UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT of 1934.
For the quarterly period ended June 30, 1999
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from ________, 19__, to _______, 19__.
Commission File Number: 0-22991
CUSIP NUMBER 64121L 10 3
NETWORK SYSTEMS INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Charter)
Nevada 87-0460247
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
200 North Elm Street, Greensboro, North Carolina 27401
(Address of Principal Executive Offices, Including Zip Code)
(336) 271-8400
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the Registrant was
required to file such reports), and has been subject to such
filing requirements for the past 90 days.
X YES ___ NO
There were 7,768,254 shares of the Registrant's $.001 par
value common stock and 4,035 shares of Registrants $.001 par
value preferred stock outstanding as of June 30, 1999.
Transitional Small Business Format (check one) Yes __ No X
NETWORK SYSTEMS INTERNATIONAL, INC.
Contents
Part I - Financial Information Page
Item 1. Consolidated Financial Statements
Consolidated Balance Sheet 3
Consolidated Statements of Operations
Three months ended June 30, 1999 and 1998 4
Nine months ended June 30, 1999 and 1998 5
Consolidated Statements of Cash Flow
Nine months ended June 30, 1999 and 1998 6
Consolidated Statement of Changes in
Stockholders' Equity 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
Part II
Item 1. Legal Proceedings 19
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
Exhibit Index 21
Item 1. Financial Statements
Network Systems International, Inc. and Subsidiaries
Consolidated Balance Sheet
June 30, 1999
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ 162,007
Accounts receivable, trade, net of
allowance of $688,000 3,379,583
Contracts receivable, net of allowance
of $62,000 1,342,478
Accounts receivable, related parties 112,691
Note receivable, current 30,000
Income tax receivable 272,024
Other current assets 112,016
Total current assets 5,410,799
Property and equipment, net of accumulated
depreciation 1,561,385
Other Assets:
Note receivable, net of current portion 93,911
Software development costs, net of
accumulated amortization 3,036,733
Excess of costs over net assets
acquired, net of accumulated
amortization 4,453,333
Other 330,937
Total other assets 7,914,914
Total assets $ 14,887,098
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade $ 1,971,285
Notes payable, current 35,000
Capital lease obligation, current 88,000
Other accrued liabilities 204,791
Unearned revenue 759,146
Revolving credit agreement, current
portion 200,000
Total current liabilities 3,258,222
Long Term Liabilities:
Revolving credit agreement 3,500,000
Deferred income taxes 975,725
Notes payable, net of current maturities 297,713
Capital lease obligation, net of
current maturities 41,317
Total long term liabilities 4,814,755
Stockholders' Equity:
Preferred Stock; $.001 par value;
authorized 12,500 shares; issued and
outstanding 4,035 shares 4
Common Stock; $.001 par value; authorized
100,000,000 shares; issued and outstanding
7,768,254 shares 7,768
Capital in excess of par value 3,377,996
Retained earnings 3,428,353
Total stockholders' equity 6,814,121
Total liabilities and stockholders' equity $14,887,098
The accompanying notes are an integral part of the
consolidated financial statements.
Network Systems International, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
Three Months Ended June 30,
1999 1998
Revenue:
Licensing and servicing revenue $ 2,379,948 1,718,295
Equipment revenue 2,198,966 1,703,906
Total revenue 4,578,914 3,422,201
Operating expenses:
Cost of sales and services 2,576,832 1,815,554
Research and development 861,977 485,743
Sales, general and administrative 1,339,911 330,017
Total operating expenses 4,778,720 2,631,314
Operating income (loss) (199,806) 790,887
Other income (expenses)
Interest, net 10,550 17,309
Other, net (9,980) 1,618
Total other income 570 18,927
Income (loss) before income tax
provision (benefit) (199,236) 809,814
Income tax provision (benefit) 48,800 263,100
Net income (loss) $ (248,036) 546,714
Dividends on preferred shares 10,125 18,388
Net income (loss) applicable to
common shares (258,161) 528,326
Earnings (loss) per common share $ (.03) $ .07
Earnings (loss) per common share-
Assuming dilution $ (.03) $ .07
The accompanying notes are an integral part of the consolidated
financial statements.
