U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 1997
Gateway Data Sciences Corporation
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(Exact name of small business issuer as specified in its charter)
Arizona 86-0527788
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(State or other jurisdiction of (IRS Employer Identification)
incorporation or organization)
3410 E. University Drive, Phoenix, AZ 85034
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(Address of principal executive offices)
(602) 968-7000
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(Issuer's telephone number, including area code)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15 (d) of the 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.
Yes X No
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APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity: 2,838,138 shares of common stock, $.01 par value (as of December 22,
1997)
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GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of October 31, 1997
and January 31, 1997 3
Consolidated Statements of Operations for the
three months and nine months ended
October 31, 1997 and 1996 4
Consolidated Statements of Cash Flows for the
nine months ended October 31, 1997 and 1996 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II. OTHER INFORMATION 18
Signatures 19
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PART I, ITEM 1. FINANCIAL STATEMENTS
GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF OCTOBER 31, 1997 ( UNAUDITED) AND JANUARY 31, 1997
<TABLE>
<CAPTION>
October 31, January 31,
1997 1997
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<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,197 $ 936,232
Trade receivables -- less allowance of
$577,000 and $112,300, respectively 1,121,159 7,684,086
Inventories 670,947 2,420,393
Prepaid expenses and other assets 521,838 432,140
------------- -------------
Total current assets 2,316,141 11,472,851
PROPERTY AND EQUIPMENT -- Net 1,020,466 1,794,894
NET INVESTMENT IN LEASE RESIDUALS 1,223,627 1,663,870
ACCOUNTS RECEIVABLE - Long Term 3,803,055 --
OTHER ASSETS 952,836 666,884
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$ 9,316,124 $ 15,598,498
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LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,596,435 1,452,775
Accrued liabilities 401,884 2,889,574
Accrued payroll and benefits 972,789 346,319
Line of Credit 1,055,549 --
Current portion of notes payable 637,153 161,438
Current portion of capital lease obligations 25,313 74,375
Deferred revenue 952,870 1,058,759
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Total current liabilities 7,641,993 5,204,674
DEFERRED REVENUE, recognized after one year 1,305,491 1,785,266
NOTES PAYABLE, less current portion 140,388 280,600
CAPITAL LEASE OBLIGATIONS, less current portion 45,990 56,445
OTHER LONG TERM LIABILITIES 56,792 --
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Total liabilities 9,190,654 8,105,552
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COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value, 5,000,000 shares authorized,
no shares issued and outstanding -- --
Common stock, $.01 par value, 20,000,000 shares authorized,
2,838,138 shares issued and outstanding at October 31, 1997 and
2,813,312 shares issued and outstanding at January 31, 1997 28,381 28,133
Additional paid-in capital 9,309,016 9,203,940
Deferred compensation (8,139) --
Accumulated deficit (9,203,788) (1,739,128)
-------------- --------------
Total shareholders' equity 125,470 7,492,946
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$ 9,316,124 $ 15,598,498
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</TABLE>
See notes to consolidated financial statements.
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GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED OCTOBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 31, October 31,
(Unaudited) (Unaudited)
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUE
Product $ 1,424,625 $ 7,163,221 $ 8,561,380 $ 14,383,153
Software license 67,659 667,587 1,780,079 2,931,028
Maintenance and support services 214,087 123,076 586,468 354,473
Professional services 216,351 709,884 1,820,775 1,751,371
-------------- ------------- ------------- --------------
Total revenue 1,922,722 8,663,768 12,748,702 19,420,025
-------------- ------------- ------------- --------------
OPERATING EXPENSES:
Products sold 4,065,166 4,909,630 8,873,991 10,064,921
Software development 1,071,410 1,016,712 3,371,696 2,825,201
Maintenance and support services 152,904 153,194 432,750 438,142
Professional services 495,424 641,523 1,467,020 1,553,840
Sales and marketing 1,278,393 492,950 2,935,396 1,365,073
General and administrative 1,544,273 625,113 2,788,303 1,442,635
Restructuring charges -- -- 107,582 --
-------------- ------------- ------------- ------------
Total expenses 8,607,570 7,839,122 19,976,738 17,689,812
-------------- ------------- ------------- --------------
INCOME (LOSS) FROM OPERATIONS (6,684,848) 824,646 (7,228,036) 1,730,213
OTHER (INCOME) EXPENSE:
Interest expense 109,432 101,469 339,595 188,505
Other, net (31,277) (294) (102,971) (1,890)
--------------- -------------- -------------- ---------------
Total other expense, net 78,155 101,763 236,624 186,615
-------------- ------------- ------------- --------------
INCOME (LOSS) BEFORE INCOME TAXES (6,763,003) 722,883 (7,464,660) 1,543,598
PROVISION FOR INCOME TAXES -- -- -- --
-------------- ------------- ------------- ------------
NET INCOME (LOSS) $ (6,763,003) $ 722,883 $ (7,464,660) $ 1,543,598
============== ============= ============= ==============
NET INCOME (LOSS) PER COMMON
AND COMMON EQUIVALENT
SHARE (Note 2) $ (2.38) $ .26 $ (2.58) $ .57
============== ============= ============= ==============
COMMON AND COMMON
EQUIVALENT SHARES
OUTSTANDING (Note 2) 2,838,138 2,819,776 3,121,394 2,610,456
============== ============= ============= ==============
</TABLE>
See notes to consolidated financial statements.
