UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to ______________
Commission File Number 0-15454
TANGRAM ENTERPRISE SOLUTIONS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Pennsylvania 23-2214726
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
11000 Regency Parkway, Suite 401
Cary, NC 27511
(Address of Principal Executive Offices) (Zip Code)
(919) 653-6000
(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, $0.01 par value
(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 [ ]
The number of outstanding shares of Common Stock, $0.01 par value per share,
as of November 13, 1998 was 15,780,124.
<PAGE>
TANGRAM ENTERPRISE SOLUTIONS, INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1 - Financial Statements:
Balance Sheets -September 30, 1998 (Unaudited) and
December 31, 1997............................................3
Statements of Operations - Three Months Ended
September 30, 1998 and 1997 (Unaudited)......................4
Statements of Operations - Nine Months Ended
September 30, 1998 and 1997 (Unaudited)......................5
Statements of Cash Flows - Nine Months Ended
September 30, 1998 and 1997 (Unaudited)......................6
Notes to the Financial Statements.................................7
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations.....................................9
PART II. OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K.............................17
Signatures............................................................18
2
<PAGE>
Tangram Enterprise Solutions, Inc.
Balance Sheets
(in thousands, except share amounts)
<TABLE>
<CAPTION>
September 30 December 31
1998 1997
-----------------------------
<S> <C> <C>
Assets (unaudited) (audited)
Current assets:
Cash and cash equivalents $ 143 $ 246
Accounts receivable, net of allowance
of $1,291 and $1,149 in 1998 and 1997 6,234 2,971
Other 414 261
-----------------------------
Total current assets 6,791 3,478
Property and equipment:
Computer equipment and software 674 614
Office equipment and furniture 116 127
Leasehold improvements 88 77
-----------------------------
878 818
Less accumulated depreciation and
amortization 473 352
-----------------------------
Total property and equipment 405 466
Other assets:
Notes receivable - officers 1,284 1,284
Deferred software costs, net 3,352 3,289
Costs in excess of net assets of business
acquired, net 3,846 4,407
Other 37 37
-----------------------------
Total other assets 8,519 9,017
-----------------------------
Total assets $15,715 $12,961
=============================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable 783 671
Accrued expenses 1,793 1,485
Deferred revenue 2,959 2,865
-----------------------------
Total current liabilities 5,535 5,021
Long-term debt - shareholder 4,576 3,006
Other liabilities 456 451
Shareholders' equity
Common stock, par value $0.01, authorized
48,000,000 shares, 15,805,817 and
15,767,747 issued in 1998 and 1997 158 158
Additional paid-in capital 44,534 44,713
Accumulated deficit (39,383) (39,888)
Treasury stock, at cost, 27,693 shares and
86,018 shares in 1998 and 1997 (161) (500)
-----------------------------
Total shareholders' equity 5,148 4,483
-----------------------------
Total liabilities and shareholders' equity $15,715 $12,961
=============================
</TABLE>
See accompanying notes.
3
<PAGE>
Tangram Enterprise Solutions, Inc.
Statements of Operations
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three months ended September 30
1998 1997
---------------------------
<S> <C> <C>
Revenues: (unaudited)
Licenses and product $ 4,210 $ 2,439
Services 1,513 1,369
---------------------------
Total revenues 5,723 3,808
Cost of revenues 1,012 911
---------------------------
Gross profit 4,711 2,897
Operating expenses:
Sales and marketing 2,462 1,756
General and administrative 883 839
Research and development 939 978
---------------------------
Total operating expenses 4,284 3,573
---------------------------
Income (loss) from operations 427 (676)
Other expense (84) (64)
---------------------------
Earnings (loss) before income taxes 343 (740)
Provision for income taxes - -
---------------------------
Net earnings (loss) $ 343 $ (740)
===========================
Earnings (loss) per common share -
Basic and diluted $ 0.02 $ (0.05)
===========================
Weighted average number of common shares outstanding:
Basic 15,770 15,623
===========================
Diluted 17,105 15,623
===========================
</TABLE>
See accompanying notes
4
<PAGE>
Tangram Enterprise Solutions, Inc.
