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 March 31, 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 May 14, 1999 was 15,794,724.
<PAGE>
TANGRAM ENTERPRISE SOLUTIONS, INC.
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
ITEM 1 - FINANCIAL STATEMENTS:
<S> <C>
Balance Sheets -March 31, 1999 (Unaudited) and December 31, 1998.............3
Statements of Operations - Three Months Ended
March 31, 1999 and 1998 (Unaudited)......................................4
Statements of Cash Flows - Three Months Ended
March 31, 1999 and 1998 (Unaudited)......................................5
Notes to the Financial Statements............................................6
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.............................................8
PART II. OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS......................................................15
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K.......................................15
Signatures......................................................................16
</TABLE>
2
<PAGE>
TANGRAM ENTERPRISE SOLUTIONS, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
1999 1998
-----------------------------------------
ASSETS (UNAUDITED) (AUDITED)
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 142 $ 245
Accounts receivable, net of allowance of $1,370 and $1,262
in 1999 and 1998 5,695 5,930
Notes receivable - officers 784 392
Other 412 262
-----------------------------------------
Total current assets 7,033 6,829
PROPERTY AND EQUIPMENT:
Computer equipment and software 750 709
Office equipment and furniture 108 102
Leasehold improvements 88 88
-----------------------------------------
946 899
Less accumulated depreciation and amortization (574) (518)
-----------------------------------------
Total property and equipment 372 381
OTHER ASSETS:
Notes receivable - officers, less current portion 500 892
Deferred software costs, net 3,383 3,369
Cost in excess of net assets of business acquired, net 3,472 3,659
Other 40 40
-----------------------------------------
Total other assets 7,395 7,960
-----------------------------------------
TOTAL ASSETS $ 14,800 $ 15,170
=========================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable 880 794
Accrued expenses 948 1,088
Deferred revenue 2,926 3,476
-----------------------------------------
Total current liabilities 4,754 5,358
LONG-TERM DEBT - SHAREHOLDER 3,460 3,576
OTHER LIABILITIES 458 472
SHAREHOLDERS' EQUITY:
Common stock, par value $0.01, authorized 48,000,000 shares, 15,805,817
issued and 15,786,724 outstanding in 1999 and
15,805,817 issued and 15,781,124 outstanding in 1998 158 158
Additional paid-in capital 44,499 44,522
Accumulated deficit (38,418) (38,772)
Treasury stock, at cost, 19,093 shares and 24,693 shares in 1999
and 1998 (111) (144)
-----------------------------------------
Total shareholders' equity 6,128 5,764
-----------------------------------------
=========================================
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 14,800 $ 15,170
=========================================
</TABLE>
SEE ACCOMPANYING NOTES.
3
<PAGE>
TANGRAM ENTERPRISE SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31
1999 1998
---------------------------------------
(UNAUDITED)
<S> <C> <C>
REVENUE:
Licenses and products $ 4,175 $ 2,503
Services 1,727 1,653
---------------------------------------
Total revenue 5,902 4,156
COST OF REVENUE:
Cost of licenses and products 1,046 532
Cost of services 579 441
---------------------------------------
Total cost of revenue 1,625 973
---------------------------------------
GROSS PROFIT 4,277 3,183
OPERATING EXPENSES:
Sales and marketing 1,948 1,624
General and administrative 877 764
Research and development 1,052 744
---------------------------------------
Total operating expenses 3,877 3,132
---------------------------------------
INCOME FROM OPERATIONS 400 51
Other (expense) income (46) (45)
---------------------------------------
Earnings before income taxes 354 6
Provision for income taxes - -
---------------------------------------
NET EARNINGS $ 354 $ 6
=======================================
EARNINGS PER COMMON SHARE:
Basic $ 0.02 $ 0.00
=======================================
Diluted $ 0.02 $ 0.00
=======================================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic 15,787 15,700
=======================================
Diluted 16,876 17,396
=======================================
</TABLE>
SEE ACCOMPANYING NOTES
4
<PAGE>
TANGRAM ENTERPRISE SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31
1999 1998
---------------------------------------
(UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net earnings $ 354 $ 6
Adjustments to reconcile net earnings to net cash used in operating
activities:
Depreciation 57 58
Amortization 665 661
Other 94 54
Cash provided by changes in working capital items:
Accounts receivable and other current assets (23) (27)
Accounts payable 86 (12)
Accrued expenses (140) (342)
Deferred revenue (550) (574)
---------------------------------------
Net cash provided by (used in) operating activities 543 (176)
INVESTING ACTIVITIES
