U.S.SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended: May 31, 1999
[ ] 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 0-18250
TMS, Inc.
(Exact name of small business issuer as specified in its charter)
OKLAHOMA 91-1098155
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
206 West Sixth Street
Post Office Box 1358
Stillwater, Oklahoma 74075
(Address of principal executive offices)
Issuer's telephone number, including area code: (405) 377-0880
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 [ ]
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date:
Title of Each Class Outstanding at May 31, 1999
Common stock, par value $.05 per share 13,605,846
Transitional Small Business Disclosure Format(check one): Yes [ ] No [X]
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
TMS, Inc.
Condensed Balance Sheets (unaudited)
May 31, 1999 and August 31, 1998
May 31, August 31,
1999 1998*
______________ ______________
Cash $ 721,870 491,696
Trade accounts receivable, net 979,581 1,293,921
Contract service work in process 449,975 597,345
Other current assets 332,027 365,050
-------------- --------------
Total current assets 2,483,453 2,748,012
-------------- --------------
Property and equipment 2,901,441 3,187,407
Accumulated depreciation and
amortization (1,529,278) (1,527,528)
-------------- --------------
Net property and equipment 1,372,163 1,659,879
-------------- --------------
Capitalized software development
costs, net 474,718 620,539
Other assets 254,974 257,153
-------------- --------------
Total assets 4,585,308 5,285,583
============== ==============
Accounts payable 90,866 147,844
Other current liabilities 420,610 504,136
-------------- --------------
Total current liabilities 511,476 651,980
Obligation under capital lease,
net of current installments 29,367 78,651
Long-term debt, net of current
installments 291,272 309,986
-------------- --------------
Total liabilities 832,115 1,040,617
-------------- --------------
Common stock 687,316 673,305
Additional paid-in capital 11,496,187 11,476,190
Unamortized deferred compensation (20,847) (23,967)
Accumulated deficit (8,333,278) (7,801,677)
Treasury stock (76,185) (78,885)
-------------- --------------
Total shareholders' equity 3,753,193 4,244,966
-------------- --------------
Total liabilities and
shareholders' equity $ 4,585,308 5,285,583
============== ==============
*Condensed from audited financial statements.
See accompanying notes to condensed financial statements.
<PAGE> 2
TMS, Inc.
Condensed Statements of Operations (unaudited)
Three and Nine Months Ended May 31, 1999 and 1998
Three Months Ended Nine Months Ended
1999 1998 1999 1998
________________________ ______________________
Revenue:
Licensing and royalties $ 839,360 1,036,068 2,437,497 3,459,937
Software development services 397,352 260,155 1,016,394 999,412
Document conversion services 123,345 420,413 438,551 1,308,590
------------------------ ----------------------
1,360,057 1,716,636 3,892,442 5,767,939
------------------------ ----------------------
Operating costs and expenses:
Cost of licensing and
royalties 140,146 264,549 717,921 715,656
Cost of software development
services 275,368 175,707 754,037 619,261
Cost of document conversion
services 59,081 303,878 232,735 944,917
Selling, general and
administrative 850,854 935,964 2,652,887 2,991,372
Restructuring charge - - 70,895 -
------------------------ ----------------------
1,325,449 1,680,098 4,428,475 5,271,206
------------------------ ----------------------
Operating income (loss) 34,608 36,538 (536,033) 496,733
Other income (expense), net 5,339 (6,648) 1,489 (27,163)
------------------------ ----------------------
Income (loss) before income
taxes 39,947 29,890 (534,544) 469,570
Income tax (benefit) expense (1,988) 5,679 (2,943) 89,261
------------------------ ----------------------
Net income (loss) $ 41,935 24,211 (531,601) 380,309
======================== ======================
Basic earnings per share $ 0.00 0.00 (0.04) 0.03
======================== ======================
Weighted average common
shares 13,602,513 13,303,156 13,553,265 13,294,693
======================== ======================
Diluted earnings per share $ 0.00 0.00 (0.04) 0.03
======================== ======================
Weighted average common and
common equivalent shares 13,743,356 13,619,269 13,553,265 13,751,598
======================== ======================
See accompanying notes to condensed financial statements.
<PAGE> 3
TMS, Inc.
Condensed Statements of Cash Flows (unaudited)
Nine Months Ended May 31, 1999 and 1998
1999 1998
_____________ _____________
Net cash provided by operating
activities $ 520,827 827,836
------------- -------------
Cash flows from investing activities:
Purchases of property and
equipment (53,751) (247,054)
Capitalized software development
costs (245,524) (355,088)
Patent costs - (2,182)
Proceeds from sale of equipment 34,546 -
------------- -------------
Net cash used in investing
activities (264,729) (604,324)
------------- -------------
Cash flows from financing activities:
Repayment of long-term debt (17,557) (18,300)
Repayment of capital lease obligation (45,075) (32,394)
Proceeds from short-term note payable - 340,000
Repayments of short-term note payable - (418,000)
Issuance of common stock 36,708 2,507
------------- -------------
Net cash used in financing
activities (25,924) (126,187)
------------- -------------
Net increase in cash 230,174 97,325
Cash at beginning of period 491,696 426,174
------------- -------------
Cash at end of period $ 721,870 523,499
============= =============
Non-cash Financing and Investing Activities:
Purchase of computer equipment
through issuance of capital
lease $ - 186,167
============= =============
See accompanying notes to condensed financial statements.