Statements of Operations
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Nine months ended September 30
1998 1997
---------------------------
<S> <C> <C>
Revenues: (unaudited)
Licenses and product $ 10,307 $ 5,165
Services 4,539 4,467
---------------------------
Total revenues 14,846 9,632
Cost of revenues 3,109 2,681
---------------------------
Gross profit 11,737 6,951
Operating expenses:
Sales and marketing 6,119 4,551
General and administrative 2,531 2,504
Research and development 2,383 2,421
---------------------------
Total operating expenses 11,033 9,476
---------------------------
Income (loss) from operations 704 (2,525)
Other expense (201) (116)
---------------------------
Earnings (loss) before income taxes 503 (2,641)
Provision for income taxes - -
---------------------------
Net earnings (loss) $ 503 $ (2,641)
===========================
Earnings (loss) per common share -
Basic and diluted $ 0.03 $ (0.17)
===========================
Weighted average number of common shares outstanding:
Basic 15,737 15,620
===========================
Diluted 17,266 15,620
===========================
</TABLE>
See accompanying notes
5
<PAGE>
Tangram Enterprise Solutions, Inc.
Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
Nine months ended September 30
1998 1997
---------------------------
<S> <C> <C>
Operating activities (unaudited)
Net earnings (loss) $ 503 $(2,641)
Adjustments to reconcile net earnings (loss)
to net cash used in operating activities:
Depreciation 161 279
Amortization 1,976 1,705
Other 122 268
Cash provided by changes in working capital items:
Accounts receivable (3,405) (1,137)
Other current assets (153) (18)
Accounts payable 112 246
Accrued expenses 346 424
Deferred revenue 94 27
---------------------------
Net cash used in operating activities (244) (847)
Investing activities
Deferred software costs (1,478) (1,191)
Expenditures for property and equipment (354) (909)
Sale-leaseback of equipment and furniture 279 826
Net borrowings by officers - (500)
Increase in other assets - 23
---------------------------
Net cash used in investing activities (1,553) (1,751)
Financing activities
Net borrowings from shareholder 1,570 3,180
Net repayments on notes payable (38) (209)
Acquisition of treasury stock - (500)
Proceeds from exercise of stock options 162 147
---------------------------
Net cash provided by financing activities 1,694 2,618
---------------------------
Net increase in cash (103) 20
Cash and cash equivalents, beginning of period 246 176
===========================
Cash and cash equivalents, end of period $ 143 $ 196
===========================
Supplemental disclosure of cash flow information
Cash paid during the period for interest $ 259 $ 182
===========================
</TABLE>
See accompanying notes
6
<PAGE>
Tangram Enterprise Solutions, Inc
Notes to the Financial Statements
(Unaudited)
Note 1. Basis of Presentation
Basis of Presentation
The accompanying unaudited interim financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting solely of
normal recurring accruals) considered necessary for a fair presentation of the
statements have been included. The interim operating results are not necessarily
indicative of the results that may be expected for a full fiscal year. For
further information, refer to the financial statements and accompanying
footnotes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 1997.
Revenue Recognition
In October 1997, the Accounting Standards Executive Committee (AcSEC) issued
Statement of Position (SOP) 97-2 Software Revenue Recognition, as amended in
March 1998 by SOP 98-4. These SOPs provide guidance on applying generally
accepted accounting principles in recognizing revenue on software transactions.
Based on the Company's interpretation of the requirements of the SOPs,
application of these statements is not expected to have a material impact on the
Company's revenue recognition policies. However, AcSEC is currently reviewing
further modifications to the SOP with the objective of providing more
definitive, detailed implementation guidelines. This guidance could lead to
unanticipated changes in the Company's operational and revenue recognition
practices including, but not limited to changes in the period over which revenue
is recognized.
Earnings per Share
The basic earnings per common share calculations for 1998 and 1997 are
computed based on the weighted-average number of common shares outstanding
during each period. Diluted earnings per common share reflect the potential
dilution that would occur assuming the exercise of stock options. Basic and
diluted earnings per share are the same in 1997 because the effect of inclusion
of the exercise of stock options would be to reduce the loss per common share.
If the exercise of stock options were included in 1997, the weighted-average
number of common shares outstanding would have increased by 1,668,500 shares for
the three months ended September 30, 1997 and 1,620,600 for the nine months
ended September 30, 1997.
Reclassifications
Certain amounts in the 1997 financial statements have been reclassified to
conform to 1998 presentation. These reclassifications had no effect on net loss
or shareholders' equity as previously reported.
7
<PAGE>
Tangram Enterprise Solutions, Inc
Notes to the Financial Statements
(Unaudited)
Note 2. Research and Development Costs
The Company capitalizes certain software development costs incurred to
enhance the Company's existing software or to develop new software. Certain
software development costs incurred after technological feasibility of the
product has been established are capitalized. Such capitalized costs are
amortized on an individual product basis commencing when a product is available
for release. Costs incurred prior to the establishment of technological
feasibility are charged to research and development expense.
