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, 1999
--------------------------------
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 11, 1999 was 15,797,124.
<PAGE>
TANGRAM ENTERPRISE SOLUTIONS, INC.
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
ITEM 1 - FINANCIAL STATEMENTS:
<S> <C>
Balance Sheets - September 30, 1999 (Unaudited) and December 31, 1998................................3
Statements of Operations - Three Months Ended
September 30, 1999 and 1998 (Unaudited)..........................................................4
Statements of Operations - Nine Months Ended
September 30, 1999 and 1998 (Unaudited)..........................................................5
Statements of Cash Flows - Nine Months Ended
September 30, 1999 and 1998 (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 1 - LEGAL PROCEEDINGS..............................................................................17
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K...............................................................18
Signatures..............................................................................................19
</TABLE>
2
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TANGRAM ENTERPRISE SOLUTIONS, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31
1999 1998
-----------------------------------------
ASSETS (UNAUDITED) (AUDITED)
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 85 $ 245
Accounts receivable, net of allowance of $449 and $1,262
in 1999 and 1998 5,400 5,930
Notes receivable - officers 1,284 392
Other 319 262
-----------------------------------------
Total current assets 7,088 6,829
PROPERTY AND EQUIPMENT:
Computer equipment and software 692 709
Office equipment and furniture 117 102
Leasehold improvements 88 88
-----------------------------------------
897 899
Less accumulated depreciation and amortization (633) (518)
-----------------------------------------
Total property and equipment 264 381
OTHER ASSETS:
Notes receivable - officers, less current portion - 892
Deferred software costs, net 3,640 3,369
Cost in excess of net assets of business acquired, net 3,098 3,659
Other 40 40
-----------------------------------------
Total other assets 6,778 7,960
-----------------------------------------
TOTAL ASSETS $ 14,130 $ 15,170
=========================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 280 $ 794
Accrued expenses 1,142 1,088
Deferred revenue 2,992 3,476
-----------------------------------------
Total current liabilities 4,414 5,358
LONG-TERM DEBT - SHAREHOLDER 2,761 3,576
OTHER LIABILITIES 448 472
SHAREHOLDERS' EQUITY:
Common stock, par value $0.01, authorized 48,000,000 shares,
15,805,817 issued and 15,797,124 outstanding in 1999 and
15,805,817 issued and 15,781,124 outstanding in 1998 158 158
Additional paid-in capital 44,458 44,522
Accumulated deficit (38,058) (38,772)
Treasury stock, at cost, 8,693 shares and 24,693 shares in 1999
and 1998 (51) (144)
-----------------------------------------
Total shareholders' equity 6,507 5,764
-----------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 14,130 $ 15,170
=========================================
</TABLE>
SEE ACCOMPANYING NOTES.
3
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TANGRAM ENTERPRISE SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30
1999 1998
---------------------------------------
(UNAUDITED)
REVENUE:
<S> <C> <C>
Licenses and products $ 2,985 $ 4,210
Services 1,851 1,513
---------------------------------------
Total revenue 4,836 5,723
COST OF REVENUE:
Cost of licenses and products 524 521
Cost of services 538 491
---------------------------------------
Total cost of revenue 1,062 1,012
---------------------------------------
GROSS PROFIT 3,774 4,711
OPERATING EXPENSES:
Sales and marketing 1,851 2,462
General and administrative 820 883
Research and development 847 939
---------------------------------------
Total operating expenses 3,518 4,284
---------------------------------------
INCOME FROM OPERATIONS 256 427
Other expense (47) (84)
---------------------------------------
Earnings before income taxes 209 343
Provision for income taxes 9 -
---------------------------------------
NET EARNINGS $ 200 $ 343
=======================================
EARNINGS PER COMMON SHARE:
Basic $ 0.01 $ 0.02
=======================================
Diluted $ 0.01 $ 0.02
=======================================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic 15,797 15,770
=======================================
Diluted 16,132 17,105
=======================================
</TABLE>
SEE ACCOMPANYING NOTES
4
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TANGRAM ENTERPRISE SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30
1999 1998
---------------------------------------
(UNAUDITED)
REVENUE:
<S> <C> <C>
Licenses and products $ 9,108 $ 10,307
Services 5,633 4,539
---------------------------------------
Total revenue 14,741 14,846
COST OF REVENUE:
Cost of licenses and products 2,031 1,713
