UNITED STATES
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 June 30, 2002
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to ____
Commission File Number: 0-21142
NEMATRON CORPORATION
(Exact name of small business issuer as specified in its charter)
Michigan 38-2483796
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
5840 Interface Drive, Ann Arbor, Michigan 48103
(Address of principal executive offices) (Zip Code)
(734) 214-2000
(Issuer's telephone number, including area code)
Check whether the issuer (1) has filed all reports required to be filed by
section 13 or 15(d) of the Securities 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. [ X ]
YES [ ] No
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: No par value Common Stock: 15,744,625
outstanding as of July 31, 2002
Transitional Small Business Disclosure Format: [ ] YES [X] NO
1
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Nematron Corporation and Subsidiaries
Consolidated Condensed Balance Sheets
June 30, 2002 and December 31, 2001
June 30,
2002 December 31,
(Unaudited) 2001
------------ ------------
Assets
------
Current assets:
Cash and cash equivalents $ 120,232 $ 291,726
Accounts receivable, net of allowance for
doubtful accounts of $86,000 at June 30, 2002
and $70,000 at December 31, 2001 2,700,090 3,284,376
Inventories (Note3) 1,890,317 1,916,235
Prepaid expenses and other current assets 268,217 190,010
----------- -----------
Total current assets 4,978,856 5,682,347
Property and equipment, net of accumulated
depreciation of $7,385,592 at June 30, 2002
and $7,192,705 at December 31, 2001 2,015,942 2,190,104
Goodwill, net of amortization (Note 4) 3,072,122 3,072,122
Intangible assets (Note 5):
Software and related development costs,
net of amortization 730,346 886,286
Other intangible assets, net of amortization 469,153 564,658
----------- -----------
Total assets $11,266,419 $12,395,517
=========== ===========
Liabilities and Shareholders' Equity
Current liabilities:
Notes payable to banks (Note 6) $1,708,658 $ 2,262,475
Accounts payable 1,780,335 1,452,658
Deferred revenue and other accrued expenses 1,396,432 1,851,956
Subordinated debt (Note 7) 2,446,160 1,500,000
Current maturities of long-term debt (Note 8) 2,568,039 2,962,536
Total current liabilities 9,899,624 10,029,625
Long-term debt, less current maturities (Note 8) 12,498 28,940
----------- -----------
Total liabilities 9,912,122 10,058,565
Shareholders' equity:
Common stock, no par value, 30,000,000 shares authorized,
15,744,625 shares outstanding 33,211,046 33,054,089
Accumulated comprehensive income 32,592 18,096
Accumulated deficit (31,889,341) (30,735,233)
----------- -----------
Total shareholders' equity 1,354,297 2,336,952
----------- -----------
Total liabilities and shareholders' equity $ 11,266,419 $ 12,395,517
=========== ===========
2
Nematron Corporation and Subsidiaries
Consolidated Condensed Statements of Operations
For The Three-and Six-Month Periods Ended
June 30, 2002 and 2001
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ -------------------------
2002 2001 2002 2001
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
----------- ---------- ----------- -----------
Net revenues $3,616,826 $4,764,477 $8,136,438 $9,549,827
Cost of revenues 2,835,348 3,755,279 5,916,308 7,717,992
---------- ---------- ---------- ----------
Gross profit 781,478 1,009,19 2,220,130 1,831,835
Operating expenses:
Product development costs 170,336 123,764 356,516 238,120
Selling, general,
administrative 1,251,990 1,733,400 2,545,051 3,289,842
---------- ---------- ---------- ----------
Total operating expenses 1,422,326 1,857,164 2,901,567 3,527,962
---------- ---------- ---------- ----------
Operating loss (640,848) (847,966) (681,437) (1,696,127)
Other income (expense):
Interest expense (334,778) (397,392) (497,779) (567,518)
Sundry income (expense) 14,437 7,164 25,106 7,690
---------- ---------- ---------- ----------
Total other income (expense) (320,341) (390,228) (472,673) (559,828)
---------- ---------- ---------- ----------
Loss before income taxes (961,189) (1,238,194) (1,154,110) (2,255,955)
Income taxes (Note 7) -0- -0- -0- -0-
---------- ---------- ---------- ----------
Net loss $(961,189) ($1,238,194) $(1,154,110) $(2,255,955)
========== =========== =========== ===========
Per share amounts (Note 8):
Basic and diluted $ (0.06) $ (0.08) $ (0.07) $ (0.15)
========== ========== =========== ===========
Weighted average shares
outstanding (Note 8):
Basic and diluted 15,744,625 15,520,749 15,744,625 14,765,862
========== ========== ========== ==========
Nematron Corporation and Subsidiaries
Consolidated Condensed Statements of Comprehensive Loss
For The Three-and Six-Month Periods Ended June 30, 2002 and 2001
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ -------------------------
2002 2001 2002 2001
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
----------- ----------- ----------- ------------
Net loss $(961,189) $(1,238,194) $(1,154,110) $(2,255,955)
Other comprehensive
income (loss) - equity
adjustment from foreign
translation 19,767 (118) 14,496 (4,507)
--------- ----------- ----------- -----------
Comprehensive loss $(941,422) $(1,238,312) $(1,139,614) $(2,260,462)
========= =========== =========== ===========
3
Nematron Corporation and Subsidiaries
Consolidated Condensed Statements of Cash Flows
For The Six-Month Periods Ended
June 30, 2002 and 2001
Six Months Ended June 30,
2002 2001
(Unaudited) (Unaudited)
----------- -----------
Cash flows from operating activities:
Net loss $(1,154,110) $(2,255,955)
Adjustments to reconcile net loss to net cash
flows provided by operating activities:
Depreciation 228,309 267,688
Amortization (Notes 4 and 5) 251,446 766,141
Non-cash interest expense for
beneficial conversion feature (Note 7) 154,117 205,200
Loss on disposal of equipment 18,503 2,308
Changes in assets and liabilities that
provided (used) cash:
Accounts receivable 584,286 846,592
Inventories 25,918 773,652
