UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended August 31, 2000
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _________ to _________
Commission File Number: 00018250
TMS, Inc.
(Name of small business issuer in its charter)
Oklahoma 91-1098155
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
206 West 6th Avenue
P.O. Box 1358
Stillwater, Oklahoma 74076
(Address of principal executive offices) (Zip Code)
(405)377-0880
(Issuer's telephone number)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: None
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT: Common
Stock, $.05 par value
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 at least the past 90 days.
YES[X] NO__
Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
The Issuer's revenues for its most recent fiscal year $3,605,249
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As of October 31, 2000 the aggregate market value of voting stock held by
nonaffiliates of such stock was $2,904,283 (based on the average bid and asked
price of such common equity on such date).
As of October 31, 2000 there were 13,331,864 shares of Common Stock
$.05 par value, outstanding.
Documents Incorporated By Reference
Following is a list of documents incorporated by reference and the Part
of the Form 10-KSB into which the document is incorporated:
The Company's Proxy Statement in connection with its Annual Meeting of
Shareholders to be held on January 26, 2001 is incorporated by reference
in Part III, Items 9, 10, 11 and 12.
Transitional Small Business Disclosure Format: YES__ NO[X]
<PAGE>
___________
Form 10-KSB
for the fiscal year ended August 31, 2000
Table of Contents PAGE
PART I 2
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Item 1. Description of Business 2
Item 2. Description of Properties 7
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote of
Security Holders 8
PART II 8
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Item 5. Market for Common Equity and Related
Stockholder Matters 8
Item 6. Management's Discussion and Analysis
or Plan of Operation 8
Item 7. Financial Statements 13
Item 8. Changes In and Disagreements With
Accountants on Accounting and
Financial Disclosure 13
PART III 13
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Item 13. Exhibits and Reports on Form 8-K 13
Signatures 14
Index to Financial Statements and
Financial Statement Schedule F1
Companies and products named in this document may be trademarks of the
respective companies with which they are associated.
________________
Part I
ITEM 1. DESCRIPTION OF BUSINESS
General Development of Business
TMS, Inc., doing business as TMSSequoia ("TMSSequoia" or the "Company") has
been engaged in the computer software business since 1981 and was incorporated
in 1990. The Company licenses computer software products and provides services
to enable businesses to use document imaging to solve critical business
problems. Typically, businesses wish to solve these problems by electronically
publishing and disseminating information. The Company offers customers the
following imaging technology solutions and services:
Component Products
Software toolkits for:
Image Viewing
Image Enhancement
Forms Processing
Color Image Processing
Software applications for:
Web-based Image Viewing
Image Enhancement
Color Image Processing
Assessment Products
Web-based Scoring Center
Services
Consulting and Integration Services
Data Capture and Conversion Services
Component Products
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TMSSequoia sells software development toolkits and applications and
receives license fees and/or royalties from the sales of these products.
Software development toolkits include the core "building block"
technologies necessary for a customer to develop new software applications or
enhance existing applications. In particular, the Company's toolkits provide
the fundamental technologies necessary for creating successful document imaging
and forms processing applications.
Applications are stand alone software programs that install directly on the
user's system or on the server in a client/server environment. This software
may function independently of any other software or may be closely associated
with another software package. Programming knowledge is not typically required
to use a software application.
<PAGE> 2
Customers use the Company's toolkit products to create custom applications
to meet critical business needs that pre-packaged software applications often
cannot achieve. They may wish to capture, display and enhance digitized images
such as engineering drawings, legal or financial transaction documents,
reference or regulatory documents and photographs on many kinds of computer
workstations or personal computers, local area networks, corporate intranets,
the Internet or extranets via secure or authenticated servers. Users may
transmit the images to other computers or facsimile machines, share the images
with other users, and annotate, manipulate, modify or print the images.
Customers use the Company's application products to enhance or optimize
images through a stand-alone interface, and to display, annotate or extract
text from digitized images through optical character recognition. The Company's
applications apply to many types of digitized images such as engineering
drawings, legal or financial transaction documents, reference or regulatory
documents and photographs that our customers may provide access to via many
kinds of computer workstations or personal computers, local area networks,
corporate intranets, the Internet and/or extranets via secure or authenticated
servers. Users may transmit the images to other computers or facsimile
machines, share the images with other users, and manipulate, modify or print
the images.
Following are the Company's primary component products.
Image Viewing Toolkits
ViewDirector(TM)Imaging Toolkit. ViewDirector(TM) products are software
development tools that provide image display capabilities for black and white
and color imaging applications. The tools are typically used for image-
enabling existing applications or for creating custom applications for the
document management industry. ViewDirector functionality includes rapid image
display and an extensive suite of image display tools including magnifiers,
rotation, hyperlinking and annotations. It is available as cross platform C
libraries or as ActiveX controls. The Company licenses ViewDirector toolkits
to a wide variety of document imaging, workflow and document management
solution providers including value-added resellers, system integrators,
independent software vendors, original equipment manufacturers, government
agencies and corporations who use the product to develop proprietary software
internally. The Company receives a royalty for each computer workstation or
server using the product.
Prizm(TM) ActiveX Controls. Prizm(TM) ActiveX controls provide essentially the
same document image viewing, manipulation and printing functionality available
through ViewDirector ActiveX controls. However, Prizm ActiveX operates in the
Microsoft Internet Explorer web browser environment. PrizmT ActiveX Controls
are licensed on a per web server basis rather than with a runtime royalty
agreement as the product is used for web-enabled image viewing. Similar to
retrieving information over the Internet, users of corporate intranets or
extranets access corporate image documents using standard web browsers. Most
standard web browsers do not have the ability or flexibility to display these
scanned images without the assistance of additional third party technology such
as the Prizm products.