Network Systems International, Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)
Nine Months Ended June 30,
1999 1998
Revenue:
Licensing and servicing revenue $ 6,855,489 $ 5,559,667
Equipment revenue 4,906,158 4,288,249
Total revenue 11,761,647 9,847,916
Operating expenses:
Cost of sales and services 5,519,534 4,796,141
Research and development 1,830,838 1,436,037
Sales, general and administrative 2,609,719 1,009,740
Total operating expenses 9,960,091 7,241,918
Operating income 1,801,556 2,605,998
Other income (expenses)
Interest, net 28,280 31,037
Other, net (8,999) 16,624
Total other income 19,281 47,661
Income before income tax provision 1,820,837 2,653,659
Income tax provision 812,300 918,600
Net income $ 1,008,537 1,735,059
Dividends on preferred shares 39,468 73,289
Net income applicable to common shares 969,069 1,661,770
Earnings per common share $ .13 $ .22
Earnings per common share-
Assuming dilution $ .13 $ .22
The accompanying notes are an integral part of the
consolidated financial statements.
Network Systems International, Inc. and Subsidiaries
Consolidated Statements of Cash Flow
(Unaudited)
Nine Months Ended June 30,
1999 1998
OPERATING ACTIVITIES
Net income $ 1,008,537 $ 1,735,059
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 1,329,967 1,231,349
Promotional fees paid with stock - 72,000
Compensation expense on stock options 85,938
Provision for bad debts 250,000 273,014
Change in operating assets and
liabilities:
Accounts receivable and
contracts receivable (1,185,288) (2,694,204)
Prepaid assets, other
receivables, and other assets (70,730) 264,280
Income tax receivable (252,399) 318,476
Accounts payable and accrued
liabilities 1,146,137 1,462,686
Unearned revenue 428,668 41,977
Deferred income taxes 508,725 (226,300)
Total adjustments 2,241,018 743,278
Net cash provided by operating activities 3,249,555 2,478,337
INVESTING ACTIVITIES
Acquisition of property and equipment (515,499) (354,957)
Software development capitalized (2,782,916) (897,550)
Issuance of note receivable - (200,000)
Payment received on note receivable 17,362 220,432
Increase in cash surrender value
of life insurance (180,925) (34,473)
Acquisition of Vercom, net of
purchased research and development (4,463,220) -
Net cash (used in) investing
activities (7,925,198) (1,266,548)
FINANCING ACTIVITIES
Payment on notes payable and
capital lease obligations (51,776) (76,137)
Proceeds (payments) on revolving
credit agreement 3,700,000 (131,382)
Dividends paid (39,468) (73,289)
Net cash provided by (used in)
financing activities 3,608,756 (280,808)
Net (decrease) increase in cash and
cash equivalents (1,066,887) 930,981
Cash and cash equivalents at October 1: 1,228,894 491,413
Cash and cash equivalents at June 30: $ 162,007 1,422,394
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION AND NONCASH INVESTING AND
FINANCING ACTIVITIES
Cash paid during the period for:
Interest $ 25,600 $ 33,740
Taxes $ 1,084,800 $ 600,124
The accompanying notes are an integral part of the
consolidated financial statements.
Network Systems International, Inc. and Subsidiaries
Consolidated Statement of Changes in Stockholders' Equity
Nine Months ended June 30, 1999
(Unaudited)
Common Stock Preferred Stock
Number $.001 Number $.001 Capital Retained Total
of Par of Par in excess Earnings
Shares Value Shares Value of par
value
Balance
October 1,
1998 7,661,754 $7,662 6,100 $ 6 $3,292,162 $2,459,284 $ 5,759,114
Issuance of
common stock 3,250 3 - - (3) - -
Conversion
of
preferred
stock 103,250 103(2,065) (2) (101) - -
Compensation
related to
grant
of stock
options - - - - 85,938 - 85,938
Dividends on
preferred
stock - - - - - (39,468) (39,468)
Net Income for
the nine
months ended
June 30, 1999 - - - - - 1,008,537 1,008,537
Balance June
30, 1999 7,768,254 $7,768 4,035 $ 4 $3,377,996 $3,428,353 $6,814,121
The accompanying notes are an integral part of the
consolidated financial statements.
Network Systems International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
A. Summary of Significant Accounting Policies
Organization and Basis of Presentation
Network Systems International, Inc. (the "Company"), a
Nevada corporation, is a vertical market company that is the
developer of the net collection(tm) and Primac software
systems. These products represent the premier suites of
supply chain management and enterprise-wide software
products for the textile, apparel, home furnishing, and
printing industries. The Company also offers hardware
products, consulting and implementation services providing a
complete solution to its customer's technology needs.
