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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2001
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to ____
Commission File Number: 0-21142
NEMATRON CORPORATION
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(Exact name of small business issuer as specified in its charter)
MICHIGAN 38-2483796
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5840 INTERFACE DRIVE, ANN ARBOR, MICHIGAN 48103
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(Address of principal executive offices) (Zip Code)
(734) 214-2000
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(Issuer's telephone number, including area code)
Check whether the issuer (1) has filed all reports required to be filed by
section 13 or 15(d) of the Securities Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
[X] YES [ ] No
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date:
No par value Common Stock: 15,744,472 OUTSTANDING AS OF NOVEMBER 2, 2001
Transitional Small Business Disclosure Format: [ ] YES [X] NO
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
SEPTEMBER 30, 2001 AND DECEMBER 31, 2000
SEPTEMBER 30, DECEMBER 31,
2001 2000
ASSETS (UNAUDITED)
------ ------------ ------------
Current assets:
Cash and cash equivalents $ 146,863 $ 74,712
Accounts receivable, net of allowance for doubtful
accounts of $99,000 at September 30, 2001 and
$78,000 at December 31, 2000 4,186,274 5,407,593
Inventories (Note3) 2,204,705 1,956,255
Prepaid expenses and other current assets 254,184 315,556
------------ ------------
Total current assets 6,792,026 7,754,116
Property and equipment, net of accumulated depreciation
of $7,070,189 at September 30, 2001 and $6,703,078
at December 31, 2000 2,295,050 2,544,041
Other assets:
Software and related development costs, net of
amortization of $3,607,985 at September 30, 2001
and $2,805,592 at December 31, 2000 2,970,263 3,369,660
Goodwill and other intangible assets, net of
amortization of $2,948,315 at September 30, 2001
and $2,589,652 at December 31, 2000 3,750,240 3,212,345
------------ ------------
Net other assets 6,720,503 6,582,005
------------ ------------
Total assets $ 15,807,579 $ 16,880,162
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Notes payable to banks (Note 4) $ 2,301,497 $ 2,059,318
Accounts payable 1,498,284 1,642,039
Deferred revenue and other accrued expenses 2,027,746 2,011,825
Convertible subordinated debt (Note 5) 1,200,000 --
Current maturities of long-term debt (Note 6) 3,204,849 3,953,908
------------ ------------
Total current liabilities 10,232,376 9,667,090
Long-term debt, less current maturities (Note 6) -- --
------------ ------------
Total liabilities 10,232,376 9,667,090
Shareholders' equity:
Common stock, no par value, 30,000,000 shares
authorized; shares issued and outstanding:
15,744,472 at September 30, 2001 and 13,969,616
at December 31, 2000 32,512,088 30,892,089
Accumulated comprehensive income (loss) 12,745 (1,606)
Accumulated deficit (26,949,630) (23,677,411)
------------ ------------
Total shareholders' equity 5,575,203 7,213,072
------------ ------------
Total liabilities and shareholders' equity $ 15,807,579 $ 16,880,162
============ ============
2
ITEM 1. FINANCIAL STATEMENTS - CONTINUED
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
FOR THE THREE-AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2001 2000 2001 2000
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
------------ ------------ ------------ ------------
Net Revenues $ 4,358,366 $ 6,249,149 $ 13,908,192 $ 15,345,568
Cost of Revenues 3,389,194 4,685,406 11,107,185 11,193,431
------------ ------------ ------------ ------------
Gross Profit 969,172 1,563,743 2,801,007 4,152,137
Operating Expenses:
Product development costs 191,812 228,613 429,932 486,957
Selling, general and
administrative expenses 1,485,509 1,562,866 4,775,351 4,810,485
------------ ------------ ------------ ------------
Total Operating Expenses 1,677,321 1,791,479 5,205,283 5,297,442