Image Viewing Applications
Prizm(TM) Plug-in. The Prizm(TM) plug-in is an application that greatly
extends the capabilities of Netscape Navigator/Communicator or Microsoft
Internet Explorer browsers by providing document image viewing, manipulation
and printing of TIFF, JPEG and other compressed images. It offers image batch
printing, virtual multi-page documents, image annotation, optical character
recognition for text extraction, hyperlinking and magnifying capabilities at
each end-users desktop. The Company sells a unit of the product for each
individual user. Units are sold both to corporate users in high volumes and on
a per unit basis over the web. The product is supported on the Windows,
Macintosh and UNIX platforms. Netscape's plug-in page
(http://home.netscape.com/plugins/image_viewers.html) lists the Prizm Plug-in
and provides the Company with a steady source of leads for the product.
Image Enhancement Toolkits
ScanFix(R) image enhancement toolkit. ScanFix(R) software technology
automatically enhances scanned images by removing specks, lines, shading,
broken characters, and black borders. It also deskews scanned images. ScanFix
C libraries and ActiveX controls are used in virtually all types of document
imaging applications, especially where optical character recognition processing
is required. The ScanFix toolkit is licensed to original equipment
manufacturers such as IBM, Minolta, Ricoh, Panasonic and Xerox as well as
corporate customers, government organizations, and service bureaus. The Company
receives a royalty for each computer workstation using the product.
Image Enhancement Application
ScanFix(R) image optimizer. The ScanFix(R) image optimizer is a stand-alone
application that offers corporate clients, small office-home office and
individual users the functionality of the ScanFix toolkit. The Company
primarily sells the ScanFix image optimizer through a direct sales channel and
plans to expand the distribution channel for this product by creating
opportunities for bundling and co-marketing this product with original
equipment manufacturers and other independent software vendors.
<PAGE> 3
Forms Processing Toolkit
FormFix(R) developer's toolkit. The Company markets to customers with highly
skilled development staffs for developing custom applications for high volume
data capture systems. Customers can create custom forms processing
applications with the FormFix(R) development tool. Users can automatically
identify a specific form and extract typed or handwritten text, which can be
read by optical character recognition systems and converted for use in
relational databases, billing systems, and other high volume data storage and
retrieval systems. Examples include tax forms, medical administration/billing,
financial transactions and insurance claims. The product is available as a C
library. The Company licenses FormFix to value-added resellers, system
integrators, software developers and government agencies, as well as companies
which use the software internally. The Company receives a royalty for each
computer workstation utilizing the FormFix product.
Color Image Processing Toolkit and Application
Color Image Processing toolkit & application. In fiscal 1999 the Company
launched SpectrumFix(R) color imaging technology to fill the market need for
color image processing. The SpectrumFix product did not provide adequate tools
for addressing this market need and the Company wrote off the investment in
SpectrumFix technology in fiscal 2000.
However, as more scanner manufacturers enter the production color
marketplace, there exists a strong opening for software tools that deskew,
crop, threshold and enhance color images, and the market is poised to accept
and implement color technology as more production level color scanners are
sold. There is also a need for software that allows organizations to process
color documents by identifying colors on a scanned document, dropping out
selected colors and selecting zones based on color information. With the depth
of the Company's background and experience in black and white image processing
and algorithms, extending the TMSSequoia product line to include color
processing is a logical next step, and the Company is poised to take advantage
of this opening in the marketplace with a suite of robust software tools. The
Company anticipates offering a color image processing toolkit in second quarter
fiscal 2001 as a result of extensive customer and scanner manufacturer input.
The Company also expects to launch a color image processing application in
third quarter fiscal 2001.
Component Product Markets
The primary markets for the Company's component products are large
corporations, system integrators, original equipment manufacturers, value-added
resellers and branches of the federal government desiring to more cost-
effectively and time-effectively use their information. The Company's products
span industry boundaries with customers including financial institutions, law
firms, pharmaceutical companies, transportation, energy, engineering and
aerospace companies, insurance companies, software companies, private and
public utilities, manufacturers, and defense agencies. The increasing use of
the World Wide Web, the Internet and secure and authenticated servers offers
marketing opportunities to these customers looking to exploit the opportunity
for distributed scanning and document handling.
TMSSequoia's marketing efforts are conducted primarily through cultivating
strategic partnerships with industry-leading original equipment manufacturers,
value-added resellers and software developers, trade show marketing, field
sales calls, telemarketing, direct mail, print and Internet advertising.
Many of the Company's products are listed in a General Services
Administration (GSA) contract schedule to enable all agencies and branches of
the federal government and government contractors to easily purchase products,
training and technical support directly from the Company.
The Company currently employs seven people in the marketing and sales of its
component products. The Company has marketing and sales offices in Stillwater
and Tulsa, Oklahoma.
Component Product Distribution Methods
The Company distributes its products through a direct sales force, domestic and
international resellers, online Internet-based stores, and through firms
creating and selling turnkey solutions.
Component Product Competition
The computer software field is highly competitive with many companies in the
industry and is characterized by rapid changes in technology and frequent
introductions of new platforms and features. TMSSequoia competes with a number
of companies that have greater financial, technical and marketing resources.
The Company believes that the primary competitive factors with respect to its
products are the features of its products, the technical capabilities of the
Company's personnel, quality of services and price. The Company believes that
it can compete favorably with respect to all of these factors and is focusing
on markets where it believes it can achieve a leadership position; however,
there can be no assurance that the Company will be able to continue to compete
effectively in its market, that competition will not intensify or that future
competition will not have a material adverse effect on the Company's business,
operating results, cash flows and financial condition.