The Company and its four wholly owned subsidiaries: Network
Information Services, Inc. ("NIS"), Network Investment
Group, Inc. ("NIG"), Network Systems International, Inc. of
North Carolina ("NESI-NC") and Vercom Software Inc.
("Vercom") (see Note C) employs approximately 105 full-time
associates. The Company is headquartered in Greensboro,
North Carolina with offices in Dallas, Texas and Greenville,
South Carolina. All intercompany transactions have been
eliminated in consolidation.
On July 10, 1998 the Company was officially approved for
listing on NASDAQ and the Company's common stock began
trading on NASDAQ Small Cap under the symbol NESI on that
date.
Basis of Preparation:
The financial statements consolidate the accounts of Network
Systems International, Inc. and its wholly owned
subsidiaries Network Information Services, Inc., Network
Investment Group, Inc., Network Systems International, Inc.
of North Carolina and Vercom Software, Inc.
The preparation of financial statements in conformity with
generally accepted accounting principles requires management
to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and
accompanying notes. Actual results could differ from those
estimates.
The interim financial information included herein is
unaudited. Certain information and footnote disclosures
normally included in the financial statements have been
condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission (SEC), although
the Company believes that the disclosures made are adequate
to make the information presented not misleading. These
consolidated financial statements should be read in
conjunction with the consolidated financial statements and
related notes contained in the Company's Form 10-KSB filed
with the SEC on December 29, 1998. Other than indicated
herein, there have been no significant changes from the
financial data published in those reports. In the opinion
of management, such unaudited information reflects all
adjustments, consisting only of normal recurring accruals
and other adjustments, necessary for a fair presentation of
the unaudited information.
Results for interim periods are not necessarily indicative
of results expected for the full year.
Certain prior year amounts have been reclassified to conform
to the current year presentation.
B. Significant Accounting Policies
Software Development Cost:
The Company capitalizes the direct costs and allocated
overhead associated with the development of software
products. Initial costs are charged to operations as
research and development prior to the development of a
detailed program design or a working model. Capitalization
of computer software development costs begins upon the
establishment of technical feasibility for the product.
Costs incurred subsequent to the product release are charged
to operations. Capitalized software development costs
amounted to $1,382,915 and $897,550 for the nine months
ended June 30, 1999 and 1998, respectively. As part of the
Vercom acquisition, the Company recorded $1,400,000 in
software development costs.
Amortization of capitalized computer software development
costs begins when the products are available for general
release to customers, and is computed on a straight-line
basis over the economic life. The Company has estimated
that the useful economic life of its products is two to five
years. Amortization expense of capitalized software cost
amounts to $1,169,977 and $1,102,251 for the nine months
ended June 30, 1999 and 1998, respectively, and is included
in research and development.
Revenue Recognition:
The Company's revenue is recognized in accordance with the
American Institute of Certified Public Accountants Statement
of Position Number 97-2 "Software Revenue Recognition".
Revenue consists of primarily the following:
Revenue from the sale of software licenses is
recognized after shipment and fulfillment of all major
obligations under the terms of the licensing agreements.
The licensing agreements are typically for the use of
Company products and are usually restricted by the number of
copies, the number of users and the term.
Revenues from fixed price contracts are recognized
using the percentage-of-completion method, measured by
direct hours. Contract costs include direct labor combined
with allocations of operational overhead and other
direct costs. Provisions for estimated losses on
uncompleted contracts are made in the period in which
such losses are determined. Changes in job performance,
job conditions and estimated profitability that may result
in revisions to costs and revisions, are recognized in
the period in which the revenues are determined.
For the nine months ended June 30, 1999, there were no
revenues from fixed priced contracts.
Support agreements generally call for the Company to
provide technical support and certain software updates
to customers. Revenue on support and software updates
is recognized ratably over the term of the support
agreement.
The Company provides consulting and educational
services to its customers. Revenue from such services
is generally recognized as the services are performed.
Hardware revenue is recognized when the product is
shipped to the customer.
Earnings Per Share:
Basic earnings per share is computed using the weighted
average number of common shares outstanding during the
period. Diluted earnings per share reflect the potential
dilution from the exercise or conversion of preferred stock
and stock options into common stock using the "treasury
stock" method.
