

Since fiscal year 1997, in additionto the working capital provided by product sales, the Company has augmented itscash needs to finance operations primarily through the issuance of convertiblesubordinated notes, the private sale of common stock and proceeds fromborrowings against the accounts receivable revolving line of credit.

 

During the nine-month periods endedJune 30, 2002 and 2001, working capital decreased $2,032 and $3,843, respectively.  Cash flows used in operating activities were$566 for the ninemonths ended June 30, 2002 and cash flows used in operating activities were $1,243 for the same period a yearearlier.  For the nine months ended June30, 2002, the utilization of cash in operating activities resulted primarilyfrom a net loss of $3,626and an increase in accounts receivable of $2,259, offset by an increase in deferred revenue of $2,014, an increase in accounts payableand accrued liabilities of $2,073,a decrease in other current assets of $300 and depreciation and amortization charges of $885.

 

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For the nine-month period ended June30, 2002, net cash used in investing activities was $22 for the acquisition of fixedassets.  During the nine-month periodended June 30, 2001, net cash provided by investing activities of $7 was comprised of disposal of fixedassets of $44 andpurchase of fixed assets of $37.

 

For the nine-month period ended June30, 2002, net cash provided by financing activities was $143, consisting primarily of $1,760 in proceeds from borrowings, offsetwith the repayment of such borrowings of $1,617.  For the nine-monthperiod ended June 30, 2001, net cash provided by financing activities was $824, comprised of $3,996 from borrowings, $63 from the sale of stock under theCompany’s employee stock purchase plan offset by repayment of borrowings of $3,235.

 

FORTEL cannot assure that it willhave access to sufficient funds to meet its operating needs, which will likelylimit the ability to continue as a going concern.  There exist uncertainties as to the Company’s ability to continueas a going concern.  FORTEL’sindependent certified public accountants have included an explanatory paragraphto this effect in their audit report on Form 10-K/A with respect to theCompany’s consolidated financial statements for the fiscal year ended September30, 2001.  Any significant increase incapital expenditures or other costs or any decrease in or elimination ofanticipated sources of revenue could deplete the available cash.  Further, should some of the Company’screditors demand immediate payment, in particular payment of liquidateddamages, FORTEL would not be in a position to satisfy theses demands.  FORTEL needs to find additional funding tofinance its operations.  If the Companydoes not realize significant additional revenue or raise additional debt orequity financing or is not able to renegotiate or obtain a waiver for thedemand for liquidated damages, the Company will be unable to continue as agoing concern.

 

The Company currently plans tomaintain its revenues to a level that will finance expected expenditures andresult in at least neutral cash flows from operations.  However, until that stage is reached, theCompany will continue to use its current cash on hand, working capital, andutilize the available accounts receivable line of credit.

 

If the Company is unable to generatesufficient cash flows from operations or should management determine it to beprudent, it may attempt to raise additional debt or equity.  There can be no assurance that in the eventthe Company requires additional financing, that such financing will beavailable in light of the current financial situation of the Company and thegeneral adverse conditions of the public and private equity markets.

 

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In the event thatthe Company is unable to increase revenue levels or financing is unavailable,management will evaluate certain strategic alternatives which includeimplementing a cost savings program, selling the Company, and reorganizing theCompany and seeking protection under the Federal Bankruptcy Code. If the Company is the subject of bankruptcy proceedings, it may beforced to reorganize or possibly dissolve, and its stockholders may not receiveany proceeds upon liquidation.  Therecan be no assurance that any of these actions will be successful in completelyeliminating the difference between expenditures and revenues or that suchactions would not have a harmful effect on the Company’s business and resultsof operations.