The Company has competitors in each of the basic imaging tools and end
user applications markets to which it supplies products. These companies,
which include AccuSoft, Pixel Translations, Snowbound Software, Kofax Image
Products, Lead Technologies, Seaport Imaging and Visionshape, are selling
products aimed at the Company's customer base in the black and white image
enhancement, forms processing, Internet/intranet image viewing and toolkit
arena. As the Company moves forward with color image processing and
enhancement software, Dunord Technologies and Picture Elements can also be
considered competitors. The Company expects additional entrants into the color
image enhancement toolkit and application market with the increased sales of
production level color scanners.
<PAGE> 4
Assessment Products
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The Company created a new operating segment during fiscal 2000 to develop
technologies that will improve the overall process of scoring large-scale
assessments, commonly referred to as tests, for grades K-12 in the education
marketplace, leveraging the Company's core competencies in forms recognition,
image processing, viewing and enhancement. Following is a description of the
status of the Company's assessment scoring product.
Web-based Scoring
Virtual Scoring Center(TM). The Company's new Virtual Scoring Center(TM)
product has been designed to provide qualified raters the ability to score
student responses to open-ended test questions in a web-enabled environment.
Open-ended test questions require students to respond in the form of an essay
or "show your work" type of answer. The Virtual Scoring Center includes
capabilities for the test answer sheets to be captured and displayed in a
standard web browser for raters to score in any location where access to the
Internet exists. The Virtual Scoring Center product will also provide self-
paced training to raters, as well as references and resource materials
including score criteria and samples. Rater accuracy is monitored by inter-
rater reliability capabilities built into the software, and test integrity is
maintained by presenting anonymous responses to raters and allowing for
multiple raters to randomly score the same test. The Company has received a
commitment from one state to adopt an early version of the Virtual Scoring
Center in the second quarter of the Company's 2001 fiscal year. The first
commercial version of the Virtual Scoring Center is currently projected to be
available by the Company's fiscal 2001 third quarter.
Assessment Product Markets
The Company plans to license its Virtual Scoring Center product to individual
state departments of education, school districts, to collections of small
school districts through educational service agencies, or to third-party
vendors that provide scoring services to states or school districts that have
the desire to control the scoring process.
TMSSequoia's marketing efforts into the educational assessment marketplace
are primarily through education industry trade conferences, field sales calls,
and telemarketing to identify leads for school districts with plans to
implement or automate the process of scoring open-ended assessments.
The Company currently employs four people in the marketing and sales of its
assessment products. The Company has marketing and sales offices in Stillwater
and Tulsa, Oklahoma.
Assessment Product Competition
The education assessment field is highly competitive and includes many vendors
with an already established presence in providing services for the scoring of
open-ended assessments. Those vendors include entities such as Harcourt
Educational Measurement, Educational Testing Services, NCS Pearson, CTB-McGraw
Hill, Measured Progress, and Measurement Inc. All of these vendors provide
both test development and scoring services, and some provide the ability for
educational entities to use their own teachers for scoring at regional centers
throughout the United States. Some of these companies have also developed
computerized assessment scoring systems for their own internal use. While we
do not know of any commercial products on the market that currently provide a
web-enabled scoring environment, the Company expects more competitors to enter
the marketplace in the future.
The market for open-ended assessments is expected to continue to grow
because many educators believe that the measurement of children is more
effective through the open-ended assessment process. Many states and school
districts have developed or are developing custom tests that expand the use of
open-ended test questions. These educators also have the desire to use their
own teachers to score these custom tests. Because open-ended responses cannot
be machine-scored, many of the existing scoring vendors are already at or have
exceeded the supply of qualified raters that are available to come to central
locations to score student responses. The rater supply issue has already
delayed the timely reporting of test results in many cases and the delays are
not expected to improve, considering the projected increase in open-ended
testing. Additionally, most of the existing scoring vendors do not currently
allow educational entities to use their own teachers to score. The Virtual
Scoring Center offers a competitive advantage against existing open-ended
scoring alternatives because it does not create limitations on the physical
location of raters and thus potentially expands the population of qualified
raters. It also provides educational entities the ability to control and have
more flexibility in assessment activities by integrating their teachers into
the scoring process and improving the turn-around time for reporting results.
Company management believes that the Virtual Scoring Center is a product
that addresses several needs in the educational assessment marketplace, but
there can be no assurance that the Company will be able to compete successfully
against current and future competitors, many of which have larger technical
staffs, greater brand name recognition and market presence, more established
and larger marketing and sales organizations and substantially greater
financial resources than the Company. There can also be no assurances that the
competitive pressures faced by the Company will not have a material adverse
effect on the Company's business, operating results, cash flows and financial
condition.
<PAGE> 5
Services
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Consulting and Integration Services
TMSSequoia has historically offered a variety of services for analyzing
business and information management processes as well as integrating business
solutions. These services are included in the Professional Services segment in
the Financial Statements. Customers who do not have in-house technical staff
or expertise in a particular area seek outsourcing services as a cost-efficient
way to meet their needs. In particular, the services that the Company has
offered include:
Requirements analysis
System design
Systems integration
Custom development
System maintenance
The Company charged for projects on a time and materials basis as well as a
flat fee basis. On occasion, some of the Company's toolkit customers have
contracted for services. Furthermore, customers who did not have in-house
technical staff desired to purchase ongoing maintenance services from the
Company. During fiscal 2000, the Company decided to transition out of its
existing professional service business model, and substantially completed
projects for all of the remaining customer contracts. The Company has on-going
system maintenance obligations for two of those customers that will continue
through fiscal 2001.