Deferred software costs (492) (507)
Expenditures for property and equipment (48) (161)
Sale-leaseback of equipment and furniture - 174
Increase (decrease) in other assets - (3)
---------------------------------------
Net cash used in investing activities (540) (497)
FINANCING ACTIVITIES
Net (repayments) borrowings from shareholder (116) 669
Net repayments on notes payable - (38)
Proceeds from exercise of stock options 10 72
---------------------------------------
Net cash (used in) provided by financing activities (106) 703
---------------------------------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (103) 30
Cash and cash equivalents, beginning of period 245 246
---------------------------------------
Cash and cash equivalents, end of period $ 142 $ 276
=======================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 114 $ 74
=======================================
</TABLE>
SEE ACCOMPANYING NOTES
5
<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 MARCH 31
1999 1998
------------- -----------------
<S> <C> <C>
Research and development costs incurred $ 1,544 $ 1,251
Less - capitalized software development costs (492) (507)
------------- -----------------
Research and development costs, net $ 1,052 $ 744
============= =================
</TABLE>
Included in cost of revenues is amortization of software development costs
of $478,000 and $474,000 for the three months ended March 31, 1999 and 1998,
respectively.
6
<PAGE>
TANGRAM ENTERPRISE SOLUTIONS, INC
NOTES TO THE FINANCIAL STATEMENTS
(UNAUDITED)
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 May 14,
1999, borrowings under the line of credit with Safeguard are $4.2 million.
NOTE 4. RELATED PARTY TRANSACTIONS
During the three months ended March 31, 1999 and 1998, the Company incurred
administrative service fees to Safeguard totaling approximately $88,000 and
$57,000, respectively. The Company also incurred $72,000 and $71,000 of interest
costs in 1999 and 1998, respectively, under the revolving line of credit with
Safeguard.
7
<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 develops and operates emerging
growth information technology businesses. Safeguard owns approximately 66% of
the outstanding voting securities of the Company.
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 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. 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.
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 compared to those experienced in the third and fourth quarters.
As a part of the annual budget process, management establishes higher
discretionary expense levels in relation to projected revenue for the first half
of the year. In addition, the Company has experienced increased market pressure
in hiring and retaining personnel. The Company's continued 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 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. Also, during a significant 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
revenue.
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 length of time required for the Company to realize sufficient
revenue from sales of the product through the reseller sales channel; the length
of time required 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.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS
REVENUE
Revenue for the three month period ended March 31, 1999 grew 42% to $5.9
million, compared with revenue of $4.2 million in 1998. The revenue increase was
driven by a 134% increase in Asset Insight revenues in 1999 over the comparable
1998 quarter. As of March 31, 1999, the Company has expanded its total number of
channel partners that promote and resell Asset Insight from 34 in March 1998 to
63 national and regional value-added resellers, system integrators and other
channel partners. In addition, Asset Insight has been sold to 106 new accounts
during the past twelve months compared to 37 for the comparable twelve months
ending March 1998. 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.
Licenses and products revenue include 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 increased
67% in 1999 to $4.2 million from $2.5 million in 1998. The increase was the
result primarily of a $1.7 million increase in Asset Insight product sales.
Services revenues include software and hardware maintenance contracts,
implementation services, and training and support services not otherwise covered
under maintenance agreements. Services revenue for the quarter increased $74,000
or 4% to $1.7 million in 1999. 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. 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 1999, the Company intends to establish a direct sales presence in
the United Kingdom, Germany and the Netherlands. 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. As a percentage of total
revenue, cost of licenses and products increased to 18% in 1999 from 13% in
1998. Cost of revenues for the quarter increased to $1.0 million in 1999 from
$532,000 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 customer. Amortization of
software development costs of $478,000 and $474,000 in 1999 and 1998,
respectively.