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GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED OCTOBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
Nine Months Ended October 31,
-----------------------------
1997 1996
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(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income...................................................................... $ (7,464,660) $ 820,716
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization............................................... 438,456 266,017
Amortization of deferred compensation....................................... 11,394 7,800
Net loss on property dispositions and other................................. 30,112 --
Effect of changes in assets and liabilities:
Trade receivables........................................................... 2,759,872 (3,429,125)
Inventories................................................................. 1,749,446 (1,078,645)
Prepaid expenses and other assets........................................... (375,651) 140,726
Accounts payable............................................................ 2,143,663 533,646
Accrued liabilities......................................................... (2,430,900) (786,993)
Accrued payroll and benefits................................................ 626,470 209,627
Deferred revenue............................................................ (585,665) 79,377
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Net cash used in operating activities............................ (3,097,463) (3,236,854)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment.............................................. (464,207) (802,424)
Proceeds from sale of property and equipment.................................... 770,067 --
Net investment in lease residuals............................................... 440,243 138,424
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Net cash (used in) provided by investing activities............. 746,103 (664,000)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from initial public offering....................................... -- 6,531,809
Proceeds from additional borrowings on notes payable........................... 454,000 --
Principal payments on notes payable............................................. (118,498) (875,350)
Principal payments on capital lease obligations................................. (59,517) (28,543)
Additional borrowings on capital lease obligations.............................. -- 66,344
Borrowings on line of credit.................................................... 1,055,549 984,011
Proceeds from issuance of common stock.......................................... 85,791 51,057
Net payments to officers and employees.......................................... -- (536,172)
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Net cash provided by financing activities........................ 1,417,325 6,193,156
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NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS............................... (934,035) 2,292,302
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD..................................... 936,232 93,402
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CASH AND CASH EQUIVALENTS, END OF PERIOD........................................... $ 2,197 $ 2,385,704
============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest........................................ $ 339,595 $ 87,036
============= =============
Cash paid during the period for income taxes.................................... $ -- $ 39,500
============= =============
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Fair market value of stock issued to non-employee directors..................... $ 19,533 $ 15,600
============= =============
</TABLE>
See notes to consolidated financial statements
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<PAGE>
GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997
1. INTERIM FINANCIAL REPORTING
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and the instructions to Form 10-QSB. Accordingly, they do
not include all the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (which include only normal recurring adjustments)
necessary to present fairly the financial position, results of operations, and
cash flows for the periods presented have been made. The results of operations
for the three and nine-month periods ended October 31, 1997 are not necessarily
indicative of the operating results that may be expected for the entire year
ending January 31, 1998. These financial statements should be read in
conjunction with the Company's Form 10-KSB for the fiscal year ended January 31,
1997.
2. NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
Net income per common and common equivalent share is computed using the
weighted average number of common and common equivalent shares outstanding
during each period. Common stock equivalents consist of stock options and
warrants.
3. OTHER
The Company is party to various legal and administrative proceedings
arising in the ordinary course of business. The Company is involved in a
material dispute with a customer. The dispute involves a receivable of
$3,803,055 at October 31, 1997. On May 30, 1997, the customer filed suit against
the Company in the United States District Court for the Eastern District of
Wisconsin (Case No. 97-C-0635). The complaint alleges that the Company breached
its contract with the customer by (i) failing to deliver and install certain
software products, (ii) failing to use its best efforts to achieve productive
use of the Company's software products, and (iii) failing to provide its
professional consulting services in a reasonable, workmanlike manner. The
customer is seeking an unspecified amount of damages and a declaratory judgment
with respect to the parties' respective rights and legal obligations. The
complaint also alleges that the Company acted in a fraudulent manner by making
false representations to the customer in connection with the contractual
agreements between the Company and the customer. On October 15, 1997, the court
dismissed the customer's fraud claim against the Company. The Company has filed
a counterclaim for the amounts that the Company claims the customer owes under
the contract and has filed an answer denying the customer's claims in the
complaint. The Company intends to vigorously pursue its counterclaim and to
vigorously defend the lawsuit by the customer. In the event that the Company is
unable to obtain a successful decision on its counterclaim or a decision adverse
to the Company is rendered with respect to the claims by the customer, the
resolution of this matter could have a material adverse effect on the Company.
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<PAGE>
4. TRANSACTIONS WITH RELATED PARTIES
Included in Other Assets is a receivable due from a related entity of
approximately $852,000. The amounts due represent a receivable of approximately
$732,000 for management and consulting services provided by Company personnel
during the year, and approximately $120,000 for certain expenses incurred for
the affiliate. Certain executives of the Company maintain a direct interest and
managerial role in the related entity. The receivable is recorded as an
arms-length transaction at the estimated fair value of services performed. In
addition, management believes the balance is fully collectible and a valuation
allowance has not been recorded.
In January 1997, the Company entered into an equipment lease agreement with
Anderson & Wells Investment Companies, an affiliate of Gregory S. Anderson and
Larry J. Wells, who are directors of the Company. The lease provides for
payments totaling approximately $675,700 to Anderson & Wells Investment
Companies during the period from January 1997 to November 1999.
In July 1997, Michael M. Gordon, the Company's Chairman of the Board,
President and Chief Executive Officer, and Mr. Gordon's spouse personally
guaranteed the Company's indebtedness under its line of credit. The guarantee
includes the pledge of all of the Company's common stock held by Mr. Gordon and
his spouse. Outstanding borrowings under the line of credit that were guaranteed
by Mr. Gordon and his spouse total approximately $1.1 million as of October 31,
1997.
