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 July 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 October 28,
1997)
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GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY
INDEX
Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of July 31, 1997
and January 31, 1997 3
Consolidated Statements of Operations for the
six months ended July 31, 1997 and 1996 4
Consolidated Statements of Cash Flows for the
six months ended July 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 8
PART II. OTHER INFORMATION 16
Signatures 18
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PART I, ITEM 1. FINANCIAL STATEMENTS
GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF JULY 31, 1997 (UNAUDITED) AND JANUARY 31, 1997
<TABLE>
<CAPTION>
July 31, January 31,
1997 1997
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 7,171 $ 936,232
Trade receivables - less allowance of $67,300 and $112,300, respectively 4,376,175 7,684,086
Inventories 2,680,448 2,420,393
Prepaid expenses and other assets 737,184 432,140
------------ ------------
Total current assets 7,800,978 11,472,851
PROPERTY AND EQUIPMENT - Net 1,839,022 1,794,894
NET INVESTMENT IN LEASE RESIDUALS 1,860,204 1,663,870
ACCOUNTS RECEIVABLE - Long Term 3,803,055 --
OTHER ASSETS 836,770 666,884
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$ 16,140,029 $ 15,598,498
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,427,430 1,452,775
Accrued liabilities 450,187 2,889,574
Accrued payroll and benefits 520,612 346,319
Line of Credit 2,807,654 --
Current portion of notes payable 175,608 161,438
Current portion of capital lease obligations 41,846 74,375
Deferred revenue 1,111,187 1,058,759
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Total current liabilities 7,534,524 5,204,674
DEFERRED REVENUE, recognized after one year 1,483,244 1,785,266
NOTES PAYABLE, less current portion 189,105 280,600
CAPITAL LEASE OBLIGATIONS, less current portion 49,565 56,445
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Total liabilities 9,256,438 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, $.01 par value, 20,000,000 shares authorized,
2,838,138 shares issued and outstanding at July 31, 1997 and
2,813,312 shares issued and outstanding at January 31, 1997 28,381 28,133
Additional paid-in capital 9,309,016 9,203,940
Deferred Compensation (13,022) --
Accumulated deficit (2,440,784) (1,739,128)
------------ ------------
Total shareholders' equity 6,883,591 7,492,946
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$ 16,140,029 $ 15,598,498
============ ============
</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 SIX MONTHS ENDED JULY 31, 1997 AND 1996
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
(Unaudited) (Unaudited)
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUE
Product $ 4,402,253 $ 6,251,184 $ 7,136,755 $ 7,219,932
Software license 695,689 1,011,141 1,712,420 2,263,441
Maintenance and support services 203,025 143,764 372,381 231,397
Professional services 854,958 555,070 1,604,424 1,041,487
------------ ------------ ------------ ------------
Total revenue 6,155,925 7,961,159 10,825,980 10,756,257
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Products sold 2,680,039 4,597,809 4,808,825 5,155,291
Software development 1,202,802 1,043,489 2,300,286 1,798,470
Maintenance and support services 149,489 162,924 279,845 294,968
Professional services 514,951 555,394 971,597 912,317
Sales and marketing 798,524 529,574 1,657,003 872,123
General and administrative 594,569 472,920 1,244,030 817,520
Restructuring charges 107,582 -- 107,582 --
------------ ------------ ------------ ------------
Total expenses 6,047,956 7,362,110 11,369,168 9,850,689
------------ ------------ ------------ ------------
INCOME FROM OPERATIONS 107,969 599,049 (543,188) 905,568
OTHER (INCOME) EXPENSE:
Interest expense 131,158 36,052 230,163 87,036
Other, net (66,284) (2,089) (71,694) (2,184)
------------ ------------ ------------ ------------
Total other expense, net 64,334 33,963 158,469 84,852
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 43,635 565,086 (701,657) 820,716
PROVISION FOR INCOME TAXES -- -- -- --
------------ ------------ ------------ ------------
NET INCOME $ 43,635 $ 565,086 $ (701,567) $ 820,716
============ ============ ============ ============
NET INCOME PER COMMON AND
COMMON EQUIVALENT
SHARE (Note 2) $ .02 $ .19 $ (.20) $ .31
============ ============ ============ ============
COMMON AND COMMON
EQUIVALENT SHARES
OUTSTANDING (Note 2) 2,831,665 2,920,574 3,177,253 2,571,292
============ ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
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GATEWAY DATA SCIENCES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED JULY 31, 1997 AND 1996
<TABLE>
<CAPTION>
Six Months Ended
July 31,
---------------------------
1997 1996
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(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................................................. $ (701,656) $ 820,716
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization ........................................... 421,964 266,017
Amortization of deferred compensation ................................... 6,511 7,800
Effect of changes in assets and liabilities:
Trade receivables ....................................................... (495,144) (3,429,125)
Inventories ............................................................. (260,055) (1,078,645)
Prepaid expenses and other assets ....................................... (474,931) 140,726
Accounts payable ........................................................ 974,655 533,646
Accrued liabilities ..................................................... (2,439,389) (786,993)
Accrued payroll and benefits ............................................ 174,293 209,627
Deferred revenue ........................................................ (249,595) 79,377
----------- -----------
Net cash used in operating activities ........................ (3,043,347) (3,236,854)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment .......................................... (466,091) (802,424)
Net investment in lease residuals ........................................... (196,334) 138,424
----------- -----------
Net cash (used in) provided by investing activities ......... (662,425) (664,000)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from initial public offering ................................... -- 6,531,809
Principal payments on notes payable ......................................... (77,325) (875,350)
Principal payments on capital lease obligations ............................. (39,409) (28,543)
Additional borrowings on capital lease obligations .......................... -- 66,344
Borrowings on line of credit ................................................ 2,807,654 984,011
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 .................... 2,776,711 6,193,156
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NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ........................... (929,061) 2,292,302
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................................. 936,232 93,402
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD ....................................... $ 7,171 $ 2,385,704
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest .................................... $ 230,163 $ 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
JULY 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 six-month periods ended July 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 July 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 $408,000. The amounts due represent a receivable of approximately
$608,000 for management and consulting services provided by Company personnel
during the year, partially offset by a loan from the related entity to the
Company of approximately $200,000. 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 obligations under its line of credit. The guaranty
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 $2.8 million as of July 31,
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.