 

Prior to June 30, 2002, the Companyhas failed to file and pay certain required state and federal payroll andwithholding taxes of approximately $1,160 to the appropriate taxing authorities.  Currently,the Company does not have sufficient funds to satisfy these obligations.  The Company has estimated approximately $520 for penaltiesand interest on the unpaid payroll-related taxes as of June 30, 2002, resultingin an estimated total liability of $1,680 for payroll and withholding taxes andpenalties and interest on the unpaid payroll-related taxes.  In addition, the Company, its officers, certain employees and directors mightbe subject to civil and criminal enforcement actions.  The Company intends tonegotiate and establish a payment plan with the taxing authorities and to paysuch taxes, penalties and interests as soon as it receives sufficientfunds.  There can be no assurance thatsuch a payment plan will be accepted by the taxing authorities or that any planproposed by the taxing authorities will be financially feasible for theCompany.  Should the Company be unableto negotiate a feasible payment plan allowing the Company to pay theseliabilities, the Company would be unable to satisfy such obligations, in whichcase the Company would cease as a going concern.

 

In July 2000, the Company, through aprivate placement, issued 2,192 shares of common stock to two institutionalinvestors, Deephaven Private Placement Trading Ltd. and Harp Investors LLC (the“Investors”), in exchange for $5,000. This private placement was pursuant to the Securities PurchaseAgreement, Registration Rights Agreement and Repricing Warrants (collectivelythe “Agreements”).  Proceeds of $4,727,net of placement agency and professional fees of $273, were received.  Pursuant to the terms of the Agreements, theInvestors have the right to demand additional warrants to purchase shares ofcommon stock from the Company in the event the market price of the Company’sstock falls below $2.28 per share. During the nine-month period ended June 30, 2002, the Company issued 234shares of common stock in partial satisfaction of the repricing rights.

 

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Recent Accounting Pronouncements

 

In June 2002, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No.146, “Accounting for Exit or Disposal Activities’”.  SFAS 146 addresses significant issues regarding the recognition,measurement, and reporting of costs that are associated with exit and disposalactivities, including restructuring activities that are currently accounted forunder Emerging Issues Task Force (“EITF”) No. 94-3, “LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring).”  The scope of SFAS 146 also includes costsrelated to terminating a contract that is not a capital lease and terminationbenefits that employees who are involuntarily terminated receive under theterms of a one-time benefit arrangement that is not an ongoing benefitarrangement or an individual deferred-compensation contract.  SFAS 146 will be effective for exit ordisposal activities that are initiated after December 31, 2002 and earlyapplication is encouraged.  The Company will adopt SFAS 146 during thesecond fiscal quarter ending March 31, 2003. The provisions of EITF No. 94-3 shall continue to apply for an exitactivity initiated under an exit plan that met the criteria of EITF No. 94-3prior to the adoption of SFAS 146.  Theeffect on adoption of SFAS 146 will change on a prospective basis the timing ofwhen restructuring charges are recorded from a commitment date approach to whenthe liability is incurred.

 

In October 2001, the FASB issued SFAS No. 144, “Accounting for Impairmentor Disposal of Long-Lived Assets”.  SFASNo. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-LivedAssets and for Long-Lived Assets to Be Disposed Of”, and addresses financialaccounting and reporting for the impairment or disposal of long-livedassets.  Additionally, SFAS No. 144expands the scope of discontinued operations to include all components of an entitywith operations that (1) can be distinguished from the rest of the entity and(2) will be eliminated from the ongoing operations of the entity in a disposaltransaction.  SFAS No. 144 is effectivefor financial statements issued for fiscal years beginning after December 15,2001 and its provisions are to be applied prospectively.  The Company is currently assessing theimpact of SFAS No. 144 on its consolidated results of operations and financialposition.

 

InJuly 2001, the FASB issued SFAS No. 141, “Business Combinations”, and No. 142,“Goodwill and Other Intangible Assets”. SFAS No. 141 requires all business combinations initiated after June 30,2001 to be accounted for using the purchase method.  Under SFAS No. 142, goodwill and intangible assets withindefinite lives are no longer amortized but are reviewed annually (or morefrequently if impairment indicators 

 

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arise)for impairment.  Separable intangibleassets that are not deemed to have indefinite lives will continue to beamortized over their useful lives (but with no maximum life).  The amortization provisions of SFAS No. 142apply to goodwill and intangible assets acquired after June 30, 2001.  With respect to goodwill and intangibleassets acquired prior to July 1, 2001, the Company is required to adopt SFASNo. 142 effective October 1, 2002.  TheCompany believes that the impact of SFAS No. 142 on the consolidated financialposition and results of operations will not be material.