Prepaid expenses and other current assets (78,207) 28,333
Accounts payable 426,955 (82,407)
Deferred revenue and accrued expenses (554,801) (276,002)
--------- ---------
Net cash provided by (used in) operating activities (97,584) 275,550
Cash flows from investing activities:
Acquisition of Optimation, Inc., net of
cash acquired (Note 2) -- (287,877)
Additions to capitalized software development costs -- (317,946)
Additions to property and equipment (73,742) (84,147)
Proceeds from disposals of property and equipment 1,094 1,983
--------- ---------
Net cash used in investing activities (72,648) (678,987)
Cash flows from financing activities:
Proceeds from issuance of subordinated notes
and warrants (Note 7) 949,000 1,200,000
Proceeds from issuance of common stock -- 278,000
Payments of long-term debt (410,941) (558,814)
Increase (decrease) in notes payable to bank (553,817) (373,850)
Payments of deferred financing fees -- (61,440)
--------- ---------
Net cash provided by (used in) financing activities (15,758) 483,896
Foreign currency translation effect 14,496 (4,507)
--------- ---------
Net increase (decrease) in cash and cash equivalents (171,494) 75,952
Cash and cash equivalents at beginning of period 291,726 74,712
--------- ---------
Cash and cash equivalents at end of period $ 120,232 $ 150,664
=========== ===========
Non-cash financing and investing activities:
Fair value of assets acquired from
Optimation, Inc., including goodwill $ 2,459,727
Less liabilities assumed (1,180,850)
Less common stock issued (1,000,000)
Net cash paid for Optimation, Inc. (Note 2) $ 278,877
Supplemental disclosures of cash flow information:
Cash paid for interest $ 391,746 $ 334,429
Cash paid for income taxes -- --
4
Nematron Corporation and Subsidiaries
Notes To Consolidated Condensed Financial Statements
For The Three- and Six-Month Periods Ended
June 30, 2002 and 2001
Note 1 - Basis of Presentation
The accompanying consolidated financial statements include the accounts of
Nematron Corporation (the "Company") and its wholly-owned subsidiaries, Nematron
Limited, a United Kingdom corporation, Nematron Canada Inc., a Canadian
corporation, A-OK Controls Engineering, Inc. ("A-OK Controls"), a Michigan
corporation, and Optimation, Inc. ("Optimation"), an Alabama corporation. All
significant intercompany transactions and balances have been eliminated in
consolidation. The Company acquired 100% of the equity of Optimation effective
at the close of business on March 30, 2001. Accordingly, the financial
statements include the operations of Optimation since the date of its
acquisition.
In the opinion of management, all adjustments (consisting solely of normal
recurring adjustments) considered necessary for a fair presentation of the
consolidated financial statements for the interim periods have been included.
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 the Securities and Exchange
Commission's rules and regulations, although the Company believes that the
disclosures are adequate to make the information presented not misleading. It is
suggested that these condensed consolidated financial statements should be read
in conjunction with the consolidated financial statements and notes thereto
included in the Company's latest annual report on Form 10-KSB.
The results of operations for the three-month and six month periods ended June
30, 2002 and 2001 are not necessarily indicative of the results to be expected
for the full year.
Note 2 - Acquisition of Optimation
On March 30, 2001, the Company completed its acquisition of Optimation, a
Huntsville, Alabama-based company that develops, produces and markets industrial
communications and display products for industrial automation. The Company
recorded this transaction using the purchase method of accounting.
The purchase price was approximately $1,660,000, including expenses of
approximately $60,000. Under the terms of the related Stock Purchase Agreement,
the Company issued 1,483,680 shares of its Common Stock to the former Optimation
shareholders in exchange for 100% of the outstanding equity of Optimation.
Additionally, the Company paid the former Optimation shareholders $300,000 and
agreed to pay the former Optimation shareholders $300,000 ninety days after the
acquisition. In connection with the Stock Purchase Agreement, the Company also
entered into three-year employment agreements and three-year agreements not to
compete with Optimation's president and vice-president, both of who were
Optimation shareholders.
The allocation of the purchase price to assets acquired and liabilities assumed
at the acquisition date are as follows:
Cash $ 21,000
Other current assets 1,605,000
Equipment 19,000
Intangible assets, including goodwill 835,000
Current notes payable (640,000)
Other current liabilities (137,000)
Long-term debt (43,000)
----------
Total purchase price $1,660,000
==========
5
The following unaudited pro forma summary presents the consolidated results of
operations for the three and six month periods ended June 30, 2001 as if the
acquisition of Optimation had occurred on January 1, 2001, the earliest period
presented in this Form 10-QSB. The pro forma summary does not purport to be
indicative of either what would have occurred had the acquisition of Optimation
actually been consummated at that date or the Company's future results of
operations:
Three Months Six Months
Ended Ended
June 30, 2001 June 30, 2001
------------- -------------
Revenues $ 4,764,000 $ 9,961,000
Net loss $(1,238,000) $(2,261,000)
Loss per share - basic and diluted $(0.08) $(0.15)
Note 3 - Inventories
Inventories consist of the following at June 30, 2002 and December 31, 2001:
June 30, December 31,
2002 2001
---- ----
Purchased parts and accessories $1,298,261 $1,402,209
Work in process 241,094 219,765
Finished goods, demo units and service stock 350,962 294,260
---------- ----------
Total Inventory $1,890,317 $1,916,235
========== ==========
Note 4 - Goodwill
Effective January 1, 2002, the Company adopted the provisions of Statement No.