The following data shows the amounts used in computing
earnings per share and the effect on income and the weighted
average number of shares of dilutive potential common stock.
Three months ended
June 30,
1999 1998
Net income (loss) $ (248,036) 546,714
Less preferred stock dividends (10,125) (18,388)
Income (loss) applicable to
common shares (258,161) 528,326
Preferred stock dividends 10,125 18,388
Income (loss) applicable to
common shares after assumed
conversion of dilutive securities (248,036) 546,714
Weighted average number of common
shares used in basic EPS 7,757,260 7,545,553
Effect of dilutive convertible
preferred stock and stock options 230,451 383,701
Weighted average number of common
shares and dilutive potential
common shares used in diluted EPS 7,987,711 7,929,254
Nine months ended
June 30,
1999 1998
Net income $ 1,008,537 1,735,059
Less preferred stock dividends (39,468) (73,289)
Income applicable to common
shares 969,069 1,661,770
Preferred stock dividends 39,468 73,289
Income applicable to common
shares after assumed conversion
of dilutive securities 1,008,537 1,735,059
Weighted average number of common
shares used in basic EPS 7,700,320 7,398,110
Effect of dilutive convertible
preferred stock and stock options 273,420 515,485
Weighted average number of common
shares and dilutive potential
common shares used in diluted EPS 7,973,740 7,913,595
C. Business Combinations
On June 16, 1999, the Company acquired all of the
outstanding capital stock of Vercom Software, Inc.
("Vercom") a vertical market company offering a specialized
software solution for the complex requirements of the
printing industry for $6.8 million in cash. The Company
funded this acquisition through cash provided by operating
activities and bank borrowings (see Note D).
The Vercom acquisition has been accounted for by the
purchase method of accounting in accordance with APB 25
"Business Combinations" and, accordingly, the results of
operations of Vercom for the period from June 17, 1999 to
June 30, 1999 are included in the accompanying consolidated
financial statements. Assets acquired and liabilities
assumed have been recorded at their estimated fair values.
In addition, approximately $300,000 of the purchase price
was allocated to purchased in-process research and
development, which was charged to Research and Development
expense for the period ended June 30, 1999. Accordingly,
the Company recorded a non-recurring charge for this
purchased in-process research and development at the date of
acquisition. The excess cost over the estimated fair value
of net assets acquired and the purchased in-process research
and development was approximately $4.5 million of goodwill
and will be amortized on a straight-line basis over its
estimated useful life.
The following unaudited pro forma information presents the
results of operations of the Company as if the acquisition
had taken place on October 1, 1998 and excludes the write-
off of purchased in-process research and development of
$300,000.
Nine months ended
June 30, 1999
Revenues $ 15,268,733
Net earnings 1,577,850
Earnings per share .20
These pro forma results of operations have been prepared for
comparative purposes only and do not purport to be
indicative of the results of operations which actually would
have resulted had the acquisition occurred on the date
indicated, or which may result in the future.
D. Long Term Debt
Note Payable
On January 21, 1999, the Company refinanced the mortgage on
its corporate office building. Monthly principal payments
on the new note are $2,896 plus interest at a fixed rate of
7.53% through January 2009. The building and substantially
all equipment collateralize the note. The note agreement
contains a covenant with respect to consolidated cash flow,
with which the Company was in compliance at June 30, 1999.
Aggregate maturities of note payable as of June 30, 1999
were as follows: 1999 - $35,000; 2000 - $35,000; 2001 -
$35,000; 2002 - $35,000; 2003 - $35,000; thereafter -
$157,713.
Revolving Credit Agreement
On June 16, 1999, the Company, in conjunction with the
acquisition Vercom Software, Inc., entered into a $4,500,000
revolving credit agreement with a bank which provided funds
to finance the acquisition (see Note C) and working capital
needs. As of June 30, 1999, the Company had $3,700,000
outstanding on this revolving credit agreement. The credit
agreement provides for interest at the Monthly LIBOR Index
plus 2.50% to 3.10% based on the Company's Consolidated Cash
Flow/Consolidated Funded Debt ratio. The revolver has the
following declining availability: $4.5 million through
September 30, 1999; $4.0 million through December 30, 1999;
$3.5 million through June 30, 2000; and $3.0 million through
June 30, 2001. The credit facility is collateralized by
substantially all of the assets of the Company. The term
of this agreement is for two years ending June 30, 2001 at
which time all unpaid principal and interest is due. The
credit facility includes financial covenants that impose
restrictions with respect to the maintenance of Consolidated
Cash Flow to Consolidated Funded Debt and Consolidated
Liabilities to Consolidated liabilities to consolidated
Tangible Net Worth that begins September 30, 1999.
