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: November 30, 1997 [ ]	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 	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 Number) incorporation or organization) 206 West Sixth Street Post Office Box 1358 Stillwater, Oklahoma 74075 (Address of principal executive offices) Issuer's telephone number, including area code: (405) 377-0880 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. Yes [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 November 30, 1997 Common stock, par value $.05 per share 13,283,906 Transitional Small Business Disclosure Format(check one): Yes [ ] No [X] 1 PART I - FINANCIAL INFORMATION Item 1. Financial Statements TMS, Inc. Condensed Balance Sheets November 30, 1997 and August 31, 1997 November 30, August 31, 1997 1997 _____________ _____________ Cash $ 509,861 426,174 Trade accounts receivable, net 1,194,933 1,235,195 Contract service work in process 1,015,980 579,137 Other current assets 266,331 322,291 ____________ ____________ Total current assets 2,987,105 2,562,797 ____________ ____________ Property and equipment 2,948,749 2,714,181 Accumulated depreciation and amortization (1,247,354) (1,167,738) ____________ ____________ Net property and equipment 1,701,395 1,546,443 ____________ ____________ Capitalized software development costs, net 515,524 499,444 Other assets 237,738 238,342 ____________ ____________ Total assets 5,441,762 4,847,026 ============ ============ Note payable 263,000 78,000 Accounts payable 336,958 247,123 Other current liabilities 504,733 442,765 ____________ ____________ Total current liabilities 1,104,691 767,888 Obligation under capital lease, net of current installments 69,919 0 Long-term debt, net of current installments 327,835 333,618 ____________ ____________ Total liabilities 1,502,445 1,101,506 ____________ ____________ Common stock 671,552 671,552 Additional paid-in capital 11,473,561 11,473,561 Unamortized deferred compensation (27,902) (30,048) Accumulated deficit (8,099,009) (8,290,660) Treasury stock (78,885) (78,885) _____________ ____________ Total shareholders' equity 3,939,317 3,745,520 _____________ ____________ Total liabilities and shareholders' equity $ 5,441,762 4,847,026 ============= ============ See accompanying notes to condensed financial statements. 2 TMS, Inc. Condensed Statements of Operations Three Months Ended November 30, 1997 and 1996 1997 1996 ____ ____ Revenue: Licensing and royalties $ 1,153,170 650,520 Software development services 452,764 429,338 Document conversion services 448,210 125,038 ____________ ____________ 2,054,144 1,204,896 ____________ ____________ Operating costs and expenses: Cost of licensing and royalties 206,173 251,238 Cost of software development services 227,646 206,454 Cost of document conversion services 272,359 107,082 Selling, general and administrative expenses 1,100,415 808,351 ____________ ____________ 1,806,593 1,373,125 ____________ ____________ Operating (loss) income 247,551 (168,229) Other (expense) income, net (11,031) 11,817 ____________ ___________ Income (loss) before income taxes 236,520 (156,412) Income tax expense 44,869 800 ____________ ___________ Net income (loss) $ 191,651 (157,212) ============ =========== Net income (loss) per common and common equivalent share $ 0.01 (0.01) ============ =========== Weighted average common and common equivalent shares 13,827,933 13,312,717 ============ =========== See accompanying notes to condensed financial statements. 3 TMS, Inc. Condensed Statements of Cash Flows Three Months Ended November 30, 1997 and 1996 1997 1996 ____ ____ Net cash flows provided by (used in) operating activities $ 155,663 (21,696) ___________ ___________ Cash flows from investing activities: Purchases of property and equipment (137,962) (32,056) Capitalized software development costs (111,833) (78,336) Patent costs 0 (4,128) Proceeds from sale of equipment 0 7,245 ___________ __________ Net cash used in investing activities (249,795) (107,275) ___________ __________ Cash flows from financing activities: Repayment of long-term debt (7,181) (5,098) Proceeds from short-term note payable 185,000 0 Repayments of short-term note payable 0 0 Issuance of common stock 0 35,750 ___________ __________ Net cash provided by (used in) financing activities 177,819 30,652 ___________ __________ Net increase (decrease) in cash 83,687 (98,319) Cash at beginning of period 426,174 546,745 ___________ __________ Cash at end of period $ 509,861 448,426 =========== ========== See accompanying notes to condensed financial statements. 4 TMS, Inc. Notes to Condensed Financial Statements Unaudited Interim Condensed Financial Statements The unaudited interim condensed financial statements and related notes were prepared by TMS, Inc.(the Company). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to rules and regulations established by the Securities and Exchange Commission (SEC). The accompanying unaudited interim condensed financial statements should be read in conjunction with the audited financial statements and related notes included in the Company's Form 10-KSB Annual Report for the fiscal year ended August 31, 1997. 