Research and development costs are comprised of the following (in thousands):
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30 September 30
1998 1997 1998 1997
-------------------- --------------------
<S> <C> <C> <C> <C>
Research and development costs incurred 1,360 $1,351 3,861 $3,612
Less - capitalized software development costs (421) (373) (1,478) (1,191)
==================== ====================
Research and development costs, net $ 939 $ 978 $ 2,383 $2,421
==================== ====================
</TABLE>
Included in cost of revenues is amortization of software development costs of
$457,000 and $390,000 for the three months ended September 30, 1998 and 1997,
respectively. Amortization of software development costs for the nine months
ended September 30, 1998 and 1997 was $1.4 million and $1.1 million,
respectively.
Note 3. Long-term Debt - Shareholder
The Company has a $6 million unsecured revolving line of credit with
Safeguard Scientifics, Inc. ("Safeguard"), a majority shareholder of the
Company, holding approximately 67% of the Company's outstanding shares. Terms of
the line of credit require monthly interest payments at the prime rate plus 1%.
Principal is due thirteen months after date of demand by Safeguard or earlier in
the case of a sale of substantially all of the assets of the Company, a business
combination or upon the closing of a debt or equity offering. As of November 13,
1998, borrowings under the line of credit with Safeguard are $3.5 million.
Note 4. Lease
In July 1997, the Company entered into a sale-leaseback agreement. Under the
arrangement, the Company has received, at varying times through September 30,
1998, $1.1 million for computer equipment and furniture that had a net book
value of $934,000. The leaseback has been accounted for as an operating lease.
The aggregate minimum monthly rental payment under these transactions is
approximately $26,700. The gains recognized in these transactions have been
deferred and are being amortized to income in proportion to rental expense over
the term of the lease.
Note 5. Related Party Transactions
During the nine months ended September 30, 1998 and 1997, the Company
incurred administrative service fees to Safeguard totaling approximately
$200,000 and $185,000, respectively. The Company also incurred $280,000 and
$163,000 of interest costs in 1998 and 1997, respectively, under the revolving
line of credit with Safeguard.
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements that
involve risks and uncertainties. The statements contained in this Quarterly
Report on Form 10-Q, that are not purely historical, are forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act, including without limitation statements regarding the
Company's expectations, beliefs, intentions, or strategies regarding the future.
All forward-looking statements included in this Quarterly Report on Form 10-Q
are based on currently available information to the Company, and the Company
assumes no obligation to update any such forward-looking statements. The
Company's actual results could differ materially from those anticipated in these
forward-looking statements as a result of a number of factors, including, but
not limited to, those set forth in this section and those set forth in the
Company's Annual Report on Form 10-K filed with the Securities and Exchange
Commission on April 8, 1998.
Overview
Tangram Enterprise Solutions, Inc. (the "Company") provides state-of-the-art
enterprise-wide solutions, including asset tracking and electronic software
distribution for large heterogeneous computing environments, encompassing
mainframe, UNIX-based mini, and LAN server platforms. Asset Insight(R), an
information technology asset tracking product launched in 1996, allows
businesses to track changes in their information technology asset base
(including hardware and software), forward plan technology requirements,
optimize end-user productivity, and calculate the cost of software and hardware
upgrades. AM:PM(R) is the Company's industry-leading solution for automated
software distribution, data distribution and collection, and remote resource
management. AM:PM, along with expert consulting services, provides businesses
with solutions to manage an enterprise's heterogeneous and remote information
technology systems. Asset Advantage(TM) is a fully automated, enterprise-wide
electronic software distribution solution that creates a standardized work flow
process across multiple platforms and is integrated with Asset Insight. The
Company is a member of the Safeguard Scientifics, Inc. ("Safeguard") partnership
of companies. Safeguard supports technology-driven growth companies with an
emphasis on information system markets. Safeguard owns approximately 67% of the
Company.
The Company believes that businesses are moving toward an enterprise-wide
computing environment where more desktop personal computers will be
interconnected into large local-area and wide-area networks, as well as the
Internet, and administered by corporate MIS departments. The Company believes
that the continued expansion of heterogeneous computer networks and current
downsizing and rightsizing trends are forcing businesses to seek automated
solutions for tracking and managing their enterprise-wide information technology
assets. While the Company expects the market's shift toward enterprise and
Internet products to continue, there can be no assurance that the Company's
Asset Insight products will be successful or will gain customer acceptance.