E. Major Customers
For the three months ended June 30, 1999, sales to two
customers amounted to approximately $2,946,000. For the
three months ended June 30, 1998, sales to two customers
amounted to approximately $1,907,000. For the nine months
ended June 30, 1999, sales to one customer amounted to
approximately $6,740,000. For the nine months ended June
30, 1998, sales to two customers amounted to approximately
$4,041,000. The June 30, 1999 and 1998 accounts receivable
balances from these customers were approximately $1,928,000
and $2,109,000 respectively.
F. Stock Options
Employee Incentive Stock Option Agreements
Effective April 13, 1999, the Company granted 201,000 shares
in incentive stock options to its employees under the
Company's qualified Incentive Stock Option Plan. Under the
terms of the plan, the options will vest equally over a four-
year period, as long as the employees remain employed with
the Company. The options were granted at $4.00 per share,
the fair market value at April 13, 1999. As of June 30,
1999 none of the granted shares have vested.
Pursuant to SFAS #123 "Accounting for Stock Based
Compensation", the Company has elected to account for its
employees stock option plan under Accounting Principles
Board Opinion 25, "Accounting for Stock Issued to
Employees". No compensation cost was recognize since the
exercise price was equal to the market price of the
underlying stock on the date of grant.
Executive Employment Agreement
On April 15, 1999 the Company entered into an employment
agreement with an executive of the Company. Among other
things, the agreement provides the executive a stock option
arrangement of 500,000 shares of the Company's stock to be
purchased at $1 and vest equally over a four-year period.
The fair market value of the Company's stock at the date of
the agreement was $3.75. During the quarter ended June 30,
1999, the Company recognized a non-cash compensation expense
of approximately $86,000. The Company will recognize this
non-cash compensation expense ratably each quarter for the
next four years based on this agreement.
G. Commitments
On June 1, 1999, the Company entered into a five year
consulting agreement with a former officer of the Company.
Among other things, the consultant has the right to sell
10,000 shares of restricted Company stock owned by the
consultant back to the Company each quarter. The Company
has the obligation to purchase those shares for four dollars
per share upon notification by the consultant. The
consultant, however, can elect to sell the quarterly
allotment on the open market relieving the Company of its
obligation to purchase the shares. The consultant may elect
to extend the term of the Company's obligation an additional
eight years or until a total of 500,000 shares have been
sold to the Company and/or on open market. During the
quarter ending June 30, 1999, the Consultant has placed all
amounts in the open markets.
H. Litigation
On June 17, 1999, the Company agreed to pay a former
customer $500,000 for full settlement of a dispute over fees
paid for licensing and servicing. The settlement payments
are to be paid out over a period of nine months with a final
payment due March 31, 2000. The Company has recorded the
entire settlement in the current quarter to general and
administrative expense.
The Company is currently and will continue to be involved in
routine legal proceedings that are incidental to the
business. In the opinion of management these routine
proceedings will not have a material adverse effect on the
Company's financial position or overall results of
operations.
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
FORWARD LOOKING INFORMATION
THIS MD&A CONTAINS FORWARD LOOKING INFORMATION. EXCEPT FOR
HISTORICAL DATA, THE MATTERS DISCUSSED IN THIS FORM 10-QSB
CONTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISK AND
UNCERTAINTIES.
The Company would caution readers that in addition to the
important factors described elsewhere in this Form 10-QSB,
the following may contain forward looking statements that
involve risk and uncertainties, including without
limitations, continued acceptance of the Company's products
and services, increased levels of competition, new products
and technological changes, the Company's dependency on
financing third party suppliers, intellectual property
rights, material customers, the Company's business
concentration risks within the textile and printing
industries, business combinations, and other risks. The
Company's actual consolidated financial results during 1999,
and beyond, could differ materially from those expressed in
any forward looking statements made by, or on behalf of, the
Company. The Company undertakes no obligation to publicly
revise these forward-looking statements to reflect events
and circumstances that arise after the date hereof.
RESULTS OF OPERATIONS
Results of the Company's newly acquired subsidiary, Vercom
Software Inc., are included in the financial statements
since its June 16, 1999 acquisition date. These results are
insignificant to the results of the Corporation for the
period presented.