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. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 	 RESULTS OF OPERATIONS This analysis of the Company's results of operations and financial condition contains certain forward-looking statements regarding the Company's business and prospects that are based upon numerous assumptions about future conditions which may ultimately prove to be inaccurate and actual events and results may materially differ from anticipated results described in such statements. The Company's ability to achieve such results is subject to certain risks and uncertainties, such as those inherent generally in the computer software industries and the impact of competition, pricing and changing market conditions. The Company disclaims, however, any intent or obligation to update these forward-looking statements. As a result, the reader is cautioned not to place reliance on these forward-looking statements. Revenue Total revenue for the first quarter of fiscal 1998 was $2,054,144 compared to $1,204,896 for the same quarter of fiscal 1997, an increase of $849,248 or 70%. Licensing and royalties revenue for the first quarter of fiscal 1998 increased $502,650, or 77%, over licensing and royalties revenue for the same quarter of fiscal 1997. First quarter revenue from imaging products increased $400,678, or 125%, over the same period last year. Approximately 70% of the increase in imaging revenue resulted from sales of the Prizm Plug-in product that was released early in the second quarter of fiscal 1997 and targets corporate intranet and Internet users. The remaining 30% of the increase was primarily attributable to additional royalties from customers that use the Company's ViewDirector product. First quarter revenue from image enhancement products (e.g. ScanFix, FormFix) increased $71,780, or 27%, over last year. Increased revenue for image enhancement occurred across all major product lines and is primarily attributable to two additional salespersons that the Company hired late in fiscal 1997 to focus on image enhancement sales and a joint marketing program with Caere Corporation, a leader in Optical Character Recognition (OCR) technology. Caere uses the Company's ScanFix technology as part of their OCR product offerings. 5 Software development service revenue for the first quarter of fiscal 1998 was $452,764 compared to $429,338 for the first quarter of fiscal 1997, an increase of $23,426 or 5%. At November 30, 1997, the Company had a software development service revenue backlog of approximately $580,000. Document conversion service revenue for the first quarter of fiscal 1998 was $448,210 compared to $125,038 for the first quarter of fiscal 1997, an increase of $323,172, or 258%. Approximately 55%, or $245,000, of the first quarter document conversion service revenue came from one customer. The Company expects that services to this customer will be substantially complete early in the second quarter, but has secured another contract that will help replace the level of revenue reported for the first quarter. At November 30, 1997, the Company had a document conversion service revenue backlog of approximately $665,000. Operating Costs and Expenses Total operating costs and expenses for the quarter ended November 30, 1997, were $1,806,593 compared to $1,373,125 for the same quarter in fiscal 1997, an increase of $433,648 or 32%. The cost of licensing and royalties decreased $45,065, or 18%, for the first quarter of fiscal 1997, compared to the same period a year ago. The gross profit margin for licensing and royalties was 82% and 61% for the three months ended November 30, 1997 and 1996, respectively. The increase in gross profit margin is partially attributable to the 36% increase in royalty revenue, which results in little or no cost to the Company. Additionally, the Company has expanded product offerings by using its toolkits to build complete software applications to address an expanding marketplace of software users. First quarter revenue from complete software applications was mostly derived from companies purchasing licenses to install multiple copies of the Company's software throughout their organizations. Revenue from multiple licenses does not result in a proportional increase in unit costs and thus had a significant impact on the Company's first quarter gross margins. The cost of software development services increased $21,192, or 10%, for the first quarter of fiscal 1998, compared to the same period a year ago. The gross profit margin for software development services was 50% and 52% for the three months ended November 30, 1997 and 1996, respectively. The cost of document conversion services increased $165,277, or 154%, for the first quarter of fiscal 1998, compared to the same period a year ago. The gross profit margin for document conversion services