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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB/A
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to ____
Commission File Number: 0-21142
NEMATRON CORPORATION
(Exact name of small business issuer as specified in its charter)
Michigan
(State or other jurisdiction of incorporation or organization)
38-2483796
(I.R.S. Employer Identification No.)
5840 Interface Drive, Ann Arbor, Michigan 48103
(Address of principal executive offices)
(734) 214-2000
(Issuer's telephone number)
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 May 14, 2003
Transitional Small Business Disclosure Format: [ ] YES [X] NO
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The Company hereby amends its Form 10-QSB for the quarterly period ended
March 31, 2003 by filing this Form 10-QSB/A to revise its description of the
line of credit facility between Compass Bank and its wholly-owned subsidiary,
Optimation, Inc. as described in Note 6 to the condensed financial statements
in Part I.
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Nematron Corporation and Subsidiaries
Consolidated Condensed Balance Sheets
March 31, 2003 and December 31, 2002
March 31,
2003 December 31,
(Unaudited) 2002
----------- ----
Assets
------
Current assets:
Cash $97,959 $103,802
Accounts receivable, net of allowance for
doubtful accounts of $83,000 at March 31, 2003,
and $75,000 at December 31, 2002 2,507,514 2,342,400
Inventories (Note 2) 1,644,291 1,653,844
Prepaid expenses and other current assets 192,082 172,550
----------- -----------
Total current assets 4,441,846 4,272,596
Property and equipment, net of accumulated
depreciation of $7,627,418 at March 31, 2003 and
$7,563,474 at December 31, 2002 1,777,740 1,850,392
Goodwill, net of amortization (Note 3) 2,922,122 2,922,122
Software and related development costs, net of
amortization (Note 4) 545,633 574,407
Other intangible assets, net of amortization (Note 5) 356,632 404,159
----------- -----------
Total assets $10,043,973 $10,023,676
=========== ===========
Liabilities and Stockholders' Deficit
Current liabilities:
Notes payable to banks (Note 6) $1,427,684 $1,397,317
Accounts payable 1,753,685 1,582,958
Deferred revenue and other accrued expenses 1,806,460 1,748,594
Subordinated debt (Note 7) 3,804,000 3,179,000
Current maturities of long-term debt (Note 8) 169,934 169,255
----------- -----------
Total current liabilities 8,961,763 8,077,124
Long-term debt, less current maturities (Note 8) 2,477,188 2,522,740
----------- -----------
Total liabilities 11,438,951 10,599,864
Stockholders' deficit:
Common stock, no par value, 30,000,000 shares
authorized, 15,744,625 shares outstanding 33,246,346 33,246,346
Accumulated comprehensive income 6,408 25,645
Accumulated deficit (34,647,732) (33,848,179)
----------- -----------
Total shareholders' deficit (1,394,978) (576,188)
----------- -----------
Total liabilities and shareholders' deficit $10,043,973 $10,023,676
=========== ===========
2
Nematron Corporation and Subsidiaries
Consolidated Condensed Statements of Operations
For The Quarters Ended March 31, 2003 and 2002
Quarter Ended March 31,
------------------------
2003 2002
(Unaudited) (Unaudited)
----------- -----------
Net revenues $3,334,223 $4,519,111
Cost of revenues 2,684,527 3,082,772
----------- -----------
Gross profit 649,696 1,436,339
Operating expenses:
Product development costs - software 44,894 190,438
Selling, general and administrative expenses 1,203,378 1,286,303
----------- -----------
Total operating expenses 1,248,272 1,476,741
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Operating loss (598,576) (40,402)
Other income (expense):
Interest expense (205,595) (163,000)
Sundry income, net of sundry expense 4,618 10,482
----------- -----------
Total other income (expense) (200,977) (152,518)
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Loss before income tax benefit (799,553) (192,920)
Income tax benefit (Note 9) -- --
----------- -----------
Net loss $(799,553) $(192,920)
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Loss per share (Note 11):
Basic and diluted $(0.05) $(0.01)
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Weighted average shares outstanding:
Basic and diluted 15,744,625 15,744,625
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Nematron Corporation and Subsidiaries
Consolidated Condensed Statements of Comprehensive Loss
For The Quarters Ended March 31, 2003 and 2002
Quarter Ended March 31,
-----------------------
2003 2002
(Unaudited) (Unaudited)
----------- -----------
Net loss $(799,553) $(192,920)
Other comprehensive loss - foreign currency
translation adjustment (19,237) (5,271)
---------- -----------
Comprehensive loss $(818,790) $(198,191)