The Company has reclassified certain costs to more
accurately reflect the proper classification of these costs.
All periods presented reflect these reclassifications.
Revenue. Total revenue for the three-month period ended
June 30, 1999 was $4,578,914. This revenue represents a 34%
increase over the Company's revenues for the three-month
comparable period in 1998. For the nine-month period ended
June 30, 1999, revenues were $11,761,647 as compared to
$9,847,916 for the same nine-month period in fiscal 1998, a
19.4% increases.
In the area of licensing and services revenues, the Company
experienced an increase of approximately 38% to $2,379,948
at the June 30, 1999 quarter end as compared to $1,718,295
in the same period ending 1998. During the nine-month period
ended June 30, 1999, licensing and services revenues
increased approximately 23% from $5,559,667 in fiscal 1998
to $6,855,489 in 1999. These increases are primarily
attributable to increases in service revenues. The software
industry as a whole, including the Company, anticipates a
temporary slowdown in sales of licenses and hardware as its
customers focus on their Year 2000 readiness and defer
purchases until year 2000.
Hardware revenue for the three-month period ended June 30,
1999 was $2,198,966 as compared to $1,703,906 or a 29%
increase over the same period in 1998. For the nine-month
period ended June 30, 1999, hardware revenues increased
approximately 14% from $4,288,249 in fiscal 1998 to
$4,906,158 in 1999. This increase in hardware revenue is
directly attributable to customer upgrades and increased
demand for radio frequency technology. Hardware revenues
will continue to be directly proportionate to software
licensing as the Company typically sells the majority of
hardware technology to its customers within a few months of
signing a licensing agreement.
Licensing and service revenue amounted to 52% of total
revenues for the Company compared to hardware revenues of
48% for the quarter ended June 30, 1999, and 58% and 42% for
the nine-months ended June 30, 1999.
Cost of Sales and Services. Cost of sales and services
amounted to $2,576,832 or 56% of total revenue during the
quarter ended June 30, 1999 as compared to $1,813,554 or 53%
of total revenue for the comparable period in fiscal 1998.
During the nine-month period, cost of sales and services
were $5,519,534 or 47% of total revenue in 1999 compared to
$4,796,144 or 49% in 1998. Margins vary based upon the mix
of revenues derived from software licenses, services and
hardware.
Software Development Costs. Software development costs
capitalized amounted to approximately $394,000 and $336,000
for the quarters ended June 30, 1999 and 1998, respectively.
During the nine-month period, software development costs
capitalized amounted to approximately $1,383,000 in fiscal
1999 as compared to $898,000 in 1998. The increase is
attributable to new development of products, technologies,
and enhancements. Additionally, as part of the Vercom
acquisition, the Company recorded $1,400,000 in software
development costs. It is anticipated that the Company will
continue software development at the current rate both
capitalized and expensed.
Sales, General and Administrative. Sales, general and
administrative expenses were 29% of revenue for the quarter
ended June 30, 1999 as compared to 10% in the comparable
period 1998. During the nine-month period ended June 30,
1999, sales, general and administrative expenses were 22%
compared to 10% for 1998. The Company incurred several one-
time charges that significantly increased sales, general and
administration for quarter ended June 30, 1999. These
charges include $130,000 for acquisition related costs,
$500,000 for a settlement of a dispute with a former
customer and $70,000 for other miscellaneous expenses.
Excluding these one-time costs, sales, general and
administrative expenses were 14% of revenue for the quarter
ended June 30, 1999 and 16% of revenue for the nine-months
ended June 30, 1999.
Research and Development. Research and development amounted
to $861,977 or 19% of total revenue during the quarter ended
June 30, 1999 as compared to $485,743 or 14% for the
comparable period in fiscal 1998. During the nine-month
period, research and development was $1,830,838 or 16% of
total revenue in 1999 compared to $1,436,037 or 15% in 1998.
During the quarter ended June 30, 1999, the Company wrote
off $300,000 of purchased in-process research and
development in connection with the acquisition of Vercom
Software, Inc.
Provisions for Income Taxes. The income tax provision for
the nine-months ended June 30, 1999 and June 30, 1998 was $
812,300 and $918,600, respectively. This represents an
effective tax rate of 45% and 35%, for the same periods. The
higher tax rate in 1999 is due to the write-off of purchased
in-process research and development that the Company does
not receive a tax benefit from.