The Company has historically experienced a certain degree of variability in
its quarterly revenue and earnings patterns. This variability is typically
driven by significant events that impact the recognition of licenses, product
and implementation service revenues. Examples of such events include: the timing
of major enterprise-wide sales of the Asset Insight product; "one-time" payments
from existing customers for license expansion rights (required to install on a
larger or an additional computer base); completion and customer acceptance of
significant implementation rollouts and the related revenue recognition;
budgeting cycles of its potential customers; changes in the mix of software
products and services sold; the cancellations of licenses or maintenance
agreements; software defects and other product quality problems; and personnel
changes. Additionally, the Company has often recognized a substantial portion of
its revenues in the last month or weeks of a quarter. As a result, license
revenues in any quarter are substantially dependent on orders booked and shipped
in the last month or weeks of that quarter. Due to the foregoing factors,
quarterly revenues and operating results are not predictable with any
significant degree of accuracy. Additionally, fluctuations in the timing and
amounts of additional operating expenses may also cause profitability to
fluctuate from one quarter to another. Also, during a significant product
launching, such as the Asset Insight product, increases in sales and marketing
and general and administrative expenses will occur prior to the realization of
incremental revenues. Historically, renewals have accounted for a significant
portion of the Company's net revenue, however, there can be no assurance that
the Company will be able to sustain current renewal rates in the future.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Many currently installed computer systems and software products are coded to
accept only two-digit entries in the date code field. These date code fields
will need to accept four-digit entries to distinguish 21st century dates from
20th century dates. As a result, in less than two years, computer systems and/or
software used by many companies may need to be upgraded to comply with such
"Year 2000" requirements. Significant uncertainty exists in the software
industry concerning the potential effects associated with such compliance.
Although Asset Insight includes Year 2000 analyses that enable organizations to
assess at-risk assets, determine the cost of correcting at-risk software, manage
the correction process, and audit the enterprise to ensure problems are not
re-emerging, the Company believes that the purchasing patterns of customers and
potential customers may be affected by Year 2000 issues. Many companies are
expending significant resources to correct their current software systems for
Year 2000 compliance. These expenditures may result in reduced funds available
to purchase software products such as those offered by the Company.
Since early 1996, the Company has refocused its business on the asset
tracking market and the launch of its Asset Insight product. The financial
results of the Company hereafter reflect the Company's growing dependence on
revenues generated by sales of Asset Insight. As a result, various risks and
uncertainties relating to the development of the asset tracking business may
cause the Company's actual results to differ materially from the results
contemplated. Such uncertainties include the ability of the Company to sell its
Asset Insight product to major accounts with full enterprise-wide deployment;
the reliability of the Asset Insight product to work in major corporate
enterprises; the possibility of the introduction of superior competitive
products; the length of time required for the Company to realize sufficient
revenue from sales of the product through the reseller sales channel; the
ability of the Company to absorb the increase in sales and marketing expenses
and other operational expenses of launching the Asset Insight product; the
length of time required to develop a sustainable stream of revenue from the sale
of the Asset Insight product; the ability to recruit key technical, sales and
marketing personnel; and the ability of the Company to secure adequate financing
on reasonable terms or at all.
Results of Operations
Revenues
Revenues for the three month period ended September 30, 1998 grew 50% to $5.7
million, compared with revenues of $3.8 million for the comparable period in
1997. The revenue increase was driven by a 157% increase in Asset Insight
revenues in 1998 over the comparable 1997 quarter. Revenues increased 54% for
the nine month period ended September 30, 1998 to $14.8 million from $9.6
million for the comparable period in 1997. As of September 30, 1998, the Company
has expanded its total number of channel partners that promote and resell Asset
Insight from 17 in September 1997 to 55 national and regional value-added
resellers, system integrators and other channel partners. In addition, Asset
Insight has been sold to 76 new accounts during the past twelve months.
License and product revenues include Asset Insight sales; AM:PM and related
product revenues; and traditional mainframe product sales of Arbiter and
gateways including product upgrades and add-ons. For the three and nine months
ended September 30, 1998, product revenues increased to $4.2 million and $10.3
million, respectively, compared to $2.4 million and $5.2 million for the
comparable periods in 1997. The 1998 revenues reflect a $5.9 million increase in
Asset Insight sales offset by a $750,000 decrease in AM:PM and Arbiter product
sales compared to the nine months ended September 30, 1997. While the Company
has seen growth in the number and size of proposals including Asset Insight,
presented by its channel partners, it is uncertain whether such proposals will
result in future sales.