Data Capture and Conversion Services
TMSSequoia has also historically provided data capture and conversion services
for customers desiring the ability to use electronic data for online
information retrieval, intranet or Internet distribution, permanent archives,
electronic publishing or printing on demand.
During fiscal 1999, TMSSequoia decided to scale back its data capture and
conversion services. The Company is not selling and marketing these services
to new customers. The Company does plan to continue to provide services to pre-
existing customers including Pennwell Publishing, TORO, ARI, US Coast Guard and
Nissan Diesel America.
Backlog
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As of October 31, 2000, the Company had a backlog of component product and
assessment product revenue of approximately $615,000 and software development
services revenue of approximately $36,000. At October 31, 1999, the Company
had a backlog of component product revenue of approximately $78,000 and
software development and document conversion services revenue of approximately
$360,000.
Copyrights, Patents, Proprietary Information, Trademarks and Licenses
------------------------------------------------------------------------------
The copyright laws permit the Company to copyright many aspects of its
software. TMSSequoia has obtained copyright registrations for its software
products and expects to apply for additional registrations in the future as
appropriate.
Patent applications relating to the Company's ScanFix product were filed in
the United States Patent and Trademark office. These applications resulted in
the Patent Office awarding eight patents. The awarded patents cover the
following technology areas: image processing, image line removal, detection of
scanned page skew, a method of deskewing (incremental digital image rotation),
document registration, dot shaded removal, images despecking, horizontal and
vertical line removal, line intersection repair, automatic correction of
inverted (white) text and general methods of high speed image manipulation.
The patents cover most of the key elements of the ScanFix product line. The
patents expire during the years 2011 through 2015. The scope and extent of
patent rights protecting computer software is evolving; therefore, the Company
cannot be assured that the issuance of such patents will be upheld as valid or
will prevent the development of competing products.
In addition, the Company has applied with the United States Patent and
Trademark office for patents covering technology developed in connection with
the Digital Mark Recognition engine. The Digital Mark Recognition technology is
described below in the Research and Development section of this report.
The Company does not believe that any of its products or soon to be released
products present questions of patent infringement or violations of any other
intellectual property rights belonging to others. There can be no assurance,
however, that claims of infringement of the intellectual property rights of
others will not arise that could require the Company to procure license for the
use of third party technology, to make additional investments to modify or
replace technologies to remove the basis for an allegation of infringement, or
to discontinue use of technology accused of infringement, any of which could
have a material adverse effect on the Company's operations or financial
condition. There can also be no assurance that others will not infringe on the
intellectual property rights of the Company or that the Company will have
financial or other resources available to adequately enforce infringement of
its intellectual property rights.
The Company treats as proprietary any software it develops and protects its
software through licensing and distribution agreements. In addition, the
Company requires written undertakings of confidentiality from all of its
employees as well as in all customer agreements, including license agreements,
which prohibit unauthorized duplication.
TMSSequoia has applied for trademark rights for the ViewDirector, Virtual
Scoring Center, DMR and Prizm marks, and has developed, through use, common law
trademark rights in RasterView, InnerView and MasterView as used in connection
with the Company's software products. The Company has registered trademarks on
the ScanFix and FormFix products.
<PAGE> 6
The Company grants its customers a nonexclusive, nontransferable license
for the ViewDirector, ScanFix, Prizm and FormFix toolkit products for use on
computers used by personnel or customers of licensees. The Company typically
receives an initial license fee for the toolkit and offers a required annual
maintenance fee for such products. Licenses of the Company's toolkits entitle
licensees to develop custom applications using the toolkits, and then
distribute the software to users inside their organization or to their end
customers. The Company then receives a royalty for each computer workstation
on which the software is used. The duration of license agreements generally
ranges from one to five years.
Research and Development
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TMSSequoia recognizes the need to continually develop new and improved
products. Current plans include efforts to further enhance the ScanFix user
interface, to improve secure server and authenticated server support in the
Prizm plug-in product, to update and improve the features and functions of the
ViewDirector product and to increase color imaging and forms processing
technology. In addition, the Company plans to move forward on development of
Internet-based document imaging products related to improving the efficiency
and economics of scoring large-scale standardized tests for K-12 public
schools. The Company also plans to continue to pursue research and development
activities specific to Digital Mark Recognition technology. A prototype of the
Digital Mark Recognition technology currently exists that was designed to
provide a software alternative to the existing optical mark recognition
hardware widely used for scoring assessments. The Company applied for a patent
on the Digital Mark Recognition technology during fiscal 2000 and is currently
in discussions with a third party independent software vendor to integrate this
technology into their forms processing software products. The Company believes
it can leverage the independent software vendor's distribution channel in
markets where entities currently rely on optical mark recognition for
processing forms, but could greatly benefit from adopting the Digital Mark
Recognition technology to increase flexibility and significantly improve many
aspects of the workflow required to process forms. Pursuing these efforts will
necessitate further improvements in the Company's core technologies and new
technology development. The Company is open to creating new products whose
concepts dovetail with the Company's development direction, and which offer
opportunities for funded development from customers with specific needs.
In fiscal years 2000 and 1999, the Company spent $909,000 and $609,000,
respectively, in research and development costs. Additionally, the Company
capitalized software development costs of $332,190 and $350,626, respectively,
related to new products and existing product enhancements. In fiscal 2000 the
Company secured a financial commitment of $237,000 for funded development from
a customer to add and enhance features to the Prizm Plug-in product.
Approximately $66,000 of the funded development dollars were applied against
development costs during fiscal 2000, with the remaining $171,000 expected to
be applied to fiscal 2001 development dollars. The Company will recognize
funded development dollars in revenue upon final acceptance of the product by
the customer to the extent that those funded development dollars exceed actual
costs.