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3
Nematron Corporation and Subsidiaries
Consolidated Condensed Statements of Cash Flows
For The Quarters Ended March 31, 2003 and 2002
Quarter Ended March 31,
-----------------------
2003 2002
(Unaudited) (Unaudited)
----------- -----------
Cash flows from operating activities:
Net loss $(799,553) $(192,920)
Adjustments to reconcile net loss to net cash flows
used in operating activities:
Depreciation 75,726 117,142
Amortization (Notes 4 and 5) 76,301 125,723
Non-cash interest for beneficial conversion
feature of warrants -- 796
Loss (gain) on disposal of property (3,890) 18,891
Changes in assets and liabilities that provided
(used) cash:
Accounts receivable (165,114) (350,567)
Inventories 9,553 33,037
Prepaid expenses and other current assets (19,532) (87,781)
Accounts payable 170,727 426,801
Deferred revenue and accrued expenses 57,867 (434,365)
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Net cash used in operating activities (597,915) (343,243)
Cash flows from investing activities:
Additions to property and equipment (2,010) (32,098)
Proceeds from disposals of property and equipment 2,824 --
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Net cash provided by (used in) investing
activities 815 (32,098)
Cash flows from financing activities:
Proceeds from issuance of subordinated notes
and warrants (Note 7) 625,000 285,000
Payments of long-term debt (44,873) (238,620)
Increase in notes payable to banks 30,367 196,883
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Net cash provided by financing activities 610,494 243,263
Foreign currency translation effect on cash (19,237) (5,271)
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Net decrease in cash (5,843) (137,349)
Cash at beginning of period 103,802 291,726
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Cash at end of period $ 97,959 $154,377
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Supplemental disclosures of cash flow information:
Cash paid for interest $188,403 $ 118,140
Cash paid for income taxes -- --
4
Nematron Corporation and Subsidiaries
Notes To Consolidated Condensed Financial Statements
For The Three Months Ended March 31, 2003 and 2002
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.
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 periods ended March 31, 2003 and
2002 are not necessarily indicative of the results to be expected for the full
year.
Note 2 - Inventories
Inventories consist of the following at March 31, 2003 and December 31, 2002:
March 31, December 31,
2003 2002
---- ----
Purchased parts and accessories $1,062,440 $1,085,811
Work in process 263,304 247,730
Finished goods, demo units and service stock 318,547 320,303
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Total Inventory $1,644,291 $1,653,844
========== ==========
Note 3 - Goodwill
Goodwill was recorded in connection with the Company's acquisition of other
entities during the years 1995 through 2001, and prior to January 1, 2002, the
Company was amortizing goodwill over periods ranging from fifteen to twenty
years. Effective with the adoption of FASB Statement No. 142, Goodwill and Other
Intangible Assets, that the Company adopted on January 1, 2002, the Company
ceased amortizing goodwill in accordance with provisions of the pronouncement.
However, goodwill is subject to certain impairment tests at least annually.
Note 4 - Software and Related Development Costs
Certain computer software development costs, primarily salaries, wages and other
payroll costs, and purchased software technology had been capitalized prior to
January 1, 2002. Capitalization of computer software development costs began
upon establishment of technological feasibility. The establishment of
technological feasibility and the ongoing assessment of recoverability of
capitalized computer software development costs required considerable judgment
by management with respect to certain external factors, including, but not
limited to, anticipated future gross revenues, estimated economic life, and
changes in software and hardware technology. The Company annually reviews the
recoverability of capitalized software costs based on estimated cash flows.
Software costs are written off at the time a determination has been made that
the amounts are not recoverable.
Amortization of capitalized computer software development costs is provided on a
product-by-product basis using the greater of the amount computed using (a) the
ratio that current gross revenues for each product bear to the total of current
5
and anticipated future gross revenues for that product, or (b) the straight-line
method over the remaining estimated economic lives of the respective products,
ranging from two to five years.
