U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 1998
OR
[ ] 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 0-23438
Effective Management Systems, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Wisconsin 39-1292200
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
12000 West Park Place, Milwaukee, WI 53224
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (414) 359-9800
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes __X___ No _______
Indicate the number of shares outstanding of each of the registrant's classes of
common stock as of the latest practicable date.
Class Outstanding as of August 31, 1998
- ---------------------------------- ----------------------------------------
Common Stock, $.01 par value 4,102,486
EFFECTIVE MANAGEMENT SYSTEMS, INC.
Form 10-Q
August 31, 1998
INDEX
PART 1 - FINANCIAL INFORMATION PAGE
Item 1 Financial Statements
Consolidated Balance Sheets at
August 31, 1998 and November 30, 1997 3
Consolidated Statements of Operations - Three and Nine
Months Ended August 31, 1998 and August 31, 1997 5
Consolidated Statements of Cash Flows - Nine 6
Months Ended August 31, 1998 and August 31, 1997
Notes to Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3 Quantitative and Qualitative Disclosures About Market Risk 17
PART II - OTHER INFORMATION
Item 2 Changes in Securities and Use of Proceeds 18
Item 6 Exhibits and Reports on Form 8-K 19
SIGNATURES 20
Page 2
PART I Financial Information
Item 1 Financial Statements
EFFECTIVE MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands) (unaudited except for November 30, 1997 amounts)
- ------------------------------------------------------------------------------
ASSETS 31-Aug 30-Nov
1998 1997
==========================================================================
CURRENT ASSETS
Cash $8 $14
Accounts Receivable:
Trade, less allowance for
doubtful accounts 8,254 12,370
Related Parties 785 604
Inventories 334 280
Refundable Income Taxes 0 312
Deferred Income Taxes 0 0
Prepaid Expenses and Other
Current Assets 338 146
-------------------------------------
TOTAL CURRENT ASSETS 9,719 13,726
LONG TERM ASSETS
Computer Software, net 3,917 7,717
Investments in and Advances to
Unconsolidated Joint Ventures 182 182
Equipment and Leasehold
Improvements, net 3,312 3,917
Intangible Assets, net 2,269 2,444
Other Assets 284 811
-------------------------------------
TOTAL LONG TERM ASSETS 9,964 15,071
-------------------------------------
TOTAL ASSETS $19,683 $28,797
==========================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
Page 3
EFFECTIVE MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited except for November 30, 1997 amounts)
- --------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 31-Aug 30-Nov
1998 1997
================================================================================
CURRENT LIABILITIES
Accounts Payable $2,301 $2,272
Accrued Liabilities 1,881 2,773
Deferred Revenues 5,810 5,887
Customer Deposits 290 63
Current portion of
Long-term Obligations 1,012 946
------------------------------
TOTAL CURRENT LIABILITIES 11,294 11,941
LONG TERM LIABILITIES
Deferred Revenue and Other
Long-term Liabilities 887 317
Long-term Obligations 3,961 3,966
Deferred Income Taxes 0 0
------------------------------
TOTAL LONG TERM LIABILITIES 4,848 4,283
Commitments and Contingencies 0 0
STOCKHOLDERS' EQUITY
Preferred Stock, $.01 par value;
authorized 3,000,000 shares, of
which 7,000 shares are designated as
Series A 8% Convertible Redeemable
Preferred Stock ("Series A"); 1005
shares of Series A issued and
outstanding (liquidation
preference at $1,000 per share) 826 0
Common Stock, $.01 par value; authorized
20,000,000 shares; issued 4,102,486 and
4,067,408 shares; outstanding 4,089,861
and 4,054,783 shares 41 41
Common Stock Warrants 77 4
Additional Paid- in Capital 11,418 11,328
Retained Earnings (Deficit) (8,761) 1,260
Cost of Common Stock in Treasury(12,625
shares) (60) (60)
------------------------------
TOTAL STOCKHOLDERS' EQUITY 3,541 12,573
------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $19,683 $28,797
================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
Page 4
EFFECTIVE MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data) (unaudited)
- --------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
31-Aug 31-Aug 31-Aug 31-Aug
1998 1997 1998 1997
NET REVENUES:
Software license fees $3,866 $4,963 $13,573 $14,491
Services 3,977 4,095 12,748 12,361
Hardware 339 624 1,455 2,687
------------- ------------- ----------- -----------
Total net revenues 8,182 9,682 27,776 29,539
COST OF PRODUCTS AND SERVICES
Software license fees 1,059 1,321 4,163 3,983
Services 3,581 3,387 10,175 10,584
Hardware 232 468 1,112 2,074
-------------- ------------- ----------- -----------
Total cost of products and
services 4,872 5,176 15,450 16,641
