U.S.SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: May 31, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE
ACT
For the transition period from ____________ to ____________
Commission File Number 0-18250
TMS, Inc.
(Exact name of small business issuer as specified in its charter)
OKLAHOMA 91-1098155
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
206 West Sixth Street
Post Office Box 1358
Stillwater, Oklahoma 74076
(Address of principal executive offices)
(405) 377-0880
(Issuer's telephone number)
Check whether the issuer (1) filed all Reports required to be filed by
Section 13 or 15 (d) of the Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the
past 90 days.
Yex [X] No [ ]
State the number of shares outstanding of each of
the issuer's classes of common equity, as of the
latest practicable date:
Title of Each Class Outstanding at July 10, 2003
Common stock, par value $.05 per share 13,112,659
Transitional Small Business Disclosure Format (check one):
Yes [] No [X]
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
TMS, Inc.
Condensed Balance Sheets
May 31, 2003 and August 31, 2002
May 31, August 31,
2003 2002*
(unaudited)
----------- -----------
Cash $ 1,295,627 $ 783,550
Trade accounts receivable, net 164,921 594,499
Due from related parties 31,125 33,743
Deferred income taxes 7,704 165,623
Other current assets 48,840 40,934
----------- -----------
Total current assets 1,548,217 1,618,349
----------- -----------
Property and equipment 2,451,210 2,492,525
Accumulated depreciation and amortization (1,625,412) (1,638,067)
----------- -----------
Net property and equipment 825,798 854,458
----------- -----------
Capitalized software development costs, net 391,502 715,365
Deferred income taxes - 318,877
Other assets 43,495 45,394
----------- -----------
Total assets $ 2,809,012 $ 3,552,443
=========== ===========
Current installments of long-term debt 30,737 29,106
Accounts payable 92,042 128,502
Due to related parties 13,741 -
Accrued payroll expenses 154,441 223,788
Deferred revenue 495,196 431,904
Deferred gain on sale of technology 9,805 -
----------- -----------
Total current liabilities 795,962 813,300
Long-term debt, net of current installments 174,983 198,269
Investment in limited liability company 26,347 -
Deferred income taxes 7,704 -
----------- -----------
Total liabilities 1,004,996 1,011,569
----------- -----------
Common stock 655,633 655,633
Additional paid-in capital 11,348,883 11,348,883
Accumulated deficit (10,200,500) (9,463,642)
----------- -----------
Total shareholders' equity 1,804,016 2,540,874
----------- -----------
Total liabilities and shareholders' equity $ 2,809,012 $ 3,552,443
=========== ===========
*Condensed from audited financial
statements.
See accompanying notes to condensed
financial statements.
1
TMS, Inc.
Condensed Statements of Operations(unaudited)
Three and Nine Months Ended May 31,
2003 and 2002
Three Months Ended Nine Months Ended
May 31, May 31, May 31, May 31,
2003 2002 2003 2002
---- ---- ---- ----
Licensing and royalties $ 377,302 468,511 1,537,087 1,594,410
Customer support and maintenance 150,659 135,606 445,244 375,675
Other 64,750 10,683 65,635 14,506
------------ ------------ ------------ ------------
Total revenue 592,711 614,800 2,047,966 1,984,591
Cost of revenue 194,925 130,428 459,080 427,542
Selling, general and administrative
expense 439,942 492,393 1,419,587 1,532,268
Research and development expense 178,667 144,905 466,991 596,966
Loss in limited liability company (55,873) - (104,530) -
------------ ------------ ------------ ------------
Operating loss (276,696) (152,926) (402,222) (572,185)
Other income (expense), net 48,500 1,778 149,864 (7,819)
------------ ------------ ------------ ------------
Loss before income taxes (228,196) (151,148) (252,358) (580,004)
Income tax expense - - 484,500 -
------------ ------------ ------------ ------------
Net loss $ (228,196) (151,148) (736,858) (580,004)
============ ============ ============ ============
Basic loss per share $ (0.02) (0.01) (0.06) (0.04)
============ ============ ============ ============
Weighted average common shares 13,112,659 13,109,659 13,112,659 13,101,649
============ ============ ============ ============
Diluted loss per share $ (0.02) $ (0.01) $ (0.06) $ (0.04)
============ ============ ============ ============
Weighted average basic and diluted
shares 13,112,659 13,109,659 13,112,659 13,101,649
============ ============ ============ ============
See accompanying notes to condensed
financial statements.