The Company historically 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 51% and 46% for the six months ended July 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 and will continue its current sales efforts dedicated
to this product and related services. 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
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<PAGE>
any changes made by IBM to the AS/400's operating system software. A significant
shift 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. 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 July 31, 1997
and 1996
Revenue. Total revenue decreased by 23% from approximately $8.0 million
in the three months ended July 31, 1996 to approximately $6.1 million in the
three months ended July 31, 1997. Product revenue decreased by 30% from
approximately $6.3 million to approximately $4.4 million during the same
periods. As a percentage of total revenue, product revenue decreased from 79%
during the three months ended July 31, 1996 to 72% during the three months ended
July 31, 1997. Software license revenue decreased by 31% from approximately $1.0
million in the three months ended July 31, 1996 to approximately $696,000 in the
three months ended July 31, 1997. As a percentage of total revenue, software
license revenue decreased from 13% to 11% during the same periods. Maintenance
and support revenue increased approximately 41% from approximately $144,000 in
the three months ended July 31, 1996 to approximately $203,000 in the three
months ended July 31, 1997. As a percentage of total revenue, maintenance
revenue increased from 2% in the three months ended July 31, 1996 to
approximately 3% in the three months ended July 31, 1997. Professional services
revenue increased 54% from approximately $555,000 to approximately $855,000
during the three months ended July 31, 1996 and 1997, respectively. As a
percentage of total revenue, professional services revenue increased from 7% to
14% during the three months ended July 31, 1996 and 1997, respectively.
The overall decrease in total revenue is attributed to decreases in
third-party products and software revenue, partially offset by increases in
maintenance and support services revenue and professional services revenue. The
decrease in third party product revenue is due (i) to the expiration of the
Company's reseller agreement in July 1997 and (ii) shipments from IBM of the
then new RISC AS/400 processors that were delayed during the three months ended
April 30, 1996 and subsequently shipped during the three months ended July 31,
1996. The Company continues to
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<PAGE>
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 new software sales and support contracts. 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 42% from
approximately $4.6 million during the three months ended July 31, 1996 to
approximately $2.7 million during the three months ended July 31, 1997. This
decrease is attributed to the corresponding decrease in sales of third-party
products during the same period. As a percentage of product revenue, cost of
products sold was approximately 74% and 61% during the three months ended July
31, 1996 and 1997, respectively.
Software Development Expense. Software development expense increased
from approximately $1.0 million to approximately $1.2 million during the three
months ended July 31, 1996 and 1997, respectively. The 15% 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 13% in the three months
ended July 31, 1996 to 20% in the three months ended July 31, 1997.
Maintenance and Support Services Expense. Maintenance and support
services expense decreased by 8% from approximately $163,000 in the three months
ended July 31, 1996, to approximately $150,000 in the three months ended July
31, 1997. As a percentage of total revenue, maintenance and support services
remained even at 2% of total revenue.
Professional Services Expense. Professional services expense decreased
by 7% from approximately $555,000 to approximately $515,000 during the three
months ended July 31, 1996 and 1997, respectively. A reduction in personnel
contributed to this decrease. As a percentage of professional services revenue,
professional services expense decreased from 100% in the three months ended July
31, 1996 to 60% in the three months ended July 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 51%
from approximately $530,000 to approximately $595,000 in the three months ended
July 31, 1996 and 1997, respectively. The increase can be attributed to 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 $473,000 in the three months ended July 31, 1996 to
approximately $595,000 in the three months ended July 31, 1997. This 26%
increase is attributed to additional personnel and associated costs, additional
insurance costs, and increased building rent costs.
Restructuring Charge. During the three months ended July 31, 1997, the
Company took a restructuring charge of approximately $108,000. This charge was
for the costs associated with an overall decrease of approximately 27% of
personnel during August 1997. This reduction of personnel was primarily due to
the expiration of the reseller agreement with IBM.
Other Income (Expense). Interest expense was approximately $36,000
during the three months ended July 31, 1996, as compared with approximately
$131,000 during the three months ended July 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 $443,400 and
approximately $2.8 million during the three months ended July 31, 1996 and 1997
respectively.
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Net Income. Net income decreased 92% from approximately $565,000, or
$.19 per share, in the three months ended July 31, 1996 to approximately
$44,000, or $.02 per share, in the three months ended July 31, 1997.