<PAGE> 4
TMS, Inc.
Notes to Condensed Financial Statements (unaudited)
Unaudited Interim Condensed Financial Statements
- -------------------------------------------------
The unaudited interim condensed financial statements and related notes were
prepared by TMS, Inc.(the Company). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to rules and regulations established by the Securities and Exchange
Commission (SEC). The accompanying unaudited interim condensed financial
statements should be read in conjunction with the audited financial statements
and related notes included in the Company's Form 10-KSB Annual Report for the
fiscal year ended August 31, 1998.
The unaudited interim financial statements reflect all adjustments that are,
in the opinion of management, necessary for a fair presentation of financial
position, results of operations and cash flows for the interim periods
presented. Except for a restructuring charge and additional provision in the
third quarter for potential uncollectable customer accounts receivable
described in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" below, all adjustments are normal and recurring.
Interim results are subject to year-end adjustments and audit by independent
auditors. The financial data for the interim periods may not necessarily be
indicative of the results expected for the year.
Net Income (Loss) Per Share
- ---------------------------
Following is a reconciliation of the numerators and the denominators of the
basic and diluted per-share computations for the three month and nine month
periods ending May 31, 1999 and 1998.
<TABLE>
<CAPTION>
Three Months Ended May 31, 1999 Three Months Ended May 31, 1998
Income Shares Per-Share Income Shares Per-Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
-------------------------------------- --------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS $ 41,935 13,602,513 $ 0.00 $ 24,211 13,303,156 $ 0.00
Effect of Dilutive
Securities:
Common stock options _ 140,843 _ _ 316,113 _
-------------------------------------- --------------------------------------
Diluted EPS $ 41,935 13,743,356 $ 0.00 $ 24,211 13,619,269 $ 0.00
====================================== ======================================
Nine Months Ended May 31, 1999 Nine Months Ended May 31, 1998
Income Shares Per-Share Income Shares Per-Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
-------------------------------------- --------------------------------------
Basic EPS $ (531,601) 13,553,265 $ (0.04) $ 380,309 13,294,693 $ 0.03
Effect of Dilutive
Securities:
Common stock options _ _ _ _ 456,905 _
-------------------------------------- --------------------------------------
Diluted EPS $ (531,601) 13,553,265 $ (0.04) $ 380,309 13,751,598 $ 0.03
====================================== ======================================
</TABLE>
<PAGE> 5
Options to purchase approximately 665,000 shares and 382,000 shares of common
stock at prices ranging from $.375-$.75 per share were outstanding at May 31,
1999 and 1998, respectively, but were not included in the three and nine month
computations of diluted net income per share at May 31, 1999, because the
options'exercise prices were greater than the weighted average market price of
the common shares. Additionally, approximately 548,000 options to purchase
common stock at prices ranging from $.125-$.310 were excluded from the per
share computation for the nine months ending May 31, 1999, because of their
anti-dilutive effect. All options expire during periods through the year 2007.
Revenue Recognition
- --------------------
The Company adopted the provisions of Statement of Position (SOP) 97-2
"Software Revenue Recognition" beginning September 1, 1998. The principle
objectives of 97-2 are to amend certain provisions in SOP 91-1 that led to
diversity in revenue recognition practices among software companies, and to
address practiceissues not previously covered under SOP 91-1. The most
significant change in accounting under SOP 97-2 is the requirement to
un-bundle multiple elements in software transactions and to allocate pricing
to each element based upon vendor specific objective evidence of fair values.
The Company offers multiple element arrangements to its customers, mostly in
the form of technical phone support and product maintenance, for fees that are
deferred and recognized in income ratably over the applicable technical
support period. The Company also, on occasion and as part of the initial
contract price, offers delivery of enhanced versions of future products to
customers on a when-and-if-available basis. SOP 97-2 generally requires that
the promise for future product deliveries be treated as separate elements and
deferred from revenue recognition until produced, delivered and accepted by
the customer. The Company was not required to defer significant revenue in
accordance with SOP 97-2 as of May 31, 1999. In December, 1998,SOP 98-9
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to
Certain Transactions" was issued and is effective for the Company's fiscal
year beginning September 1, 1999. SOP 98-9, is not expected to have a
material effect on the overall financial condition or operating results of
the Company.
Reclassification
- ----------------
Certain 1998 balances have been reclassified to conform to the 1999 condensed
financial statement presentation.