Service revenues include software and hardware maintenance contracts,
implementation services, and training and support services not otherwise covered
under maintenance agreements. Service revenues for the quarter increased 10% to
$1.5 million in 1998 from $1.4 million in 1997. The increase is due principally
to an increase in Asset Insight maintenance revenues offset by lower maintenance
renewals from the AM:PM and Arbiter product lines. For the nine months ended
September 30, 1998 and 1997, respectively, service revenues remained constant at
$4.5 million with an increase of approximately $800,000 in Asset Insight
maintenance
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
10
<PAGE>
Revenues (continued)
and service revenues offset by an equal decline in AM:PM and Arbiter maintenance
revenues. As the Company continues to refocus its business on the asset tracking
market and away from automated software distributing and the traditional
mainframe product lines, it expects this trend to continue.
International sales (including maintenance contracts) represented
approximately 10% and 9% of the Company's total revenues in 1998 and 1997,
respectively. In 1998, the Company recognized revenue related to the final phase
of a contract awarded in September 1997 for an enterprise-wide Asset Insight
implementation. To date, international revenue has been denominated in United
States currency and the Company has not otherwise experienced material adverse
effects associated with doing business overseas. If the Company's international
sales grow, the Company will be exposed to risks inherent with international
revenue. Some of the risk factors include the impact of longer payment cycles,
greater difficulty in accounts receivable collection, and unexpected changes in
regulatory requirements and tariffs. If future international sales are
denominated in local currency, there is an additional risk associated with
fluctuating exchange rates.
Cost of Revenues
Cost of revenues includes costs principally related to the distribution of
licensed software and hardware products and the amortization of capitalized
software development costs. Cost of revenues also reflects the cost of the
direct labor force, including the associated personnel, travel and subsistence,
and occupancy costs incurred in connection with providing implementation and
maintenance services. A significant component of cost of revenues is
attributable to the amortization of deferred development costs, which is fixed
in nature. Therefore, as a result of higher revenues in 1998, cost of revenues
as a percentage of total revenues for the three months ended September 30, 1998
decreased to 18% from 24% for the comparable period in 1997. Cost of revenues
for the quarter increased 11% to $1.0 million in 1998 from $911,000 in 1997. The
overall increase in the amount of cost of revenues is due to higher amortization
of deferred development costs, primarily associated with the development of the
Asset Insight product, and higher implementation services costs resulting from
increased Asset Insight consulting services revenues. Amortization of software
development costs of $457,000 and $390,000 for the three months ended September
30, 1998 and 1997, respectively. For the nine months ended September 30, 1998,
cost of revenues as a percentage of total revenues decreased to 21% from 28% for
the comparable period in 1997. Cost of revenues for the nine months ended
September 30, 1998 increased 16% to $3.1 million from $2.7 million for the
reasons stated above. Amortization of software development costs for the nine
months ended September 30, 1998 and 1997 was $1.4 million and $1.1 million,
respectively.
Sales and Marketing Expenses
Sales and marketing expenses consist principally of salaries, commissions and
benefits for sales, marketing, and channel support personnel, and the costs
associated with product promotions and related travel. With the introduction of
Asset Insight, the Company converted from a direct sales channel to an indirect
sales organization for the distribution of this product. By developing
relationships with resellers, systems integrators, and other third-party vendors
that provide consulting and integration services and deliver products developed
for this market, the Company seeks to acquire an early presence in the market,
cover the expected demand for the product, manage the geographically dispersed
nature of the target market, and build a large number of salespeople in the
field. As such, sales and marketing expenses increased 40% to $2.5 million for
the three month period ended September 30, 1998 from $1.8 million for the
comparable period in 1997. For the nine months ended September 30, 1998 and
1997, sales and marketing expenses increased to $6.1 million from $4.6 million,
respectively, representing a 34% increase. Sales and marketing expenses however,
decreased as a percentage of revenue for the three and nine months ended
September 30, 1998 to 43% and 41%, respectively, from 46% and 47%, respectively,
in 1997. The increase in absolute dollars was primarily due to the Company's
continuing investment in staffing, marketing and increased travel costs to
promote market awareness of the Asset Insight product. The number of sales and
marketing personnel has increased 11% since September 1997. In addition, the
Company has experienced increased market pressure related to hiring and
retaining personnel resulting in increased staffing costs. The Company has
developed a total of 55 channel partner relationships to date for the promotion
and
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Sales and Marketing Expenses (continued)
11
<PAGE>
sale of Asset Insight. The Company is currently investing and intends to
continue to invest significant resources in developing additional sales and
marketing channels through value-added resellers ("VARs"), system integrators,
original equipment manufacturers ("OEMs"), and other channel partners. There can
be no assurance that the Company will be able to attract channel partners that
will be able to market the Company's products effectively and will be qualified
to provide timely and cost-effective customer support and service. Any failure
by the Company to establish and maintain such distribution relationships could
have a material adverse effect on the Company's business, operating results and
financial condition.
