FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 1995 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-15935 ALPHAREL, INC. -------------- (Exact name of registrant as specified in its charter) CALIFORNIA 95-3634089 - ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 9339 CARROLL PARK DRIVE, SAN DIEGO, CA 92121 ----------------------------------------------------- (Address of principal executive offices and zip code) (619) 625-3000 --------------------------------------------------- (Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ----- Number of shares of Common Stock outstanding at October 16, 1995: 14,082,347 ------------------- Number of Sequentially Numbered Pages: 13 ---- Exhibit Index at Page 12 ---- 1 ALPHAREL, INC. INDEX PAGE NUMBER ----------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheet 3 Consolidated Statement of Operations 4 Consolidated Statement of Cash Flows 5 Notes to the Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8 PART II. OTHER INFORMATION 11 2 ALPHAREL, INC. PART 1. FINANCIAL INFORMATION CONSOLIDATED BALANCE SHEET ASSETS SEPTEMBER 30, 1995 DECEMBER 31, 1994 ------------------ ----------------- (unaudited) Current assets: Cash and cash equivalents $ 2,246,000 $ 1,036,000 Short term investments 450,000 1,585,000 Short term investments, restricted - 219,000 Receivables, net 3,559,000 2,973,000 Inventory, net 405,000 726,000 Other current assets 564,000 373,000 -------------- ------------ Total current assets 7,224,000 6,912,000 Property and equipment, net 935,000 770,000 Computer software, net 1,923,000 1,336,000 Other assets 1,026,000 753,000 -------------- ------------ Total assets $ 11,108,000 $ 9,771,000 -------------- ------------ -------------- ------------ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,032,000 $ 959,000 Accrued liabilities 815,000 750,000 Payable to former Optigraphics shareholders 21,000 192,000 Notes payable to former Optigraphics shareholders 1,634,000 1,734,000 Billings in excess of cost 22,000 - Deferred revenue 255,000 419,000 Note payable 200,000 59,000 -------------- ------------ Total current liabilities 3,979,000 4,113,000 Long term note payable 500,000 - Commitments Shareholders' equity: Common stock, 20,000,000 shares authorized; 14,082,347 and 13,740,847 issued and outstanding, respectively 43,193,000 43,103,000 Accumulated deficit (36,564,000) (37,445,000) -------------- ------------ Total shareholders' equity 6,629,000 5,658,000 -------------- ------------ Total liabilities and shareholders' equity $ 11,108,000 $ 9,771,000 -------------- ------------ -------------- ------------ See accompanying notes to the consolidated financial statements 3 ALPHAREL, INC. CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited) (In thousands except per share data) For the three months For the nine months ended September 30, ended September 30, -------------------- ------------------- 1995 1994 1995 1994 ---- ---- ---- ---- Revenue $ 3,127 $ 2,002 $ 9,629 $ 6,928 Cost of revenue 1,276 1,127 4,390 3,501 -------- -------- -------- -------- Gross profit 1,851 875 5,239 3,427 -------- -------- -------- -------- Operating expenses: Research and development 326 58 886 490 Marketing and sales 942 647 2,413 1,954 General and administrative 357 286 1,078 815 -------- -------- -------- -------- Total operating expenses 1,625 991 4,377 3,259 -------- -------- -------- -------- Income (loss) from operations 226 (116) 862 168 Interest and other income 31 78 101 173 Interest and other expense (28) (25) (82) (86) -------- -------- -------- -------- Income (loss) before taxes 229 (63) 881 255 Provision for taxes - - - - -------- -------- -------- -------- Net income (loss) $ 229 $ (63) $ 881 $ 255 -------- -------- -------- -------- -------- -------- -------- -------- Net income (loss) per share $ .02 $ - $ .06 $ .02 -------- -------- -------- -------- -------- -------- -------- -------- Weighted average shares outstanding 14,993 13,743 14,364 13,958 See accompanying notes to the consolidated financial statements. 4 ALPHAREL, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) (In thousands) For the nine months ended September 30, ---------------------- 1995 1994 ---- ---- Cash flows from operating activities: Net income (loss) $ 881 $ 255 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 508 440 Changes in assets and liabilities: Receivables (586) (468) Inventory 321 22 Other assets (593) (223) Accounts payable 73 28 Accrued liabilities 65 (897) Billings in excess of costs 22 (231) Deferred revenue (164) (495) ------- ------- Net cash provided by (used in) operating activities 527 (1,569) ------- ------- Cash flows from investing activities: Short term investments maturing 1,354 250 Purchases of property and equipment (448) (187) Proceeds from sale of property and equipment 4 - Purchases of software (67) (154) Computer software capitalized (720) (642) Cash paid to former Optigraphics shareholders (171) (130) ------- ------- Net cash used in investing activities (48) (863) ------- ------- Cash flows from financing activities: Principal payments under capital lease obligations - (72) Principal payments under