Segment Disclosures
- -------------------
Information about the Company's reportable segments are included in
Management's Discussion and Analysis of Financial Condition and Results of
operations in Item 2 below.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
This Quarterly Report on Form 10-QSB 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. The Company's actual results could
differ materially from those set forth in the forward-looking statements
because of certain risks and uncertainties, such as those inherent generally
in the computer software industry and the impact of competition, pricing, and
changing market conditions. As a result, the reader is cautioned not to place
reliance on these forward-looking statements.
Reportable Segments
- -------------------
Effective September 1, 1998, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS No. 131). SFAS No. 131 establishes
standards for the way public business enterprises report information about
operating segments in both annual and interim financial statements.
The Company's reportable segments include: Tools and Utilities, End-user
Applications, Professional Services and Document Conversion Services. The
tools and utilities segment develops core image viewing, image enhancement and
forms processing software products that are necessary for developing new
software applications or enhancing existing software applications. The
Company's tools and utilities products are primarily licensed to developers,
system integrators, value added resellers (VARs) and/or companies who use the
software internally. The Company generally receives royalties for each
workstation/system that is utilizing the product. The end-user application
segment develops software products that may function independently from any
other software package or may be closely associated with other software
packages. These products install directly on a user's system or on a server
in a client/server environment. The end-user applications are primarily
licensed to entities who require the capability to view and manipulate
images through their Internet or intranet web browsers. The professional
services segment offers a variety of consulting and integration services for
business and information management processes. In general, the professional
service projects focus on an entity's need for document imaging solutions.
The Company charges for projects on a time and materials or fixed fee basis.
The document conversion segment primarily offers services for electronic
publishing of documents. These services include indexing - for
large volume searching of on-line information; hyperlinking - for navigating
through complex sets of on-line information; and document markup - for
electronic publishing of documents on CD-Rom and the Internet/intranet.
Document conversion also participates in a limited amount of data capture
activities - converting paper documents to electronic forms.
<PAGE> 6
The accounting policies for the segments are the same as those described in
the "Summary of Significant Accounting Policies" in the Form 10-KSB annual
report for the fiscal year ended August 31, 1998. Certain selling, general
and administrative expenses for corporate services (i.e. marketing, accounting,
information systems, facilities administration et. al.) are allocated to the
segments based on various factors such as segment full-time equivalent
employees, segment revenue or segment costs. The results of operations below
include summarized operating income and loss information for each segment.
Financial results are measured in accordance with the manner in which
management assesses segment performance and allocates resources. Financial
results do not include separately identifiable balance sheet assets for each
segment as this is not a common measure that management uses to assess segment
performance or allocate resources. In the software development business, the
most important assets are the employees. Performance measures of the employees
are included in the derivation of operating income and loss.
Following are the results of operations for each reportable segment for the
three month and nine month periods ending May 31, 1999 and 1998. All revenue
and expenses are from unaffiliated sources:
Tools and Utilities
- -------------------
Three Months Ended Nine Months Ended
May 31, May 31,
1999 1998 1999 1998
--------------------- ---------------------
Revenue:
Image viewing $ 150,909 331,966 598,207 1,049,967
Image enhancement 163,356 228,050 504,836 735,532
Forms processing 159,977 61,950 299,173 269,378
Other 63,106 96,492 208,129 377,325
--------------------- ---------------------
Total revenue 537,348 718,458 1,610,345 2,432,202
Cost of revenue 62,400 146,242 289,869 401,933
--------------------- ---------------------
Gross profit 474,948 572,216 1,320,476 2,030,269
Selling and marketing
expense 194,686 171,748 418,606 449,569
General and administra-
tive expense 178,326 124,292 377,469 425,397
--------------------- ---------------------
Operating income $ 101,936 276,176 524,401 1,155,303
===================== =====================
Fiscal 1999 third quarter revenue for tools and utilities (TU) was $537,348
compared to $718,458 for the same period last year, a decrease of $181,110,
or 25%. TU revenue for the nine months ending May 31, 1999 was $1,610,345
compared to $2,432,202 for the same nine month period last year, a decrease of
$821,857, or 34%. Image viewing products (e.g. ViewDirector) accounted for the
majority of the decrease in TU revenue for the three and nine month periods
ending May 31, 1999, respectively. The decline in image viewing products is
almost entirely due to a decline in the number of units reported/purchased
from royalty bearing customers. The Company believes that the population of
image viewing royalty reporting customers is slowly declining and the number
of units utilized by customers is also declining. Revenue from image viewing
toolkit direct sales and related royalty unit purchases has declined because
of increased competition. Over the past 36 months, the Company has focused the
majority of its development efforts on image enhancement, forms processing and
internet viewing and image management products. This has affected the
Company's ability to maintain a competitive position with regard to features
and functions of its image viewing toolkits. As reported in the Form 10-KSB
for the fiscal year ending August 31, 1998, the Company believes that image
viewing revenue will be lower throughout fiscal 1999 as compared to fiscal
1998 because of competition and the Company's emphasis on developing and
marketing other technologies. Image enhancement products (e.g. ScanFix)
declined approximately 28% over the same three month period last year and 31%
for the nine months ending May 31, 1999. The decline in image enhancement
products is primarily due to fewer direct sales as compared to the same
periods last year. The Company believes that fewer sales employees and
inadequate promotion of the image enhancement product line are the primary
reasons for the decline in image enhancement direct sales revenue. The Vice
President of Marketing and Sales who was hired in the fiscal year 1999 second
quarter to focus a significant amount of attention to the promotion of the
Company's image enhancement products resigned from the Company during the
third quarter period. The Company is currently seeking a candidate to fill
the senior marketing position, however, if the position remains vacant for an
extended period of time future revenue and profits may be adversely affected.