In August 1997,the Company entered into an equipment lease agreement with
Anderson & Wells Investment Companies, an affiliate of Gregory S. Anderson and
Larry J. Wells, who are directors of the Company. The lease provides for
payments totaling approximately $770,100 to Anderson & Wells Investment
Companies during the period from August 1997 to November 1999.
Included in Notes Payable are amounts due to certain directors and
affiliates of directors of the company. In October 1997, the Company entered
into a unsecured note payable transaction with Steven A. Rothstein, a director
of the Company. The note payable is in the amount of $100,000 and matures on
December 31, 1997, together with interest payable at 14% per annum, or 18% per
annum should the principal payment become overdue. The note provides for the
Company to issue 30,769 shares of common stock of the Company in conjunction
with the note; the Company to issue an additional 30,769 shares of Common Stock
of the Company should the note not be paid before November 14, 1997; and
warrants to purchase 61,538 shares of Common Stock of the Company at an exercise
price of $1.63 per share if the note is not paid before November 28, 1997. The
Company issued those shares of Common Stock of the Company and the warrants to
Mr. Rothstein in December 1997.
In October 1997, the Company entered into a unsecured note payable
transaction with Sundance VenturePartners, L.P., an affiliate of Gregory S.
Anderson and Larry J. Wells, who are directors of the Company. The note payable
is in the amount of $54,000 and matures on December 29, 1997, together with
interest payable at 14% per annum, or 18% per annum should the principal payment
become overdue. The note provides for the Company to issue 16,615 shares of
Common Stock of the Company in conjunction with the note; the Company to issue
an additional 16,616 shares of Common Stock of the Company should the note not
be paid before November 12, 1997; and warrants to purchase 33,231 shares of
Common Stock of the Company at an exercise price of $1.63 per share if the note
is not paid before November 26, 1997. The Company issued those shares of Common
Stock of the Company and the warrants to Mr. Anderson in December 1997.
In November 1997, the Company entered into a unsecured note payable
transaction with Gregory S. Anderson, a director of the Company. The note
payable is in the amount of $46,000 and matures on January 3, 1998, together
with interest payable at 14% per annum, or 18% per annum should the principal
payment become overdue. The note provides for the Company to issue 14,154
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shares of Common Stock of the Company in conjunction with the note; the Company
to issue an additional 14,153 shares of Common Stock of the Company should the
note not be paid before November 17, 1997; and warrants to purchase 28,307
shares of Common Stock of the Company at an exercise price of $1.63 per share if
the note is not paid before November 28, 1997. The Company issued those shares
of common stock of the Company and the warrants to Mr. Anderson in December
1997.
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Statement Regarding Forward-Looking Statements
The statements contained in this Report that are not purely historical
are forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
including statements regarding the Company's "expectations," "anticipation,"
"intentions," "beliefs," or "strategies" regarding the future. Forward-looking
statements include statements regarding revenue, margins, expenses, and earnings
analysis for fiscal 1998 and thereafter; future products or product development;
future research and development spending and the Company's product development
strategy; and liquidity and anticipated cash needs and availability. All
forward-looking statements included in this Report are based on information
available to the Company on the date of this Report, and the Company assumes no
obligation to update any such forward-looking statement. It is important to note
that the Company's actual results could differ materially from those in such
forward-looking statements. Among the factors that could cause actual results to
differ materially are the factors discussed in the Company's Report on Form
10-KSB, Item 1, "Special Considerations."
Operations
Gateway Data Sciences Corporation (the "Company") and its wholly owned
subsidiary, Gateway Credit Corporation ("GCC"), design, develop, market, and
implement software products and provide related customer support services for
retail and warehouse management systems. The Company also provides professional
services including product installation, training, maintenance, and
customization in conjunction with sales of its software products.
Prior to August 1, 1997, the Company has generated the majority of its
revenue from the resale of hardware and software products produced by third
parties, primarily International Business Machines Corp. ("IBM") AS/400 and
related peripheral equipment. The Company also has historically generated a
portion of its revenue from the sale of its proprietary software products,
primarily the Kinetics(TM) warehouse management system, which was developed
exclusively for use on the AS/400 platform, and from providing professional
services related to these products. Sales of IBM products, including hardware,
software, and maintenance, accounted for approximately 66% and 56% of the
Company's total revenue for the years ended January 31, 1996 and 1997,
respectively, and approximately 54% and 49% for the nine months ended October
31, 1996 and 1997, respectively. The Company's reseller agreement with IBM
expired in July 1997. During the year ended January 31, 1996, the Company
changed its business strategy to focus on the development and marketing of its
proprietary software products. In conjunction with this change in strategy, the
Company has since dedicated many of its resources to the development and
marketing of new software products. The Company anticipates that this will
result in a change in its revenue mix. The Company believes that, although the
change in revenue mix may initially result in lower total revenue, it should
also result in improved gross profit margins as software revenue increases as a
percentage of total revenue. There can be no assurance, however, that the
Company will be able to successfully complete this transition in its business
focus.