 

Risks Associatedwith FORTEL’s Business and Future Operating Results (Amounts inthousands except per share data)

 

FORTEL May Seek Protection OrFORTEL’s Creditors May Seek Involuntary Proceedings Against Us Under theFederal Bankruptcy Code

 

FORTEL may in thefuture elect to seek protection under Chapter 11 or Chapter 7 of the FederalBankruptcy Code.  Additionally, theCompany is subject to the risk that creditors may seek to commence involuntarybankruptcy proceedings against the Company. If the Company files for Chapter 11 or Chapter 7 bankruptcy protectionor if involuntary proceedings are commenced against the Company by itscreditors, its creditors or other parties in interest may be permitted topropose their own plan, and the Company could be unsuccessful in having a planof reorganization confirmed which is acceptable to the requisite number ofcreditors and equity holders entitled to vote on such a plan.  This could lead to the Company’s inabilityto emerge from a Chapter 11 filing. Moreover, once bankruptcy proceedings are commenced, either by thefiling of a voluntary petition or if an involuntary petition is filed againstFORTEL, the Company’s creditors could seek FORTEL’s liquidation.  If a plan were consummated or if the Companywere liquidated, it would almost certainly result in its creditors receivingless than 100% of the face value of their claims, and in the claims of itsequity holders being cancelled in whole. Even if FORTEL does propose a plan and it is accepted, the Company isunable to predict at this time what treatment would be accorded under any suchplan to Company indebtedness, licenses, transfer of goods and services andother intercompany arrangements, transactions and relationships.  In addition, during any bankruptcy orsimilar proceeding, the Company would need court approval to take many actionsout of the ordinary course, which could result in its inability to manage thenormal operations of the Company and which would cause the Company to incuradditional costs associated with the bankruptcy process.

 

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FORTEL cannotassure that it will have access to sufficient funds to meet its operatingneeds, which will likely limit the ability to continue as a going concern.  There exist uncertainties as to theCompany’s ability to continue as a going concern.  FORTEL’s independent certified public accountants have includedan explanatory paragraph to this effect in their audit report on Form 10-K/Awith respect to the Company’s consolidated financial statements for the fiscalyear ended September 30, 2001.  Anysignificant increase in capital expenditures or other costs or any decrease inor elimination of anticipated sources of revenue could deplete the availablecash.  Further, should some of theCompany’s creditors demand immediate payment, in particular payment ofliquidated damages, FORTEL would not be in a position to satisfy thesesdemands.  FORTEL needs to findadditional funding to finance its operations. If the Company does not realize significant additional revenue or raiseadditional debt or equity financing or is not able to renegotiate or obtain awaiver for the demand for liquidated damages, the Company will be unable tocontinue as a going concern.  If theCompany is the subject of bankruptcy proceedings, it may be forced toreorganize or possibly dissolve, and its stockholders may not receive anyproceeds upon liquidation.

 

RecentLevels of Liquidity Have Been Low and Might Be Insufficient to Remain a ViableOperating Company

 

The Company hasexperienced a shortage of available cash or readily available funds to satisfyall its current obligations towards vendors and service providers.  This has caused and might continue to causedisruptions or terminations of relationships with service providers and thenon-delivery of needed goods and services. The Company has taken several steps to remedy this situation such asrenegotiating for accelerated cash payments instead of long-term royaltypayments and to arrange for payment plans with various service providers andvendors as well as numerous other cost-saving measures.  If the Company is unable to increase itscurrent levels of available cash or funds available, there can be no assurancethat vital and material goods or services will be available to the Company andthat it will remain a viable operating entity.