note payable to bank (59) (47) Net borrowings under revolving loan agreement 700 - Retirement of note payable to former Optigraphics shareholder - (36) Proceeds from exercise of stock options 90 26 ------- ------- Net cash provided by (used in) financing activities 731 (129) ------- ------- Net increase (decrease) in cash and cash equivalents 1,210 (2,561) Cash and cash equivalents at beginning of period 1,036 3,373 ------- ------- Cash and cash equivalents at end of period $ 2,246 $ 812 ------- ------- ------- ------- Supplemental cash flow information: Interest paid $ 83 $ 85 ------- ------- ------- ------- Schedule of noncash financing activity: Indemnification obligations applied against notes payable to former Optigraphics shareholders $ 100 $ - ------- ------- ------- ------- See accompanying notes to the consolidated financial statements. 5 ALPHAREL, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1 - BASIS OF PRESENTATION The accompanying consolidated balance sheet of Alpharel, Inc. (the "Company") as of September 30, 1995 and the consolidated statement of operations and of cash flows for the three and nine month periods ended September 30, 1995 and 1994 are unaudited. The consolidated financial statements and related notes have been prepared in accordance with generally accepted accounting principles applicable to interim periods. In the opinion of management, the consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the consolidated financial position, operating results and cash flows for the periods presented. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated. NOTE 2 - NET INCOME PER SHARE Net income (loss) per share is computed on the basis of weighted average shares and common stock equivalent shares outstanding for each period presented, if dilutive. NOTE 3 - INVENTORY Inventory consists of parts, supplies, and subassemblies stated at the lower of cost or market value. Cost is determined using the first-in, first-out (FIFO) method. As of September 30, 1995 and December 31, 1994, the Company's reserve against excess quantities totaled $2,119,000 and $2,323,000, respectively. NOTE 4 - BALANCE SHEET INFORMATION SEPTEMBER 30, DECEMBER 31, ------------- ------------ 1995 1994 ---- ---- OTHER CURRENT ASSETS: Current portion of net sales lease receivable $ 77,000 Prepaid maintenance contracts 154,000 $ 54,000 Prepaid expenses and other 333,000 319,000 ----------- ---------- Total $ 564,000 $ 373,000 ----------- ---------- ----------- ---------- OTHER ASSETS: Long term portion of net sales lease receivable $ 330,000 Goodwill, net 320,000 $ 369,000 Other intangible assets, net 90,000 106,000 Other 286,000 278,000 ----------- ---------- Total $ 1,026,000 $ 753,000 ----------- ---------- ----------- ---------- ACCRUED LIABILITIES: Employee compensation and related expenses $ 287,000 $ 113,000 Accrued vacation 247,000 215,000 Deferred rent 170,000 184,000 Other 111,000 238,000 ----------- ---------- Total $ 815,000 $ 750,000 ----------- ---------- ----------- ---------- 6 NOTE 5 - NOTES PAYABLE In September 1995, the Company entered into a revolving loan and security agreement, which provides for borrowings of up to $1,000,000, for refinancing notes payable to former Optigraphics shareholders and to finance capital equipment and software purchases. At September 30, 1995, $700,000 was outstanding on the revolving loan agreement and $300,000 was unused. The maximum credit available under this facility declines by $200,000 in September of each year hereafter. The loan balance is payable in monthly installments of $16,667 with interest at the rate of the 30-day Commercial Paper Rate plus 2.95% (8.78% at September 30, 1995). Total borrowings under the revolving loan agreement are collateralized by the Company's assets. At September 30, 1995, the Company has outstanding notes payable to former Optigraphics shareholders having a principal balance of $1,634,000. The notes which had interest payable quarterly at 6% per annum were issued as part of the total consideration paid in connection with the acquisition of Optigraphics Corporation. The principal balance was due September 24, 1995, upon presentation of the notes by former Optigraphics shareholders in accordance with the agreement. At September 30, 1995, no notes have been presented for payment. 7 RESULTS OF OPERATIONS THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1995 COMPARED WITH THE THREE AND NINE MONTHS ENDED SEPTEMBER, 1994. Revenue Revenue for the three and nine months ended September 30, 1995 was $3,127,000 and $9,629,000, respectively, as compared to $2,002,000 and $6,928,000 for the three and nine months ended September 30, 1994. The increase of 56% and 39%, respectively, in revenue for the three and nine months ended September 30, 1995 is primarily due to revenues generated from new system sales. The Company's increased system sales resulted primarily from increased demand for imaging systems in the marketplace which management believes is due to the reduction in the cost of client servers and workstations which, combined with imaging software, has brought about a more cost effective solution to