The Company has marketed the Kinetics(TM) warehouse management software
product for several years. Kinetics currently operates only on the IBM AS/400
family of midrange computers. Prior to January 31, 1997, the Company had derived
substantially all of its software revenue from Kinetics and other IBM-based
software products. Future revenue from sales of Kinetics and related services
will depend upon continued widespread use of IBM midrange computers and upon the
continued support of such computers by IBM. In addition, the Company will be
required to adapt Kinetics to any changes made by IBM to the AS/400's operating
system software. A significant shift
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<PAGE>
away from IBM midrange computer systems by the Company's customers or the
failure by IBM to continue its support of these systems could have a material
adverse effect on the Company.
During the year ended January 31, 1997, the Company introduced
Transact(TM), a point-of-sale software product developed in Java(TM) that can be
utilized on a wide variety of point-of-sale hardware platforms. Subsequent to
January 31, 1997, the Company introduced MarketBuilder(TM), a relationship
marketing system for retailers, and Crossfire(TM), an Internet-based store
communication system, both of which are also developed in Java. The Company
intends to increase the resources dedicated to software development and
marketing in support of its newly introduced retail point-of-sale software
products. These products have been generally available since October 1997 and
although the Company has not yet generated significant sales of its new
Java-based products, it expects that the functionality of its new products, the
flexibility of Java-based software, and the personnel changes that have been
made to focus on software development and marketing efforts will result in
sufficient future revenue to fund its ongoing operations.
Cost of products sold includes costs of those software and hardware
products not manufactured by the Company and maintenance resold by the Company.
The Company does not capitalize any software development costs associated with
the development of its proprietary software products and has expensed all
payroll and related costs for software development as incurred. Software
development cost also includes all other general and administrative costs
associated with software development personnel. Maintenance and support services
includes cost of personnel and related administrative costs associated with
telephone support of the Company's software products. Professional services
expense consists of salaries, benefits, and other general and administrative
costs attributable to professional services personnel. Sales and marketing
expenses consist primarily of salaries, commissions, benefits, marketing
materials, travel expenses, and other general and administrative costs
associated with or allocated to the Company's sales and marketing personnel.
General and administrative expenses include the cost of finance and accounting,
human resources, corporate information systems, and other administrative
functions of the Company.
Results of Operations of the Company for the Three Months Ended October 31, 1997
and 1996
Revenue. Total revenue decreased by 78% from approximately $8.7 million
in the three months ended October 31, 1996 to approximately $1.9 million in the
three months ended October 31, 1997. Product revenue decreased by 80% from
approximately $7.1 million to approximately $1.4 million during the same
periods. As a percentage of total revenue, product revenue decreased from 83%
during the three months ended October 31, 1996 to 74% during the three months
ended October 31, 1997. Software license revenue decreased by 90% from
approximately $668,000 in the three months ended October 31, 1996 to
approximately $68,000 in the three months ended October 31, 1997. As a
percentage of total revenue, software license revenue decreased from 8% to 4%
during the same periods. Maintenance and support revenue increased approximately
74% from approximately $123,000 in the three months ended October 31, 1996 to
approximately $214,000 in the three months ended October 31, 1997. As a
percentage of total revenue, maintenance revenue increased from 1% in the three
months ended October 31, 1996 to approximately 11% in the three months ended
October 31, 1997. Professional services revenue decreased 70% from approximately
$710,,000 to approximately $216,000 during the three months ended October 31,
1996 and 1997, respectively. As a percentage of total revenue, professional
services revenue increased from 8% to 11% during the three months ended October
31, 1996 and 1997, respectively.
The overall decrease in total revenue is attributed to decreases in
third-party product revenue, software revenue and professional services revenue,
partially offset by increases in maintenance and support services revenue. The
decrease in third party product revenue is due to the expiration of the
Company's IBM reseller agreement in July 1997. The Company continues to believe
that revenue from third-party products will decrease as a percentage of total
revenue and that the total dollar amounts of revenue from third-party products
may decrease in the future. The
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<PAGE>
decrease in software revenue is attributed to reduced sales of Kinetics, the
unavailability of the Company's new software products, delayed customer purchase
orders, and the cash flow difficulties experienced by the Company during the
quarter. See "Liquidity and Capital Resources". The increase in maintenance and
support services revenue is attributed to ongoing support contracts, primarily
from sales during the prior fiscal year and prior periods in the current fiscal
year. The decrease in professional services revenue resulted from the Company's
reduced software sales during the three months ended October 31, 1997.
Cost of Products Sold. Cost of products sold decreased 17% from
approximately $4.9 million during the three months ended October 31, 1996 to
approximately $4.0 million during the three months ended October 31, 1997. As a
percentage of product revenue, cost of products sold was approximately 69% and
286% during the three months ended October 31, 1996 and 1997, respectively. Due
to the cash flow difficulties during the nine months ending October 31, 1997,
and continued cash flow difficulties subsequent to October 31, 1997, and in an
effort to quickly raise capital, the Company liquidated equipment inventories
and recorded substantial losses on such sales during the three months ended
October 31, 1997.
Software Development Expense. Software development expense increased
from approximately $1.0 million to approximately $1.1 million during the three
months ended October 31, 1996 and 1997, respectively. The 5% increase is
attributed to increased research and development efforts associated with the
development of the Company's proprietary software products. As a percentage of
total revenue, software development costs increased from 12% in the three months
ended October 31, 1996 to 56% in the three months ended October 31, 1997.
Maintenance and Support Services Expense. Maintenance and support
services expense remained even at approximately $153,000 in the three months
ended October 31, 1996 and in the three months ended October 31, 1997. As a
percentage of total revenue, maintenance and support services increased from at
2% to 8% of total revenue during the three months ended October 31, 1996 and
1997, respectively.