Selling and marketing expenses 3,017 4,259 10,043 11,103
General and administrative expenses 624 631 2,837 2,993
Product development expenses 597 621 2,118 1,817
Restructuring and Other Charges 0 0 6,836 0
------------- ------------- ----------- -----------
Total costs and operating
expenses 9,110 10,687 37,284 32,554
------------- ------------- ----------- -----------
LOSS FROM OPERATIONS (928) (1,005) (9,508) (3,015)
Other (Income)/ Expense
Equity in (earnings)/loss
of unconsolidated joint
ventures 0 (55) (1) (57)
Interest (income) (19) (13) (39) (41)
Interest expense 184 107 521 274
------------- ------------- ----------- -----------
165 39 481 176
------------- ------------- ----------- -----------
LOSS BEFORE INCOME TAXES (1,093) (1,044) (9,989) (3,191)
Income tax (benefit) expense 0 0 33 (883)
------------- ------------- ----------- -----------
NET LOSS ($1,093) ($1,044) ($10,022) ($2,308)
============= ============= =========== ===========
Loss per share - basic and diluted ($0.27) ($0.26) ($2.45) ($0.57)
============= ============= =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
EFFECTIVE MANAGEMENT SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) (unaudited)
- -----------------------------------------------------------------------
NINE MONTHS ENDED
31-Aug 31-Aug
1998 1997
===============================================================================
OPERATING ACTIVITIES
Net Loss ($10,022) ($2,308)
Adjustments to reconcile net loss
to net cash provided by (used in)
operating activities:
Depreciation and amortization 1,044 862
Amortization of capitalized
computer software development costs 2,277 2,077
Equity in earnings of joint ventures - -
Goodwill Amortization 176 170
Deferred income taxes - -
Restructuring and Other Charges 6,836
Changes in operating assets and
liabilities:
Accounts Receivable 3,054 1,226
Inventories and other current assets (25) (1,266)
Accounts payable and other liabilities (1,684) (921)
--------------------------
Total adjustments 11,678 2,148
--------------------------
Net cash provided by(used in) in
operating activities 1,656 (160)
INVESTING ACTIVITIES
Additions to equipment and
leasehold improvements (439) (1,101)
Proceeds from sale of securities - 504
Software development costs capitalized (2,800) (3,207)
Other 527 (97)
--------------------------
Net cash (used in) investing
activities (2,712) (3,901)
FINANCING ACTIVITIES
Proceeds on long-term debt and
other notes payable 61 3,466
Additional paid-in capital 90 -
Proceeds from sale of stock 899 136
--------------------------
Net cash provided by financing activities 1,050 3,602
--------------------------
Net decrease in cash ($6) ($459)
Cash-beginning of period $14 $866
==========================
Cash-end of period $8 $407
===============================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
Page 6
EFFECTIVE MANAGEMENT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 1998
(Unaudited) (In Thousands)
Note 1 - Basis of Presentation
The accompanying consolidated interim financial statements included
herein have been prepared by Effective Management Systems, Inc. (the "Company"),
without an audit, in accordance with generally accepted accounting principles
for interim financial information and pursuant to the rules and regulations of
the Securities and Exchange Commission. 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 such rules and regulations, although the Company believes that the
disclosures made are adequate to make the information presented not misleading.
In the opinion of management, the information furnished for the three
and nine month periods ended August 31, 1998 and August 31, 1997 includes all
adjustments, consisting solely of normal recurring accruals, necessary for a
fair presentation of the financial position and results of operations for the
interim periods. The results of operations for the nine months ended August 31,
1998 are not necessarily indicative of the results of operations to be expected
for the entire fiscal year ending November 30, 1998. It is suggested that the
interim financial statements be read in conjunction with the audited
consolidated financial statements for the year ended November 30, 1997 included
in the Company's Annual Report on Form 10-K filed with the Securities and
Exchange Commission.
Note 2 - Additional Financial Disclosure
Equipment and leasehold improvements consisted of the following:
31-August-1998 30-Nov-1997
Gross $9,798 $9,359
Less: Accumulated
Depreciation ( 6,486 ) ( 5,442 )
-------- --------
Net $3,312 $3,917
Allowance for doubtful accounts consisted of the following:
31-August-1998 30-Nov-1997
Balance $ 547 $ 462
Provision for doubtful accounts consisted of the following:
31-August-1998 30-Nov-1997
$ 82 $ 17
Page 7
Note 3 - Net Loss Per Share
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." SFAS No.