Employees
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At August 31, 2000, the Company had 36 full-time employees and 6 hourly
employees for a total of 42 employees. The Company's business depends in large
part on its ability to attract and retain qualified technical, marketing and
management personnel, and the Company must compete with larger and more
established companies for such persons.
Customers
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One customer accounted for $414,807, or 12%, of the Company's total revenue in
fiscal 2000. Total funding under the agreement with that customer is
approximately $890,000. Of that amount, $450,000 is license fee revenue of
which a portion is recognized upon the delivery and acceptance of each of the
operating platforms provided to the customer. In addition, $237,000 is for
funded development as discussed in the "Research and Development" section
above. The remaining $203,000 is maintenance revenue to be recognized as
revenue over the three-year maintenance agreement term. The remaining license
fee will be recognized as revenue by the end of the second quarter of fiscal
2001. The Tinker Small Business Innovation Research grant contract accounted
for approximately $495,000, or 10%, of the Company's total revenue in fiscal
1999.
Sales to Foreign Customers
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Approximately 15% and 13% of total revenues for fiscal 2000 and 1999,
respectively, are attributable to sales to foreign customers. See Note 8 to the
Financial Statements.
ITEM 2. DESCRIPTION OF PROPERTIES
The Company's headquarters consist of approximately 14,700 square feet of
office space located at 206 West Sixth Avenue in Stillwater, Oklahoma. The
Company purchased the building in fiscal 1994 and occupied the space in fiscal
1995 after renovation was complete. The Company secured a mortgage on the
building in fiscal 1995 and at August 31, 2000, $281,000 in principal remained
owing under such mortgage.
The Company has approximately 2,000 square feet of office space in Tulsa,
Oklahoma with a monthly rental of approximately $2,500. In the second quarter
of fiscal 2000 the Company closed its Burlingame, California office. Monthly
rental on that property was approximately $3,500.
<PAGE> 7
The Company believes its facilities are in adequate condition and will meet
capacity requirements for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
On September 12, 2000, the Company filed arbitration proceedings with the
American Arbitration Association against one of the Company's value added
resellers for failing to comply with royalty reporting and payment obligations
as outlined in the Company's value added reseller agreement. The Company is
seeking a one-time royalty payment of $440,000 plus interest and legal fees
from the reseller.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
--------------
Part II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
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The Company's Common Stock is traded in the over-the-counter market, and prices
are quoted by Pink Sheets LLC (formerly the National Quotation Bureau,
Incorporated) on the "pink sheets," and the NASD Non-NASDAQ OTC Bulletin Board.
The following table sets forth the quarterly range of high and low bid prices
of the Company's Common Stock for fiscal years 2000 and 1999. The quotations
are inter-dealer prices without retail markups, markdowns, or commissions and
may not represent actual transactions. The source of such quotations is Pink
Sheets LLC.
<TABLE>
<CAPTION>
BID PRICES
FISCAL 2000 HIGH LOW
------------------------------------------
<S> <C> <C>
First Quarter $.300 .140
Second Quarter .750 .150
Third Quarter 1.188 .250
Fourth Quarter .438 .210
<CAPTION>
FISCAL 1999 HIGH LOW
------------------------------------------
<S> <C> <C>
First Quarter $.375 .260
Second Quarter .380 .260
Third Quarter .350 .290
Fourth Quarter .340 .260
</TABLE>
Dividends
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The Company has not declared nor paid any cash dividends since its
incorporation, nor does it anticipate that it will pay dividends in the
foreseeable future. Any earnings realized by the Company are expected to be
reinvested in the Company's business; however, the declaration and payment of
dividends in the future will be determined by the Board of Directors in light
of conditions then existing, including, among others, the Company's earnings,
its financial condition and capital requirements (including working capital
needs), and any arrangements restricting the payment of dividends.
Shareholders
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As of October 31, 2000, there were approximately 700 shareholders of record
according to the records of the Company's transfer agent. As of that date, the
Company had approximately 1,860 shareholders including beneficial owners
holding shares in nominee.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This analysis of the Company's results of operations and financial condition
should be read in conjunction with the financial statements, description of the
Company's business and other information included elsewhere herein. Except for
the historical information contained herein, this Form 10-KSB contains certain
forward-looking statements regarding the Company's business and prospects that
are based upon numerous assumptions about future conditions which may
ultimately prove to be inaccurate and actual events and results may materially
differ from anticipated results described in such statements. The Company's
ability to achieve such results is subject to certain risks and uncertainties,
such as those inherent generally in the computer software industry and the
impact of competition, pricing and changing market conditions. The Company
disclaims, however, any intent or obligation to update these forward-looking
statements. As a result, the reader is cautioned not to place reliance on these
forward-looking statements.
Component Product Technologies Segment
2000 1999
-----------------------------------------------------------------------
Revenue from external customers $ 2,982,195 3,260,443
-----------------------------------------------------------------------
Operating income $ 649,007 382,417
-----------------------------------------------------------------------
Fiscal 2000 revenue for the component product technologies segment was
$2,982,195 compared to $3,260,443 for fiscal 1999, a decrease of $278,248, or
9%. Despite this overall decrease, image viewing products increased 4% in
fiscal 2000 due to the recognition of approximately $415,000 of revenue from
one customer in the fourth quarter. This revenue results from the largest
Prizm Plug-in product sales contract in the Company's history. Total funding
<PAGE> 8
under the agreement is approximately $890,000. Of that amount, $450,000 is
license fee revenue of which a portion is recognized upon the delivery and
acceptance of each of the operating platforms provided to the customer. In
addition, $237,000 is for funded development to add and enhance features to the
Prizm Plug-in product. Approximately $66,000 of the funded development dollars
were applied against development costs during fiscal 2000, with the remaining
$171,000 expected to be applied to fiscal 2001 development dollars. The
Company will recognize funded development dollars in revenue upon final
acceptance of the product by the customer to the extent that those funded
development dollars exceed actual costs. The remaining $203,000 of funding
under the contract is maintenance revenue to be recognized as revenue over the
three-year maintenance agreement term. The remaining license fee revenue will
be recognized as revenue by the end of the second quarter of fiscal 2001.