2
TMS, Inc.
Condensed Statements of Cash Flows (unaudited)
Nine Months Ended May 31, 2003 and 2002
May 31, May 31,
2003 2002
---- ----
Net cash flows provided by (used in)
operating activities $ 482,338 $ (181,349)
----------- -----------
Cash flows from investing activities:
Purchases of property and equipment (33,692) (26,086)
Capitalized software development costs (181,670) (347,771)
Proceeds from sale of technology 250,000 -
Investment in limited liability company (183,244) -
Distribution from limited liability company 200,000 -
----------- -----------
Net cash provided by (used in) investing
activities 51,394 (373,857)
----------- -----------
Cash flows from financing activities:
Repayments of long-term debt (21,655) (20,109)
Sale of treasury stock, at cost - 4,913
----------- -----------
Net cash used in financing activities (21,655) (15,196)
----------- -----------
Net increase (decrease) in cash 512,077 (570,402)
Cash at beginning of period 783,550 669,287
----------- -----------
Cash at end of period $ 1,295,627 $ 98,885
=========== ===========
Noncash investing activity:
Investment in limited liability company
through contribution of technology 94,939 -
See accompanying notes to condensed
financial statements.
3
TMS, Inc.
Notes to Condensed Financial Statements (unaudited)
Unaudited Interim Condensed Financial Statements
- ------------------------------------------------
The unaudited interim condensed financial statements and related notes were
prepared by TMS, Inc. Certain information and disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed or omitted pursuant
to rules and regulations established by the Securities and Exchange Commission.
The accompanying unaudited interim condensed financial statements should be read
in conjunction with the audited financial statements and related notes included
in our Form 10-KSB Annual Report for the fiscal year ended August 31, 2002.
The unaudited interim financial statements reflect all adjustments that are,
in the opinion of management, necessary for a fair presentation of financial
position, results of operations and cash flows for the interim periods
presented. All adjustments are normal and recurring.
Interim results are subject to year-end adjustments and audit by independent
auditors. The financial data for the interim periods may not necessarily be
indicative of the results expected for the year.
Income Taxes
- ------------
The income tax provision for the nine months ended May 31, 2003, included a
deferred tax benefit of $94,656 and an increase in the valuation allowance for
deferred tax assets of $579,156. The income tax benefit for the nine months
ended May 31, 2003, differed from the amount computed by applying the U.S.
Federal income tax rate of 34% to pretax loss from operations primarily because
of the increase in the valuation allowance for deferred tax assets.
The following table sets forth the tax effects of temporary difference that give
rise to significant portions of the deferred tax assets and liabilities at May
31, 2003 and August 31, 2002:
May 31, August 31,
2003 2002
Deferred tax assets:
Tax operating loss carryforwards 872,442 1,036,142
Other 44,239 55,277
--------- ----------
Total gross deferred tax assets 916,681 1,091,419
Less valuation allowance 756,491 321,352
--------- ----------
Net deferred tax assets 160,190 770,067
Deferred tax liabilities:
Property and equipment (11,388) (14,014)
Capitalized software costs (148,802) (271,553)
--------- ----------
Net deferred taxes - 484,500
========== ==========
4
Deferred tax assets are recognized when it is more likely than not that
benefits from deferred tax assets will be realized. The ultimate
realization of deferred tax assets is dependent upon our ability to generate
future taxable income during the periods in which the temporary differences
that create deferred tax assets become deductible. We consider the
scheduled reversal of deferred tax liabilities, projected future taxable
income, past earnings history, sales backlog and tax operating loss
carryforward expiration dates when determining the amount of deferred
tax assets to recognize.