128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options and warrants.
Earnings per share amounts for all periods have been presented and, where
appropriate, restated to conform to SFAS No. 128 requirements.
The following table sets forth the computation of basic and diluted earnings per
share.
Three Months Ended
August 31,
1998 1997
Denominator
Denominator for basic earnings per share -
weighted average common shares 4,098 4,054
Effect of dilutive securities - stock options
and warrants 0 0
Effect of dilutive securities - preferred stock 0 0
---------- ------------
Denominator for diluted earnings per share -
adjusted weighted average common shares 4,098 4,054
========== ============
Nine Months Ended
August 31,
1998 1997
Denominator
Denominator for basic earnings per share -
weighted average common shares 4,084 4,038
Effect of dilutive securities - stock options
and warrants 0 0
Effect of dilutive securities - preferred stock 0 0
---------- ------------
Denominator for diluted earnings per share -
adjusted weighted average common shares 4,084 4,038
========== ============
Note 4 - Restructuring and Other Charges
The company recorded charges for a restructuring in the second quarter of fiscal
1998 totaling $6.8 million of which $6.6 million was paid or expensed as of
August 31, 1998. The company anticipates the remaining liability of $.2 million
to be paid in the fourth quarter of fiscal 1998, which will be financed through
working capital.
Page 8
Note 5 - Preferred Stock
On August 28, 1998, the Company issued 1,005 shares of Series A 8% Convertible
Redeemable Preferred Stock (the "Series A Preferred Stock"). Legal and
investment banking fees of $101,000 were deducted from the total proceeds.
The Series A Preferred Stock accrues cumulative dividends at a 8% rate per annum
(using a liquidation value of $1,000 per share), and all dividends in arrears
must be paid prior to any payment of dividends on common stock. Dividends, if
declared by the board of directors, generally must be paid in cash.
The Series A Preferred Stock is convertible into common stock at the preferred
shareholders' option at the initial conversion price of $3.50 per share, subject
to adjustment, with each share of Series A Preferred Stock valued at $1,000 for
purposes of conversion. An adjustment to the conversion rate may be made upon
any of the following circumstances: subdivision or reverse split of the
outstanding shares of common stock into a greater or lesser number of shares of
common stock, declaration of a dividend or other distribution by the Company
upon the common stock payable in common stock, capital reorganization or
reclassification of the common stock of the Company, and in certain other
instances. The Company may force conversion of the Series A Preferred Stock
under certain conditions.
The holders of the Series A Preferred Stock shall be entitled to vote and shall
receive the number of votes they would have assuming full conversion of the
Series A Preferred Stock into common stock.
There are 7,000 shares of Series A Preferred Stock authorized for issuance, with
1,005 shares being issued and outstanding. The Company has 3,000,000 shares of
Preferred Stock authorized for issuance. Such shares may be issued in separate
series. The Series A Preferred Stock is currently the only series of Preferred
Stock authorized, issued and outstanding.
Note 6 - Warrants
During August 1998 the Company's investment banker earned the right to receive a
warrant as consideration for the Preferred Stock issued. The investment banker
has the right through August 2003 to purchase up to 10% of the total number of
shares of common stock issuable upon exercise of the Series A Preferred Stock at
an exercise price of $4.20 per share.
As required by SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company calculated the fair value of the warrants using the Black Scholes option
pricing model with a risk-free interest rate of 5.0%; dividend yield of 0%, and
an expected life of 5 years. The Company recorded $73,000 or $2.56 per warrant
as a reduction of proceeds on Series A Preferred Stock issued in August 1998.
Page 9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The Company recorded a decrease of 15.5% in net revenues and a net loss of
$1,093,000 for the third quarter of fiscal 1998 compared with a net loss of
$1,044,000 for the third quarter of fiscal 1997. The third quarter of fiscal
1998 does not reflect a tax benefit relating to the loss since because the
Company is in a loss carryforward position for financial reporting purposes.
Software revenues were down 22.1% in the third quarter of fiscal 1998 compared
to the same period in the prior year. Management believes this decrease in
software revenues was mainly the result of the attention and efforts spent in
the transition to adding the new Baan product line, reduced revenues from
restructured operations (a reduction of $716,000 from the third quarter of 1997)
and reduced revenues due to lower levels of personnel caused by attrition. The
Company recorded a decrease in net revenues of 6.0% and a net loss of
$10,022,000 (including a $6,836,000 restructuring charge incurred in the second
quarter of 1998) for the first three quarters of fiscal 1998, compared with a
net loss of $2,308,000 for the first three quarters of fiscal 1997.