Professional Services Expense. Professional services expense decreased
by 23% from approximately $641,000 to approximately $495,000 during the three
months ended October 31, 1996 and 1997, respectively. A reduction in personnel
contributed to this decrease. As a percentage of professional services revenue,
professional services expense increased from 91% in the three months ended
October 31, 1996 to 229% in the three months ended October 31, 1997. This
increase as a percentage is attributed to decreased levels of professional
services revenue during the three months ended October 31, 1997.
Sales and Marketing Expense. Sales and marketing expense increased 159%
from approximately $493,000 to approximately $1.3 million in the three months
ended October 31, 1996 and 1997, respectively. The increase can be attributed to
the retirement of a prepaid marketing agreement, additional sales and marketing
personnel, and an increased marketing presence at industry trade shows.
General and Administrative Expense. General and administrative expense
increased from approximately $625,000 in the three months ended October 31, 1996
to approximately $1.5 million in the three months ended October 31, 1997. This
147% increase is attributed to increased reserves in bad debt expense,
additional personnel and associated costs, additional insurance costs, and
increased building rent costs.
Other Income (Expense). Interest expense was approximately $101,000
during the three months ended October 31, 1996, as compared with approximately
$109,000 during the three months ended October 31, 1997.
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Net Income (Loss). Net income decreased 1,036% from approximately
$723,000, or $.26 per share, in the three months ended October 31, 1996 to a
deficit of approximately $(6.8 million), or $(2.38) per share, in the three
months ended October 31, 1997. The expiration of the reseller agreement with IBM
in July 1997, the material dispute with a customer, and delayed customer
purchases have caused significant cash flow difficulties, which forced the
liquidation of assets below market value and resulted in the substantial loss
subsequent to July 31, 1997.
Results of Operations of the Company for the Nine Months Ended October 31, 1997
and 1996
Revenue. Total revenue decreased 40% from approximately $19.4 million
in the nine months ended October 31, 1996 to approximately $12.7 million at
October 31, 1997. Product revenue decreased by 39% from approximately $14.4
million to approximately $8.6 million during the same periods. As a percentage
of total revenue, product revenue decreased from 74% during the nine months
ended October 31, 1996 to 67% during the nine months ended October 31, 1997.
Software license revenue decreased by 39% from approximately $2.9 million in the
nine months ended October 31, 1996 to approximately $1.8 million in the nine
months ended October 31, 1997. As a percentage of total revenue, software
license revenue decreased from 15% to 14% during the same periods. Maintenance
and support services revenue increased approximately 65% from approximately
$354,000 in the nine months ended October 31, 1996 to approximately $586,000 in
the nine months ended October 31, 1997. As a percentage of total revenue,
maintenance revenue increased from 2% in the nine months ended October 31, 1996
to approximately 5% in the nine months ended October 31, 1997. Professional
services revenue increased 4% from approximately $1.7 million to approximately
$1.8 million during the nine months ended October 31, 1996 and 1997,
respectively. As a percentage of total revenue, professional services revenue
increased from 9% to 14% during the nine months ended October 31, 1996 and 1997,
respectively.
The Company continues to believe that revenue from third-party products
will decrease as a percentage of total revenue and that the total dollar amounts
of revenue from third-party products may decrease in the future. The decrease in
software revenue is attributed to reduced sales of Kinetics and the
unavailability of the Company's new software products. The increase in
maintenance and support services revenue is attributed to ongoing support
contracts, primarily from sales during the prior fiscal year and prior periods
in the current fiscal year. The increase in professional services revenue
resulted from the Company's continued focus on sales of its proprietary software
products, as well as the Company's continuing efforts to provide professional
services to implement its software products.
Cost of Products Sold. Cost of products sold decreased 12% from
approximately $10 million during the nine months ended October 31, 1996 to
approximately $8.9 million during the nine months ended October 31, 1997. As a
percentage of product revenue, cost of products sold was approximately 70% and
104% during the nine months ended October 31, 1996 and 1997, respectively. Due
to the cash flow difficulties during the nine months ending October 31, 1997,
and continued cash flow difficulties subsequent to October 31, 1997, and in an
effort to quickly raise capital, the Company liquidated equipment inventories
and recorded substantial losses on such sales during the three months ended
October 31, 1997.
Software Development Expense. Software development expense increased
from approximately $2.8 million to approximately $3.4 million during the nine
months ended October 31, 1996 and 1997, respectively. The 19% increase is
attributed to increased research and development efforts associated with the
development of the Company's proprietary software products. As a percentage of
total revenue, software development costs increased from 15% in the nine months
ended October 31, 1996 to 26% in the nine months ended October 31, 1997.
Maintenance and Support Services Expense. Maintenance and support
services expense decreased by 1% from approximately $438,000 in the nine months
ended October 31, 1996, to
-12-
<PAGE>
approximately $432,000 in the nine months ended October 31, 1997. As a
percentage of total revenue, maintenance and support services increased from 2%
to 3% of total revenue during the nine months ended October 31, 1996 and 1997,
respectively.
Professional Services Expense. Professional services expense decreased
by 6% from approximately $1.6 million to approximately $1.4 million during the
nine months ended October 31, 1996 and 1997, respectively. As a percentage of
professional services revenue, professional services expense decreased from 89%
in the nine months ended October 31, 1996 to 81% in the nine months ended
October 31, 1997. This decrease as a percentage is attributed to better
utilization of professional services personnel.