A summary of capitalized software and related development costs as of
March 31, 2003 is as follows:
Balance at beginning of period $574,407
Additions --
Amortization (28,774)
--------
Total Capitalized software $545,633
========
Note 5 - Other Intangible Assets
Intangible assets, which consist primarily of acquired intangible assets, patent
costs and deferred financing charges, are carried at cost less accumulated
amortization, which is calculated on a straight-line basis over the estimated
useful lives of the assets. The estimated useful lives of the assets range from
three to ten years.
The carrying value of intangible assets is periodically reviewed, and
impairments are recognized when the expected future cash flows derived from such
intangible assets are less than their carrying value.
A summary of activity in the intangible asset account as of
March 31, 2003 is as follows:
Balance at beginning of period $404,159
Additions --
Amortization (47,527)
--------
Total Other Intangible Assets $356,632
========
Note 6 - Notes Payable to Banks
The Company and its subsidiary, A-OK Controls, are parties to two loan and
security agreements (the "Agreements") with a Wisconsin-based bank. The
Agreements, as amended through April 2003, provide for a total of $1,575,000 in
two lines of credit. The Agreements provide for credit facilities through July
15, 2003, and the lender has notified the Company that the facility will not be
renewed at that date. The Agreements further provide that in the event that the
Company has not secured at least three financing proposals from alternative
lenders by May 15, 2003, the lines of credit will be reduced by $175,000 at that
date, and if the Company has not secured at least one financing commitment from
an alternative lender by June 15, 2003, the lines of credit will be further
reduced by $175,000 at that date.
The amount available under the line of credit is limited by a borrowing formula
that allows for advances up to a maximum of a specified percentage of eligible
accounts receivable, less the amount, if any, of outstanding letters of credit
issued by the Company. Based upon such borrowing formula, approximately $77,000
of the available line is eligible for advance at March 31, 2003. Amounts
borrowed under the line of credit facility total $1,202,684 at March 31, 2003,
and such borrowings bear interest at the prime rate plus 4.50% (9.25 % effective
rate at March 31, 2003). The line of credit is collateralized by substantially
all assets of the Company and a second position on the mortgage on the Company's
Ann Arbor facility.
The Agreements 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. The Company is not
in compliance with the tangible net worth, interest coverage and debt service
coverage covenants as of March 31, 2003. The bank has issued a forbearance
letter to the Company in October 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.
6
The Company's wholly owned subsidiary, Optimation, is party to a loan and
security agreement with Compass Bank, an Alabama-based bank (the "Optimation
Loan Agreement"). The Company and Compass Bank have been renewing the
Optimation Loan Agreement on consecutive 90-day revolving bases since the
Company acquired Optimation in March 2001. The Optimation Loan Agreement,
amended through January 3, 2003, provided for a total line of credit of
$270,000 that reduces in amount with all principal repayments made (the
"Optimation credit facility"). The amount available under the Optimation credit
facility is limited by a borrowing formula that allows for advances up to a
maximum of the sum of a specified percentage of eligible accounts receivable
and a specified amount of inventory. Amounts borrowed under the Optimation line
of credit facility total $225,000 at March 31, 2003, and such borrowings bear
interest at the prime rate plus .50% (5.25% effective rate at March 31, 2003),
but not less than 5.0% per annum. The Optimation Loan Agreement required
monthly repayments of $15,000 during its 90-day period, and prohibits the
transfer of funds from Optimation to the parent company except for customary
inter-company cost reimbursements. The Optimation line of credit is
collateralized by substantially all assets of Optimation, a guaranty by
Nematron and a partial guaranty by Optimation's president. The Optimation Loan
Agreement provided for the credit facility through April 3, 2003, and it had
not been renewed as of May 14, 2003. Management expects that the facility will
renewed in the amount of the current balance on substantially the same terms
and conditions as the current facility. On May 23, 2003, the Company renewed
the Optimation Agreement and Optimation credit facility and in connection
therewith, paid an additional $41,250 against the principal of the note to
allow Compass Bank to release the partial guaranty by Optimation's president.