 

Significant Withholding and PayrollTax Liabilities

 

Prior to June 30,2002, the Company has failed to file and pay certain required state and federalpayroll and withholding taxes of approximately $1,160 to the appropriate taxingauthorities.  Currently, the Company does not have sufficient funds to satisfy theseobligations.  The Company has recordedan estimate for penalties and interest on the unpaid payroll-related taxes inthe amount of $520.  As of June 30, 2002, an estimated total 

 

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liability of $1,680 for payroll and withholding taxes and penaltiesand interest on the unpaid payroll-related taxes, is recorded in accruedliabilities.  In addition, theCompany, its officers, certain employees and directors might be subject tocivil and criminal enforcement actions. The Company intends to negotiate andestablish a payment plan with the taxing authorities and to pay such taxes,penalties and interests as soon as it receives sufficient funds.  There can be no assurance that such apayment plan will be accepted by the taxing authorities or that any planproposed by the taxing authorities will be financially feasible for theCompany.  Should the Company be unable tonegotiate a feasible payment plan allowing the Company to pay theseliabilities, the Company would be unable to satisfy such obligations, in whichcase the Company would cease as a going concern.

 

SignificantDefault Liabilities for Liquidated Damages and Liability for Issuance ofRepricing Warrants to Private Investors Seriously Threaten the Company as aGoing Concern

 

On July18, 2000, the Company, through a private placement, issued 2,191 shares ofcommon stock to two institutional investors, Deephaven Private PlacementTrading Ltd. and Harp Investors LLC (the “Investors”), in exchange for$5,000.  This private placement waspursuant to the Securities Purchase Agreement, Registration Rights Agreementand Repricing Warrants and as subsequently amended by Letter Agreement onNovember 6, 2000 (collectively the “Agreements”), copies of which were filedwith the Company’s Current Reports on Form 8-K filed on July 27, 2000 and onNovember 17, 2000.  Proceeds of $4,727, netof placement agency and professional fees of $273, were received.  Pursuant to the terms of the Agreements, theInvestors have the right to demand additional warrants to purchase shares ofcommon stock from the Company in the event the market price of the Company’sstock falls below $2.28 per share.  TheCompany has registered 5,341 shares of common stock of which 3,692 shares had been issued as of June 30,2002.

 

On July25, 2001, the Company received demand letters from the Investors demandingliquidated damages upon default under the Agreements in the aggregate amount of$1,400 due to the Company’s delisting from The Nasdaq SmallCap Market effectiveMay 16, 2001, its failure to register and its failure to authorize additionalsecurities.  These three claims forliquidated damages have, through the passage of time, reached their contractualmaximum of $3,000 ($1 million per incident) plus interest at a rate of 18% perannum or such lesser maximum amount that is permitted to be paid by applicablelaw, accruing daily until such liquidated damages, plus all interest thereon,are paid in full.  To date, the eventsof default, as stated by the Investors, have not been 

 

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** **

remedied,nor has the demand for payment been satisfied by the Company.  The Company does not currently have thecapabilities to satisfy these demands and therefore will be incurringadditional interest expense at the rate of 18% per annum on the unpaidliquidated damages.

 

TheCompany will have to negotiate a significant reduction or waiver of suchdemands or the Company will not be able to satisfy its obligations and might,therefore, cease to continue as a going concern.

 

On February12, 2002, the Company received election notices from the Investors with respectto the exercise of Repricing Warrants for an aggregate of 65,062 shares ofCommon Stock.  Harp Investors LLC notified FORTEL of itsexercise notice and demanded the issuance of a stock certificate for 16,673shares of Common Stock.  DeephavenPrivate Placement Trading, Ltd. notified FORTEL of its exercise notice anddemanded the issuance of a stock certificate for 48,389 shares of CommonStock.  The total number of authorizedshares of Common Stock is 40,000 as of June 30, 2002 and 30,624 shares of Common Stock are issuedand outstanding.  Thus, the Company isnot in a position to fully satisfy these exercise requests as the number ofshares demanded exceeds the number of authorized and unissued shares of CommonStock, therefore the Company has not issued any shares of Common Stock pursuantof these exercise notices.  If issued,these shares would increase our outstanding common stock by over 300%.  The Investors have confirmed that thisrequest does not trigger any additional liquidating damages.