------------ ------------ ------------ ------------
Operating Loss (708,149) (227,736) (2,404,276) (1,145,305)
Other Income, net:
Interest expense (310,802) (205,087) (878,320) (352,712)
Sundry income (expense) 2,685 26,043 10,376 404,212
------------ ------------ ------------ ------------
Total Other, Net (308,117) (179,044) (867,944) 51,500
------------ ------------ ------------ ------------
Loss Before Income Taxes (1,016,266) (406,780) (3,272,220) (1,093,805)
Income Tax Benefit
(Expense) (Note 7) -- (4,383) -- 17,217
------------ ------------ ------------ ------------
Net Loss $ (1,016,266) $ (411,163) $ (3,272,220) $ (1,076,588)
============ ============ ============ ============
Per share amounts (Note 8):
Basic and diluted $ (0.06) $ (0.03) $ (0.21) $ (0.08)
============ ============ ============ ============
Weighted average shares
outstanding (Note 8):
Basic and diluted 15,744,472 13,209,616 15,095,650 12,857,425
============ ============ ============ ============
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE LOSS
FOR THE THREE-AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2001 2000 2001 2000
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
------------ ------------ ------------ ------------
Net loss $ (1,016,266) $ (411,163) $ (3,272,220) $ (1,076,588)
Other comprehensive income
(loss) - equity adjustment
from foreign translation 18,848 (9,591) 14,351 (28,848)
------------ ------------ ------------ ------------
Comprehensive income (loss) $ (997,418) $ (420,754) $ (3,257,869) $ (1,105,436)
============ ============ ============ ============
3
ITEM 1. FINANCIAL STATEMENTS - CONTINUED
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
NINE MONTHS ENDED SEPTEMBER 30,
2001 2000
(UNAUDITED) (UNAUDITED)
------------ ------------
Cash Flows From Operating Activities:
Net loss $ (3,272,220) $ (1,076,588)
Adjustments to reconcile net loss to net cash flows
from operating activities:
Depreciation 397,956 476,564
Amortization 1,161,066 918,264
Deferred income tax benefit -- (32,400)
Non-cash interest expense for beneficial conversion feature
of warrants (Note 5) 342,000 --
Loss (gain) on disposal of property 3,754 (3,681)
Changes in assets and liabilities that provided (used) cash,
net of effects of acquisitions:
Accounts receivable 1,403,413 2,246,715
Inventories 1,169,869 (642,581)
Prepaid expenses and other current assets 65,463 56,068
Accounts payable (240,939) (245,372)
Deferred revenue and other accrued expenses (384,413) (803,284)
------------ ------------
Net Cash Provided By Operating Activities 645,949 893,705
------------ ------------
Cash Flows From Investing Activities:
Acquisition of A-OK Controls, Inc., net of cash acquired (Note 2) -- (2,851,722)
Acquisition of Optimation, Inc., net of cash acquired (Note 2) (278,877)
Additions to capitalized software development costs (402,995) (554,244)
Additions to property and equipment (111,517) (160,347)
Proceeds from disposals of property and equipment 50 2,749
------------ ------------
Net Cash Used In Investing Activities (793,339) (3,563,564)
------------ ------------
Cash Flows From Financing Activities:
Proceeds from issuance of convertible subordinated notes
and warrants (Note 5) 1,200,000
Proceeds from issuance of common stock 278,000
Proceeds from long-term debt agreement -- 1,500,000
Repayments of long-term debt (813,549) (336,247)
Increase (decrease) in note payable to bank (397,821) 1,393,048
Payments of deferred financing fees (61,440) (85,319)
------------ ------------
Net Cash Provided By Financing Activities 205,190 2,471,482
------------ ------------
Foreign Currency Translation Effect on Cash 14,351 (28,848)
------------ ------------
Net Increase (Decrease) In Cash and Cash Equivalents 72,151 (227,225)
Cash and Cash Equivalents at Beginning of Period 74,712 356,668
------------ ------------
Cash and Cash Equivalents at End of Period $ 146,863 $ 129,443
============ ============
Continued on next page.