Partially offsetting the effect of the Prizm revenue increase is a $230,000, or
34%, decrease in ViewDirector revenue in fiscal 2000 compared to fiscal 1999.
The Company believes this continuing decline in ViewDirector revenue is a
result of the Company's product development and marketing focus over the past
three years on products that did not result in adequate financial return to the
Company (see a discussion of Scan `n' Store, SpectrumFix Version 1.0, Prizm
Image Server and ScanFix Twain Filter Version 1.0 below). This has impacted
the Company's ability to potentially benefit from updated product releases of
not only the ViewDirector product, but also the Company's image enhancement
products. Image enhancement revenue decreased approximately $118,000, or 17%,
from fiscal 1999 to fiscal 2000.
Fiscal year 2000 forms processing revenue decreased approximately $165,000,
or 47%, compared to fiscal 1999. This decrease is due to fewer direct toolkit
sales and declining revenue from royalty reporting customers. In addition, in
fiscal 1999, the Company had one sale of FormFix that totaled $138,000, or 39%
of the forms processing revenue for fiscal 1999. No forms processing product
sales of that magnitude were made in fiscal 2000.
The Company has reallocated resources in fiscal 2000 from the professional
services segment as projects are completed in order to further develop the
image viewing and image enhancement products in an effort to make them more
competitive in the current marketplace. Additionally, the Company is
leveraging its expertise in image enhancement and forms processing to produce a
new color image processing suite of products to support the emerging document
imaging color market. These products build upon existing image enhancement and
forms processing technologies, but will support the processing of color images
rather than black and white images. Management believes its decision to
refocus on its core competencies as a software product company is warranted
based on the positive financial operating results reported by the component
product technologies segment over the past two years.
Operating income margins for the component product technologies segment were
22% and 12% for the fiscal year ending August 31, 2000 and 1999, respectively.
The increase in the operating margin is primarily due to a $545,000, or 19%,
decrease in operating expenses in fiscal 2000 compared to fiscal 1999. Selling
and marketing expenses decreased approximately $183,000, or 19%, due to
management's decision to attend fewer trade shows and spend less on advertising
expenses in fiscal 2000 than in fiscal 1999, and because the Company had fewer
sales personnel as a result of closing the Burlingame, California office in the
second quarter of fiscal 2000.
Amortization expense for capitalized software development costs decreased by
$100,000, or 30%, due to the development costs of several products released in
prior years becoming fully amortized in fiscal 2000. Offsetting these
decreases was an increase of $155,000, or 30%, in research and development
personnel costs in fiscal 2000 due to the Company's refocus on developing its
component product and assessment product technologies.
The Company also had several specific charges and credits to expenses that,
on a net basis, decreased operating expenses by approximately $65,000 in fiscal
2000 and increased operating expenses by approximately $241,000 in fiscal 1999.
In fiscal 2000, these transactions included the recovery of a previously
recorded bad debt of approximately $258,000. This credit to expenses was
offset by approximately $193,000 of capitalized development costs written off
because those products were not expected to result in adequate financial return
for the Company. Of the $193,000 in write-offs, $71,000 was charged to expense
during the fourth quarter of fiscal 2000. During fiscal 1999, these operating
transactions included charges of $130,000 for a potential uncollectible account
and $111,000 to write-down the remaining unamortized software development costs
for Scan `n' Store.
Assessment Product Technologies Segment
2000 1999
-----------------------------------------------------------------------
Revenue from external customers $ 3,000 --
-----------------------------------------------------------------------
Operating loss $ (420,978) --
-----------------------------------------------------------------------
The assessment product technologies segment was created during fiscal 2000 to
focus on developing technologies to improve the overall process of scoring
large-scale assessments, commonly referred to as tests, for grades K-12 in the
educational marketplace. The technologies being developed within this segment
leverage the Company's existing core competencies in forms recognition, image
processing, viewing enhancement. The Company incurred combined costs of
approximately $424,000 in research and development and business development in
two primary product areas. The first product area resulted in the creation of
the Digital Mark Recognition software product prototype. The Digital Mark
Recognition software prototype was designed to replace the need for hardware
<PAGE> 9
based optical mark recognition. Digital Mark Recognition offers many
competitive advantages over optical mark recognition because Digital Mark
Recognition provides significantly more flexibility in printing and processing
of certain types of forms. The Company incurred approximately $23,000 in costs
during fiscal 2000 to apply for a patent on the Digital Mark Recognition
technology. The Company is currently in discussions with an independent
software vendor to integrate the Digital Mark Recognition into their forms
processing software in an effort to offer an alternative to vendors and/or
educational entities that process large volumes of "fill in the bubble" form
answer sheets for standardized tests. The second area of focus within the
assessment product technologies segment during fiscal 2000 was on the design of
a new product called Virtual Scoring Center. The Virtual Scoring Center
provides the ability for qualified raters to score student responses to open-
ended test questions in a web-enabled environment. Open-ended test questions
require students to respond in the form of an essay or "show your work" type of
an answer. The Company has received a commitment from one state to adopt an
early version of the Virtual Scoring Center during the second quarter of fiscal
2001. The first commercial version of the product is expected to be available
by the third quarter of fiscal 2001.