 

Should the Company elect to seek therequired shareholder approval to authorize additional shares of Common Stocksufficient to satisfy the demands made by the Investors, in full or in part, itappears questionable whether the Company will be able to obtain suchshareholder approval in light of the Company’s failure at the 2001 AnnualMeeting to obtain shareholder approval for a proposed amendment of the 2000Equity Incentive Plan.

 

In addition, FORTEL might not havean effective registration statement in place to allow for the resale of all theshares requested by the Investors. Furthermore, FORTEL’s failure to timely file its annual report on Form10-K might have caused the failure to provide for a continuously effectiveregistration statement for the resale of shares held or to be received by theInvestors, as required under the Registration Rights Agreement, dated July 18,2000, which might lead to additional claims for liquidated damages.

 

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Significant Losses

 

For the first nine months of fiscalyear 2002, the Company reported a net loss of $3,626.  The Company reported total net losses of $6,759, $8,653, $13,103,$43,205 and $17,501 for fiscal years 2001, 2000, 1999, 1998 and 1997, respectively.

 

The Company has taken a number of steps to attempt toreturn to profitability, although there is no assurance that it will besuccessful.  A significant portion ofthe cumulative losses were caused by the funding of MatriDigm Corporation, andoperations of the Company’s former storage systems business, which was sold inJuly 1998.  MatriDigm filed Chapter 7bankruptcy in October 1999 so there were no additional fundings.  The Company has subleased its Fremont, CAheadquarters, and moved to substantially smaller and less costly premises.

 

The Company continues to consideroptions and take actions necessary to bring costs into line with anticipatedrevenues.  There can be no assurancethat the Company will be successful in this effort and remain a viableoperating entity.

 

Recent Levels of Net Sales Have Been Insufficient

 

FORTEL has not generated net sales sufficient to produce an operatingprofit in recent years.  The Company hasrelied on significant financings to support its activities.  FORTEL has sustained substantial operatinglosses and net losses in the fiscal years 1997 through 2001.  FORTEL must generate substantial additionalnet sales and gross margins on its products and services and must continue tosuccessfully implement programs to manage cost and expense levels in order toremain a viable operating entity.  Thereis no assurance that FORTEL can achieve these objectives.

 

Fluctuations in Quarterly Results and Lackof Predictability of Sales

 

A material portion of our revenues has been derivedfrom large orders, as major customers deployed FORTEL’s products.  Increases in the dollar size of someindividual license transactions would also increase the risk of fluctuation infuture quarterly results.  Moreover,recent adverse economic conditions in the United States, particularly thoserelated to the technology industry, may increase the likelihood that customerswill unexpectedly delay or cancel orders and result in revenue shortfalls.  This risk is particularly relevant withrespect to large customer orders which are more likely to be cancelled ordelayed and also have a greater financial impact on FORTEL’s operatingresults.  A large number of technologycompanies, particularly software companies that, like FORTEL, sell 

** **

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e–commerce relatedsoftware solutions, have recently announced that these conditions haveadversely affected their financial results. Additionally, the Company’s operating expenses are based in part on itsexpectations for future revenues and are difficult to adjust in the shortterm.  Any revenue shortfall belowFORTEL’s expectations could have an immediate and significant adverse effect onthe Company’s results of operations.

