SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended October 31, 1998 Commission File No. 0-14880
MICROLOG CORPORATION
(Exact name of Registrant as specified in its charter)
VIRGINIA 52-0901291
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20270 GOLDENROD LANE 20876-4070
GERMANTOWN, MARYLAND (Zip Code)
(Address of principal executive offices)
(301) 428-9100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of class)
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained herein, and
will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. ( )
The aggregate market value of shares of Common Stock held by non-affiliates
(based on the March 4, 1999 closing price of these shares) was approximately
$5.4 million. The Common Stock is traded over-the-counter and quoted through the
Nasdaq National Market.
As of March 4, 1999, 4,287,585 shares of the Registrant's Common
Stock were outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
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Parts I, II and IV incorporate information by reference from portions of the
Company's Annual Report to Shareholders for the fiscal year ended October 31,
1998 attached as an exhibit hereto (the "Annual Report to Shareholders").
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PART I
ITEM 1. BUSINESS
GENERAL
Microlog Corporation ("Microlog" or the "Company") designs, assembles, and
supports, a variety of interactive communications systems which allow users to
remotely interact with computer systems via voice, touch-tone phone, or
graphical means and to access information on computer databases as well as
provides open solutions for customer contact center management. In addition, the
Company provides performance analysis and technical and administrative support
services to the Applied Physics Laboratory (APL), a prime contractor to the U.S.
Navy. Although this segment of its business, historically, has provided a stable
source of sales and profits, the Company believes that its principal
opportunities for growth are in the interactive communications and contact
center solutions segments and has been concentrating its efforts on those
segments.
The Company had a net loss of $8.6 million (($2.02) per basic and diluted share)
for the fiscal year ended October 31, 1998. These results include a write-off of
$2.15 million (($.50) per basic and diluted share) related to the deferred tax
asset. As a result of the losses in fiscal year 1998 and the uncertainty of
future profitability, management believes that the expected future realization
of the Company's net operating loss carryforwards is not likely to be realized
in the near future. By comparison, the Company had net income of $3.7 million
($.89 per basic share and $.82 per diluted share) for the fiscal year ended
October 31, 1997, which included a $1.5 million ($.36 per basic share and $.33
per diluted share) income tax benefit. The Company had net income of $2.7
million ($.67 per basic share and $.59 per diluted share) for the fiscal year
ended October 31, 1996, which included a $650,000 ($.16 per basic share and $.14
per diluted share) income tax benefit. The Company is now reporting basic and
diluted earnings per share as required under Statement of Financial Accounting
Standards (SFAS No.128), "Earnings per Share", which became effective for the
Company in fiscal year 1998.
The net loss of $8.6 million for fiscal year 1998 was attributable to the
Company's voice processing operations. Approximately $5.3 million of this loss
was due primarily to insufficient voice processing revenues and a change in the
sales mix in the Company's voice processing operations. The loss was also due in
part to a write-off of the deferred tax asset ($2.15 million), a large increase
in the reserve for inventory obsolescence ($1.3 million), the write-off of
goodwill ($0.5 million), and reserves associated with the relocation of its
operations facility in The Netherlands ($0.3 million). These losses were offset
by the $1.0 million net income generated from the Company's performance analysis
and supports services operations.
Over the past fiscal year the Company has been experiencing reduced demand,
increased competition and reduced margins in the voice processing area, which
the Company attributes to market forces. The Company believes that interactive
information response (IIR) systems in general, and in the retail pharmacy
vertical market targeted by the Company's commercial sales efforts in
particular, are becoming commodities which are more readily available from an
increased number of vendors and require less engineering customization. In
addition, governmental customers have been procuring large IIR systems as part
of major procurements from larger vendors, which has required the Company to
work through prime contractors, also resulting in greater difficulty in making
sales and increased pressure on margins. One of the Company's short-term
responses to these market trends has included increased marketing efforts
focusing on the capabilities of the Company's Intela product and its ability to
customize the product to meet specific application requirements.
In February 1999, the Company restructured its voice processing operations in
order to bring expenses in line with forecasted revenues. In connection with
this restructuring, the Company reduced its voice processing workforce by
approximately 25% and wrote off equipment associated with its headcount
reductions. As a result of the restructuring and cost reduction plan the Company
expects to reduce total voice processing operating expenses by approximately
$4.0 million annually and approximately $2.3 million for the remainder of fiscal
year 1999, starting in the second quarter of fiscal year 1999.
In February 1999, the Company and its financial institution put in place a
$750,000 line-of-credit facility, which allows the Company to borrow up to 75%
of the eligible receivables of Old Dominion Systems Inc. of Maryland.
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The line of credit bears interest at the bank's prime rate plus 1.25% (9% at
February 11, 1999) and is payable upon demand. At March 17, 1999, $500,000 was
outstanding against this line-of-credit. This credit facility will be terminated
upon closing of the $2.0 million revolving line-of-credit facility with the new
financial institution discussed below.
The Company has a commitment for a $2.0 million revolving line-of-credit
facility with a new financial institution, which allows the Company to borrow up
to 75% of its eligible receivables to a maximum of $2,000,000, subject to the
right of the financial institution to make loans at its discretion. The Company
expects to close on this loan facility by the end of March, 1999. The
line-of-credit bears interest at the bank's prime rate plus 2.25% (10.00% at
March 17, 1999), and contains a 0.025% fee on the average unused portion of the
line as well as a monthly collateral fee and a 1% upfront commitment fee. The
term of the loan is one year, and subjects the Company to a restrictive covenant
of not exceeding 115% of its consolidated planned quarterly losses for its
second and third quarters of fiscal year 1999, and a requirement for
consolidated profitability beginning in the fourth quarter of fiscal year 1999.
The line also subjects the Company to a number of restrictive covenants
including restrictions on mergers or acquisitions, payment of dividends, and
certain restrictions on additional borrowings. The line will be secured by all
of the Company's assets.
In fiscal year 1999, the Company's strategy for addressing the market trends
will be to move aggressively into the customer contact center market, which was
a new vertical market for the Company in late fiscal year 1997 and fiscal year
1998. The Company will be focusing sales of its UNIX-based Intela product, the
Company's principal interactive communications system, on contact center
applications. The Company also will be promoting its newest product line,
uniQue(TM), a family of open solutions for customer contact center management
that leverages the effectiveness of unified queuing, priority and skills-based
routing, and "zero administration" at the agent's desktop. With "zero
administration" the system administrator makes changes to the configuration or
application from a central location and distributes to the agents' desktops
automatically. In fiscal year 1998, the Company launched its first product from
the uniQue suite of contact center products, uniQue Agent(TM), an application
that allows the contact center agent to seamlessly manipulate all of the
different media types: email, fax, Web, and voice contacts all at one work
station. The Company is devoting significant efforts to promote market
acceptance of uniQue Agent(TM), and is commencing an advertising campaign
directed specifically at contact centers, collections, and interactive
communications industries.
To a lesser extent, the Company also will be focusing on another Intela
application, The Automated Collector (TAC), which has recently been enhanced to
add features the Company believes will meet market requirements. The Company
will be seeking technology partners and resellers for this product in fiscal
year 1999.
Also in fiscal year 1999, the Company will continue to market its Intela product
to its base of VCS 3500 customers. The Company no longer offers the VCS 3500
product; there were no VCS 3500 product revenues in fiscal years 1998 or 1997
and limited revenues ($0.6 million) in fiscal year 1996. The Company continues
to support its base of VCS 3500 customers and receives service revenues from
this support, but expects these revenues to decline since the Company has not
updated the product including with respect to Year 2000 compliance since fiscal
year 1996.
The Company is subject to the risk that its new strategy will not be successful.
The new strategy is dependent on market acceptance of the Company's new focus
and new products, ongoing research and development efforts and sales activities
over the near term. In addition, the new strategy is also dependent on the
Company's ability to successfully reduce costs. The Company is subject to the
risk that it will not be able to obtain and maintain the necessary debt
financing it requires to implement its new strategy. Failure to obtain and
maintain required financing would have a material adverse effect on the Company.
The Company's fiscal year 1999 operating budget includes significant
expenditures relating to the development and marketing of its new product line,
uniQue, and requires the Company to utilize debt financing to maintain its new
strategy. The Company's anticipated cash flows from existing operations will not
generate the required cash flows to successfully launch the Company's new
strategy. If the Company is unable to obtain and maintain the necessary debt
financing, the Company will not be able to successfully implement its new
strategy and it will be forced to reduce expenditures in addition to those
associated with the restructuring discussed above in order to continue as a
going concern. The Company is subject to the risks that it may not make the
necessary decisions to reduce expenditures in enough time to avoid severe
adverse consequences. In March 1999, the Company has a commitment for a new
line-of-credit facility with a new financial institution.
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The results of the Company's performance during fiscal 1998, 1997, and 1996, are
discussed in greater detail in "Management's Discussion and Analysis of
Financial Condition and Results of Operations," incorporated by reference into
Item 7 of the report. That section should be read in its entirety in conjunction
with the discussion of the Company's business in this Item 1. Information
concerning the Company's operations by business segment is hereby incorporated
by reference from Note 1 of the "Notes to Consolidated Financial Statements"
incorporated by reference into Item 8 of this Report.
Microlog, a Virginia corporation, was organized in 1969. The Company's wholly
owned subsidiaries are Microlog Corporation of Maryland, Old Dominion Systems
Incorporated of Maryland, and Microlog Europe.
INTERACTIVE COMMUNICATIONS
INTERACTIVE COMMUNICATIONS INDUSTRY
Interactive communications systems are designed to serve the needs of
organizations which are searching for an efficient, cost-effective means to
deliver and communicate information and complete business transactions in a
timely manner. These systems use specialized computer hardware and software to
store, retrieve, and transmit digitized voice messages and to access information
on computer databases. In traditional Interactive Voice Response, callers hear
voice prompts and then use a touch-tone telephone to enter information into,
and/or retrieve information from, a computer database. Voice processing systems
have evolved to interactive communications systems, which provide information
not only through voice, but through a wide range of additional input devices and
interfaces, including the Internet, fax, Telecommunications Device for the Deaf
(TDD), Analog Display Services Interface (ADSI) screen phones, and pagers.
Interactive communications typically includes a voice processing system
connected to an external computer that contains data of interest to callers.
With touch-tone or voice commands (using speech recognition software), which
often include passwords, codes or account numbers, callers can query the
computer and have data read back to them in voice form. Depending on the
customer's application, callers may also change data on the computer or input
new data with touch-tone or voice commands. Interactive communications is widely
used for functions such as reporting account balances, checking on inventory, or
determining the status of applications or permits in process. Interactive
communications systems range from small systems with basic voice processing
features utilizing a few phone lines, to larger more complex distributed systems
with hundreds of lines.
PRODUCTS
The Company's interactive communications products include the Intela(TM), a
UNIX-based platform product, which is capable of running many different
applications simultaneously, including pre-packaged applications, such as The
Automated Collector(TM), and numerous development tools, and its newest product
line, the uniQue(TM) family of open solutions for customer contact center
management. The Company also offers a Retail Solutions product line that
operates under either a UNIX or DOS operating system, and the VCS 3500(TM)
products which are DOS-based only. Microlog emphasizes the interactive
communications applications of its Intela product, but also provides much of the
same application functionality through the VCS 3500 and Retail Solutions product
lines.
The following functionality is provided through the Company's interactive
communications products:
Audiotex is used by organizations to construct a "library" of pre-recorded
messages, which outside callers can access through touch-tone or voice
commands without live operator assistance. Customers can record and change
menus and messages themselves over the telephone at any time. Libraries of
information may be presented in different languages, and callers with
rotary telephones may also access menus and information. Up to 50,000
messages may be presented. Audiotex software finds wide use by
organizations that receive large volumes of highly-repetitive telephone
requests for information. Major advantages of audiotex over live
information operators include the availability of information at every hour
of the day and the consistency in information disseminated.
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Automated Attendant uses touch-tone or voice commands to route and connect
inbound calls to extensions faster and more accurately than live operators.
Microlog's software allows different phone lines to be answered with
various greetings and menus of options presented to different callers. In
the event of a busy or unanswered extension, the software permits callers
to hold, transfer, leave a message or disconnect. The system can be
name-based, in which callers input the first three letters of the party's
last name, or extension-based, in which callers dial an extension number.
For extension-based systems, the software incorporates a directory of
names, allowing callers to use touch-tone commands to find extension
numbers they do not know.
Service Management System (SMS) allows network and operations managers to
configure and manage their interactive communications system through a
simple, consistent graphical "point & click" interface. SMS allows network
managers to monitor the status, retrieve usage statistics, configure
hardware and software resources, and install software on any Intela-based
system installed in the network.
Fax Software allows system users to automatically receive stored fax
documents on demand from the voice processing system. Customer service and
sales support operations are frequent users of fax software. A service
representative can take a request for documents from the system and
designate faxes to be sent in response without exiting the interactive
communications system.
Interactive Voice Response (IVR) provides a telephone interface to computer
systems. IVR allows a user to call into a computer and access various
information systems using a touch-tone telephone or voice commands.
Interactive Web Response (IWR) allows the interactive communications
platform to handle web-originated input as it would data collected from a
standard phone interaction. IWR performs activities such as database
lookups, outgoing faxes, conferencing, or sending information to agents for
customer callbacks. Acting as the interface between a web site and the
interactive communications system, IWR passes information collected through
a web contact using CGI and sockets. The results are delivered though a web
page that is sent back to the user.
Local Database provides similar functionality to interactive communications
systems as IVR, but allows the data of interest to reside on the system
rather than a host mini- or mainframe computer. This provides a
cost-effective approach for many interactive communications applications.
It also allows large interactive communication applications to do local
batch processing of data by downloading to the system for data
manipulation.
Multiple Languages Interface Software allows system messages to be played
in multiple languages. It also interfaces TDD terminals to VCS 3500 systems
over telephone lines. The interface enables TDD users to interact with most
VCS 3500-software modules as if voice communications were being used. Users
simply type messages onto their TDD terminals and send them to the voice
processing system, which understands the input and responds with menus,
prompts and messages which are printed on the TDD terminal. It has broad
application in areas where the hearing-impaired must have access to
information sources.
Outbound Dialing permits an organization to send messages automatically to
large lists of external phone numbers and to record responses to those
messages, if necessary. This flexible software can handle multiple lists
with thousands of names per list. It can draw from a library of 50,000
messages and send different combinations of messages to individual phone
numbers as directed. The software also generates management reports about
the number of successful connections, the length of calls, and the content
of responses.
Release Line Trunking (RLT) provides the ability to transfer the same call
several times. After the call to each transfer destination is complete, the
telephone line to that destination is released. A call may, for example,
initially be transferred to a phone number, which can provide information
required for the second transfer. In the Microlog applications, RLT is
often used for long distance transfers.
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Speech Recognition allows the caller to speak responses that are understood
by the VCS 3500 and Intela systems. Continuous and discrete speech
recognition can be combined in a single system. The standard vocabulary
includes digits "0-9", "yes", and "no" responses. Microlog has incorporated
speech recognition technology from several U.S. and international based
companies. All technologies are speaker independent and therefore require
no special training or development to recognize individual voice or speech
patterns.
Text-to-Speech converts typed ASCII data, resident on host computers or
databases, to computer-generated synthetic speech on demand. It has an
extensive vocabulary, since it can pronounce any string of letters, which
are sent to it. Microlog's text-to-speech module is ideal for applications
requiring information from large text databases. Because text-to-speech
works with external databases, the module works with the interactive voice
response module that provides the link between the VCS 3500 or Intela
interactive communications system and the customer's database.
Transaction Processing allows the inbound caller to place orders, request
information, respond to surveys or complete other transactions without
personal handling by a live operator, using either touch-tone or voice
commands. The caller can initiate transactions any hour of any day, and the
company can process the transactions at its convenience, including
processing outside normal business hours. Such transactions allow orders
and requests to be filled faster and at lower cost than traditional
methods.
Voice Mail provides an organization with "voice mailboxes" in which
internal or external callers may leave detailed, confidential messages at
any time. Voice mail overcomes many limitations of telephone systems,
allowing people to exchange information and transact business without
having to be on the phone together. It eliminates paperwork and adds
meaning and content, which written messages can not reflect. Benefits
include, increased office productivity through fewer interruptions, timely
and accurate message delivery, increased message detail, and reduced
callbacks and "telephone tag." Messages may be left for groups of people as
well as individuals. Callers may edit messages, reviewing and re-recording
until satisfied. Mailbox owners may review, save, forward or discard voice
messages.
uniQue(TM)
Microlog's new uniQue product family will offer comprehensive open
architecture, cross platform solutions for customer contact centers. uniQue
is designed for the contact center with 5 to 5,000 agents and seamlessly
integrates all of the contact center's telephony, computer and business
applications. uniQue is designed for the contact center manager and offers
the agent appropriate tools necessary to handle customer interactions.
The uniQue product includes the following features:
Multiple Media - uniQue accepts and intelligently routes all customer
contacts, whether from a traditional telephone call, Web contact, email,
facsimile, or even simple postal mail. By accepting any type of contact
from the customers, uniQue becomes the single source repository of all
customer interaction providing the user with a powerful information tool
that summarizes customer behavior and provides better customer
satisfaction.
Contact Prioritization - In addition to handling all types of media, uniQue
prioritizes the contact based upon the rules established by the contact
center manager in order to ensure that all of the user's customers are
handled in the most appropriate manner, such as servicing the most
important customers first.
Intelligent Routing - uniQue leverages the effectiveness of skills-based
routing by matching the customer contact to the most appropriate agent
skill required to service the contact. uniQue's simple system
administration feature allows the supervisor to quickly and easily add or
remove skills to any agent on-line. This allows the contact center's
management to schedule and maintain the most appropriate level of agents at
all times.
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Easy Configuration & Remote Administration - Being a completely Web-based
Java application, uniQue offers the contact center management zero
administration at the agent 's workstation. The Java applet is hosted on
the uniQue server. It is loaded only once, and each time an agent logs into
the application, the uniQue applet is downloaded to the agent's workstation
eliminating any agent workstation configuration or administration.
Web-Based System - Keeping with the concept of open systems, uniQue
operates on any agent computer with any operating system provided there is
a properly configured Java-enabled Web browser on the agent's desktop. This
concept frees the user from being tied to a single computer environment,
system architecture or operating system. uniQue will operate in an
environment where there may be multiple types of computers. The open system
approach provides tremendous flexibility to a contact center's computing
requirements and simplifies the task of integration.
Reporting - Included with uniQue is a powerful statistical data capturing
and reporting component. Contact center managers can generate any number of
statistical reports from the system. uniQue stores each customer contact
along with the detailed information about the contact. Detailed information
which could be stored include but are not limited to: contact duration,
agent wrap-up time, total contact length, contact outcome, contact result
and contact reason. With uniQue, contact center managers are able to
develop their own reports which summarize agent productivity, contact
center accomplishments, and even business success statistics.
INTELA
The Intela platform is an interactive communications product designed for
simultaneous support of multiple applications and interactive information
solutions. Prices for Intela systems are dependent on the number of ports
in the system (from 4 to over 1000), the amount of voice storage, the need
for additional equipment, and in the case of direct sales, the time needed
to develop a customized application.
Microlog has installed Intela for many different customers, with one of our
largest Intela customers being the Internal Revenue Service (IRS). Projects
for the IRS included Voice Balance Due (VBD), which enables eligible
taxpayers to check the status of their debt to the U.S. Government and set
up repayment plans. The Refund Inquiry application enables taxpayers to
call the IRS and, by selecting the Refund Inquiry on Intela, automatically
obtain their refund status, including the amount of the refund. Microlog
also employed the Intela for call center solutions in Europe for companies
such as, Sykes, KLM Royal Dutch Airlines, and Xerox.
Intela is based on an Intel Pentium(R) hardware platform utilizing a UNIX
operating system with a Graphical User Interface (GUI) for application
development. The Intela system has a non-proprietary open architecture.
User screens, voice prompts, and documentation are available in many
foreign languages. Intela also supports text-to-speech, speech recognition,
remote and local databases, host connectivity, web and fax.
Each Intela system incorporates multiple servers with hard disk storage and
several voice cards. Intela uses distributed servers, each of which handles
a part of the total processing task, rather than one large central
processor. By increasing the number of voice cards and the number of
distributed servers, the Company can configure the interactive
communications systems with a greater number of ports and hours of message
storage. Depending upon customer specifications, systems are provided as
tabletop, floor-standing, or rack mounted units. These units can be
networked to create a larger system with thousands of ports, and they can
be configured to run on -48 volt DC for use in a Central Office (CO).
The Intela architecture supports a variety of configurations that meet
varying functional, processing, and voice port and storage needs. This
platform is designed for simultaneous support of multiple applications,
including both voice response and voice messaging services. Within the
architecture, particular hardware configurations may be proposed to provide
cost-effective solutions to a wide range of system requirements. All
systems can be configured with built-in redundancy so that at least 50% of
total system capacity is
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maintained across any single component failure. Growth capability is
achieved by the modular upgrade of application servers, port servers, disk
storage, additional communications links, and additional voice response
units. The Intela system includes a monitor, keyboard, and printer. These
are used to program the system, organize the storage of information (which
will be accessible to users), produce reports, and monitor system activity.
Customers that contract for the Company's system maintenance services also
purchase modems so that the Company can perform remote diagnostic
procedures.
The basic Intela architecture consists of three major system components:
the Application Server(s), the Port Server(s), and the Intelaware software
platform.
Application Server defines the computing environment in which Intelaware
software resides and provides centralized management and control, as well
as optional secure voice storage. The application server can be a personal
computer, a workstation, or mini-computer. It interfaces to a voice
processing peripheral, or Intela port server, via a command link on a LAN
or a serial communications link.
Port Server consists of tabletop, tower, and rackmount models, each
providing call and speech processing, as well as voice storage. Interfacing
to either a CO- or PBX-based telephone system, these units answer calls,
and process and store speech, all under the direction of commands coming
from Intelaware software on the application server across a command link.
Intelaware Software Platform is an application development and deployment
environment for interactive communications applications, supporting the
on-line creation and administration of multiple applications. From an
X-Windows graphic terminal connected to the application server, users
access major functions of the software through several interfaces:
Application Editor, Prompt Loading and Management, System Administration,
Reports and Database Access, Integration Manager, Agency Manager, and
Calendar Manager.
Through these interfaces, users control the development and operation of
their voice applications, using a graphical user interface. This interface
provides the developer with a set of tools to create voice applications.
Following is a description of each of these interfaces.
Application Editor is used to create and edit applications and is oriented
towards programmer productivity, with several developers able to access
different applications simultaneously. The editor is GUI-based and allows
programmers to develop call flows using a click-and-place approach similar
to many standard drawing packages. Cells from a palette are placed onto a
drawing pane and are connected using a set of mouse actions. Standard
Windows(R)-like pull-down menus allow file control, editing features (cut,
copy, and paste), object search (by cell number, name, or type), and user
preferences for appearance of the palette. Applications can be developed
and tested on-line without interrupting those currently running.
Prompt Loading and Management Facility provides the capability for prompt
creation, a major function in voice applications. With the Intelaware
prompt loading facility, prompts can be reviewed, recorded, installed,
deleted, backed up to removable media, restored, and distributed over a
local or wide-area data network (LAN/WAN). They can be loaded on-line over
the telephone, a microphone, or from a tape, and the process can be semi-
or fully- automatic, depending on whether dual-tone multifrequency (DTMF)
tones are coded on the tape to identify the prompts. Users can record
individual prompts, a list of prompts, or record with DTMF prompt numbers,
and the prompts will be replaced only after they have been reviewed and
accepted. New or updated prompts will be phased in automatically while
applications remain on-line.
Prompt Manager allows users to retrieve a prompt from storage on a port
server and have the graphical representation shown in a window. The user
can modify the prompt simply by clicking on the window and performing any
of the following actions: cut, copy, paste, delete, trim silence, adjust
again, convert sections of a prompt to silence, and change sampling rate.
System Administration allows for the loading and unloading of applications,
and the management of the port servers connected to the application
processor. If a system has network hardware in the system
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configuration, administration can be performed through one central point.
Administrators can bring up a new revision of an application or move an
application to another trunk while the system is on-line. If a caller
happens to be on the line at the time, the changes on that trunk will take
effect after the caller hangs up. Intelaware can support multiple Intela
systems to expand to larger port and storage capacity by networking systems
and clusters of systems together.
Centralized System Management provides a graphical means to address the
operation, administration, and maintenance (OA&M) of a distributed system.
It provides a graphical representation of the application server and its
attached Intela systems, including the command link mode used, Ethernet or
serial links. Further, by clicking on the Intela icon, an additional window
is displayed. In this window, a graphic of the Intela display panel, with
active trunk status indicators and disk usage indicators, is shown.
Clicking on a trunk status indicator opens an additional window that
depicts information about the running application.
Reports are designed to track significant statistical information for
activities such as billing and to justify services. Intelaware offers a
choice of reports that can be created and viewed without interrupting the
operation of an application. These reports can then be sent to a printer
for a hard copy print-out. Available reports include call detail, cell
usage, trunk usage, subscriber information, and transaction log.
Statistical requirements beyond those addressed by the standard reports can
be met from the raw call data records (CDRs).
Database Access allows interfaces to be built between Intelaware and
Standard Query Language (SQL) relational databases, such as Oracle, Sybase,
Informix and Ingress. The Application Editor contains an SQL cell type,
which allows information to be extracted from databases to support
interactive communication applications. This cell type allows users to
delete, insert, select, and update data. Intelaware also supports two
internal proprietary databases: message and information databases. The
message database used in voice mail applications, consists of mailboxes
associated with a number, usually the phone number of the user who will
access the box for the messages deposited in it. More than one message
database can be supported within Intelaware to accommodate multiple
applications. Messages can be retrieved either first in, first out (FIFO)
or last in, first out (LIFO), determined on a system basis.