Forms processing revenue increased 158% over the same three month period last
year and 11% for the nine months ending May 31, 1999. One customer accounted
for 84% and 45% of forms processing revenue for the three and nine month
period ending May 31, 1999. The decline in "other" TU revenue for both the
three and nine month periods ending May 31, 1999, resulted from text product
royalty streams. The Company no longer develops text products for sale, but
continues to benefit from royalties from customers that purchased text
products two to three years ago. Variability from this revenue source is
entirely dependent on customer usage/distribution of the Company's text
technology and is expected to continue to decline over time. The Company is
currently developing two new products that are expected to be released in the
fourth quarter of fiscal 1999. One of the two new products is SpectrumFix 1.0
which received the "best" product award at the recent AIIM tradeshow. AIIM
is the "premiere" tradeshow for companies that operate in the imaging industry.
<PAGE> 7
Gross profit margins for TU were 88% and 80% for the three months ending May
31, 1999 and 1998, respectively, and 82% and 84% for the nine months ending
May 31, 1999 and 1998, respectively. The higher gross margin in the three
month period ending May 31, 1999 compared to the same period of 1998 was
primarily due to an increase in capitalized software costs because of the two
new products that are currently under development. The lower gross profit
margin for the nine month period ending May 31, 1999 compared to the same nine
month period in 1998 is almost entirely a result of the decline in revenue.
The increase in selling and marketing expense for the three month period
ending May 31, 1999 was due to the increase in marketing resources devoted to
the tools and utilities products compared to the same period last year. The
decline during the nine month period ending May 31, 1999, is due to a
reduction in direct sales and marketing personnel compared to the same periods
last year. During the fiscal 1999 third quarter, the Company charged $70,000
to general and administrative expense for a potential uncollectable customer
account. The increase in general and administrative expense for the three
month period ending May 31, 1999 was due to the increase in the allowance for
uncollectable accounts. The decline in general and administrative costs for
the nine month period ending May 31, 1999, resulted from a re-allocation of
management attention and related costs to other segments, and a $25,000 credit
to re-allocate bad debt expense to the document conversion segment for a
specific write-off of another customer account during the first quarter.
Operating income margins for TU were 19% and 38% for the three months ending
May 31, 1999 and 1998, respectively, and 33% and 48% for the nine months
ending May 31, 1999 and 1998, respectively.
End-user Applications
- ---------------------
Three Months Ended Nine Months Ended
May 31, May 31,
1999 1998 1999 1998
--------------------- ---------------------
Revenue:
Internet/intranet $ 282,806 239,532 752,778 874,840
Image management 5,453 44,601 31,113 62,617
Other 13,753 33,477 43,261 90,278
--------------------- ---------------------
Total revenue 302,012 317,610 827,152 1,027,735
Cost of revenue 77,746 118,307 428,052 313,723
--------------------- ---------------------
Gross profit 224,266 199,303 399,100 714,012
Selling and marketing
expense 104,915 151,427 381,594 439,101
General and administra-
tive expense 71,770 121,556 335,369 380,250
--------------------- ---------------------
Operating income(loss) $ 47,581 (73,680) (317,863) (105,339)
===================== =====================
Fiscal 1999 third quarter revenue for end-user applications (EUA) was $302,012
compared to $317,610 for the same period last year, a decrease of $15,598, or
5%. EUA revenue for the nine months ending May 31, 1999 was $827,152 compared
to $1,027,735 for the same nine month period last year, a decrease of
$200,583, or 20%. Approximately 20% of the revenue for the nine month period
ending May 31, 1998, included a multiple licensing arrangement of
Internet/intranet products (e.g. Prizm Plug-in) to a single customer. No one
customer accounted for greater than 10% of the EUA segment's revenue during
the three and nine month periods ending May 31, 1999. Release of the Company'
s new Prizm Image Server (Prizm IS) occurred late in the first quarter of the
current fiscal year. The Prizm IS expands the Company's Prizm Plug-in
technology by offering a client/server alternative and multi-platform Java
technology. The Company has distributed several copies of Prizm IS to
prospective customers for evaluation and has enhanced the Prizm IS based on
feedback from these prospective customers. The next version of Prizm IS was
released at the end of June of the current fiscal year. The Company believes
that the enhanced version of Prizm IS will be a more marketable product than
the version released in the first quarter of fiscal 1999 and is expected to
contribute to revenue during the fiscal year 1999 fourth quarter. However,
there is no guarantee that this will be the case. Company management assesses
the net realizable value of the Prizm IS product against unamortized
capitalized software development costs on a periodic basis. If the net
realizable value of the Prizm IS product falls below the unamortized
capitalized costs, the Company may be required to charge the excess costs to
operations during future quarters.