Results of Operations of the Company for the Six Months Ended July 31, 1997 and
1996
Revenue. Total revenue remained constant at approximately $10.8 million
in the six months ended July 31, 1996 and July 31, 1997. Product revenue
decreased by 1% from approximately $7.2 million to approximately $7.1 million
during the same periods. As a percentage of total revenue, product revenue
decreased from 67% during the six months ended July 31, 1996 to 66% during the
six months ended July 31, 1997. Software license revenue decreased by 24% from
approximately $2.3 million in the six months ended July 31, 1996 to
approximately $1.7 million in the six months ended July 31, 1997. As a
percentage of total revenue, software license revenue decreased from 21% to 16%
during the same periods. Maintenance and support services revenue increased
approximately 61% from approximately $231,000 in the six months ended July 31,
1996 to approximately $372,000 in the six months ended July 31, 1997. As a
percentage of total revenue, maintenance revenue increased from 2% in the six
months ended July 31, 1996 to approximately 3% in the six months ended July 31,
1997. Professional services revenue increased 54% from approximately $1.0
million to approximately $1.6 million during the six months ended July 31, 1996
and 1997, respectively. As a percentage of total revenue, professional services
revenue increased from 10% to 15% during the six months ended July 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 new software sales and
support contracts. 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 7% from
approximately $5.1 million during the six months ended July 31, 1996 to
approximately $4.8 million during the six months ended July 31, 1997. As a
percentage of product revenue, cost of products sold was approximately 71% and
67% during the six months ended July 31, 1996 and 1997, respectively.
Software Development Expense. Software development expense increased
from approximately $1.8 million to approximately $2.3 million during the six
months ended July 31, 1996 and 1997, respectively. The 28% 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 17% in the six months
ended July 31, 1996 to 21% in the six months ended July 31, 1997.
Maintenance and Support Services Expense. Maintenance and support
services expense decreased by 5% from approximately $295,000 in the six months
ended July 31, 1996, to approximately $280,000 in the six months ended July 31,
1997. As a percentage of total revenue, maintenance and support services
remained even at 3% of total revenue.
Professional Services Expense. Professional services expense increased
by 6% from approximately $912,000 to approximately $972,000 during the six
months ended July 31, 1996 and 1997, respectively. As a percentage of
professional services revenue, professional services expense decreased from 88%
in the six months ended July 31, 1996 to 61% in the six months ended July 31,
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1997. This decrease as a percentage is attributed to better utilization of
professional services personnel.
Sales and Marketing Expense. Sales and marketing expense increased 90%
from approximately $872,000 to approximately $1.7 million in the six months
ended July 31, 1996 and 1997, respectively. The increase can be attributed to
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 $817,000 in the six months ended July 31, 1996 to
approximately $1.2 million in the six months ended July 31, 1997. This 52%
increase is attributed to additional personnel and associated costs, additional
insurance costs, and increased building rent costs.
Restructuring Charge. During the three months ended July 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. This reduction of personnel was primarily due to the
expiration of the reseller agreement with IBM.
Other Income (Expense). Interest expense was approximately $87,000
during the six months ended July 31, 1996, as compared with approximately
$230,000 during the six months ended July 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 $402,100 and
approximately $2.8 million during the six months ended July 31, 1996 and 1997,
respectively.
Net Income. Net income decreased 185% from approximately $820,000, or
$.31 per share, in the six months ended July 31, 1996 to a deficit of
approximately $(702,000) or $(.20) per share, in the six months ended July 31,
1997.
Liquidity and Capital Resources
The Company's working capital position decreased from approximately
$2.6 million at January 31, 1997 to approximately $266,000 at July 31, 1997.
The Company used net cash of approximately $3.0 million for operations
during the six months ended July 31, 1997, primarily as a result of the decrease
in accrued liabilities and an increase in accounts receivable, inventories and
prepaid expenses, partially offset by an increase in accounts payable.
Capital expenditures for the six months ended July 31, 1997 totaled
approximately $466,000 for the purchase of computer hardware and software
products needed for the continued efficient development of the Company's
proprietary software products.
Financing activities provided net cash of approximately $2.8 million in
the six months ended July 31, 1997. This cash was provided 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 July 31, 1997, and October 27, 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 $2.8 million at July 31, 1997 and
-12-
<PAGE>
approximately $1.1 million at October 27, 1997. In addition, in October 1997
Norwest exercised its right to not provide any 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. 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 six months ended July 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, 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 $700,000 (unaudited) for the six months ended July 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 have been prepared on a going concern basis and 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 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 internal 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 six months ended July 31, 1997 indicate that revenue has remain
essentially unchanged, the Company continues to believe that although total
revenue may decrease in the near future, software and services revenue should
contribute to 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 six months
ended July 31, 1997 the Company announced new software products that are
platform independent and contain added and improved functionality. 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
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<PAGE>
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 softwareproducts 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 is in default under certain covenants in its line
of credit agreement, and the lender has exercised its right to not provide any
further advances under the line of credit. In addition, 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 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 six 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.
-14-
<PAGE>
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.
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.
-15-
<PAGE>
PART II OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in a material dispute with a customer.
The dispute involves a receivable of $3,803,055 at July 31, 1997 and at
October 27, 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.
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
-16-
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.17 Second Amendment to Credit and Security
Agreement, dated as of June 10, 1997,
between Gateway Data Sciences Corporation,
Gateway Credit Corporation, and Norwest
Business Credit, Inc.
10.18 Third Amendment to Credit and Security
Agreement, dated as of August 8, 1997,
between Gateway Data Sciences Corporation,
Gateway Credit Corporation, and Norwest
Business Credit, Inc.