Although the goal of the Company is to return to profitability, no assurance can
be given that the various measures that the Company has taken will actually
result in the achievement of this goal. The Company's long term success is also
dependent on its ability to attract and retain a highly qualified sales,
development and service staff. The Company has recently experienced attrition at
rates higher than its historical experience. The Company has taken steps to
curtail the attrition, but no assurance can be given that these steps will be
successful or that further attrition will not materially impact the Company's
financial performance.
Results of Operations
Net Revenues
Net revenues were $8,182,000 for the three months ended August 31, 1998, which
was a decrease of 15.5% from the $9,682,000 for the same quarter in the previous
year. Net revenues were $27,776,000 for the nine months ended August 31, 1998,
which was a decrease of 6.0% from the $29,539,000 for the same period in the
previous year. The overall decrease in revenues for the three months ended
August 31, 1998 was attributable primarily to the attention and efforts spent
planning and executing the restructuring plan. The mix of revenues comparing
software, services and hardware revenues as a percentage of net revenues was
47.3%, 48.6%, and 4.1%, respectively, in the third quarter of fiscal 1998, as
compared with 51.3%, 42.3%, and 6.4%, respectively, in the third quarter of
fiscal 1997. The mix of revenues comparing software, services and hardware
10
revenues as a percentage of net revenues was 48.9%, 45.9%, and 5.2%,
respectively, in the first three quarters of fiscal 1998, as compared with
49.1%, 41.9%, and 9.0%, respectively, in the first three quarters of fiscal
1997. International revenues represented less than 10% of net revenues for all
periods presented.
The Company's operating revenues can vary substantially from quarter to quarter
based on the size and timing of customer software orders and market acceptance
of new products. The Company has historically operated with little software
backlog because software orders are generally shipped as orders are received. As
a result, product revenue in any quarter is substantially dependent on software
orders booked and shipped during that quarter.
Software License Fees
Software license fees are customer charges for the right to use the Company's
software products. Software license fees decreased 22.1% to $3,866,000 in the
third quarter of fiscal 1998 from $4,963,000 in the third quarter of fiscal
1997. The decrease in software license fees was mainly attributable to the
attention and efforts spent in the transition to adding the new Baan product
lines, reduced revenues from restructured operations(a reduction of $664,000
from the third quarter of fiscal 1997), and reduced revenues due to lower levels
of sales personnel caused by attrition. As additional sales personnel continue
to train in the Baan products, sales productivity temporarily decreases. The
length of the sales cycle can range from two to twelve months depending on such
factors as the size of the prospect or complexity of the prospect need. The
Company is also in the process of building a sufficient level of prospect leads
to maintain and enhance necessary levels of sales activity. Management expects
that this decrease in productivity will mainly continue during the next fiscal
quarter, and, thereafter, productivity is expected to increase. Management is
also actively recruiting new sales talent through various methods. Software
license fees decreased 6.3% to $13,573,000 in the first three quarters of fiscal
1998 from $14,491,000 in the first three quarters of fiscal 1997. The decrease
was mainly attributable to the reasons mentioned above for the third quarter of
the 1998 fiscal year except that software revenues rose in the first quarter of
fiscal 1998 due to the introduction of new products.
Service Revenues
The Company offers a number of optional services to its customers, including
such services as a telephone support program, systems integration, custom
software development, implementation consulting, and formal classroom and
on-site training. Service revenues decreased to $3,977,000 for the three months
ended August 31, 1998, as compared with $4,095,000 for the same period of the
prior year. This decrease was mainly the result of a lower level of service
personnel though attrition. Service revenues increased to $12,748,000 for the
nine months ended August 31, 1998, as compared with
11
$12,361,000 for the same period of the prior year. Management expects the level
of service demand to grow as the Company transitions to the addition of the Baan
product line and recognizes the incremental revenues associated with that
transition. The Company has expanded its recruiting efforts and has begun to
hire additional service personnel.