<PAGE> 8
Gross profit margins for EUA were 74% and 63% for the three months ending May
31, 1999 and 1998, respectively, and 48% and 70% for the nine months ending
May 31, 1999 and 1998, respectively. During the fiscal 1999 first quarter,
the Company charged approximately $111,000 to cost of revenue for a non-
recurring write-down of the remaining unamortized development costs for
Scan 'n' Store (SNS). The combination of the SNS write-down and 20% decline in
EUA revenue for the nine month period ending May 31, 1999, were the primary
reasons for lower gross profit margin as compared to the same period last year.
During December 1998, the Company decided to eliminate SNS as a separate
product for sale because financial returns from the product were not expected
to be enough to warrant the Company allocating additional promotion,
development, and technical support resources that would be required to enhance
its market viability. The Company believes that because of certain competitive
strengths, devoting the majority of its resources on expanding
Internet/intranet products, image and forms processing technologies and custom
software development solutions, will result in better financial returns than
SNS. In conjunction with the elimination of SNS, the Company incurred
approximately $30,000 in non-recurring selling, general and administrative
costs during the second quarter for employee severance, closing down a remote
sales office, and contractual technical support obligations with VARs who have
already purchased the product.
Selling and marketing expense declined 31% and 13% for the three and nine
month periods ending May 31, 1999, respectively. Additionally, general and
administrative expenses declined 41% and 12%, for the same
three and nine month periods, respectively. The elimination of SNS had the
most significant impact on the decrease because of an overall reduction in
personnel, a decrease in marketing activities and a reduction in both direct
and general overhead costs.
Professional Services
- ----------------------
Three Months Ended Nine Months Ended
May 31, May 31,
1999 1998 1999 1998
--------------------- ---------------------
Revenue:
Software development
services $ 397,352 260,155 1,016,394 999,412
Cost of revenue 275,368 175,707 754,037 619,261
--------------------- ---------------------
Gross profit 121,984 84,448 262,357 380,151
Selling and marketing
expense 57,255 82,761 178,245 247,686
General and administra-
tive expense 101,461 76,044 309,041 261,943
--------------------- ---------------------
Operating loss $ (36,732) (74,357) (224,929) (129,478)
===================== =====================
Fiscal 1999 third quarter revenue for Professional Services (PS) was $397,352
compared to $260,155 for the same period last year, an increase of $137,197
or 53%. PS revenue for the nine months ending May 31, 1999 was $1,016,394
compared to $999,412 for the same nine month period last year, an increase of
$16,982, or 2%. Approximately 84% and 66% of the three and nine month revenue
for the period ending May 31, 1998, respectively, came from one customer
contract. For the three and nine month periods ending May 31, 1999, three
customer contracts accounted for approximately 89% and 85% of total revenue,
respectively. As of May 31, 1999, the PS segment had an estimated revenue
backlog of approximately $400,000. This backlog is more in line with the
direct labor capacity that is projected to be available through the Company's
fourth quarter; however, approximately 50% of the estimated backlog is through
a Small Business Innovation Research grant that is contracted at rates
significantly below the Company's commercial service rates.
Gross profit margins for PS were 31% and 33% for the three months ending
May 31, 1999 and 1998, respectively, and 26% and 38% for the nine months
ending May 31, 1999 and 1998, respectively. In addition to revenue shortfalls
experienced during the first quarter of the current fiscal year, gross profit
and operating margins were negatively impacted by unanticipated cost overruns
in the Oklahoma County (OK County) project. The OK County project was the
predominant source of revenue throughout fiscal 1998. The Company estimates
that this overrun cost the PS segment approximately $78,000 during the nine
month period ending May 31, 1999. The Company expects to have final sign-off
by the end of the fourth quarter and does not expect to incur additional
significant costs. Recently the PS segment has experienced a high degree
of employee turnover. The loss of engineering staff in the PS segment may
have a negative impact on future revenue streams. The market for technical
engineers is competitive, however, the Company is actively seeking engineers
to fill the vacant positions. If the company is not able to hire and train
new service engineers, revenue and net operating results could be negatively
impacted.
<PAGE> 9
Selling and marketing expense declined 31% and 28% for the three and nine
month periods ending May 31, 1999, respectively; whereas, general and
administrative expenses increased 33% and 18% for the same three
and nine month periods, respectively. The decline in selling and marketing
expenses primarily resulted from two fewer sales employees in the segment and
less direct marketing dollars dedicated to advertising and tradeshows because
historical investments in direct marketing efforts have not provided adequate
returns. The increase in general and administrative expenses primarily relates
to the recent cost restructuring within the Company (See "Total Company
Operating Results" below) resulting in more management time and costs being
dedicated to a formal process for continuous improvement of customer
contracting and management, project planning and management, and quality
control of software development processes.