In 1998, the Company delivered Intela System Release 6 (SR6), and completed
work on several functional enhancements to the product. In addition, work
was completed to support Dialogic SCbus capabilities and improvements in
speech technology services. Additional Intela features released in SR6
included IntelaSMS(TM) that provides Simple Network Management Protocol
(SNMP) capabilities and a standard Management Information Base (MIB) to
allow centralized management of distributed Intela systems. IntelaWeb(TM)
combines the best of traditional touch-tone based interactive
communications and the Web experience. IntelaWeb allows traditional call
flows and applications to be Web-enabled, without complex redesign or code
rewrites. IntelaWeb also supports industry standard HTML, CGI and Java
Script.
System enhancements provided in the SR6 release include:
o Year 2000 Compliance;
o SCbus Support - a real time, high-speed communications bus that
provides for transmission of digital information between SCbus
compliant products. SCbus allows systems to efficiently share
resources so that multiple technologies can be connected to each port
as needed which provides more scaleable IVR systems at a cost savings
because of more efficient resource deployment;
o Enhanced Speech Recognition and Text-to-Speech services including
integration of Dialogic's Antares DSP platform, dynamic language
specification for both Automatic Speech Recognition (ASR) and
Text-To-Speech (TTS), improved ASR and TTS cut-through support,
addition of PureSpeech and VCS ASR technologies, and the addition of
Centigram TTS.
8
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THE AUTOMATED COLLECTOR
The Automated Collector is a flexible, robust, interactive communications
application that automates the process of collecting outstanding debt from
consumers. It is designed to handle both inbound and outbound calls. The
Automated Collector uses scripted messages to collect promises to pay --
debtors are asked to either commit to pay their debt in full, or are given
the opportunity to negotiate a payment schedule over a period of months.
Microlog created The Automated Collector based on a custom application
developed for the Internal Revenue Service (IRS), one of the largest
collections call centers in the world. The IRS required an automated means
of allowing taxpayers in arrears to commit to a federal tax repayment plan.
This application, called Voice Balance Due (VBD), has lead to a significant
increase in incremental collections by the IRS. Based on the application
developed for the IRS, the Company created The Automated Collector for
commercial customers.
The Automated Collector can operate 24-hours per day, 7 days a week, 365
days a year. The Automated Collector verifies right party contact by asking
debtors to enter an identification number, such as their social security
number or other data known only to them. When necessary, the caller can
choose to transfer to a live collector. The Automated Collector is flexible
enough to accommodate a variety of debt collection strategies including
small balance accounts, and most-likely-to-pay accounts.
The Automated Collector can:
o Handle both inbound and outbound collections calls
o Verify "Right Party Contact"
o Collect Promises to Pay or set up payment schedules
o Accommodate a variety of debt collection strategies
Automating Collections will:
o Increase contact rates
o Increase productivity
o Drive down variable costs
o Increase capacity
o Expand hours of operations
RETAIL SOLUTIONS
Retail Solutions consists of several applications designed and manufactured
specifically for the retail pharmacy industry. These applications include
the Automated Prescription Refill System (APRS(R)), Photo Ready(TM),
Prescription Ready(TM), and the ProNouncer(R).
AUTOMATED PRESCRIPTION REFILL SYSTEM (APRS)
APRS is the primary product available under Microlog's Retail Solutions
product line. The APRS product helps pharmacies improve operating
efficiencies and customer service. Prices for APRS are dependent on the
number of ports in the system (from 4 to 16), the amount of voice storage,
the need for additional equipment, and the need for any customization of
the application. Patients calling into the APRS can use the touch-tone
keypad on their phone to enter their prescription refill orders, inquire
about store location and hours of operation, and request a transfer to a
specific department. This system processes calls 24 hours a day, 7 days a
week, allowing pharmacy staff to spend more time consulting with in-store
patients. As managed care continues to change the way health care is
delivered, APRS technology becomes a part of the pharmacist's newly
evolving role -- that of providing a broad range of pharmacy care services
by assisting pharmacists with the traditional dispensing of medications.
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APRS is a UNIX-based system available as a stand-alone configuration, or a
"board-and-software" solution. The "board-and-software" solution is
designed for customers who already have an in-store processor with spare
capacity. Customized management software allows selected control functions
to be executed from a remote, central location. Such features include
loading of new software modules, running diagnostics, and implementing
system changes. Enhanced features of the system include more comprehensive
out-dial reports, GUI for system administration, multi-level passwords, and
easy expandability of systems through the use of a variety of voice cards.
A direct link can be established between the APRS and the pharmacy
database, enabling the automated refill system to access the extensive
medical, customer, and marketing information stored on the pharmacy
database as a part of every call. For instance, the APRS can provide drug
interaction information to customers calling in to place refill orders,
promote complementary over-the-counter products available for purchase at
the same store, alert patients when they are about to run out of refills,
and so on.
The APRS product includes the following features:
Doctor's Messaging - Doctors can leave refill authorizations, new
prescription instructions, and other important messages on a voice mailbox.
Physicians needing to speak with a pharmacist about an urgent matter during
normal operating hours can immediately transfer out of the system to a live
pharmacist.
Caller ID - The APRS can accept Caller ID information from the local
telephone company. This allows pharmacies to automatically transfer
pre-defined patients and doctors directly to pharmacy staff. Pharmacies are
also able to capture the caller's telephone number and verify it against
their prescription number for validation purposes.
Call Routing - The APRS can answer all incoming calls, greet customers with
a store-specific recording, and then, based on call routing, transfers to
the desired department.
Multi-Language Capability - Callers of varying nationalities can use the
system at the same time, and yet hear prompts spoken in their own native
tongue. The APRS product supports 24 different languages, including Mexican
and Cuban Spanish, Canadian and Franco-French, Slavic languages including
Ukrainian and Polish, and a number of Asian languages. This enables
pharmacies to better serve ethnically diverse customer bases.
In-Store Paging - When calls are transferred, pages can be made over the
store public address system (PA) or the dedicated APRS pharmacy paging
subsystem. This allows physicians to quickly reach pharmacists regarding
urgent patient matters and expedites customer and staff calls to the
manager, among other functions.
In-store Patient Notification - APRS in-store notification enables patients
waiting for their prescription refills to shop throughout the rest of the
store. When the prescription is ready, the customer is paged by their
prescription number.
Voice Mail - Each pharmacy employee can be assigned a voice mailbox,
enabling better communication among employees as well as with management.
The system can also be designed to enable outside callers to leave messages
for employees. This level of flexibility is particularly valuable in
supporting communication across multiple shifts and between part-time and
full-time workers.
Prescription Pick-up Time - The APRS can prompt callers for their preferred
pick-up time, and then confirm for the patient the time by which their
refill will be ready for pick-up. This can help pharmacy staff in
scheduling personnel workloads.
Prescription Status Check - Prescription Status Check enables patients to
call and directly query the pharmacy system to determine whether their
prescription has been filled and what time it will be ready for pick-up.
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Prescription Ready(TM) Out-Dial - The Prescription Ready Out-Dial
capability enhances a pharmacy's compliance program by placing reminder
calls to those patients who have not used all their refills. This
capability also reduces restocking costs and increases pharmacy revenue.
Pharmacy staff can either create the lists of patients to be called, or the
lists can be automatically generated through a direct link to the pharmacy
database.
System Performance Reports - The product's reporting functionality is
designed to help pharmacies gauge how well the system is operating and to
measure performance activity. Reports can be printed automatically on a
daily basis and can also be generated on demand by the system
administrator.
OTHER RETAIL SOLUTIONS PRODUCTS
Photo Ready Out-Dial - The Photo Ready Out-Dial feature calls customers to
remind them to pick up their film development order(s). Photo department
staff prepare the list of customers to be called, or a direct link can be
established with the photo database for automatic generation of calling
lists.
ProNouncer - Pharmacies and grocery stores can complement their own
store-specific or chain-wide advertising efforts with Microlog's patented
automated digital in-store announcement system. The ProNouncer guides
customers to specific promotional items, giving an added boost to sales of
perishable and/or high-margin products, and helping to promote impulse
purchases. The ProNouncer can also automate a store's closing messages or
holiday greetings and can be used to make repetitive public service
messages.
KeyStar(TM) - KeyStar is a separate hardware device that connects directly
to a set of incoming telephone lines, the APRS, and the store/pharmacy
telephone system. KeyStar provides all the necessary interface and
switching to receive and transfer calls to the in-store telephone system.
KeyStar provides an interface to a PA system amplifier for in-store paging,
a music on hold interface for an external music source, and a system
administration telephone interface.
KeyStar offers a number of key benefits designed for the retail pharmacy
market. It allows APRS to interface to any existing telephone system,
supports Caller ID, and minimizes telephone system add on/upgrade expenses.
KeyStar provides a direct modem connection to the APRS for remote system
access, alleviating the need to reallocate or purchase additional telephone
lines. Automated/bypass routing of all incoming telephone lines under
failure conditions - KeyStar is available in two configurations: all-in-one
packaging with Microlog's APRS and software, or as a stand-alone device.
VCS 3500
The Microlog VoiceConnect System 3500 (VCS 3500) is a DOS-based system
which accommodates varying numbers of ports, utilizes proprietary software
modules, and can support up to 12 separate voice response or voice
messaging applications.
Due to the greater versatility of the UNIX System (Intela), as compared to
the DOS operating system (VCS 3500), there has been a shift in sales from
the VCS 3500 to Intela. Consequently, VCS 3500 is not actively sold and
will be discontinued in 1999. The Company continues to support its base of
VCS 3500 customers and receives service revenues from this support, but
expects these revenues to decline since the Company has not updated the
product, including with respect to Year 2000 compliance, since fiscal year
1996.
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SALES AND MARKETING
The Company's Retail Solutions systems are sold primarily through direct sales.
The Intela and The Automated Collector products are sold through a combination
of direct sales, value added resellers, original equipment manufacturers, and
government contract vehicles. It is expected that during the first two quarters
of 1999, uniQue will be sold directly, followed by sales through our channel
partners and resellers.
For 1999, Microlog's strategy will be to focus on the contact center by selling
Intela, The Automated Collector, and uniQue into selected vertical markets.
Channel Sales - A Channel Business team of marketing and sales has been created
to obtain technology partners, as well as resellers of the Microlog's products.
Direct Sales Force - The direct sales force has a sales manager in charge of
North America, sales personnel, sales engineers, marketing manager, and sales
support personnel. The Company's direct sales force is presently based in the
Washington-Baltimore metropolitan area with a satellite office in Salt Lake
City, Utah. The Company compensates its direct and distribution sales personnel
through a base salary plus commissions, which generally represent a percentage
of the net sales for which they are responsible.
The Company's direct sales personnel will continue to focus on national accounts
assigned to them and on certain vertical markets, including retail, health care,
debt collection, wagering, and Federal, state and local government. The
principal potential customers for the Company's interactive communications
applications and products in these vertical markets are organizations which
receive or make a large volume of telephone calls that primarily are repetitive
in nature, and the caller desires information stored on the organizations data
system.
International Sales - The international sales force currently has a general
manager in charge of international sales, sales personnel, sales engineers, and
sales support personnel. The sales force and support group is presently located
in the Washington-Baltimore metropolitan area, and in Eindhoven, The
Netherlands.
In addition to a significant reduction in its international voice processing
operations which occurred as a result of the restructuring, the Company is
currently evaluating options for the transfer or sale of its existing Microlog
Europe interactive voice response operations, sales, and support activities to
organizations in similar lines of business. The Company is continuing to explore
uniQue opportunities in Europe through these organizations.
The Company has entered into non-exclusive distribution agreements with
international companies, including Philips Communication Systems B.V. (Philips)
of The Netherlands, and Jebson and Jessen in Singapore, along with five other
companies in Europe, Asia, and the Middle East, to market and support the Intela
product line worldwide. Philips markets the Intela interactive communications
system as the VoiceManager 800 series. In 1997, the Company signed PTT Telecom
of The Netherlands to a five-year distribution agreement to sell Microlog's
Intela product within the Dutch interactive communications market. PTT Telecom
is a full service telecommunications company providing a wide-range of
communication products to businesses and consumers both nationally and
internationally.
Marketing - The marketing organization currently has a vice president who
manages the Company's product and marketing-related activities. Marketing
consists of product managers and marketing communications personnel. This
organization interfaces with direct and international sales in marketing, and
selling the Company's products, applications, and services.
Promotional Activities - In support of Microlog's sales and marketing strategy
for the coming year, an increased advertising campaign directed specifically at
contact centers, collections, and interactive communications industries is
underway. In addition, an increased presence at industry-specific trade shows is
planned, as well as a direct mail campaign, and the development of new sales
tools and collateral.
SERVICES
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The Company provides limited warranties for parts and labor on its products
ranging from 90 days to two years, from the date of delivery. The Company also
offers its customers annual maintenance contracts under which the Company
maintains and services the systems. Microlog charges an annual fee of
approximately 10% to 16% of the purchase price of its systems for maintenance
contracts covering normal business hours. The fee is highest for maintenance
contracts providing for 24-hour or weekend assistance.
The Company generally performs maintenance for its interactive communications
systems in the Washington, D.C. metropolitan area from its Germantown, Maryland
headquarters, where an inventory of spare parts is maintained. Microlog also has
an agreement with a subcontractor to perform on-site maintenance on its
interactive communications systems nationwide. The Company operates a hotline
which customers with maintenance contracts may use to request assistance or to
ask questions concerning operation of the Company's interactive communications
systems. Microlog can perform many diagnostic procedures remotely and,
historically, has been able to correct many of the difficulties experienced by
its customers through telephone consultation. International maintenance is
performed by the third party distributor and is supported by Microlog service
personnel in Eindhoven, The Netherlands, and Microlog's service center in
Germantown, Maryland.
Microlog also offers a variety of other services to its customers. Microlog will
customize interactive communications systems to a customer's specific needs by
using the application software matrix in the VCS 3500 or the GUI in its Intela,
or by making appropriate changes in the underlying source code in all of
Microlog's products. The Company may charge for this service on a time and
materials basis, or may include the service in the price of the system being
sold. Training on system operations also is offered to customers. In addition,
the Company generally provides certain improvements to its software modules free
of charge to customers who contract for its system maintenance services.
BACKLOG
As of October 31, 1998, the Company had a backlog of existing orders for voice
processing systems totaling $2.0 million. The backlog, as of October 31, 1997,
was $2.9 million. The Company has experienced fluctuations in its backlog at
various times during the past attributable primarily to the seasonality of
governmental purchases. The Company anticipates that all of the outstanding
orders at October 31, 1998 will be shipped and the sales recognized during
fiscal year 1999. Although the Company believes that its entire backlog of
orders consists of firm orders, because of the possibility of customer changes
in delivery schedules and delays inherent in the government contracting process,
the Company's backlog as of any particular date may not be indicative of actual
sales for any future period.
COMPETITION
The interactive communications industry is highly competitive and the Company
believes that competition will intensify. The Company competes with a large
number of companies, which produce interactive communications products offering
one or more of the 14 major voice processing applications performed by the
Company's products. Microlog's competitors include companies such as IBM,
InterVoice, Inc., Lucent, Periphonics, Brite and Syntellect, that have
emphasized sales of systems with interactive voice response applications. Direct
competition with the Company's interactive communications systems also arises
from a substantial number of companies, such as Centigram and Active Voice, that
focus on the market for small or medium-size voice messaging (voice mail or
automated attendant) systems. In addition, the Company also competes with
dealers and distributors that sell voice products of these and other
competitors. New or enhanced products can be expected from the Company's
competitors. It is also likely that there will be new entrants into the
interactive communications industry because of the absence of any major
technological barriers to entry.
The contact center marketplace in which the uniQue product is expected to
compete is also very competitive. New competitors are entering the market
frequently. Some are long established telephony vendors with a large market
share such as Lucent, Nortel, and Aspect, while others are new start-up
companies such as Interactive Intelligence, ATIO, and Apropos. Since the market
is large and expanding rapidly, the Company believes competition will continue
to emerge among existing vendors and expects new competitors to enter this
marketplace.
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Competition for the sale of interactive communications systems has been based in
part on the application required by the customer. In marketing its Intela and
VCS 3500 products, the Company places emphasis on the 12 major interactive
communications functions (refer to "Products" section) that can be performed and
the ability of these systems to be expanded to incorporate additional
applications. As a result of this emphasis on openness and expandability, the
Company believes that many of its competitors' products cannot be customized as
easily to the user's specific needs as the Intela and VCS 3500.
In marketing its Retail Solution, the Company places emphasis on the suite of
applications and solutions that these applications offer. Potential customers
have the ability to add additional solutions as the need arises. The Company is
also able to customize these applications to meet the user's needs. The Company
is actively developing additional features to the Retail Solution and new
solutions for release in fiscal 1999.
Marketing and product recognition also play a substantial role in competition
within the interactive communications industry and within particular vertical
markets. Most of the Company's competitors have considerably greater financial,
marketing, and sales resources than Microlog. Many of these competitors have
concentrated on one or two voice applications or on specific vertical markets
and may enjoy advantages in selling to customers seeking only those applications
or to companies in those markets. The Company believes that it has advantages
over some competitors in sales to government and retail pharmacy customers
because of its experience in marketing products to these customers and in
participating in competitive procurements.
The Company believes that the other principal factors affecting competition in
the interactive communications market are product applications and features,
quality and reliability, customer support and service, and price.
The Company believes that it competes favorably with respect to these factors.
RESEARCH AND DEVELOPMENT AND PRODUCT ENGINEERING
Research and development expenses for 1998 were focused on the Intela, TAC,
APRS, and uniQue products. uniQue Agent was announced and substantially
completed in November 1998 as a product offering available for customer trial in
the contact center market. uniQue Agent is the first in a series of offerings
the Company is developing to provide a comprehensive range of solutions within
the contact center market in fiscal year 1999. The uniQue development activities
will also be a major focus in fiscal year 1999 for the Company's research and
development efforts. Intela was enhanced for new features and Year 2000
compliance in the System Release 6 (SR6) version of the product. TAC was
enhanced to meet market requirements to readily integrate with both custom and
widely available collections databases in use in customer sites. APRS was
extended and customized for a number of customer opportunities in 1998 which did
not materialize. A significant amount of custom engineering is undertaken by the
Company in providing special features, application development, and system
integration services to our customers. The Company is subject to the risks that
it may not have the financial resources to support its research and development
strategy.
The following table sets forth for the periods indicated the Company's research
and development expenditures and the percentage of interactive communications
net sales represented by these expenditures.
Research and Development Expenditures
(In thousands, except percentage amounts)
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
----------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Research and development expense $2,094 $3,579 $3,256
Percentage of voice
processing net sales 13% 19% 22%
</TABLE>
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Costs incurred in basic research and development are expensed as incurred. The
Company has determined that the process of establishing technological
feasibility with its new products is completed approximately upon the release of
the products to its customers. Accordingly, software development costs are
expensed as incurred.
MANUFACTURING AND OPERATIONS
The Company assembles its own equipment using standard parts obtained from
outside sources. The proprietary aspects of the Company's systems are primarily
in the software provided with the equipment and in the specific applications
development designed for the customer. Systems are built to order as they vary
in size and sophistication of software modules. Equipment assembly, along with
testing and quality control, are performed at its Gaithersburg, Maryland
facility. The Company has a lease on a manufacturing and training facility
located in Gaithersburg, Maryland which expires in September, 1999. Microlog
currently has 6 employees in its manufacturing group. The Company generally uses
standard parts and components obtained from a variety of computer vendors and
specially configures these components to produce the hardware for its systems.
Certain components used in the Company's products are presently available from
limited sources. To date, the Company has been able to obtain supplies of these
components in a timely manner from these sources.
RESTRUCTURING OF OPERATIONS
In February 1999, the Company restructured its voice processing operations in
order to bring expenses in line with forecasted revenues. In connection with
this restructuring, the Company reduced its voice processing workforce by
approximately 25% and wrote off equipment associated with its headcount
reductions.
The Company will incur a restructuring charge of approximately $260,000 in the
second quarter of fiscal 1999, for severance and benefits costs for the
reduction of approximately 25 employees in February 1999. Temporary employees
and contractors will also be reduced. Included in the restructuring charge is a
write-off of assets of approximately $50,000 which includes the write-off of
equipment associated with headcount reductions.
As a result of these restructuring activities, the Company expects to reduce its
annual voice processing operating expenses, in the form of reduced salaries and
wages, by approximately $1.8 million. The Company expects to complete most of
the actions associated with the restructuring by the end of the second quarter
of fiscal year 1999.
The Company expects to also decrease expenses as a result of the reduced
headcount in areas such as travel, training and communications expenses.
Additionally, the Company is initiating a cost reduction plan in areas such as
advertising, recruiting, office and computer supplies, and professional fees to
further reduce voice processing operating expenses. As a result of the
restructuring and cost reduction plan the Company expects to reduce total voice
processing operating expenses by approximately $4.0 million annually and
approximately $2.3 million for the remainder of fiscal year 1999, starting in
the second quarter of fiscal year 1999.
In addition to a significant reduction in its international voice processing
operations which occurred as a result of the restructuring, the Company is
currently evaluating options for the transfer or sale of its existing Microlog
Europe interactive voice response operations, sales, and support activities to
organizations in similar lines of business. The Company is continuing to explore
uniQue opportunities in Europe through these organizations.
SOFTWARE PROTECTION, TECHNOLOGY LICENSES, AND TRADEMARKS
The Company regards its software as proprietary and has implemented protective
measures both of a legal and a practical nature to ensure that the software
retains that status. The Company derives protection for its software by
licensing only the object code to customers and keeping the source code
confidential. Like many other companies in the interactive communications
industry, Microlog does not have patent protection for its software (although
some of the inventions for which Microlog has received patents can be
implemented in software). It, therefore, relies upon the copyright laws to
protect against unauthorized copying of the object code of its software, and
upon copyright and trade secret laws for the protection of the source code of
its software. Despite this protection, competitors could copy certain aspects of
the Company's software or hardware or obtain information which the Company
regards as a trade secret.
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The Company has patents on an Interactive Audio Telecommunications Message
Storage, Forwarding and Retrieval System, Software Switch for Digitized Audio
Signals, Automated Telephone System Using Multiple Languages, Telecommunications
System for Transferring Calls without a Private Branch Exchange, Detection of
TDD Signals in an Automated Telephone System, Automated Telephone System with
TDD Capabilities, Automated Announcement System, and Methods for Communicating
with a Telecommunications Device for the Deaf (TDD). The Company also has a
pending patent application on an Apparatus and Method for Coupling an Automated
Attendant to a Telecommunications System. EVR, Microlog, Call Installer, Truant,
CINDI, ProNouncer, CallStar, CallStar FXD, and APRS are all registered
trademarks owned by the Company. Intela, Intelaware, Intelaview, VCS Intela,
Intela0Powerdial, KeyStar, Connecting People to a World of Information, The
Automated Collector, uniQue, uniQue Agent, and uniQue The Best Seat In The House
are all trademarks or service marks which are the subject of applications for
registration owned by the Company which are pending in the United States Patent
and Trademark Office. INTEL Corporation has filed oppositions with the U.S.
Trademark Trial and Appeal Board to registration by the Company of the marks
Intela, VCS Intela, Intelaware, and Intelaview. Discovery is currently ongoing
in this consolidated opposition proceeding. The Company is currently using, and
claims common law rights in the following additional, unregistered marks: Voice
Connect, Genesis, Voice Path, VCS 3500, Retail Solution, RLT, and Release Line
Trunking. In addition, the Company enters into confidentiality agreements with
its employees, distributors, and customers and limits access to and distribution
of its software, documentation, and other proprietary information. There can be
no assurance that the steps taken by the Company to protect its proprietary
rights will be adequate to deter misappropriation of its technology. Further,
there can be no assurance that any patent issued or that its registered
copyrights can be successfully defended. In any event, the Company believes that
factors such as technological innovation and expertise and market responsiveness
are more important than the legal protections described above.
PERFORMANCE ANALYSIS AND SUPPORT SERVICES
GENERAL
Since the early 1970s, the Company and its subsidiaries have been providing
performance analysis and technical and administrative support services
(principally in the form of data processing and analysis, engineering and
scientific analysis, and computer services) to government and commercial
customers. These services, which comprised the Company's original business,
presently are provided through the Company's subsidiary, Old Dominion Systems
Incorporated of Maryland. The Company believes that its performance analysis and
support services business will continue to provide a stable stream of sales,
although its interactive communications business offers greater potential for
growth.
The principal customer for the Company's performance analysis and technical and
administrative support services is The Johns Hopkins University's Applied
Physics Laboratory (APL), a United States Navy contractor, for which the Company
or its subsidiaries have been performing services since 1972. Sales from
contracts with APL accounted for 38%, 39% and 44% of the Company's net sales for
fiscal 1996, 1997, and 1998, respectively.
The Company's performance analysis and support services personnel perform a
variety of analytical and science-related support services under several
contracts. These services usually are performed on the customer's premises or at
test-site locations. The Company's technical staff works jointly with the
customer's scientists and engineers in the acquisition, processing, analysis,
and management of certain major weapon systems data. This work is directed to
quantifying and reducing the impact of current and future threats to the United
States' submarine fleet through the use of ocean sensor systems. The technical
support rendered by the Company includes real-time data acquisition, digital
signal processing, software development and systems applications, data
management, and data analysis.
