SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
{X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For Six Months Ended September 30, 1997
Commission File Number 0-3296
ETHIKA CORPORATION
(Exact name of registrant as specified in its charter)
MISSISSIPPI 64-0440887
(State of other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
107 The Executive Center
Hilton Head Island, South Carolina 29928
(Address of Principal Executive Office)
Registrant's telephone number including area code: (803) 785-7850
NONE
Former name, former address, and former fiscal year, if changed since last
report.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
CLASS Outstanding at November 10, 1997
Common Stock, $1.00 par value 15,155,018
<PAGE>
ETHIKA CORPORATION
INDEX
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - September 30, 1997 and
December 31, 1996
Consolidated Statement of Operations and Changes in
Retained Deficit for the Three and Nine Months Ended
September 30, 1997 and 1996
Consolidated Statement of Cash Flows for the Nine
Months Ended September 30, 1997 and 1996
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
PART II. OTHER INFORMATION
None
SIGNATURES
<PAGE>
<TABLE>
<CAPTION>
Ethika Corporation and Subsidiaries
Consolidated Balance Sheet September 30, 1997 and December 31, 1996
(Unaudited)
September 30 December 31
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents ................................................ $ 852,221 $ 1,908,142
Accounts receivable, net of allowance for doubtful accounts of
$3,291and $8,258 ......................................................... 193,709 137,487
Federal income tax refund receivable ..................................... -- 135,817
Leases receivable ........................................................ 112,764 105,705
Note Receivable .......................................................... 256,755 --
Inventory ................................................................ 10,917 21,672
------------ ------------
Total Current Assets ....................................................... 1,426,366 2,308,823
Property and equipment , net of accumulated depreciation ................... 219,242 544,943
Leases receivable ......................................................... 192,356 277,430
Intangible and other assets, net of accumulated amortization of $952,594 and
$596,572.................................................................... 626,679 913,551
------------ ------------
Total Assets ............................................................... $ 2,464,643 $ 4,044,747
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses .................................... $ 391,971 $ 591,048
Current portion of notes payable ......................................... -- 134,916
Deferred revenue ......................................................... 368,245 285,944
------------ ------------
Total Current Liabilities .................................................. 760,216 1,011,908
Notes payable .............................................................. -- 205,092
Deferred income taxes ...................................................... 45,500 45,500
------------ ------------
Total Liabilities .......................................................... 805,716 1,262,500
------------ -------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Ethika Corporation and Subsidiaries
Consolidated Balance Sheet September 30, 1997 and December 31, 1996
(Unaudited) (continued)
September 30 December 31
1997 1996
------------ ------------
<S> <C> <C>
Stockholders' Equity
Common Stock, $1 par value authorized 50,000,000 shares; issued 15,155,018
shares and 13,851,585; outstanding 15,127,706 shares and 14,947,706 shares;
September 30, 1997 and December 31, 1996 ................................... 12,627,706 12,447,706
Include 2,500,000 contingently returnable shares
Discount on Common Stock ................................................... (1,202,459) (1,123,709)
Accumulated Deficit ........................................................ (9,766,320) (8,541,750)
------------ ------------
Total Stockholders' Equity ................................................. 1,658,927 2,782,247
------------ ------------
Contingencies .............................................................. --
------------ ------------
Total Liabilities and Stockholders' Equity ................................. $ 2,464,643 $ 4,044,747
============ ============
</TABLE>
The Accompanying notes are an integral part of these Consolidated Financial
Statements
<PAGE>
<TABLE>
<CAPTION>
Ethika Corporation and Subsidiaries
Consolidated Statement of Operations and Changes in
Retained Deficit for the Three and Nine Months Ended September 30, 1997 and 1996
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Software sales ............................. $ 433,957 $ 292,246 $ 1,122,134 $ 682,032
Costs and expenses
Cost of Sales ............................ 195,384 69,357 551,539 104,981
Selling, general and administrative and
product .................................... 603,566 861,216 1,763,646 2,009,734
Development
Depreciation and Amortization ............ 147,994 160,043 456,805 317,483
----------- ----------- ----------- -----------
Loss from operations ....................... (512,987) (798,370) (1,649,856) (1,750,166)
Other income ( expense)
Rental Income ............................ -- 45,500 -- 138,775
Interest Income .......................... 36,762 30,171 107,837 119,538