142, Goodwill and Other Intangible Assets, issued by the Financial Accounting
Standards Board in July 2001 ("FASB-142"). FASB-142, which is effective for
years beginning after December 15, 2001, addresses how intangible assets that
are acquired individually or with a group of other assets should be accounted
for in financial statements upon their acquisition. FASB-142 also specifies that
intangible assets must be amortized over their useful lives unless such lives
are indefinite, in which case the intangible assets are not subject to
amortization. FASB-142 further specifies that goodwill is not subject to
amortization but is subject to impairment tests at least annually. Under
FASB-142, the Company was required to test all existing goodwill for impairment
as of January 1, 2002, on a "reporting unit" basis. A reporting unit is the
operating segment unless, at businesses one level below that operating segment
(the "component" level), discrete financial information is prepared and
regularly reviewed by management, in which case such component is the reporting
unit. A fair value approach is used to test goodwill for impairment. An
impairment charge is recognized for the amount, if any, by which the carrying
amount of goodwill exceeds its fair value. Fair values were established using
discounted cash flows. The result of testing goodwill for impairment in
accordance with FASB-142, as of January 1, 2002, resulted in no impairment. The
Company recorded goodwill in connection with its acquisition A-OK Controls in
June 2000 and its acquisition of Optimation in March 2001. In connection with
the Company's acquisition of Intec Controls Corp. in March 1997, the Company
recorded intangible assets related to an acquired workforce and a distribution
network that, pursuant to FASB-142, have been reclassified to goodwill as of
January 1, 2002 and which are no longer subject to periodic amortization. After
the reclassification, recorded goodwill totals $5,469,356 and accumulated
amortization is $2,397,234 as of January 1, 2002. The net amount of goodwill,
$3,072,122 as of January 1, 2002, will not be amortized but is subject to
certain impairment tests at least annually. A reconciliation of loss reported in
the consolidated statement of operations to the loss adjusted for the effect of
goodwill amortization for all periods presented is as follows:
6
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
Net loss:
Reported net loss $(961,189) $(1,238,194) $(1,154,110) $(2,255,955)
Goodwill amortization -- 42,657 -- 73,259
Workforce and distribution
network amortization -- 23,052 -- 46,104
--------- ----------- ----------- -----------
Adjusted net loss $(961,189) $(1,172,485) $(1,154,110) $(2,136,592)
========= =========== =========== ===========
Basic and diluted loss per share:
Reported net loss $(0.06) $(0.08) $(0.07) $(0.15)
Goodwill amortization -- -- -- .01
Workforce and distribution
network amortization -- -- -- --
------ ------ ------ ------
Adjusted net loss $(0.06) $(0.08) $(0.07) $(0.14)
====== ====== ====== ======
Note 5 - Other Intangible Assets
Other intangible assets consists of the following at June 30, 2002:
Amortization Gross Net
Period Carrying Accumulated Carrying
(Years) Amount Amortization Amount
------- ------ ------------ ------
Amortizable intangible assets:
Software development costs 5.7 $6,661,735 $(5,931,389) $730,346
========== =========== ========
Other:
Acquired non-compete
agreement 5.0 300,000 (120,000) 180,000
Acquired patent costs 10.0 590,000 (398,250) 191,750
Internally developed
patent costs 6.0 75,589 (54,318) 21,271
Deferred financing fees 4.0 263,612 (187,480) 76,132
---------- --------- --------
Total other intangible assets $1,229,201 $(760,048) $469,153
========== ========= ========
Amortization expense for other intangible assets for the periods presented are
as follows:
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
Software development costs $77,970 $267,711 $155,940 $484,681
Other amortizable assets 47,753 58,072 95,506 162,097
-------- -------- -------- --------
Total $125,723 $325,783 $251,446 $646,778
======== ======== ======== ========
Estimated amortization expense for other intangible assets for the five years
ending December 31, 2006 is as follows:
Software Other
Development Intangible
Year Ending December 31, Costs Assets Total
- ------------------------ ----- ------ -----
2002 $311,880 $179,012 $490,892
2003 155,898 175,150 331,048
2004 139,502 123,894 263,396
2005 139,502 74,604 214,106
2006 139,503 -- 139,503
7
Note 6 - Notes Payable to Banks
The Company and its A-OK Controls subsidiary are parties to two loan and
security agreements (the "Agreements") with LaSalle Business Credit, Inc., a
Wisconsin bank ("LBCI"). The Agreements, which have been amended through
February 2002, provide for a total of $3.5 million in two lines of credit, a
$2.9 million term loan and a $1.5 million special accommodation term loan for
the purpose of the Company's acquisition of A-OK Controls on June 30, 2000. The
Agreements provide for credit facilities through November 2003, and may be
extended for an additional one-year period at the option of the Company, unless
the lender gives prior notice of termination.
The amount available under the lines of credit are limited by a borrowing
formula that allows for advances up to a maximum of the sum of specified
percentages of eligible accounts receivable, less the amount, if any, of
outstanding letters of credit issued by the Company. Based upon such borrowing
formula, approximately $40,000 of the available lines are eligible for advance
at June 30, 2002. Amounts borrowed under the lines of credit facility total
$1,343,658 at June 30, 2002, and such borrowings bear interest at the prime rate
plus 4.5% (9.25% effective rate at June 30, 2002). The lines of credit and the
term loans (discussed in Note 8) are collateralized by substantially all assets
of the Company and a mortgage on the Company's Ann Arbor facility.
The Company's wholly owned subsidiary, Optimation, is party to a loan and
security agreement with Compass Bank, an Alabama bank. The agreement, as amended
through July 2002, provides for a total line of credit of $365,000 limited by a
borrowing formula that allows for advances up to a maximum of the sum of
specified percentages of eligible accounts receivable and inventory. Amounts
borrowed under the line of credit facility total $365,000 at June 30, 2002, and
such borrowings bear interest at the prime rate plus .50% (5.25% effective rate
at June 30, 2002), but not less than 5.25% per annum. The agreement requires
monthly line reductions of $10,000 through its expiration date. The line of
credit is collateralized by substantially all assets of Optimation. The credit
facility, which has been on a short-term rolling basis since June 2001, expires
October 5, 2002, at which time the Company expects to renew the facility on
essentially the same terms and conditions for another ninety-day period.