In addition, the Company supports naval strategic programs through its role as
an independent evaluator of the performance of submarine-based strategic missile
systems. This is accomplished through extensive data processing, technical
evaluation, and data analysis relating to sonar, fire control, missile,
launcher, and navigation subsystems.
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The Company's performance analysis and support services employees also engage in
communications testing and evaluation for mobile communications network
exercises. The Company's communications analysts assist in preparing
presentations to the Navy and in designing and implementing communications
analysis software.
The Company's employees perform various technical support services in connection
with several Ballistic Missile Defense Organization (BMDO) projects. These
include advanced technical support in the design, development, and
implementation of space-qualified equipment, systems analysis, and the operation
of a VAX computer-based mission control center for the MSX mission.
CONTRACTS
The Company's contracts are generally one-year in duration, and many of such
contracts contain two one-year extension options, with a fixed level of work
authorized under the contract. Several of the Company's larger contracts with
APL have been renewed or re-awarded to the Company annually, and the level of
work authorized at the time of contract renewal has provided for, in the
aggregate, the same or a greater level of services.
The Company provides services under three types of contracts. The majority of
contracts are on a time-and-materials basis, pursuant to which the Company
receives a pre-set fee for all services provided under the contract, without
regard to the Company's cost of supplying these services, and is reimbursed only
for the cost of materials. Other contracts are on a purchase order basis which
operates similar to a time and materials contract, and on a cost plus fixed fee
basis. Occasionally, the Company experiences delays in contract awards, contract
funding, and payment, which the Company believes is customary under contracts
which involve performance of services for Federal Government agencies.
The Company monitors performance under existing contracts and requests for
proposal (RFPs) for performance analysis and support services by contractors or
government agencies. The Company has received a number of blanket contracts by
responding to RFPs. In order to increase the new contracts, the Company must
locate skilled programmers and other technical personnel with the qualifications
specified by the open requisitions. The Company uses agencies and internal
resources to locate these personnel. The Company believes that its reputation in
the industry enables it to attract qualified individuals for inclusion in the
Company's proposals.
COMPETITION
The Company's Government contracts can be opened to competitive bidding upon
their expiration at the discretion of the contractor or agency. Although
contracts presently comprising a substantial percentage of the Company's sales
have been renewed annually, these contracts may and have been open to
competitive bidding. There can be no assurance that these contracts will be
awarded to the Company if competitive bidding occurs.
The Company encounters substantial competition in its procurements. The
Company's competitors include, Allied Signal, Comsys, EISI, Orbital, SAIC, and
Sachs/Freeman Associates. The Company has instituted policies and procedures
designed to maintain a low overhead to enhance its ability to compete with
respect to new contracts and to existing contracts that are to be renewed or
extended. During the last three years, the contracts that have been lost through
competitive bidding or otherwise have not been material to the Company, either
individually or in the aggregate. During this three-year period, the Company has
received several new contracts as a result of competitive procurements and also
increases in the level of work authorized under contracts which have been
renewed or re-awarded to the Company.
The Company has had no success in obtaining contracts with government agencies
or contractors other than APL. Many of these contracts have been renewed with
the incumbent on a sole source basis, rather than being competitively bid. In
the case of contracts that have been opened to competitive bidding, the contract
incumbents generally have had advantages because of their prior relationships
with the agencies and the experience of their personnel in performing the
requested services. In addition, incumbents or other competitors often have
substantially greater financial and other resources than the Company.
BACKLOG
17
<PAGE>
As of October 31, 1998, the Company had a backlog of funding on existing
contracts for performance analysis and support services totaling $0.2 million.
By comparison, the backlog as of October 31, 1997 was $2.9 million. The decrease
in backlog was primarily due to the types of contracts that the Company had in
backlog at October 31, 1998, as compared to October 31, 1997. At October
31,1998, the Company's contracts consisted primarily of indefinite delivery,
indefinite quantity (IDIQ) contracts which generally do not have a funding
amount and therefore are not included in backlog. At October 31, 1997, the
Company had a contract portfolio which included fixed price and time and
materials contracts which have a funding amount, as well as IDIQ contracts which
generally do not have a funding amount. The Company estimates that the entire
$0.2 million of backlog at October 31, 1998 will be recognized as sales in
fiscal year 1999. Because of the delays inherent in the government contracting
process or possible changes in defense priorities or spending, the Company's
backlog as of any particular date may not be indicative of actual sales for any
future period. Although the Company believes that its backlog of funding on
existing contracts is firm, the possibility exists that funding for some
contracts on which the Company is continuing to work, in the expectation of
renewal, may not be authorized. In addition, the Government has the right to
cancel contracts, whether funded or not funded, at any time, although to date
this has not occurred.
GOVERNMENT REGULATION
In order to maintain contracts with contractors or Government agencies, the
Company must comply with a variety of regulations and Department of Defense
guidelines, including regulations or guidelines covering security, record
keeping, and employment practices. The majority of the employees assigned to the
Company's contracts with contractors or agencies are required to have security
clearances. The Company historically has not experienced any significant
difficulty in obtaining the necessary security clearances. The Company's sales
under these contracts are subject to audit by the Defense Contract Audit Agency
(the DCAA). The DCAA has completed audits through fiscal 1992, and any
adjustments required as a result of these audits have been minor. The
implementation by the Federal Government of spending cutbacks, or a change in
national defense priorities, could reduce the Company's sales.
EMPLOYEES
At January 15, 1999, the Company and its subsidiaries employed a total of 263
persons, including three part-time employees. Of these personnel, 106 are
engaged principally in the Company's interactive communications systems
operations,151 are engaged in performance analysis and support services, and six
serve as officers or managers or perform administrative services for the Company
and all of its subsidiaries.
In February 1999, the Company restructured its interactive communications
systems operations which included a workforce reduction of approximately 25%.
The Company's interactive communications systems operations currently employs
approximately 77 persons and six will continue to serve as officers or managers
or perform administrative services for the Company and all of its subsidiaries.
The Company believes that its success will continue to depend, in part, on its
ability to attract and retain skilled sales and marketing, technical, and
management personnel. Because of the high turnover rate typically associated
with sales and marketing personnel, the Company anticipates that it will need to
replace some of the sales and marketing personnel who do not meet the Company's
performance expectations. The Company has not experienced any significant
difficulty in hiring qualified technical personnel. Neither the Company nor any
of its subsidiaries is a party to a collective bargaining agreement, and the
Company considers its employee relations to be satisfactory.
ITEM 2. PROPERTIES
In May 1998, the Company entered into a 15 year non-cancelable lease commitment,
commencing on or about June 1999, for office space intended to consolidate the
Company's headquarters, warehouse, and training facilities. The Company and its
new landlord are in the process of discussing potential alternatives concerning
the new facility. At this time management cannot predict the potential outcome
of these discussions. In August 1998, the Company sold its 24,000 square foot
office building and land and committed to lease back the building prior to its
occupation of the new leased space.
18
<PAGE>
The Company presently leases and occupies a 24,000 square foot building in
Germantown, Maryland, which it uses for its principal executive offices and its
interactive communications operations center. The Company also leases 22,700
square feet of office space in Rancho Cordova, California, which was the
headquarters of Genesis Electronics acquired by the Company in 1991, under a 10
year lease, which began in 1989 and expires in 1999. Additionally, the Company
leases and occupies 12,000 square feet in Gaithersburg, Maryland, which it uses
for production and warehousing of its interactive communications products. In
February 1993, the Company entered into a sublease for a five-year term for its
Rancho Cordova facility. The sublease was extended in 1998 and is now
coterminous with the lease that expires in April 1999.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to litigation from time to time arising from its
operations and receives occasional letters alleging infringement of patents
owned by third parties. Management believes that such litigation and claims are
without merit and will not have a material effect on the Company's financial
position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated herein by reference from
"Price Range of Common Stock" and "Dividend Policy" on page 35 of the Company's
Annual Report to Shareholders.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is incorporated herein by reference from
"Selected Consolidated Financial Data" on page 36 of the Company's Annual Report
to Shareholders.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this item is incorporated herein by reference from
pages 30 through 36 of the Company's Annual Report to Shareholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company, including Consolidated
Statements of Operations for the years ended October 31, 1998, 1997, and 1996,
Consolidated Balance Sheets as of October 31, 1998 and 1997, Consolidated
Statements of Changes in Stockholders' Equity for the years ended October 31,
1998, 1997, and 1996, Consolidated Statements of Cash Flows for the years ended
October 31, 1998, 1997, and 1996 and Notes to Consolidated Financial Statements,
together with the report thereon of PricewaterhouseCoopers LLP dated March 17,
1999, are incorporated by reference from pages 10 through 27 of the Company's
Annual Report to Shareholders.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
19
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Shown below are the names of all Directors and executive officers of the
Company, the age of each such person as of January 18, 1999, all positions and
offices held by each such person, the period during which each person has served
as such, and the principal occupations and employment of each such person during
the last five years:
RICHARD A. THOMPSON, age 52, has been President and Chief Executive Officer
of the Company since January 1, 1997. He was President and Chief Operating
Officer of the Company from June 1992 through January 1, 1997. Mr. Thompson was
elected a director of the Company in September 1992. Prior to joining Microlog
Corporation, Mr. Thompson was President and a director of General Kinetics,
Inc., a diversified manufacturing company from October 1989 to December 1991.
Other positions he has held have been as President of Thompson Associates, a
management consulting firm from 1988 to 1989 and as Marketing Manager with
General Electric Company from 1985 to 1988. Mr. Thompson is also a Captain in
the U. S. Naval Reserve.
JOE J. LYNN, age 67, presently serves as a part-time consultant to the
Company, having retired from his position as Chief Development Officer of the
Company, in which he served from January 1, 1997 through January 15, 1998.
Previously, Mr. Lynn was Chief Executive Officer of the Company from May 1, 1991
through January 1, 1997 and President of the Company from October 1989 to June
1992, and prior thereto he served as Executive Vice President of the Company and
as President of the Company's subsidiary, Microlog Corporation of Maryland. He
has been a director of the Company since its formation in 1969. From 1966 until
1970, Mr. Lynn was employed as a manager with DBA Systems, Inc. From 1961 to
1966, he served as a manager at the Kennedy Space Flight Center for RCA, which
is presently a subsidiary of General Electric Company.
ROBERT E. GRAY, JR., age 57, has been a director of the Company since 1977.
He is currently Executive Vice President of Prosperity Bank and Trust, in
Springfield, Virginia. Mr. Gray was appointed to Prosperity Bank and Trust's
Board of Directors in December 1997. He was employed by Hallmark Bank & Trust
Co. from 1985 to 1992 - as Director and Executive Vice President from 1989 to
1992, and prior thereto as Senior Vice President and Chief Lending Officer. From
1992 to 1993, he served as Senior Vice President of Suburban Bank of Virginia,
NA in McLean, Virginia.
DAVID M. GISCHE, age 49, has been a director of the Company since April
1985. Mr. Gische, an attorney, has been associated with the law firm of Ross,
Dixon & Bell in Washington, D.C. since November 1983. From September 1978 until
November 1983, Mr. Gische was associated with the Washington, D.C. law firm of
Hogan & Hartson LLP, counsel to the Company.
DAVID B. LEVI, age 64, has been a director of the Company since December
1997. Since November, 1998, Mr. Levi also has served as a consultant to the
Company. Mr. Levi served as President of Natural MicroSystems Corporation, a
provider of hardware and software for developers of high-value
telecommunications solutions from June 1991 to April 1995. In November 1995, Mr.
Levi became President of Voice Processing Corp. (VPC). and Mr. Levi served as
Chief Operating Officer of VCS until his retirement in October 1997. Prior to
1991, Mr. Levi held Chief Executive Officer and Chief Operating Officer
positions at Raytheon Data Systems (a division of Raytheon Corp.), Centronics
Data Computer Corp., and Raster Technologies, Inc., and consulted to Regional
Bell Operating Companies.
STEVEN R. DELMAR, age 43, the Company's Executive Vice President and Chief
Financial Officer, has been Executive Vice President of the Company since
October 1989 and was President of Microlog Corporation of Maryland, a
wholly-owned subsidiary of the Company, from May 1991 to July 1992. Mr. Delmar
was Microlog's Chief Financial Officer from January 1987 to May 1991. He served
as Chief Operating Officer of Microlog (rather than Chief Financial Officer)
from May 1991 until July 1992, and following the hiring of Mr. Thompson as
President and Chief Operating Officer, Mr. Delmar resumed his position as Chief
Financial Officer. He was Vice President of the Company from January 1987 to
October 1989. Since 1979, Mr. Delmar has held various offices with the Company
and its subsidiaries, including Assistant Comptroller, Comptroller, General
Manager and Vice President.
20
<PAGE>
A certified public accountant, Mr. Delmar held accounting positions with Bechtel
Power Corporation, a commercial construction firm, and the Veterans
Administration prior to his employment with Microlog.
DEBORAH M. GROVE, age 46, has been President of Old Dominion Systems
Incorporated of Maryland, a wholly-owned subsidiary of the Company, since May
1991. From 1983 until May 1991, Ms. Grove was Vice President of Old Dominion
Systems Incorporated of Maryland and from 1985 until May 1991, Vice President of
Old Dominion Services, Inc. Ms. Grove holds a Master of Science degree in
Business and Finance and a Bachelor of Science degree in Business
Administration.
JOHN C. MEARS, age 45, has been the Senior Vice President Product
Development for Microlog since August 1996. Mr. Mears was with International
Business Machines (IBM) from 1990 to 1996 in key management positions associated
with their IVR, CTI, and Network product departments. From 1978 to 1990 he held
various technical, business development, and management positions in multiple
divisions of IBM. Mr. Mears holds both a bachelor's and master's degree in
electrical engineering from the University of Florida.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Each director and officer of the Company, and each person who beneficially
owns more than 10% of the Company's Common Stock, is required by Section 16(a)
of the Securities Exchange Act of 1934 to file reports with the Securities and
Exchange Commission ("SEC") of beneficial ownership of the Company's equity
securities and certain changes to such ownership. Based on its review of the
reports and written representations furnished by the persons required to file
reports under Section 16(a), Richard A. Thompson and Steven R. Delmar each filed
one late report with the SEC of one transaction involving changes in beneficial
ownership. This was due to the fact that the purchase was made through the
Company's 401k plan which could not provide share price and number of shares
purchased in a timely manner.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION
The following table shows, for the fiscal years ending October 31, 1996,
1997, and 1998, the salary, bonus, and certain other forms of compensation paid
or accrued for those years by the Company and its subsidiaries to the Chief
Executive Officer and each of the three other executive officers whose salary
and bonus compensation exceeded $100,000 in fiscal 1998 ("named executive
officers").
<PAGE>
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM COMPENSATION
------------------- ----------------------
AWARDS PAYOUTS
------ -------
SECURITIES
RESTRICTED UNDERLYING
OTHER ANNUAL STOCK OPTIONS/ LTIP ALL OTHER
FISCAL YEAR SALARY BONUS ($) COMPENSATION AWARD(S) SARS PAYOUTS COMPENSATION
NAME AND PRINCIPAL POSITION ($)(A) ($)(B) ($) (#) ($) ($)(C)
- --------------------------- ------------ ---------- ----------- ----------------- ------------ ----------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Richard A. Thompson 1998 215,000 22,952 11,491
President and Chief 1997 181,664 23,952 12,035
Executive Officer 1996 164,994 31,500 16,341 150,000 (d) 13,000
Steven R. Delmar 1998 165,006 6,855 11,443
Executive Vice President 1997 143,333 9,479 10,618
and Chief Financial Officer 1996 135,000 25,500 8,861 10,555
Deborah M. Grove 1998 135,013 23,674 10,525
President of subsidiary, 1997 123,334 10,000 18,332 9,732
Old Dominion Systems 1996 115,003 23,500 12,609 9,117
Incorporated of Maryland
Joe J. Lynn 1998 160,158 25,288 4,172
Retired Chief Executive 1997 191,671 16,489 11,424
Officer and Chief Development 1996 184,206 24,500 22,410 10,908
Officer
John Mears (e) 1998 135,013 7,000 10,281
Senior Vice President Product
Development
</TABLE>
(a) Includes deferred compensation and consulting fees.
For fiscal 1998, 1997, and 1996 Mr. Lynn's deferred compensation included
in his salary was $14,679, $15,188, and $14,200, respectively. Also
included in the 1998 compensation is deferred compensation that was earned
in his account of $20,509. Mr. Lynn retired in January 1998. The amounts
shown in the table include consulting fees from January 1998 through the
end of the fiscal year of $90,576.
(b) Other annual compensation consists primarily of reimbursements under the
Company's Executive Medical Reimbursement Plan, paid personal leave, and
personal use of automobiles.
(c) All other compensation consists of 401k matching contributions and pension
plan contributions. For fiscal 1998 Mr. Thompson's 401k matching and
pension contributions were $1,891, and $9,600 respectively. For fiscal 1998
Mr. Delmar's 401k matching and pension contributions were $1,843, and
$9,600 respectively. For fiscal 1998 Ms. Grove's 401k matching and pension
contributions were $1,801, and $8,724 respectively. For fiscal 1998 Mr.
Lynn's 401k matching and pension contributions were $646, and $3,526
respectively.
(d) Mr. Thompson also received options to purchase 100,000 additional shares
based upon achieving certain targets; such targets were not met and the
options expired.
(e) Mr. Mears became an executive officer following determination of the Board
in January 1999. His salary for 1999 has been set at $165,000, and he
received stock options in fiscal 1999 of 30,000 shares.
STOCK OPTIONS
The following table contains information with respect to grants of stock
options to each of the named executive officers during the fiscal year ended
October 31, 1998. All such grants were made under the Employee Plan.
21
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL
REALIZABLE VALUE AT
INDIVIDUAL GRANTS ASSUMED ANNUAL
------------------------------------------------------------ RATES OF STOCK PRICE
% OF TOTAL APPRECIATION FOR
OPTIONS GRANTED OPTION TERM (A)
NUMBER OF TO EMPLOYEES EXERCISE EXPIRATION -----------------------
OPTIONS GRANTED IN FISCAL YEAR PRICE ($/SH) DATE 5% ($) 10% ($)
--------------- -------------- ------------ ---- ----------- -------
<S> <C> <C> <C> <C> <C> <C>
Richard A. Thompson (b) 0 0% $0.000 N/A $0 $0
Steven R. Delmar (b) 0 0% $0.000 N/A $0 $0
Deborah M. Grove (b) 10,000 0.9% $0.9375 2008 $7,925 $18,225
John Mears (b) 30,000 2.9% $0.9375 2008 $23,775 $54,675
</TABLE>
- --------------------
(a) Share prices for Mr. Thompson assuming a 5% and 10% annual appreciation at
the end of the term of his option are $0 and $0, respectively; share prices
for Mr. Delmar assuming a 5% and 10% annual appreciation at the end of the
term of his option are $0 and $0 respectively; share prices for Ms. Grove
assuming a 5% and 10% annual appreciation at the end of the term of her
option are $1.73 and $2.76, respectively, and shares prices for Mr. Mears
assuming a 5% and 10% annual appreciation at the end of the term of her
option are $1.73 and $2.76, respectively.
(b) These options vest over a five year period with 20% vesting at the end of
each year.
The following table provides information concerning the exercise of stock
options by the named executive officers during fiscal 1998.
AGGREGATED OPTION EXERCISES IN LAST FISCAL
YEAR, AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING IN-THE-MONEY OPTIONS AT
UNEXERCISED OPTIONS FISCAL YEAR
AT FISCAL YEAR END ($)
END (#)
SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
NAME ON EXERCISE (#) REALIZED ($) UNEXERCISABLE UNEXERCISABLE (A)
---- --------------- ------------ ------------- -----------------
<S> <C> <C> <C> <C>
Richard A. Thompson 0 0 190,000 / 40,000 $0 / $0
Deborah M. Grove 0 0 19,000 / 16,000 $625 / $0
Steven R. Delmar 0 0 59,000 / 6,000 $0 / $0
John Mears 0 0 12,000 / 33,000 $0 / $0
</TABLE>
- -----------------------------
(a) Calculations based on closing price of stock of $1.0625 on October 31, 1998.
EMPLOYMENT, DEFERRED COMPENSATION AND CONSULTING AGREEMENTS
The Company is a party to an employment agreement with Mr. Thompson. The
agreement provides for employment of Mr. Thompson through December 31, 1999. Mr.
Thompson's annual salary under his employment agreement is subject to increase
and discretionary bonuses each year as determined by the Board of Directors. The
employment contract entitles Mr. Thompson to certain fringe benefits, including
insurance coverage and various executive perquisites. Upon termination of
employment without cause, the existing base salary, plus all benefits, will be
paid in monthly installments for twelve months. The employment agreement also
entitles Mr. Thompson to continue to serve as a director of the Company for so
long as he continues to be an officer of the Company.
The Company is a party to a consulting agreement with Mr. Lynn, which
provides for Mr. Lynn to serve as a consultant through December 31, 1999. The
consulting agreement provides for Mr. Lynn to perform consulting services
reasonably requested by the Company. Mr. Lynn is to receive annual compensation
of approximately $118,000 per year and certain benefits, generally those
available to the Company's executive officers, but not including participation
in the incentive stock option plan or executive bonus plan.
The Company is a party to a noncontributory deferred compensation agreement
with Mr. Lynn under which the Company is obligated to make payments to Mr. Lynn
(or his beneficiaries) over the ten-year period subsequent to his retirement (on
or after age 65), permanent disability, or death. The aggregate amount owed to
Mr. Lynn under this agreement is payable either in equal monthly installments
over the ten-year period or in an appropriately discounted single sum payment
(at the election of Mr. Lynn). This amount is determined by multiplying $2,500
by the number of months of employment during the period April 1, 1988 to January
1, 1995 and adding an initial
22
<PAGE>
contribution of $10,000. During the fiscal year ended October 31, 1998, the
Company accrued $14,679 in interest for Mr. Lynn under this contract.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None.
COMPENSATION OF DIRECTORS
Compensation of Mr. Gische, Mr. Gray, and Mr. Levi through fiscal 1998,
consisted of $2,500 per quarter with a maximum of $10,000 per year for each such
director (no per meeting fees were paid). Employee directors are not paid for
attending meetings of the Board of Directors.
The Company has a non-employee director stock option plan (the "Director
Plan"), which was approved by the shareholders, pursuant to which 250,000 shares
of Common Stock are presently reserved for issuance to non-employee directors of
the Company upon exercise of options granted under the Plan. The Board has
adopted amendments to the Director Plan, including the ability to make
discretionary grants to directors serving as consultants, which amendments are
subject to shareholder approval. The Company believes that options issued under
the Director Plan create an incentive for non-employee directors to expend
maximum effort for the growth and success of the Company. Options for 4,000
shares of Common Stock were granted during fiscal 1998 to each of Messrs.
Gische, Gray, and Levi under the Director Plan. The option price of all options
granted under the Director Plan equal the fair market value of the shares
underlying the option on the date of grant. Options granted under the Director
Plan expire if not exercised within ten years from the date of the grant of the
option.
Since November, 1998 Mr. Levi has been a non-employee member of the new
Microlog Office of the President. The company has been compensating Mr. Levi in
the amount of $1,000 for each Meeting of the Office of the President he attends,
commencing with the first meeting on November 5, 1998, and proposes to grant Mr.
Levi an option to purchase 20,000 shares of the Company's common stock pursuant
to the Company's Director Plan, if the proposed amendment to the Director Plan
is approved by the shareholders. This arrangement is expected to continue into
the third quarter of fiscal 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of February 10, 1999 with
respect to the ownership of shares of Common Stock by (i) owners of more than 5%
of the Company's outstanding Common Stock, (ii) each director and nominee for
director of the Company, (iii) each of the named executive officers of the
Company, and (iv) all directors and officers of the Company as a group. The
information is based on the most recent filings with the SEC by such persons or
upon information provided by such persons to the Company. Unless otherwise
indicated, the persons shown in the table are believed to have sole voting and
investment power with respect to the entire number of shares reported.
<TABLE>
<CAPTION>
NAME AND ADDRESS OF NUMBER OF SHARES PERCENTAGE OF
BENEFICIAL OWNER (1) BENEFICIALLY OWNED OWNERSHIP (2)
- -------------------- ------------------ -------------
<S> <C> <C>
Hathaway & Associates, Ltd 373,000 8.7%
119 Rowayton Avenue
Rowayton, Connecticut 06853
Joe J. Lynn 310,000 7.2%
20270 Goldenrod Lane
Germantown, MD 20876-4070
Richard A. Thompson 222,000 (3) 5.0%
20270 Goldenrod Lane
Germantown, MD 20876-4070
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Steven R. Delmar 112,300 (4) 2.6%
20270 Goldenrod Lane
Germantown, MD 20876-4070
Deborah M. Grove 53,711 (5) 1.2%
20270 Goldenrod Lane
Germantown, MD 20876-4070
David M. Gische 48,000 (6) 1.1%
20270 Goldenrod Lane
Germantown, MD 20876-4070
John C. Mears 44,000 (7) 1.0%
20270 Goldenrod Lane
Germantown, MD 20876-4070
Robert E. Gray, Jr. 35,520 (8) *
20270 Goldenrod Lane
Germantown, MD 20876-4070
David B. Levi 12,000 (9) *
20270 Goldenrod Lane
Germantown, MD 20876-4070
All officers and directors as
a group (10 persons) 821,081 (10) 17.6%
</TABLE>
- ----------------------------
* Less than 1% of the shares outstanding.