was 39% and 14% for the three months ended November 30, 1997 and 1996, respectively. The increase in cost represents the hiring of additional personnel to meet service contract requirements. The increase in gross profit margin is the result of the document conversion group operating at or near full capacity during the fiscal 1998 first quarter. In the prior year first quarter, the Company was in the process of rebuilding its service backlog and had to maintain a certain number of employees and level of overhead to be responsive to new opportunities. Selling, general and administrative expenses for the first quarter of fiscal 1998 increased $292,064, or 36%, when compared to the first quarter of fiscal 1997. The increase in costs is almost entirely due to personnel related expenses. As mentioned in the Company's 10-KSB for the fiscal year ending August 31, 1997, the Company made several market adjustments to salaries in addition to regular merit and cost of living increases. The Company also improved employee benefit offerings by implementing a 401(k)-retirement plan matching program and absorbing 25% more of the cost of employee medical insurance premiums. The majority of these changes occurred at the beginning of the fiscal 1997 third quarter. During the first quarter of fiscal 1998, the Company implemented an incentive compensation plan that provides cash rewards to all employees if certain revenue and profit goals are achieved. The Company recognized approximately $45,000 related to the incentive plan during the fiscal 1998 first quarter. All of the increases in personnel related costs were deemed necessary to retain and attract competent technical, sales/marketing and management staff. Management expects the employment environment will continue to remain competitive, which may adversely impact future earnings through increased costs. 6 Income Taxes Deferred tax expense of $89,878 for the quarter ended November 30, 1997, was offset by deferred tax benefit of approximately $45,000 attributable to the decrease in the valuation allowance for deferred tax assets. The Company assesses the realizability of deferred tax assets at least quarterly, and adjusts the valuation allowance to reflect the future benefits that will more likely than not be realized from those deferred tax assets. Net Income/Loss Net income for the first quarter of fiscal 1998 was $191,651 or $.01 per share, compared to a net loss of $157,212, or $.01 per share, for the first quarter of fiscal 1997. The 70% increase in revenue resulting in improved gross margins for licensing and royalties and document conversion services, were the primary factors that resulted in a significant improvement in earnings over the prior year. FINANCIAL CONDITION Working capital, at November 30, 1997 was $1,882,414 with a current ratio of 2.7:1 compared to $1,794,909 with a current ratio of 3.3:1, at August 31, 1997. Net cash provided by operations for the three months ended November 30, 1997 was $155,663 compared to net cash used in operations of $21,696 for the same period last year. The current quarter pre-tax profit was the primary reason for improved operating cash flow over the same period last year. Net cash used in investing activities for the first three months of fiscal 1998 was $249,795 compared to $107,275 for the same period in fiscal 1997. The increase in investing activities primarily relates to additional equipment needed to meet requirements under document conversion service contracts. During the quarter ended November 30, 1997, the Company borrowed $185,000 against its $800,000 line of credit for general operating purposes. This resulted in a balance of $263,000 outstanding against the line of credit at November 30, 1997. The Company also entered into a $100,000 capital lease obligation to obtain the scanners needed to meet requirements under document conversion contracts. The Company believes that operating cash flow and the $800,000 operating line of credit will be adequate to meet its current obligations and current operating and capital requirements. The funding of long-term needs is dependent upon increased revenue and profitability and obtaining funds through outside debt and equity sources. The funding for long-term needs includes funding for increased product development, expanded sales and technical staff and adequate promotion of the Company and its products. PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K Reports on Form 8-K None Exhibits Exhibit No. Name of Exhibit 27	Financial Data Schedule as of and for the three month period ending November 30, 1997. 7 SIGNATURES 	 In accordance with the requirements of the Exchange Act, the registrant caused the report to be signed on its behalf by the undersigned, thereunto duly authorized. TMS, Inc. January 8, 1998 /s/ Arthur D. Crotzer Date: ____________________ _______________________ Chief Executive Officer January 8, 1998 /s/ Deborah D. Mosier Date: ____________________ _______________________ Chief Financial Officer