4
ITEM 1. FINANCIAL STATEMENTS - CONTINUED
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS - CONTINUED
FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
NINE MONTHS ENDED SEPTEMBER 30,
2001 2000
(UNAUDITED) (UNAUDITED)
------------ ------------
Non-cash financing and investing activities:
Fair value of assets acquired from Optimation, Inc.,
including goodwill $ 2,459,727
Less liabilities assumed (1,180,850)
Less common stock issued (1,000,000)
------------
Net cash paid for Optimation, Inc. (Note 2) $ 278,877
============
Fair value of assets acquired from A-OK Controls
Engineering, Inc. including goodwill $ 6,078,722
Less liabilities assumed (1,977,000)
Less Common Stock issued (1,250,000)
------------
Net cash paid for A-OK Controls Engineering, Inc. (Note 2) $ 2,851,722
============
Supplemental disclosures of cash flow information:
Cash paid for interest $ 485,895 $ 328,140
Cash paid for income taxes -- 15,183
5
ITEM 1. FINANCIAL STATEMENTS - CONTINUED
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
FOR THE THREE-AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
NOTE 1 - BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts
of Nematron Corporation (the "Company") and its wholly-owned subsidiaries,
Nematron Limited, a United Kingdom corporation, Nematron Canada Inc., a Canadian
corporation, A-OK Controls Engineering, Inc. ("A-OK Controls"), a Michigan
corporation, and Optimation, Inc. ("Optimation"), an Alabama corporation. All
significant intercompany transactions and balances have been eliminated in
consolidation. The Company acquired 100% of the equity of A-OK Controls and
Optimation effective on June 30, 2000 and March 30, 2001, respectively (see Note
2). The consolidated condensed financial statements presented herein include the
results of operations of A-OK Controls and Optimation since the dates of their
acquisition by Nematron.
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- and nine-month periods ended
September 30, 2001 and 2000 are not necessarily indicative of the results to be
expected for the full year.
NOTE 2 - ACQUISITIONS
ACQUISITION OF A-OK CONTROLS
----------------------------
On June 30, 2000, the Company completed its acquisition of A-OK
Controls, an Auburn Hills, Michigan-based provider of automation control
engineering and system integration services. The Company recorded this
transaction using the purchase method of accounting.
The purchase price was approximately $4,538,000, including expenses of
approximately $186,000. Under the terms of the related A-OK Controls Stock
Purchase Agreement, the Company issued 604,186 shares of its common stock to the
former A-OK Controls shareholder in exchange for 100% of the outstanding equity
of A-OK Controls. Additionally, the Company paid the former shareholder of A-OK
Controls $2,750,000 cash and agreed to pay the remaining amount of $352,000
after December 31, 2000. In connection with the A-OK Controls Stock Purchase
Agreement, the Company also entered into a three-year employment agreement and a
five-year agreement not to compete with A-OK Controls' former shareholder.
6
The allocation of the total purchase price to assets acquired and liabilities
assumed as of the June 30, 2000 acquisition date is as follows:
Cash $ 64,000
Accounts receivable and other current assets 3,139,000
Equipment 611,000
Intangible assets, including goodwill 2,328,000
Current notes payable (1,420,000)
Other current liabilities (448,000)
Long-term debt (109,000)
-----------
Total purchase price - A-OK Controls $ 4,165,000
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ACQUISITION OF OPTIMATION
-------------------------
On March 30, 2001, the Company completed its acquisition of Optimation,
a Huntsville, Alabama-based company that develops, produces and markets
industrial communications and display products for industrial automation. The
Company recorded this transaction using the purchase method of accounting.
The purchase price was approximately $1,660,000, including expenses of
approximately $60,000. Under the terms of the related Optimation Stock Purchase
Agreement, the Company issued 1,483,680 shares of its common stock to the former
Optimation shareholders in exchange for 100% of the outstanding equity of
Optimation. Additionally, the Company paid the former Optimation shareholders
$300,000 and agreed to pay the former Optimation shareholders $300,000 ninety
days after the acquisition. In connection with the Optimation Stock Purchase
Agreement, the Company also entered into three-year employment agreements and
three-year agreements not to compete with Optimation's president and
vice-president, both of whom were Optimation shareholders.