Document Conversion
- --------------------
Three Months Ended Nine Months Ended
May 31, May 31,
1999 1998 1999 1998
--------------------- ---------------------
Revenue:
Data capture $ 53,943 282,082 159,281 1,008,963
Electronic publishing 69,402 138,331 279,270 299,627
--------------------- ---------------------
Total revenue 123,345 420,413 438,551 1,308,590
Cost of revenue 59,081 303,878 232,735 944,917
--------------------- ---------------------
Gross profit 64,264 116,535 205,816 363,673
Selling and marketing
expense 879 39,242 20,039 132,836
General and administra-
tive expense 53,569 81,926 274,452 258,418
Restructuring charge _ _ 70,895 _
--------------------- ---------------------
Operating income (loss) $ 9,816 (4,643) (159,570) (27,581)
===================== =====================
Fiscal 1999 third quarter revenue for Document Conversion (DC) was $123,345
compared to $420,413 for the same period last year, a decrease of $297,068 or
71%. DC revenue for the nine months ending May 31, 1999 was $438,551 compared
to $1,308,590 for the same nine month period last year, a decrease of $870,039,
or 67%. The most significant portion of business development and contract
conversion work in the prior periods focused on large back-file conversion of
documents for imaging and database management. This revenue is classified as
"Data capture" in the above table. Because of the low margins and competitive
nature of back-file jobs that became evident throughout the prior fiscal year,
the Company made a decision in late May 1998, to discontinue pursuit of large
back-file conversion/data capture activities and focus its efforts on
electronic publishing of documents. Electronic publishing has traditionally
resulted in higher margins for the Company and is more in line with the
Company's core competencies. In late October of the current fiscal year, the
Company decided to restructure DC operations and only continue to support
customer relationships which primarily relate to electronic publishing
activities and for which there are contractual obligations. Many of these
customers are using technology that is unique to the Company which thus makes
the Company a sole source provider. The Company's DC segment strategy is to
retain the current customer contracts that are more profitable and not
actively seek new customers. There are no selling or marketing efforts
currently being undertaken for the DC segment. During the first quarter the
Company charged $70,895 to operations to restructure the DC segment. The
restructuring charge included in the current year nine month results ending
May 31, 1999 includes approximately $53,000 of equipment write-downs, $15,000
of employee severance costs, and $3,000 for closing down the leased DC
facility. All remaining DC employees were relocated to the Company's
headquarters building. In addition to the non-recurring restructuring charge,
general and administrative expense includes a $55,000 non-recurring write-off
of a portion of a customer account, of which $25,000 was an internal
reallocation of bad debt expense from the TU segment. Late in the second
quarter of 1999, the Company was notified by a customer that it would be
phasing out the Company's services over the next five to seven months for
data capture activities. This customer accounted for approximately 79% of the
Data Capture revenue during the first nine months of the current year. The
data capture activity that is currently being performed for this customer
results in very low margins. Accordingly, phasing out this contract is not
expected to have a significant impact on future operating results.
Total Company Operating Results
- --------------------------------
Following is a report of total company revenue and a reconciliation of
reportable segments' operating income (loss) to the Company's total net
income (loss) for the three and nine month periods ending May 31, 1999 and
1998.
<PAGE> 10
Three Months Ended Nine Months Ended
May 31, May 31,
1999 1998 1999 1998
--------------------- ---------------------
Total company revenue $ 1,360,057 1,716,636 3,892,442 5,767,939
---------------------- ---------------------
Operating income (loss)
for reportable segments 122,601 123,506 (177,961) 892,905
Unallocated corporate
expenses 87,993 86,968 358,072 396,172
Interest income 9,027 3,441 18,408 9,032
Interest expense (7,889) (10,164) (24,697) (32,638)
Other, net 4,201 75 7,778 (3,557)
Income tax (benefit)
expense (1,988) 5,679 (2,943) 89,261
--------------------- --------------------
Net income (loss) $ 41,935 24,211 (531,601) 380,309
===================== ====================
Income (loss) per share:
Basic $ 0.00 0.00 (0.04) 0.03
Diluted 0.00 0.00 (0.04) 0.03
===================== ====================
Total revenue for the third quarter of fiscal 1999 was $1,360,057 compared to
$1,716,636 for the same quarter of fiscal 1998, a decrease of $356,579, or 21%.
Net income for the third quarter of fiscal 1999 was $41,935 or $0.00 per share
(basic and diluted), compared to net income of $24,211, or $0.00 per share
(basic and diluted), for the third quarter of fiscal 1998. Income tax expense
of approximately $15,000 for the third quarter of fiscal 1999 was offset by a
corresponding decrease to the valuation allowance for deferred tax assets.