General and Administrative Expenses
General and administrative expenses consist principally of salaries and
benefit costs for administrative personnel, general operating costs and legal,
accounting and other professional services. General and administrative expenses
for the three months ended September 30, 1998 increased 5% to $883,000 from
$839,000 for the comparable period in 1997. For the nine months ended September
30, 1998 and 1997, general and administrative expenses remained constant at $2.5
million for both periods. As a percentage of total revenues, general and
administrative expenses decreased for the three and nine months ended September
30,1998 to 15% and 17%, respectively, from 22% and 26%, respectively, in 1997,
principally as a result of a larger revenue base in 1998.
Research and Development
Research and development expenses consist primarily of salaries and benefits
for the Company's software development and technical support staff and, to a
lesser extent, costs associated with independent contractors. The Company
capitalizes certain software development costs incurred to develop new software
or to enhance the Company's existing software. Such capitalized costs are
amortized on an individual product basis commencing when a product is generally
available for release. Costs incurred prior to the establishment of
technological feasibility are charged to research and development expense.
Gross expenditures for research and development for the three months ended
September 30, 1998 and 1997 remained constant at $1.4 million for both periods.
Comparing the nine months ended September 30, 1998 and 1997; gross research and
development costs increased 7% to $3.9 million from $3.6 million, respectively.
The increase is due to personnel increases and the related staffing costs
associated with the Company's continuing commitment to developing enhancements
and improvements of the Asset Insight product and its other product lines. In
addition, the Company has experienced increased market pressure related to
hiring and retaining personnel, which has also resulted in increased staffing
costs. For the three and nine months ended September 30, gross research and
development costs decreased as a percentage of revenues to 24% and 26%,
respectively, in 1998 from 35% and 37%, respectively, in 1997. Net research and
development expenses decreased to $939,000 for the three months ended September
30, 1998 from $978,000 for the same period in 1997. Net research and development
expenses for the nine months ended September 30, 1998 and 1997 remained constant
at $2.4 million. As a percentage of gross research and development expenditures,
deferred development costs for the three and nine months ended September 30,
1998 were 31% and 38%, respectively, compared to 28% and 33%, respectively, in
1997. This increase was due primarily to higher deferral of development costs
relating to the introduction of some major components in Asset Insight. The
Company will continue to commit substantial resources to research and
development efforts in the future.
Provision for Income Taxes
There was no provision for income taxes in 1998 and 1997, as result of the
net operating loss carryforwards available for 1998 and the loss reported in
1997.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
12
<PAGE>
Net Earnings (Loss)
The Company recorded net income of $343,000, or $0.02 per share (diluted),
for the three months ended September 30, 1998 as compared to a net loss of
$740,000, or $0.05 per share, for the comparable period in 1997. For the nine
months ended September 30, 1998, the Company reported net income of $503,000, or
$0.03 per share (diluted), compared to a net loss of $2.6 million, or $0.17 per
share, for the same period in 1997. The revenue growth and the increase in
operating expenses in 1998 are the result of the Company's substantial
expenditures towards market awareness, channel establishment and continued
product development of Asset Insight. The Company expects to continue devoting
substantial resources to developing sales and to product research and
development.
Impact of Recently Issued Accounting Standards
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standard No. 131, ("SFAS 131"), "Disclosures about Segments
of an Enterprise and Related Information". The Company was required to adopt the
provisions of this pronouncement, if applicable, for the fiscal year ending
December 31, 1998. The adoption of this pronouncement is not expected to have an
impact on the Company's financial position and results of operation nor is it
expected to significantly change the presentation of the Company's financial
statements and related notes and data thereto.
In 1998, the Accounting Standards Executive Committee issued a statement of
position on accounting for the costs of computer software developed or obtained
for internal use ("SOP 98-1"). SOP 98-1 is effective for transactions entered
into in fiscal years beginning after December 15, 1998. The Company has reviewed
the statement of position and believes its adoption will not have a material
effect on the Company's financial position or results of operations.
In October 1997, the Accounting Standards Executive Committee (AcSEC) issued
Statement of Position (SOP) 97-2 Software Revenue Recognition, as amended in
March 1998 by SOP 98-4. These SOPs provide guidance on applying generally
accepted accounting principles in recognizing revenue on software transactions.
Based on the Company's interpretation of the requirements of the SOPs,
application of these statements is not expected to have a material impact on the
Company's revenue recognition policies. However, AcSEC is currently reviewing
further modifications to the SOP with the objective of providing more
definitive, detailed implementation guidelines. This guidance could lead to
unanticipated changes in the Company's operational and revenue recognition
practices including, but not limited to changes in the period over which revenue
is recognized. Such changes may have a material adverse effect on the Company's
reported revenue, increase administrative costs, or otherwise adversely modify
existing operations.