Cost of services 1,687 1,396
---------------------------------------
Total cost of revenue 3,718 3,109
---------------------------------------
GROSS PROFIT 11,023 11,737
OPERATING EXPENSES:
Sales and marketing 5,912 6,119
General and administrative 1,518 2,531
Research and development 2,726 2,383
---------------------------------------
Total operating expenses 10,156 11,033
---------------------------------------
INCOME FROM OPERATIONS 867 704
Other expense (138) (201)
---------------------------------------
Earnings before income taxes 729 503
Provision for income taxes 15 -
---------------------------------------
NET EARNINGS $ 714 $ 503
=======================================
EARNINGS PER COMMON SHARE:
Basic $ 0.05 $ 0.03
=======================================
Diluted $ 0.04 $ 0.03
=======================================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic 15,792 15,737
=======================================
Diluted 16,695 17,266
=======================================
</TABLE>
SEE ACCOMPANYING NOTES
5
<PAGE>
TANGRAM ENTERPRISE SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30
1999 1998
---------------------------------------
(UNAUDITED)
OPERATING ACTIVITIES
<S> <C> <C>
Net earnings $ 714 $ 503
Adjustments to reconcile net earnings to net cash provided by (used
in) operating activities:
Depreciation 147 161
Amortization 1,942 1,976
Other (655) 122
Cash provided by changes in working capital items:
Accounts receivable and other current assets 1,083 (3,558)
Accounts payable (514) 112
Accrued expenses 54 346
Deferred revenue (484) 94
---------------------------------------
Net cash provided by (used in) operating activities 2,287 (244)
INVESTING ACTIVITIES
Deferred software costs (1,652) (1,478)
Expenditures for property and equipment (114) (354)
Sale-leaseback of equipment and furniture 105 279
---------------------------------------
Net cash used in investing activities (1,661) (1,553)
FINANCING ACTIVITIES
Net borrowings from shareholder (815) 1,570
Net repayments on notes payable - (38)
Proceeds from exercise of stock options 29 162
---------------------------------------
Net cash (used in) provided by financing activities (786) 1,694
---------------------------------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (160) (103)
Cash and cash equivalents, beginning of period 245 246
=======================================
Cash and cash equivalents, end of period $ 85 $ 143
=======================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 168 $ 259
=======================================
</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, 1998.
REVENUE RECOGNITION
The Accounting Standards Executive Committee (AcSEC) amended Statement of
Position (SOP) 97-2 Software Revenue Recognition in March 1998 by SOP 98-4 and
October 1998 by SOP 98-9. These SOPs provide guidance on applying generally
accepted accounting principles in recognizing revenue on certain software
transactions. The Company adopted SOP 98-4 for software transactions entered
into beginning January 1, 1999. Based on the current requirements of the SOPs,
application of these statements did not 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. Such
changes may have a material adverse effect on the Company's reported revenue,
increase administrative costs, or otherwise adversely modify existing
operations.
EARNINGS PER SHARE
The basic earnings per common share calculations for 1999 and 1998 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.
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 SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
1999 1998 1999 1998
------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
Research and development costs incurred $ 1,361 $ 1,360 $ 4,377 $ 3,861
Less - capitalized software development costs (514) (421) (1,651) (1,478)
============= ============== ============== =============
Research and development costs, net $ 847 $ 939 $ 2,726 $ 2,383
============= ============== ============== =============
</TABLE>
7
<PAGE>
TANGRAM ENTERPRISE SOLUTIONS, INC
NOTES TO THE FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2. RESEARCH AND DEVELOPMENT COSTS (CONTINUED)
Included in cost of revenues is amortization of software development costs
of $462,000 and $457,000 for the three months ended September 30, 1999 and 1998,
respectively. Amortization of software development costs for the nine months
ended September 30, 1999 and 1998 was $1.4 million and $1.4 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 66% 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 10,
1999, borrowings under the line of credit with Safeguard are $2.5 million.
NOTE 4. RELATED PARTY TRANSACTIONS
During the nine months ended September 30, 1999 and 1998, the Company
incurred administrative service fees to Safeguard totaling approximately
$149,000 and $200,000, respectively. The Company also incurred $213,500 and
$280,000 of interest costs in 1999 and 1998, respectively, under the revolving
line of credit with Safeguard.