During the first nine months of the current fiscal year we increased our
valuation allowance for deferred tax assets and reduced our deferred tax
asset, net of valuation allowance, from $770,067 at August 31, 2002 to
$160,190 at May 31, 2003. In order to fully realize our net deferred tax
asset prior to the expiration of our tax operating loss carryforwards, we
will have to generate approximately $425,000 in taxable income through
increased income from operations, the reversal of deferred tax liabilities,
or both. At May 31, 2003, we had approximately $2.3 million of tax operating
loss carryforwards, of which approximately 78% do not begin to expire until
our fiscal year 2019.
We made the decision to reduce the carrying amount of our net deferred tax
assets during the first nine months of the current fiscal year because our
ability to time the closing of significant revenue opportunities has recently
become more difficult. Prior to the events of September 11, 2001, we began
to see improvement in our financial results with our operating losses
becoming significantly reduced over the prior two years. Subsequent to the
events of September 11, 2001, we experienced an immediate downturn in
revenue, but made adjustments to our cost structure to help mitigate the
delay in closing several revenue transactions which we believe resulted
from the events of September 11, 2001, and the strugglingnational
economy. Since that time and through the first quarter of the current
fiscal year, we began to experience revenue totals at a level that we
believed could be sustained and result in profitability for our company.
During the second and third quarters of the current year we experienced
another downturn in revenue and believe that the continuation of a
struggling national economy coupled with recent international conflicts,
including the war, is having an impact on the timing and amount of revenue
that we can expect from our current customers and prospects in both the
private and governmental sectors. Accordingly, we believe that a reduction
in the carrying amount of our net deferred tax assets is necessary to
properly account for the recent increased difficulties we have
experienced in predicting the timing of future revenue.
Net Loss Per Share
- ------------------
Options to purchase approximately 587,000 and 628,000 shares of common stock
at prices ranging from $.125 to $.40 per share were outstanding at May 31, 2003
and 2002, respectively, but were not included in the computation of diluted net
loss per share because the options' exercise prices were greater than the
average market price of common shares. Additionally, approximately 54,000
options to purchase common stock at prices ranging from $.125 to $.1875 per
share were excluded from the computations of diluted loss per share for the
three and nine months ended May 31, 2002 because of their anti-dilutive effect.
Approximately 587,000 and 682,000 options to purchase shares of common stock
were outstanding at May 31, 2003 and 2002, respectively. All options expire
during periods through the year 2008.
5
Legal Proceeding
- ----------------
We are a party to a lawsuit involving the Virtual Scoring Center technology we
transferred to VSC Technologies, LLC. On October 23, 2002, we, along with VSC
Technologies, LLC and Measurement Incorporated, filed an action in the United
States District Court for the Eastern District of North Carolina against NCS
Pearson, Inc. In the complaint, we and the other plaintiffs seek a declaratory
judgment that the Virtual Scoring Center technology owned by VSC Technologies,
LLC and marketed by Measurement Incorporated and us does not infringe twenty
patents belonging to NCS Pearson. On June 3, 2003, NCS filed their answer to
our complaint, along with a set of counterclaims that assert infringement of
thirteen of their patents.
We believe that the Virtual Scoring Center technology does not infringe the
NCS Pearson patents and we designed that technology to carefully avoid
infringement, but we cannot assure you that we will be successful in our
claims or our defense against NCS Pearson's counterclaims.
If the court rules that the Virtual Scoring Center infringes the NCS Pearson
patents and NCS Pearson prevails in their counterclaims, this could result
in a monetary judgment against us. Because this action is at an early stage,
we cannot estimate the extent of any potential damages if there is a judgment
against us.
An injunction against us and VSC Technologies, LLC would be severely damaging
to our business growth opportunities and our plans to exploit the Virtual
Scoring Center technology. Measurement Incorporated has agreed to indemnify
us against our costs and any liability arising in connection with the action
against NCS Pearson. But that indemnification responsibility has certain dollar
limitations and other conditions. Consequently, we may have financial exposure
if we do not prevail in this action and the conditions for indemnification are
not met or our costs and liability exceed the indemnification coverage.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
This Quarterly Report on Form 10-QSB contains forward-looking statements within
the meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. Our actual results could differ materially from those set forth in the
forward-looking statements because of certain risks and uncertainties, such as
those inherent generally in the computer software industry and the impact of
competition, pricing and changing market conditions. As a result, you should not
rely on these forward-looking statements.