 

FORTEL’s quarterly operating results have in the past varied and may inthe future vary significantly depending on a number of factors, including:

 

•                  Thelevel of competition, the size, timing, cancellation or rescheduling ofsignificant orders;

 

•                  Marketacceptance of new products and product enhancements;

 

•                  Newproduct announcements or introductions by FORTEL’s competitors;

 

•                  Deferralsof customer orders in anticipation of new products or product enhancements;

 

•                  Changesin pricing by FORTEL or its competitors;

 

•                  Theability of FORTEL to develop, introduce and market new products and productenhancements on a timely basis;

 

•                  FORTEL’ssuccess in expanding its sales and marketing programs;

 

•                  Technologicalchanges in the market for FORTEL’s products;

 

•                  Productmix and the mix of sales among FORTEL’s sales channels;

 

•                  Levelsof expenditures on research and development;

 

•                  Changesin FORTEL’s strategy; personnel changes; and,

 

•                  Generaleconomic trends and other factors.

 

Due to all of the foregoing factors, FORTEL believes thatperiod-to-period comparisons of its results of operations are not necessarilymeaningful and should not be relied upon as an indicator of futureperformance.  It is possible that insome future quarter the Company’s operating results may be below theexpectations of public market analysts and investors.

 

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FORTEL Stock Price Has Been Highly Volatile

 

The price of FORTEL’s common stock during the nine-month period offiscal year 2002 ranged from the low closing bid price of $0.06 to the highclosing bid price of $0.14.  During thefiscal year 2001, the price of the Company’s common stock was volatile, rangingfrom the low closing bid price of $0.2031 to the high closing bid price of$1.03125.

 

In December 2000, the Company wasnotified by Nasdaq that it no longer satisfied the minimum bid pricerequirement listing requirements.  TheCompany was provided 90 calendar days, or until March 19, 2001, to regaincompliance; however, the Company was unable to demonstrate compliance on orbefore March 19, 2001, and, therefore, was delisted from The Nasdaq SmallCapMarket, effective May 16, 2001.  Thede-listing of the Company’s common stock may materially and adversely affectthe trading liquidity or the price of the Company’s common stock.

 

Trading Restrictions and Reduced Liquidity May Adversely AffectFORTEL’s Stock Price and the Ability to Trade Its Stock

 

Followingthe delisting of FORTEL’s common stock from The Nasdaq SmallCap Marketeffective May 16, 2001, its common stock is currently traded on the OTCBulletin Board market.  FORTEL’s commonstock may be subject to regulation as a “penny stock”.  The SEC has adopted regulations whichgenerally define “penny stock” to be any equity security that has a marketprice or exercise price less than $5.00 per share, subject to certainexceptions, including listing on The Nasdaq SmallCap Market.  If no other exception applies, the Company’scommon stock may become subject to the SEC’s Penny Stock Rules, Rule 15g-1through Rule 15g-9 under the Exchange Act. For transactions covered by these rules, broker-dealers must make aspecial suitability determination for the purchase of such securities and musthave received the purchaser’s written consent to the transaction prior to thepurchase.  Additionally, for anytransaction involving a penny stock, unless exempt, the rules require thedelivery, prior to the transaction, of a risk disclosure document mandated bythe SEC relating to the penny stock market. The broker-dealer must also disclose the commission payable to both thebroker-dealer and the registered representative, current quotations for thesecurities and, if the broker-dealer is the sole market maker, thebroker-dealer must disclose this fact and the broker-dealer’s presumed controlover the market.  Finally, monthlystatements must be sent disclosing recent price information for the penny stockheld in the account and information on the limited market in penny stocks.  Consequently, the penny stock rules mayrestrict the ability of broker-dealers to sell the Company’s securities and mayaffect the ability of holders to sell these 

** **

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securitiesin the secondary market and the price at which such holders can sell any suchsecurities.  Rule 15g-9 under theExchange Act imposes additional sales practice requirements on broker-dealerswho sell such securities except in transactions exempted from such rule.  Such exempt transactions include thosemeeting the requirements of Rule 505 or 506 of Regulation D promulgated underthe Securities Act and transactions in which the purchaser is an institutionalaccredited investor or an established customer of the broker-dealer.  As a result, holders of FORTEL’s commonstock may be unable to readily sell the stock they hold or may not be able to sellit at all.