Hardware Revenues
Hardware revenues decreased 45.7% to $339,000 in the third quarter of fiscal
1998 compared with $624,000 for the corresponding period of 1997. Hardware
revenues decreased 45.9% to $1,455,000 in the first three quarters of fiscal
1998 compared with $2,687,000 for the corresponding period of 1997. The decrease
was mainly due to increased sales of software on platforms for which the Company
does not supply hardware and the discontinuation of hardware sales to an
affiliate of the Company, EMS Solutions, Inc. (a decrease of $93,000 and
$334,000 from the third quarter and first three quarters of 1997,
respectively)(See General and Administrative Expense below). Management expects
the trend of declining hardware sales to continue due to the increasing sales of
software licenses operating on the Microsoft Windows NT platform. Hardware used
with the Microsoft Windows NT platform is either generally already in place at
the customer site or readily available from local suppliers who can also provide
local support.
Cost of Software License Fees
The cost of software license fees as a percentage of related revenue was 27.4%
for the third quarter of fiscal 1998, an increase from 26.6% for the
corresponding period of 1997. The cost of software license fees as a percentage
of related revenue was 30.7% for the first three quarters of fiscal 1998, an
increase from 27.5% for the corresponding period of 1997. Cost of software
license fees is composed of both amortization of past investment in software
development and the third party costs associated with the software revenues.
Software amortization is related to past investment in software development and
does not vary consistently with variations in software revenues. The Company
wrote off a substantial portion of its past investment in software development
in conjunction with its restructuring efforts in the quarter ended May 31, 1998.
(See the discussion under the caption "Restructuring and Other Charges" in the
section of the Company's Form 10-Q for the period ended May 31, 1998 titled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations". Software amortization decreased $379,000 in the third quarter of
fiscal 1998 as compared to the same period of 1997 as a result of the amounts
written off of previously capitalized development costs in the restructuring.
The cost of software license fees is also dependent on the level of third party
costs associated with certain software revenues and includes such items as
purchased licenses and other components. The third party costs includes costs
associated with the new Baan product line revenues and vary directly with those
revenues. The remaining increases in the cost of software license fees as a
percentage of related revenue was due to these third party costs and to lower
levels of software revenue.
12
Cost of Services
The cost of services as a percentage of related revenue increased to 90.0% for
the three months ended August 31, 1998 as compared with 82.7% for the same
quarter in the previous year. The increase was mainly due to additional
compensation for current personnel, higher costs of outside sourced labor, and
additional warranty work associated with new versions of the Company's software.
The cost of services as a percentage of related revenue decreased to 79.8% for
the nine months ended August 31, 1998 as compared with 85.6% for the same period
in the previous year. The decrease was mainly due to increased levels of
customer billing generated by existing personnel less the factors listed above
for performance during the third quarter of fiscal 1998. The Company has
experienced increased levels of service business from its customer base and a
reduction in employees through attrition. The current service backlog exceeds
current capacity and the Company continues efforts to hire additional service
personnel. Management expects the cost of services as a percentage of related
revenue to increase slightly with the additional training costs associated with
the hiring of new personnel. The Company also continues to take further steps to
reduce the level of customer warranty work by enhancing the quality of its
software through improved internal processes.
Cost of Hardware
The cost of hardware as a percentage of related revenue decreased to 68.4% in
the third quarter of fiscal 1998 from 75.0% in the third quarter of fiscal 1997.
The cost of hardware as a percentage of related revenue decreased to 76.4% in
the first three quarters of fiscal 1998 from 77.2% in the first three quarters
of fiscal 1997. The cost of hardware as a percentage of related revenue varies
with the size of the system, the margin mix of items comprising the system being
sold, and the competitive pressure of the customer sale. The cost of hardware as
a percentage of related revenue also varies with the amount of low margin
hardware sales to affiliates. Hardware sales to affiliates declined by $93,000
in the third quarter of fiscal 1998 compared to the third quarter of fiscal 1997
and declined by $334,000 in the first three quarters of fiscal 1998 compared to
the first three quarters of fiscal 1997.
Selling and Marketing Expenses
Selling and marketing expenses decreased $1,242,000, or 29.2%, from $4,259,000
in the third quarter of fiscal 1997 to $3,017,000 in the third quarter of fiscal
1998. Selling and marketing expenses decreased $1,060,000, or 9.6%, from
$11,103,000 in the first three quarters of fiscal 1997 to $10,043,000 in the
first three quarters of fiscal 1998. This
13
decrease was mainly due to the restructuring resulting in reduced staffing and
closed locations, and reduced marketing expense. The Company also experienced
lower compensation expense related to employee attrition.
General and Administrative Expenses
General and administrative expenses decreased $7,000, or 1.1%, from $631,000 in
the third quarter of fiscal 1997 to $624,000 in the third quarter of fiscal
1998. General and administrative expenses decreased $156,000, or 5.2%, from
$2,993,000 in the first three quarters of fiscal 1997 to $2,837,000 in the first
three quarters of fiscal 1998. The decrease in general and administrative
expenses was mainly due to a reduction of expense related to the restructuring.