The allocation of the total purchase price to assets acquired and
liabilities assumed as of the March 30, 2001 acquisition date is as follows:
Cash $ 21,000
Accounts receivable and other current assets 1,605,000
Equipment 19,000
Intangible assets, including goodwill 835,000
Current notes payable (640,000)
Other current liabilities (137,000)
Long-term debt (43,000)
-----------
Total purchase price - Optimation $ 1,660,000
===========
The following unaudited pro forma summary presents the consolidated
results of operations as if the acquisition of A-OK Controls and Optimation had
occurred on January 1, 2000, the earliest period presented in this Form 10-QSB,
and does not purport to be indicative of either what would have occurred had the
acquisition of A-OK Controls and Optimation actually been consummated at that
date or the Company's future results of operations:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
Revenues $ 4,358,000 $ 6,900,000 $14,319,000 $22,159,000
Net loss (1,016,000) (298,000) (3,277,000) (764,000)
Loss per share, diluted $ (0.06) $ (0.02) $ (0.21) $ (0.05)
7
NOTE 3 - INVENTORIES
Inventories consist of the following at September 30, 2001 and December
31, 2000:
September 30, December 31,
2001 2000
------------ ------------
Purchased parts and accessories $ 1,666,691 $ 1,544,890
Work in process 213,261 105,742
Finished goods, demo units and service stock 324,753 305,623
------------ ------------
Total inventory $ 2,204,705 $ 1,956,255
============ ============
NOTE 4 - NOTES PAYABLE TO BANKS
The Company and its A-OK Controls subsidiary are parties to two loan
and security agreements, amended through April 12, 2001 (the "Agreements"), with
a Wisconsin-based bank. The Agreements provide for a total of $6.0 million in
two lines of credit, a $2.9 million term loan and a $1.5 million special
accommodation advance for the purpose of the Company's acquisition of A-OK
Controls on June 30, 2000. The Agreements provide for credit facilities through
November 2003, and may be extended for an additional one-year period at the
option of the Company, unless the lender gives prior notice of termination.
The amount available under the lines of credit are limited by a
borrowing formula that allows for advances up to a maximum of the sum of
specified percentages of eligible accounts receivable, less the amount, if any,
of outstanding letters of credit issued by the Company. Amounts borrowed under
the lines of credit facilities total $1,766,497 at September 30, 2001, and such
borrowings bear interest at the prime rate plus 2.5% (8.5% effective rate at
September 30, 2001). Based upon such borrowing formula, $275,000 of the
available lines is eligible for advance at September 30, 2001. The lines of
credit and the term loans (see Note 6) are collateralized by substantially all
assets of the Company and a mortgage on the Company's Ann Arbor facility.
The Company's wholly owned subsidiary, Optimation, is party to a loan
and security agreement with an Alabama-based bank. The agreement, amended
through July 9, 2001, provides for a total line of credit of $620,000. The
amount available under the line of credit is limited by a borrowing formula that
allows for advances up to a maximum of the sum of specified percentages of
eligible accounts receivable and inventory. Amounts borrowed under the line of
credit facility total $535,000 at September 30, 2001, and such borrowings bear
interest at the prime rate plus .50% (6.5% effective rate at September 30,
2001). Based upon such borrowing formula, none of the available line is eligible
for additional advance at September 30, 2001. The agreement provides for line of
credit facility through November 1, 2001. 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 Company is negotiating the
terms of a line of credit with another bank, such line to replace the current
line of credit that expires November 1, 2001.
NOTE 5 - CONVERTIBLE SUBORDINATED DEBT
In March and April 2001, the Company sold $1,200,000 of principal
amount of convertible subordinated promissory notes, bearing interest at 10% per
annum ("Subordinated Notes") and warrants to purchase a total of 800,000 shares
of Common Stock ("Warrants"). The Subordinated Notes were due August 31, 2001
and remain outstanding. The Company intends to complete a private offering of
equity securities by December 31, 2001. If such offering is completed, the
Noteholders may convert the principal amount of the Subordinated Notes and
accrued interest thereon into the same class of shares that the Company issues
in such offering at a conversion price per share equal to the offering price per
share of the shares sold in such offering. The Noteholders may convert the
principal amount of the Subordinated Notes and
8
accrued interest thereon into shares of Common Stock at $0.30 per share.
However, if the daily closing price of the Common Stock, as traded on the
American Stock Exchange, falls below $0.30 per share for five consecutive days,
the conversion price will be adjusted downward to the lowest price during such
five trading day period.
The Warrants, which are non-assignable, allow the holders to purchase
Common Stock at $0.30 per share (the "Per Share Warrant Price") at any time
until March 31, 2006. 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. In the event that the Company completes its
proposed equity offering at less than the Per Share Warrant Price, the holders
have the option to exchange the Warrants for warrants to purchase a greater
number of shares based on the difference between the Per Share Warrant Price and
the proposed equity offering price per share. Because the Per Share Warrant
Price was less than the closing price of the Common Stock, as traded on the
American Stock Exchange, on the dates the notes were sold, the Warrants were
ascribed a value of $342,000 and such amount was credited to shareholders
equity, and the Subordinated Notes were ascribed a value of $858,000. The value
of the beneficial conversion has been charged to interest over the life of the
Subordinated Note, resulting in a total non-cash charge to interest expense of
$342,000 between April 1, 2001 and August 31, 2001, including $136,800 for the
three-month period ended September 30, 2001.