Gain (Loss) from investment securities ... -- 1,625 -- 672,785
Interest expense ......................... (89) (30,189) (24,400) (55,588)
Equity in net loss of affiliate .......... (265,643)
Gain on sale of building ................. 341,849 -- 341,849
----------- ----------- ----------- -----------
Income/(Loss) before taxes ................. (134,465) (751,763) (1,224,570) (1,140,299)
----------- ----------- ----------- -----------
Income taxes................................ -- -- -- --
----------- ----------- ----------- -----------
Net income/(Loss) .......................... (134,465) (751,763) (1,224,570) (1,140,299)
Retained deficit at beginning of period .. (9,631,855) (6,491,327) (8,541,750) 6,102,791)
----------- ----------- ----------- -----------
Retained deficit at end of period ........ ($9,766,320) ($7,243,090) ($9,766,320) ($7,243,090)
=========== =========== =========== ===========
Primary and fully diluted net loss per share ($ .011) ($ .061) ($ .097) ($ .096)
=========== =========== =========== ===========
</TABLE>
The Accompanying notes are an integral part of these Consolidated Financial
Statements
<PAGE>
<TABLE>
<CAPTION>
Ethika Corporation and Subsidiaries
Consolidated Statement of Cash Flows for the Six Months Nine Months Ended
Ended June 30, 1997 and 1996 (Unaudited) September 30
1997 1996
----------- -----------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income (loss) from operations ................................ ($1,224,570) ($ 388,537)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and Amortization .................................... 456,805 157,440
Net loss in earnings of affiliate ................................ -- 265,643
Realized and unrealized (gain) loss on investment securities ..... -- (672,785)
Changes in balance sheet accounts:
(Increase) decrease in accounts, receivables, and other assets ... (110,476) 32,381
(Increase) decrease in income taxes .............................. 135,817 --
(Increase) decrease in inventory ................................ 10,755 (41,288)
Decrease in accrued investment income ............................ -- --
Increase ( decrease) in accounts payable and other liabilities ... (199,077) 94,440
Increase ( decrease) in deferred revenue ......................... 82,301 45,400
Gain on sale of facility ......................................... (341,849) --
----------- -----------
Net cash provided by (used from) operating activities ............ (1,190,294) (507,306)
----------- -----------
Cash flows from investing activities:
Purchases of equipment ........................................... (93,864) (77,553)
Payments received from leases .................................... 125,000 66,590
Others ........................................................... (14,654)
Issuance of note receivable ...................................... (256,755) --
Proceeds from investments ........................................ 2,078,680
----------- -----------
Proceeds on sale of facility ..................................... 700,000 --
----------- -----------
Net cash (used for) provided by investing activities ............. 474,381 2,053,063
----------- -----------
Cash flows from financing activities:
Net borrowing (payments) on debt ................................. (340,008) (54,405)
----------- -----------
Net cash provided by financing activities ........................ (340,008) (54,405)
----------- -----------
Net increase (decrease) in cash and cash equivalents ............. (1,055,921) 1,491,352
Cash and cash equivalents - beginning of period .................. 1,908,142 1,378,325
----------- -----------
Cash and cash equivalents - end of period ........................ $ 852,221 $ 2,869,677
=========== ===========
Supplemental Cash Flow Information: .............................. $ -- $ --
=========== ===========
Supplemental Schedule of Non-Cash
Investing and Financing Activities:
Common stock issued for equity securities of nonaffiliated company 1,303,433
===========
</TABLE>
The Accompanying notes are an integral part of these Consolidated Financial
Statements
<PAGE>
ETHIKA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 1997
Note 1 - Basis of Presentation
The accompanying unaudited consolidated financial statements of Ethika
Corporation and subsidiaries ("Corporation") have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with instruction to Form 10-Q and Article 10 of Regulations S-X.
Accordingly, they do not include all of the detail and disclosures required by
generally accepted accounting principles for complete financial statements.
Operating results for the nine months ended September 30, 1997 are not
necessarily indications of the results that may be expected for the year ending
December 31, 1997. More detailed information is contained in the Notes to
Consolidated Financial Statements included in the Corporation's Form 10-K Annual
Report for the year ended December 31, 1996.
Nature of operations: The Corporation operates as an applied technology company
through three of its wholly-owned subsidiaries, Text Retrieval Systems, Inc.
(TRS), Compass Data Systems (CDS), and Legislative Information Systems
Corporation (LIS). See business combination information in Note 2. TRS, CDS, and
LIS are engaged in publishing electronic libraries that link related data
sources for convenient access by personal computers. Certain products of TRS,
CDS, and LIS are sold nationally, while others are specific to states such as
Florida, Missouri, and Kansas.