11. Computation of Net Income Per Share
27. Financial Data Schedule
(b) Reports on Form 8-K
Not applicable
-17-
<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, October 29, 1997
- ------------------------- President, and Chief
Michael M. Gordon Executive Officer
(Principal Executive
Officer)
/s/ Vickie B. Jarvis Vice President, Finance and October 29, 1997
- ------------------------- Chief Financial Officer
Vickie B. Jarvis (Principal Financial and
Accounting Officer)
-18-
SECOND AMENDMENT TO CREDIT AND SECURITY AGREEMENT
This Second Amendment to Credit and Security Agreement (the
"Second Amendment") is made as of the 10th day of June 1997 by and between
GATEWAY DATA SCIENCES CORPORATION, an Arizona corporation, and GATEWAY CREDIT
CORPORATION, an Arizona corporation (jointly, the "Borrower"), and NORWEST
BUSINESS CREDIT, INC., a Minnesota corporation (the "Lender").
Recitals
The Borrower and the Lender have entered into the Credit and
Security Agreement dated as of February 21, 1997 (the "Credit Agreement"), which
was amended by the First Amendment To Credit and Security Agreement dated as of
April 23, 1997 (the "First Amendment").
The Lender has agreed to make certain loan advances to the
Borrower and to issue or cause to be issued certain letters of credit for the
account of the Borrower pursuant to the terms and conditions set forth in the
Credit Agreement as previously amended.
The loan advances under the Credit Agreement are evidenced by
the Borrower's Revolving Note dated as of February 21, 1997, in the maximum
principal amount of $3,000,000.00 and payable to the order of the Lender (the
"Note"). (Pursuant to the First Amendment, the Revolving Note was replaced,
renewed and amended, but not repaid, by the Temporary Replacement Note. As of
May 1, 1997, the definition of "Note" and all references thereto in the Credit
Agreement were deemed amended to describe the Revolving Note dated as of
February 21, 1997, which Revolving Note replaced, renewed and amended, but did
not repay, the Temporary Replacement Note referred to in the First Amendment.)
All indebtedness of the Borrower to the Lender is secured
pursuant to the terms of the Credit Agreement and all other Security Documents
as defined therein (collectively, the "Security Documents").
The Borrower has requested that certain amendments be made to
the Credit Agreement, which the Lender is willing to make pursuant to the terms
and conditions set forth herein.
NOW, THEREFORE, in consideration of the premises and of the
mutual covenants and agreements herein contained, it is agreed as follows:
1. Terms used in this Second Amendment which are defined in
the Credit Agreement, as previously amended, shall have the same meanings as
defined therein, unless
<PAGE>
otherwise defined herein.
2. The Credit Agreement as previously amended is hereby
amended as follows:
(a) In section 1.1 of the Credit Agreement, the
definition of "Floating Rate" is hereby deleted in its entirety and replaced
with the following definition:
"'Floating Rate' means an annual rate equal to the sum of the
Base Rate plus two percent (2%), which Floating Rate shall
change when and as the Base Rate changes."
(b) In section 1.1 of the Credit Agreement, the
following definition is added:
"'Net Loss' has the meaning specified in Section 6.14
hereof.'"
(c) Under section 6.1(a) of the Credit Agreement, the
Borrower failed to deliver to the Lender, within ninety (90) days after the end
of the Borrower's fiscal year ending January 31, 1997, audited financial
statements of the Borrower with the unqualified opinion of independent certified
public accountants, the report signed by such accountants concerning their
investigations and knowledge of any Default or Event of Default and the
certificate of the chief financial officer of the Borrower concerning the
preparation of said financial statements and such officer's knowledge of any
Default or Event of Default, together with the other materials specified in said
section of the Credit Agreement. The Lender hereby waives said default and
extends the deadline for delivery of such materials to July 31, 1997.
(d) Under the Net Income Covenant of section 6.12 of
the Credit Agreement, the Borrower failed to achieve the minimum Net Income
requirement of $500,000 for the fiscal quarter ending April 30, 1997, and
therefore is in default. The Lender hereby waives said default.
(e) Section 6.12 ("Net Income Covenant") of the
Credit Agreement is hereby deleted in its entirety and replaced with the
following:
"Section 6.12 Net Income Covenant. 'Net Income' means after
tax net income of the Borrower from continuing operations
determined on a consolidating and consolidated basis in
accordance with generally accepted accounting principles
consistent with those used in preparing Borrower's most
recent consolidating and consolidated audited financial
statement. So long as this Agreement remains in effect,
Borrower will, as of the last day of each fiscal quarter
beginning with the quarter ending July 31, 1997, achieve a
minimum Net Income as follows:
$ 0 for the fiscal quarter ending July 31, 1997;
$550,000 for each fiscal quarter ending October 31;
2
<PAGE>
$600,000 for each fiscal quarter ending January 31;
$500,000 for each fiscal quarter ending April 30; and
$550,000 for each fiscal quarter ending July 31."
(f) Under the Net Worth Covenant of section 6.13 of
the Credit Agreement, the Borrower failed to maintain a minimum book Net Worth
of Seven Million Two Hundred Thousand Dollars ($7,200,000) as of the last day of
the following calendar months: February, March, April and May of 1997; and
failed to increase its minimum book Net Worth for the fiscal quarter ending
April 30, 1997 by $500,000 over the previous fiscal quarter's minimum book Net
Worth; and therefore is in default. The Lender hereby waives said defaults.