As a percentage of net revenues, general and administrative expenses were 7.6%
and 6.5% in the third quarter of fiscal 1998 and 1997, respectively. As a
percentage of net revenues, general and administrative expenses were 10.2% and
10.1% in the first three quarters of fiscal 1998 and 1997, respectively. The
increase in general and administrative expenses as a percentage of net revenues
was mainly attributable to the reduced level of revenues during the transition
to adding the Baan product line.
Product Development Expense
Product development expense decreased 3.9% from $621,000 in the third quarter of
fiscal 1997 to $597,000 in the third quarter of fiscal 1998. Product development
expense, exclusive of reductions for capitalized software, decreased by
$332,000, and capitalized software decreased by $308,000. Product development
expense increased 16.6% from $1,817,000 in the first three quarters of fiscal
1997 to $2,118,000 in the first three quarters of fiscal 1998. The Company
capitalizes costs in accordance with Statement of Financial Accounting Standard
(SFAS) No. 86. The Company capitalized $737,000 of product development costs in
the third quarter of fiscal 1998 compared to $1,045,000 in the third quarter of
fiscal 1997. The Company capitalized $2,800,000 of product development costs in
the first three quarters of fiscal 1998 compared to $3,207,000 in the first
three quarters of fiscal 1997. With the completion of two major development
projects and with the cessation of development of software products for large
customers which software is now supplied through the relationship with Baan, the
Company has reduced the level of investment in product development.
Restructuring and Other Charges
In the second quarter of fiscal 1998, the Company recorded a restructuring
charge of $6,836,000 related to entering into a new distributor arrangement for
manufacturing software, and a reduction of costs focused on improving the
Company's financial
14
performance. Approximately $6,600,000 of the total charge has been paid or
expensed as of August 31, 1998. The Company anticipates the remaining liability
of approximately $200,000 to be paid in the fourth quarter of fiscal 1998, which
will be financed through working capital.
Other Income\Expense-Net
Other income\expense-net was $39,000 of expense for the third quarter of fiscal
1997 compared to $165,000 of expense for the third quarter of fiscal 1998. Other
income\expense-net was $176,000 of expense for the first three quarters of
fiscal 1997 compared to $481,000 of expense for the first three quarters of
fiscal 1998. The increase in the level of expense was mainly the result of an
increase in interest expense as a result of increased borrowings under the
Company's borrowing facility.
Income Tax
No income tax benefit was recorded for the third quarter of fiscal 1998 or the
third quarter of fiscal 1997. A small tax expense of $33,000 (for state and
local taxes) and no income tax benefit was recorded for the first three quarters
of fiscal 1998 compared to a benefit of $883,000 for the first three quarters of
fiscal 1997. At August 31, 1998, the Company, for financial reporting purposes,
is in a tax loss carryforward position. Generally accepted accounting principles
prohibit the Company from recording a tax benefit under these circumstances.
Liquidity and Capital Resources
At August 31, 1998, the Company had cash and marketable securities aggregating
$8,000. During the first three quarters of fiscal 1998, the Company's operating
activities provided $1,656,000 of cash compared to using $160,000 of cash for
the same period of the prior year. This decrease in the use of cash was mainly
attributable to the Company's restructuring of its operations and the reduction
in accounts receivable. On September 29, 1998, the Company received payment in
full of $307,000 on a note from EMS Solutions, Inc. which was previously to be
paid over a six year term beginning January 1, 1998.
Investing activities used cash of $2,712,000 in the first three quarters of
fiscal 1998 compared to using $3,901,000 of cash in the first three quarters of
fiscal 1997. The principal use of the cash in the first three quarters of fiscal
1998 was $2,800,000 for capitalized product development. The principal uses of
cash in the first three quarters of fiscal 1997 included $3,207,000 for
capitalized product development and $1,101,000 for purchases of equipment and
furniture.
15
Financing activities provided $1,050,000 of cash in the first three quarters of
fiscal 1998 compared with providing $3,602,000 of cash in the first three
quarters of fiscal 1997. The cash provided in fiscal 1998 mainly reflected the
equity contribution from the Company's preferred stock offering. (See Note 5 to
the Consolidated Financial Statements) As of August 31, 1998, the Company, based
on the level of of eligible accounts receivables, had $1,828,000 of availability
under its then $6,000,000 line of credit. As of September 30, 1998, the Company
had $569,000 of availability under its line of credit.