Following is selected financial information for each of our reportable segments
for the three and nine months ended May 31, 2003 and 2002.
6
Component Product Technologies
- ------------------------------
Three Months Ended Nine Months Ended
May 31, May 31, May 31, May 31,
2003 2002 2003 2002
---- ---- ---- ----
Revenue from external customers $ 514,831 595,324 1,895,967 1,934,586
------------ ------------ ------------ -----------
Operating (loss) income $ (73,280) 55,829 312,000 254,274
------------ ------------ ------------ -----------
Revenue from the component product technologies segment is primarily derived
from licensing, royalties, and the customer support and maintenance of our
Prizm(R) plug-in, ScanFix(R), Prizm(R) color image processing, Prizm(R)Gray,
ViewDirector(TM) and FormFix(R) products. Revenue for this segment for the
three months ended May 31, 2003 was $514,831 compared to $595,324 for the same
period last year, a decrease of $80,493, or 14%. For the nine months ended May
31, 2003 revenue for this segment was $1,895,967 compared to $1,934,586 for the
same period last year, a decrease of $38,619, or 2%.
We believe that the struggling national economy and international events
continued to negatively impact our revenue opportunities in both the private and
governmental sectors during the third quarter of the current fiscal year. Since
the events of September 11, 2001, we have consistently experienced longer sales
cycles and smaller quantity license purchases from many of our commercial
customers. Additionally, we have experienced delays from prospective customers
affiliated with the United States government during the first nine months of the
current fiscal year because funds for approved projects have not been released
due to war related uncertainties. We also believe that internal delays in the
release of certain new and enhanced products and slower adoption of color-based
technology in the document imaging marketplace further impacted our ability to
generate more revenue during the first nine months of the current fiscal year as
we strive to replace revenue from our more mature viewing and black and white
image processing products. Because of the factors described above, our ability
to predict the timing and extent of revenue transactions has become increasingly
difficult. If uncertainties surrounding the national economy and recent
international events do not improve and/or we are unable to release new and
enhanced products on a timelier basis, our revenue may continue to be lower
which could have a material adverse effect on our business, operating results
and financial position.
The operating loss for the segment was 14% of revenue for the three months ended
May 31, 2003 compared to operating income of 9% for the same period last year.
The decline in revenue for the third quarter coupled with an increase in
research and development expense for new and enhanced product development were
the primary factors that contributed to an operating loss position compared to
the same three month period last year. For the nine-month periods ended May 31,
2003 and 2002, operating income for the segment was 16% and 13% of revenue,
respectively. The effects of a workforce reduction implemented in November 2001,
and a partial write-off of an uncollectible trade account receivable during the
prior year first quarter were the primary factors that resulted in improved
operating margins for the first nine months of the current fiscal year compared
to the same period last year.
The profitability of this segment depends on our ability to secure significant
sales of multiple licenses to individual customers. One customer accounted for
14% of our revenue for the current year third quarter and another customer
accounted for 13% of revenue for the same period last year. For the nine months
ended May 31, 2003, one customer accounted for 13% of our revenue, while no one
customer accounted for greater than 10% of our revenue for the same nine-month
period last year. We can provide no assurance that we will be able to continue
to secure significant sales transactions with individual customers or that we
will be able to increase the volume of customers and reduce our reliance on
significant sales transactions. Our inability to generate more revenue by
securing such transactions and/or increasing the volume of customers could have
a material adverse effect on our business, operating results and financial
position.