(1) In accordance with Rule 13d-3 under the Securities Exchange Act of 1934, a
person is deemed to be the beneficial owner of a security for purposes of
the Rule if he or she has or shares voting power or investment power with
respect to such security or has the right to acquire such ownership within
60 days. As used herein, "voting power" is the power to vote or direct the
voting of shares, and "investment power" is the power to dispose or direct
the disposition of shares.
(2) For the purpose of computing the percentage of ownership of each
beneficial owner, any securities which were not outstanding but which were
subject to options, warrants, rights, or conversion privileges held by
such beneficial owner exercisable within 60 days were deemed to be
outstanding in determining the percentage owned by such person but are not
deemed outstanding in determining the percentage owned by any other
person.
(3) Includes 190,000 shares that may be acquired by Mr. Thompson within 60
days of the record date upon the exercise of stock options and
approximately 25,000 shares in a 401k Plan. Does not include 40,000 shares
that may be acquired by Mr. Thompson more than 60 days after the record
date upon the exercise of stock options. The percentage of ownership as
been rounded up to 5.0%, but Mr. Thompson is not, as of the date hereof,
the beneficial owner of 5% or more of the Common Stock.
(4) Includes 59,000 shares that may be acquired by Mr. Delmar within 60 days
of the record date upon the exercise of stock options and approximately
24,300 shares in a 401k Plan. Does not include 6,000 shares that may be
acquired by Mr. Delmar more than 60 days after the record date upon the
exercise of stock options.
24
<PAGE>
(5) Includes 21,000 shares that may be acquired by Ms. Grove within 60 days of
the record date upon the exercise of stock options. Does not include
24,000 shares that may be acquired by Ms. Grove more than 60 days after
the record date upon the exercise of stock options.
(6) Includes 35,000 shares that may be acquired within 60 days of the record
date upon the exercise of stock options. Includes 3,000 shares held by Mr.
Gische's spouse. Mr. Gische disclaims beneficial ownership of such shares.
(7) Includes 16,000 shares that may be acquired by Mr. Mears within 60 days of
the record date upon the exercise of stock options and approximately
28,000 shares in a 401k Plan. Does not include 59,000 shares that may be
acquired by Mr. Mears more than 60 days after the record date upon the
exercise of stock options.
(8) Includes 25,000 shares that may be acquired within 60 days of the record
date upon the exercise of stock options that have been granted. Includes
6,500 shares held by Mr. Gray's spouse. Mr. Gray disclaims beneficial
ownership of such shares.
(9) Includes 12,000 shares that may be acquired by Mr. Levi within 60 days
after the record date upon the exercise of stock options. Does not include
6,000 shares that may be acquired by Mr. Levi more than 60 days after the
record date upon the exercise of stock options.
(10) Includes 368,550 shares that may be acquired within 60 days of the record
date upon the exercise of stock options. Does not include 173,100 shares
that may be acquired more than 60 days after the record date upon the
exercise of stock options.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
The following financial statements are included on pages 10 through 27 of the
Company's printed Annual Report to Shareholders and are incorporated herein by
reference.
Consolidated Statements of Operations for the years ended October 31, 1998,
1997, and 1996
Consolidated Balance Sheets as of October 31, 1998 and 1997
Consolidated Statements of Changes in Stockholders' Equity for the years
ended October 31, 1998, 1997, and 1996
Consolidated Statements of Cash Flows for the years ended October 31, 1998,
1997, and 1996
Notes to Consolidated Financial Statements
Report of Independent Accountants
(a)(2) Financial Statement Schedule
25
<PAGE>
Unaudited supplementary data entitled "Selected Quarterly Financial Data
(unaudited)" is incorporated herein by reference in Item 8 (included in "Notes
to Consolidated Financial Statements" as Note 16).
The following financial statement schedule and auditor's report in connection
therewith are attached hereto as pages F-1 and F-2:
F-1 Schedule II Valuation and Qualifying Accounts and Reserves
F-2 Report of Independent Accountants on Financial Statement Schedule
All other schedules are omitted because they are not applicable or the required
information is shown in the financial statements or notes thereto.
(a)(3) Exhibits
26
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
3.1 Amended and Restated Articles of Incorporation of Registrant, as amended 1/
3.2 By-laws of Registrant, as amended 1/
4.1 Specimen Stock Certificate 1/
10.1 Employment Agreement between the Company and Joe J. Lynn 9/
10.2 Deferred Compensation Agreement between the Company and Joe J. Lynn 2/
10.3 Employment Agreement between the Company and Richard A. Thompson 9/
10.4 Microlog Corporation Medical Reimbursement Plan 3/
10.5 Microlog Corporation 1989 Non-Employee Director Non-Qualified Stock Option Plan 10/
10.6 Microlog Corporation 1995 Employee Stock Option Plan 8/
10.7 Agreements with Farmers & Mechanics National Bank 7/
10.8 Amendments to Farmers & Mechanics National Bank Agreements 9/
10.9 Sub-contracting Agreement with Aspect Telecommunications Corporation 4/
10.10 Sub-contracting Agreement with Applied Physics Laboratory 4/
10.11 Agreement with Philips Communication Systems B.V.*/ 6/
13 Annual Report to Shareholders for the fiscal year ended October 31, 1998
22 Subsidiaries of the Registrant 11/
24 Consent of PricewaterhouseCoopers LLP
</TABLE>
- ---------
*/ Confidential treatment has been granted for portions of this document.
1/ Filed as an Exhibit to Registration Statement on Form S-1, File No.
33-31710, and incorporated herein by reference.
2/ Filed as an Exhibit to Annual Report on Form 10-K for the fiscal year ended
October 31, 1988.
3/ Filed as an Exhibit to Annual Report on Form 10-K for the fiscal year ended
October 31, 1991.
4/ Filed as an Exhibit to Annual Report on Form 10-K for the fiscal year ended
October 31, 1992.
5/ Filed as an Exhibit to Annual Report on Form 10-K for the fiscal year ended
October 31, 1993.
6/ Filed as an Exhibit to Annual Report on Form 10-K for the fiscal year ended
October 31, 1994.
7/ Filed as an Exhibit to Annual Report on Form 10-K for the fiscal year ended
October 31, 1995.
8/ Filed as an Exhibit to Registration Statement on Form S-8, File No.
333-07981, and incorporated herein by reference.
9/ Filed as an Exhibit to Annual Report on Form 10-K for the fiscal year ended
October 31, 1997.
10/ Filed as an Exhibit to Registration Statement on Form S-8, File No.
333-69025, and incorporated herein by reference.
11/ Filed as an Exhibit to Annual Report on Form 10-K for the fiscal year ended
October 31, 1998.
Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the fiscal year ended
October 31, 1998.
27
<PAGE>
OTHER MATTERS
- -------------
For the purposes of complying with the amendments to the rules governing Form
S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned
registrant hereby undertakes as follows, which undertaking shall be incorporated
by reference into registrant's Registration Statements on Form S-8, Nos.
33-30965 (filed September 11, 1989) and 33-34094 (filed March 30, 1990):
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
of 1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
28
MICROLOG CORPORATION - CONNECTING PEOPLE TO A WORLD OF INFORMATION(TM)
----------------------------------------------------------------------
In today's competitive business environment, customer satisfaction is every
company's bottom line. Microlog's interactive communications and contact center
solutions give our clients powerful tools to enhance customer service while
maintaining competitive costs. Since 1977, we have helped clients in government
and private industry operate more efficiently and profitably.
Microlog designs and supports a robust line of interactive communications
systems and applications for customers worldwide. Interactive communications
defines the myriad of ways users interact with information. Microlog's solutions
take advantage of new technologies that provide information not only by
telephone but also through other media, including facsimile and the Internet.
Microlog's Intela(TM) interactive voice response (IVR) platform is unparalleled
in the industry for supporting robust features, enabling rapid application
development, and ensuring reliable performance. Intela supports call center
solutions for customers worldwide as well as applications for corporations,
government agencies, and service bureaus.
With the introduction of our uniQue(TM) family of contact center solutions in
1998, Microlog is helping clients revolutionize the traditional "call center"
concept. Tapping into the pervasiveness of the Internet and the increasing
familiarity of web browsers, uniQue changes the traditional rules of engagement
for contact center operations. The result? Fully enabled, completely interactive
customer contact centers that support virtually any inbound contact media.
The difference is dramatic. With products like uniQue Agent(TM), the customer
has an alternative to the frustration of dial and wait. Instead, customers
interact in their most preferred mode of communications. And with real-time
skills-based contact routing, questions get answers quickly and efficiently.
uniQue makes total customer care a competitive reality.
Old Dominion Systems Incorporated of Maryland (ODSM), a subsidiary of Microlog,
provides technical performance analysis, engineering services and consultation,
as well as technical and administrative support services to prime U.S.
government contractors.
Since 1995, the Company has held ISO 9001 certification, the highest level of
certification from the International Organization for Standardization, which
sets international standards for quality assurance and management.
Microlog Corporation is headquartered in Germantown, Maryland, outside
Washington, DC. Its European headquarters is in Eindhoven, The Netherlands, and
Microlog U.K. is located in Windsor, England.
A publicly held company since 1986, Microlog's stock trades on Nasdaq, under the
symbol MLOG.
1
<PAGE>
LETTER TO THE SHAREHOLDERS
--------------------------
In my letter to shareholders last year, I stated Microlog would "leap to the
future in 1998." From a product development standpoint, we were successful in
accomplishing this goal. But from a financial performance perspective, 1998 was
disappointing. Old Dominion Systems Incorporated of Maryland (ODSM), turned in
another solid year highlighted by a $7 million contract award with The Johns
Hopkins University's Applied Physics Laboratory (APL). However, increased
competition and the declining rate of growth for stand-alone interactive voice
response (IVR) systems impacted the voice processing side of the business.
On a consolidated basis, our revenues declined 17% to $26.5 million, and the
Company had a net loss of $8.6 million, which includes the reversal of a
deferred tax asset of $2.2 million.
IMPORTANT SALES
The IRS awarded a contract in excess of $3 million to Microlog to upgrade all
Intela systems for Y2K compliance. This was an enormous project that the Company
delivered flawlessly; a fact that did not go unnoticed by the IRS. Microlog also
upgraded 28 IRS sites with an integrated Intela/Geotel interface, allowing them
to perform intelligent routing of calls to other IRS sites. Intela System
Release 6 (SR6), which was released in April 1998 provided the features,
functionality, and Y2K compliance required to win these awards and complete the
upgrades.
Internationally, Microlog successfully installed our largest Intela system to
date, 1500 ports, for KPN Telecom in The Netherlands. In addition, systems of
120 ports each were purchased by KPN's Mobile Group, and KPN Orange, a KPN
mobile service venture with Orange in Belgium. Microlog continued to upgrade our
Intela install base internationally as well, with Y2K compliant Intela software.
Global One has been actively upgrading over 1000 ports to Intela SR6.
On the commercial side, Eckerd Drug, who originally bought the Automated
Prescription Refill System (APRS(TM)) for their stores in 1996, purchased over
$3 million from Microlog during 1998.
These follow-on sales confirm the benefits of APRS not only to Eckerd, but also
to their customers.
Microlog completed its first installation of The Automated Collector(TM) system
in September. Based on the success of this installation, subsequent orders have
been received. New versions of The Automated Collector are in development that
include features and functionality that will further enhance the attractiveness
of the product in the collections industry.
LEAP TO THE FUTURE
As stated earlier, the market growth of IVR is slowing significantly. Microlog
acknowledged this trend in 1997, and began investing significant time and money
in determining the best direction for the future of the Company. Based on the
extensive analysis performed, the Company's strategic direction shifted in 1998
to become one of the premier companies in the call center arena. Microlog
believes this industry leverages the Company's current strengths and offers
attractive growth opportunities. Call Centers (or what we now term Contact
Centers) is one of the fastest growing markets in the U.S.-- estimated to be
over $12.1 billion by 2001. Growing even more rapidly is the United Kingdom (UK)
and several other European countries, but on a smaller base. Recognizing this
growth and the significant revenue potential it represents, Microlog began
pursuing a number of prospects in the UK in late 1998.
2
<PAGE>
As the first step in realizing our new direction, Microlog began development of
uniQue(TM) (pronounced uni-queue), an open standards-based family of call center
solutions in early summer. uniQue was unveiled at the CT Expo & Demo show in New
York City on September 23, 1998. Microlog's bold leap to the future started to
come to fruition when uniQue received CT's "Best of Show" award. Since then,
uniQue has received other awards including four "Product of the Year" awards
from Computer Telephony Magazine, Call Center Solutions, CTI Magazine, and Call
Center Magazine.
Intela, our Unix-based interactive communications solution, remains a key
product for Microlog. There are attractive opportunities to pursue in the IVR
market in the future. In addition, Intela combined with uniQue provides a total
solution to those contact centers which have not yet purchased an IVR system.
LOOKING TOWARDS THE FUTURE
The initial success of uniQue, and the validation received by partners and
industry experts, as well as the enthusiasm shown by current and potential
customers for this product, positions Microlog to be a strong player in the
contact center space for 1999 and beyond. However, attaining a leadership
position will require continued significant investment and focus. Recognizing
this, the Company undertook a restructuring of the IVR portion of the business
in February, 1999, reducing expenses and cutting staff by approximately one
third. This move brings expenses in line with revenues from our major customers
and provides a way to fund uniQue development and marketing. Operations are now
consolidated primarily into the Germantown, MD facility, with major reductions
in manufacturing, international operations, and IVR expansion business not
related to our major customers.
We want to thank our shareholders and customers for their continued confidence
in the Company. We also wish to recognize our distributors and business partners
for their support. And finally, we thank our dedicated employees of whom we are
especially proud. It was a difficult year, but it's behind us. Microlog has
termed 1999 as our "Year for Success." Together, we WILL make it happen!
3
<PAGE>
MICROLOG CORPORATION CHANGES STRATEGIC DIRECTION
Microlog Corporation will offer comprehensive, open, and standards-based call
center solutions as an expansion of its existing interactive voice response
business. This action is in response to the needs of customers, as well as the
need to expand the range of revenue-generating applications that the Company can
offer in the cross-industry interactive communications marketplace. Call centers
often incorporate interactive voice response applications, and increasingly
include interactive web response applications, among other communications types,
as a means of augmenting and facilitating the efforts of the traditional human
call center agents. The trend among customers to contact businesses by many
communications media--phone, web, e-mail, fax, hardcopy mail--while requiring
the same types of transactions and queries, has transformed the traditional call
center into a customer contact center and strategic information hub for
business. Microlog is establishing a framework for moving existing solutions
into the customer contact centers for these businesses. In addition, Microlog
will make a phased series of product and market moves over the next year to
properly position itself in the contact center market.
The Company based its decision to move aggressively into the customer contact
market space upon months of market research including primary customer
interviews, secondary research, competitive analysis, internal capabilities
assessment, and the observed strong secular and economic trends which underpin
the growing needs of business customers. Looking just at the interactive voice
response business, the market is still growing at approximately 10% compound
annual growth rate, but this rate of growth is decreasing in the markets in
which Microlog sells. However, the cross-industry call center opportunity in the
U.S. in 1998 was estimated to be around $5 billion, growing strongly at 20%
CAGR. The European opportunity is smaller in absolute terms at $2 billion, but
is growing even more rapidly at 48% CAGR. Approximately 14% of the call center
opportunity is traditional IVR. The remainder of this revenue opportunity is
non-IVR, and with the exception of the switch or ACD function, which Microlog
doesn't and will not supply, requires strongly related interactive
communications skills, channels, and technologies that Microlog has
traditionally possessed. Within the framework described here, Microlog is
therefore in a position to expand its market opportunities beyond just IVR into
the other related offerings and services necessary to a modern customer contact
center. The framework is broken into constituent tenets, listed below, with
specific implementation milestones announced as appropriate over the period of
this statement of direction.
TENET 1: MULTIPLE MEDIA CONTACT DATA TYPES SUPPORTED
Market research shows that most of the world's networks have reported over the
last two years that data has overtaken voice in bandwidth share, comprising more
than 50% of the network traffic, even though voice traffic is still increasing
in an absolute sense. People are increasingly comfortable using e-mail to
contact companies, sometimes as an alternative to waiting in a telephone queue.
Interactive web response is a useful adjunct to IVR for those people so equipped
to browse the web, and it provides a graphical alternative to the voice-only
plain old telephone. People contact companies by faxing, and they sometimes even
write letters for delivery by the postal system. While voice will continue to be
an essential form of the contact types with which customer contact centers will
deal, it will not be the only one. Indeed, in order to achieve maximum
efficiency, modern contact centers will need to deal with the same types of
requests and transactions, delivered by voice, e-mail, fax, web interactions,
and traditional hardcopy. Microlog's vision accommodates these media types in
multiple languages for voice support, and for non-voice media types. The first
phase supports only the English language, however, additional languages will be
added for the later phases based on business need.
4
<PAGE>
TENET 2: SUPPORT FOR EXISTING PHONE SYSTEMS
Businesses have substantial investments in PBX systems and call center ACDs,
which currently work very well, and are likely to continue to serve significant
business needs well into the next century. Customers have told us that it is
their preference not to replace their existing telephone systems. Therefore,
Microlog's strategy is to work openly with all major switch and ACD vendors in a
non-biased, market-driven way to affect the integration of voice with the other
media types through computer-telephony integration (CTI). Microlog's long
experience with switch integration, primarily through its work with voice
messaging systems, provides the skills background to accomplish this difficult,
and somewhat esoteric work, in a quality fashion - a need our customers often
cite.
TENET 3: SUPPORT FOR EXISTING CTI SERVERS
Many customer contact centers have not only invested significantly in switches,
but also in CTI servers. Businesses have stated that they are likewise unwilling
to accept a solution that requires them to replace their existing CTI server. It
is Microlog's strategy to interface to, and interoperate with, the major CTI
server manufacturers including Dialogic's CT Connect (through Microlog's
existing IntelaCTI product), Genesys, and CallPath.
TENET 4: OPEN INTERFACE TO BACK-END DATA SYSTEMS
Microlog will continue its policy of integrating to existing back-end business
customer hosts and data systems through its systems integration operations group
within the Company. Microlog's first phase of implementation will emphasize
web-accessible data found on corporate intranets.
TENET 5: OPEN INTERFACE TO EXISTING WORKFLOW OR CONTACT MANAGEMENT SOFTWARE
Many companies have re-engineered around workflow products or have chosen to use
specific contact management tracking software. Microlog's strategy is to
integrate openly with any of the contact or workflow management packages our
customers may specify. Microlog will focus on accomplishing the integrations
with highest demand first.
TENET 6: OPEN INTERFACE TO EXISTING IVR SERVER
Microlog will prefer its own Intela IVR product, but will publish Application
Program Interface (API) specifications to allow other IVR companies to interface
to Microlog's contact center solutions. This approach allows Microlog's open
contact center solutions to integrate smoothly into call centers that have
another IVR product already installed.
TENET 7: STANDARDS-BASED DEVELOPMENT AND LICENSING
Where standards exist--for example, e-mail and fax standards--Microlog will
integrate to current industry standards. Our customers often have existing
e-mail and/or fax servers, or they have a strong preference for certain types of
these systems. Microlog's policy will be to integrate openly to existing
de-facto industry standards in order to accommodate those customer desires.
TENET 8: OPEN CROSS-PLATFORM DEVELOPMENT
5
<PAGE>
Microlog's strategic direction is to initially provide NT-based server functions
and multi-platform browser-based client functions for the contact center agents.
However, development on the servers will be based on the C++ programming
language and, as much as possible, on Java for the client software at the
agent's desk. The design methodology will be object-oriented and Corba will be
used for interprocess communications. In this way, server portability to many
operating system platforms, such as Unix, is preserved as a near-term option.
Client portability is assured by Java-enabled browsers on the agent desktop.
TENET 9: CROSS-INDUSTRY MARKETING
Microlog is developing its contact center solutions to address the general
cross-industry opportunities. However, the marketing rollout will focus on
Microlog's current government and commercial customers, as well as international
customers with requirements for English support. Expansion to other vertical
markets will occur as soon as appropriate channel programs and/or product
enhancements will allow.
TENET 10: NETWORK COMPUTING
Because of Microlog's approach to the contact center desktop - a thin-client
design using Java and downloaded as a Java applet - any Java-enabled browser can
be "morphed" into a contact center agent's desktop client. This means that the
contact center can realize the significant reduction in costs associated with
the network-computing model of operations. Whether the contact center chooses to
buy true network computers (NCs) or has traditional fat-client Windows(R)
desktops, significant savings in administrative effort, hardware, installation,
and long-term costs can be achieved by taking advantage of this computing model.
Microlog supports both traditional and NC computing models while providing
functional and cost advantages for both.
TENET 11: MICROLOG'S VALUE PROPOSITION
Currently, there is no effective means for contact centers to manage multiple
media contacts and interactions with their customers which also manage costs,
provide consistent quality of service, and maintain control of the customer
contact. Microlog's strategic direction is to provide turn-key integration
solutions including reliable easy-to-use tools to enable Call Center Managers to
prioritize and control the routing of customer contacts, independent of their
media. This results in cost savings by optimizing the most expensive asset a
call center has -- its people -- while improving its responsiveness to its most
important asset -- its customers.
INTRODUCING UNIQUE: CONTACT CENTER SOLUTIONS FOR THE NEXT CENTURY
-----------------------------------------------------------------
Everyone knows--you only get one chance to make a first impression. But in a
busy contact center, organizations face the challenge of making the right
impression thousands of times a day. In a matter of seconds, whether the contact
is made by phone, fax, e-mail, or other media, customers are judging a company's
ability to meet their needs. Contact centers not only answer questions but also
create the customer confidence necessary to build ongoing business
relationships. Mistakes and poor service speak volumes about organizational
efficiency, management effectiveness, product quality, and service performance.
Microlog understands these concerns, and is bringing the power of technology to
the goal of total customer satisfaction.
6
<PAGE>
Since 1977, global clients have looked to Microlog for software solutions that
turn the customer call center experience into a powerful opportunity for
companies to gain competitive advantage. Products like Intela(TM) for IVR have
established Microlog's reputation for excellence.
But telephone-based IVR systems are just one part of a total customer contact
center solution that is rapidly changing to incorporate new forms of media and
new expectations for support service delivery. Building on what it does best,
the Company introduced uniQue Agent in 1998, the first in a series of open
standards, web-based software solutions that raises the bar in the rapidly
growing customer contact center marketplace.
uniQue Agent gives organizations the flexible information access they need to
deliver total customer satisfaction on every contact whether a contact is made
by phone, web, e-mail, fax, postal mail or other formats. Contacts are
prioritized, routed and resolved by appropriately skilled agents in a seamless
process that eliminates mistakes, minimizes queuing delays, and reduces
administrative clutter.
The uniQue family also expands and adapts in response to changing customer
requirements. uniQue software logic supports an unlimited number of
prioritization and routing requirements, while HTML and Java-based technology
allows system administrators down the hall or around the world to monitor
contact center performance, expand agent networks, and even edit the content of
applications in use.
The uniQue family of contact center solutions is designed to build true customer
confidence and loyalty by building on top of legacy databases, intranets and
extranets. As contacts are received, uniQue simultaneously delivers existing
customer information, including previous transactions and preferences, to the
agent's fingertips.
Integration with back office and workflow systems means uniQue is maximizing the
business potential of every customer contact, gathering information that can
lead to critical management decisions in the future. uniQue provides this
capability and more while residing on a Windows NT server and saves money by
working in tandem with the client's installed base of computer and
communications hardware and software.
An interview with Howard Bubb -
"When customers have questions, they expect more than just having their calls
answered in turn. Call centers are changing and Microlog is too."
Call centers are becoming customer contact centers, or at least more
customer-centric, and Microlog is one of the companies leading this important
business process transformation, according to Howard Bubb, President and CEO of
Dialogic, Inc. Bubb should know. His company is a key technology supplier to
Microlog. In fact, Dialogic hardware is found in one out of three voice
processing system solutions at work today. So Bubb is more motivated than most
to see the industry's bigger picture.
Microlog's web-enabled, customer-centric approach maximizes the contact center's
productivity. The strategy creates a far richer interaction, giving customers
the opportunity to make decisions, solve problems, and retrieve information all
before speaking to a contact center agent. The approach also reduces the contact
center's reliance on voice telephony, allowing customers to
7
<PAGE>
choose how they communicate--whether by voice recognition, touch-tone key
padding, fax, web form or e-mail.
"Web-enabled is where people want to be," Bubb says. Contact centers can be
confining because agents lack the requisite skills or experience to really solve
customer problems. At the same time, many companies lack the critical mass to
provide dedicated, state-of-the-art, contact center service.
The web makes a critical difference.
"Microlog's use of Java applets means that any computer in the organization can
pull up the customer's record and interact in a very distributed and intelligent
manner." This Internet-based access allows an important business process
transformation to take place. The entire company becomes the contact center,
moving customer interactions to the point in the organization best equipped to
help. "The bigger opportunity is to deploy customer-centered thinking across the
organization, better matching transaction flows to on-going business
activities," Bubb says. Adding that "this puts customers in touch with accurate
information, faster than ever before. "
An interview with Eric Arnum -
"The Web gives messaging companies the opportunity to create
exciting new business solutions by removing the boundaries
between e-mail, fax, voicemail and other media."
"That's what makes Microlog's move to the Net so significant," according to Eric
Arnum, editor of Electronic Mail & Messaging Systems. He says Microlog has made
a strategic decision to build its products around the Internet architecture, and
the uniQue customer contact center solution is just the beginning. "When
Microlog makes a product as modular as [uniQue], it's able to link to virtually
any media," Arnum says. "There are many directions they can go."