NOTE 5. CONTINGENCIES
Since February 1998, the Company has disclosed a dispute regarding a
customer's failure to pay for software products sold and delivered by the
Company. As a result of the customer's non-payment, the Company fully reserved
for the outstanding receivable due. In May 1999, the Company and the customer
reached an amicable resolution to the dispute that resulted in the recovery of
$925,000 of the outstanding receivable which is reflected in the nine months
statements of operations as a reduction to general and administrative expenses.
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"
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934, including, among others, statements
containing the words "believes," "anticipates," "estimates," "expects" and words
of similar import. Such statements are subject to certain risks and
uncertainties, which include but are not limited to those important factors
discussed in cautionary statements throughout the section below and those set
forth in the Company's Annual Report on Form 10-K filed with the Securities and
Exchange Commission on March 31, 1999, and are qualified in their entirety by
those cautionary statements.
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, 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 is an automated software distribution, data distribution and
collection, and remote resource management solution that provides businesses
with solutions to manage an enterprise's heterogeneous and remote information
technology systems. The Company is a member of the Safeguard Scientifics, Inc.
("Safeguard") partnership of companies. Safeguard is an information technology
holding company that identifies, acquires, operates and manages information
technology companies. Safeguard owns approximately 66% of the outstanding voting
securities of the Company.
Since early 1996, the Company has refocused its business on the asset tracking
market and the introduction and sale of its Asset Insight product. The financial
results of the Company hereafter reflect the Company's growing dependence on
revenue 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 possibility of the introduction of superior competitive products; the
ability of the company to develop a sustainable stream of revenue from the sale
of the Asset Insight product; the ability to recruit and retain key technical,
sales and marketing personnel; and the ability of the Company to secure adequate
financing on reasonable terms or at all.
The Company has been and will continue to be dependent on closing large
Asset Insight product sales in a given quarter. The license of the Company's
software generally requires the Company to engage in a sales cycle that
typically takes approximately three to nine months to complete. The length of
the sales cycle may vary depending on factors over which the Company has little
or no control, such as the size of the transaction, the internal activities of
potential customers, and the level of competition which the Company encounters
in selling its products. As such, the Company has historically experienced a
certain degree of variability in its quarterly revenue and earnings patterns.
This variability, in addition to the foregoing reason, is typically driven by
significant events that impact the recognition of licenses, product and
implementation services revenue. 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; organizational changes within the Company's channel
partners; software defects and other product quality problems. Historically,
renewals have accounted for a significant portion of the Company's revenue;
however, there can be no assurance that the Company will be able to sustain
current renewal rates in the future. In addition, the Company has and may
continue to encounter potential customers that are unwilling to purchase any
additional software for their enterprise as the result of Year 2000 initiatives.
If a significant number of the Company's future and potential prospects defer
software purchases for their IT enterprise because of Year 2000 issues, this may
have an adverse effect on the Company's future revenue. Additionally, the
Company has often shipped and booked a substantial portion of its product
revenue in the last month or weeks of a quarter. Due to the foregoing factors,
quarterly revenue is not predictable with any significant degree of accuracy.
In addition, the Company is experiencing increased market pressure in
hiring and retaining personnel. The Company's growth and success depends 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
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
OVERVIEW (CONTINUED)
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. These fluctuations in the
timing and amounts of additional operating expenses may also cause profitability
to fluctuate from one quarter to another.
RESULTS OF OPERATIONS
Revenue for the three month period ended September 30, 1999 decreased15% to $4.8
million, compared with revenue of $5.7 million for the comparable period in
1998. Revenues decreased 1% for the nine month period ended September 30, 1999
to $14.7 million from $14.8 million for the comparable period in 1998. The
Company has been and will continue to be dependent on large Asset Insight
product sales. The past two quarter's results have been negatively impacted when
several large opportunities were not finalized, however there is no certainty
that such opportunities will result in future sales. Additionally, the Company
is beginning to experience increased pressure from competitors. Historically,
the Company has encountered competition from a number of sources, including
system management and infrastructure management companies. Recently, vendors of
asset management software and infrastructure management offerings have enhanced
their products to include functionality that is currently provided by asset
tracking and low-end discovery tool software. Even though the asset tracking
functionality provided as standard features by asset management software or
infrastructure management offerings is more limited than that of the Company's
Asset Insight products, there can be no assurance that a significant number of
customers would not elect to accept such functionality in lieu of purchasing
additional software. While we maintain a strong competitive advantage in
functionality and features, this emergence of asset management software or
infrastructure management offerings is having the effect of extending the sales
cycle for the large deals opportunities the Company is pursuing as well as
creating pressure on the Company to reduce prices for the AI product line.