The balance of the line of credit, after payment of the additional principal on
May 23, 2003, is $173,750. The credit facility matures on October 3, 2003. The
Company expects that the Optimation Loan Agreement will be renewed at that time
on substantially the same terms as the current credit facility until the
balance of the line is repaid in full.
Note 7 - Subordinated Debt
Subordinated debt consists of the following:
March 31, December 31,
2003 2002
---- ----
Convertible subordinated promissory notes,
interest at 10% perannum, due August 31, 2001.
Accrued interest and the principal of the note
may be converted into common stock at the lower
of $0.09 per share or the lowest price of the
underlying common stock during the period the
notes are outstanding $1,200,000 $1,200,000
Convertible subordinated promissory notes,
interest at 8% per annum, due October 15, 2002.
The notes may be converted into preferred stock
during the period the notes are outstanding, and
the terms of the preferred stock, if issued,
would allow the holders to convert the preferred
stock into common stock on a one-for-one basis 200,000 200,000
Convertible subordinated promissory notes,
interest at 14% per annum, due on demand. The
notes may be converted into preferred stock during
the period the notes are outstanding, and the terms
of the preferred stock, if issued, would allow the
holders to convert the preferred stock into common
stock on a one-for-one basis 2,404,000 1,779,000
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Total $3,804,000 $3,179,000
========== ==========
The 10% Convertible Subordinated Promissory Notes
- -------------------------------------------------
The 10% convertible subordinated notes due August 31, 2001 (the "10% Notes")
included detachable warrants. The warrants, which are non-assignable, initially
allowed the holders to purchase Common Stock at $0.30 per share (the "Per Share
Warrant Price") at any time until March 31, 2006 (the "Warrants"). If at any
time prior to the exercise of the Warrants the daily closing price of the Common
Stock, as traded on the American Stock Exchange, 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. As
the lowest price per share has been $0.05, the Per Share Warrant Price has been
adjusted to that amount.
7
The 14% Subordinated Promissory Notes
- -------------------------------------
The 14% subordinated promissory notes due on demand (the "14% Notes") were
issued pursuant to an agreement initially dated in October 2001 and modified in
March and October 2002. The modified agreement allows the Company to draw up to
$3 million upon request and upon approval by the 14% Note holder upon its sole
discretion. In the event of any equity financing by the Company, the 14% Note
holder may convert any or all of the outstanding principal of the 14% Note and
accrued interest thereon into the securities offered in such financing at the
offering price per share. The modified agreement further provides that the
principal and accrued interest payable under the 14% Note may be converted in
whole or part into shares of Series A Preferred Shares beginning on September 1,
2002 at $0.10 per share. Provisions of the Series A Preferred Shares include: a)
participation in dividends, if any, with the Common Stock shareholders; b) a
liquidation preference up to the initial purchase price of the Series A
Preferred Shares; c) a conversion feature allowing conversion into Common Stock
on a one-to-one basis; d) full voting powers; e) the right to elect one person
to the Board of Directors; f) the consent of a majority in interest of the
Series A Preferred will be required to (i) purchase or redeem any Common or
Preferred Stock, (ii) authorize or issue any senior or parity securities, (iii)
declare or pay dividends on or make any distribution on account of the Common
Stock, (iv) merge, consolidate or sell or assign all or substantially all of the
Company's assets, (v) increase or decrease authorized Preferred Stock and (vi)
amend Articles or Incorporation to change the rights, preferences, privileges or
limitations of any Preferred Stock; g) the conversion price for the Series A
Preferred shall be subject to proportional antidilution protection for stock
splits, stock dividends, etc. and in the event that the Company issues
additional shares of Common Stock or Common Stock equivalents (other than shares
issues to officers or employees of the Company pursuant to plans approved by the
Company's board of directors) at a purchase price less than the applicable
Series A Preferred conversion price, the Series A Preferred Stock conversion
price shall be adjusted to that same lower purchase price; and h) each holder of
Series A Preferred Stock shall have the right to participate in any Company
financing up to its pro-rata ownership.
The 14% Notes sold included detachable warrants. The warrants, which are
non-assignable, initially allowed the holders to purchase Common Stock at $0.10
per share (the "Per Share Warrant Price") in an amount of 20% of the principal
of the 14% Notes and accrued interest thereon for a period of five years from
the date of the advance (the "Warrants"). In connection with the October 2002
modification the securities into which the Warrants could be converted were
changed to Series A Preferred Stock as described above.