13
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Liquidity and Capital Resources
The Company has funded its operations through borrowings and cash generated
from operations. To fund the Company's growth plan, the Company has arranged a
$6.0 million unsecured revolving line of credit with Safeguard. Terms of the
line of credit require monthly interest payments at the prime rate plus 1%.
Principal is due thirteen months after date of demand by Safeguard or earlier in
the case of a sale of substantially all of the assets of the Company, a business
combination or upon the closing of a sale of a debt or equity offering. As of
November 13, 1998, borrowings under the line of credit with Safeguard were
reduced to $3.5 million.
In July 1997, the Company entered into a sale-leaseback agreement. Under the
arrangement, the Company has received, at varying times through September 30,
1998, $1.1 million for computer equipment and furniture that had a net book
value of $934,000. The leaseback has been accounted for as an operating lease.
The aggregate minimum monthly rental payment under these transactions is
approximately $26,700. The gains recognized in these transactions have been
deferred and are being amortized to income in proportion to rental expense over
the term of the lease.
Net cash used in operating activities consisted primarily of non-cash
expenses offset by the net change in working capital items. The decrease in net
cash used by operating activities in 1998 was primarily due to an increase in
net earnings offset by an increase in accounts receivable when compared to 1997.
The increase in accounts receivable is the result of increased sales and the
high percentage of sales recognized in the final weeks of the quarter.
Net cash used in investing activities for 1998 consisted primarily of the
investment associated with the Company's ongoing commitment to developing
enhancements and improvements of the Asset Insight product and the purchase of
furniture and equipment to support the anticipated growth of the business,
offset by the proceeds received under the sale-leaseback agreement described
above.
Net cash provided by financing activities in 1998 consisted primarily of
borrowings under the Safeguard line of credit to fund the Company's growth plan.
In the past, the Company has generated cash from operating activities to fund
development and finance activities despite its net losses due to significant
levels of depreciation and amortization. However, cash requirements are
forecasted to continue to increase through 1998 due to the planned expenditures
for marketing and the increased staffing required to enhance, support and market
the Asset Insight product. As stated above, Safeguard has agreed to assist in
funding the Company's projected cash requirements by providing a $6.0 million
line of credit, of which $2.5 million is available for future borrowings as of
November 13, 1998. However, the Company anticipates that this credit facility
may not be adequate to meet the Asset Insight product rollout expenses. Although
operating activities may provide cash in certain periods, to the extent the
Company experiences growth in the future, the Company anticipates that its
operating and investing activities may use cash. Consequently, any such future
growth may require the Company to obtain additional equity or debt financing.
However, the Company has no present understanding, commitment, or agreement with
respect to any such transaction. Accordingly, there can be no assurance that the
Company will have access to adequate debt or equity financing or that, if
available, it will be under terms and conditions satisfactory to the Company or
which may not be dilutive.
14
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Risks and Uncertainties
The Company has traditionally reported flat to negative revenue growth in the
first quarter as well as lower profit margins in the first two quarters of the
fiscal year than those experienced in the third and fourth quarters. As part of
the annual budget process, management establishes higher discretionary expense
levels in relation to projected revenue for the first half of the year.
Historically, the Company's combined third and fourth quarter revenues have been
greater than the first half of the year, as these two quarters coincide with
clients calendar year budget periods and culmination of the Company's annual
sales plan. These historically higher second half revenues have resulted in
significantly higher profit margins since total expenses have not increased in
proportion to revenue. However, past financial performance should not be
considered to be a reliable indicator of future performance.
The Company's continued growth and success depend to a significant extent on
the continued service of its senior management and other key employees and the
hiring of new qualified employees. Competition for highly-skilled business,
product development, technical and other personnel is increasingly intense due
to lower overall unemployment rates and the boom in information technology
spending. Accordingly, the Company expects to experience increased compensation
costs that may not be offset through either improved productivity or higher
prices. There can be no assurances that the Company will be successful in
continuously recruiting new personnel and in retaining existing personnel.
Year 2000
The Company is currently assessing the nature and extent of the effect of the
Year 2000 issue on the Company. The Company has identified four main areas of
its Year 2000 risk:
1. The Company could be exposed to cost if certain of the earlier versions of
software distribution and mainframe applications sold by the Company are
disrupted or fail and the Company is obligated to remediate those
applications;
2. The Company's internal computer systems could be disrupted or fail,
causing an interruption or decrease in the Company's ability to continue
its operations;
3. The computer systems of third parties with whom the Company regularly
deals, including but not limited to its clients, suppliers, vendors,
utilities, financial institutions, and others ("Material Third Parties")
could be disrupted or fail, causing an interruption or decrease in the
Company's ability to continue its operations; and
4. The Company's sources of revenue could decline if clients' resources are
diverted to the Year 2000 problem.