7
Assessment Scoring Technologies
- -------------------------------
Three Months Ended Nine Months Ended
May 31, May 31, May 31, May 31,
2003 2002 2003 2002
---- ---- ---- ----
Revenue $ 68,000 10,683 116,439 20,506
------------ ------------ ------------ -----------
Operating loss $ (147,002) (186,431) (504,013) (670,632)
------------ ------------ ------------ -----------
For the three and nine months ended May 31, 2002 this segment included the costs
associated with the continued development and marketing of our Virtual Scoring
Center(TM) and Digital Mark Recognition(TM) software products that are designed
to target and take advantage of the expected growth in the market for scoring K-
12 tests. On October 10, 2002, we entered into an agreement with Measurement
Incorporated, one of the nation's leading providers of writing and performance
assessment hand-scoring services, to further develop the Virtual Scoring Center
technology and bring it to market through a new entity, VSC Technologies, LLC.
The Company transferred its rights in the Virtual Scoring Center technology to
the LLC in exchange for a one-time cash payment of $250,000 and a 50% ownership
interest. Measurement Incorporated holds the remaining 50% ownership interest.
Accordingly, for the nine months ended May 31, 2003 the financial results for
this segment predominantly reflect the operating activities associated with the
continued development and marketing of the Digital Mark Recognition software
product and our 50% equity interest in the newly formed entity, VSC
Technologies, LLC.
Upon formation of the LLC, we entered into an agreement with the LLC whereby we
provide software development services, at a fixed rate per hour. The segment's
operating expenses were reduced by approximately $91,000 and $292,000 for such
costs during the three and nine-month periods ended May 31, 2003, respectively,
of which 50% was billed to the LLC and 50% was recorded as an increase to our
investment in the LLC.
The decrease in operating loss for the three and nine month periods ended May
31, 2003 compared to the same period last year primarily resulted from the
increase in revenue and the reduction in expenses associated with our
development services agreement with the LLC described above. Revenue for this
segment for the three-month period ended May 31, 2003, was primarily derived
from the resale of a document image scanner to Measurement Incorporated. In
addition to the sale of the scanner, the nine-month revenue from this segment
included the sale of a license to our Digital Mark Recognition software product
that is associated with the image scanner to Measurement Incorporated.
Included in the operating loss for the three and nine month periods ended May
31, 2003, is approximately $56,000 and $105,000, respectively, for our 50% share
of the LLC net loss.
Total Company Operating Results
- -------------------------------
Following is a report of total company revenue and a reconciliation of
reportable segments' operating loss to our total net loss for the three and nine
months periods ending May 31, 2003 and 2002.
Three Months Ended Nine Months Ended
May 31, May 31, May 31, May 31,
2003 2002 2003 2002
---- ---- ---- ----
Total company revenue $ 592,711 614,800 2,047,966 1,984,591
----------- ----------- ------------ ------------
Operating loss for
reportable segments (210,981) (122,580) (159,035) (390,926)
Unallocated corporate expenses (65,715) (30,346) (243,187) (181,259)
Interest income 5,715 5,867 16,170 12,893
Interest expense (3,970) (4,501) (12,184) (13,732)
Gain on sale of technology 45,296 - 145,256 -
Other, net 1,459 412 622 (6,980)
Deferred income tax expense - - 484,500 -
----------- ------------ ------------ ------------
Net loss $ (228,196) (151,148) (736,858) (580,004)
=========== ============ ============ ============
Loss per share:
Basic $ (0.02) (0.01) (0.06) (0.04)
Diluted (0.02) (0.01) (0.06) (0.04)
=========== ============ ============ ============
8
Total revenue for the three months ended May 31, 2003 was $592,711 compared to
$614,800 for the same quarter of fiscal year 2002, a decrease of $22,089 or 4%.
Total revenue for the nine months ended May 31, 2003 was $2,047,966 compared to
$1,984,591 for the same nine-month period of fiscal year 2002, an increase of
$63,375 or 3%.
Our net loss for the three months ended May 31, 2003 was $228,196 or $0.02 net
loss per share (basic and diluted), compared to a net loss of $151,148 or $0.01
net loss per share (basic and diluted) for the same quarter of fiscal 2002. The
increased net loss for the current fiscal year third quarter primarily resulted
from lower revenue, increased research and development expense, and higher
unallocated corporate costs due to a change in the timing of our annual
shareholder's meeting compared to the same quarter last year.