The 8% Subordinated Promissory Notes
- ------------------------------------
The 8% subordinated promissory notes due October 15, 2002 (the "8% Notes")
included detachable warrants. The warrants, which are non-assignable, initially
allowed the 8% Notes holders to purchase Common Stock at $0.22 per share (the
"Per Share Warrant Price") at any time until March 31, 2007 (the "Warrants").
The Company did not repay the 8% Notes when due and in connection with the
noteholders' forbearance, the conversion feature was modified to allow
conversion into the same securities and at the same price as that set forth in
the 14% Notes described above.
A total of $750,000 of the 10% Notes and all of the 8% Notes and 14% Notes were
issued to Board members or their affiliates. At March 31, 2003, a total of
$473,979 of interest has been accrued for convertible subordinated promissory
notes, including $383,582 related to notes due to related parties.
8
Note 8 - Long-Term Debt
Long-term debt includes the following debt instruments at March 31, 2003 and
December 31, 2002:
March 31, December 31,
2003 2002
---- ----
Variable rate term loan payable to a bank,
interest at prime plus 3.5% per annum (8.25%
effective rate at March 31, 2003), payable in
monthly installments of $31,000 through October
2005, at which time the remaining principal and
interest is due. The term loan is collateralized
by a mortgage on the Ann Arbor facility. $2,621,354 $2,663,056
Other notes, secured by equipment 25,768 28,939
Total long-term debt 2,647,122 2,691,995
Less current maturities (169,934) (169,255)
---------- ----------
Long-term debt, less current maturities $2,477,188 $2,522,740
========== ==========
Note 9 - Taxes on Income
The Company has net operating loss carryforwards ("NOLs") of approximately $26.9
million as of December 31, 2002 that may be applied against future taxable
income. The NOLs expire in varying amounts from 2004 and through 2022.
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 - Stock Based Compensation
At March 31, 2003, the Company has stock-based employee and director
compensation plans, which are described more fully in Note 11 to the Company's
December 31, 2002 financial statements. The Company accounts for those plans
under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. No
stock-based employee compensation cost is reflected in net loss, as all options
granted under those plans had an exercise price greater than or equal to the
market value of the underlying common stock on the date of grant. The following
table illustrates the effect on net loss and loss per share if the Company had
applied the fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation.
Three Months Ended
March 31,
------------------
2003 2002
---- ----
Net loss, as reported $(799,553) $(192,920)
Deduct: Total stock-based employee compensation
expense determined under fair value-based method
for all awards, net of tax (54,787) (66,566)
--------- ---------
Pro forma net loss $(854,340) $(259,486)
========= =========
Loss per share:
Basic and diluted, as reported $(0.05) $(0.01)
Basic and diluted, pro forma $(0.05) $(0.02)
9
Note 11 - Earnings Per Share
The weighted average shares outstanding used in computing loss per share were
15,744,625 for the three-month periods ended March 31, 2003 and 2002.
For the three-month periods ended March 31, 2003 and 2002, outstanding options
and warrants were not included in the computation of diluted loss per share
because the inclusion of such securities is antidilutive. Information relative
to the excluded options and warrants is as follows:
Outstanding Options Outstanding Warrants
------------------------ ---------------------------
Expiration Expiration
Quarter Ended Amount Dates Amount Dates
-------------- ------ ----- ------ -----
March 31, 2003 2,017,528 2003 to 2011 4,791,333 2002 to 2007
March 31, 2002 2,162,942 2003 to 2011 1,470,910 2002 to 2006
10
Item 2. Management's Discussion and Analysis of Results of Operations
Three Months Ended March 31, 2003 Compared with
Three Months Ended March 31, 2002
- ---------------------------------
Net revenues for the first quarter of 2003 decreased $1,185,000 (26.2%) to
$3,334,000 compared to $4,519,000 for the comparable period last year. The
decrease is attributable primarily to a decrease in sales of software licenses,
system integration services and repair services. Revenues from software licenses
decreased in the current period compared to the prior year period because of a
significant sale of FloPro software licenses to one customer in the first
quarter of 2002. Revenues from system integration decreased in the current
period compared to the prior year period because of postponements of program
work to future periods by a significant customer and the recognition in the
first quarter of 2002 of significant services revenue for which costs had been
previously incurred; revenue recognition had been postponed pending realization
due to the uncertainty of collection of such revenue. Revenues from repair
services decreased because of spending declines by the Company's customers.