(g) Section 6.13 ("Net Worth Covenant") of the Credit
Agreement is hereby deleted in its entirety and replaced with the following:
"Section 6.13 Net Worth Covenant. 'Net Worth' means the net
worth of the Borrower determined on a consolidating and
consolidated basis, determined in accordance with generally
accepted accounting principles consistent with those used in
preparing Borrower's most recent consolidating and
consolidated audited financial statement. So long as this
Agreement remains in effect, the Borrower's minimum book Net
Worth shall be increased as of the end of each fiscal quarter
over the previous fiscal quarter's minimum book Net Worth, as
follows:
Increase of $0 for the fiscal quarter ending July 31,
1997;
Increase of $550,000 for each fiscal quarter ending
October 31;
Increaseof $600,000 for each fiscal quarter ending
January 31;
Increase of $500,000 for each fiscal quarter ending
April 30; and
Increase of $550,000 for each fiscal quarter ending
July 31."
(h) A new section 6.14 "Net Loss Covenant" is hereby
added as follows:
"Section 6.14 Net Loss Covenant. 'Net Loss' means an after
tax net loss of the Borrower from continuing operations
determined on a consolidating and consolidated basis, to be
determined in accordance with generally accepted accounting
principles consistent with those used in preparing Borrower's
most recent consolidating and consolidated audited financial
statement. For the calendar month of May 1997 and thereafter,
Borrower will not incur in any calendar month a Net Loss
greater than Eight Hundred Fifty Thousand Dollars ($850,000),
and Borrower will not incur in any two consecutive calendar
months a combined Net Loss greater than One Million Two
Hundred Thousand Dollars ($1,200,000)."
(i) Under the Salaries Covenant of section 7.17 of
the Credit Agreement, the Borrower has during the first quarter of the fiscal
year beginning February 1, 1997 increased the salaries of officers Michael M.
Gordon (President), Matthew J. Gordon
3
<PAGE>
(Secretary) and Vickie B. Jarvis (Vice President Finance and Treasurer) by more
than twenty per cent (20%) in the aggregate, and the Borrower therefore is in
default. The Lender hereby waives said default.
3. Except as explicitly amended by this Second Amendment, all
of the terms and conditions of the Credit Agreement as previously amended shall
remain in full force and effect and shall apply to any advance or letter of
credit thereunder.
4. The Borrower agrees to pay the Lender a fully earned,
non-refundable fee in the amount of $5,000.00 in consideration of the execution
by the Lender of this Second Amendment. Said amount shall be advanced to
Borrower's account under this Credit Facility with Lender on July 1, 1997.
5. This Second Amendment shall be effective upon receipt by
the Lender of an executed original hereof, together with each of the following,
each in substance and form acceptable to the Lender in its sole discretion:
(a) Certificate of the Secretary of each Borrower
certifying as to (i) the resolutions of the board of directors of the Borrower
approving the execution and delivery of this Second Amendment, (ii) the fact
that the Articles of Incorporation and Bylaws of the Borrower, which were
certified and delivered to the Lender pursuant to the Certificate of the
Borrower's Secretary dated as of February 28, 1997 as to Gateway Data Sciences
Corporation and as of February 18, 1997 as to Gateway Credit Corporation, in
connection with the execution and delivery of the Credit Agreement, continue in
full force and effect and have not been amended or otherwise modified except as
set forth in the Certificate to be delivered, and (iii) certifying that the
officers and agents of the Borrower who have been certified to the Lender,
pursuant to the Incumbency Certificate of the Borrower's Secretary dated as of
February 18, 1997, as being authorized to sign and to act on behalf of the
Borrower continue to be so authorized or setting forth the sample signatures of
each of the officers and agents of the Borrower authorized to execute and
deliver this Second Amendment and all other documents, agreements and
certificates on behalf of the Borrower; and
(b) Opinion of the Borrower's counsel as to the
matters set forth in paragraphs 6(a) and (b) hereof and as to such other matters
as the Lender shall require.
6. The Borrower hereby represents and warrants to the Lender
as follows:
(a) The Borrower has all requisite power and
authority to execute this Second Amendment and to perform all of its obligations
hereunder, and this Second Amendment has been duly executed and delivered by the
Borrower and constitutes the legal, valid and binding obligation of the
Borrower, enforceable in accordance with its terms.
(b) The execution, delivery and performance by the
Borrower of this Second Amendment has been duly authorized by all necessary
corporate action and does not (i) require any authorization, consent or approval
by any governmental department, commission, board, bureau, agency or
instrumentality, domestic or foreign, (ii) violate any provision of any
4
<PAGE>
law, rule or regulation or of any order, writ, injunction or decree presently in
effect, having applicability to the Borrower, or the articles of incorporation
or by-laws of the Borrower, or (iii) result in a breach of or constitute a
default under any indenture or loan or credit agreement or any other agreement,
lease or instrument to which the Borrower is a party or by which it or its
properties may be bound or affected.
(c) All of the representations and warranties
contained in Article V of the Credit Agreement are correct on and as of the date
hereof as though made on and as of such date, except to the extent that such
representations and warranties relate solely to an earlier date.
7. All references in the Credit Agreement to "this Agreement"
shall be deemed to refer to the Credit Agreement as previously amended and as
amended hereby; and any and all references in the Security Documents to the
Credit Agreement shall be deemed to refer to the Credit Agreement as previously
amended and as amended hereby.
8. The execution of this Second Amendment and any documents
related hereto shall not be deemed to be a waiver of any Default or Event of
Default under the Credit Agreement as previously amended or breach, default or
event of default under any Security Document or other document held by the
Lender, whether or not known to the Lender and whether or not existing on the
date of this Second Amendment, except as expressly set forth herein.