 

Dependence on KeyPersonnel

 

TheCompany’s future performance depends significantly upon the continued serviceof its key technical and senior management personnel.  The Company provides incentives such as salary, benefits andoption grants (which are typically subject to vesting over four years) toattract and retain qualified employees. Recently, the Company’s stock price has been volatile and, as such, manyof the Company’s employees hold options with exercise prices greater than themarket price of the Company’s Common Stock and, therefore, may not be anincentive to retain the services of these individuals.  As a result, in October 2001, the Company’sBoard of Directors authorized the repricing of previously-granted options,reducing the original exercise prices when initially granted to $0.04 pershare, which represented the market value on the date of repricing.  The loss of the services of one or more ofthe Company’s officers or other key employees could have a material adverseeffect on the Company’s business, operating results and financial condition.  The Company’sfuture success depends on its continuing ability to retain highly qualifiedtechnical and management personnel.  Competition for such personnel isintense and there can be no assurance that the Company can retain its keytechnical and management employees or that it can attract, assimilate andretain other highly qualified key technical and management personnel in thefuture.

 

Competition

 

The market for eBusiness and internet performance management tools inwhich the Company’s software products business competes is intenselycompetitive.  Many of the companies withwhich the Company competes, such as Computer Associates International, Inc.,Hewlett-Packard Company, and BMC Software, Inc. have substantially largerinstalled bases and greater financial resources than the Company.  New companies will appear and may competewith certain of the Company’s products and services.  The Company believes the important considerations for softwarecustomers are ease of use, automated functionality, product 

 

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reliability, quality and price, as well as complementary servicesoffered.  There can be no assurance thatthe Company’s competitors or new companies will not develop products comparableor superior to those developed by the Company or adapt more quickly than theCompany to new technologies, evolving industry standards, new productintroductions, or changing customer requirements.  The Company believes that it competes favorably in each of theseareas.

 

Dependence on New Products; Rapid Technological Change

 

The markets in which the Company operates are characterized by rapidtechnological change, changing customer needs, frequent new productintroductions and evolving industry standards. The introduction of products embodying new technologies and/or theemergence of new industry standards could render the Company’s existingproducts and services obsolete and unmarketable.  The Company’s future success will depend upon its ability todevelop and to introduce new products and services on a timely basis that keeppace with technological developments and emerging industry standards andaddress the increasingly sophisticated needs of its customers.  There can be no assurance that the Companywill be successful in developing and marketing products or services thatrespond to technological changes or evolving industry standards, that theCompany will not experience difficulties that could delay or prevent thesuccessful development, introduction and marketing of new products or services,or that its new products or services will adequately meet the requirements ofthe marketplace and achieve market acceptance. If the Company is unable, for technological or other reasons, to developand introduce new products or services in a timely manner in response tochanging market conditions or customer requirements, the Company’s business,operating results and financial condition will be materially and adverselyaffected.

 

Dependence on Proprietary Technology

 

The Company’s success depends significantly upon itsproprietary technology.  The Companycurrently relies on a combination of patent, copyright and trademark laws,trade secrets, confidentiality agreements and contractual provisions to protectits proprietary rights.  The Companyseeks to protect its software, documentation and other written materials undertrade secret and copyright laws, which afford only limited protection.  The Company has registered its FORTEL andSightLine trademarks and will continue to evaluate the registration ofadditional trademarks as appropriate. The Company generally enters into confidentiality agreements with itsemployees and with key vendors and suppliers. The Company currently holds a United States patent on one of itssoftware technologies.  There can be 

 

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no assurance that this patent will provide the Companywith any competitive advantages or will not be challenged by third parties, orthat the patents of others will not have a material adverse effect on theCompany’s ability to do business.  TheCompany believes that the rapidly changing technology in the computer industrymakes the Company’s success depend more on the technical competence andcreative skills of its personnel than on patents.