Management expects that net revenues for the last nine months of 2003 will be
comparable to the year earlier period based on the current order rate and
scheduled deliveries.
Gross profit for the first quarter of 2002 decreased $787,000 (54.8%) to
$650,000 compared to $1,436,000 for the comparable period last year. Gross
profit as a percentage of revenue in the first quarter of 2003 was 19.5%
compared to 31.8% in the comparable period last year. The decrease in the gross
profit percentage results from the profit margins on the FloPro license sold in
the first quarter of 2002 and the revenue from the system integration services
in the first quarter of 2002 for which the costs were incurred in prior periods,
as discussed in the first paragraph above. Management expects that gross profit
margins will increase in the remaining quarters of the year as revenues increase
over the revenue rate of the first quarter, and that the gross profit rates for
the remaining nine months of 2002 will be comparable to the year earlier period.
Product development expenses incurred for software development for the first
quarter of 2003 decreased $145,000 (76.4%) to $45,000 compared to $190,000 for
the comparable period last year. The decrease is attributable to a reduction of
development efforts and an emphasis on software and systems support. Management
expects that product development expenses will increase moderately in the
remaining quarters of 2003 as development and enhancement efforts are planned to
increase moderately.
Selling, general and administrative expenses for the first quarter of 2003
decreased $83,000 (6.4%) to $1,203,000 compared to $1,286,000 for the comparable
period last year and increased as a percentage of net revenue to 36.1% in the
first quarter of 2003 from 28.5% in the comparable period of 2002. The decrease
results primarily from decreases in staff levels and certain sales and marketing
costs in the current period compared to the year earlier period. Management
expects that selling, general and administrative expenses will increase
moderately in the remaining quarters of 2003 because of an expansion of its
marketing and sales initiatives compared to current activities as management
anticipates new product releases and related sales and marketing efforts on such
new products during the remaining months of 2003.
Interest expense for the first quarter of 2003 increased $43,000 (26.1%) to
$206,000 compared to $163,000 for the comparable period last year. The increase
results primarily from higher overall average borrowing levels during the
current period compared to the year ago period.
Sundry income was not significant in either reported period.
Liquidity and Capital Resources
- -------------------------------
Primary sources of liquidity are advances under subordinated debt agreements and
the Company's secured lines of credit that total $1,575,000 as of March 31, 2003
from LaSalle Business Credit ("LBCI") and $225,000 from Compass Bank. As of
March 31, 2003, the Company had $1,428,000 outstanding under the lines of credit
and approximately $77,000 of additional borrowing capacity available under such
credit lines. The Company's operations used $598,000 in cash during the first
quarter of 2003 as a result of the net loss and the effects of changes in
working capital and the noncash depreciation and amortization charges. During
the first quarter of 2003, the Company also used $15,000 of cash in net line of
credit and long-term debt repayments. Primary sources of cash in the first
quarter of 2003 were $625,000 from proceeds from sales of subordinated
promissory notes and warrants.
11
Management estimates that the Company will incur net cash losses in the next
quarter and be cash neutral in the last two quarters of 2003. Based upon this
projection, the Company will be in a net borrowing position in its second
quarter of 2003 and will need to sell additional subordinated debt and warrants
to sustain operations.
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. LBCI has issued a
forbearance letter to the Company concerning these covenant violations provided
that the Company makes progress on securing alternate sources of senior
financing. In the forbearance letter, LBCI has specifically reserved its right
to take any action permitted under the agreement, including the immediate pay
down of its lines of credit through its lock box mechanism, without any notice
to the Company. Pursuant to the April 25, 2003 amendment to the credit
agreements between the Company and LBCI, LBCI has stated that in the event that
the Company has not secured at least three financing proposals from alternative
lenders by May 15, 2003, the lines of credit will be reduced by $175,000 at that
date, and if the Company has not secured at least one financing commitment from
an alternative lender by June 15, 2003, the lines of credit will be further
reduced by $175,000 at that date.