For now, Arnum sees Microlog poised to leverage its experience with contact
centers using not just its own products but those of other companies as well. By
designing its products into a series of modular components, the Company
approaches the market with solutions that will provide seamless, web-based
access to messaging, calendars, software applications, office data, text files
and more.
"Voicemail, fax and e-mail systems need not be separate," Arnum says. "uniQue
allows you to treat all these messaging formats as digital objects. Anything you
can do with a Windows file you can do with a message. Calling in for voicemail,
dialing in for e-mail or fax forwarding are time consuming, to say the least.
Web browsers are a user console that will allow you to put everything on the
screen and operate with a mouse, no matter what type of message is involved."
By integrating its products with the web, Microlog has created market access to
every browser in the world. And because customers already understand the basic
functionality of the web and web browsers, Microlog product functionality can be
added and used easily with little customer training.
The uniQue product and the Company's technical direction appear to be correct,
and its growth opportunities are extensive. With the move to the Internet,
Microlog is well positioned for the future.
An interview with Yves de Talhouet -
8
<PAGE>
"Systems integrators pick the best products and technology in the marketplace
and fit them into complete solutions for their clients."
Sema Group, the second largest systems integrator in Europe, sees Microlog's
uniQue product family as an important part of its approach to satisfying even
the most demanding customer contact center requirements.
"uniQue is a great product," says Yves de Talhouet.
Mr. de Talhouet heads up the Sema Group's Networks and Communications Branch,
and says "traditional call centers are undergoing an evolution to fully capable
customer contact centers. As this evolves, the contact center must be able to
handle both telephone and Internet-based interactions in an equally efficient
manner. uniQue is an important element in bridging the gap between the two
formats," he says.
"I think we will see a product like uniQue in every contact center," de Talhouet
says. "E-mail interaction is a top priority," he adds, noting that in the U.S.
over 50 percent of contact center traffic is now handled electronically. "This
is clearly an indication of how important this type of interaction has become
and why every contact center will include the Internet as an access medium."
From a technology viewpoint, Microlog has a multimedia router with the logic to
send voice calls to the appropriate agent," de Talhouet says. "The same is true
for e-mail messages. uniQue looks at the message and routes it to the
appropriate agent. What's important is the software's ability to apply the same
logic to either telephone calls or Internet contacts."
uniQue's flexible approach means that contacts can be prioritized and routed,
according to their content, to the appropriate person in the company, whether
that is a hot line operator, help desk employee, sales agent, technical support
representative or other professional. "uniQue brings out the synergies between
contact formats," de Talhouet says.
Microlog is helping its customers turn the traditional voice telephony-based
call center into a strategic information hub that better suits the demanding
pace of business today.
As industry leaders like Howard Bubb, Eric Arnum, and Yves de Talhouet have
suggested, Microlog's uniQue family of solutions allows companies to transform
their customer contact operations with combinations options that include voice,
e-mail, facsimile, web forms and hardcopy documents. This choice allows
customers to select the media with which they are most comfortable. It makes
interaction as familiar and easy to use as an Internet browser and adds a high
degree of quality control, regardless of the contact type selected. Microlog's
product design philosophy capitalizes on existing investments in hardware and
software. Microlog's open standards-based products work seamlessly with existing
PBX systems, phone switches, ACDs, and CTI servers. Microlog's value proposition
helps customers leverage their installed base of equipment, reach new levels of
performance through integration with back-end data systems and workflow
processes, and with the growing popularity of network computing, provide
full-featured customer contact center functionality to agents using thin client
network computers as well as traditional desktop PCs. uniQue routes customers to
the right information while cutting the administrative costs of delivering high
caliber service.
9
<PAGE>
The call center has become the customer contact center. With uniQue, Microlog
now offers the total solution for meeting today's most demanding expectations
for quality service, cost savings and contact management. As the Company looks
to the future, Microlog is confident that its superior reputation, business
process expertise, and integrated and innovative turnkey solutions will propel
it into the forefront of this evolving marketplace.
Microlog Corporation
Consolidated Statements of Operations
(In thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended October 31,
1996 1997 1998
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales:
Products $ 11,459 $ 13,970 $ 9,367
Services 14,248 17,798 17,090
Total net sales 25,707 31,768 26,457
- -----------------------------------------------------------------------------------------------------------------------
Costs and expenses:
Cost of products 5,190 7,203 8,688
Cost of services 9,918 12,238 11,855
Selling, general and administrative 6,394 6,374 9,088
Research and development 2,094 3,579 3,256
Total costs and expenses 23,596 29,394 32,887
- -----------------------------------------------------------------------------------------------------------------------
(Loss) income from operations 2,111 2,374 (6,430)
Investment income 11 29 58
Interest expense (92) (119) (56)
Other income (expense), net 44 (53) 86
- -----------------------------------------------------------------------------------------------------------------------
(Loss) income before income taxes 2,074 2,231 (6,342)
(Provision) benefit for income taxes 639 1,501 (2,299)
- -----------------------------------------------------------------------------------------------------------------------
Net (loss) income $ 2,713 $ 3,732 $ (8,641)
=======================================================================================================================
Net (loss) income per share:
Basic $ 0.67 $ 0.89 $ (2.02)
Diluted $ 0.59 $ 0.82 $ (2.02)
=======================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
10
<PAGE>
Microlog Corporation
Consolidated Balance Sheets
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
October 31,
- -------------------------------------------------------------- ------------------- --------------------
1997 1998
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 3,980 $ 2,340
Receivables, net 3,883 3,057
Inventories, net 1,921 872
Deferred tax asset 1,200 --
Other current assets 423 534
- --------------------------------------------------------------------------------------------------------
Total current assets 11,407 6,803
Fixed assets, net 3,734 1,353
Licenses, net 295 181
Deferred tax asset 950 --
Other assets 61 223
Goodwill, net 608 --
- --------------------------------------------------------------------------------------------------------
Total assets $ 17,055 $ 8,560
========================================================================================================
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of long-term debt $ 61 $ 68
Accounts payable 1,872 1,079
Accrued compensation and related expenses 1,808 2,082
Deferred revenue 695 719
Other accrued expenses 300 902
- --------------------------------------------------------------------------------------------------------
Total current liabilities 4,736 4,850
Long-term debt 142 74
Deferred officers' compensation 256 249
Other liabilities 33 17
- --------------------------------------------------------------------------------------------------------
Total liabilities 5,167 5,190
- --------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' equity:
Serial preferred stock, $.01 par value,
1,000,000 shares authorized, no shares issued and outstanding -- --
Common stock, $.01 par value, 10,000,000 shares
authorized, 4,889,205 and 4,872,753 shares issued and 4,287,335
and 4,270,883 outstanding 49 49
Capital in excess of par value 16,294 16,417
Treasury stock, at cost, 601,870 shares (1,177) (1,177)
Accumulated deficit (3,278) (11,919)
- --------------------------------------------------------------------------------------------------------
Total stockholders' equity 11,888 3,370
Total liabilities and stockholders' equity $ 17,055 $ 8,560
========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
11
<PAGE>
Microlog Corporation
Consolidated Statements of Changes in Stockholders' Equity
(In thousands)
<TABLE>
<CAPTION>
Capital In
Common Stock Excess of Treasury Stock Accumulated
Shares Par Value Par Value Shares Cost Deficit Total
- ---------------------------------------------------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance as of October 31, 1995 4,508 $ 45 $ 15,015 602 $ (1,177) $ (9,723) $ 4,160
Exercise of common stock options 219 2 306 -- -- -- 308
Issuance of common stock in
conjunction with acquisition of
Phonatic International B.V 65 1 584 -- -- -- 585
Net income for the year ended
October 31, 1996 -- -- -- -- -- 2,713 2,713
- ---------------------------------------------------- -------- -------- -------- -------- -------- -------- --------
Balance as of October 31, 1996 4,792 48 15,905 602 (1,177) (7,010) 7,766
Exercise of common stock options 81 1 189 -- -- -- 190
Consulting expense funded through
stock options granted -- -- 200 -- -- -- 200
Net income for the year ended
October 31, 1997 -- -- -- -- -- 3,732 3,732
- ---------------------------------------------------- -------- -------- -------- -------- -------- -------- --------
Balance as of October 31, 1997 4,873 49 16,294 602 (1,177) (3,278) 11,888
Exercise of common stock options 16 -- 23 -- -- -- 23
Consulting expense funded through
stock options granted -- -- 100 -- -- -- 100
Net loss for the year ended
October 31, 1998 -- -- -- -- -- (8,641) (8,641)
- ---------------------------------------------------- -------- -------- -------- -------- -------- -------- --------
Balance as of October 31, 1998 4,889 $ 49 $ 16,417 602 $ (1,177) $(11,919) $ 3,370
==================================================== ======== ======== ======== ======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
12
<PAGE>
Microlog Corporation
Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
Year Ended October 31,
1996 1997 1998
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income $ 2,713 $ 3,732 $ (8,641)
Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:
Depreciation 633 839 847
Amortization of goodwill and licensing agreement 228 314 722
Loss (gain) on disposition of fixed assets (56) 84 65
Gain on sale of building and land -- -- (290)
Provision for sales returns and doubtful accounts 81 49 29
Provision for inventory reserves -- 93 1,299
Consulting expense funded through stock options
granted -- 200 100
Changes in assets and liabilities:
Receivables (1,279) 328 797
Inventories (781) 205 (250)
Deferred tax asset (650) (1,500) 2,150
Other assets 32 (174) (273)
Accounts payable (425) 909 (793)
Accrued compensation and related expenses (229) (67) 274
Deferred revenue (110) 110 (193)
Deferred gain on sale of building and land -- -- 217
Other accrued expenses and accrued liabilities (213) (265) 586
Deferred officers' compensation (1) (12) (7)
- -----------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by operating activities (57) 4,845 (3,361)
- -----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of fixed assets (1,319) (778) (517)
Proceeds from sale of fixed assets 72 7 --
Proceeds from sale of building and land -- -- 2,276
Purchase of Phonatic International B.V. (111) -- --
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (1,358) (771) 1,759
- -----------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Reduction in long-term debt (45) (55) (61)
Net borrowings under line-of-credit agreement 1,400 (1,400) ---
Exercise of common stock options 308 190 23
- -----------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities 1,663 (1,265) (38)
- -----------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents 248 2,809 (1,640)
Cash and cash equivalents at beginning of year 923 1,171 3,980
- -----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 1,171 $ 3,980 $2,340
=================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
13
<PAGE>
Notes to Consolidated Financial Statements
Note 1: Basis of Presentation and Major Customers
The accompanying consolidated financial statements include the accounts of
Microlog Corporation and its wholly-owned subsidiaries (collectively, the
Company). All intercompany transactions have been eliminated.
Microlog Corporation of Maryland, and Microlog Europe, both subsidiaries,
design, assemble, market, and service customized voice processing systems and
other communications products. Old Dominion Systems Incorporated of Maryland, a
subsidiary, is engaged in providing performance analysis of certain major
weapons systems and related data processing support to the Federal Government
through prime contractors.
A summary of information about the Company's operations by business segment is
as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended October 31,
1996 1997 1998
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales:
Voice processing systems and other
communications products and services $ 15,836 $ 19,277 $ 14,743
Performance analysis and
support services 9,871 12,491 11,714
- ------------------------------------------------------------------------------------------------------------
Net sales $ 25,707 $ 31,768 $ 26,457
============================================================================================================
(Loss) income from operations:
Voice processing systems and other
communications products and services $ 1,131 $ 829 $ (7,515)
Performance analysis and
support services 980 1,545 1,085
- ------------------------------------------------------------------------------------------------------------
(Loss) income from operations $ 2,111 $ 2,374 $ (6,430)
============================================================================================================
Identifiable assets:
Voice processing systems and other
communications products and services $ 10,822 $ 14,333 $ 8,163
Performance analysis and
support services 645 600 397
Buildings for common use 2,246 2,122 --
- ------------------------------------------------------------------------------------------------------------
Identifiable assets $ 13,713 $ 17,055 $ 8,560
============================================================================================================
Capital expenditures:
Voice processing systems and other
communications products and services $ 1,537 $ 772 $ 509
Performance analysis and
support services 15 6 8
Buildings for common use 25 -- --
- ------------------------------------------------------------------------------------------------------------
Capital expenditures $ 1,577 $ 778 $ 517
============================================================================================================
Depreciation expense:
Voice processing systems and other
communications products and services $ 501 $ 704 $ 734
Performance analysis and
support services 8 11 12
Buildings for common use 124 124 101
- ------------------------------------------------------------------------------------------------------------
Depreciation expense $ 633 $ 839 $ 847
============================================================================================================
</TABLE>
Approximately 37%, 31% and 30% of the Company's consolidated net sales for
fiscal years 1996, 1997, and 1998, respectively, involved the sale of voice
processing systems and other communications products and services to the Federal
Government.
Approximately 10%, 18% and 10% of the Company's consolidated net sales for
fiscal years 1996, 1997, and 1998 respectively, involved the sale of voice
processing systems and other communications products and services to one
customer in the pharmaceutical industry.
Approximately 6%, 9%, and 13% of the Company's consolidated net sales for fiscal
years 1996, 1997, and 1998, respectively, involved the sale of voice processing
systems and other communications products and services to foreign countries.
14
<PAGE>
Approximately 38%, 39%, and 44% of the Company's consolidated net sales for
fiscal years 1996, 1997, and 1998, respectively, involved performance analysis
and support services subcontracts with prime contractors to the U.S. Navy and
NASA. These contracts have been extended, or have options to extend, to various
dates in fiscal years 1999 through 2001.
The Company extends credit to its customers and billings are made in accordance
with contract terms.
Note 2: Summary of Accounting Policies
Use of Estimates
The preparation of the consolidated financial statements, in conformity with
generally accepted accounting principles, requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities on
the consolidated financial statements and the reported amounts of revenue and
expenses during the reporting periods. Actual results could differ from those
estimates and assumptions. Due to the change in market strategy associated with
voice processing technology, certain uncertainties exist with the introduction
of new products and the Company's ability to continue as a going concern. (Note
3).
Revenue Recognition
Sales of products and services are recognized at the time deliveries are made or
services are performed. When customers, under terms of specific orders, request
that the Company manufacture and invoice goods on a bill and hold basis, the
Company recognizes revenue based on the completion of the manufacturing process,
acceptance by the customer, and passage of title to the customer. For fiscal
years 1996, 1997, and 1998, the Company recognized $0, $3.5 million, and $0,
respectively, in sales under such bill and hold agreements.
Contract revenues are recognized on the percentage of completion basis for
fixed-price contracts. Revenues are recorded to the extent costs have been
incurred for cost-plus-fixed-fee contracts, including a percentage of the fixed
fee computed in accordance with the contract provisions. Revenues for time and
materials contracts are recognized at negotiated hourly rates as incurred and as
materials are delivered. Provisions for losses on contracts in progress are
provided when, in the opinion of management, such losses are anticipated.
Certain contracts are subject to audit, possible adjustment, or termination for
convenience by the Federal Government. Contract costs have been examined and
settled through fiscal year 1992.
Cash and Cash Equivalents
The Company considers all liquid investments with an original maturity of less
than three months to be cash equivalents. Cash equivalents consist of U.S.
treasury bills, certificates of deposit, and repurchase agreements, (which are
collateralized by securities issued or guaranteed by the U.S. Treasury).
Fair Value of Financial Instruments
The carrying amounts of cash, accounts receivable, accounts payable, and accrued
expenses approximate fair value because of the short maturity of these items.
The carrying amounts of debt issued pursuant to the Company's bank credit
agreements approximate fair value because the interest rates on these
instruments change with market interest rates.
Inventories
Inventories are stated at the lower of cost, determined on the first-in
first-out method, or market.
Fixed Assets
Fixed assets are recorded at cost and depreciated on a straight-line basis for
financial reporting purposes and accelerated methods for income tax purposes.
Intangible Assets
Licenses are recorded at cost and amortized on a straight-line basis over seven
years. Accumulated amortization at October 31, 1997 and 1998 was $505,000 and
$619,000, respectively.
Goodwill arising from the acquisition of companies is being amortized on a
straight-line basis over six to seven years. Accumulated amortization at October
31, 1997 and 1998 was $882,000 and $1,490,000, respectively. As a result of the
Company's periodic analysis of its goodwill recoverability, the goodwill balance
was fully written off during fiscal year 1998 (Note 4).
15
<PAGE>
Costs incurred in basic research and development are expensed as incurred. The
Company determined that the process of establishing technological feasibility
with its new products is completed approximately upon the release of the
products to its customers. Accordingly, software development costs are expensed
as incurred.
Warranty Reserve
Normal product warranty for service and repairs is generally provided for 90
days to two years, subsequent to delivery. Based on experience, the Company has
accrued expenses related to warranty obligations.
Stock-Based Compensation
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25 (APB No. 25),
"Accounting for Stock Issued to Employees" and related interpretations. Under
APB No. 25, compensation cost is measured as the excess, if any, of the market
price of the Company's stock at the date of the grant over the exercise price of
the option granted. Compensation cost for stock options, if any, is recognized
ratably over the vesting period. The Company provides additional pro forma
disclosures as required under Statement of Financial Accounting Standards No.
123 (SFAS No. 123), "Accounting for Stock-Based Compensation" (Note 11).
Transactions for which non-employees are issued equity instruments for goods or
services received are recorded by the Company based upon the fair value of the
goods or services received or the fair value of the equity instruments issued,
whichever is more reliably measured.
Net (Loss) Income Per Share
In February 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 128, "Earnings per Share." SFAS No. 128 simplifies the earnings per share
(EPS) computation and replaces the presentation of primary EPS with a
presentation of basic EPS. This statement also requires dual presentation of
basic and diluted EPS on the face of the income statement for entities with a
complex capital structure and requires a reconciliation of the numerator and
denominator used for the basic and diluted EPS computations. The Company has
implemented SFAS No. 128 in fiscal 1998, as required. Accordingly, all prior
period EPS data has been restated (Note 13).
Newly Issued Accounting Standards
In June 1997, the FASB issued SFAS No. 130, "Comprehensive Income." This
statement requires that changes in the amounts of certain items, including
foreign currency translation adjustments and gains and losses on certain
securities, be shown in the financial statements. SFAS No. 130 does not require
a specific format for the financial statement in which comprehensive income is
reported, but does require that an amount representing total comprehensive
income be reported in that statement. SFAS No. 130 will be effective for the
Company's fiscal year 1999 and requires reclassification of earlier financial
statements for comparative purposes. The Company believes the adoption of SFAS
No. 130 will not have a material effect on the consolidated financial
statements.
Also, in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This statement will change the way
public companies report information about segments of their business in annual
financial statements and requires them to report selected segment information in
their quarterly reports issued to stockholders. SFAS No. 131 also requires
entity-wide disclosures about the products and services an entity provides, the
material countries in which it holds assets and reports revenues, and its major
customers. SFAS No. 131 will be effective for the Company's fiscal year 1999.
The Company believes the adoption of SFAS No. 131 will not have a material
effect on the consolidated financial statements.
In October 1997, the Accounting Standards Executive Committee (AcSEC) issued
Statement of Position 97-2 (SoP 97-2), "Software Revenue Recognition," which
supersedes SoP 91-1. This statement provides guidance on when revenue should be
recognized and in what amounts for licensing, selling, leasing or otherwise
marketing computer software. SoP 97-2 will be effective for the Company's fiscal
year 1999. The Company does not expect the adoption of SoP 97-2 to have a
material effect on the current operations. However, the effect of this statement
is uncertain as it relates to future products (Note 3).
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures About
Pensions and Other Postretirement Benefits." This statement standardizes the
disclosure requirements for pensions and other postretirement benefits to the
extent practicable and requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate analysis.
Additionally, SFAS No. 132 eliminates certain disclosures that are no longer as
useful as they were when SFAS No. 87, "Employers' Accounting for Pensions", SFAS
No. 88, "Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits", and SFAS No. 106,
"Employers Accounting for Postretirement Benefits Other than Pensions" were
issued. SFAS No. 132 will be effective for the Company's fiscal year 1999. The
Company believes the adoption of SFAS No. 132 will not have a material effect on
the consolidated financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
16
<PAGE>
value. Gains or losses resulting from changes in the values of those derivatives
would be accounted for depending on the use of the derivative and whether it
qualifies for hedge accounting. SFAS No. 133 will be effective for the Company's
fiscal year 2000. The Company believes the adoption of SFAS No. 133 will not
have a material effect on the consolidated financial statements.
The FASB, in its APB No. 25 Repairs and Maintenance Project, is in the process
of drafting an interpretation that provides guidance on certain practice issues
related to APB No. 25. Although not yet in final form, the FASB anticipates that
the interpretation will become effective in September 1999 and should be applied
(on a prospective basis) to transactions occurring after December 15, 1998.
Under the new interpretation, stock option plans under which options have been
repriced subsequent to December 15, 1998, must be accounted for as variable
plans. Additionally, the FASB has clarified the definition of "employee" to be
the common-law definition and, accordingly, options granted to outside directors
(non-employees) are to be accounted for under SFAS No. 123. If approved by the
FASB, options granted to the Company's Board of Directors will have to be valued
at fair market value and, accordingly, compensation expense will be recorded.
The Company believes that this will not have a material effect on the
consolidated financial statements.
Reclassifications
Certain reclassifications have been made to the prior year's financial
statements in order to conform to the fiscal year 1998 presentation.
Note 3: Uncertainty of Future Operations
In fiscal year 1999, the Company's strategy for addressing the market trends
will be to move aggressively into the customer contact center market, which was
a new vertical market for the Company in late fiscal year 1997 and fiscal year
1998. The Company will be focusing sales of its UNIX-based Intela product, the
Company's principal interactive communications system, on contact center
applications. The Company also will be promoting its newest product line,
uniQue(TM), a family of open solutions for customer contact center management
that leverages the effectiveness of unified queuing, priority and skills-based
routing, and "zero administration" at the agent's desktop.
In February 1999, the Company restructured its voice processing operations in
order to bring expenses in line with forecasted revenues. In connection with
this restructuring, the Company reduced its voice processing workforce by
approximately 25% and wrote off equipment associated with its headcount
reductions.
The Company will incur a restructuring charge of approximately $260,000 in the
second quarter of fiscal 1999, for severance and benefits costs for the
reduction of approximately 25 employees in February 1999. Temporary employees
and contractors will also be reduced. Included in the restructuring charge is a
write-off of assets of approximately $50,000 which includes the write-off of
equipment associated with headcount reductions. As a result of these
restructuring activities, the Company expects to reduce its annual voice
processing operating expenses, in the form of reduced salaries and wages, by
approximately $1.8 million. The Company expects to complete most of the actions
associated with the restructuring by the end of the second quarter of fiscal
year 1999.
The Company expects to also decrease expenses as a result of the reduced
headcount in areas such as travel, training and communications expenses.
Additionally, the Company is initiating a cost reduction plan in areas such as
advertising, recruiting, office and computer supplies, and professional fees to
further reduce voice processing operating expenses. As a result of the
restructuring and cost reduction plan the Company expects to reduce total voice
processing operating expenses by approximately $4.0 million annually and
approximately $2.3 million for the remainder of fiscal year 1999, starting in
the second quarter of fiscal year 1999.
The Company is subject to the risk that its new strategy will not be successful.
The new strategy is dependent on market acceptance of the Company's new focus
and new products, ongoing research and development efforts and sales activities
over the near term. In addition, the new strategy is also dependent on the
Company's ability to successfully reduce costs. The Company is subject to the
risk that it will not be able to obtain and maintain the necessary debt
financing it requires to implement its new strategy. Failure to obtain and
maintain required financing would have a material adverse effect on the Company.
The Company's fiscal year 1999 operating budget includes significant
expenditures relating to the development and marketing of its new product line,
uniQue and requires the Company to utilize debt financing to maintain its new
strategy. The Company's anticipated cash flows from existing operations will not
generate the required cash flows to successfully launch the Company's new
strategy. If the Company is unable to obtain and maintain the necessary debt
financing, the Company will not be able to successfully implement its new
strategy and it will be forced to reduce expenditures in addition to those
associated with the restructuring discussed above in order to continue as a
going concern. The Company is subject to the risks that it may not make the
necessary decisions to reduce expenditures in enough time to avoid severe
adverse consequences. In March 1999, the Company has a commitment for a new
line-of-credit facility with a new financial institution (Note 9).
Upon closing of the $2.0 million revolving line-of-credit facility with a new
financial institution as discussed above, the Company has estimated that it will
have adequate resources to sustain operations through at least March 2000, based
upon management's planned expenditures for fiscal year 1999. The Company is
subject to the risks as to the ultimate success of its research and development
efforts and sales activities. The Company is subject to the risks that it will
not be able to obtain and maintain adequate financing to implement its new
strategy. Financing activities to date have primarily consisted of cash
generated from operating activities, the sale of the building and land, and the
availability of debt financing. The Company has generated operating losses
resulting in an accumulated deficit of $11,919,000 at October 31, 1998.
17
<PAGE>
Note 4: Microlog Europe
In June 1996, the Company acquired Phonatic International B.V. of The
Netherlands. The Company changed the name of Phonatic to Microlog Europe, a
wholly-owned subsidiary of Microlog Corporation of Maryland. To acquire
Phonatic, the Company acquired assets of $152,000, issued 65,000 shares of its
common stock valued at $584,000, paid $234,000 in cash to the Phonatic
shareholders, assumed $108,000 in liabilities, and incurred acquisition costs
totaling approximately $46,000. The acquisition has been accounted for as a
purchase and, therefore, only activity subsequent to the acquisition date has
been included in consolidated results. The excess of the purchase price over the
fair value of net assets acquired totaled $775,000 and has been recorded as
goodwill.
