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 June 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 August 12, 1999 was 15,797,124.
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TANGRAM ENTERPRISE SOLUTIONS, INC.
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS:
Balance Sheets -June 30, 1999 (Unaudited) and December 31, 1998............3
Statements of Operations - Three Months Ended
June 30, 1999 and 1998 (Unaudited).....................................4
Statements of Operations - Six Months Ended
June 30, 1999 and 1998 (Unaudited).....................................5
Statements of Cash Flows - Six Months Ended
June 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 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS................17
ITEM 5 - OTHER INFORMATION....................................................17
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K.....................................18
Signatures....................................................................19
2
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<TABLE>
<CAPTION>
TANGRAM ENTERPRISE SOLUTIONS, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
JUNE 30 DECEMBER 31
1999 1998
-----------------------------------------
ASSETS (UNAUDITED) (AUDITED)
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 268 $ 245
Accounts receivable, net of allowance of $366 and $1,262
in 1999 and 1998 4,269 5,930
Notes receivable - officers 1,284 392
Other 441 262
-----------------------------------------
Total current assets 6,262 6,829
PROPERTY AND EQUIPMENT:
Computer equipment and software 689 709
Office equipment and furniture 117 102
Leasehold improvements 88 88
-----------------------------------------
894 899
Less accumulated depreciation and amortization (596) (518)
-----------------------------------------
Total property and equipment 298 381
OTHER ASSETS:
Notes receivable - officers, less current portion - 892
Deferred software costs, net 3,588 3,369
Cost in excess of net assets of business acquired, net 3,285 3,659
Other 40 40
-----------------------------------------
Total other assets 6,913 7,960
=========================================
TOTAL ASSETS $ 13,473 $ 15,170
=========================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 605 $ 794
Accrued expenses 758 1,088
Deferred revenue 2,549 3,476
-----------------------------------------
Total current liabilities 3,912 5,358
LONG-TERM DEBT - SHAREHOLDER 2,811 3,576
OTHER LIABILITIES 443 472
SHAREHOLDERS' EQUITY:
Common stock, par value $0.01, authorized 48,000,000 shares, 15,805,817
issued and 15,797,024 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 (38,258) (38,772)
Treasury stock, at cost, 8,793 shares and 24,693 shares in 1999
and 1998 (51) (144)
-----------------------------------------
Total shareholders' equity 6,307 5,764
=========================================
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 13,473 $ 15,170
=========================================
</TABLE>
SEE ACCOMPANYING NOTES.
3
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TANGRAM ENTERPRISE SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED JUNE 30
1999 1998
--------------------------------------
(UNAUDITED)
REVENUE:
Licenses and products $ 1,948 $ 3,594
Services 2,055 1,373
--------------------------------------
Total revenue 4,003 4,967
COST OF REVENUE:
Cost of licenses and products 461 660
Cost of services 570 464
--------------------------------------
Total cost of revenue 1,031 1,124
--------------------------------------
GROSS PROFIT 2,972 3,843
OPERATING EXPENSES:
Sales and marketing 2,113 2,033
General and administrative (179) 884
Research and development 827 700
--------------------------------------
Total operating expenses 2,761 3,617
--------------------------------------
INCOME FROM OPERATIONS 211 226
Other (expense) income (45) (72)
--------------------------------------
Earnings before income taxes 166 154
Provision for income taxes 6 -
--------------------------------------
NET EARNINGS $ 160 $ 154
======================================
EARNINGS PER COMMON SHARE:
Basic $ 0.01 $ 0.01
======================================
Diluted $ 0.01 $ 0.01
======================================
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES OUTSTANDING:
Basic 15,794 15,739
======================================
Diluted 16,825 17,267
======================================
SEE ACCOMPANYING NOTES
4
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TANGRAM ENTERPRISE SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SIX MONTHS ENDED JUNE 30
1999 1998
---------------------------------------
(UNAUDITED)
REVENUE:
Licenses and products $ 6,123 $ 6,097
Services 3,782 3,026
---------------------------------------
Total revenue 9,905 9,123
COST OF REVENUE:
Cost of licenses and products 1,507 1,192
Cost of services 1,149 905
---------------------------------------
Total cost of revenue 2,656 2,097
---------------------------------------
GROSS PROFIT 7,249 7,026
OPERATING EXPENSES:
Sales and marketing 4,061 3,657
General and administrative 698 1,648
Research and development 1,879 1,444
---------------------------------------
Total operating expenses 6,638 6,749
---------------------------------------
INCOME FROM OPERATIONS 611 277
Other (expense) income (91) (117)
---------------------------------------
Earnings before income taxes 520 160
Provision for income taxes 6 -
---------------------------------------
NET EARNINGS $ 514 $ 160
=======================================
EARNINGS PER COMMON SHARE:
Basic $ 0.03 $ 0.01
=======================================
Diluted $ 0.03 $ 0.01
=======================================
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES OUTSTANDING:
Basic 15,790 15,720
=======================================
Diluted 16,852 17,331