The Company's credit agreement with Foothill Capital Corporation also contains
certain restrictive covenants relating to income (EBITDA), tangible net worth,
and level of capital expenditures. On October 6, 1998, the Company amended its
loan facility to reset the tangible net worth and EBITDA covenants to levels in
keeping with the Company's current financial position. The amendment also
restructured the loan facility to increase the term loan by $776,553 with an
amortization period of 36 months and to reduce the revolving line of credit to a
limit of $5,000,000. These changes will provide the Company with additional
short-term working capital. In order to meet financial covenants in the future,
the Company will need positive operational results in the short term. In the
event that the Company's performance does not improve in the short term, the
Company will need to secure additional waivers and/or alternative sources of
financing. The Company is continuing its review of alternative sources of
financing to deal with its current financial status. Although management
believes that waivers and/or additional financing can be obtained, if needed, no
assurance can be given that waivers or such additional financing will be
available to the Company on acceptable terms. In the event that the Company is
unable to secure necessary waivers or additional financing, it would likely have
a material adverse effect on the Company's liquidity, including its ability to
fund continuing operations at current levels.
Year 2000
The Company utilizes a combination of its own software and custom-written
systems for running its own operations. Based on its own evaluation, the Company
believes that it will incur no significant costs associated with ensuring year
2000 compliance of its internal systems. Since the release of version 5.1.2 of
the Company's software product, the Company's software product has been year
2000 compliant.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
IN ADDITION TO HISTORICAL INFORMATION, THIS QUARTERLY REPORT ON FORM 10-Q
CONTAINS "FORWARD-LOOKING STATEMENTS", INCLUDING INFORMATION REGARDING FUTURE
ECONOMIC PERFORMANCE AND PLANS AND OBJECTIVES OF MANAGEMENT. STATEMENTS INCLUDED
IN THIS QUARTERLY REPORT ON FORM 10-Q THAT ARE NOT OF A HISTORICAL NATURE ARE
FORWARD-LOOKING STATEMENTS. SUCH FORWARD LOOKING STATEMENTS ARE SUBJECT TO
CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
16
MATERIALLY FROM THOSE REFLECTED IN THE FORWARD-LOOKING STATEMENTS. SUCH
UNCERTAINTIES AND RISKS INCLUDE, BUT ARE NOT LIMITED TO, PRODUCT DEMAND AND
MARKET ACCEPTANCE FOR THE COMPANY'S AND THIRD PARTY SUPPLIED PRODUCTS; THE
COMPANY'S ABILITY TO SUCCESSFULLY IMPLEMENT ITS RESTRUCTURING PLAN; THE
COMPANY'S ABILITY TO SUCCESSFULLY TRANSITION TO THE BAAN PRODUCT OFFERINGS; THE
IMPACT OF COMPETITIVE PRODUCTS; THE COMPANY'S ABILITY TO MAINTAIN EFFICIENT
MARKETING AND DISTRIBUTION OPERATIONS WITH RESPECT TO NEW PRODUCTS; FUTURE
ECONOMIC, COMPETITIVE AND MARKET CONDITIONS; THE COMPANY'S ABILITY TO RETAIN KEY
TECHNICAL AND MANAGEMENT PERSONNEL; THE COMPANY'S SUCCESS IN IMPROVING ITS
FINANCIAL PERFORMANCE; TO THE EXTENT NECESSARY, THE COMPANY'S ABILITY TO SECURE
AMENDMENTS, WAIVERS AND/OR REFINANCING OR EXTENSION OF ITS LINE OF CREDIT;
TIMING OF PRODUCT DEVELOPMENT; PRODUCT PRICING AND OTHER FACTORS DETAILED IN
THIS QUARTERLY REPORT ON FORM 10-Q AND IN OTHER FILINGS MADE BY THE COMPANY WITH
THE SECURITIES AND EXCHANGE COMMISSION.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Not Applicable
17
Part II - Other Information
Item 2. Changes in Securities and Use of Proceeds
(a) None
(b) On August 28, 1998 the Company sold and issued 1,005 shares of its
Series A 8% Convertible Redeemable Preferred Stock (the "Series A
Preferred") at a price of $1,000 per share, for aggregate gross
proceeds of $1 million. Holders of Series A Preferred are entitled
to receive an 8% cumulative dividend ($80 per share) before any
dividends may be paid on the Common Stock. Also, in the event of
liquidation of the Company holders of Series A Preferred are
entitled to receive $1,000 per share, plus all accrued but unpaid
dividends, before any payment can be made on the Common Stock.