Income tax expense of $11,000 for the third quarter of fiscal 1998 was net of
a decrease of approximately $5,000 to the valuation allowance for deferred tax
assets. The increase in profitability for the three month period ending May
31, 1999 compared to the same period last year is primarily due to the cost
reductions that the Company implemented late in the current year first quarter
and the significant employee turnover that the Company has recently
experienced.(see below for additional discussion of employee turnover)
Total revenue for the first nine months of fiscal 1999 was $3,892,442 compared
to $5,767,939 for the same period in fiscal 1998, a decrease of $1,875,497, or
33%. Net loss for the first nine months of fiscal 1999 was $531,601 or
negative $.04 per share (basic and diluted), compared to net income of
$380,309 or $.03 per share (basic and diluted), for the same period in fiscal
1998. Income tax benefit of approximately $203,000 for the first nine months
of fiscal 1999 was offset by a corresponding increase to the valuation
allowance for deferred tax assets. Income tax expense of approximately
$178,000 for the same period in fiscal 1998 was net of a decrease of
approximately $89,000 to the valuation allowance for deferred tax assets. The
Company assesses the realizability of deferred tax assets at least quarterly,
and adjusts the valuation allowance to reflect the future benefits that will
more likely than not be realized from those deferred tax assets.
The net loss of $531,601 reported for the first nine months of fiscal 1999, is
primarily the result of the revenue and related operating margin shortfalls,
described above in the individual reportable segment discussions, combined
with an approximate $111,000 write-off for the elimination of SNS, $71,000 of
DC segment restructuring costs and a $70,000 additional charge for a
potentially uncollectable customer account. The revenue decline for the DC
segment was expected, and related decreases in recurring operating expenses
were also achieved during the first nine months. In addition to the DC
segment restructuring charge, the Company implemented other actions late in
the current year first quarter to help reduce costs on a going forward basis.
These actions included additional reductions to the Company's workforce and
elimination of other in-process product development projects that were not
expected to result in significant returns on investments and/or are not core
to on-going operations. The Company also incurred costs of approximately
$40,000 during the first nine months of the current fiscal year in an effort
to acquire certain intellectual properties that would provide more complete
end-user solutions to entities requiring high volume forms processing. The
Company was unsuccessful in a competitive bidding process to acquire those
assets, but plans to pursue other opportunities that might strengthen the
Company's Internet/intranet imaging, image and forms processing and custom
software development services offerings. The total Company cost reductions
implemented during the first quarter as well as the significant employee
turnover were the primary factors contributing to the profitable results for
the current year third quarter.
<PAGE> 11
As mentioned above, the Company has experienced a high degree of employee
turnover especially in the technical staff. The market for hiring software
engineers is extremely competitive. The inability to hire new software
engineers could limit the Company's ability to create service backlog and
develop new software products on a timely basis. Both of these factors could
adversely affect future operating results. The Company is advertising through
various sources and has retained a recruiting firm to assist in finding
candidates to fill the vacancies.
As discussed in the "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in the Company's Form 10-KSB for the
fiscal year ended August 31, 1998, uncertainty exists about collection of one
significant VAR customer account. Effective October 1, 1998, a security
agreement went into effect whereby the VAR is required to make monthly
payments to the Company equal to 100% of the revenue that the VAR generates
from distribution of products that contain the Company's technology.
Subsequent to the end of the fiscal year 1998, the Company has collected
approximately $50,000 from the VAR pursuant to the security agreement. The
current uncollected balance from this VAR approximates $311,000. Because of
the uncertainty that exists about the VAR's ability to pay, the Company added
$70,000 during the current third quarter to its allowance for uncollectable
accounts to write the account down to a level that the Company believes may
reasonably be collected. If the VAR does not adhere to the security agreement
or revenue from VAR Product distributions is significantly lower than historical
trends, the Company may be required to make additional adjustments to its
allowance in future quarters.
Impact of Year 2000 Issue
- -------------------------
The Company is addressing the need to ensure that its operations will not be
adversely impacted by software or other system failures related to year 2000
(Y2K). The Company has formed an oversight committee and has developed a plan
to coordinate the identification, evaluation and implementation of any
necessary changes to internal computer systems, applications and business
processes. As of December 31, 1998, the Y2K committee had identified and
prioritized the Company's systems that could potentially be impacted by Y2K.
The Company is currently in the process of determining Y2K readiness for all
identified systems and expects to be completed by the end of July 1999. The
Y2K committee is undertaking three primary steps to validate systems readiness:
(1) obtaining a vendor readiness statement, (2) internal
testing, and (3) third-party validation through an authorized organization
that has already tested the systems. The Company plans to perform the
procedures described in steps (1) and (2) for all systems that are not already
validated through a third-party authorized organization. Prior to the end of
July 1999, the Company plans to have a detailed schedule of events that will
be required to correct Y2K problems, if any. This schedule will include a list
of identified problems, prioritization of the problems, and identified
solutions. In July 1999, the Company will begin implementing solutions for any
systems identified to have a Y2K problem. This phase will include applying
solutions, verifying that solutions make the system(s) Y2K ready, and
developing a contingency plan for any critical system that is not deemed Y2K
compliant. The Company plans to have completed all Y2K readiness and
contingency planning by November of 1999. The Company anticipates that the Y2K
processes discussed above will be performed utilizing existing employees. The
Company does not track the internal costs incurred for the Y2K project since
such costs are principally related to the payroll costs for its employees.