Our net loss for the nine months ended May 31, 2003 was $736,858 or $0.06 loss
per share (basic and diluted), compared to a net loss of $580,004 or $0.04 net
loss per share (basic and diluted) for the same period in fiscal 2002. The
current fiscal year nine-month net loss included net deferred income tax expense
of $484,500. See "Income Taxes" below for further discussion. Without the
effect of the net deferred income tax expense, the pre-tax loss for the nine
months ended May 31, 2003 was $252,358 compared to a pre-tax loss of $580,004.
The decline in pre-tax loss over the same period last year is attributable to
the effects of a workforce reduction and other cost control measures that were
implemented in November 2001 and the approximate $145,000 gain on sale of the
Virtual Scoring Technology to the newly formed LLC. See "Gain on Sale of
Technology" below for additional discussion.
Gain on Sale of Technology
- --------------------------
Upon formation of VSC Technologies, LLC during the current year first quarter we
realized a gain of approximately $155,000 upon transfer of the Virtual Scoring
Center technology to the LLC. During the three and nine month periods ended May
31, 2003, $45,296 and $145,256 of the gain was recognized as income in the
Condensed Statement of Operations, respectively. The remaining portion of the
gain was deferred and will be recognized in income periodically as the Company
fulfills its ongoing commitment to fund its 50% share of future Virtual Scoring
Center software development costs.
Income Taxes
- ------------
The income tax provision for the nine months ended May 31, 2003, included a
deferred tax benefit of $94,656 and an increase in the valuation allowance for
deferred tax assets of $579,156.
During the current fiscal year we increased our valuation allowance for deferred
tax assets and reduced our net deferred tax asset from $770,067 at August 31,
2002 to $160,190 at May 31, 2003. In order to fully realize our deferred tax
asset, net of the valuation allowance, prior to the expiration of our tax
operating loss carryforwards, we will have to generate approximately $425,000 in
taxable income through increased income from operations, the reversal of
deferred tax liabilities, or both. At May 31, 2003, we had approximately $2.3
million of tax operating loss carryforwards, of which approximately 78% do not
begin to expire until our fiscal year 2019.
We made the decision to reduce the carrying amount of our net deferred tax
assets during the second quarter of the current fiscal year because our ability
to time the closing of significant revenue opportunities has recently become
more difficult. Prior to the events of September 11, 2001, we began to see
improvement in our financial results with our operating losses becoming
significantly reduced over the prior two years. Subsequent to the events of
September 11, 2001, we experienced an immediate downturn in revenue, but made
adjustments to our cost structure to help mitigate the delay in closing several
revenue transactions which we believe resulted from the events of September 11,
2001, and the struggling national economy. Since that time and through the first
quarter of the current fiscal year, we began to experience revenue totals at a
level that we believe could be sustained and result in profitability for our
company. During the second and third quarters of the current year we
experienced another downturn in revenue and believe that the continuation of a
struggling national economy coupled with recent international conflicts,
including the war, is having an impact on the timing and amount of revenue that
we can expect from our current customers and prospects in both the private and
governmental sectors. Accordingly, we believe that a reduction in the carrying
amount of our net deferred tax assets is necessary to properly account for the
recent increased difficulties we have experienced in predicting the timing of
future revenue.
9
FINANCIAL CONDITION
Working capital at May 31, 2003 was $752,255 with a current ratio of 2.0:1,
compared to $805,049 with a current ratio of 2.0:1 at August 31, 2002.
Net cash provided by operations for the nine months ended May 31, 2003 was
approximately $482,000 compared to net cash used in operations of approximately
$181,000 for the same nine-month period last year. During the prior fiscal year
we paid approximately $97,000 in employee severance and unpaid vacation during
the prior year first quarter as well as approximately $93,000 in legal fees
associated with arbitration proceedings. The remaining use of operating cash
flow in the prior fiscal year nine-month period related to our operating loss
position resulting from downturn in revenue during the prior year first quarter.