NOTE 6 - LONG-TERM DEBT
The bank agreements governing the lines of credit (see Note 4) and the
term loans contain several financial covenants, including specified levels of
tangible net worth, interest coverage and debt service coverage. The terms of
the Agreements also prohibit the payment of dividends, limit the amount of
annual capital expenditures and include other restrictive covenants. On March 1,
2001, the bank agreements were amended to reduce the available lines of credit
from $8.0 million to $6.0 million. On April 12, 2001, the Agreements were
further amended and the covenant violations that existed at December 31, 2000
and at the date of the amendment were waived. The bank lender established new
covenants and extended the credit facility for an additional one-year period to
be in place through November 2003.
The Company reported to its senior bank lender that it is not in
compliance with the tangible net worth covenant as of June 30, 2001, and that
the Company may not meet its annual interest coverage and debt service coverage
covenants which will be measured as of December 31, 2001. On October 3, 2001,
the senior bank lender notified the Company that the Company is in default, but
that the senior lender will allow the Company to proceed under the Credit
Agreements until further notice, provided that there occurs no additional events
of default and that there occurs no material adverse change in the Company or
its business. The senior lender has retained its right to take any action
permitted under the Credit Agreements and related agreements in the future
without any notice to the Company. The senior lender and management continue to
discuss management plans to cure the defaults, including, without limitation, a
capital infusion by accredited investors. This capital infusion, if successful,
may cure the tangible net worth covenant, but it will not cure the debt service
and interest coverage covenants. Management is hopeful, however, that a
successful capital infusion will cause the lender to continue its forbearance.
In view of the continuing default, the Company has classified all indebtedness
to the lender as current liabilities.
9
Long-term debt includes the following debt instruments at September 30,
2001 and December 31, 2000:
September 30, December 31,
2001 2000
------------ ------------
Term note payable to a bank, interest at prime plus 2.5% (8.5% effective
rate as of September 30, 2001), payable in monthly installments of
$16,111 through November 2002 at which time any remaining principal
and interest thereon is due $ 2,561,667 $ 2,706,667
Term note payable to a bank, interest at prime plus 3.0%, (9.75% effective
rate as of September 30, 2001), payable in monthly installments of
$62,500 through August 2002 at which time the remaining principal and
interest thereon is due 625,000 1,187,500
Capitalized lease obligations and other notes 18,182 59,741
------------ ------------
Total long-term debt 3,204,849 3,953,908
Less current maturities (3,204,849) (3,953,908)
------------ ------------
Long-term debt, less current maturities $ -- $ --
============ ============
NOTE 7 - TAXES ON INCOME
The current tax benefits computed for the three-and nine-month periods
ended September 30, 2000 reflects the tax benefit associated with the
amortization of non-deductible acquired intangible assets during the same
period.
The Company has net operating loss carryforwards ("NOLs") of
approximately $20 million that may be applied against future taxable income. The
NOLs expire in varying amounts from 2004 and through 2020. Utilization 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 8 - LOSS PER SHARE
Basic loss per share is based on the weighted average number of shares
outstanding for each period presented because common stock equivalents are
anti-dilutive. Diluted earnings per share is the same as basic earnings per
share for all periods presented because the inclusion of options and warrants
would have an antidilutive effect on loss per share during all periods
presented.
Information as to options and warrants outstanding that have been
excluded from the computation of diluted earnings per share is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Options:
Number 2,183,692 1,076,906 2,183,692 1,076,906
Expiration dates 2003-2011 2003-2010 2003-2011 2003-2010
Warrants:
Number 997,678 197,678 997,678 197,678
Expiration dates 2002-2006 2002 2002-2006 2002
10
NOTE 9 - RECENT ACCOUNTING PRONOUNCEMENTS
On July 20, 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 141, BUSINESS COMBINATIONS
("SFAS 141"), and No. 142, GOODWILL AND INTANGIBLE ASSETS ("SFAS 142"). SFAS 141
is effective for all business combinations completed after June 30, 2001. SFAS
142 is effective for years beginning after December 15, 2001; however, certain
provisions of SFAS 142 apply to goodwill and other intangible assets acquired
between July 1, 2001 and the effective date of SFAS 142 (January 1, 2002 for the
Company). Major provisions of these pronouncements and their effective dates for
the Company are as follows:
o All business combinations initiated after June 30, 2001 must use the
purchase method of accounting. The pooling of interest method of
accounting is prohibited except for transactions initiated before July
1, 2001. The Company has used the purchase method of accounting for
all of its business combinations.