Note 7 -Subordinated Debt
Subordinated debt consists of the following:
June 30, December 31,
2002 2001
---- ----
Convertible subordinated promissory notes, interest at 10% per annum, due August
31, 2001. Accrued and unpaid interest and the principal of the note may be
converted into common stock at the lower of $0.30 per share or the lowest
closing price of the underlying common stock during the period the notes are
outstanding. $1,200,000 $1,200,000
Subordinated promissory notes, interest at 14% per annum, due on demand. The
notes are callable by the Company at any time, and the notes may be converted
into common or preferred stock if the Company issues such equity during the
period the notes are outstanding. Detachable warrants with an
exercise price of $0.10 -$0.18 per share were sold with the notes 1,049,000 300,000
Subordinated promissory notes, interest at 8% per annum, due October 15, 2002
The notes are callable by the Company at any time. The face amount of the notes
is $285,000, and $6,477 of the proceeds to the Company was ascribed to the
detachable warrants sold with the notes, and such amount is being charged to
interest expense, with a corresponding increase in the
recorded value amount of the notes, over the term of the notes 197,160 --
---------- ----------
Total $2,446,160 $1,500,000
========== ==========
8
The convertible subordinated notes due August 31, 2001 (the "10% Convertible
Notes") included detachable warrants. The warrants, which are non-assignable,
allowed the holders to purchase the Company's common stock at $0.30 per share
(the "Per Share Warrant Price") at any time until March 31, 2006 (the "2006
Warrants"). If at any time prior to the exercise of the 2006 Warrants the daily
closing price of the Company's common stock, as traded on the American Stock
Exchange ("AMEX"), falls below the Per Share Warrant Price for five consecutive
days, the Per Share Warrant Price will be adjusted downward to the lowest price
during such five trading day period. In the event that the Company completes an
equity offering at less than the Per Share Warrant Price, the holders have the
option to exchange the 2006 Warrants for other warrants to purchase a greater
number of shares based on the difference between the Per Share Warrant Price and
the proposed equity offering price per share. Because the Per Share Warrant
Price was less than the closing price of the common stock, as traded on the
AMEX, on the dates the notes were sold, the 2006 Warrants were ascribed a value
of $342,000 and such amount was credited to shareholders equity, and the 10%
Convertible Notes were ascribed a value of $858,000. The $342,000 was charged to
interest over the term of the 10% Convertible Notes, resulting in a total
non-cash charge to interest expense of $342,000 between April 1, 2001 and August
31, 2001, with the 10% Convertible Notes increasing in recorded amount to
$1,200,000 by August 31, 2001.
The 14% Subordinated Notes due on demand (the "14% Subordinated Notes") were
issued pursuant to a $1.5 million master promissory note with North Coast
Technology Investors L.P. ("North Coast"), an affiliate of Mr. Hugo Braun, a
member of the Company's Board of Directors. Requests for advances under the
master promissory note shall be funded at the option of North Coast. In the
event of an equity offering by the Company, North Coast, at its option, may
convert any or all of the outstanding principal of and accrued interest on the
14% Subordinated Notes into securities offered in such financing, at the
offering price per share of such financing. If the Company does not complete an
equity financing pursuant to which it receives proceeds of at least $1.5 million
on or before August 31, 2002, the principal and interest due and payable under
the master promissory note may be converted at the option of North Coast into
shares of common stock of the Company at $0.10 per share. The 14% Subordinated
Notes were issued with immediately exercisable detachable warrants. The
warrants, which are non-assignable, allow the holder to purchase the Company's
common stock at $0.18 per share for 607,777 shares and $0.10 for 1,004,000
shares at any time until October 31, 2007. The detachable warrants have been
ascribed a value of $150,480, and such amount has been charged to interest
expense for the three- and six-month periods ended June 30, 2002.
The subordinated notes due October 15, 2002 (the "8% Subordinated Notes")
included detachable warrants. The warrants, which are non-assignable, allow the
holders to purchase the Company's common stock at $0.22 per share at any time
until March 31, 2007 (the "2007 Warrants"). Because the $0.22 per share exercise
price was less than the closing price of the common stock, as traded on the
American Stock Exchange, on the dates the notes were sold, the 2007 Warrants
have been ascribed a value of $6,477 and such amount was credited to
shareholders equity, and the 8% Subordinated Notes were ascribed a value of
$193,523. The $6,477 is being charged to interest over the term of the 8%
Subordinated Notes, resulting in a total non-cash charge to interest expense of
$2,841 and $3,636, respectively, for the three- and six-month periods ended June
30, 2002.
All of the subordinated promissory notes in the above table are subordinated to
the debt due to the Company's senior bank lender, and such notes are
collateralized by a second mortgage on the Company's Ann Arbor facility. The
agreements underlying the notes provide for detachable warrants that allow the
Noteholders to purchase common stock at specified exercise prices for a
five-year period from the date of issuance of the notes.
A total of $750,000 of the 10% Convertible Notes, all of the 14% Subordinated
Notes and all of the 8% Subordinated Notes were issued to certain members of the
Company's Board of Directors or their affiliates. At June 30, 2002 and December
31, 2001, accrued interest on the subordinated notes described above total
$195,306 and $96,795, respectively, including $138,689 and $62,493,
respectively, due to related parties.