In addition, the Company has encountered and may continue to encounter potential
customers that are unwilling to purchase any additional software for their
enterprise as the result of Year 2000 initiatives. However, the Company has
experienced continued growth in the number and size of Asset Insight proposals
presented by its channel partners, but there is no certainty that such
proposals will result in future sales.
The Company recorded net income of $200,000, or $0.01 per share (diluted) for
the three months ended September 30, 1999 compared to a net income of $343,000,
or $0.02 per share (diluted) for the comparable period in 1998. For the nine
months ended September 30, 1999, the Company reported net income of $714,000, or
$0.04 per share (diluted), compared to net income of $503,000, or $0.03 per
share (diluted), for the same period in 1998. The current nine months' results
reflect the recovery of $925,000 of a previously reserved outstanding
receivable, which was disclosed in the Company's March 31, 1999 Form 10-Q.
As a result of the current unpredictability of the revenue as discussed above,
the Company has made certain reductions in operating expenses, including
staffing through normal attrition. However, the Company will maintain product
development at current levels and take appropriate actions to maintain the sales
and marketing organization. The Company has decreased its number of personnel
from 147 as of January 1, 1999 to 128 as of November 11, 1999 through normal
attrition and has chosen not to replace those positions at this time.
REVENUE
Licenses and products revenue includes the sales of Asset Insight; AM:PM
and related products, and the traditional mainframe products of Arbiter and
gateways including product upgrades and add-ons. Licenses and products revenue
decreased 29% for the three months ended September 30, 1999 to $3 million from
$4.2 million for the comparable period in 1998. The decrease was the result
primarily of a decrease in Asset Insight product sales for the reasons stated
above. Licenses and products revenue decreased 12% to $9.1 million for the nine
months ended September 30, 1999 from $10.3 million for the comparable
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
REVENUE (CONTINUED)
period in 1998. Twenty seven new Asset Insight customers were added during the
third quarter of 1999, bringing the total nodes sold to date to approximately
1.3 million.
Services revenue includes software and hardware maintenance contracts,
implementation services, and training and support services not otherwise covered
under maintenance agreements. Services revenue for the quarter increased 22% to
$1.9 million in 1999 from $1.5 million in 1998. The increase is due principally
to an increase in Asset Insight consulting services and maintenance revenues.
This increase reflects the demand for implementation assistance from customers.
For the nine months ended September 30, 1999 and 1998, respectively, services
revenue increased 24% to $5.6 million from $4.5 million with an increase of
approximately $2.1 million in Asset Insight consulting services ($0.9 million)
and maintenance revenues ($1.2 million) offset by a $1.0 million decrease in
AM:PM and Arbiter services revenue and maintenance renewals. 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.
During the first nine months of 1999, the Company has taken the initial
steps to establish a direct sales presence in the United Kingdom, Germany and
the Netherlands. International revenue for the three months ended September 30,
1999 was $243,000. If the Company's international revenues grow as anticipated,
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 REVENUE
Cost of licenses and products includes costs related to the distribution of
licensed software and hardware products, third party software products and the
amortization of capitalized software development costs. A significant component
of cost of licenses and products is attributable to the amortization of deferred
development costs, which is generally fixed in nature. Therefore, as a result of
lower revenues in 1999, cost of licenses and products as a percentage of
licenses and products revenue increased to 18% for the three months ended
September 30, 1999 from 12% for the comparable period in 1998. Cost of licenses
and products for the quarter increased slightly to $524,000 in 1999 from
$521,000 in 1998. For the three months ended September 30, 1999 and 1998,
respectively, amortization of software development costs was $462,000 and
$457,000. For the nine months ended September 30, 1999, cost of licenses and
products as a percentage of licenses and products revenue increased to 22% from
17% for the comparable period in 1998. Costs of licenses and products for the
nine months ended September 30, 1999 increased 19% to $2.0 million from $1.7
million for the comparable period in 1998. The overall increase in the cost of
licenses and products is related primarily to the purchase and bundling of a
third party software product, that integrates with Asset Insight, for a sale in
the first quarter. Amortization of software development costs was $1.4 million
in each of the nine months ended September 30, 1999 and 1998.