During fiscal year 1998, the Company reevaluated its international marketing
strategy and, as a result, decided to terminate three employees and intends to
relocate its office and the remaining employees. As of October 31, 1998, the
Company established reserves of $281,000 representing costs associated with the
termination of employees, the remaining net operating lease obligation
associated with its Netherlands facility and the relocation of its office.
Additionally, the Company, based on current undiscounted cash flow projections,
evaluated the recoverability of its goodwill balance and determined that the
goodwill balance was impaired. Accordingly, the Company wrote off the remaining
goodwill balance of $473,000 in October 1998.
In addition to a significant reduction in its international voice processing
operations which occurred as a result of the restructuring, the Company is
currently evaluating options for the transfer or sale of its existing Microlog
Europe interactive voice response operations, sales, and support activities to
organizations in similar lines of business. The Company is continuing to explore
uniQue opportunities in Europe through these organizations.
Note 5: Receivables
Receivables consist of the following (in thousands):
<TABLE>
<CAPTION>
October 31,
1997 1998
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Billed accounts receivable $ 3,647 $ 2,932
Contract retention 43 23
Accumulated unbilled costs and fees 345 246
- --------------------------------------------------------------------------------------------------
4,035 3,201
Less: Allowance for doubtful accounts (152) (144)
- --------------------------------------------------------------------------------------------------
$ 3,883 $ 3,057
==================================================================================================
</TABLE>
Note 6: Inventories
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
October 31,
1997 1998
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Components $ 1,475 $ 1,357
Work-in-process and finished goods 791 1,159
- --------------------------------------------------------------------------------------------------
2,266 2,516
Less: Reserve for obsolescence (345) (1,644)
- --------------------------------------------------------------------------------------------------
$ 1,921 $ 872
==================================================================================================
</TABLE>
During fiscal year 1998, the Company increased its reserve for obsolescence by
$1,299,000. The increase is related to inventory for certain product lines for
which there has been a significant decline in gross margins and demand and,
therefore, future sales are doubtful.
Note 7: Fixed Assets
Fixed assets consist of the following (in thousands):
<TABLE>
<CAPTION>
October 31,
1997 1998
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Building $ 2,511 $ --
Land 520 --
Office furniture and equipment 3,451 3,700
Vehicles 24 24
Leasehold improvements 176 171
- --------------------------------------------------------------------------------------------------
6,682 3,895
Less: Accumulated depreciation (2,948) (2,542)
- --------------------------------------------------------------------------------------------------
$ 3,734 $ 1,353
==================================================================================================
</TABLE>
18
<PAGE>
Estimated useful lives are as follows:
Building: 30 years
Office furniture, equipment and vehicles: 2-7 years
Leasehold improvements: Shorter of estimated
useful life or lease term
In August 1998, under a sale-leaseback agreement, the Company sold its office
building and land with a net book value of $1,986,000 for $2,420,000, less
selling costs of $144,000. The gain of $290,000 is being amortized over the
anticipated term of the lease, which is expected to terminate on or about June
1999. At October 31, 1998, the deferred gain is $217,000 (Note 10).
Note 8: Accrued Expenses
Accrued compensation and related expenses consist of the following (in
thousands):
<TABLE>
<CAPTION>
October 31,
1997 1998
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Accrued wages $ 630 $ 1,016
Accrued vacation and personal leave 686 693
Other related expenses 492 373
- --------------------------------------------------------------------------------------------------
$ 1,808 $ 2,082
==================================================================================================
</TABLE>
Other accrued expenses consist of the following (in thousands):
<TABLE>
<CAPTION>
October 31,
1997 1998
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Accrued marketing, travel and other expenses $ 300 $ 689
Accrued legal and consulting expenses -- 213
- --------------------------------------------------------------------------------------------------
$ 300 $ 902
==================================================================================================
</TABLE>
Note 9: Debt
In January 1999, the Company learned that its line-of-credit facility will not
be renewed by its financial institution under the same terms and conditions. As
discussed in Note 3, the Company's fiscal year 1999 operating budget includes
significant expenditures relating to the development and marketing of the
Company's new product line, uniQue and requires the Company to utilize debt
financing to maintain its new strategy. If the Company is unable to obtain and
maintain adequate financing, the Company will not be able to implement its new
strategy and will be forced to reduce expenditures in addition to those
associated with the restructuring, discussed in Note 3, in order to continue as
a going concern. The Company is subject to the risk that it may not make the
necessary decision to reduce expenditures in enough time to avoid severe adverse
consequences. On February 28,1999, the line-of-credit expired.
In February 1999, the Company and its financial institution put in place a
$750,000 line-of-credit facility, which allows the Company to borrow up to 75%
of the eligible receivables of Old Dominion Systems Inc. of Maryland. The line
of credit bears interest at the bank's prime rate plus 1.25% (9% at February 11,
1999) and is payable upon demand. At March 17, 1999, $500,000 was outstanding
against this line-of-credit. This credit facility will be terminated upon
closing of the $2.0 million revolving line-of-credit facility with the new
financial institution discussed below.
The Company has a commitment for a $2.0 million revolving line-of-credit
facility with a new financial institution, which allows the Company to borrow up
to 75% of its eligible receivables to a maximum of $2,000,000, subject to the
right of the financial institution to make loans at its discretion. The Company
expects to close on this loan facility by the end of March, 1999. The
line-of-credit bears interest at the bank's prime rate plus 2.25% (10.00% at
March 17, 1999), and contains a 0.025% fee on the average unused portion of the
line as well as a monthly collateral fee and a 1% upfront commitment fee. The
term of the loan is one year, and subjects the Company to a restrictive covenant
of not exceeding 115% of its consolidated planned quarterly losses for its
second and third quarters of fiscal year 1999, and a requirement for
consolidated profitability beginning in the fourth quarter of fiscal year 1999.
The line also subjects the Company to a number of restrictive covenants
including restrictions on mergers or acquisitions, payment of dividends, and
certain restrictions on additional borrowings. The line will be secured by all
of the Company's assets.
19
<PAGE>
In February 1998, the Company renewed its line-of-credit facility with its bank,
which allows the Company to borrow up to 70% of its eligible receivables to a
maximum of $2,000,000. The line-of-credit bears interest at the bank's prime
rate plus 1.25% (9.00% at October 31, 1998), and contains a 0.5% commitment fee
on the average unused portion of the line. The line expires on February 28, 1999
and subjects the Company to a number of restrictive covenants, including a
requirement to maintain a minimum consolidated tangible net worth, a maximum
ratio of total liabilities to tangible net worth, and a minimum current ratio.
There are restrictions on mergers or acquisitions, payment of dividends, and
certain restrictions on additional borrowings. The line is secured by all of the
Company's tangible assets. At October 31, 1998, the Company was not in
compliance with the covenants for a minimum consolidated tangible net worth and
the maximum ratio of total liabilities to tangible net worth. The bank waived
these covenants at October 31, 1998 and through January 30, 1999. There was no
outstanding debt against this line-of-credit at October 31, 1998. At January
31,1999, the Company was again not in compliance with the covenants for which a
waiver has not been obtained.
In February 1998, the Company also renewed its $1,000,000 loan facility. The
loan facility bears interest at the bank's prime rate plus 0.5% (8.25% at
October 31, 1998), and contains a 0.5% commitment fee on the average unused
portion. At October 31, 1998, there was no outstanding debt against this loan
facility. The loan facility was secured by the Company's principal headquarters
building. In August 1998, this loan facility was terminated as a result of the
sale of the Company's office building (Note 7).
In June 1996, the Company entered into a contract to purchase a new management
information system including a five-year maintenance plan. The purchase,
including maintenance, is being financed by the vendor over a five-year term at
an annual interest rate of 8%. The financing terms require five annual payments
of $140,000 each, including interest, which began on June 30, 1996. Three annual
payments have been made to date. The final payment is due on June 30, 2000.
Note 10: Commitments and Contingencies
Compensation Arrangements
In February 1988, the Company entered into non-contributory deferred
compensation contracts (the Contracts) with three officers. Under the terms of
the Contracts, (i) the Company's total annual contributions for the three
officers was limited to $72,000, (ii) contributions ceased at the earlier of
January 31, 1993 or the officer's retirement and (iii) accumulated contributions
accrue interest at the prime rate through the officer's retirement. Subsequent
to retirement and at the officer's option, the officer is eligible to receive
his deferred compensation balance in either monthly payments over a 10-year
period or one lump-sum payment. Two individuals retired in May 1991 and January
1998 and elected to receive their deferred compensation balances over a 10-year
period. The company has incurred interest expense of $10,000, $25,000 and
$27,000 in fiscal years 1996, 1997, and 1998, respectively.
The Company is a party to employment agreements, expiring in 1999, with several
of its executive officers. In the event that these individuals are terminated,
they would be entitled to receive lump sum or monthly payments which aggregate
approximately $380,000.
Operating Lease Obligations
In May 1998, the Company entered into a 15 year lease commitment, commencing on
or about June 1999, for office space intended to consolidate the Company's
headquarters, warehouse, and training facilities. Total rental payments under
this lease agreement are approximately $10,600,000 over the lease term. The
Company and its new landlord are in the process of discussing potential
alternatives concerning the new facility. At this time management cannot predict
the potential outcome of these discussions. In August 1998, the Company sold its
office building and committed to lease back the building prior to its occupation
of the new leased space (Note 7).
Additionally, the Company leases certain facilities and other equipment through
noncancellable operating leases, which expire in various years through 2014.
Minimum future noncancellable operating lease payments, assumes that the Company
will occupy the new facility, discussed above, as of October 31, 1998 are as
follows (in thousands):
<TABLE>
<CAPTION>
Year Ending October 31, Gross Sublease Net
------------------------------------------------------------------------------
<S> <C> <C> <C>
1999 $ 807 $ (159) $ 648
2000 624 -- 624
2001 632 -- 632
2002 631 -- 631
2003 641 -- 641
Thereafter 7,979 -- 7,979
------------------------------------------------------------------------------
Total $ 11,314 $ (159) $ 11,155
==============================================================================
</TABLE>
20
<PAGE>
Rent expense under noncancellable operating lease agreements in fiscal years
1996, 1997, and 1998 was approximately $275,000, $299,000, and $389,000 (net of
sublease income of $278,000, $278,000, and $281,000), respectively.
Legal
The Company is subject to litigation from time to time arising from its
operations and receives occasional letters alleging infringement of patents
owned by third parties. Management believes that such litigation and claims are
without merit and will not have a material effect on the Company's financial
position or results of operations.
Royalties
The Company is committed to pay annual license maintenance fees of $120,000 to a
certain party under certain call processing patents, which expire in 2007. The
Company will receive a credit against future license maintenance fees equal to
12% of the purchase price paid for products purchased from the certain party.
Note 11: Stock Option Plans
The Company has two incentive stock option plans. Under the first plan, the
Company may grant options to Directors and employees to purchase up to 750,000
shares of common stock at not less than fair market value at the time of grant.
Under the second plan, the Company may grant options to employees to purchase up
to 1,000,000 shares of common stock at not less than fair market value at the
time of grant. Additional information with respect to both of the incentive
stock option plans is summarized in the following table:
<TABLE>
<CAPTION>
Number Weighted Average
of Shares Exercise Price
- ------------------------------------------------------------------------------------
<S> <C> <C>
Shares under option, October 31, 1995 909,532 $ 2.68
Options granted 253,875 5.73
Options canceled (104,279) 3.25
Options exercised (194,114) 1.38
- ------------------------------------------------------------------------------------
Shares under option, October 31, 1996 865,014 3.79
Options granted 300,000 5.75
Options canceled (75,344) 5.09
Options exercised (80,749) 2.35
- ------------------------------------------------------------------------------------
Shares under option, October 31, 1997 1,008,921 4.39
Options granted 1,122,400 1.83
Options canceled (1,159,875) 4.26
Options exercised (16,452) 1.45
- ------------------------------------------------------------------------------------
Shares under option, October 31, 1998 954,994 $ 1.59
====================================================================================
</TABLE>
Due to the decline in the market value of the Company's common stock, the Board
of Directors authorized the Company to reprice stock options granted to
employees and officers with exercise prices in excess of the fair market value
on August 14, 1998. Stock options held by optionees other than directors and
non-employees, which were granted under the incentive stock plans and which had
an exercise price greater than $1.75 per share, were amended to reduce their
exercise price to $1.63 per share, which was the closing price of the Company's
common stock on August 14, 1998. The stock options that were repriced have the
same terms as the original options to which they relate. A total of 907,150
options with a weighted average exercise price of $5.01 were repriced and are
included in options canceled and granted for fiscal year 1998.
Options granted under the plans vest at various dates from immediately to
ratably over five years and expire ten years from the date of grant. Certain
options contain possible accelerated vesting clauses should specific financial
measures be met. As of October 31, 1998, options available for granting were
282,200. Subsequent to October 31, 1998, the Company issued options to employees
to purchase 146,100 shares at an exercise price of $0.94.
Additionally, the Company maintains a non-employee Director stock option plan.
Under this plan, the Company may grant up to 125,000 shares at not less than the
fair market value at the time of grant. Subsequent to October 31, 1998, the
Company increased the number of authorized shares to 250,000. Additional
information is as follows:
<TABLE>
<CAPTION>
Number Weighted Average
of Shares Exercise Price
- ------------------------------------------------------------------------------------
<S> <C> <C>
Shares under option, October 31, 1995 61,000 $ 2.64
Options granted 6,000 5.50
Options exercised (23,000) 1.52
- ------------------------------------------------------------------------------------
Shares under option, October 31, 1996 44,000 3.61
Options granted 6,000 5.63
- ------------------------------------------------------------------------------------
Shares under option, October 31, 1997 50,000 3.85
Options granted 22,000 6.13
- ------------------------------------------------------------------------------------
Shares under option, October 31, 1998 72,000 $ 4.55
====================================================================================
</TABLE>
21
<PAGE>
Options granted under the plan vest immediately and expire ten years from the
date of grant. As of October 31, 1998, options available for granting were
30,000.
The Company also issued stock options to non-employee consultants outside of the
above plans. These shares may be granted at such times and under such terms as
the Board of Directors determines. Additional information is as follows:
<TABLE>
<CAPTION>
Number Weighted Average
of Shares Exercise Price
- -------------------------------------------------------------------------------------
<S> <C> <C>
Shares under option, October 31, 1995 48,000 $ 1.25
Options granted 5,000 8.38
Options exercised (2,000) 2.13
- -------------------------------------------------------------------------------------
Shares under option, October 31, 1996 51,000 1.91
Options granted 205,000 5.00
Options canceled (16,000) 4.10
- -------------------------------------------------------------------------------------
Shares under option, October 31, 1997 240,000 4.40
Options granted 21,000 1.84
- -------------------------------------------------------------------------------------
Shares under option, October 31, 1998 261,000 $ 4.20
=====================================================================================
</TABLE>
Generally, options vest upon the achievement of certain events and expire from
two to five years from the date of grant.
In fiscal year 1997, the Company entered into a consulting agreement with The
Parthenon Group, Inc. ("Parthenon"), a strategic marketing and consulting
organization. The Company granted Parthenon non-statutory options to purchase up
to 195,000 shares of the common stock of the Company at an exercise price of $5
per share. Options to purchase 40,000 shares became exercisable in the third
quarter of fiscal year 1997 upon Parthenon's commencement of work. Future
options become exercisable based upon the achievement of certain average closing
prices of the Company's common stock on the Nasdaq National Market. The expense
associated with these options of $300,000 has been recorded over the term of the
engagement. The Company recorded $200,000 and $100,000 as consulting expense in
fiscal years 1997 and 1998, respectively.
Subsequent to October 31, 1998, the Company issued options to non-employee
consultants to purchase 52,000 shares at an exercise price of $0.94. In
addition, the Company entered into a second consulting agreement with Parthenon.
Under the terms of this second consulting agreement, the Company has agreed to
reprice options granted in fiscal year 1997 to purchase 195,000 shares of the
common stock of the Company at an exercise price of $0.94 per share.
Additionally, the vesting terms have been revised and options to purchase
145,000 shares of the common stock of the Company became exercisable on the date
they were repriced. The remaining options to purchase 50,000 shares of the
common stock of the Company become exercisable once a target associated with the
uniQue(TM) product line is met. The expense associated with the repricing of
these options of $75,000 will be recorded over the term of the engagement, which
is expected to commence in fiscal year 1999.
The Company also reserved 50,000 shares for issuance outside these plans as
stock options or stock bonuses to key employees. These shares may be granted at
such times and under such terms as the Board of Directors determines.
No grants or issuances have been made as of October 31, 1998.
The following table summarizes information about all stock options outstanding
at October 31, 1998:
22
<PAGE>
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------- ---------------------------
Weighted-
Average
Range Years of Weighted- Weighted-
Of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
---------------- --------------- ------------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Incentive $1.00 - $1.25 57,893 6.2 $ 1.04 55,643 $ 1.03
Stock Option $1.63 897,101 7.2 1.63 416,326 1.63
---------------- --------------- ------------- ------------ ------------- -------------
Plans $1.00 - $1.63 954,994 7.1 $ 1.59 471,969 $ 1.55
================ =============== ============= ============ ============= =============
Non-Employee $1.38 14,000 4.7 $ 1.38 14,000 $ 1.38
Director $2.00 - $2.75 6,000 3.7 2.50 6,000 2.50
Plan $4.75 - $6.75 52,000 5.9 5.64 42,000 5.54
---------------- --------------- ------------- ------------ ------------- -------------
$1.38 - $6.75 72,000 5.5 $ 4.55 62,000 $ 4.30
================ =============== ============= ============ ============= =============
Non-Employee $1.00 - $1.06 51,000 5.4 $ 1.01 21,000 $ 1.00
Plan $2.44 - $2.94 10,000 1.4 2.69 10,000 2.69
$5.00 195,000 3.6 5.00 80,000 5.00
$8.38 5,000 2.4 8.38 -- --
---------------- --------------- ------------- ------------ ------------- -------------
$1.00 - $8.38 261,000 3.8 $ 4.20 111,000 $ 4.04
================ =============== ============= ============ ============= =============
</TABLE>
The weighted-average fair value of options granted during fiscal years 1996,
1997 and 1998 was $2.89, $3.43 and $0.97, respectively. The fair value of each
significant option grant is estimated on the date of grant using the
Black-Scholes model. The following weighted average assumptions are included in
the Company's fair value calculations:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Expected life (years) 3.3 3.9 2.5
Risk-free interest rate 5.5% 6.2% 5.5%
Volatility 80.0% 78.0% 62.5%
Dividend yield -- -- --
</TABLE>
The Company continues to apply APB No. 25 in accounting for stock-based
compensation for the incentive and non-employee Director plans. To date, all
stock options have been issued at market value; accordingly, no compensation
cost has been recognized. Had the Company determined costs for these plans in
accordance with SFAS No. 123, the Company's pro forma net (loss) income and pro
forma (loss) income per share would have been as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended October 31,
1996 1997 1998
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Pro forma net (loss) income applicable to common
stockholders $ 2,584 $ 3,447 $(8,699)
- -------------------------------------------------------------------------------------------------------------
Pro forma net (loss) income per share:
Basic $ 0.64 $ 0.82 $(2.03)
Diluted $ 0.57 $ 0.76 $(2.03)
- -------------------------------------------------------------------------------------------------------------
</TABLE>
The SFAS No. 123 method of accounting does not apply to options granted prior to
November 1, 1995, and accordingly, the resulting pro forma compensation cost may
not be representative of amounts expected in the future.
23
<PAGE>
Note 12: Income Taxes
Income taxes are provided for the tax effects of transactions reported in the
financial statements and consist of taxes currently due plus deferred taxes
related primarily to differences between the basis of fixed and intangible
assets and revenue recognition for financial and income tax reporting. The
deferred tax assets and liabilities represent the future tax consequences of
those differences, which will either be taxable or deductible when the assets or
liabilities are recovered or settled.
The (benefit) provision for income taxes in fiscal years 1996, 1997, and 1998
consists of (in thousands):
<TABLE>
<CAPTION>
Year Ended October 31,
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Income taxes payable (refundable) $ 11 $ (1) $ 149
Decrease (increase) in deferred tax asset (650) (1,500) 2,150
- ---------------------------------------------------------------------------------------------
$ (639) $ (1,501) $ 2,299
=============================================================================================
</TABLE>
Income taxes payable (refundable) in fiscal years 1996, 1997, and 1998 relate to
state income taxes and the alternative minimum tax for Federal income tax. As a
result of the Company's profitability in fiscal years 1995 through 1997, the
Company recorded a deferred tax asset of $650,000 and $1,500,000 in fiscal years
1996 and 1997, respectively, reflecting the benefit of approximately $5.5
million in loss carryforwards. Due to the unprofitable operations in fiscal year
1998 and the uncertain future profitability, the Company reassessed the
probability of realizing these net operating loss carryforwards and determined
that their expected future realization is not likely to be realized in the near
future. Accordingly, the Company wrote off the deferred tax asset of $2,150,000
in fiscal year 1998. The Company has provided a full valuation allowance for the
Company's $10.3 million net operating losses as management determined it more
likely than not that this amount will not be realized.
A reconciliation of the statutory Federal tax rate to the Company's effective
tax rate is as follows:
<TABLE>
<CAPTION>
Year Ended October 31,
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Statutory Federal tax rate 34.0% 34.0% (34.0)%
State income taxes, net of
Federal tax benefit 5.0 5.0 (5.0)
Benefit not recorded due to carryforward position -- -- 38.6
Utilization of net operating loss (40.9) (43.6) --
Goodwill amortization 3.0 3.0 3.3
Change in deferred tax asset (31.3) (67.2) 33.9
Other (0.6) 1.5 (0.5)
- -----------------------------------------------------------------------------------------------------
(30.8)% (67.3)% 36.3%
=====================================================================================================
</TABLE>
Deferred tax assets are comprised of the following (in thousands):
<TABLE>
<CAPTION>
October 31,
1997 1998
---- ----
<S> <C> <C>
Accounts receivable reserve $ 59 $ 84
Inventory reserves 134 641
Accrued vacation and benefits 182 181
Deferred compensation 109 105
Deferred revenues 271 261
Other 223 451
Research and development credits 293 406
Foreign net operating losses 89 265
Loss carryforwards 2,756 4,006
- -----------------------------------------------------------------------
Gross deferred tax assets 4,116 6,400
Valuation allowance (1,966) (6,400)
- ------------------------------------------------------------------------
Net deferred tax asset $ 2,150 $ --
========================================================================
</TABLE>
The net change in the valuation allowance for deferred tax assets was an
increase of $4,434,000 during the year. The Company has provided a full
valuation allowance against the Company's gross deferred tax assets since
management believes that the realization of such deferred tax assets is not
likely in the near future.
24
<PAGE>
Approximately $10.3 million of tax loss carryforwards and $406,000 of research
and development tax credits can be utilized by the Company through 2013. If
certain substantial changes in the Company's ownership should occur, there would
be an annual limitation on the amount of the carryforwards which can be
utilized.
Note 13: Net (Loss) Income Per Share Calculation
The following is a reconciliation of the numerators and denominators of the
basic net (loss) income per common share ("basic EPS") and diluted net (loss)
income per common and dilutive potential common share ("diluted EPS"). Basic EPS
is computed using the weighted average number of common shares outstanding and
diluted EPS is computed using the weighted average number of common and common
stock equivalent shares outstanding.
<TABLE>
<CAPTION>
October 31,
(in thousands) 1996 1997 1998
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net (loss) income $2,713 $3,732 $ (8,641)
==========================================================================================
Weighted average common stock outstanding 4,065 4,216 4,282
Stock options, if converted 501 335 --
- ------------------------------------------------------------------------------------------
Weighted average common and common stock equivalent shares
Outstanding 4,566 4,551 4,282
==========================================================================================
</TABLE>
Options outstanding in fiscal year 1998 are not reflected in the computation of
diluted EPS because the effect is anti-dilutive and would increase diluted EPS.
Note 14: Pension and Profit Sharing Plans
The Company has a defined contribution pension plan covering all employees.
After an employee completes one-year of service, the plan provides for annual
contributions by the Company equal to 6% of the employee's gross salary,
excluding bonuses and commissions. The Company's contributions to the plan vest
after a five-year period. Employees may also make voluntary contributions to the
plan up to a maximum of 10% of their gross salary on an after-tax basis. In
accordance with the plan, unvested amounts relating to terminated employees are
credited against pension contributions by the Company. Such forfeitures amounted
to $111,000, $81,000, and $128,000 in fiscal years 1996, 1997, and 1998,
respectively. It is the Company's policy to fund pension costs accrued. Net
expense of the plan was approximately $365,000, $441,000, and $518,000 in fiscal
years 1996, 1997, and 1998, respectively.
The Company also maintains a 401(k) profit sharing plan and trust. The plan
allows for employees to contribute up to 10% of gross salary on a pre-tax basis
and 5% of gross salary on an after-tax basis. The Company matches 50% of
employee contributions up to 4% of eligible salary. Total expense of the plan
was approximately $176,000, $224,000, and $196,000 in fiscal years 1996, 1997,
and 1998, respectively.