o Intangible assets acquired in a business combination must be recorded
separately from goodwill if such assets arise from contractual or
other legal rights or are separable from the acquired entity and can
be sold, transferred, licensed, rented or exchanged either
individually or as part of a related contract, asset or liability.
o Goodwill, as well as intangible assets with indefinite lives, acquired
after June 30, 2001, will not be amortized. Effective January 1, 2002,
all previously recognized goodwill and intangible assets with
indefinite lives will no longer be subject to amortization.
o Intangible assets that have finite useful lives will continue to be
amortized over their useful lives, but without the restraint of an
arbitrary ceiling.
o Effective January 1, 2002, goodwill and intangible assets with
indefinite lives will be tested for impairment annually and whenever
there is an impairment indicator.
o All acquired goodwill must be assigned to reporting units for purposes
of impairment testing and segment reporting.
The Company will continue to amortize goodwill recognized prior to July
1, 2001, under its current method until January 1, 2002, at which time quarterly
and annual goodwill amortization of $42,655 and $170,620, respectively, will no
longer be recognized. By December 31, 2002 the Company will have completed a
transitional fair value based impairment test of goodwill as of January 1, 2002.
Impairment losses, if any, resulting from the transitional testing will be
recognized in the quarter ended March 31, 2002, as a cumulative effect of a
change in accounting principle.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
The Company acquired 100% of the equity of A-OK Controls effective at
the close of business on June 30, 2000, and acquired 100% of the equity of
Optimation effective at the close of business on March 30, 2001. The
consolidated condensed financial statements include the results of operations of
A-OK Controls and Optimation (the "acquired companies") since June 30, 2000 and
March 31, 2001, respectively.
THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE
------------------------------------------------------------------------
THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2000
------------------------------------------------------
Net revenues for the three- and nine-month periods ended September 30,
2001 decreased $1,891,000 (30.3%) and $1,437,000 (9.4%), respectively, to
$4,358,000 and $13,908,000, respectively, compared to the same periods last
year. The revenue decreases are primarily attributable to decreases in sales of
hardware products and bundled Industrial Control Computers under a major supply
program with a major automotive company, partially offset revenues of the
acquired companies totaling $2,192,000 and $6,317,000 during the three- and
nine-month periods ended September 30, 2001. Management expects that net
revenues for the last quarter of 2001 will be consistent with the year earlier
period totals, based on existing scheduled production releases and scheduled and
anticipated services.
Gross profit for the three- and nine-month periods ended September 30,
2001 decreased $595,000 (38.0%) and $1,351,000 (32.5%), respectively, to
$969,000 and $2,801,000, respectively, compared to the same periods last year.
Gross profit as a percentage of net revenues for the three- and nine-month
periods ended September 30, 2001 was 22.2% and 20.1% respectively, compared to
25.0% and 27.1% in the same periods last year. The decreases in gross profit
percentage resulted from the effect of fixed cost on lower hardware-based
revenues in the current periods and from a lower percentage of sales of higher
margin bundled hardware/software products under the major supply program with a
major automotive company in the current periods compared to the same periods
last year. Additionally, the percentage of high margin software sales decreased
in both the three- and nine-month periods ended September 30, 2001, resulting in
a deterioration of overall gross profit margin. Management expects that gross
profit margins will remain relatively constant for the last quarter of 2001 as
the mix of sales in the fourth quarter of 2001 is expected to be similar to the
sales mix experienced in the first nine months of the year, based on the current
backlog and forecasts.
Product development expenses for software products for the three- and
nine-month periods ended September 30, 2001 decreased $37,000 (16.1%) and
$57,000 (11.7%), respectively, to $192,000 and $430,000, respectively, compared
to the same periods last year. The decreases are attributable to a smaller
development staff in the current periods compared to a year ago. Management
expects that product development expenses will decrease slightly in the last
quarter of 2001 as staff levels and new software development efforts are planned
to decrease from current levels.