9
Note 8 - Long-Term Debt
Long-term debt includes the following debt instruments at June 30, 2002 and
December 31, 2001:
June 30, December 31,
2002 2001
---- ----
Term note payable to a bank, interest at prime plus 4.50% (9.25% effective rate
as of June 30, 2002), payable in monthly installments of $62,500 beginning June
2002 through August 2003, at which time any remaining principal and interest is
due. The term loan is collateralized by substantially all assets of the Company
and a mortgage on the Ann Arbor facility. $2,545,556 $2,561,667
Term note payable to a bank, interest at prime plus 6.0%, payable
in monthly installments of $78,611 through May 2002 -- 389,166
Capitalized lease obligations and other notes, secured by specific
equipment being financed 34,981 40,643
---------- ----------
Total long-term debt 2,580,537 2,991,476
Less current maturities (2,568,039) (2,962,536)
---------- ----------
Long-term debt, less current maturities $ 12,498 $ 28,940
========== ==========
The Agreements, under which the Company has the line of credit with LBCI (see
Note 6) and the term note, contain several financial covenants, including
specified levels of tangible net worth, interest coverage and debt service
coverage. The terms of the Agreement also prohibit the payment of dividends,
limit the amount of annual capital expenditures and include other restrictive
covenants. Although the Company is not in compliance with the tangible net
worth, interest coverage and debt service coverage covenants as of June 30,
2002, the bank issued a forbearance letter to the Company in February 2002
concerning these covenant violations. In such letter, the bank has specifically
reserved its right to take any action permitted under the Agreements in the
future without any notice to the Company. The bank and management are in
discussion to revise the Agreements and management is pursuing other solutions
to the violations, including the private placement of additional capital. The
Company has classified the debt with LBCI as current liabilities.
Note 9 - Taxes on Income
The Company has net operating loss carryforwards ("NOLs") of approximately $24
million as of December 31, 2001 that may be applied against future taxable
income. The NOLs expire in varying amounts from 2004 and through 2021.
Utilization of certain of these NOLs is subject to annual limitations under
current Internal Revenue Service regulations. The Company has established a
valuation allowance for the estimated amount of the total limitation on the
utilization of the NOLs. Realization of net deferred tax assets associated with
the NOLs is dependent upon generating sufficient taxable income prior to their
expiration.
Note 10 - Earnings Per Share
Basic earnings per share ("EPS") are based on the weighted average number of
shares outstanding for each period presented because common stock equivalents
are anti-dilutive. Diluted earnings per share is the same as basic earnings per
share for all periods presented because the inclusion of options and warrants
would have an antidilutive effect on loss per share during all periods
presented.
10
Information as to options and warrants outstanding that have been excluded from
the computation of diluted earnings per share is as follows:
Three Months Ended June 30, Six Months Ended June 30,
2002 2001 2002 2001
Options:
Number 2,162,942 2,230,692 2,162,942 2,230,692
Expiration dates 2003-2011 2003-2011 2003-2011 2003-2011
Warrants:
Number 2,286,882 997,678 1,887,822 997,678
Expiration dates 2002-2006 2002-2006 2002-2006 2002-2006
11
Item 2. Management's Discussion and Analysis of Results of Operations
The Company acquired 100% of the equity of Optimation, Inc. effective at the
close of business on March 30, 2001. The consolidated condensed financial
statements include the results of operations of Optimation since that date.
Three- and Six Month Periods Ended June 30, 2002 Compared With The
Three- and Six-Month Periods Ended June 30, 2001
Net revenues for the three- and six-month periods ended June 30, 2002 decreased
$1,148,000 (24.1%) and $1,413,000 (14.8%), respectively, to $3,617,000 and
$8,136,000, respectively, compared to the same periods last year. The net
revenue decrease in the three-month period ended June 30, 2002 compared to the
prior year period results from lower sales of all product lines except repair
services, which increased 15.9%. The net revenue decrease in the six-month
period ended June 30, 2002 compared to the prior year period results primarily
from decreases in sales of bundled Industrial Control Computers ("ICCs"), other
hardware control products and system engineering services, partially offset by
increased revenues from software licenses and operator panels, including
$362,000 attributable to the revenues of Optimation which the Company acquired
on March 30, 2001. Revenues from ICCs and other hardware control products were
below the prior year periods as customers have continued to restrict their
capital spending. Revenues from software licenses increased in the current
six-month period compared to the prior year period because of a significant sale
of software licenses to one customer. Revenues from system integration in the
current six-month period includes revenue recognized from one customer for
certain application services performed in prior years, the revenue from which
was previously not recorded pending certainty of collection. Management expects
that net revenues for the last six months of 2002 increase compared to the first
six-month period and will be comparable to the year earlier period based on the
current order rate and scheduled deliveries.
Gross profit for the three- and six-month periods ended June 30, 2002 decreased
$228,000 (22.6%) and increased $388,000 (21.2%), respectively, to $781,000 and
$2,220,000, respectively, compared to the same periods last year. Gross profit
as a percentage of net revenues for the three- and six-month periods ended June
30, 2002 was 21.6% and 27.3% respectively, compared to 21.2% and 19.2% in the
same periods last year. The increase in gross profit percentage in the
three-month period ended June 30, 2002 results from lower material costs and
lower software amortization costs in the current period compared to the year ago
period. The increase in gross profit percentage in the six-month period ended
June 30, 2002 results from these same factors, plus the profit margins on the
FloPro license sold in the current period and the revenue from the system
integration services for which the costs were incurred in prior periods, as
discussed in the first paragraph above. Management expects that gross profit
margins will remain relatively constant with the margin realized in the second
quarter of 2002 as the mix of sales in the remaining two quarters of 2002 is
expected to be similar to the sales mix experienced in the first six months of
the year, based on the current backlog and forecasts.
Product development expenses incurred for software development for the three-
and six-month periods ended June 30, 2002 increased $47,000 (37.6%) and $118,000
(49.7%), respectively, to $170,000 and $357,000, respectively, compared to the
same periods last year. The increases are attributable to the lack of any
capitalizable expenditures in the current period whereas $135,000 and $318,000
of software development expenditures were capitalized in the three- and
six-month periods ended June 30, 2001. Software development expenditures,
including those expensed in the current period and those capitalized, have
decreased in the current period compared to the prior year periods resulting
from smaller development staffs and lower overhead and other fixed costs.
Management expects that product development expenses will increase moderately in
the remaining quarters of 2002 as development and enhancement efforts are
planned to increase.