customers. Revenue derived from new systems varies depending on number of users, features and complexity of the system. Revenue fluctuations will vary based on the demands for and timing of new system orders. For the three and nine months ended September 30, 1995 revenue consisted of new system revenue of $1,683,000 (54%) and $5,249,000 (55%), respectively, and revenue related to system enhancements, expansion and maintenance of $1,444,000 (46%) and $4,380,000 (45%), respectively. This compares to revenue in the comparable periods of 1994 of $634,000 (32%) and $2,530,000 (37%), respectively, in new system revenue and revenue related to system enhancements, expansion and maintenance of $1,368,000 (68%) and $4,398,000 (63%), respectively. The difference from 1994 to 1995 is primarily due to the fact that in 1995 the Company has sold over 20 new systems, while in 1994 a higher percentage of revenue was generated from system expansions. In the past, a small number of customers have typically accounted for a large percentage of the Company's annual revenue. In the first nine months of 1995, no customers accounted for over 10% of total revenue. During the first nine months of 1994, one customer accounted for 11% of total revenue. Although the Company's dependence on a small number of customers on an annual basis has been reduced as a result of a wider customer base, revenue can still fluctuate significantly on a quarterly basis. The Company's reliance on relatively few customers could have a material adverse effect on the results of its quarterly operations, particularly in light of the current prevailing adverse general economic conditions, which have adversely affected certain industries, including aerospace and defense-related manufacturing, in which many of the Company's principal customers operate. Additionally, a significant portion of the Company's revenues has historically been derived from the sale of systems to new customers. The addition of over 20 new systems in 1995 has reduced the Company's dependence on a small number of customers. As additional new systems are installed the future dependence on new system sales will continue to decrease. Gross Profit Gross profit was $1,851,000 or 59% and $5,239,000 or 54% for the three and nine months ended September 30, 1995. For the comparable periods in 1994, gross profit was $875,000 or 44% and $3,427,000 or 50%, respectively. During the third quarter of 1995 the significant increase in gross profit was attributable to a higher percentage of software sales as opposed to 1994. Gross profit percentage can fluctuate quarterly based on the revenue mix of Company software, services, proprietary hardware, and third party software or hardware. Third party products are resold at a lower gross profit percentage in order for the Company to remain competitive in the market place. 8 Operating Expenses Research and development expense for the three and nine months ended September 30, 1995 was $326,000 and $886,000 versus $58,000 and $490,000 for the same periods in the prior year. This increase resulted from the expansion of the Company's engineering workforce in connection with its efforts to continue to enhance and expand the current product suite. Technical expenses on customer-funded projects are included in cost of revenues, while expenses on internal projects are included in research and development expense. For the three and nine months ended September 30, 1995, technical expense included in cost of revenues was $512,000 and $1,635,000, respectively, versus $288,000 and $1,454,000, respectively, for the same period last year. The increase in technical expense is due to the added resources required to implement the increase in new system orders. Research and development expense can vary year to year based on the amount of engineering service contract work required for customers versus purely internal development projects. Marketing expense for the three and nine months ended September 30, 1995 was $942,000 and $2,413,000 as compared to $647,000 and $1,954,000 for the three and nine months ended September 30, 1994. The increase in 1995 is primarily due to additional sales and support personnel hired along with additional costs associated with the Company's revenue growth. During the nine months ended September 30, 1995, the Company opened new sales offices in Detroit in January, Chicago in May and Washington, D.C. in July. General and administrative expense for the three and nine months ended September 30, 1995 increased to $357,000 and $1,078,000 from $286,000 and $815,000 for the three and nine months ended September 30, 1994. The increase in general and administrative expense was due primarily to costs associated with three additional personnel as compared to 1994. Interest and Other Income Interest and other income was $31,000 and $101,000 for the three and nine months ended September 30, 1995 as compared to $78,000 and $173,000 in the prior year. The decrease is due primarily to reduced interest income resulting from lower short term investment balances during 1995 versus 1994. LIQUIDITY AND CAPITAL RESOURCES At September 30, 1995, the Company's