The Company's Asset Insight product was developed to be Year 2000 compliant;
however, the risk does exist that certain code may not be compliant. In
addition, the Company has designed and tested the most current versions of its
software distribution and mainframe applications product lines to be Year 2000
compliant. However, some of the Company's customers are running product versions
that are not Year 2000 compliant. The Company has been encouraging its customers
to migrate to current product versions. It is possible that the Company may
experience increased expenses in addressing migration issues for such customers.
In addition, there can be no assurances that the Company's current products do
not contain undetected errors or defects associated with Year 2000 date
functions that may result in material costs to the Company. As such, the Company
has established a project team to perform an on-going analysis of its products
and undertake any work necessary to ensure that the current versions continue to
operate correctly when the Year 2000 is reached. The expense associated with
this project will be expensed as incurred. The Company is unable to quantify the
resources that may have to be committed to modify software and is unable at this
time to determine if such expense will be material to the Company.
The Company is conducting an assessment of its internal information
technology ("IT") systems and non-IT systems (such as telephone, voice mail,
building management and security systems) and is in the process of determining
the nature and extent of the work required, if any, to make any material
internal systems Year 2000 compliant. The Company's material internal IT systems
consist principally of accounting, human resources, sales and customer tracking
and development software applications and tools. For third party software
applications, the Company is requesting written confirmation that the software
applications are Year 2000 compliant. The Company has created and implemented an
overall plan to make its internal financial and administrative systems Year 2000
ready by June 1999.
15
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Risks and Uncertainties (continued)
The Company is communicating with critical suppliers, channel partners,
financial institutions and others with which it does business to coordinate Year
2000 conversion. If any of the Company's Material Third Parties are not Year
2000 compliant and their noncompliance causes a material disruption to any of
their businesses, the operations of the Company could be materially adversely
impacted. These disruptions could include, among other things: a client's
inability to process payments to the Company; a financial institution's
inability to process checks drawn on the Company's bank accounts, accept
deposits or process wire transfers; a client's, supplier's, or financial
institution's business failure; a loss of voice and data connections the Company
uses to share information; a loss of electric power to the Company's facilities;
and other interruptions to the normal conduct of business by the Company, the
nature and extent of which the Company cannot foresee. The Company will evaluate
the nature and extent of this risk, but at this time is unable to determine the
probability that any of such risks will be realized, or if they are, the nature
or length thereof, or effect, if any they may have on the Company.
The Company does not have an estimate of the total cost of evaluating and
fixing these potential problems. However, most of the costs incurred in
addressing the Year 2000 problems are expected to be expensed as incurred, in
compliance with generally accepted accounting principles. The Company does
believe that a portion of the cost will be handled through the normal course of
software upgrades and replacements; however, the project may impact capital
expenditure budgets, through accelerated expenditures for software and computer
hardware. However, if compliance efforts of which the Company is not aware are
required and are not completed on time, or if the cost of any required updating,
modification or replacement of the Company's systems exceeds the Company's
estimates, the Year 2000 issue could have a material adverse effect on the
Company.
At the present time, the Company does not have a contingency plan to operate
in the event that its computer systems or those of its vendors or customers are
not Year 2000 compliant. The Company expects to have a contingency plan
completed by June 1999.
While the Company believes that it is addressing the Year 2000 issue, there
can be no assurance that the Company's Year 2000 analyses will be completed on a
timely basis, or that the costs and liabilities associated with the Year 2000
issue will not materially adversely impact the business, prospects, revenues or
financial position of the Company.
16
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit
Number Exhibit Description
------ -------------------
27* Financial Data Schedule
* Filed herewith
b) Reports on Form 8-K
No reports on Form 8-K have been filed by the Registrant during the
quarter ended September 30, 1998.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Tangram Enterprise Solutions, Inc.
Date November 13, 1998 /s/ John N. Nelli
----------------- ----------------------------------
John N. Nelli
Chief Financial Officer and Senior Vice President
(Principal Financial & Accounting Officer)
18
<PAGE>
EXHIBIT INDEX
The following exhibits were filed with the Company's Current Report on Form
10-Q, dated September 30, 1998.
Exhibit
Number Exhibit Description
------ -------------------
27* Financial Data Schedule
* Filed herewith
19
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<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jul-01-1998
<PERIOD-END> Sep-30-1998
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