12
Selling, general and administrative expenses for the three- and six-month
periods ended June 30, 2002 decreased $481,000 (27.8%) and $745,000 (22.6%) to
$1,251,000 and $2,545,000, respectively, compared to the comparable periods last
year. The decreases result primarily from more efficient marketing and sales
initiatives during the current quarter compared to the comparable period last
year and the effects of cost reduction initiatives implemented over the last
several quarters. Management expects that selling, general and administrative
expenses will increase moderately in the remaining quarters of 2002 because of
an expansion of its marketing and sales initiatives compared to current
activities as management anticipates several new product releases during the
remaining months of 2002.
Interest expense for the three- and six-month periods ended June 30, 2002
decreased $63,000 (15.8%) and $70,000 (12.3%), respectively, to $335,000 and
$498,000, respectively, compared to the comparable periods last year. Interest
expense for the three- and six-month periods ended June 30, 2002 includes
$153,000 and $154,000, respectively of non-cash interest expense related to the
beneficial conversion feature of warrants sold in 2002 wherein the conversion
price of the warrants was below the market price of the common stock into which
the warrants may be converted, on the date of the sale of the warrants and
convertible subordinated debt which raised $949,000. Interest expense for both
the three- and six-month periods ended June 30, 2001 includes $205,000 of
non-cash interest expense related to the beneficial conversion feature of
warrants sold in 2001 wherein the conversion price of the warrants was below the
market price of the common stock into which the warrants may be converted, on
the date of the sale of the warrants and convertible subordinated debt which
raised $1,200,000. Absent the non-cash charges for the beneficial conversion
features described above, interest expense for the three- and six-month periods
ended June 30, 2002 would have decreased $114,000 and $121,000, respectively,
compared to the comparable 2001 periods, and this results from lower borrowing
levels in 2002 compared to 2001 as term debt was repaid in accordance with
scheduled maturities. Management expects that interest expense will decrease in
the remaining quarters of 2002 because of lower borrowing levels as debt is
repaid as scheduled.
Sundry income was not significant in either reported period.
Liquidity and Capital Resources
Primary sources of liquidity are cash generated from operations, short term
subordinated debt and the Company's secured lines of credit that total
$3,500,000 as of June 30, 2002 from LaSalle Business Credit ("LBCI") and
$365,000 from Compass Bank. As of June 30, 2002, the Company had $1,709,000
outstanding under the lines of credit and approximately $40,000 of additional
borrowing capacity available under such credit lines. The Company's operations
used $98,000 in cash during the six-month period ended June 30, 2002 as a result
of the $1,154,000 net loss, the effects of changes in working capital (providing
$404,000) and the noncash depreciation, amortization, loss on disposal of
equipment and interest charges (totaling $652,000). During the six-month period
ended June 30, 2002, the Company used $74,000 of cash for purchases of equipment
and $965,000 of cash for repayments of the lines of credit and long term debt.
The primary source of cash in the six-month period ended June 30, 2002 was
$949,000 from the proceeds from sales of subordinated promissory notes and
warrants.
Based upon current estimates, operations for the next two quarters will also
result in net cash losses unless sales improve over forecasted levels or costs
and expenditures can be further reduced. Management estimates that it will
require approximately $700,000 through the remainder of 2002 in order to sustain
operations at their current levels. Management has included in these projections
an assumption that the borrowings from LBCI and Compass Bank will be refinanced
with LBCI and Compass Bank, respectively, or with other lenders on substantially
the same terms as the current agreements.
The Company is in compliance with the terms of its Compass Bank financing
agreement. However, since mid-2001, the Company has not been in compliance with
the certain financial covenants contained in the financing agreement with LBCI
financing agreement under which it has two lines of credit totaling $3.5 million
and two term loans. LBCI has issued a forbearance letter to the Company
13
concerning these covenant violations. However, in such letter LBCI has
specifically reserved its right to take any action permitted under the agreement
without any notice to the Company. LBCI and Company management are discussing
management plans to cure the defaults, including, without limitation, a capital
infusion. This capital infusion, if successful, may cure the tangible net worth
covenant, but it will not cure operating covenants that were not met beginning
in 2001. Management is hopeful, however, that a successful capital infusion will
cause LBCI to continue its forbearance. In view of the continuing default, the
Company has classified all indebtedness to LBCI as current liabilities.
In the short term, in addition to having to fund its projected net cash losses
over the next two quarters, the Company will be required to make payments on
term debt of approximately $18,000 per month, plus interest. Additionally, of
the total principal amount of subordinated debt, $2,250,000 plus accrued
interest thereon is due currently and $200,000 plus accrued interest thereon
will become due October 15, 2002.
Management is attempting to complete as soon as practical a private placement of
preferred stock to accredited investors whereby the Company would raise a
minimum of $3,000,000, a portion of the proceeds of which would be applied to
the repayment of current liabilities, liabilities arising from operations over
the next two quarters and subordinated debt.
The Company is in the process of raising a bridge financing in the range of
$200,000 to $400,000 in the form of subordinated debt with detachable warrants
until such time as it can close a private placement of preferred stock.
Management can offer no assurance that the private placements of subordinated
notes in a bridge financing or of preferred stock will be successful, or that if
the private placement of subordinated notes or preferred stock should occur,
that the funds raised will be sufficient to persuade LBCI to continue its
forbearance on demanding repayment of the LBCI debt because of the continuing
covenant violations. If the private placements are not successful, the Company
will not have sufficient liquidity to satisfy its liabilities and obligations as
they become due and it may be forced to curtail its operations, sell product
lines or the operations of subsidiaries or sell the Company to a third party.
Based upon the Company's existing financial position, forecasted revenue and
expense levels and forecasted lines of credit availability, and assuming the
conversion of the subordinated notes to common or preferred stock, the Company
believes it has sufficient liquidity to satisfy its liabilities as they become
due. The Company believes that its long-term liquidity needs will be satisfied
through the proceeds of the private equity offering it expects to complete on or
prior to September 30, 2002.