Cost of services reflects the cost of the direct labor force, including the
associated personnel, travel and subsistence, and occupancy costs incurred in
connection with providing consulting and maintenance services. As a percentage
of services revenue, cost of services decreased to 29% for the three months
ended September 30, 1999 from 32% for the comparable period in 1998. In absolute
dollars, cost of services for the quarter increased 10% in 1999 to $538,000 from
$491,000 in 1998. The overall increase in cost of services is primarily a result
of higher consulting services costs associated with increased Asset Insight
product services revenue. The Company utilizes consultants trained in the
deployment of Asset Insight who are either employees of the Company or
selected subcontractors. The consultants who are subcontractors of the Company
generally cost significantly more than the consultants employed by the Company.
While the growth in the absolute cost reflects the growth in Asset Insight
product services revenue, the Company's gross profit can fluctuate based upon
the mix of use of subcontractors
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
COST OF REVENUE (CONTINUED)
versus consultants employed by the Company. Cost of services as a percentage of
services revenue for the nine months ended September 30, 1999 was 30% a decrease
from 31% for the comparable period in 1998. Cost of services for the nine months
ended September 30, 1999 increased 21% to $1.7 million from $1.4 million for the
comparable period in 1998 for the reason stated above.
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. Sales and marketing
expenses decreased 25% to $1.9 million for the three month period ended
September 30, 1999 from $2.5 million for the comparable period in 1998. For the
nine months ended September 30, 1999, sales and marketing expenses decreased to
$5.9 million from $6.1 million for the same period in 1998, representing a 3%
decrease. Sales and marketing expenses decreased as a percentage of revenue for
the three and nine months ended September 30, 1999 to 38% and 40% from 43% and
41%, respectively, in 1998. The reduction in spending is attributable to lower
sales commissions paid resulting from the decline in sales revenue and reduction
in travel and marketing cost associated with more effective cost management in
these two areas. However, the Company has experienced increased market pressure
related to hiring and retaining personnel resulting in increased staffing costs.
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, 1999 decreased 7% to $820,000 from
$883,000 for the comparable period in 1998, principally reflecting lower
personnel related costs. For the nine months ended September 30, 1999, general
and administrative expenses decreased 40% to $1.5 million from $2.5 million for
the comparable period in 1998 principally reflecting the benefit arising from
the resolution of an outstanding dispute as described in footnote 5 to the
financial statements. As a percentage of total revenues, general and
administrative expenses for the three and nine months ended September 30, 1999
were 17% and 10% as compared to 15% and 17%, respectively, in 1998, principally
as a result of the reasons noted above.
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, 1999 remained relatively constant at $1.4
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
RESEARCH AND DEVELOPMENT (CONTINUED)
million in relation to the comparable period in 1998. Comparing the nine months
ended September 30, 1999 and 1998; gross research and development costs
increased 13% to $4.4 million from $3.9 million, respectively. The increase in
absolute dollars is due to personnel increases and the related staffing and
facility costs associated with the Company's continuing commitment to developing
enhancements and improvements of the Asset Insight product and its other product
lines. The Company is dependant upon its ability to attract, hire and retain
information technology professionals who possess the skills and experience
necessary to meet the product development requirements of the market.
Competition for qualified individuals with proven technical skills is highly
intense and has resulted in increased staffing costs. The Company expects the
trend of increased market pressure relating to retaining personnel to continue.
While the Company maintains an active development effort, the number of
personnel has decreased through normal attrition from 62 at the beginning of the
year to 44 currently. For the three and nine months ended September 30, 1999
gross research and development costs increased as a percentage of revenues to
28% and 30%, respectively, from 24% and 26%, respectively, in 1998, principally
as a result of lower revenues realized in 1999.