Quarterly Results. Net income (loss) for the three months
ended June 30, 1999 and 1998 was $(248,036) and $546,714,
respectively. For the nine-month period, net income was $
1,008,537 in fiscal 1999 and $1,735,059 for 1998. On a per
share basis, earnings (losses) were $(.03) and $.07 for the
three months ended June 30, 1999 and 1998, respectively.
Per share earnings are $.13 for the nine-months ending June
30, 1999 in comparison to $.22 for the nine-months ending
June 30, 1998. The decrease in earnings is directly related
to the one-time charges the Company incurred during the
third quarter as described in the sales, general and
administrative and research and development notes above.
Without the one-time charges, the Company's earnings per
share would have been (tax adjusted) $ .06 for the quarter
ended June 30, 1999 and $ .22 for the nine months ended
June 30, 1999.
Liquidity and Capital Resources. Cash and Cash Equivalents
were $162,007, representing a decrease of approximately
$1,000,000 during the nine-months ended June 30, 1999. The
decrease is due to the acquisition of Vercom Software, Inc.
in which the Company utilized cash from operations and a
revolving credit arrangement with a bank. The revolver has
the following declining availability: $4.5 million through
September 30, 1999; $4.0 million through December 30, 1999;
3.5 million through June 30, 2000; and 3.0 million through
June 30, 2001.
Recent Accounting Pronouncements:
In June 1997, the Financial Accounting Standards Board
issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information." The Statement requires
publicly owned companies to report certain financial
information about operation segments, as well as certain
information about those operating segment's products and
services, the geographic areas in which they operate, and
their major customers. The Statement was effective for
fiscal years beginning after December 15, 1997. The Company
adopted the provisions of SFAS No. 131 during fiscal year
ended 1998.
In June 1998, the Financial Accounting Standards Board
issued SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." The Statement establishes
accounting and reporting standards for derivative
instruments and hedging activities. The Statement is
effective for fiscal years beginning after June 15, 1999.
The Financial Accounting Standards Board issued SFAS No. 137
"Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB
Statement No. 133" deferring the effective date to all
fiscal quarters of all fiscal years beginning after June 15,
2000. The Company's current policy is not to
enter into any derivative instruments or hedging activities.
OTHER MATTERS
Some of the key variables and other qualitative and
quantitative factors that might be deemed necessary to gain
an understanding of the Company's business and risks
associated therewith are as follows:
Rapid Technological Changes. The computer software industry
is characterized by rapid technological change and
uncertainty as to the impact of emerging software solutions
and services to the general process manufacturing industry.
The Company's success will depend upon its ability to
enhance its current products and develop new products that
address technological and market developments. Major changes
in technology and/or additional competition could negatively
impact the Company's future performance.
Long-term Investment Cycle. Developing software is
expensive and the investment in software development often
involves a long payback cycle. The Company plans to
continue to make significant investments in software
development. Expenditure of funds for research and
development may or may not generate anticipated revenues in
the event the final product developed does not meet market
expectations and acceptance.
Sales Cycle. Traditionally, the Company experiences a
significant period between the time a customer is introduced
to the Company's products and services and the final date
upon which actual contracts are signed. The period to
complete these efforts often takes up to twelve months. As
a result, it is difficult to build a firm foundation for
predicting revenues over an extended period of time.
Additionally, by the time prospects become customers, time
is usually of the essence and proper predictions for
staffing needs must be made well in advance of the time
implementation services are required. Although the Company
has historically achieved a significant level of success in
accurately predicting ongoing staffing needs, the
uncertainties stated above could ultimately create a
negative impact on the overall revenues and profitability of
the Company.
Material Customers. The Company could potentially face the
risks related to loss of material customers. Such loss of
customers would have an immediate negative impact on the
profitability of the Company.
Business Concentration Risk. The Company develops
enterprise-wide software products for complex manufacturers
to be utilized in all process manufacturing industries.
However, the Company's current customer base is
predominantly with companies in the textiles, apparel, home
fashions, and printing industries. A downturn in these
industries could cause a negative impact on the Company's
operating result.
Year 2000 Issues. Year 2000 compliance issues are currently
a grave concern throughout the software industry as a whole.