Sales and Marketing Expense. Sales and marketing expense increased 115%
from approximately $1.4 million to approximately $2.9 million in the nine months
ended October 31, 1996 and 1997, respectively. The increase can be attributed to
the retirement of a prepaid marketing agreement, costs incurred for marketing
literature, additional sales and marketing personnel, and an increased marketing
presence at industry trade shows.
General and Administrative Expense. General and administrative expense
increased from approximately $1.4 million in the nine months ended October 31,
1996 to approximately $2.8 million in the nine months ended October 31, 1997.
This 93% increase is attributed to increased reserves for bad debt, additional
personnel and associated costs, additional insurance costs, additional
professional fees, and increased building rent costs.
Restructuring Charge. During the nine months ended October 31, 1997,
the Company took a restructuring charge of approximately $108,000. This charge
was for costs associated with an overall decrease of approximately 27% of
personnel during August 1997.
Other Income (Expense). Interest expense was approximately $189,000
during the nine months ended October 31, 1996, as compared with approximately
$340,000 during the nine months ended October 31, 1997. Interest expense
incurred on the Company's line of credit contributed to this increase. The
average outstanding balance on the line of credit was approximately $600,000 and
approximately $2.1 million during the nine months ended October 31, 1996 and
1997, respectively.
Net Income (Loss). Net income decreased 584% from approximately $1.5
million, or $.57 per share, in the nine months ended October 31, 1996 to a
deficit of approximately $(7.4 million), or $(2.58) per share, in the nine
months ended October 31, 1997. The expiration of the reseller agreement with IBM
in July 1997 and the material dispute with a customer have caused significant
cash flow difficulties, which forced the liquidation of assets below market
value and resulted in the substantial loss subsequent to July 31, 1997.
Liquidity and Capital Resources
The Company's working capital position decreased from approximately
$2.6 million at January 31, 1997 to a deficit of approximately $(5.3 million) at
October 31, 1997.
The Company used net cash of approximately $3.1 million for operations
during the nine months ended October 31, 1997, primarily as a result of the loss
from operations and the decrease in accrued liabilities, partially offset by
decreases in accounts receivable and inventories, and an increase in accounts
payable and accrued payroll and benefits.
Capital expenditures for the nine months ended October 31, 1997 totaled
approximately $464,000 for the purchase of computer hardware and software
products needed for the continued efficient development of the Company's
proprietary software products. In August 1997, the
-13
<PAGE>
Company sold assets to a related party which resulted in the Company leasing
those assets from Anderson and Wells Investment Companies, an affiliate of
Gregory S. Anderson and Larry J. Wells, who are directors of the Company. This
sale-leaseback provided approximately $770,000 to the Company. Subsequent to
October 1997, the Company sold its interest in the residual value of certain
customer-owned leases to raise cash for operations that resulted in the decrease
of the value of those assets.
Financing activities provided net cash of approximately $1.4 million in
the nine months ended October 31, 1997. This cash was provided by $454,000 of
notes payable with certain affiliated parties (see "Related Party Transactions")
and by borrowings on the Company's line of credit agreement with Norwest
Business Credit, Inc. ("Norwest"). That line of credit, which matures on
February 21, 2000 provides borrowing capacity in the amount of the lower of $3.0
million or 80% of accounts receivable, plus the lower of $250,000 or 50% of
eligible inventory, as defined in the agreement. Borrowings under the line of
credit are secured by substantially all of the Company's tangible and intangible
assets. The agreement, as subsequently amended, requires a $5,000 minimum
monthly fee that includes interest calculated at the base lending rate (prime
rate) plus 2%, plus an unused facility fee of .25%. As of October 31, 1997 the
Company was in default under certain covenants on this line of credit.
Accordingly, Norwest has the right to demand payment of all amounts outstanding,
which amounted to approximately $1.1 million at October 31, 1997. In addition,
in October 1997, Norwest exercised its right not to provide further advances
under the line. In July 1997, Michael M. Gordon, the Company's Chairman of the
Board, President, and Chief Executive Officer and Mr. Gordon's spouse personally
guaranteed the Company's indebtedness under this line of credit. In November
1997, Norwest amended its agreement in a Forbearance Letter Agreement with the
following terms: (i) the Maximum Borrowing Base Loan Amount to be $275,000 until
December 31, 1997 and $250,000 on or after December 31, 1997; (ii) an
Overadvance Loan (the "Overadvance") not to exceed $250,000 to be paid in full
on or before December 31, 1997 with 25% of proceeds from Ineligible Accounts (as
defined in the Security Agreement) and 10% from the sale of lease residuals to
be applied as a permanent reduction of the Overadvance; and (iii) on or before
December 31, 1997, borrowers and/or Guarantors shall cause the principal balance
to be permanently reduced to not more than $250,000. Pursuant to this
arrangement, Norwest resumed making advances to the Company in November 1997.
The Company currently is seeking additional sources of financing, which may
include one or more private placements of debt or equity securities. There can
be no assurance that any additional financing will be available to the Company
or as to the terms of any such financing that is available. The inability to
obtain such financing could result in the inability of the Company to continue
as a going concern. If such financing is not available in sufficient amounts or
on satisfactory terms, the Company also may be unable to expand its business or
to develop new customers at the rate desired and its operating results may be
adversely affected.