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 total revenue, cost of services decreased to 10% in 1999 from 11% in 1998. As
a percentage of services revenue, cost of services increased to 34% in 1999
compared to 27% in 1998. Cost of services increased 31% in 1999 to $579,000 from
$441,000 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.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 sought to acquire an early market share, 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 20% to $1.9 million in 1999 from
$1.6 in 1998. Sales and marketing expenses however, decreased as a percentage of
revenue in 1999 to 33% from 39% in 1998. The increase in absolute dollars was
primarily due to increased commission costs associated with higher revenues and
the Company's continuing investment in staffing and marketing to promote market
awareness and revenue growth of the Asset Insight products. 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 63 channel partner relationships to date for the promotion
and 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
increased 15% in 1999 to $877,000 from $764,000 for the comparable period in
1998. As a percentage of total revenues, general and administrative expenses
decreased in 1999 to 15% from 18% in 1998, principally as a result of a larger
revenue base in 1999.
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 increased 23% in 1999 to
$1.5 million from $1.3 million in 1998. In 1999, gross research and development
costs decreased as a percentage of revenues to 26% from 30% in 1998. The
increase in absolute dollars 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. The Company expects the trend of increased market pressure
relating to hiring and retaining personnel to continue.
Net research and development expenses increased to $1.1 million in 1999
from $744,000 in 1998. As a percentage of gross research and development
expenditures, deferred development costs decreased in 1999 to 32% from 41% in
1998. 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 for the three months ended March
31, 1999 and 1998, respectively, as result of the net operating loss
carryforwards available in both years.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
NET EARNINGS
The Company recorded net income of $354,000, or $0.02 per share (diluted)
for the three months ended March 31, 1999 compared to a net income of $6,000, or
$0.00 per share (diluted) for the comparable period in 1998. The revenue growth
and the increase in operating expenses in 1999 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
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.
11
<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
May 14, 1999, borrowings under the line of credit with Safeguard were $4.2
million.
Net cash used in 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 when compared to 1998.
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 provided by financing activities in 1999 consisted primarily of
borrowings under the Safeguard line of credit to fund the Company's growth plan.
Cash requirements are forecasted to continue to increase through 1999 due
to the planned expenditures for marketing and the increased staffing required to
enhance, support and market Asset Insight and related products. 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 $1.8 million
is available for future borrowings as of May 14, 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 is currently assessing the nature and extent of the effect of
the Year 2000 issue on the Company. In addressing the Year 2000 issue, the
Company has 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 need to
be remediated based on their potential impact to the Company. The REMEDIATION
PHASE includes 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 includes a thorough testing of all proposed repairs,
including present and forward date testing which simulates dates in the Year
2000. The IMPLEMENTATION PHASE consists of placing all items that have been
remediated and successfully tested into production.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
YEAR 2000 (CONTINUED)
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; 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 costs
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 has completed the awareness and assessment 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. Remediation is substantially complete for all
mission-critical applications. Validation and implementation phases will
commence in the second quarter and continue through 1999.
The Company is 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. The Company has
completed the awareness phase of its evaluation of material third parties. The
Company has not yet received sufficient information from all parties about their
remediation plans to predict the outcomes of their efforts. 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. The Company has evaluated the nature
and extent of these risks, 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.
Within the next year, 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
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
YEAR 2000 (CONTINUED)
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.
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
and is working on plans for others. 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.
The Company expects most of the costs incurred in addressing the Year 2000
issues to be expensed as incurred, in compliance with generally accepted
accounting principles. To date, the awareness, assessment and remediation phases
have been conducted by the Company's existing personnel and the incremental cost
has been insignificant. Most of the remaining costs to be incurred in addressing
the Year 2000 issues are expected to be expensed as incurred, in compliance with
generally accepted accounting principles. 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.
14
<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, previously disclosed in the Company's periodic
reports filed with the Securities and Exchange Commission, including most
recently 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 March 31, 1999.
15
<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 May 14, 1999 /s/ John N. Nelli
------------ --------------------------------------------------
John N. Nelli
Senior Vice President and Chief Financial Officer
(Principal Financial & Accounting Officer)
16
<PAGE>
EXHIBIT INDEX
The following exhibits were filed with the Company's Current Report on Form
10-Q, dated March 31, 1999.
Exhibit
Number Exhibit Description
------ -------------------
27* Financial Data Schedule
* Filed herewith
17
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