(c) On August 28, 1998, the Company sold and issued 1,005 shares of
its Series A 8% Convertible Redeemable Preferred Stock ("Series A
Preferred") at a price of $1,000 per share. Series A Preferred was
sold pursuant to a Preferred Stock Placement Agreement between the
Company and Taglich Brothers, D'Amadeo, Wagner & Company,
Incorporated ("Taglich") in which Taglich agreed to use its best
efforts to sell, on a private placement basis, up to $5,000,000 of
Series A Preferred. The 1,005 shares of Series A Preferred were
sold to investors qualifying as "accredited investors" under
Regulation D of the Securities Act of 1933, as amended (the
"Securities Act").
The aggregate offering price was $1 million. For its services, the
Company paid Taglich 8% of gross proceeds plus five (5) year
warrants to purchase shares of Common Stock equal to 10% of the
total number of shares of Common Stock issuable upon exercise of
the Series A Preferred Stock sold in the Private Placement.
Exemption from registration for the sale is claimed pursuant to
Section 4 (2) and Regulation D under the Securities Act. The
securities were sold is a private placement only to "accredited
investors" as defined in Regulation D.
The Series A Preferred is convertible into Common Stock at an
initial exercise price of $3.50 per share, with the value of the
Series A Preferred Stock pegged at $1,000 per share for conversion
purposes. The exercise price of $3.50 may be reduced in certain
circumstances to prevent dilution.
Page 18
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Restated Articles of Incorporation
3.2 Articles of Amendment relating to Series A 8% Convertible
Redeemable Preferred Stock
4.1 Waiver and Second Amendment to Loan Agreement between
Foothill Capital Corporation and Effective Management Systems,
Inc., EMS-East, Inc., and Effective Management Systems of
Illinois, Inc., dated August , 1998.
4.2 Third Amendment to Loan Agreement between Foothill Capital
Corporation and Effective Management Systems, Inc., EMS-East,
Inc., and Effective Management Systems of Illinois, Inc.,
dated October 6, 1998.
10.1 Preferred Stock Placement Agreement, dated as of August
28, 1998 between Effective Management Systems, Inc. and
Taglich Brothers, D'Amadeo, Wagner & Company, Incorporated
10.2 Loan Agreement by and between EMS Solutions, Inc. and
Effective Management Systems, Inc. dated January 1, 1998.
10.3 Special Compensation and Separation Agreement by and
between Jeffrey J. Fossum and Effective Management Systems,
Inc. effective January 1, 1998.
10.4 Special Compensation and Separation Agreement by and
between Wayne T. Wedell and Effective Management Systems, Inc.
effective January 1, 1998.
27 Financial Data Schedule [EDGAR version only]
(b) Reports on Form 8-K
None
Page 19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EFFECTIVE MANAGEMENT SYSTEMS, INC.
October 15, 1998 By: /s/ MICHAEL D. DUNHAM
Michael D. Dunham
President (principal executive officer)
By: /s/JEFFREY J. FOSSUM
Jeffrey J. Fossum
Chief Financial Officer and Assistant
Treasurer (principal financial and
accounting officer)
Page 20
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
3.1 Restated Articles of Incorporation
3.2 Articles of Amendment relating to Series A 8% Convertible Redeemable
Preferred Stock
4.1 Waiver and Second Amendment to Loan Agreement between Foothill
Capital Corporation and Effective Management Systems, Inc.,
EMS-East, Inc., and Effective Management Systems of Illinois, Inc.,
dated August , 1998.
4.2 Third Amendment to Loan Agreement between Foothill Capital
Corporation and Effective Management Systems, Inc., EMS-East, Inc.,
and Effective Management Systems of Illinois, Inc., dated October 6,
1998.
10.1 Preferred Stock Placement Agreement, dated as of August 28, 1998
between Effective Management Systems, Inc. and Taglich Brothers,
D'Amadeo, Wagner & Company, Incorporated
10.2 Loan Agreement by and between EMS Solutions, Inc. and Effective
Management Systems, Inc. dated January 1, 1998.
10.3 Special Compensation and Separation Agreement by and between Jeffrey
J. Fossum and Effective Management Systems, Inc. effective January
1, 1998.
10.4 Special Compensation and Separation Agreement by and between Wayne
T. Wedell and Effective Management Systems, Inc. effective January
1, 1998.
27 Financial Data Schedule [EDGAR version only]