The Company's financial statements for the nine months ended October
31, 1997 have been prepared assuming that the Company will continue as a going
concern. The Company had negative cash flow from operations of $2,612,680 for
the year ended January 31, 1997, and approximately $3.1 million for the nine
months ended October 31, 1997, is in default of the terms of its line of credit
agreement, does not have any readily available financing, is engaged in material
litigation with a significant customer, recorded a net loss of approximately
$6.7 million (unaudited) for the nine months ended October 31, 1997, and has not
yet generated sufficient revenue from its software products to fund its ongoing
operations. Additionally, its IBM reseller agreement expired in July 1997. These
factors raise substantial doubt about the Company's ability to continue as a
going concern. The Company's plans with regards to these matters are described
in "Business Outlook and Risk Factors," below. The consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of asset carrying amounts or the amount and classification of
liabilities that might result should the Company be unable to continue as a
going concern.
The Company's independent public accountants have reported to the
Company that, in the course of their audit of the Company's financial statements
for the fiscal year ended January 31, 1997
-14-
<PAGE>
and their review of the unaudited financial statements for the six months ended
July 31, 1997, they discovered various conditions that they believe constitute
material weaknesses in the Company's internal controls. These conditions consist
of (i) weaknesses in forecasting internal cash requirements; (ii) weaknesses in
policies and procedures to ensure the accurate timing, classification, and
recording of significant transactions; and (iii) weaknesses in maintaining
formal documentation regarding acquisitions and dispositions of assets. The
Company has been taking various steps intended to strengthen its financial
controls, including engaging more experienced personnel in both operational and
financial positions.
Business Outlook and Risk Factors
Although the trends reflected by the operating results of the Company
in the nine months ended October 31, 1997 indicate that total revenue has
decreased, the Company continues to believe that while total revenue may
decrease in the near future, software and services revenue should contribute a
larger share of overall revenue, which should result in an increase in gross
profit margins and net margins. The Company continues to invest heavily in
research and development of new and enhanced software products in order to reach
a larger segment of its targeted market. During the nine months ended October
31, 1997 the Company announced new software products that are platform
independent and contain added and improved functionality. The general
availability for two of the three announced software products occurred during
the three months ended October 31, 1997. The transition to hardware platform
independence is designed to lead to a broader market for the Company's products.
The Company's total revenue and product mix could be materially and adversely
affected by many factors, some of which are beyond the control of the Company.
Those factors include the Company's ability to maintain the software design and
development capabilities necessary to design and produce innovative and
desirable products on a timely and cost-effective basis; the Company's ability
to penetrate new markets and attract new customers; the budgeting and purchasing
practices or constraints of its customers; the length of the Company's sales
cycles; the complicated nature of the Company's product installations; and
unanticipated postponement or cancellation of significant orders. There also can
be no assurance that the Company's software products will achieve market
acceptance or that the Company will be able to develop new products and services
in a timely and cost-effective manner. The failure of the Company to
successfully develop and market its own software products and to overcome the
loss of revenue from the sale of hardware and software products developed by
others could have a material adverse effect on the Company.
As a result of the factors discussed in "Liquidity and Capital
Resources" above, the Company has not yet generated sufficient revenue from its
software products to fund its ongoing operations. The Company currently is
seeking additional sources of financing, which may include one or more private
placements of debt or equity securities. There can be no assurance that such
financing will be available.
During July 1997, the Company's reseller agreement with IBM expired and
the Company entered into an agreement with Information Systems of North
Carolina, Inc. ("ISI") with respect to future sales of specified IBM AS/400 and
related products and services to certain of the Company's customers. Under this
agreement, the Company has ceased selling, and ISI has begun selling, the
specified AS/400-related products and services to the designated customers. The
agreement provides that ISI will pay to the Company 50% of its operating profits
(as defined) from sales of the specified products to the designated customers
during the four-year term of the agreement. The Company has the right to
terminate the agreement and resume direct sales of the specified AS/400-related
products and services to the designated customers in the event that ISI's
payments to the Company are less than $50,000 in each of two consecutive
quarterly periods. In addition, ISI has the right to terminate the agreement
upon written notice to the Company, provided that ISI ceases selling the
specified AS/400-related products and services to the designated customers for a
period
-15-
<PAGE>
of two years after such termination. As of the date of this Report, this
arrangement has not provided the Company with any meaningful revenue, and there
can be no assurance that the Company will derive significant revenue from this
arrangement in the future.
The Company operates in an industry that is characterized by
fast-changing technology. As a result, the Company will be required to expend
substantial funds for continuing product development, including expenses
associated with research and development activities and additional engineering
and other technical personnel. There can be no assurance that such funds will be
available to the Company given its current financial condition and results of
operations. Any failure by the Company to anticipate or respond adequately to
technological developments, customer requirements, or new design and production
techniques, or any significant delays in product development or introduction,
could have a material adverse effect on the operating results of the Company.
The Company continues to invest in sales and marketing in order to
enhance its image and brand awareness. The Company has continued to add new
marketing and sales personnel during the last nine months, and has invested in
updating its industry trade-show presence and image. Although the Company
believes that its increased sales and marketing efforts will contribute to an
increased number of customers and increased revenue associated with the sales of
software products, certain risk factors exist that could have a material adverse
effect on the Company's operating results. Those risk factors include lack of
assurance that its products will achieve or maintain market acceptance; the
complexity of the Company's software programs, which may cause delays in product
development and could result in loss of market acceptance, loss of sales, and
reduction of market share; and the fact that the Company's software products
compete with those of many major domestic and international companies, many of
which have greater market recognition and substantially greater financial,
technical, and marketing resources than the Company possesses.