Professional Consulting and Integration Services Segment
2000 1999
------------------------------------------------------------------------
Revenue from external customers $360,615 1,204,403
------------------------------------------------------------------------
Operating loss $(318,092) (441,757)
------------------------------------------------------------------------
Fiscal 2000 revenue for the professional consulting and integration services
segment was $360,615 compared to $1,204,403 for fiscal 1999, a decrease of
$843,788, or 70%. The revenue decline was anticipated due to the Company's
decision in fiscal 2000 to transition out of the existing professional service
business model. Three customer contracts accounted for approximately 80% and
84% of service revenue for fiscal years 2000 and 1999, respectively.
Operating losses for the professional consulting and integration services
segment were 88% and 37% of revenue for fiscal year ending 2000 and 1999,
respectively. Fiscal year 2000 operating margins were negatively impacted by
continuing cost overruns on two fixed-fee projects. These two projects
accounted for approximately 65% of fiscal 2000 revenue. One project was
completed and accepted by the customer by August 31, 2000, while the other
project was substantially completed by August 31, 2000 and accepted by the
customer in the first quarter of fiscal 2001. This project is in a loss
situation, therefore the estimated costs to complete the contract have been
recorded at August 31, 2000. Approximately $21,000 was accrued at August 31,
2000 for the anticipated costs to complete this project in fiscal 2001. The
segment will provide maintenance during fiscal 2001 for these projects. The
Company has been allocating segment resources for product development upon the
completion of these projects.
Document Conversion Segment
2000 1999
---------------------------------------------------------------------
Revenue from external customers $259,439 491,291
---------------------------------------------------------------------
Operating loss $ (906) (186,288)
---------------------------------------------------------------------
Fiscal 2000 revenue for the document conversion segment was $259,439 compared
to $491,291 for fiscal 1999, a decrease of $231,852 or 47%. Approximately 92%
of fiscal 2000 revenue came from four customers and 65% of fiscal 1999 revenue
came from three customers. The significant reduction in document conversion
revenue was expected and resulted from the Company's decision to restructure
document conversion operations during the first quarter of fiscal 1999.
Operating loss margins were 0% and 38% for fiscal year ending 2000 and 1999,
respectively. The reduction in the loss margin in fiscal 2000 from 1999
primarily resulted from the prior year transitional costs associated with the
restructuring of the document conversion segment, a $25,000 inter-segment bad
debt charge from the component product technologies segment in the prior year
for an uncollectible account, and an increase in the proportion of services
performed in fiscal 2000 under higher margin electronic publishing contracts.
Total Company Operating Results
Following is a report of total company revenue and a reconciliation of
reportable segments' operating loss to the Company's total net loss for fiscal
year ending 2000 and 1999.
<TABLE>
<CAPTION>
2000 1999
-------------------------------------------------------------
<S> <C> <C>
Total company revenue $3,605,249 4,956,137
-------------------------------------------------------------
Operating loss for
reportable segments (90,969) (245,628)
Unallocated corporate expenses (350,016) (449,296)
Interest income 60,531 25,971
Interest expense (21,161) (31,793)
Other, net 5,857 17,964
-------------------------------------------------------------
Income tax expense (800) (3,702)
-------------------------------------------------------------
Net loss $ (396,558) (686,484)
-------------------------------------------------------------
Loss per share:
Basic $(0.03) (0.05)
Diluted (0.03) (0.05)
-------------------------------------------------------------
</TABLE>
Total revenue for fiscal 2000 was $3,605,249 compared to $4,956,137 for
fiscal 1999, a decrease of $1,350,888, or 27%. Licensing and royalty revenue of
$2,982,195 decreased by 9% from fiscal 1999. Although image viewing revenue
increased by $75,000, or 4%, due to the recognition of Prizm revenue in the
fourth quarter of 2000 from one customer that accounted for 14% of total
licensing and royalty revenue, the $118,000, or 17%, decrease in image
<PAGE> 10
enhancement revenue and the $165,000, or 47%, decrease in forms processing
revenue offset the image viewing increase, leading to the overall decline in
licensing and royalty revenue. In addition, professional consulting and
integration services revenue decreased $844,000, or 70%, due to the Company's
plan to only complete the projects in process at the end of 1999 and then
reallocate resources from the professional consulting and integration services
segment to other segments for product development. Document conversion revenue
of $259,000 decreased 47% based on the restructuring of the document conversion
service operations in the first quarter of fiscal 1999. Net loss for fiscal
year ending 2000 was $396,558, or $0.03 loss per share (basic and diluted),
compared to net loss of $686,484, or $0.05 loss per share (basic and diluted),
for fiscal 1999. The net loss of $396,558 reported for the fiscal year ending
2000 is primarily the result of the continuing cost overruns for the
professional consulting and integration services segment, investment in new
product development for the assessment product technologies segment, and the
product write-offs of $193,000 for Scanfix Twain, Prizm Image Server and
SpectrumFix.
The Company's income tax expense rate was 0% and 1% for fiscal 2000 and
1999, respectively. The effective income tax rates for both fiscal years 2000
and 1999 differed from the "expected" Federal tax expense rate of 34%,
primarily because of a change in the valuation allowance provided against the
Company's deferred tax assets. Deferred tax assets are primarily the result of
the Company's net operating loss carryforwards. See "Income Taxes" in Note 3 to
the Financial Statements.
Financial Condition
Working capital at August 31, 2000, was $1,376,235 with a current ratio of
2.9:1 compared to $1,797,164 with a current ratio of 4.3:1, at August 31, 1999.