Principles of Consolidation: The consolidated financial statements include the
financial statements of the Corporation and its wholly owned subsidiaries. All
significant inter-company accounts and transactions have been eliminated.
On June 10, 1997 (See Business Combinations information in Note 2), the
Corporation acquired Legislative Information Systems Corporation in a business
combination accounted for as a pooling of interests. LIS became a wholly owned
subsidiary of the Corporation through the exchange of 1,123,433 shares of the
Corporation's common stock for all of the outstanding stock of LIS. The
accompanying financial statements for the year ended December 31, 1996 and the
three and nine months ended September 30, 1997 and 1996 are based on the
assumption that the companies were combined for the entire period presented.
Revenue Recognition: The Corporation recognizes revenue for software sales
ratably over the period of each product's subscription life. The Corporation's
various products are updated annually, quarterly, and monthly based on content
availability and/or specific customer agreements. Revenue associated with
certain sales of TRS' primary product are not recognized until cash is collected
due to the customers' right of return and limited history of returns for the
product.
Intangible assets: Intangible assets consist primarily of assets acquired
through the acquisitions of TRS, CDS, and CodeManager. See Business Combination
information in Note 2. Acquired goodwill and software products are amortized
over three years. Non-compete agreements are amortized over the life of the
related agreement (2-3 years). The Corporation regularly reviews its ability to
realize future economic benefit from software products and goodwill based upon
the expected future cash flows of the related subsidiary or product.
Use of estimates: The preparation of financial statements in accordance with
generally accepted accounting principles requires the use of certain estimates.
Actual results may differ from those estimates.
<PAGE>
Earnings Per Share: Primary and fully diluted earnings per share are based on
the weighted average number of common shares of 12,607,706 and 11,882,563
outstanding for the nine months ended September 30, 1997 and 1996 respectively
and 12,627,706 and 12,205,502 for the three months ended September 30, 1997 and
1996 respectively. Earnings per share calculations include contingently
returnable shares only if their impact is dilutive.
Note 2 - Business Combinations
On April 2, 1996 the Corporation completed the acquisition of Text Retrieval
Systems, Inc. ("TRS"), a privately-held corporation based in Ponte Vedra Beach,
Florida. The transaction has been accounted for as a purchase and accordingly
the results of operations of TRS since April 2, 1996 have been included in the
Corporation's Results of Operations. TRS publishes electronic reference
libraries that link related data sources for convenient access by personal
computers. The Corporation had previously acquired a 35% initial ownership
interest in TRS through the issuance of 100,000 shares of its stock to the TRS
shareholders and the extension of a line of credit during 1995. The completion
of the purchase transaction included cash paid through prior advances to TRS and
the issuance of 2,500,000 shares of contingently returnable common stock. The
shares are returnable to the Corporation if certain 1997 earning targets are not
achieved. Management originally believed that it was probable that the
established targets would be met in total; accordingly, as of April 2, 1996, the
fair value of the 2,500,000 contingent returnable shares ($1,991,250) was
included in the purchase price resulting in a total estimated purchase price at
acquisition of $2,659,482. In the fourth quarter of 1996, Management determined
that the earnings targets would not be met in total and accordingly, recorded an
adjustment to the purchase price reducing intangible assets by the remaining
unamortized balance related to the contingent shares of $1,792,125. The
Corporation has amended the agreement with TRS whereby the earnings targets have
been revised and extended through December 31, 1997. The Corporation will adjust
intangible assets as the contingencies are resolved. If the earnings targets are
not totally met, the former shareholders will return all or part of the
contingent shares to the Corporation. Based upon current performance and
estimated results, it appears that a substantial number of shares will be
surrendered to the Corporation after the December 31, 1997 measurement period.
During the first quarter of 1996, the Corporation accounted for its initial
investment in TRS by the equity method under which the Corporation's share of
the net loss of the affiliate was recognized in the Corporation's operations and
included as an adjustment to the investment balance. The loss recorded by the
Corporation was $265,643 for the quarter ended March 31, 1996.
Effective August 17, 1996, the Corporation purchased 100% of the outstanding
common stock of CDS, a privately-held corporation based in Salt Lake City, Utah
for a total purchase price of $500,000 which included the issuance of 726,612
shares of the Corporation's common stock with a fair market value of $400,000.