In the short term, in addition to having to fund its projected net cash losses
over the next quarter, the Company will be required to repay by term debt of
approximately $18,000 per month, plus interest. Additionally, all of the
subordinated debt, $3,804,000 plus accrued interest thereon is due currently.
Management is attempting to complete as soon as practical a private placement of
preferred stock or subordinated debt to accredited investors, the proceeds of
which would be applied to the repayment of bank debt and other current
liabilities plus new liabilities arising from operations. Management is also
attempting to secure alternative working capital arrangements with commercial
credit companies in an amount sufficient to sustain operations and to replace
the expiring LBCI credit facilities. Management can offer no assurance that it
can secure alternative working capital facilities or that the proposed private
placements of preferred stock or subordinated will be successful. Additionally,
management can offer no assurance that if the Company is successful in securing
alternative working capital facilities, or if the private placement of
subordinated notes or preferred stock should occur, that the funds raised will
be sufficient to fund future operations. If the efforts to secure alternative or
additional capital 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 operations, sell product lines or sell the Company to a
third party.
Uncertainties Relating to Forward Looking Statements
- ----------------------------------------------------
"Item 2. Management's Discussion and Analysis 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 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;
- - The potential inability to convince its lead bank, LBCI, to continue its
forbearance and exercising its remedies available to LBCI resulting from loan
covenant violations;
- - A further decline of economic conditions in general and conditions in the
automotive manufacturing industry in particular;
- - Delays in introduction of planned hardware and software product offerings;
- - Reductions in product life cycles;
- - 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
participate effectively in the industrial automation market migration from
closed architecture PLCs to open architecture PC-based solutions or to
effectively changes its corporate strategy to capitalize on market changes.
12
Item 3. Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer have concluded, based on
their evaluation within 90 days of the filing date of this report, that our
disclosure controls and procedures are effective for gathering, analyzing and
disclosing the information we are required to disclose in our reports filed
under the Securities Exchange Act of 1934. There have been no significant
changes in our internal controls or in other factors that could significantly
affect these controls subsequent to the date of the previously mentioned
evaluation.
PART II - OTHER INFORMATION
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 March 31, 2003, the Company filed a report on Form
8-K concerning its press release dated March 31, 2003 concerning its fourth
quarter and year ended December 31, 2002 operating results.
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
May 14, 2003 /s/ Matthew S. Galvez
- ------------ ----------------------------------
Date Matthew S. Galvez, President & CEO
May 14, 2003 /s/ David P. Gienapp
- ------------ ----------------------------------
Date David P. Gienapp, Vice President -
Finance and Administration
13
CERTIFICATION
Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
I, Matthew S. Galvez, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Nematron Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such internal controls to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's internal controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 14, 2003
/s/ Matthew S. Galvez
- ---------------------
Matthew S. Galvez
Chief Executive Officer
See also the certification pursuant to Section 906 of the Sarbanes Oxley Act of
2002, which is also attached to this report.
14
CERTIFICATION
Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
I, David P. Gienapp, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Nematron Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such internal controls to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's internal controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 14, 2003
/s/ David P. Gienapp
- --------------------
David P. Gienapp
Chief Financial Officer
See also the certification pursuant to Section 906 of the Sarbanes Oxley Act of
2002, which is also attached to this report.
15
INDEX TO EXHIBITS
Exhibit
Number Description of Exhibit
4.1 Amended and Restated Promissory Note in the amount of $225,000 between
Compass Bank and Optimation, Inc. dated April 3, 2003
4.2 Amended Subordinated Promissory Note between North Coast Technology
Investors, L.P. and the Registrant dated April 14, 2003
4.3 Amendment dated April 25, 2003, to the Amended and Restated Loan and
Security Agreement dated as of June 30, 2000 between the A-OK Controls
Engineering, Inc. and LaSalle Business Credit, Inc.
4.4 Amendment, dated April 25, 2003, to the Amended and Restated Loan and
Security Agreement dated as of June 30, 2000 between the Company and
LaSalle Business Credit, Inc.
99.1 Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
16