9. The Borrower hereby absolutely and unconditionally
releases and forever discharges the Lender, and any and all participants, parent
corporations, subsidiary corporations, affiliated corporations, insurers,
indemnitors, successors and assigns thereof, together with all of the present
and former directors, officers, agents and employees of any of the foregoing,
from any and all claims, demands or causes of action of any kind, nature or
description, whether arising in law or equity or upon contract or tort or under
any state or federal law or otherwise, which the Borrower has had, now has or
has made claim to have against any such person for or by reason of any act,
omission, matter, cause or thing whatsoever arising from the beginning of time
to and including the date of this Second Amendment, whether such claims, demands
and causes of action are matured or unmatured or known or unknown.
10. The Borrower hereby reaffirms its agreement under the
Credit Agreement to pay or reimburse the Lender on demand for all costs and
expenses incurred by the Lender in connection with the Credit Agreement, the
Security Documents and all other documents contemplated thereby, including
without limitation all reasonable fees and disbursements of legal counsel.
Without limiting the generality of the foregoing, the Borrower specifically
agrees to pay all fees and disbursements of counsel to the Lender for the
services performed by such counsel in connection with the preparation of this
Second Amendment and the documents and instruments incidental hereto. The
Borrower hereby agrees that the Lender may, at any time or from time to time in
its sole discretion and without further authorization by the Borrower, make a
loan to the Borrower under the Credit Agreement, or apply the proceeds of any
loan, for the purpose of paying any such fees, disbursements, costs and expenses
and the fee required under section 4 hereof.
5
<PAGE>
11. This Second Amendment may be executed in any number of
counterparts, each of which when so executed and delivered shall be deemed an
original and all of which counterparts, taken together, shall constitute one and
the same instrument.
12. Regarding "Eligible Inventory", Borrower acknowledges and
agrees that its inventory is currently ineligible because Lender has not
received a landlord's subordination, disclaimer and consent with respect to each
lease of the Premises, a condition precedent in section 4.1(c) of the Credit
Agreement.
13. Any breach by Borrower of the terms and conditions in this
Second Amendment shall be an Event of Default under section 8.1 of the Credit
Agreement. Upon the occurrence of an Event of Default or at any time thereafter,
the Lender may exercise any or all of the rights and remedies specified in
section 8.2 of the Credit Agreement.
IN WITNESS WHEREOF, the parties hereto have caused this Second
Amendment to be duly executed as of the day and year first above written.
GATEWAY DATA SCIENCES
CORPORATION, an Arizona corporation
By /s/ Michael Gordon
--------------------------------
Printed Name: Michael Gordon
---------------------
Its President
-------------------------------
GATEWAY CREDIT CORPORATION,
an Arizona corporation
By /s/ Michael Gordon
--------------------------------
Printed Name: Michael Gordon
---------------------
Its President
-------------------------------
NORWEST BUSINESS CREDIT, INC.,
a Minnesota corporation
By /s/ Darcy Della Flora
--------------------------------
Printed Name: Darcy Della Flora
---------------------
Its Vice President
-------------------------------
6
THIRD AMENDMENT TO CREDIT AND SECURITY AGREEMENT
THIS THIRD AMENDMENT TO CREDIT AND SECURITY AGREEMENT (the
"Amendment"), dated as of August __________, 1997, is made by and between
GATEWAY DATA SCIENCES CORPORATION, an Arizona corporation and GATEWAY CREDIT
CORPORATION, an Arizona corporation ("collectively, the Borrower"), and NORWEST
BUSINESS CREDIT, INC., a Minnesota corporation (the "Lender").
RECITALS
The Borrower and the Lender have entered into a Credit and
Security Agreement dated as of February 21, 1997, as amended by a First
Amendment to Credit and Security Agreement dated as of April 23, 1997 and a
Second Amendment to Credit and Security Agreement dated as of June 10, 1997 and
forbearance letter agreement dated August 8, 1997(as so supplemented and
amended, the "Credit Agreement"). Capitalized terms used in these recitals have
the meanings given to them in the Credit Agreement unless otherwise specified.
Borrower has requested that Lender forbear for a period of
time from the exercise of its rights and remedies otherwise available to Lender
at law, in equity, by agreement or otherwise as a result of Borrower's defaults
under the Credit Agreement;
NOW, THEREFORE, in consideration of the premises and of the
mutual covenants and agreements herein contained, it is agreed as follows:
1. Defined Terms. Capitalized terms used in this Amendment
which are defined in the Credit Agreement shall have the same meanings as
defined therein, unless otherwise defined herein.
1. Recitals. The recitals set forth above are true and
accurate in every respect.
2. No Offsets. Borrower and Guarantor acknowledge with respect
to the amounts owing to Lender that neither Borrower nor Guarantor has any
offset, defense or counterclaim with respect thereto, no claim or defense in the
abatement or reduction thereof, nor any other claim against Lender or with
respect to any document forming part of the transaction in respect of which the
Note was made or forming part of any other transaction under which Borrower and
Guarantor are indebted to Lender. Borrower and Guarantor acknowledge that all
interest imposed under the Note through the date hereof, and all fees and other
charges that have been collected from or imposed upon Borrower with respect to
the Loan evidenced by the Note were and are agreed to, and were properly
computed and collected, and that Lender has fully performed all obligations that
it may have had or now has to
<PAGE>
Borrower or Guarantor, and that Lender has no obligation to make any additional
loan or extension of credit to or for the benefit of Borrower.