cash and cash equivalents totaled $2,246,000 as compared to $1,036,000 at December 31, 1994. Short term investments were $450,000 at September 30, 1995 versus $1,804,000 at December 31, 1994. Short term investments are comprised primarily of certificates of deposit and treasury bills. At September 30, 1995, the Company's current ratio was nearly 2 to 1. For the first nine months of 1995, the Company generated cash of $527,000 in operating activities, used $48,000 in investing activities, and generated $731,000 in financing activities. During the first nine months of 1994, the Company used cash of $1,569,000 in operating activities, $863,000 in investing activities, and $129,000 in financing activities. In September 1993, the Company acquired Optigraphics Corporation. As part of the transaction, the Company issued notes that became due in September 1995 totaling $1,634,000 with interest payable quarterly at 6% per annum. The principal balance is payable upon presentation of the notes by the former Optigraphics shareholders in accordance with the agreement. As of September 30, 1995, no notes had been presented for payment. In September 1995, the Company entered into a revolving loan and security agreement with Merrill Lynch for the borrowing of up to $1,000,000 to re-finance the principal balance due on notes payable to former Optigraphics shareholders and to finance capital equipment and software purchases. As of September 30, 1995, the Company borrowed $700,000 under the credit facility and $300,000 remained unused. The maximum credit available under this facility declines by $200,000 in September of each year hereafter. The Company believes that current working capital and funds generated from operations will be adequate to meet expected needs for working capital and capital expenditures over the next twenty-four months. 9 Net Operating Loss Tax Carryforwards As of December 31, 1994, the Company had a net operating loss carryforward ("NOL") for Federal income tax purposes of $36,400,000. In addition, the Company generated but has not used research and investment tax credits for Federal income tax purposes of approximately $600,000. Under the Internal Revenue Code of 1986, as amended (the "Code"), the Company generally would be entitled to reduce its future Federal income tax liabilities by carrying unused NOL forward for a period of 15 years to offset future taxable income earned, and by carrying unused tax credits forward for a period of 15 years to offset future income taxes. The Company's ability to utilize any NOL and credit carryforwards in future years may be restricted, however, in the event the Company undergoes an "ownership change," generally defined as a more than 50 percentage point change of ownership by one or more statutorily defined "5-percent stockholders" of a corporation, as a result of future issuances or transfers of equity securities of the Company within a three-year testing period. In the event of an ownership change, the amount of NOL attributable to the period prior to the ownership change that may be used to offset taxable income in any year thereafter generally may not exceed the fair market value of the Company immediately before the ownership change (subject to certain adjustments) multiplied by the applicable long-term, tax-exempt rate announced by the Internal Revenue Service in effect for the date of the ownership change. A further limitation would apply to restrict the amount of state NOL and credit carryforwards that might be used in any year after the ownership change. As a result of these limitations, in the event of an ownership change, the Company's ability to use its NOL and credit carryforwards in future years may be delayed and, to the extent the carryforward amounts cannot be fully utilized under these limitations within the carryforward periods, these carryforwards will be lost. Accordingly, the Company may be required to pay more Federal income taxes or to pay such taxes sooner than if the use of its NOL and credit carryforwards were not restricted. Over the past three years the Company has issued equity securities in connection with the Optigraphics acquisition in September 1993, and through traditional stock option grants to employees. This activity, combined with the liquidity available to stockholders as a result of the Company's common stock trading on the NASDAQ National Market System, increases the potential for an ownership change" for income tax purposes. 10 PART II. OTHER INFORMATION ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K: (a) Exhibits - See Exhibit Index on Page 12. (b) There were no reports on Form 8-K filed for the three months ended September 30, 1995. 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. ALPHAREL, INC. By: /s/ John W. Low ----------------------------- John W. Low Chief Financial Officer By: /s/ Stephen P. Gardner ------------------------------ Stephen P. Gardner President and Chief Executive Officer Dated: October 19, 1995 --------------------------- 11 EXHIBIT INDEX Exhibit Page Number - ------- ----------- 11 Statement Re Computation of 13 Net Income Per Share 27 Financial Data Schedule 14 12