The Company has hired a new Vice President - Marketing and Chief
Operating Officer who has considerable experience in the sale of software
products to retail enterprises and in the management of software development
companies. The Company believes that this individual's expertise in the
development of retail software applications, his contacts in the retail
industry, and his expertise in the management of software development companies
will enhance the Company's ability to generate significant sales of its
proprietary software products.
The Company plans to continue to increase the utilization of
professional services personnel. An increase in utilization of professional
services personnel can have a direct impact on revenue without any additional
associated costs. Risk factors that could, however, materially affect the
ability of the Company to increase utilization rates and professional services
revenue include factors such as fluctuating demand for professional services and
lack of assurance that there will continue to be a demand for the Company's
services. The Company may not be able to react to a significant decrease in
demand for its services during any given quarter, which could result in
continued expenses for professional personnel without offsetting revenue.
Although the Company has focused on controlling administrative costs,
it recognizes the added costs associated with attracting and retaining key
personnel. Because it operates in an industry that is characterized by a high
cost of recruiting and a current lack of qualified personnel, the Company
constantly evaluates employee benefits and the work environment that it provides
for its employees. The high cost associated with industry hiring practices could
have a material adverse effect on the Company's quarterly operating results. The
Company intends to continue to moderate general and administrative costs so that
revenue growth will continue to exceed operating expenses. There can be no
assurance, however, that the Company will be able to predict or respond to a
shortfall in sales during any given quarter in order to reduce its fixed general
and administrative expenses on a timely basis.
-16-
<PAGE>
The Company believes that the industry in which it markets its products
and services has a strong outlook, with expanding markets characterized by a
highly fragmented group of competitors. As competition for consumer products
rises, retailers that represent a significant portion of the Company's current
and potential customers increasingly are aware of the need for business
information systems that allow them to focus on efficiently managing inventory
and of finding new ways to bring customers into their stores. The Company
strives to provide market-leading solutions that address those real-world
problems. Due to the risk factors discussed above and in the Company's Report on
Form 10-KSB, Item 1, "Special Considerations," as well as other factors that
generally affect high technology companies, there can be no assurance that the
Company will be able to successfully penetrate these markets in the future.
-17-
<PAGE>
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Reference is made to the disclosure included under this Item
in the Company's Quarterly Report on Form 10-QSB for the
quarter ended July 31, 1997.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Securities
Not Applicable
Item 4. Submissions of Matter to a Vote of Security Holders
Not Applicable
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11. Computation of Net Income Per Share
27. Financial Data Schedule
(b) Reports on Form 8-K
Not applicable
-18-
<PAGE>
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.
Signature:
- ----------
GATEWAY DATA SCIENCES CORPORATION
/s/ Michael M. Gordon Chairman of the Board, December 22, 1997
- ---------------------------- President, and Chief
Michael M. Gordon Executive Officer
(Principal Executive
Officer)
/s/ Vickie B. Jarvis Vice President, Finance and December 22, 1997
- ---------------------------- Chief Financial Officer
Vickie B. Jarvis (Principal Financial and
Accounting Officer)
-19-
EXHIBIT 11
SCHEDULE OF COMPUTATION OF NET INCOME PER SHARE
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
Three Months Ended October 31, Nine Months Ended October 31,
1996 1997 1996 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income for primary income
per common share $ 723 $ (6,763) $ 1,544 $ (7,465)
=========== =========== ========== ===========
Weighted average number of
common shares outstanding
during the year 2,804,721 2,838,138 2,595,401 2,825,753
Add common equivalent shares
(determined using the treasury
stock method) representing
shares issuable upon exercise
of incentive stock options and
warrants 15,055 -- 15,055 295,641
----------- ----------- ---------- -----------
Weighted average number of
shares used in calculation of
primary earnings per share 2,819,776 2,838,138 2,610,456 3,177,253
=========== =========== ========== ===========
Primary earnings per share .26 (2.38) .57 (2.58)
=========== =========== ========== ===========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This Exhibit contains summary financial
information extracted from the Registrant's
unaudited consolidated financial statements for
the period ended October 31, 1997 and is qualified
in its entirety by reference to such financial
statements. This Exhibit shall not be deemed filed
for purposes of Section 11 of the Securities Act
of 1933 and Section 18 of the Securities Exchange
Act of 1934, or otherwise subject to the liability
of such Sections, nor shall it be deemed a part of
any other filing which incorporates this report by
reference, unless such other filing expressly
incorporates this Exhibit by reference.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-START> FEB-01-1997
<PERIOD-END> OCT-31-1997
<EXCHANGE-RATE> 1
<CASH> 2
<SECURITIES> 0
<RECEIVABLES> 1,698
<ALLOWANCES> 577
<INVENTORY> 671
<CURRENT-ASSETS> 6,119
<PP&E> 2,798
<DEPRECIATION> 1,778
<TOTAL-ASSETS> 9,316
<CURRENT-LIABILITIES> 7,642
<BONDS> 0
0
0
<COMMON> 28
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 9,316
<SALES> 12,749
<TOTAL-REVENUES> 12,749
<CGS> 8,874
<TOTAL-COSTS> 19,977
<OTHER-EXPENSES> (103)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 340
<INCOME-PRETAX> (7,465)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,465)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,465)
<EPS-PRIMARY> (2.58)
<EPS-DILUTED> (2.58)
</TABLE>