The improved operating cash position for the current fiscal year nine-month
period is in large part attributable to the collection of a trade account for
the customer that represented approximately 13% of our component product
technology revenue during the first nine months of the current fiscal year and
an approximate $346,830 advance collection from that same customer for product
enhancements that we delivered during the current year third quarter that is
currently being tested by that customer and for which we expect final acceptance
during the fourth quarter of the current fiscal year.
Net cash provided by investing activities for the nine months ended May 31, 2003
approximated $51,000 and included the $250,000 in cash that we received upon
formation of VSC Technologies, LLC and a subsequent cash distribution from the
LLC of $200,000. Pursuant to the agreement with the LLC, for the first five
years of LLC operations we are eligible to receive cash distributions at the end
of each calendar year beginning on December 31, 2002. We are eligible for such
distributions, subject to certain maximum amounts which graduate downward over
the five year period, if our financial return from the LLC is not at least equal
to the amount of software development cost that we have invested in the LLC.
When and if the LLC becomes profitable, we will be required to pay back such
distributions by foregoing a portion of future cash profits from the LLC. The
$450,000 received pursuant to LLC items was offset by approximately $182,000 in
software development costs for investment in new and enhanced software products
and our approximate $183,000 cash investment for our share of LLC software
development and other operating costs. Net cash used in investing activities
for the nine months ended May 31, 2002 approximates $374,000 the majority of
which represents our investment in new and enhanced software products.
Net cash flows used in financing activities during the nine month periods ended
May 31, 2003 and 2002 primarily represent repayments of long-term debt and
approximated $22,000 and $15,000, respectively.
We have a line of credit with a bank for which borrowing is secured by and based
on a percentage of certain eligible trade accounts receivable. The maximum
borrowing under the line of credit is $1 million, of which approximately $87,000
was available to us at May 31, 2003, based on eligible trade accounts receivable
of $108,408. There was no balance outstanding against our line of credit at May
31, 2003.
The advanced payments by our customer for product enhancements, discussed in the
operating cash flow section above, along with the receipt of $450,000 in funds
related to the formation of VSC Technologies, LLC, has increased our cash
position during the first nine months of the current year and has contributed to
our ability to maintain a positive level of working capital even though we have
experienced operating losses over the past two years. The ability for us to
maintain an adequate level of working capital is currently dependent upon our
ability to become profitable through increased revenue, reduced expenses, or
both. Although our management is currently exploring various options for
improving the overall financial position of the Company, we can give no
assurance that we will be successful in such endeavors or that we will be able
to become profitable and thus maintain the necessary level of working capital to
adequately fund the continued development and promotion of our products.
Future Strategic Considerations
- -------------------------------
We have sustained losses in the last several fiscal years and losses have
continued into this fiscal year. Our revenues have been flat over that period of
time. Although we believe that our initiatives in Assessment Scoring
Technologies offer opportunities for revenue growth, there can be no assurance
that we will be successful in that market.
Additionally, the cost burden of being publicly-held is significant to a company
our size and that cost burden is difficult to justify if our company's business
is not growing rapidly.
Continued losses or lack of revenue growth may require that we consider
strategic alternatives in order to maximize value to our shareholders.
Options available to us could be a "going private" transaction, sale of the
Company and other possibilities. We have made no plans at this time to make any
proposals to our shareholders to address this situation, but we may find it
necessary in the future to do so.
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Impact of Recently Issued Accounting Standards
- ----------------------------------------------
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities". This
Interpretation sets forth guidance in determining whether certain equity
investments should be consolidated in situations in which an equity investor
does not have the characteristics of a controlling financial interest or does
not have a sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. We believe
that it is reasonably possible that our equity investment in VSC Technologies,
LLC, may qualify for consolidation in our financial statements in accordance
with this Interpretation. We have a 50% equity interest in the LLC to further
develop the Virtual Scoring Center technology and bring it to market through the
LLC. In general, the equity investor that is required to consolidate a variable
interest entity is the "primary beneficiary" of the entity and is the investor
that is expected to absorb the majority of its expected losses, receive a
majority of its expected residual returns, or both. We are in the process of
evaluating whether we qualify as the primary beneficiary of the LLC. If we are
required to consolidate the LLC in accordance with this Interpretation, it will
effect our fiscal year 2004 financial statements through a prospective
cumulative-effect adjustment as of the beginning of that year. The amount of
potential maximum exposure to loss as a result of our involvement with the LLC
is not currently determinable.