Selling, general and administrative expenses for the three- and
nine-month periods ended September 30, 2001 decreased $77,000 (4.9%) and $35,000
(0.7%) to $1,486,000 and $4,775,000, respectively, compared to the comparable
periods last year. The decreases in selling, general and administrative expenses
resulted primarily from reductions of sales and marketing expenses at Nematron,
offset in part by sales and administrative expenses of the acquired companies
during the periods. During the three-month period ended September 30, 2001, the
acquired companies incurred $538,000 of selling, general and administrative
expenses while historical expenses decreased by $302,000 over the year earlier
period. During the nine-month period ended September 30, 2001, the acquired
companies incurred $1,470,000 of selling, general and administrative expenses
while historical expenses decreased by $1,192,000 over the year earlier period.
Management expects that selling, general and administrative expenses for the
last quarter of 2001 will remain consistent with the level of expenses incurred
in the first three quarters of the year.
12
Interest expense for the three- and nine-month periods ended September
30, 2001 increased $106,000 (51.5%) and $526,000 (149.0%), respectively, to
$311,000 and $878,000, respectively, compared the same periods last year.
Interest expense for the three- and nine-month periods ended September 30, 2001
includes $137,000 and $342,000 of non-cash interest expense related to the
beneficial conversion feature of warrants sold in March and April 2001, This
results from the conversion price of the warrants being below the market price
of the common stock, into which the warrants may be converted, on the date of
the sale of the warrants and convertible subordinated debt which raised $1.2
million. The total discount to market, assuming all warrants will be converted
to common stock, totals $342,000, and such amount was amortized to interest
expense over the term of the convertible subordinated debt, April through August
2001, at $68,400 per month. Absent the non-cash charge for the beneficial
conversion feature described above, the increase in interest expense for the
three- and nine-month periods ended September 30, 2001 decreased $31,000 and
increased $184,000, respectively, compared to the comparable 2000 periods. The
increase in interest expense in each period results form increased borrowing
levels beginning June 30, 2000 when the Company funded a portion of the purchase
price of A-OK Controls with bank borrowings and the effect of the beneficial
conversion feature of warrants.
Sundry income for the three-month period ended September 30, 2001 was
$3,000 versus $26,000 for the comparable 2000 period and results primarily from
rental and other non-operating transactions. Sundry income for the nine-month
period ended September 30, 2001 was $10,000 versus $404,000 for the comparable
2000 period; $378,000 of the amount for the nine months ended September 30, 2000
resulted from the sale of an unused domain name during the period.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Primary sources of liquidity are cash generated from operations,
short-term subordinated debt and the Company's three secured lines of credit
that total $6.6 million. As of September 30, 2001, the Company had $2,301,000
outstanding under the lines of credit and approximately $275,000 of additional
borrowing capacity available under the credit lines. The Company has two
agreements with its principal bank providing two lines of credit totaling $6.0
million through November 2003. The Company also has a secured line of credit
through its wholly owned subsidiary, Optimation, with an Alabama-based bank, and
such line of credit totals $620,000 through November 1, 2001. The Company
intends to obtain a replacement credit line for the current expiring agreement
to provide funding for the Optimation operations.
The Company reported to its senior bank lender that it is not in
compliance with the tangible net worth covenant as of June 30, 2001, and that
the Company may not meet its annual interest coverage and debt service coverage
covenants, which will be measured as of December 31, 2001. On October 3, 2001,
the senior bank lender notified the Company that the Company is in default, but
that the senior lender will allow the Company to proceed under the Credit
Agreements until further notice, provided that there occurs no additional events
of default and that there occurs no material adverse change in the Company or
its business. The senior lender has retained its right to take any action
permitted under the Credit Agreements and related agreements in the future
without any notice to the Company. The senior lender and management continue to
discuss management plans to cure the defaults, including, without limitation, a
capital infusion by accredited investors. This capital infusion, if successful,
may cure the tangible net worth covenant, but it will not cure the debt service
and interest coverage covenants. Management is hopeful, however, that a
successful capital infusion will cause the lender to continue its forbearance.
In view of the continuing default, the Company has classified all indebtedness
to the lender as current liabilities.