CDS publishes electronic information reference services to a wide variety of
industries and organizations. Among its principal product offerings are state
tax law reference libraries which keep subscribers current on tax law changes.
The transaction has been accounted for as a purchase, accordingly the results of
operations of CDS since August 17, 1996 have been included in the accompanying
statement of operations. Intangible assets of $460,765 are being amortized over
a three-year period.
On January 31, 1997 Ethika purchased for 180,000 shares valued at $101,250 the
publishing, distribution, and future development rights of the CodeManager
Reference Library from American Practice Management and Consulting Concepts,
Inc.
<PAGE>
On June 10, 1997 the Corporation acquired Legislative Information Systems
Corporation in a business combination accounted for as a pooling of interests.
LIS became a wholly owned subsidiary of the Corporation through the exchange of
1,123,433 shares ($616,203) of the Corporation's common stock for all of the
outstanding stock of LIS. The accompanying financial statements for the year
ended December 31, 1996 and the three and nine months ended September 30, 1997
and 1996 are based on the assumption that the companies were combined for the
entire period presented. LIS is an electronic publishing company specializing in
federal aviation regulations, banking regulations, and custom service contracts.
Effective October 1, 1996, the Corporation revised estimates used in determining
the lives of intangible assets acquired through its acquisition of TRS and CDS
from five years to three years. Total amortization of $129,387 and $564,430 was
recorded during the three months ended September 30, 1997 and the year ended
December 31, 1996 respectively.
Note 3 - Note Receivable
On June 5, 1997 the Corporation entered into a loan agreement with InfoDynamics,
Inc. of Orem, Utah whereby Ethika provided development capital in the form of a
line of credit not to exceed $250,000. At September 30, 1997 a total of $250,000
had been advanced against this line. Ethika also acquired an 8% interest in
InfoDynamics as part of this transaction. In addition, the agreement gives
Ethika the right to acquire the remaining outstanding shares of InfoDynamics on
or before December 31, 1997. InfoDynamics is a developer of software tools and
applications based on the Folio infobase platform.
Note 4 - Leasing Activities
During 1995, the Company entered into leasing activities which consist of the
leasing of fry cook units to be placed in various locations and operated by the
lessee. All of the Company's leases are classified as direct financing leases.
Under the direct financing method of accounting for leases, the total net
rentals receivable under the lease contracts are recorded as a net investment in
direct financing leases, and the unearned income on each lease is recognized
each month at a constant periodic rate of return on the unrecovered investment.
Note 5 - Contingencies
A lawsuit was filed in the United States District Court for the Southern
District of Mississippi, Jackson Division, styled EURAM B.V., Peeper, et al. vs.
Ethika by certain plaintiffs against Ethika and its Chairman, S.L. Reed, Jr.
This suit alleges breach of fiduciary duties, fraud, conspiracy to breach
fiduciary duty of loyalty and care, breach of contract, misrepresentation, and
conversion. These allegations arise from the transactions surrounding the
Corporation's issuance of 2,000,000 shares of its stock in exchange for 16%
interest in PMM, and the sale by the Corporation of $2,000,000 of its stock in
exchange for shares of Alanco stock valued at $2,000,000. On October 30, 1996
Ethika filed answers to the suit and instituted a counterclaim against the
individuals named in the above suit and other defendants not named in the
original suit. The Corporation, on advice of outside legal counsel, believes the
plaintiffs' suit is without merit, and that its resolution will not have a
material effect on the Corporation, however, it is too early in the proceedings
to assure the outcome.
<PAGE>
The Corporation was notified by Standard Management Corporation on June 26, 1997
that its subsidiary, Standard Life Insurance of Indiana, had received a Citation
and Original Petition captioned "Rilla Lindley versus Standard Life Insurance
Company of Indiana, Dixie National Life Insurance Company, Randy Owens" filed in
the 2nd Judicial District Court, Parish of Brenville, State of Louisiana.
Standard's notification constituted a claim notice pursuant to Section 10.3 of
the Second Restated Stock Purchase Agreement dated August 30, 1995 by and among
Standard Life and Dixie National Life and Dixie National Corporation (now Ethika
Corporation) in which Ethika agreed to indemnify Standard under certain
conditions against qualified third-party claims originating prior to the sale of
Dixie National Life to Standard. The scope of Ethika's indemnity obligation, if
any, under the Agreement is limited to claims predicated upon occurrences prior
to closing based on actions or inactions of Dixie National Life Insurance
Company.