Accordingly, the Company has not incurred any material incremental costs and
has not identified any incremental future costs associated with Y2K activities.
Upon completion of the systems readiness phase in July, the Company will
evaluate whether incremental costs will need to be incurred for systems that
are critical to the organization and not deemed to be Y2K compliant. The
Company has not identified the most reasonably likely worst case scenario in
the event the Company does not obtain Y2K readiness. This will be performed
during contingency planning.
No assurances can be given that the Company will be able to completely
identify or address all year 2000 compliance issues, or that third parties
with whom the Company does business will not experience system failures as a
result of the year 2000 issue, nor can the Company fully predict the
consequences of noncompliance.
The Company has reviewed all of its software products for sale and determined
them to be year 2000 compliant and accordingly, does not believe it will be
adversely impacted by year 2000 issues as it relates to its own products for
sale.
FINANCIAL CONDITION
Working capital, at May 31, 1999, was $1,971,977 with a current ratio of 4.9:1
compared to $2,096,032 with a current ratio of 4.2:1, at August 31, 1998. Net
cash provided by operations for the nine months ending May 31, 1999 was
$520,827 compared to $827,836 for the same period last year. Despite the
significant operating loss reported for the nine months ending May 31, 1999,
operating cash flow was strong because of improved customer collection
processes and final acceptance of several significant service contracts
resulting in current year payments for revenue recognized in the prior fiscal
year. Net cash used in investing activities for the first nine months of
fiscal 1999 was $264,729 compared to $604,324 for the same period in fiscal
1998. The decrease in investing activities primarily relates to additional
equipment needed to meet requirements under document conversion service
contracts in the first nine months of the prior year.
<PAGE> 12
During the first nine months of the prior fiscal year, the Company borrowed
$340,000 against its $800,000 line of credit for general operating purposes
and repaid $418,000 during the same nine month time period. This resulted in
a balance of $0 outstanding against the line of credit at May 31, 1998. The
Company also entered into $186,000 of capital lease obligations during the
first nine months of the prior year to obtain the scanners needed to meet
requirements under document conversion contracts. No borrowings were
required during the first nine months of fiscal year 1999, and $800,000
remains available under the operating line of credit.
During the current year first quarter and beginning of the second quarter, the
Company took significant actions to reduce its operating cost structure on a
going-forward basis. Specific actions included a headcount reduction of 20,
the closing down of three offices and elimination of products/services that
were not expected to produce significant financial returns for the Company.
These changes are expected to have a positive impact on operating cash flow
and accordingly, the Company believes that operating cash flow and the
$800,000 operating line of credit will be adequate to meet its current
obligations and current operating and capital requirements. The funding of
long-term needs is dependent upon increased revenue and profitability and
obtaining funds through outside debt and equity sources. The funding for
long-term needs includes funding for increased product development, for
expanded marketing and promotion of the Company and its products, and for
potential merger/acquisition activities.
PART II - OTHER INFORMATION
Item 5. Other Information
Effective May 19,1999 David D. Wood was appointed to the Company's board of
directors. Mr. Wood is the president of David Wood Associates, Inc. His firm
produces the Wood Seminars, which tour many major U.S. cities attracting
thousands of participants. The purpose of the seminars is to educate the
market on new imaging and forms processing technologies and trends. Mr. Wood
obtained his Masters degree from Stanford, then went into the imaging industry
where he has been a marketing and sales executive for Cornerstone (the
leading big screen monitor company), Plexus (part of BancTec), Calera
(the OCR company that merged with Caere), and was the vice president of
business development for Law Cypress (the largest distributor in the imaging
industry, with sales over $100 million). At Law Cypress Mr. Wood worked
closely with most of the major suppliers and customers in TMSSequoia's
industry. Mr. Wood also writes for most of the imaging related publications
on a regular basis, and is one of the best known consultants to scanning and
forms processing companies.
Item 6. Exhibits
Exhibits
Exhibit No. Name of Exhibit
27 Financial Data Schedule as of and for the nine month period
ending May 31, 1999.
<PAGE> 13
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
the report to be signed on its behalf by the undersigned, thereunto duly
authorized.
TMS, Inc.
Date: July 12, 1999 /s/ Dana R. Allen
______________________________
Dana R. Allen
Chief Executive Officer
Date: July 12, 1999 /s/ Anita K. Kunneman
_____________________________
Anita K. Kunneman
Chief Accounting Officer
<PAGE> 14
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the third
quarter 10-QSB for the fiscal year ending August 31, 1999 and is qualified in
its entirety by reference to such financial statements.
</LEGEND>
<CIK> 0000835412
<NAME> TMS, INC.
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<PERIOD-END> MAY-31-1999
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