=======================================
SEE ACCOMPANYING NOTES
5
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<TABLE>
<CAPTION>
TANGRAM ENTERPRISE SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
SIX MONTHS ENDED JUNE 30
1999 1998
---------------------------------------
(UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net earnings $ 514 $ 160
Adjustments to reconcile net earnings to net cash provided by (used
in) operating activities:
Depreciation 109 110
Amortization 1,292 1,333
Other (947) 81
Cash provided by changes in working capital items:
Accounts receivable and other current assets 2,379 (2,297)
Accounts payable (189) 351
Accrued expenses (330) (11)
Deferred revenue (927) (597)
---------------------------------------
Net cash provided by (used in) operating activities 1,901 (870)
INVESTING ACTIVITIES
Deferred software costs (1,137) (1,057)
Expenditures for property and equipment (111) (235)
Sale-leaseback of equipment and furniture 106 174
Increase (decrease) in other assets - (3)
---------------------------------------
Net cash used in investing activities (1,142) (1,121)
FINANCING ACTIVITIES
Net (repayments) borrowings from shareholder (765) 2,070
Net repayments on notes payable - (38)
Proceeds from exercise of stock options 29 129
---------------------------------------
Net cash (used in) provided by financing activities (736) 2,161
---------------------------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 23 170
Cash and cash equivalents, beginning of period 245 246
=======================================
Cash and cash equivalents, end of period $ 268 $ 416
=======================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 162 $ 94
=======================================
</TABLE>
SEE ACCOMPANYING NOTES
6
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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 JUNE 30 SIX MONTHS ENDED JUNE 30
1999 1998 1999 1998
------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Research and development costs incurred $ 1,472 $ 1,250 $ 3,016 $ 2,501
Less - capitalized software development costs (645) (550) (1,137) (1,057)
============= ============= ============= ==============
Research and development costs, net $ 827 $ 700 $ 1,879 $ 1,444
============= ============= ============= ==============
</TABLE>
7
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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 $441,000 and $485,000 for the three months ended June 30, 1999 and 1998,
respectively. Amortization of software development costs for the six months
ended June 30, 1999 and 1999 was $919,000 and $959,000, 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 August 12,
1999, borrowings under the line of credit with Safeguard are $3.1 million.
NOTE 4. RELATED PARTY TRANSACTIONS
During the six months ended June 30, 1999 and 1998, the Company incurred
administrative service fees to Safeguard totaling approximately $119,000 and
$137,000, respectively. The Company also incurred $144,000 and $170,000 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, 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 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") partner 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 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.
The Company has been and will continue to be dependent in closing large
Asset Insight product sales in any given quarter. 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. 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 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.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS
Revenue for the three month period ended June 30, 1999 decreased 19% to
$4.0 million, compared with revenue of $5.0 million for the comparable period in
1998. Revenues increased 9% for the six month period ended June 30, 1999 to $9.9
million from $9.1 million for the comparable period in 1998. The Company has
been and will continue to be dependent on large Asset Insight product sales. The
quarter's results were negatively impacted when several large opportunities were
not finalized in the quarter. 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 "lock down"
their IT enterprise because of Year 2000 issues, this may have an adverse
effect on the Company's future revenue. 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 $160,000, or $0.01 per share
(diluted) for the three months ended June 30, 1999 compared to a net income of
$154,000, or $0.01 per share (diluted) for the comparable period in 1998. For
the six months ended June 30, 1999, the Company reported net income of $514,000,
or $0.03 per share (diluted), compared to net income of $160,000, or $0.01 per
share (diluted), for the same period in 1998. The current quarter's 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 model, the Company expects
to make certain reductions in operating expenses, including staffing through
normal attrition. However, the Company is committed to a rational business
model, which will maintain new product development at current levels and provide
a stable sales and marketing organization. The Company has decreased its number
of personnel from 147 at the beginning of the year to 133 currently 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 46% for the three months ended June 30, 1999 to $1.9 million from $3.6
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 remained constant at $6.1 million for the six
months ended June 30, 1999 and 1998, respectively. Asset Insight has been sold
to 105 new accounts during the past twelve months compared to 58 for the
comparable twelve months ending June 1998. While the Company has seen growth in
the number and size of proposals including Asset Insight, presented by its
channel partners, there is no certainty that such proposals will result in
future sales.