Note 15: Supplemental Cash Flow Information
The Company paid cash for interest expense and income taxes as follows (in
thousands):
<TABLE>
<CAPTION>
Year Ended October 31,
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Interest $ 71 $ 94 $ 29
Income taxes $ 21 $ 25 $ 125
Non-cash investing and financing activities:
Note issued for purchase of fixed assets $ 258
Details of acquisition (Note 4):
Fair value of assets acquired $ 926
Liabilities assumed 108
Common stock issued 584
- -------------------------------------------------------------------------------------------------
Cash paid 234
Less: cash acquired 123
- -------------------------------------------------------------------------------------------------
Net cash paid for acquisition $111
=================================================================================================
</TABLE>
25
<PAGE>
Note 16: Selected Quarterly Financial Data (Unaudited)
The following table presents unaudited quarterly operating results and the price
range of common stock for the Company's last eight fiscal quarters.
(In thousands, except per share data)
<TABLE>
<CAPTION>
Jan. 31, April 30, July 31, Oct. 31,
1997 1997 1997 1997
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales $ 7,094 $ 7,239 $ 8,842 $ 8,593
Gross margin 3,043 2,716 3,375 3,193
Income from operations 607 554 512 701
Net income per share: 669 615 615 1,833
Basic $ 0.16 $ 0.15 $ 0.15 $ 0.43
- ----------------------------------------------------------------------------------------------------------
Diluted $ 0.15 $ 0.14 $ 0.14 $ 0.39
==========================================================================================================
Stock prices
High $ 7.375 $ 6.500 $ 5.984 $ 8.750
Low $ 5.125 $ 5.250 $ 4.188 $ 4.500
- ----------------------------------------------------------------------------------------------------------
Jan. 31, April 30, July 31, Oct. 31,
1998 1998 1998 1998
- ----------------------------------------------------------------------------------------------------------
Net sales $6,555 $7,651 $6,929 $5,322
Gross margin 1,775 2,087 1,324 728
Loss from operations (1,117) (727) (1,626) (2,960)
Net loss per share: (1,169) (749) (3,855) (2,868)
Basic and diluted $ (0.27) $ (0.17) $ (0.90) $ (0.68)
==========================================================================================================
Stock prices
High $ 7.375 $ 5.875 $ 4.250 $ 2.063
Low $ 5.156 $ 4.000 $ 2.063 $ 0.938
==========================================================================================================
</TABLE>
As discussed in Note 4, the Company wrote off goodwill and established reserves
relating to Microlog Europe which resulted in a fourth quarter adjustment of
$754,000.
26
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
---------------------------------
To the Board of Directors and Stockholders
Microlog Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Microlog Corporation and its subsidiaries at October 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended October 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 3 to the
financial statements, the Company has suffered recurring losses from operations
and has been unable to obtain sufficient debt financing for working capital
purposes. These conditions raise substantial doubt about its ability to continue
as a going concern. Management's plans in regards to these matters are also
described in Note 3. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
PRICEWATERHOUSECOOPERS LLP
McLean, Virginia
March 17, 1999
27
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
<TABLE>
<CAPTION>
Period-to-Period
Percentage Changes
Percentage of Net Sales
Year Ended October 31, 1996 1997
to to
1996 1997 1998 1997 1998
------------------------------ ------------------
<S> <C> <C> <C> <C> <C>
Net sales:
Voice processing 61.6% 60.7% 55.7% 21.7% (23.5)%
Performance analysis 38.4% 39.3% 44.3% 26.5% (6.2)%
- -----------------------------------------------------------------------------------
Total net sales 100.0% 100.0% 100.0% 23.6% (16.7)%
- -----------------------------------------------------------------------------------
Costs and expenses:
Cost of sales 58.8% 61.2% 77.6% 28.7% 5.7%
Selling, general and administrative 24.9% 20.1% 34.4% (0.3)% 42.6%
Research and development 8.1% 11.3% 12.3% 70.9% (9.0)%
- -----------------------------------------------------------------------------------
Total costs and expenses 91.8% 92.6% 124.3% 24.6% 11.9%
- -----------------------------------------------------------------------------------
Investment and other income
(expense), net (0.1%) (0.4%) 0.3% (286.5)% 161.5%
- -----------------------------------------------------------------------------------
(Loss) income before income taxes 8.1% 7.0% (24.0)% 7.6% (384.3)%
- -----------------------------------------------------------------------------------
(Provision) benefit for income taxes 2.5% 4.7% (8.7)% 134.9% (253.2)%
- -----------------------------------------------------------------------------------
Net (loss) income 10.6% 11.7% (32.7)% 37.6% (331.5)%
- -----------------------------------------------------------------------------------
</TABLE>
Results of Operations
The Company had a net loss of $8.6 million (($2.02) per basic and diluted share)
for the fiscal year ended October 31, 1998. These results include a write-off of
$2.15 million (($.50) per basic and diluted share) related to the deferred tax
asset. As a result of the losses in fiscal year 1998 and the uncertainty of
future profitability, management believes that the expected future realization
of the Company's net operating loss carryforwards is not likely to be realized
in the near future. By comparison, the Company had net income of $3.7 million
($.89 per basic share and $.82 per diluted share) for the fiscal year ended
October 31, 1997, which included a $1.5 million ($.36 per basic share and $.33
per diluted share) income tax benefit. The Company had net income of $2.7
million ($.67 per basic share and $.59 per diluted share) for the fiscal year
ended October 31, 1996, which included a $650,000 ($.16 per basic share and $.14
per diluted share) income tax benefit. The Company is now reporting basic and
diluted earnings per share as required under Statement of Financial Accounting
Standards (SFAS No.128), "Earnings per Share", which became effective for the
Company in fiscal year 1998.
The net loss of $8.6 million for fiscal year 1998 was attributable to the
Company's voice processing operations. Approximately $5.3 million of this loss
was due primarily to insufficient voice processing revenues and a change in the
sales mix in the Company's voice processing operations. The loss was also due in
part to a write-off of the deferred tax asset ($2.15 million), a large increase
in the reserve for inventory obsolescence ($1.3 million), the write-off of
goodwill ($0.5 million), and reserves associated with the relocation of its
operations facility in The Netherlands ($0.3 million). These losses were offset
by the $1.0 million net income generated from the Company's performance analysis
and supports services operations.
Over the past fiscal year the Company has been experiencing reduced demand,
increased competition and reduced margins in the voice processing area, which
the Company attributes to market forces. The Company believes that interactive
information response (IIR) systems in general, and in the retail pharmacy
vertical market targeted by the Company's commercial sales efforts in
particular, are becoming commodities which are more readily available from an
increased number of vendors and require less engineering customization.
Accordingly, competition has increased, margins have been reduced, and it has
become more difficult to sell these products. In addition, governmental
customers have been procuring large IIR systems as part of major procurements
from larger vendors, which has required the Company to work through prime
contractors, also resulting in greater difficulty in making sales and increased
pressure on margins. One of the Company's short-term responses to these market
trends has included increased marketing efforts focusing on the capabilities of
the Company's Intela product and its ability to customize the product to meet
specific application requirements.
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In February 1999, the Company restructured its voice processing operations in
order to bring expenses in line with forecasted revenues. In connection with
this restructuring, the Company reduced its voice processing workforce by
approximately 25% and wrote off equipment associated with its headcount
reductions. As a result of the restructuring and cost reduction plan the Company
expects to reduce total voice processing operating expenses by approximately
$4.0 million annually and approximately $2.3 million for the remainder of fiscal
year 1999, starting in the second quarter of fiscal year 1999.
In fiscal year 1999, the Company's strategy for addressing the market trends
will be to move aggressively into the customer contact center market, which was
a new vertical market for the Company in late fiscal year 1997 and fiscal year
1998. The Company will be focusing sales of its UNIX-based Intela product, the
Company's principal interactive communications system, on contact center
applications. The Company also will be promoting its newest product line,
uniQue(TM), a family of open solutions for customer contact center management
that leverages the effectiveness of unified queuing, priority and skills-based
routing, and "zero administration" at the agent's desktop. With "zero
administration", the system administrator makes changes to the configuration or
application from a central location and distributes to the agents' desktops
automatically. In fiscal year 1998, the Company launched its first product from
the uniQue(TM) suite of contact center products, uniQue Agent(TM), an
application that allows the contact center agent to seamlessly manipulate all of
the different media types: email, fax, Web, and voice contacts all at one work
station. The Company is devoting significant efforts to promote market
acceptance of uniQue Agent(TM), and is commencing an advertising campaign
directed specifically at contact centers, collections, and interactive
communications industries.
To a lesser extent, the Company also will be focusing on another Intela
application, The Automated Collector(TM) (TAC), which has recently been enhanced
to add features the Company believes will meet market requirements. The Company
will be seeking technology partners and resellers for this product in fiscal
year 1999.
Also in fiscal year 1999, the Company will continue to market its Intela product
to its base of VCS 3500 customers. The Company no longer offers the VCS 3500
product; there were no VCS 3500 product revenues in fiscal years 1998 or 1997
and limited revenues ($0.6 million) in fiscal year 1996. The Company continues
to support its base of VCS 3500 customers and receives service revenues from
this support, but expects these revenues to decline since the Company has not
updated the product, including with respect to Year 2000 compliance, since
fiscal year 1996.
The Company is subject to the risk that its new strategy will not be successful.
The new strategy is dependent on market acceptance of the Company's new focus
and new products, ongoing research and development efforts and sales activities
over the near term. In addition, the new strategy is also dependent on the
Company's ability to successfully reduce costs. The Company is subject to the
risk that it will not be able to obtain and maintain the necessary debt
financing it requires to implement its new strategy. Failure to obtain and
maintain required financing would have a material adverse effect on the Company.
The Company's fiscal year 1999 operating budget includes significant
expenditures relating to the development and marketing of its new product line,
uniQue and requires the Company to utilize debt financing to maintain its new
strategy. The Company's anticipated cash flows from existing operations will not
generate the required cash flows to successfully launch the Company's new
strategy. If the Company is unable to obtain and maintain the necessary debt
financing, the Company will not be able to successfully implement its new
strategy and it will be forced to reduce expenditures in addition to those
associated with the restructuring discussed above in order to continue as a
going concern. The Company is subject to the risks that it may not make the
necessary decisions to reduce expenditures in enough time to avoid severe
adverse consequences. In March 1999, the Company has a commitment for a new
line-of-credit facility with a new financial institution (Note 9).
Net Sales
Net sales for fiscal year 1998 were $26.5 million, which represented a decrease
of 17% from net sales in fiscal year 1997. Net sales for fiscal year 1997 were
$31.8 million, which represented an increase of 24% from net sales in fiscal
year 1996. Net sales for fiscal year 1996 were $25.7 million. The decrease in
fiscal year 1998 was due to a decrease in voice processing net sales of $4.5
million and a decrease in performance analysis net sales of $0.8 million. The
increase in fiscal year 1997 was due to an increase in voice processing net
sales of $3.4 million and an increase in performance analysis net sales of $2.6
million.
Voice Processing Net Sales
The Company's voice processing net sales decreased 24% in fiscal year 1998 to
$14.7 million, compared to $19.3 million in fiscal year 1997. The decrease in
voice processing net sales during fiscal year 1998 was primarily due to a 32%
decrease in voice processing product sales. The decrease in voice processing
product sales was primarily attributable to a decrease in sales of the Company's
Automated Prescription Refill System (APRS) product to commercial customers
($3.1 million), a decrease in sales to government customers ($1.7 million), and
a decrease in sales to distributors ($0.2 million), offset by an increase in
sales to international customers ($0.5 million). The Company believes that the
decrease in sales is largely attributable to the market trends discussed above.
The Company's voice processing net sales increased 22% in fiscal year 1997 to
$19.3 million, compared to $15.8 million in fiscal year 1996. The increase in
voice processing net sales during fiscal year 1997 included a 22% increase in
voice processing product sales and a 21% increase in product support and
services sales. The increase
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in voice processing net sales was primarily attributable to an increase in sales
of the Company's APRS product, to commercial customers ($2.5 million) and an
increase in sales to international customers ($1.3 million), offset by a
decrease in sales to distributors ($0.5 million).
In fiscal year 1998, sales to the Company's 10 largest customers accounted for
85% of voice processing sales. One of the three largest customers was in each of
the Company's three sectors: government, commercial, and international. In
fiscal year 1997, sales to the Company's 10 largest customers accounted for 90%
of voice processing sales. Two of the four largest customers were in the
government sector while one customer was in the commercial sector and one
customer was in the international sector. In fiscal year 1996, sales to the
Company's 10 largest customers accounted for 82% of voice processing sales. One
of the three largest customers was in each of the Company's three sectors:
government, commercial, and international.
Sales to government customers for fiscal year 1998 were $8.0 million (54% of
voice processing net sales and 30% of consolidated net sales) which represented
an 18% decrease from sales to government customers in fiscal year 1997. Sales to
government customers for fiscal year 1997 were $9.7 million (51% of voice
processing net sales and 31% of consolidated net sales) which represented a 1%
increase from sales to government customers in fiscal year 1996. Sales to
government customers for fiscal year 1996 were $9.6 million (61% of voice
processing net sales and 37% of consolidated net sales). Fiscal year 1997
included a $3.5 million sale on a bill and hold basis requested by the customer.
The system was accepted and title passed to the customer in fiscal year 1997,
and just after year-end, in November 1997, the system was operational at the
customer's premises. Although the Company increased sales ($1.8 million) to
existing government customers in fiscal year 1998, the Company was unable to
replace a $3.5 million sale to a large customer that occurred in fiscal year
1997. In addition, the Company was unable to secure any new government customers
in fiscal year 1998. Government sales remained relatively flat in fiscal year
1997 as compared to fiscal year 1996. The Company believes sales to government
customers also are being affected by the market trends discussed above.
Sales to commercial customers for fiscal year 1998 were $3.3 million (23% of
voice processing net sales and 12% of consolidated net sales ) which represented
a 48% decrease from sales to commercial customers in fiscal year 1997. Sales to
commercial customers for fiscal year 1997 were $6.4 million (33% of voice
processing net sales and 20% of consolidated net sales) which represented a 64%
increase from sales to commercial customers in fiscal year 1996. Sales to
commercial customers for fiscal year 1996 were $3.9 million (24% of voice
processing net sales and 15% of consolidated net sales). The decrease in
commercial sales in fiscal year 1998, as well as the increase in commercial
sales in fiscal year 1997 compared to fiscal year 1996, was primarily
attributable to significant sales of the APRS product in the retail pharmacy
market to the Company's principal customer in the retail pharmacy market. As
discussed above, due to market trends the Company's commercial sales of the APRS
product are subject to increased competition, including the internal MIS
departments of potential retail pharmacy customers.
Sales to international customers for fiscal year 1998 were $3.4 million (23% of
voice processing net sales and 13% of consolidated net sales) which represented
a 17% increase from sales to international customers in fiscal year 1997. Sales
to international customers in fiscal year 1997 were $2.9 million (15% of voice
processing net sales and 9% of consolidated net sales) which represented an 80%
increase from sales to international customers in fiscal year 1996. Sales to
international customers for fiscal year 1996 were $1.6 million (10% of voice
processing net sales and 6% of consolidated net sales). The increase in
international sales in fiscal year 1998 was primarily due to a $1.6 million sale
to a subsidiary of KPN Telecom of The Netherlands, offset by decreased sales of
$1.1 million to the Company's European third party resellers. During fiscal year
1998, the Company and its Board of Directors approved a plan to relocate its
facility based in The Netherlands. As of October 31, 1998, the Company has
established reserves of $0.3 million representing costs associated with the
termination of employees, the remaining net operating lease obligation
associated with its Netherlands facility and the relocation of its office. The
increase in international sales in fiscal year 1997 was primarily due to sales
from new third party resellers of the Company's products such as Devotech of
France and KPN Telecom of The Netherlands.
As of October 31, 1998, the Company had a backlog of existing orders for voice
processing systems totaling $2.0 million. By comparison, the backlog, as of
October 31, 1997, was $2.9 million. The Company has experienced fluctuations in
its backlog at various times in the past attributable primarily to the
seasonality of governmental purchases. The Company anticipates that all of the
outstanding orders at October 31, 1998 will be shipped and the sales recognized
during fiscal year 1999. Although the Company believes that its entire backlog
of orders consists of firm orders, because of the possibility of customer
changes in delivery schedules and delays inherent in the government contracting
process, the Company's backlog as of any particular date may not be indicative
of actual sales for any future period.
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Performance Analysis and Support Services Net Sales
Net sales from performance analysis and support services for fiscal year 1998
were $11.7 million which represented a 6% decrease from net sales from
performance analysis and support services in fiscal year 1997. Net sales of
performance analysis and support services in fiscal year 1997 were $12.5 million
which represented a 27% increase over net sales of performance analysis and
support services of $9.9 million in fiscal year 1996. The decrease in net sales
from performance analysis and support services in fiscal year 1998 resulted from
a reduction in the level of work authorized under existing contracts from the
Johns Hopkins University Applied Physics Laboratory (APL), the Company's
principal customer for these services. The increase in net sales from
performance analysis and support services in fiscal year 1997 resulted from the
addition of new contracts as well as increases in the level of work authorized
under existing contracts with APL.
The Company believes that its performance analysis contracts are likely to
continue to provide a stable source of sales for the Company. The Company is
beginning to experience (indirectly, through its contracts with APL) the effects
of some reductions in defense spending due to changes in U.S. defense
priorities. The Company is not aware of any proposed reductions in spending that
will result in any material adverse affect over the next fiscal year on its net
sales from performance analysis and support services nor alter the manner in
which it procures contracts for such services. However, there is no assurance
that changes in defense priorities or continuing budget reductions will not
cause such an effect during the fiscal year or thereafter.
As of October 31, 1998, the Company had a backlog of funding on existing
contracts for performance analysis and support services totaling $0.2 million.
By comparison, the backlog as of October 31, 1997 was $2.9 million. The decrease
in backlog was primarily due to the types of contracts that the Company had in
backlog at October 31, 1998, as compared to October 31, 1997. At October
31,1998, the Company's contracts consisted primarily of indefinite delivery,
indefinite quantity (IDIQ) contracts which generally do not have a funding
amount, and therefore are not included in backlog. At October 31, 1997, the
Company had a contracts portfolio which included fixed price and time and
materials contracts which have a funding amount, as well as IDIQ contracts which
generally do not have a funding amount. The Company estimates that the entire
$0.2 million of backlog at October 31, 1998 will be recognized as sales in
fiscal year 1999. Because of the delays inherent in the government contracting
process or possible changes in defense priorities or spending, the Company's
backlog as of any particular date may not be indicative of actual sales for any
future period. Although the Company believes that its backlog of funding on
existing contracts is firm, the possibility exists that funding for some
contracts on which the Company is continuing to work, in the expectation of
renewal, may not be authorized. In addition, the Government has the right to
cancel contracts, whether funded or not funded, at any time, although to date
this has not occurred.
Costs and Expenses
Cost of sales of products were $8.7 million, or 93% of net sales of products,
for fiscal year 1998; $7.2 million, or 52% of net sales of products, for fiscal
year 1997; and $5.2 million, or 45% of net sales of products, for fiscal year
1996. The increase in cost of sales of products, both in dollar amount and as a
percentage of sales, for fiscal year 1998 was primarily attributable to an
increase in the reserve for inventory obsolescence ($1.3 million) related to
inventory for certain product lines for which there has been a significant
decline in gross margins and demand, and therefore future sales are doubtful.
The increase is also attributable to lower margins on products sales to
commercial and government customers. The Company believes both of these factors
are due to the market trends discussed above. The fiscal year 1998 lower margins
are attributable to the lack of sales of software licenses in fiscal year 1998
compared to sales of software licenses ($3.1 million) in fiscal year 1997. Sales
of software licenses have significantly lower costs of sales than product sales.
Additionally, the increase in cost of sales of products, as a percentage of
sales, for fiscal year 1998 was attributable to certain fixed costs that do not
vary directly with sales volume, therefore, the decline in net sales of products
did not result in a similar decline in costs.
The increase in cost of sales of products, both in dollar amount and as a
percentage of sales, for fiscal year 1997 was primarily attributable to
increased pricing pressures in the international sector resulting in higher
costs as a percentage of sales, as well as a large government contract which
yielded lower margins than the Company's average margins.
Cost of sales of services were $11.9 million, or 69% of net sales of services,
for fiscal year 1998; $12.2 million, or 69% of net sales of services, for fiscal
year 1997; and $9.9 million, or 70% of net sales of services, for fiscal year
1996. The decrease in cost of sales in fiscal year 1998 was primarily
attributable to the decrease in net sales of performance analysis services. The
increase in cost of sales in fiscal 1997 was primarily attributable to the
increase in net sales of performance analysis services.
Selling, general and administrative costs were $9.1 million or 34% of net sales,
for fiscal year 1998; $6.4 million, or 20% of net sales, for fiscal year 1997;
and $6.4 million, or 25% of net sales, for fiscal year 1996. The increase in
fiscal year 1998, both in dollar amount and as a percentage of sales, was
primarily attributable to increased staffing in the sales and marketing
departments, expanded marketing programs, the write-off of the remaining
goodwill balance resulting from the determination that the goodwill balance was
impaired, and the relocation of operations associated with the Company's voice
processing operations in The Netherlands. The decrease in fiscal year 1997, as a
percentage of sales, was primarily attributable to increased sales. The Company
anticipates that selling,
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general, and administrative costs, excluding certain one-time charges in fiscal
year 1998, will decrease in fiscal year 1999 as a result of the restructuring
discussed below.
Research and development expenses reflect costs associated with the development
of applicable software and product enhancements for the Company's voice
processing systems. The Company believes that the process of establishing
technological feasibility with its new products is completed approximately upon
release of the products to its customers. Hence, the Company does not anticipate
capitalizing research and development costs. Research and development expenses
were $3.3 million, or 12% of net sales for fiscal year 1998; $3.6 million, or
11% of net sales for fiscal year 1997; and $2.1 million, or 8% of net sales for
fiscal year 1996.
Research and development expenses for 1998 were focused on the Intela, TAC,
APRS, and uniQue products. uniQue Agent was announced and substantially
completed in November 1998 as a product offering available for customer trial in
the contact center market. uniQue Agent is the first in a series of offerings
the Company is developing to provide a comprehensive range of solutions within
the contact center market in fiscal year 1999. This open, standards-based
product enables companies to route and prioritize phone calls, e-mails, web
contacts, faxes, and hardcopy mail and other contact types to the appropriate
skilled agent for handling. The uniQue development activities will also be a
major focus in fiscal year 1999 for the Company's research and development
efforts. The Company is subject to the risk that it may not have the financial
resources to support its research and development strategy. Intela was enhanced
for new features and Year 2000 compliance in the System Release 6 (SR6) version
of the product. TAC was enhanced to meet market requirements to readily
integrate with both custom and widely available collections databases in use in
customer sites. APRS was extended and customized for a number of customer
opportunities in 1998 which did not materialize. A significant amount of custom
engineering is undertaken by the Company in providing special features,
application development, and system integration services to our customers.
Investment and Other Income, Net
The Company had net investment and other income of $88,000 for fiscal year 1998,
as compared to net investment and other expense of $143,000 for fiscal year 1997
and $37,000 for fiscal year 1996. The higher income level in fiscal year 1998
was primarily due to the recognized gain of $73,000 on the sale of the Company's
office building and land, higher interest income on short term investments, and
less interest expense on short term borrowings. The higher expense level in
fiscal year 1997 resulted from an $84,000 write off of obsolete fixed assets.
Provision for Income Taxes
Income taxes payable (refundable) of $149,000 in fiscal year 1998, $(545) in
fiscal year 1997, and $11,000 in fiscal year 1996 relate to state income taxes,
and the alternative minimum tax for Federal income tax. Based on the Company's
recent profitability in fiscal years 1995 through 1997, the Company recorded a
deferred tax asset of $650,000 and $1,500,000 in fiscal years 1996 and 1997,
respectively, reflecting the benefit of approximately $5.5 million in loss
carryforwards. Due to the unprofitable operations in fiscal year 1998 and the
uncertain future profitability, the Company has reassessed the probability of
realizing these net operating loss carryforwards and has determined that their
expected future realization is not likely to be realized in the near future. The
Company wrote off the deferred tax asset of $2.15 million in fiscal year 1998.
The Company has provided a valuation allowance for $10.3 million of net
operating losses as management has determined it was not likely that this amount
will be realized.
The Company has exhausted its ability to carry losses back for income tax
refunds. Net operating loss and tax credit carryforwards for income tax
reporting purposes of approximately $10.3 million and $0.4 million,
respectively, will be available to offset taxes generated from future taxable
income through 2013. If certain substantial changes in the Company's ownership
should occur, there would be an annual limitation on the amount of the
carryforwards which can be utilized.
Restructuring of Operations
In February 1999, the Company restructured its voice processing operations in
order to bring expenses in line with forecasted revenues. In connection with
this restructuring, the Company reduced its voice processing workforce by
approximately 25% and wrote off equipment associated with its headcount
reductions.
The Company will incur a restructuring charge of approximately $260,000 in the
second quarter of fiscal 1999, for severance and benefits costs for the
reduction of approximately 25 employees in February 1999. Temporary employees
and contractors will also be reduced. Included in the restructuring charge is a
write-off of assets of approximately $50,000 which includes the write-off of
equipment associated with headcount reductions.
As a result of these restructuring activities, the Company expects to reduce its
annual voice processing operating expenses, in the form of reduced salaries and
wages, by approximately $1.8 million. The Company expects to complete most of
the actions associated with the restructuring by the end of the second quarter
of fiscal year 1999.
The Company expects to also decrease expenses as a result of the reduced
headcount in areas such as travel, training and communications expenses.
Additionally, the Company is initiating a cost reduction plan in areas such as
advertising, recruiting, office and computer supplies, and professional fees to
further reduce voice processing
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operating expenses. As a result of the restructuring and cost reduction plan the
Company expects to reduce total voice processing operating expenses by
approximately $4.0 million annually and approximately $2.3 million for the
remainder of fiscal year 1999, starting in the second quarter of fiscal year
1999.