Net research and development expenses for the three months ended September
30, 1999 decreased to $847,000 from $939,000 for the same period in 1998,
principally as the result of higher deferral of development costs associated
with new product development. Net research and development expenses for the nine
months ended September 30, 1999 and 1998, respectively, increased to $2.7
million from $2.4 million. As a percentage of gross research and development
expenditures, deferred development costs of the three and nine months ended
September 30, 1999 were 38% and 38%, respectively, compared to 31% and 38%,
respectively, in 1998. The Company will continue to commit substantial resources
to research and development efforts in the future.
PROVISION FOR INCOME TAXES
In 1999, the Company incurred income tax expense of $15,000 as a result of
the impact of the alternative minimum tax requirements. The Company had net
operating loss carryforwards available in 1999 and 1998.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
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") effective for transactions entered into in fiscal
years beginning after December 15, 1998. The adoption of SOP 98-1 is not
expected to have a material impact on the Company's results of operation.
The Accounting Standards Executive Committee (AcSEC) amended Statement of
Position (SOP) 97-2 Software Revenue Recognition in March 1998 by SOP 98-4 and
October 1998 by SOP 98-9. These SOPs provide guidance on applying generally
accepted accounting principles in recognizing revenue on software transactions.
The Company adopted SOP 98-4 for software transactions entered into beginning
January 1, 1999. Based on the current requirements of the SOPs, application of
these statements did not 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. 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. Net cash provided by operating activities consisted primarily of
non-cash expenses offset by the net change in working capital items. The
increase in net cash provided by operating activities in 1999 was primarily due
to an increase in net earnings and a lower accounts receivable balance at
September 30, 1999 offset by a decrease in other working capital items when
compared to 1998. The lower accounts receivable balance is primarily
attributable to improved collection efforts and lower comparable revenue for the
period ended September 30, 1999. Also, as indicated in Note 5 of the financial
statements, the Company and a customer reached an amicable resolution to a
dispute that resulted in the recovery of $925,000 of an outstanding receivable,
previously fully reserved, which is reflected in the statement of cash flows as
an increase in cash provided by accounts receivable and a reduction to the
reserve for uncollectible accounts.
To supplement the Company's operations, 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 10,
1999, borrowings under the line of credit with Safeguard were $2.5 million.
Net cash used in investing activities for 1999 consisted primarily of the
investment associated with the Company's ongoing commitment to developing
enhancements and improvements of the Asset Insight product.
Net cash used in financing activities in 1999 consisted primarily of
repayment of borrowings under the Safeguard line of credit.
The Company intends to maintain its position at the forefront of the market
for asset tracking; pursue strategic opportunities, including mergers,
acquisitions, alliances, and partnerships with other industry companies in the
asset management market; expand worldwide sales and marketing operations,
focusing initially on Europe and North America; and develop and enhance its
product line. Implementation of these plans will require significant operating
expense and capital expenditures. 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 $3.5 million is available for future borrowings
as of November 10, 1999. 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.
YEAR 2000
Some computers, software and other equipment include programming code in
which calendar year data is abbreviated to only two digits. As a result of this
design decision, some of these systems could fail to operate or fail to produce
correct results if "00" is interpreted to mean the year 1900 instead of 2000.
The Company has completed its assessment but continues to monitor the
possible extent of the effect of the Year 2000 issue on the Company. In
addressing the Year 2000 issue, the Company identified the following five
phases. In the AWARENESS PHASE, the Company defined the Year 2000 issue,
obtained executive level support and identified areas of risk. In the ASSESSMENT
PHASE, the Company collected a comprehensive list of items that may be affected
by Year 2000 compliance issues in each risk area and evaluated the items to
determine which will function properly with the change to the new century and
ranked items that will
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
YEAR 2000 (CONTINUED)
need to be remediated based on their potential impact to the Company. The
REMEDIATION PHASE included an analysis of the items that are affected by Year
2000, the identification of problem areas and the repair of essential
non-compliant items. The VALIDATION PHASE included a thorough testing of all
proposed repairs, including present and forward date testing which simulates
dates in the Year 2000. The IMPLEMENTATION PHASE consisted of placing all items
that have been remediated and successfully tested into production.
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 channel partners, 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. 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 costs associated with this project will be expensed as incurred.