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 50% to
$2.1 million in 1999 from $1.4 million in 1998. The increase is due principally
to an increase in Asset Insight consulting services and maintenance revenues.
For the six months ended June 30, 1999 and 1998, respectively, services revenue
increased 25% to $3.8 million from $3.0 million with an increase of
approximately $1.3 million in Asset Insight consulting services and maintenance
revenues offset by a $600,000 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 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.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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 24% for the three months ended June
30, 1999 from 18% for the comparable period in 1998. Cost of licenses and
products for the quarter decreased 30% to $461,000 in 1999 from $660,000 in
1998. For the three months ended June 30, 1999 and 1998, respectively,
amortization of software development costs was $441,000 and $485,000. For the
six months ended June 30, 1999, cost of licenses and products as a percentage of
licenses and products revenue increased to 25% from 20% for the comparable
period in 1998. Costs of licenses and products for the six months ended June 30,
1999 increased 26% to $1.5 million from $1.2 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 $919,000 and $959,000 for the six months ended
June 30, 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 services revenue, cost of services decreased to 28% for the three months
ended June 30, 1999 from 34% for the comparable period in 1998. Cost of services
for the quarter increased 23% in 1999 to $570,000 from $464,000 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.
Cost of services as a percentage of services revenue for the six months ended
June 30, 1999 and 1998, respectively, was 30% for both periods. Cost of services
for the six months ended June 30, 1999 increased 27% to $1.1 million from
$900,000 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. 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. Sales
and marketing expenses increased 4% to $2.1 million for the three month period
ended June 30, 1999 from $2.0 million for the comparable period in 1998. For the
six months ended June 30, 1999, sales and marketing expenses increased to $4.1
million from $3.7 million, for the same period in 1998 representing an 11%
increase. Sales and marketing expenses increased as a percentage of revenue for
the three and six months ended June 30, 1999 to 53% and 41% from 41% and 40%,
respectively, in 1998, principally resulting from lower revenues realized in the
three months ended June 30, 1999. The increase in absolute dollars was primarily
due to the Company's continuing investment in 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 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.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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 June 30, 1999 decreased 120% to $(179,000) from
$884,000 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. For the six months ended June 30, 1999, general and
administrative decreased 58% to $698,000 from $1.6 million for the comparable
period in 1998. As a percentage of total revenues, general and administrative
expenses decreased for the three and six months ended June 30, 1999 to (4)% and
7% from 18% and 18%, respectively, in 1998, principally as a result of the
impact of the resolution of the dispute.
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
June 30, 1999 increased 18% to $1.5 million from $1.2 million for the comparable
period in 1998. Comparing the six months ended June 30, 1999 and 1998; gross
research and development costs increased 21% to $3.0 million from $2.5 million,
respectively. 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 May 1999, the Company released Asset Insight version 3.0
which offers several new functions, including: a new procurement module that
helps managers improve their purchasing practices; an Intranet-based "newspaper"
that brings IT information to managers' desktops; an additional subsystem that
allows customers to manage enterprise changes and outsourcing projects; expanded
discovery capabilities and platform support; and a new database structure for
enhanced performance and future expansion. The Company has also experienced
increased market pressure related to hiring and retaining personnel, which has
resulted in increased staffing costs. 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 56 currently. For the three
and six months ended June 30, 1999 gross research and development costs
increased as a percentage of revenues to 37% and 30%, respectively, from 25% and
27%, respectively, in 1998, principally as a result of lower revenues realized
in the three months ended June 30, 1999. The Company expects the trend of
increased market pressure relating to retaining personnel to continue.
Net research and development expenses for the three months ended June 30,
1999 increased to $827,000 from $700,000 for the same period in 1998. Net
research and development expenses for the six months ended June 30, 1999 and
1998, respectively, increased to $1.9 million from $1.4 million. As a percentage
of gross research and development expenditures, deferred development costs of
the three and six months ended June 30, 1999 were 44% and 38%, respectively,
compared to 44% and 42%, 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 $6,000 as a result of
the impact of the alternative minimum tax requirements. The Company had net
operating loss carryforwards available in 1999 and 1998.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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.