3. Acknowledgment of Default and Lender's Right to Accelerate.
Borrower and Guarantor acknowledge and agree that (i) a material Event of
Default exists and continues to exist under the Note and Loan Documents; (ii)
timely, adequate and proper notice of the occurrence of such Event of Default
has been received by Borrower and Guarantor; (iii) all grace periods, if any,
applicable to the cure of such Event of Default after receipt of such notice
have expired; (iv) such Event of Default is continuing without timely cure by
Borrower; (v) Lender has not waived in any respect such Event of Default or its
rights and remedies with respect thereto; (vi) on and as of the date hereof,
Lender has the right to accelerate and declare the indebtedness evidenced by the
Note to be immediately due and payable and to make demand upon Borrower and
Guarantor for the payment in full of all such indebtedness; (vii) such
acceleration and demand for payment, if made, would be in all respects adequate
and proper; and (viii) Borrower and Guarantor waive any and all further notice,
presentment, notice of dishonor or demand with respect to the indebtedness
evidenced by the Note.
4. Representations and Warranties of Borrower. To induce
Lender to enter into this Amendment and the arrangement contemplated by this
Amendment, Borrower represents and warrants to Lender as follows:
(a) The Borrower has all requisite power and
authority to execute this Amendment and to perform all of its obligations
hereunder, and this Amendment has been duly executed and delivered by the
Borrower and constitutes the legal, valid and binding obligation of the
Borrower, enforceable in accordance with its terms.
(b) The execution, delivery and performance by the
Borrower of this Amendment have been duly authorized by all necessary corporate
action and do not (i) require any authorization, consent or approval by any
governmental department, commission, board, bureau, agency or instrumentality,
domestic or foreign, (ii) violate any provision of any law, rule or regulation
or of any order, writ, injunction or decree presently in effect, having
applicability to the Borrower, or the articles of incorporation or by-laws of
the Borrower, or (iii) result in a breach of or constitute a default under any
indenture or loan or credit agreement or any other agreement, lease or
instrument to which the Borrower is a party or by which it or its properties may
be bound or affected.
(c) All of the representations and warranties
contained in Article V, Paragraph 3 of the Credit Agreement are correct on and
as of the date hereof as though made on and as of such date, except to the
extent that such representations and warranties relate solely to an earlier
date.
5. Forbearance Period. For the period (the "Forbearance
Period"), commencing on the date hereof and terminating on the Termination Date
(as hereinafter defined), Lender shall forbear from exercising its rights and
remedies under the Credit
-2-
<PAGE>
Agreement until after the Termination Date. Because the Borrowers are in
default, pursuant to Section 4.2 of the Agreement, Lender has no obligation to
make any further Advance. Any Advances during the Forbearance Period shall be in
the sole discretion of Lender. For purposes hereof, the Termination Date shall
mean the earlier of (a) a default under this Amendment or any additional Default
under the Credit Agreement, the Note or any Security Documents, which
termination shall be automatic, or (b) October 31, 1997.
6. Termination of Forbearance Period. Upon the termination of
the Forbearance Period pursuant to Section 6 above, all forbearances, deferrals
and indulgences granted by Lender shall automatically terminate, and Lender
shall thereupon have, and shall be entitled to exercise, any and all rights and
remedies which Lender may have upon the occurrence of an Event of Default, and
the indebtedness evidenced by the Credit Agreement and Note and the Note shall
become immediately due and payable, without further notice of any kind.
8. No Further Default. During the Forbearance Period, Borrower
shall comply with, and not violate the terms and provisions of, the Credit
Agreement and the Security Documents, all of which are incorporated herein by
reference, and shall fully comply with all of the terms of this Amendment. In
addition, Borrower shall not allow any other Default to occur during the
Forbearance Period. Should any additional Default occur during the Forbearance
Period, including, but not limited to, the filing of a tax lien by any
governmental authority, the Forbearance Period shall automatically terminate
without notice or demand.
9. Loan Balance. At no time during the Forbearance Period
shall the indebtedness owed to Lender exceed $3,000,000, including any and all
overadvances.
10. Reduction of Overadvance Amount. Borrower shall by August
22, 1997 reduce the overadvance to $750,000. Any and all overadvance shall be
paid in full by September 19, 1997. Furthermore, Borrower shall pay in full all
amounts due under the Credit Agreement on or before October 31, 1997.
11. Maximum Overadvance Per Week. Between August 22, 1997 and
September 19, 1997, the maximum overadvance per week shall not exceed $50,000
plus the prior week's actual total cumulative overadvance. For example, as of
August 22, 1997, the total cumulative overadvance shall not exceed $750,000. For
the next week ending August 29, 1997, the total overadvance shall not exceed
$50,000 more than the actual overadvance as of the end of the prior week, but in
no event more than $800,000. Notwithstanding anything to contrary contained
herein, the maximum overadvance prior to the payment in full of the overadvance
on September 19, 1997 shall be no more than $950,000.
-3-
<PAGE>
12. Amendment Fee. Simultaneously with the execution of this
Amendment, the Borrower shall pay the Lender a fully earned, non-refundable
forbearance fee in the amount of $_______ (the "Forbearance Fee"), which shall
not be applied to reduce the principal indebtedness of Borrower under the Loan.
13. Conditions Precedent. This Amendment shall be effective
when the Lender has received an executed original hereof, together with the
Forbearance Fee.
14. References. All references in the Credit Agreement to "the
Credit Agreement" shall be deemed to refer to the Credit Agreement as amended
hereby; and any and all references in the Security Documents and the amendments
referred to in the Recitals hereto to the Credit Agreement shall be deemed to
refer to the Credit Agreement as amended hereby.
15. No Waiver. The execution of this Amendment shall not be
deemed to be a waiver of any Default or Event of Default under the Credit
Agreement or breach, default or event of default under any Security Document or
other document held by the Lender, whether or not known to the Lender and
whether or not existing on the date of this Amendment.