On June 11, 2003, the Financial Accounting Standards Board issued a Staff
Position about Accounting for Intellectual Property Infringement
Indemnifications under FASB Interpretation No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. As an element of our standard commercial terms, our
software license agreements include indemnification clauses that indemnify our
licensees against liability and damages (including legal defense costs) arising
from claims of patent, copyright, trademark or trade secret infringement by our
software. Such indemnification clauses constitute a guarantee subject to the
scope of Interpretation No. 45.
As discussed in the "Legal Proceedings" section below, we are party to a patent
infringement lawsuit involving the Virtual Scoring Center technology we
transferred to VSC Technologies, LLC. Subject to certain dollar limitations
and other conditions, we are indemnified for costs and any liability associated
with such lawsuit. In addition to financial exposure that may result if the
conditions for indemnification provided to us are not met, if the Virtual
Scoring Center technology is found to be infringing, we may also incur financial
exposure under indemnification clauses that we have provided to certain
licensees of the Virtual Scoring Center technology. Because this action is in
an early stage, we cannot estimate the extent of any potential damages if there
is a judgment against us. At present, there are no other claims of infringement
against any of our software products that would require us to fulfill guarantees
associated with indemnification clauses in our standard commercial software
license agreements.
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PART II - Other Information
Item 1. Legal Proceedings
We are a party to a lawsuit involving the Virtual Scoring Center technology we
transferred to VSC Technologies, LLC. On October 23, 2002, we, along with VSC
Technologies, LLC and Measurement Incorporated, filed an action in the United
States District Court for the Eastern District of North Carolina against NCS
Pearson, Inc. In the complaint, we and the other plaintiffs seek a declaratory
judgment that the Virtual Scoring Center technology owned by VSC Technologies,
LLC and marketed by Measurement Incorporated and us does not infringe twenty
patents belonging to NCS Pearson. On June 3, 2003, NCS filed their answer to
our complaint, along with a set of counterclaims that assert infringement of
thirteen of their patents.
We believe that the Virtual Scoring Center technology does not infringe the NCS
Pearson patents and we designed that technology to carefully avoid infringement,
but we cannot assure you that we will be successful in our claims or our defense
against NCS Pearson's counterclaims.
If the court rules that the Virtual Scoring Center infringes the NCS Pearson
patents and NCS Pearson prevails in their counterclaims, this could result in a
monetary judgment against us. Because this action is at an early stage, we
cannot estimate the extent of any potential damages if there is a judgment
against us.
An injunction against us and VSC Technologies, LLC would be severely damaging to
our business growth opportunities and our plans to exploit the Virtual Scoring
Center technology. Measurement Incorporated has agreed to indemnify us against
our costs and any liability arising in connection with the action against NCS
Pearson. But that indemnification responsibility has certain dollar limitations
and other conditions. Consequently, we may have financial exposure if we do not
prevail in this action and the conditions for indemnification are not met or our
costs and liability exceed the indemnification coverage.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99.1 Certification of Principal Executive Officer Pursuant to SEC Rule 13a-14
99.2 Certification of Principal Financial Officer Pursuant to SEC Rule 13a-14
99.3 Certification of Principal Executive and Financial Officers Pursuant to 18
U.S.C. Section 1350
(b) Reports on Form 8-K
None
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Registrant: TMS, Inc.
Date: July 10, 2003 /s/ Deborah L. Klarfeld
------------- -----------------------
Deborah L. Klarfeld, President
Principal Executive Officer
Date: July 10, 2003 /s/ Deborah D. Mosier
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Deborah D. Mosier, Chief Financial Officer
Principal Financial Officer
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