Management can offer no assurance that the private placement of securities will
be successful, nor if the private placement occurs, that the equity raised will
be sufficient persuade the LBCI to continue its forbearance on calling its debt
because of the continuing covenant violations. If the private placement is not
successful, the Company will not have sufficient liquidity to satisfy its
liabilities and obligations as they become due and it may be forced to curtail
its operations.
Uncertainties Relating to Forward Looking Statements
"Item 2. Management's Discussion and Analysis of Results of Operation" and other
parts of this Form 10-QSB contain certain "forward-looking statements" within
the meaning of the Securities Act of 1934, as amended. . While the Company
believes any forward-looking statements it has made are reasonable, actual
results could differ materially since the statements are based on current
management expectations and are subject to risks and uncertainties. These risks
and uncertainties include, but are not limited to the following:
* Uncertainties discussed elsewhere in "Management's Discussion and Analysis
or Results of Operation" above;
* The potential inability to raise additional equity or debt financing in a
sufficient amount to sustain operations and allow management to execute its
strategies;
14
* The potential inability to modify bank covenants as it may be
necessary from time to time or continue the lender's forbearance exercising
its remedies;
* A further decline of economic conditions in general and conditions in the
automotive manufacturing industry in particular;
* Delays in introduction of planned new product offerings and product
enhancements;
* Changes in customer requirements or reductions in demand for the Company's
products and services;
* The inability of the Company to successfully implement its strategy to lead
the industrial automation market migration from closed architecture PLCs to
open architecture PC-based solutions or changes in corporate strategy to
capitalize on market changes;
* Competitive factors, including the introduction or enhancement of products by
the Company's competitors;
* Product pricing decreases and/or component price increases that may result in
materially reduced selling prices and/or reduced gross profit margins from
sale of the Company's products;
* Software defects and latent technological deficiencies in existing and new
hardware products and enhancements thereto;
* Unforeseen increases in operating expenses or adverse fluctuations in foreign
exchange rates;
* The inability to attract or retain management personnel and sales and
engineering staff;
* Evolving industrial automation industry standards that may cause the
Company's current or proposed product portfolio to become obsolete.
15
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
On May 14, 2002, the Company held its Annual Meeting of Shareholders. There was
one matter voted upon, which was the election of Directors. Prior to the
election but subsequent to preparation and mailing of the Proxy Statements, Mr.
James H. Wicker resigned from the Board of Directors and declined to stand for
re-election to the Board of Directors. Pursuant to the terms of the Company's
bylaws, the Board of Directors may select members to fill vacancies on the Board
of Directors. As of the date of this Form 10-QSB, the Board of Directors has not
selected anyone to fill the vacancy created by the resignation of Mr. Wicker.
The following table sets forth the results of the voting on the election of
Directors.
Nominees Votes For Votes Withheld Total Votes
-------- --------- -------------- -----------
Hugo E. Braun 11,512,508 43,214 11,555,722
James H. Wicker 11,513,058 42,664 11,555,722
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits included herewith are set forth on the Index to Exhibits,
which is incorporated herein by reference.
(b) During the quarter ended June 30, 2002, the Company did not file any
current reports on Form 8-K.
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Nematron Corporation
By:
August 12, 2002 /s/ Matthew S. Galvez
- --------------- ---------------------
Date Matthew S. Galvez, President & CEO
(Duly Authorized Officer)
August 12, 2002 /s/ David P. Gienapp
- --------------- --------------------
Date David P. Gienapp, Executive Vice President -
Finance &Administration
(Chief Accounting Officer)
16
INDEX TO EXHIBITS
Exhibit
Number Description of Exhibit
4.0 Modification and Amendment to Loan Documents Regarding the Revolving
Credit and Security Agreement dated July 9, 1999, by and between
Optimation, Inc. and Compass Bank, entered into on July 5, 2002.
99.1 Chief Executive Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.2 Chief Financial Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
17
Exhibit 4.0
-----------
As of July 5, 2002 (the "Replacement Date"), this Modification Agreement and
Amendment to Loan Documents supersedes and replaces in its entirety that certain
Modification Agreement and Amendment to Loan Documents executed by Borrower and
Bank on July 19, 2000, that certain Modification Agreement executed by Borrower
and Bank on June 8, 2001, that certain Modification Agreement executed by
Borrower and Bank on November 27, 2001, that certain Modification Agreement
executed by Borrower and Bank on February 25, 2002, and that certain
Modification Agreement executed by Borrower and Bank on May 5, 2002, (the
"Former Modification"). The Former Modification shall be of no force or effect
as of the Replacement Date.
MODIFICATION AGREEMENT AND AMENDMENT TO LOAN DOCUMENTS
THIS MODIFICATION AGREEMENT AND AMENDMENT TO LOAN DOCUMENTS is being
entered into as of the 5th day of July 2002 by and between COMPASS BANK, a state
banking corporation ("Bank") and OPTIMATION, INC., an Alabama corporation
("Borrower").
PREAMBLE
On July 9, 1999, Bank and Borrower executed that certain Revolving
Credit and Security Agreement (the "Agreement"), Revolving Credit Commercial
Note in the principal amount of SIX HUNDRED FIFTY THOUSAND AND 00/100 DOLLARS
($650,000.00) (the "Note"), and other Loan Documents, providing for a line of
credit in the maximum aggregate amount of SIX HUNDRED FIFTY THOUSAND AND NO/100
DOLLARS ($650,000.00) (the "Revolving Line"). The Borrower has requested and the
Bank has agreed to, among other things, (i) decrease the aggregate principal
amount available under the Revolving Line to THREE HUNDRED SIXTY FIVE THOUSAND
AND NO/100 DOLLARS ($620,000.00), (ii) extend the due date to October 5, 2002,
and (iii) modify certain covenants.