In addition to a significant reduction in its international voice processing
operations which occurred as a result of the restructuring, the Company is
currently evaluating options for the transfer or sale of its existing Microlog
Europe interactive voice response operations, sales, and support activities to
organizations in similar lines of business. The Company is continuing to explore
uniQue opportunities in Europe through these organizations.
Year 2000 Compliance
In fiscal year 1998, the Company began the process of identifying and
determining the appropriate resolution to all of the Company's issues relating
to the "Millennium Bug". These issues arise because of the date sensitive
software programs which use two digits to define the applicable year, resulting
in interpretation of a date using "00" as the Year 1900 rather than the Year
2000. This could result in miscalculations or a major system failure. The
Company has concluded that if no action is taken to avoid these consequences,
its Year 2000 issues will have a material effect on the Company's results of
operations and financial condition.
Areas which require remediation are: 1) in-house systems and software programs
used to run the business; 2) products sold to the Company's customers; and 3)
systems and services provided by vendors.
The Company has reviewed its in-house systems for compliance and determined that
all systems will be affected. During fiscal year 1998, the Company completed the
conversion of its accounting, inventory, manufacturing control and information
systems to a new system in order to provide more efficient management
information throughout the Company. In October 1998, as part of system
maintenance, a Year 2000 compliant software release was installed. The vendor
has certified that the new system is Year 2000 compliant. As part of the
Company's computer upgrade plan, approximately $0.5 million of hardware and
software upgrades were purchased for the internal computer network in fiscal
year 1998. These systems were all Year 2000 compliant and were also part of the
Company's Year 2000 compliance program. All remaining in-house computer systems
which are mission critical have been identified, including operating systems and
applications software, and studies are currently being conducted to determine
which programs are compliant and which are not. The Company believes that the
majority of its mission critical systems is currently compliant or can be made
compliant at minimal cost. Non-compliant systems must be replaced or abandoned
prior to the beginning of the Year 2000.
The Company has made a thorough review and testing of its products and believes
that its current products, Intela and uniQue, are Year 2000 compliant. The
Company's assessment of its current products is partially dependent upon the
accuracy of representations concerning Year 2000 compliance made by its
suppliers, such as Aspect, Dialogic, Microsoft and SCO (Santa Cruz Operation),
among others. Many of the Company's customers are, however, using earlier
versions of the Company's current products, previous products or discontinued
products, which are not Year 2000 compliant. The Company has initiated programs
to proactively notify such customers of the risks associated with using these
products and to actively encourage such customers to migrate to the Company's
current products. The Company presently receives service and maintenance
revenues with respect to certain of these products, and such revenues are likely
to cease upon migration to the Company's current products or at the end of the
Year 1999.
In addition, the Company's products are generally integrated within a customer's
enterprise system, which may involve products and systems developed by other
vendors. A customer may mistakenly believe that Year 2000 compliance problems
with its enterprise system are attributable to products provided by the Company.
The Company may, in the future, be subject to claims based on Year 2000
compliance issues related to a customer's enterprise system or other products
provided by third parties, custom modifications to the Company's products made
by third parties, or issues arising from the integration of the Company's
products with other products. The Company has not been involved in any
proceeding involving its products or services in connection with Year 2000
compliance. However, there is no assurance that the Company will not, in the
future, be required to defend its products or services in such proceedings
against claims of Year 2000 compliance issues. Any resulting liability of the
Company for damages could have a material adverse effect on the Company's
business, operating results and financial condition.
The Company purchases components and services which have been evaluated for Year
2000 compliance. The Company has divided its vendors into those who supply
critical services, manufacturing suppliers and manufacturing contractors. The
Company has obtained certification from each of its material vendors as to its
Year 2000 compliance. The costs to evaluate and obtain certification from its
key vendors were not material.
Despite the Company's intent to complete the modifications necessary to be Year
2000 compliant, there exists the risk that the Company will be unable to
complete all tasks required in a timely manner, or that certain issues or
systems could be over-looked. If the required modifications are not made, or
should they not be completed in a timely manner, this issue could materially and
adversely affect the Company's operating results and financial condition. The
Company estimates that the total costs for Year 2000 compliance will not exceed
$0.6 million.
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Factors That May Effect Future Results of Operations
Various paragraphs of this Item 2 (Management's Discussion and Analysis of
Financial Condition and Results of Operations) contain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Actual results could differ materially from those projected in the
forward-looking statements as a result of the factors set forth below and
elsewhere in this document.
The Company believes that its results of operations will be affected by factors
such as the timing of introduction by the Company of new and enhanced products
and services, market acceptance of new voice processing products and
enhancements of existing products, continuation of market trends in the voice
processing market, growth in the voice processing market in general,
competition, commitments to automation by potential large purchasers of the
Company's Retail Solutions products, fluctuations in the buying cycles of
governmental customers, changes in general economic conditions, and changes in
the U.S. defense industry and their impact on the prime contractor for which the
Company provides performance analysis and support services.
The Company is subject to the risk that its new strategy will not be successful.
The new strategy is dependent on market acceptance of the Company's new focus
and new products, ongoing research and development efforts and sales activities
over the near term. In addition, the new strategy is also dependent on the
Company's ability to successfully reduce costs. The Company is subject to the
risk that it will not be able to obtain and maintain the necessary debt
financing it requires to implement its new strategy. Failure to obtain and
maintain required financing would have a material adverse effect on the Company.
The Company's fiscal year 1999 operating budget includes significant
expenditures relating to the development and marketing of its new product line,
uniQue and requires the Company to utilize debt financing to maintain its new
strategy. The Company's anticipated cash flows from existing operations will not
generate the required cash flows to successfully launch the Company's new
strategy. If the Company is unable to obtain and maintain the necessary debt
financing, the Company will not be able to successfully implement its new
strategy and it will be forced to reduce expenditures in addition to those
associated with the restructuring discussed above in order to continue as a
going concern. The Company is subject to the risks that it may not make the
necessary decisions to reduce expenditures in enough time to avoid severe
adverse consequences. In March 1999, the Company has a commitment for a new
line-of-credit facility with a new financial institution (Note 9).
Liquidity and Capital Resources
Working capital as of October 31, 1998 was $2.0 million, as compared to $6.7
million as of October 31, 1997. The decrease was primarily attributable to a
decrease in cash and cash equivalents ($1.6 million), a decrease in accounts
receivable ($0.8 million), a decrease in inventories ($1.0 million), and a
decrease in the current portion of the deferred tax asset ($1.2 million). The
decline in cash was primarily attributable to the losses in fiscal year 1998.
Accounts receivable as of October 31, 1998 were $3.1 million as compared to $3.9
million as of October 31, 1997. The decrease in accounts receivable was
primarily attributable to decreased sales in voice processing, and to a lesser
extent, decreased sales in performance analysis and support services.
Fixed assets as of October 31, 1998 were $1.4 million as compared to $3.7
million as of October 31, 1997. The net decrease in fixed assets resulted
primarily from the sale of the Company's office building and land with a net
book value ($2.0 million), depreciation expense ($0.8 million), offset by the
purchase of assets ($0.5 million). Major assets purchased were primarily
hardware and software upgrades to the Company's internal computer network and
workstations.
In January 1999, the Company learned that its line-of-credit facility will not
be renewed by its financial institution under the same terms and conditions. As
discussed in Note 3, the Company's fiscal year 1999 operating budget includes
significant expenditures relating to the development and marketing of the
Company's new product line, uniQue and requires the Company to utilize debt
financing to maintain its new strategy. If the Company is unable to obtain and
maintain adequate financing, the Company will not be able to successfully
implement its new strategy and will be forced to reduce expenditures in addition
to those associated with the restructuring, discussed above, in order to
continue as a going concern. The Company is subject to the risk that it may not
make the necessary decision to reduce expenditures in enough time to avoid
severe adverse consequences. On February 28,1999, the line-of-credit expired.
In February 1999, the Company and its financial institution put in place a
$750,000 line-of-credit facility, which allows the Company to borrow up to 75%
of the eligible receivables of Old Dominion Systems Inc. of Maryland. The line
of credit bears interest at the bank's prime rate plus 1.25% (9% at February 11,
1999) and is payable upon demand. At March 17, 1999, $500,000 was outstanding
against this line-of-credit. This credit facility will be terminated upon
closing of the $2.0 million revolving line-of-credit facility with the new
financial institution discussed below.
The Company has a commitment for a $2.0 million revolving line-of-credit
facility with a new financial institution, which allows the Company to borrow up
to 75% of its eligible receivables to a maximum of $2,000,000, subject to the
right of the financial institution to make loans at its discretion. The Company
expects to close on this loan facility by the end of March, 1999. The
line-of-credit bears interest at the bank's prime rate plus 2.25% (10.00% at
March 17,
34
<PAGE>
1999), and contains a 0.025% fee on the average unused portion of the line as
well as a monthly collateral fee and a 1% upfront commitment fee. The term of
the loan is one year, and subjects the Company to a restrictive covenant of not
exceeding 115% of its consolidated planned quarterly losses for its second and
third quarters of fiscal year 1999, and a requirement for consolidated
profitability beginning in the fourth quarter of fiscal year 1999. The line also
subjects the Company to a number of restrictive covenants including restrictions
on mergers or acquisitions, payment of dividends, and certain restrictions on
additional borrowings. The line will be secured by all of the Company's assets.
In February 1998, the Company renewed its line-of-credit facility with its bank,
which allows the Company to borrow up to 70% of its eligible receivables to a
maximum of $2,000,000. The line-of-credit bears interest at the bank's prime
rate plus 1.25% (9.00% at October 31, 1998), and contains a 0.5% commitment fee
on the average unused portion of the line. The line expires on February 28, 1999
and subjects the Company to a number of restrictive covenants, including a
requirement to maintain a minimum consolidated tangible net worth, a maximum
ratio of total liabilities to tangible net worth, and a minimum current ratio.
There are restrictions on mergers or acquisitions, payment of dividends, and
certain restrictions on additional borrowings. The line is secured by all of the
Company's tangible assets. At October 31, 1998, the Company was not in
compliance with the covenants for a minimum consolidated tangible net worth and
the maximum ratio of total liabilities to tangible net worth. The bank waived
these covenants at October 31, 1998 and through January 30, 1999. There was no
outstanding debt against this line-of-credit at October 31, 1998. At January
31,1999, the Company was again not in compliance with the covenants for which a
waiver has not been obtained.
In February 1998, the Company also renewed its $1,000,000 loan facility. The
loan facility bears interest at the bank's prime rate plus 0.5% (8.25% at
October 31, 1998), and contains a 0.5% commitment fee on the average unused
portion. At October 31, 1998, there was no outstanding debt against this loan
facility. The loan facility was secured by the Company's principal headquarters
building. In August 1998, this loan facility was terminated as a result of the
sale of the Company's office building (Note 7).
In June 1996, the Company entered into a contract to purchase a new management
information system including a five-year maintenance plan. The purchase,
including maintenance, is being financed by the vendor over a five-year term at
an annual interest rate of 8%. The financing terms require five annual payments
of $140,000 each, including interest, which began on June 30, 1996. Three annual
payments have been made to date. The final payment is due on June 30, 2000.
The Company is subject to the risk that its new strategy will not be successful.
The new strategy is dependent on market acceptance of the Company's new focus
and new products, ongoing research and development efforts and sales activities
over the near term. In addition, the new strategy is also dependent on the
Company's ability to successfully reduce costs. The Company is subject to the
risk that it will not be able to obtain and maintain the necessary debt
financing it requires to implement its new strategy. Failure to obtain and
maintain required financing would have a material adverse effect on the Company.
The Company's fiscal year 1999 operating budget includes significant
expenditures relating to the development and marketing of its new product line,
uniQue and requires the Company to utilize debt financing to maintain its new
strategy. The Company's anticipated cash flows from existing operations will not
generate the required cash flows to successfully launch the Company's new
strategy. If the Company is unable to obtain and maintain the necessary debt
financing, the Company will not be able to successfully implement its new
strategy and it will be forced to reduce expenditures in addition to those
associated with the restructuring discussed above in order to continue as a
going concern. The Company is subject to the risks that it may not make the
necessary decisions to reduce expenditures in enough time to avoid severe
adverse consequences. In March 1999, the Company has a commitment for a new
line-of-credit facility with a new financial institution (Note 9).
Upon closing of the $2.0 million revolving line-of-credit facility with a new
financial institution as discussed above, the Company has estimated that it will
have adequate resources to sustain operations through at least March 2000, based
upon management's planned expenditures for fiscal year 1999. The Company is
subject to the risks as to the ultimate success of its research and development
efforts and sales activities. In particular, the Company is subject to the risk
that its new strategy (described above) will not be successful. The new strategy
is dependent on market acceptance of the Company's new focus and new products,
ongoing research and development efforts and sales activities over the near
term.
The Company is subject to the risk that it will not be able to obtain and
maintain adequate financing to implement its new strategy. Financing activities
to date have primarily consisted of cash generated from operating activities,
the sale of the building and land, and the availability of debt financing. The
Company has generated operating losses resulting in an accumulated deficit of
$11,919,000 at October 31, 1998. Failure to obtain and maintain required
financing would have a material adverse effect on the Company.
This report contains "forward-looking statements" within the meaning of the
Federal Securities laws. The Company's business is subject to significant risks
that could cause the Company's results to differ materially from those expressed
in any forward-looking statements made in this report.
35
<PAGE>
Quarterly Results
Note 16 of the Notes to Consolidated Financial Statements of the Company
contained in this Annual Report presents unaudited quarterly operating results
for the Company's last eight fiscal quarters. The Company believes that this
unaudited information contains all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the selected
quarterly information when read in conjunction with the Consolidated Financial
Statements and Notes thereto. The operating results for any quarter are not
necessarily indicative of results for any subsequent period.
The Company experienced losses in all four quarters of fiscal year 1998. The
losses in each quarter were primarily attributable to insufficient sales in the
Company's voice processing operations, a change in the sales mix in the
Company's voice processing operations, and increases in the reserve for
inventory obsolescence. In the third quarter, the Company wrote-off the deferred
tax asset of $2.15 million ($0.50) per basic and diluted share). In the fourth
quarter, the Company established reserves for the relocation of its operations
facility in The Netherlands, and wrote-off the remaining goodwill balance which
aggregated $0.8 million (($0.19) per basic and diluted share).
The Company was profitable in all four quarters of fiscal year 1997. The
Company's quarterly results showed continued growth in net sales, net income,
and net income per common share. The quarterly fluctuations for the first three
quarters of fiscal 1997 were not significant. In each of the three quarters, the
Company's net income was increased by a $100,000 ($0.02 per basic and diluted
share) income tax benefit, and in the fourth quarter, the Company's net income
was increased by a $1,200,000 ($0.28 per share basic and $0.26 per share
diluted) income tax benefit.
Price Range of Common Stock
The Common Stock is presently traded on the over-the-counter market under the
symbol MLOG. As of February 10, 1999, there were approximately 242 holders of
record of the Common Stock. This number does not reflect the number of
individuals or institutional investors holding stock in nominee name through
banks, brokerage firms, and others.
Note 16 of the Notes to Consolidated Financial Statements of the Company
contained in this Annual Report sets forth, for the period indicated, the range
of high and low transaction prices for the Common Stock as reported on the
NASDAQ Market. The closing price of the Common Stock on February 10, 1999 was
$2.125 per share.
In February 1999, the Company was notified by the Nasdaq National Market System
that it had failed to maintain certain maintenance standards for continued
listing on the Nasdaq National Market System. The Company did not meet the
requirements for minimum net tangible assets and was delinquent in filing its
10K report. The Company has requested a hearing with Nasdaq to discuss its plans
for compliance with the minimum standards. The Company's common stock was
delisted from the Nasdaq National Market System on one prior occasion. In
February 1996, the company returned to the Nasdaq National Market System. The
common stock was traded on the Nasdaq Small Caps Market until its market value
of public float had risen and the Company was able to re-list on the Nasdaq
National Market System. If the common stock is delisted from the Nasdaq National
Market System, there can be no assurance that it will be able to re-list such
securities on that system.
On March 5, 1999, Nasdaq informed the Company that it was halting trading of the
Company's stock pending receipt and review of additional information. The
Company has provided this information to Nasdaq, but has not been advised by
Nasdaq regarding the status of Nasdaq's review.
Dividend Policy
The Company has not paid any dividends in over 10 years. Certain of the
Company's debt agreements restrict the payment of dividends. See Note 9 of the
Notes to Consolidated Financial Statements. The Company does not anticipate
paying any cash dividends in the foreseeable future.
Newly Issued Accounting Standards
In June 1997, the FASB issued SFAS No. 130, "Comprehensive Income." This
statement requires that changes in the amounts of certain items, including
foreign currency translation adjustments and gains and losses on certain
securities be shown in the financial statements. SFAS No. 130 does not require a
specific format for the financial statement in which comprehensive income is
reported, but does require that an amount representing total comprehensive
income be reported in that statement. SFAS No. 130 will be effective for the
Company's fiscal year 1999 and requires reclassification of earlier financial
statements for comparative purposes. The Company believes the adoption of SFAS
No. 130 will not have a material effect on the consolidated financial
statements.
Also, in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This statement will change the way
public companies report information about segments of their business in annual
financial statements and requires them to report selected segment information in
their quarterly reports issued to stockholders. SFAS No. 131 also requires
entity-wide disclosures about the products and services an entity provides, the
material countries in which it holds assets and reports revenues, and its major
customers. SFAS No. 131 will be effective for the Company's fiscal year 1999.
The Company believes the adoption of SFAS No. 131 will not have a material
effect on the consolidated financial statements.
36
<PAGE>
In October 1997, the Accounting Standards Executive Committee (AcSEC) issued
Statement of Position 97-2 (SoP 97-2), "Software Revenue Recognition," which
supersedes SoP 91-1. This statement provides guidance on when revenue should be
recognized and in what amounts for licensing, selling, leasing or otherwise
marketing computer software. SoP 97-2 will be effective for the Company's fiscal
year 1999. The Company does not expect the adoption of SoP 97-2 to have a
material effect on the current operations. However, the effect of this statement
is uncertain as it relates to future products.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures About
Pensions and Other Postretirement Benefits." This statement standardizes the
disclosure requirements for pensions and other postretirement benefits to the
extent practicable and requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate analysis.
Additionally, SFAS No. 132 eliminates certain disclosures that are no longer as
useful as they were when SFAS No. 87, "Employers' Accounting for Pensions", SFAS
No. 88, "Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits", and SFAS No. 106,
"Employers Accounting for Postretirement Benefits Other than Pensions" were
issued. SFAS No. 132 will be effective for the Company's fiscal year 1999. The
Company believes the adoption of SFAS No. 132 will not have a material effect on
the consolidated financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the values of those derivatives
would be accounted for depending on the use of the derivative and whether it
qualifies for hedge accounting. SFAS No. 133 will be effective for the Company's
fiscal year 2000. The Company believes the adoption of SFAS No. 133 will not
have a material effect on the consolidated financial statements.
The FASB, in its APB No.25 Repairs and Maintenance Project, is in the process of
drafting an interpretation that provides guidance on certain practice issues
related to APB No. 25. Although not yet in final form, the FASB anticipates that
the interpretation will become effective in September 1999 and should be applied
(on a prospective basis) to transactions occurring after December 15, 1998.
Under the new interpretation, stock option plans under which options have been
repriced subsequent to December 15, 1998, must be accounted for as variable
plans. Additionally, the FASB has clarified the definition of "employee" to be
the common-law definition and, accordingly, options granted to outside directors
(non-employees) are to be accounted for under SFAS No. 123. If approved by the
FASB, options granted to the Company's Board of Directors will have to be valued
at fair market value and, accordingly, compensation expense will be recorded.
The Company believes that this will not have a material effect on the
consolidated financial statements.
37
<PAGE>
Selected Consolidated Financial Data
The following selected consolidated financial data should be read in conjunction
with the Company's Consolidated Financial Statements and Notes thereto and with
Management's Discussion and Analysis of Financial Condition and Results of
Operations included elsewhere herein.
INCOME STATEMENT DATA (IN THOUSANDS, EXCEPT PER SHARE DATA):
<TABLE>
<CAPTION>
Year Ended October 31,
1994 1995 1996 1997 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net sales $ 18,669 $ 22,386 $ 25,707 $ 31,768 $ 26,457
(Loss) income from
operations (4,917) 1,500 2,111 2,374 (6,430)
Net (loss) income (4,984) 1,387 2,713 (1) 3,732 (1) (8,641) (2)
Net (loss) income per share:
Basic $ (1.29) $ .36 $ .67 $ .89 $ (2.02)
Diluted $ (1.29) $ .34 $ .59 $ .82 $ (2.02)
</TABLE>
BALANCE SHEET DATA (IN THOUSANDS):
<TABLE>
<CAPTION>
October 31,
1994 1995 1996 1997 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Working capital $ (704) $ 749 $ 3,144 $ 6,671 $1,953
Total assets 9,056 9,426 13,713 17,055 8,560
Long-term debt, net
of current maturities 45 --- 203 142 74
Stockholders' equity 2,524 4,160 7,766 11,888 3,370
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
1) Net income includes a $0.65 million ($0.16 per share basic and $0.14 per
share diluted) and a $1.5 million ($0.36 per share basic and $0.33 per
share diluted) income tax benefit for fiscal years 1996 and 1997,
respectively. See Note 12 of the Notes to Consolidated Financial
Statements.
2) Net loss for fiscal year 1998 includes a $2.15 million (($0.50) per basic
and diluted share) write-off of the deferred tax asset. Due to the
unprofitable operations in fiscal year 1998 and the uncertain future
profitability, the Company reassessed the probability of realizing these
net operating loss carryforwards and determined that their expected future
realization is not likely to be realized in the near future. See Note 12 of
the Notes to Consolidated Financial Statements.
38
EXHIBIT 22
----------
SUBSIDIARIES OF THE REGISTRANT
------------------------------
<PAGE>
Subsidiaries of Microlog Corporation
------------------------------------
Old Dominion Systems Incorporated of Maryland
---------------------------------------------
Microlog Corporation of Maryland
--------------------------------
Exhibit 24
Consent of PricewaterhouseCoopers LLP
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (No. 33-30965, 33-34094, 333-07981, and 333-69025) of
Microlog Corporation of our report dated March 17, 1999 which appears on page 28
of the 1998 Annual Report to Shareholders of Microlog Corporation, which is
incorporated by reference in this Annual Report on Form 10-K for the year ended
October 31, 1998. We also consent to the incorporation by reference of our
report on the Financial Statement Schedule, which appears on page F-2 of this
Form 10-K.
PRICEWATERHOUSECOOPERS LLP
McLean, Virginia
March 17, 1999
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Germantown, State of Maryland on March 18, 1999.
MICROLOG CORPORATION
By /s/ Richard A. Thompson
------------------------------------
Richard A. Thompson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this report has been signed below by the following persons in the capacities and
on the dates indicated.
/s/ Richard A. Thompson
- ------------------------------------------- March 18, 1999
Richard A. Thompson
President and Chief Executive Officer
/s/ Steven R. Delmar
- ------------------------------------------- March 18, 1999
Steven R. Delmar
Executive Vice President and Chief Financial Officer
(Principal Accounting and Financial Officer)
- --------------------------------------------
/s/ David M. Gische
- ------------------------------------------- March 18, 1999
David M. Gische
Chairman of the Board and Director
/s/ Robert E. Gray, Jr.
- ------------------------------------------- March 18, 1999
Robert E. Gray, Jr.
Director
/s/ David B. Levi
- ------------------------------------------- March 18, 1999
David B. Levi
Director
/s/ Joe J. Lynn
- ------------------------------------------- March 18, 1999
Joe J. Lynn
Director
<PAGE>
F-1, SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(IN THOUSANDS)
<TABLE>
<CAPTION>
Balance Balance
Fiscal Year Ended 10/31/98 11/01/97 Additions Deletions 10/31/98
========================================== -------- --------- --------- --------
<S> <C> <C> <C> <C>
Receivables
Allowance for Doubtful Accounts 152 29 37 144
Inventory
Reserve for Obsolescence 345 1,299 0 1,644
Income Taxes
Valuation Allowance 1,966 4,434 0 6,400
Balance Balance
Fiscal Year Ended 10/31/97 11/01/96 Additions Deletions 10/31/97
========================================== -------- --------- --------- --------
Receivables
Allowance for Doubtful Accounts 207 49 104 152
Inventory
Reserve for Obsolescence 253 92 0 345
Income Taxes
Valuation Allowance 3,462 0 1,496 1,966
Balance Balance
Fiscal Year Ended 10/31/96 11/01/95 Additions Deletions 10/31/96
========================================== -------- --------- --------- --------
Receivables
Allowance for Doubtful Accounts 167 81 41 207
Inventory
Reserve for Obsolescence 1,055 379 1,181 253
Income Taxes
Valuation Allowance 4,932 0 1,470 3,462
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
-----------------------------------------------------------------
To The Board of Directors
Microlog Corporation
Our audits of the consolidated financial statements referred to in our report
dated March 17, 1999 appearing on page 27 of the 1998 Annual Report to
Shareholders of Microlog Corporation (which report and consolidated financial
statements are incorporated by reference in this Annual Report on Form 10-K)
also included an audit of the Financial Statement Schedule listed in Item 14(a)
of this Form 10-K. In our opinion, the Financial Statement Schedule presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.
PRICEWATERHOUSECOOPERS LLP
McLean, Virginia
March 17, 1999
F-2