16. Release. The Borrower, and each Guarantor by signing the
Acknowledgment and Agreement of Guarantors set forth below, each hereby
absolutely and unconditionally releases and forever discharges the Lender, and
any and all participants, parent corporations, subsidiary corporations,
affiliated corporations, insurers, indemnitors, successors and assigns thereof,
together with all of the present and former directors, officers, agents and
employees of any of the foregoing, from any and all claims, demands or causes of
action of any kind, nature or description, whether arising in law or equity or
upon contract or tort or under any state or federal law or otherwise, which the
Borrower or such Guarantors have had, now has or has made claim to have against
any such person for or by reason of any act, omission, matter, cause or thing
whatsoever arising from the beginning of time to and including the date of this
Amendment, whether such claims, demands and causes of action are matured or
unmatured or known or unknown.
17. Costs and Expenses. The Borrower hereby reaffirms its
agreement under the Credit Agreement to pay or reimburse the Lender on demand
for all costs and expenses incurred by the Lender in connection with the Credit
Agreement, the Security Documents and all other documents contemplated thereby,
including without limitation all reasonable fees and disbursements of legal
counsel. Without limiting the generality of the foregoing, the Borrower
specifically agrees to pay all fees and disbursements of counsel to the Lender
for the services performed by such counsel in connection with the preparation of
this Amendment and the documents and instruments incidental hereto. The Borrower
hereby agrees that the Lender may, at any time or from time to time in its sole
discretion and without further authorization by the Borrower, make a loan to the
Borrower under the Credit Agreement, or apply the proceeds of any loan, for the
purpose of paying any such fees,
-4-
<PAGE>
disbursements, costs and expenses and the Forbearance Fee required under
paragraph ___ hereof.
18. Counterparts. This Amendment and the Acknowledgment and
Agreement of Guarantors may be executed in any number of counterparts, each of
which when so executed and delivered shall be deemed an original and all of
which counterparts, taken together, shall constitute one and the same
instrument.
19. Voluntary Agreement. Borrower, and each Guarantor by
signing the Acknowledgment and Agreement of Guarantors set forth below,
represents and warrants to Lender that (i) each has had an opportunity to be
represented by legal counsel of its choice in regard to the transaction provided
for by this Amendment; (ii) each is fully aware and clearly understands all of
the terms and provisions contained in this Amendment; (iii) each has
voluntarily, with full knowledge and without coercion or duress of any kind,
entered into this Amendment and the documents executed in connection with this
Amendment; (iv) neither Borrower nor Guarantors is relying on any
representations, either written or oral, express or implied, made to it by
Lender other than as set forth in this Amendment; and (v) the consideration
received by Borrower and Guarantors to enter into this Amendment and the
arrangement contemplated by this Amendment has been actual and adequate.
20. No Other Changes. Except as explicitly amended by this
Amendment, all of the terms and conditions of the Credit Agreement shall remain
in full force and effect and shall apply to any advance or letter of credit
thereunder.
-5-
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this
Amendment to be duly executed as of the date first written above.
BORROWER:
GATEWAY DATA SCIENCES
CORPORATION, an Arizona corporation
By: /s/ Michael M. Gordon
------------------------------
Name: Michael M. Gordon
----------------------------
Title: President
---------------------------
GATEWAY CREDIT CORPORATION,
an Arizona corporation
By: /s/ Michael M. Gordon
------------------------------
Name: Michael M. Gordon
----------------------------
Title: President
---------------------------
LENDER:
NORWEST BUSINESS CREDIT, INC.,
a Minnesota corporation
By:___________________________
Name:_________________________
Title:________________________
-6-
EXHIBIT 11
SCHEDULE OF COMPUTATION OF NET INCOME PER SHARE
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
Three Months Ended July 31, Six Months Ended July 31,
1996 1997 1996 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income for primary income
per common share $ 565 $ 44 $ 821 $ (702)
--------- --------- --------- ---------
Weighted average number of
common shares outstanding
during the year 2,798,490 2,824,180 2,462,818 2,819,562
Add common equivalent shares
(determined using the treasury
stock method) representing
shares issuable upon exercise
of incentive stock options
and warrants 122,084 7,485 108,474 357,691
--------- --------- --------- ---------
Weighted average number of
shares used in calculation of
primary earnings per share 2,920,574 2,831,665 2,571,292 3,177,253
========= ========= ========= =========
Primary earnings per share .19 .02 .31 (.20)
========= ========= ========= =========
</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
July 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> 6-MOS
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-START> FEB-01-1997
<PERIOD-END> JUL-31-1997
<EXCHANGE-RATE> 1
<CASH> 7
<SECURITIES> 0
<RECEIVABLES> 4,443
<ALLOWANCES> 67
<INVENTORY> 2,680
<CURRENT-ASSETS> 7,801
<PP&E> 3,626
<DEPRECIATION> 1,787
<TOTAL-ASSETS> 16,140
<CURRENT-LIABILITIES> 7,534
<BONDS> 0
0
0
<COMMON> 28
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 16,140
<SALES> 10,826
<TOTAL-REVENUES> 10,826
<CGS> 4,809
<TOTAL-COSTS> 11,369
<OTHER-EXPENSES> (72)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 230
<INCOME-PRETAX> (702)
<INCOME-TAX> 0
<INCOME-CONTINUING> (702)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (702)
<EPS-PRIMARY> (.20)
<EPS-DILUTED> (.20)
</TABLE>