Accordingly, the Bank and Borrower have agreed that the Revolving Line
shall be modified and that the documents and instruments evidencing, securing,
relating to, guaranteeing, or executed or delivered in connection with the
Revolving Line (collectively the "Loan Documents") shall be amended as set forth
below.
AGREEMENT
NOW, THEREFORE, in consideration of the premises, the mutual agreements
of the parties as set forth herein, and for other good and valuable
consideration, the receipt and sufficiency of which are hereby acknowledged, and
to induce the Bank to modify the Revolving Line, the parties, intending to be
legally bound hereby, agree as follows:
1. AMENDMENT OF LOAN AGREEMENT. The Loan Agreement shall be and
the same hereby is amended as follows:
(a) The first paragraph of Page 1 shall be deleted in its entirety and in
place thereof shall be substituted:
"This Revolving Credit and Security Agreement (the "Agreement") is executed and
delivered this 9th day of July, 1999 by and between OPTIMATION, INC., an Alabama
corporation ("Borrower"), with its chief executive office and its principal
place of business at 2800 Bob Wallace Avenue, Suite L-3, Huntsville, Alabama
35805, and COMPASS BANK, an Alabama banking corporation ("Bank"), with its
principal offices at 114 Governors Drive, Huntsville, Alabama 35801. Borrower
has applied to Bank for a revolving line of credit not to exceed an aggregate
principal amount at any one time outstanding the sum of Three Hundred Sixty Five
Thousand and No/100 Dollars ($365,000.00) to be evidenced by a Revolving Credit
18
Commercial Note (the "Note") in such amount, and to be secured by a security
interest in all of the Collateral (as defined herein) now owned or hereafter
acquired by Borrower on the terms hereinafter set forth."
(b) Section 1.10 shall be deleted in its entirety and in place thereof shall be
substituted:
""Loan Documents" shall mean and include the Note, this Agreement and any other
agreement, document or instrument now or hereafter evidencing, securing,
guaranteeing (including, without limitation, Continuing Limited Guaranty
executed in connection herewith by Dennis and Sheila Sierk (up to $166,250.00)
and Continuing Unlimited Guaranty executed in connection herewith by Nematron
Corporation (such individuals and entities are jointly and severally included
within the term "guarantor" as the same is used in this Agreement)) or relating
to the Revolving Line or any other Liability, obligation or indebtedness of
Borrower to Bank, as the same may be amended."
(c) Section 3.1 shall be deleted in its entirety and in place thereof shall be
substituted:
"From the date hereof until October 5, 2002, or such future date to which the
expiration date of the Revolving Line may be extended, subject to the terms and
conditions of this Agreement and Borrower's and all guarantor's performance of
and compliance with each of the Loan Documents, and so long as no event of
default hereunder or under any of the other Loan Documents shall have occurred
or be continuing, Bank agrees to extend to Borrower an open-end credit line on
the basis of the following advance formula (such advance formula being
hereinafter referred to as the "Borrowing Base"): eighty percent (80%) of the
value of Borrower's Eligible Accounts Receivable, not to exceed $365,000.00 at
any one time outstanding, plus fifty percent (50%) of the value of Borrower's
Eligible Inventory, not to exceed $350,000.00 at any one time, and provided that
in no event shall the aggregate sum of all advances made by Bank to Borrower at
any one time outstanding hereunder exceed the sum of $365,000.00. Within such
limits and subject to the terms of this Agreement, Borrower may borrow, repay
without penalty or premium, and re-borrow hereunder, from the date of this
Agreement until the Maturity Date. It is expressly understood and agreed that
Bank shall have no obligation to make an advance under the Revolving Line if the
amount of such advance together with the amount outstanding under the Revolving
Line exceeds or would exceed the lesser of (i) $365,000.00 or (ii) the Borrowing
Base."
(d) Section 3.3 is hereby amended by deleting the amount "$650,000.00" and
substituting in place thereof the amount "$365,000.00".
(e) Section 7.1 (iii) shall be deleted in its entirety and in place thereof
shall be substituted: "annual personal financial statements of Dennis and Sheila
Sierk and quarterly internally prepared financial statements from Nematron
Corporation".
(f) Section 7.4 shall be deleted in its entirety and in place thereof shall be
substituted: "Borrower shall maintain a minimum Tangible Net Worth of not less
than $850,000."
(g) Section 14 is hereby amended by deleting the date "June 1, 2000" and
substituting in place thereof "October 5, 2002".
2. EFFECT ON LOAN DOCUMENTS. Each of the Loan Documents shall be
deemed amended as set forth herein to the extent necessary to carry out the
intent of this Agreement; provided, however, all terms, conditions,
representations, warranties and agreements contained in each of the Loan
Documents not amended by this Agreement shall remain in full force and effect
and are hereby reaffirmed.
19
IN WITNESS WHEREOF, the parties have caused this Agreement to be fully
executed as of the date first set forth above.
BORROWER:
Attest: OPTIMATION, INC.
By: /s/ David P. Gienapp By: /s/ Dennis A. Sierk
-------------------- -------------------
Its: Secretary Its: President
BANK:
Witness: COMPASS BANK
/s/ Margaret Henshaw By: /s/ Arlene Stackhouse
- -------------------- ---------------------
Its: Senior Vice President
20
Exhibit 99.1
------------
CHIEF EXECUTIVE OFFICER CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF
THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Nematron Corporation (the "Company")
on Form 10-QSB for the period ended June 30, 2002 as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), I, Matthew S. Galvez,
Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ Matthew S. Galvez
- ---------------------
Matthew S. Galvez
Chief Executive Officer
August 12, 2002
21
Exhibit 99.2
------------
CHIEF FINANCIAL OFFICER CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF
THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Nematron Corporation (the "Company")
on Form 10-QSB for the period ended June 30, 2002 as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), I, David P. Gienapp,
Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
that:
(3) The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Act of 1934; and
(4) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ David P. Gienapp
- --------------------
David P. Gienapp
Chief Financial Officer
August 12, 2002
22