From a legal context, no case law has yet been established
that enables the industry to definitively address issues
before they arrive. As such, the uncertainties in this area
are significant and potentially devastating. Although the
Company has fully established internal Year 2000 compliance
committees to conduct a detailed analysis of its products
and believes that its products are fully compliant, there
can be no assurance that some unknown and unanticipated
negative event will not occur. The Company has made changes
to its internal systems to insure compliance and will
continually assess capability of its products throughout
1999 during 2000 and beyond.
The Company has contacted critical suppliers of hardware and
software to determine that the suppliers' operations and the
products and services they provide are Year 2000 compliant.
There can be no assurance that another company's failure to
ensure Year 2000 capability would not have an adverse effect
on the Company.
To date, the Company has incurred limited expenses
associated with its Year 2000 efforts in connection with
both internal systems and products, which are immaterial to
the Company's financial position. Management expects that
the future costs of the Year 2000 assessment will not have a
material effect on the Company's financial position.
Part II
Item 1. Legal Proceedings
The Company is currently and will continue to be involved in
routine legal proceedings that are incidental to the
business. In the opinion of management, these routine
proceedings will not have a material adverse effect on the
Company's financial position or overall results of
operations.
On June 17, 1999, the Company agreed to pay a former
customer $500,000 for full settlement of a dispute over fees
paid for licensing and servicing. The settlement payments
are to be paid out over a period of nine months with a final
payment due March 31, 2000. The Company has recorded the
entire settlement in the current quarter to general and
administrative expense.
The potential impact on the Company's financial position or
overall results of operations for the above legal
proceedings could change in the future.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits included herewith are:
( 2) Plan of Acquisition
(10) Material Contracts
(11) Schedule of Computation of Net Income Per Common
Share
(27) Financial Data Schedule
(b) Reports on Form 8-K
1. Form 8-K filed with the Securities and Exchange
Commission January 26, 1999 announcing the appointment of
KPMG LLP as the Company's independent accountants to audit
the Company's financial statements for the year-ended
September 30, 1999. This Form 8-K is incorporated by
reference.
2. Form 8-K filed with the Securities and Exchange
Commission April 14, 1999 announcing the hiring of
Christopher Baker as President and Chief Operating Officer.
This Form 8-K is incorporated by reference.
3. Form 8-K filed with the Securities and Exchange
Commission May 12, 1999 announcing the signing of a letter
of intent with a privately held Dallas, Texas based company.
This Form 8-K is incorporated by reference.
4. Form 8-K filed with the Securities and Exchange
Commission June 30, 1999 announcing the acquisition of
Vercom Software, Inc. This Form 8-K is incorporated by
reference.
SIGNATURES
In accordance with the requirements of the Securities
and Exchange Act, the registrant has caused this report to
be signed on its behalf by the undersigned, thereto duly
authorized.
NETWORK SYSTEMS INTERNATIONAL, INC.
Date: 08/16/1999 /s/ Robbie M. Efird
Robbie M. Efird, Chief Executive Officer
Date: 08/16/1999 /s/ Michael T. Spohn
Michael T. Spohn, Chief Financial Officer
EXHIBIT INDEX
Exhibit
( 2) Plan of Acquisition
2.1 Stock Purchase Agreement of Vercom Software, Inc.
(10) Material Contracts
10.1 Consulting Agreement Between Network Systems
International, Inc. and E. W. Miller, Jr.
10.2 Executive Employment Agreement Between Network Systems
International, Inc. and Christopher N. Baker
(11) Schedule of Computation of Net Income Per Share(Unaudited)
(27) Financial Data Schedule
Nine Months Ended June 30,
Primary 1999 1998
Net income $ 1,008,537 $ 1,735,059
Less - preferred stock
dividends (39,468) (73,289)
Net income applicable for
common shares $ 969,069 $ 1,661,770
Weighted average number of
common shares outstanding
during the year 7,700,320 7,398,110
Basic income per common share $ .13 $ .22
Fully Diluted
Net income applicable for
common share $ 969,069 $ 1,661,770
Add - dividends on
convertible preferred stock 39,468 73,289
Net income for fully diluted
net income per share $ 1,008,537 $ 1,735,059
Weighted average number of
shares used in calculating
primary income per common
share 7,700,320 7,398,110
Assuming conversion of
convertible preferred stock
and stock options (weighted
average) 273,420 515,485
Weighted average number of
common shares outstanding
as adjusted 7,973,740 7,913,595
Fully diluted earnings per
common share $ .13 $ .22