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
August 12, 1999, borrowings under the line of credit with Safeguard were $3.1
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 as a result of higher revenues for the six months ended June 30,
1999 and an increase provided by a lower accounts receivable balance at June 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 quarter ended June 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.
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.
Cash requirements are forecasted to continue to increase through 1999 due
to the planned expenditures for marketing and the 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 $2.9 million
is available for future borrowings as of August 12, 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.
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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.
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 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
continue through 1999.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
YEAR 2000 (CONTINUED)
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. 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.
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,
determine the cost of correcting at-risk software, manage the correction
process, and audit the enterprise to ensure problems are not re-emerging, the
Company believes that the purchasing patterns of customers and potential
customers may be affected by Year 2000 issues. Many companies are expending
significant resources to correct their current software systems for Year 2000
compliance. These expenditures may result in reduced funds available to purchase
software products such as those offered by the Company. 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 "lock down" 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
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, remediation, and
validation 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.
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
YEAR 2000 (CONTINUED)
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 19, 1999, the Annual Meeting of Shareholders of the Company was
held at which the following matters were submitted to and the requisite number
of shares of Common Stock of the Company were voted on by the stockholders, with
the results set forth below:
a) The following persons were elected to the Board of Directors to serve
as directors until the next annual meeting of shareholders in 2000 and
until their respective successors are duly elected and qualified. Each
person received the number of votes set forth next to their names
below:
<TABLE>
<CAPTION>
PROPOSAL I - ELECTION OF DIRECTORS
FOR WITHHELD
--- --------
<S> <C> <C>
W. Christopher Jesse 15,189,614 37,017
Steven F. Kuekes 15,210,518 16,113
John F. Owens 15,195,517 31,114
Charles A. Root 15,195,251 31,380
Carl G. Sempier 15,196,551 30,080
Carl Wilson 15,195,485 31,146
Michael H. Forster 15,195,517 31,114
James A. Ounsworth 15,195,718 30,913
</TABLE>
ITEM 5. OTHER INFORMATION
Shareholders intending to present proposals at the next Annual Meeting
of Shareholders to be held in 2000 must notify the Company of the proposal no
later than December 9, 1999 if they wish to include the proposal on the
Company's proxy card and, along with any supporting statement, in the Company's
proxy statement. As to any proposal presented by a shareholder at the Annual
Meeting of Shareholders that has not been included in the Proxy Statement, the
management proxies will be allowed to use their discretionary voting authority
unless notice of such proposal is received by the Company no later than March
15, 2000.
17
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit
Number Exhibit Description
------ -------------------
27* Financial Data Schedule
* Filed herewith
b) Reports on Form 8-K
No reports on Form 8-K have been filed by the Registrant during the
quarter ended June 30, 1999.
18
<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 August 13, 1999 /s/ John N. Nelli
--------------- ----------------------------------------------
John N. Nelli
Senior Vice President and Chief Financial Officer
(Principal Financial & Accounting Officer)
19
<PAGE>
EXHIBIT INDEX
The following exhibits were filed with the Company's Current Report on Form
10-Q, dated June 30, 1999.
Exhibit
Number Exhibit Description
27* Financial Data Schedule
* Filed herewith
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 268
<SECURITIES> 0
<RECEIVABLES> 4,635
<ALLOWANCES> (366)
<INVENTORY> 136
<CURRENT-ASSETS> 6,262
<PP&E> 894
<DEPRECIATION> (596)
<TOTAL-ASSETS> 13,473
<CURRENT-LIABILITIES> 3,912
<BONDS> 2,811
0
0
<COMMON> 158
<OTHER-SE> 6,149
<TOTAL-LIABILITY-AND-EQUITY> 13,473
<SALES> 6,123
<TOTAL-REVENUES> 9,905
<CGS> 1,507
<TOTAL-COSTS> 6,717
<OTHER-EXPENSES> 2,577
<LOSS-PROVISION> (747)
<INTEREST-EXPENSE> 91
<INCOME-PRETAX> 520
<INCOME-TAX> 6
<INCOME-CONTINUING> 514
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 514
<EPS-BASIC> 0.03
<EPS-DILUTED> 0.03
</TABLE>