The third-party claim involves, among other things, allegations regarding a
vanishing premium life insurance policy issued by Dixie National Life which was
purchased by the plaintiff in August 1989 from defendant Owens, an employee of a
general insurance agency in Louisiana. The claim appears to be styled in the
form of a class action. An investigation into the Citation's allegations by the
defendants, including legal representation of the Corporation, has been
initiated. Potential liabilities, if any, of the various defendants have not
been determined.
Nasdaq recently (September 16, 1997) notified the Corporation that it has ninety
days to address the deficiencies in meeting the minimum bid price ($1 per share)
or alternative capital and surplus requirements ($2,000,000) for continued
listing in the Nasdaq SmallCap Market. The Corporation has been intensely
focused on meeting the more stringent requirements set for implementation by
Nasdaq on February 23, 1998 for all SmallCap companies. Management is working
jointly with Nasdaq on a definitive plan to meet the new quantitative
maintenance and corporate governance requirements. At this time there can be no
assurance that a satisfactory plan will be developed to meet the listing
requirements within the defined time period.
<PAGE>
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations
Liquidity and Capital Resources
The Corporation accomplished the acquisitions of TRS, CDS, CodeManager, and LIS
through the issuance of its common stock. Management anticipates to continue
using its common stock to acquire additional companies. Management believes that
its current working capital and anticipated levels of internally generated funds
will be sufficient to fund its operating, product development, and capital
expenditure requirements. This belief is based on the Corporation's current and
planned level of operations.
Results of Operations
Nine Months Ended September 30, 1997
Compared to Nine Months Ended September 30, 1996
The nine months ended September 30, 1997, generated a net loss from operations
of $1,224,570 ($.097 per share) compared to a net loss from operations of
$1,140,299 ($.096 per share) for the comparable period of September 30, 1996.
This increase in loss resulted primarily from the recognition of a full nine
months amortization of goodwill in connection with acquisition activity totaling
$387,024. The Corporation recognizes revenue for its software sales ratably over
the period of each products' subscription life thereby generating currently
earned revenue and deferred revenue each time a product is sold. Costs
associated with production of the product, however, are recorded as incurred and
not deferred. Revenues for the nine months ended September 30, 1997 increased by
$440,102 while total operational costs decreased by $100,310 over the same
period of 1996. In addition, the Corporation had deferred revenue of $368,245 at
September 30, 1997.
Three Months Ended September 30, 1997
Compared to Three Months Ended September 30, 1996
For the three months ended September 30, 1997, the Corporation had a net loss of
$134,465 ($.011 per share) compared to a net loss of $751,763 ($.061 per share)
for the comparable period in 1996. This decrease in loss is attributable to the
increased in recognized sales to $433,957 for the three months ended September
30, 1997 compared to $292,246 for the comparable period in 1996 together with a
$285,383 decrease in operational expenses over the comparable 1996 period.
Part II. Other Information
Subsequent Event
Ethika's previous headquarters building in Jackson, Mississippi was sold on July
16, 1997 for $700,000 less closing costs of $55,630 and the mortgage balance of
$255,398 netting $388,972 in cash to Ethika.
Item 6 - Exhibits and Reports on Form 8-K.
(a) Exhibits
(27) Financial Data Schedule
(b) None
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Ethika Corporation
(Registrant)
/s/G. Thomas Reed
-----------------
Date: November 15, 1997 G. Thomas Reed
President and
Chief Operating Officer
/s/David E. Williams
--------------------
Date: November 15, 1997 David E. Williams
Vice President Finance
And Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 852,221
<SECURITIES> 0
<RECEIVABLES> 563,228
<ALLOWANCES> 3,291
<INVENTORY> 10,917
<CURRENT-ASSETS> 1,426,366
<PP&E> 465,363
<DEPRECIATION> 246,122
<TOTAL-ASSETS> 2,464,643
<CURRENT-LIABILITIES> 805,716
<BONDS> 0
0
0
<COMMON> 12,627,706
<OTHER-SE> (1,202,459)
<TOTAL-LIABILITY-AND-EQUITY> 2,464,643
<SALES> 0
<TOTAL-REVENUES> 1,122,134
<CGS> 551,539
<TOTAL-COSTS> 551,539
<OTHER-EXPENSES> 2,220,451
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,224,570)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,224,570)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,224,570)
<EPS-PRIMARY> (0.97)
<EPS-DILUTED> (0.97)
</TABLE>