The Company's operations generated $646,000 of cash in the first nine
months of 2001, including a $2,013,000 positive effect from changes in working
capital items.
In the short term, the Company will be required to repay its $1.2
million principal amount of subordinated notes unless the holders convert such
notes. The Company also has commitments to make payments approximating $250,000
on term debt prior to year end 2001.
13
Management intends to complete an equity offering to accredited investors prior
to December 31, 2001, whereby the Company would raise a minimum of $5 million, a
portion of the proceeds of which would be applied to the repayment of the
subordinated notes. If such offering is not completed, the Company expects the
subordinated notes to be converted into common stock.
Based upon the Company's existing working capital, forecasted revenue
and expense levels and forecasted lines of credit availability, and assuming the
conversion of the subordinated notes to common stock, the Company believes it
has sufficient liquidity to satisfy its liabilities as they become due. The
Company believes that its long-term liquidity needs will be satisfied through
the proceeds of the private equity offering it expects to complete on or prior
to December 31, 2001.
Management can offer no assurance that the private placement of
securities will be successful, nor if the private placement occurs, that the
equity raised will be sufficient persuade the bank to continue its forbearance
on calling the debt because of the continuing covenant violations. If the
private placement is not successful, the Company will not have sufficient
liquidity to satisfy its liabilities and obligations as they become due and it
may be forced to curtail its operations.
UNCERTAINTIES RELATING TO FORWARD LOOKING STATEMENTS
----------------------------------------------------
"Item 2. Management's Discussion and Analysis or Plan 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:
o Uncertainties discussed elsewhere in "Management's Discussion and
Analysis or Plan of Operation" above;
o The potential inability to raise additional equity or debt financing
in a sufficient amount to sustain operations and allow management to
execute its strategies;
o The potential inability to modify bank covenants as it may be
necessary from time to time or continue the lender's forbearance
exercising its remedies;
o The decline of general economic conditions or conditions in the
automotive industry in particular;
o The inability of the Company to successfully implement its strategy to
capitalize on the industrial automation market migration from closed
architecture PLCs to open architecture PC-based solutions or changes
in the Company general strategy;
o The ability of the Company to effectively integrate the operations of
acquired companies;
o Competitive factors (including changes in competitive products and
pricing pressures);
o Changes in customer requirements or a reduction in demand for the
Company's products and services or reductions in product life cycles;
o Component price increases and availabilities, and the availability
alternative components;
o Delays in introduction of planned hardware and software product
offerings;
o Software defects and latent technological deficiencies in new hardware
products;
o Unforeseen increases in operating expenses;
o Adverse fluctuations in foreign exchange rates;
o The inability to attract or retain sales and/or engineering talent;
and
o Evolving industrial automation industry standards.
14
PART II - OTHER INFORMATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company reported to its senior bank lender that it is not in
compliance with the tangible net worth covenant as of June 30, 2001, and that
the Company may not meet its annual interest coverage and debt service coverage
covenants, which will be measured as of December 31, 2001. On October 3, 2001,
the senior bank lender notified the Company that the Company is in default, but
that the senior lender will allow the Company to proceed under the Credit
Agreements until further notice, provided that there occurs no additional events
of default and that there occurs no material adverse change in the Company or
its business. The senior lender has retained its right to take any action
permitted under the Credit Agreements and related agreements in the future
without any notice to the Company. The senior lender and management continue to
discuss management plans to cure the defaults, including, without limitation, a
capital infusion by accredited investors. This capital infusion, if successful,
may cure the tangible net worth covenant, but it will not cure the debt service
and interest coverage covenants. Management is hopeful, however, that a
successful capital infusion will cause the lender to continue its forbearance.
In view of the continuing default, the Company has classified all indebtedness
to the lender as current liabilities.
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.
15
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Nematron Corporation
By:
November 6, 2001 /s/ Matthew S. Galvez
---------------- -------------------------------------------
Date Matthew S. Galvez, President & CEO
(Duly Authorized Officer)
November 6, 2001 /s/ David P. Gienapp
---------------- -------------------------------------------
Date David P. Gienapp, Executive Vice President-
Finance & Administration
(Chief Accounting Officer)
16
INDEX TO EXHIBITS
Exhibit Number Description of Exhibit
-------------- ----------------------
None None
17