 

There has also been substantial litigation in the computer industryregarding intellectual property rights, and litigation may be necessary toprotect the Company’s proprietary technology. The Company has not received significant claims that it is infringingthird parties’ intellectual property rights, but there can be no assurance thatthird parties will not in the future claim infringement by the Company withrespect to current or future products, trademarks or other proprietary rights.

 

The Company expects that companies in its markets will increasingly besubject to infringement claims as the number of products and competitors in theCompany’s target markets grows.  Anysuch claims or litigation may be time consuming and costly, cause productshipment delays, require the Company to redesign its products or require theCompany to enter into royalty or licensing agreements, any of which could havea material adverse effect on the Company’s business, operating results orfinancial condition.  Despite theCompany’s efforts to protect its proprietary rights, unauthorized parties mayattempt to copy aspects of the Company’s products or to obtain and useinformation that the Company regards as proprietary.  There can be no assurance that the Company’s means of protectingits proprietary rights will be adequate or that the Company’s competitors willnot independently develop similar technology, duplicate the Company’s productsor design around patents issued to the Company or other intellectual propertyrights of the Company.

 

Product Liability

 

The Company’s agreements with its customers typically containprovisions intended to limit the Company’s exposure to potential productliability claims.  It is possible thatthe limitation of liability provisions contained in the Company’s agreementsmay not be effective.  Although theCompany has not received any product liability claims to date, the sale andsupport of products by the Company and the incorporation of products from othercompanies may entail the risk of such claims. A successful product liability claim against the Company could have amaterial adverse effect on the Company’s business, operating results andfinancial condition.

 

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International Sales and Operations

Sales to customers outside the United States haveaccounted for significant portions of the Company’s net sales.  The Company currently has offices in and is operatingin the United Kingdom, The Netherlands, Switzerland, Germany, and France.  International sales pose certain risks notfaced by companies that limit themselves to domestic sales.  Fluctuations in the value of foreigncurrencies relative to the U.S. dollar, for example, could make the Company’sproducts less price competitive. International sales could be adversely affected by factors beyond theCompany’s control, including the imposition of government controls, exportlicense requirements, restrictions on technology exports, changes in tariffsand taxes and general economic and political conditions.  The laws of some countries do not protectthe Company’s intellectual property rights to the same extent as the laws ofthe United States.  The Company does notbelieve these additional risks are significant in the United Kingdom, TheNetherlands, Germany, France or in Switzerland.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

The Company has considered the provisions of Financial ReportingRelease No. 48, “Disclosure of Accounting Policies for Derivative FinancialInstruments and Derivative Commodity Instruments, and Disclosure ofQuantitative and Qualitative Information about Market Risk Inherent inDerivative Financial Instruments, Other Financial Instruments and DerivativeCommodity Instruments”.  The Company hadno holdings of derivative financial or commodity instruments at June 30,2002.  A review of other financialinstruments and risk exposures at that date revealed the Company did not haveexposure to interest rate risk.

 

The Company sells it products worldwide.  Consequently, the financial results could be affected by factorssuch as changes in foreign currency exchange rates or weak economic conditionsin foreign markets.  Because a majorportion of the Company’s revenue is currently denominated in U.S. Dollars, astrengthening of the dollar could make the Company’s products less competitivein foreign markets.

 

PART II.  OTHER INFORMATION

 

Item 6.    Exhibitsand Reports on Form 8-K

(a)        Exhibits

 

CEO and CFO Certification

 

(b)        Reportson Form 8-K

None

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,Registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                         | FORTEL INC.                                                  |
|------------------------------|--------------------------------------------------------------|
|                         |                                                         |
|                         |                                                         |
| Date:  August  14, 2002 | By                                                           | /s/  Romeo R.  Dizon |   |
|                         | Romeo R. Dizon                                               |
|                         | Chief Accounting Officer and Acting Chief Financial  Officer |

 

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