The Company has completed the awareness, assessment and remediation of its
internal information technology ("IT") systems and non-IT systems (such as
telephone, voice mail, building management and security systems). 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 has requested written
confirmation that the software applications are Year 2000 compliant or has
obtained relevant information directly from vendors' websites and other publicly
available sources. Monitoring the possible extent of the effect of the Year 2000
issue on the Company's internal IT systems and non-IT systems will continue
through the end of 1999.
The Company has been communicating directly with critical suppliers,
channel partners, and financial institutions and gathering information from
their websites, SEC filings and other public sources to identify and, to the
extent possible, resolve issues relating to their Year 2000 readiness. However,
the Company has limited or no control over the actions of such third parties. If
any of the Company's material third parties are not Year 2000 ready 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 channel partner'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 channel partner's, supplier's, or financial institution's business
failure; a loss of voice and data connections the Company uses to share
information; and other interruptions to the normal conduct of business by the
Company, the nature and extent of which the Company cannot foresee. While the
Company is unaware of any specific risk or failure area, it 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.
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
YEAR 2000 (CONTINUED)
Significant uncertainty exists in the software industry concerning the
potential effects associated with Year 2000 compliance. Although Asset Insight
includes Year 2000 analyses that enable organizations to assess at-risk assets,
determinethe 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. In addition, the Company has and
may continue to encounter potential customer sites that are unwilling to
purchase any additional software for their enterprise as the result of Year 2000
initiatives. If a significant number of the Company's future and potential
prospects defer software purchases for their IT enterprise because of Year 2000
issues, this may have an adverse effect on the Company's future revenue.
The Company expects to identify and resolve, before December 31, 1999, all
significant Year 2000 issues that could materially adversely affect its
business, financial condition or results of operations. However, the Company
does not believe it is possible to determine with complete certainty that all
Year 2000 issues affecting the Company have been identified or corrected. In
addition, the Company cannot accurately predict how many failures related to
Year 2000 will occur or the severity, duration or financial consequences of such
failures. As a result, although the Company believes that its Year 2000 efforts
will enable the company to avoid suffering a material adverse effect in this
regard, the Company has considered that it could possibly suffer:
o a significant number of operational inconveniences and inefficiencies
for the Company and its customers that may divert management's time and
attention and financial and human resources from its ordinary business
activities; or
o a lesser number of serious system failures that may require significant
efforts by the Company or its customers to prevent or alleviate material
business disruptions.
The Company has contingency plans for certain mission-critical
applications. These contingency plans involve, among other actions, manual
workarounds, increasing inventories, seeking alternate vendors and adjusting
staffing strategies. Certain internal applications, third party software and
products have been determined to be non-compliant and have a minimal risk of
impacting or disrupting the Company's operations or product performance. As
such, no contingency plans are expected to be developed for these items.
However, these items will be monitored throughout 1999 and contingency plans
will be created if the potential for significant impact arises for any of these
items.
Most of the costs incurred in addressing the Year 2000 issues has been
expensed as incurred, in compliance with generally accepted accounting
principles. To date, the awareness, assessment, remediation, and validation
phases have been conducted by the Company's existing personnel and the
incremental cost has been insignificant. The Company does believe that a portion
of the remaining cost will be handled through the normal course of software
upgrades and replacements and is currently estimated to be under $100,000.
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.
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, revenue or
financial position of the Company.
16
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On May 14, 1999, the Company and State Farm Mutual Automobile Insurance
Company ("State Farm") reached an amicable resolution of their outstanding
software licensing dispute (see Note 5 to the financial statements), previously
disclosed in the Company's periodic reports filed with the Securities and
Exchange Commission, including its disclosure at Item 3 of its Annual Report on
Form 10-K for the year ended December 31, 1998. The parties have further agreed
to terminate the related legal proceedings. Neither party was determined to be
at fault.
There are no other material pending legal proceedings to which the Company
is a party or of which any of its property is subject.
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, 1999.
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 11, 1999 /s/ John N. Nelli
----------------- -------------------------------------------------
John N. Nelli
Senior Vice President and Chief Financial Officer
(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, 1999.
Exhibit
Number Exhibit Description
------ -------------------
27* Financial Data Schedule
* Filed herewith
19
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