The working capital and current ratio declines are due to a combination of
factors. Current assets decreased by approximately $260,000 at August 31, 2000
primarily due to the reclassification of deferred tax assets from current
assets to long-term assets to reflect the Company's expectation of the timing
for realization of the benefits related to the deferred tax assets. Also,
current liabilities increased by approximately $162,000 primarily as a result
of increased deferred revenue related to software maintenance agreements sold
to customers in fiscal 2000. Net cash provided by operations for the fiscal
year ending 2000 was $865,864 compared to $1,023,821 for fiscal year ending
1999. Despite the decrease in total revenue and the operating loss reported for
the current fiscal year, operating cash flow remained strong because of
aggressive customer collection processes and the completion of several
significant service contracts, resulting in the final billing and collection on
the contracts in the current year. Net cash used in investing activities for
fiscal year ending August 31, 2000 was $397,471 compared to $384,158 for the
same period in fiscal 1999. Net cash used in financing activities was $166,411
and $73,649 for fiscal year ending August 31, 2000 and 1999, respectively. This
increase is primarily due to repurchase and subsequent retirement of 350,000
shares of common stock in fiscal 2000.
During fiscal years 2000 and 1999 the Company did not borrow against its
line of credit. The Company did not renew the line of credit upon its
expiration in the third quarter of fiscal 2000 and anticipates that operating
cash flows 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.
Factors Affecting Business
The computer software industry is subject to rapid change that could result in
significant additional costs or the Company's products and services becoming
obsolete.
The markets for the Company's products are characterized by rapid technological
advances and can be significantly affected by new product introductions and
changing customer requirements. The Company's future success will depend upon
its ability to continue to improve existing products and to develop and
introduce products with new or enhanced capabilities that address the
increasingly sophisticated needs of its customers and keep pace with
technological and competitive developments. There can be no assurance that the
Company will be able to successfully develop and market new or enhance products
or respond effectively to technological changes or new product announcements by
others. Any failure by the Company to anticipate or respond adequately to
technological developments and customer requirements, or any significant delays
in product development or introduction, could result in a material adverse
effect on the Company's business, operating results, cash flows and financial
condition.
The Company's markets are highly competitive, and if the Company does not
compete effectively, the Company could suffer price reductions and loss of
market share.
The computer software and education assessment fields are highly competitive
and include many companies in those industries. The computer software field is
characterized by rapid changes in technology and frequent introductions of new
platforms and features. Competitors in this market include AccuSoft, Pixel
Translations, Snowbound Software, Kofax Image Products, Lead Technologies,
Seaport Imaging and Visionshape. As the Company moves forward
<PAGE> 11
with color image processing and enhancement software, Dunord Technologies and
Picture Elements can also be considered competitors. Certain of the Company's
competitors for is component products have greater financial, technical and
marketing resources than the Company. The Company believes that the primary
competitive factors with respect to its component products are the features of
its products, the technical capabilities of the Company's personnel, quality of
services and price. The Company believes that is can compete favorably with
respect to all of these factors and is focusing on markets where it believes it
can achieve a leadership position; however, there can be no assurance that the
Company will be able to continue to compete effectively in its market, that
competition will not intensify or that future competition will not have a
material adverse effect on the Company's business, operating results, cash
flows and financial condition.
The education assessment market includes many vendors with an already
established presence in providing services for the scoring of open-ended
assessments. Those vendors include entities such as Harcourt Educational
Measurement, Educational Testing Services, NCS Pearson, CTB-McGraw Hill,
Measured Progress, and Measurement Inc. Company management believes that the
Virtual Scoring Center is a product that addresses several needs in the
educational assessment marketplace, but there can be no assurance that the
Company will be able to compete successfully against current and future
competitors, many of which have larger technical staffs, greater brand name
recognition and market presence, more established and larger marketing and
sales organizations and substantially greater financial resources than the
Company. There can also be no assurances that the competitive pressures faced
by the Company will not have a material adverse effect on the Company's
business, operating results, cash flows and financial condition.
If the Company is unable to protect its intellectual property it may lose a
valuable asset, experience reduced market share or incur costly litigation to
protect its rights.
The Company relies on a combination of patent rights, copyright and trademark
laws, nondisclosure agreements and other contractual provisions and technical
measures to protect its intellectual property rights. The Company does not
believe that any of its products or soon to be released products present
questions of patent infringement or violations of any other intellectual
property rights belonging to others. There can be no assurance, however, that
claims of infringement of the intellectual property rights of others will not
arise that could require the Company to procure license for the use of third
party technology, to make additional investments to modify or replace
technologies to remove the basis for an allegation of infringement, or to
discontinue use of technology accused of infringement, any of which could have
a material adverse effect on the Company's operations or financial condition.
There can also be no assurance that others will not infringe on the
intellectual property rights of the Company or that the Company will have
financial or other resources available to adequately enforce infringement of
its intellectual property rights. There can be no assurance that a third party
will not assert that the Company's technology violates its intellectual
property rights in the future. As the number of products in the Company's
target markets increases and the functionality of these products further
overlap, developers may become increasingly subject to infringement claims. Any
such claims, with or without merit, can be time consuming and expensive to
defend. There can be no assurance that third parties will not assert
infringement claims against the Company in the future with respect to its
current or future products or that any such assertion will not require the
Company to enter into royalty arrangements or litigation that could be costly
to the Company.
Defects in the Company's products could result in claims against the Company
that could cause unanticipated losses.
The Company's license agreements with its customers typically contain
provisions designed to limit the Company's exposure to potential product
liability claims. It is possible, however, that the limitation of liability
provisions contained in the Company's license agreements may not be effective
under the laws of certain state and foreign jurisdictions. The sale and support
of products by the Company and its retailers and other resellers may entail the
risk of such claims, and there can be no assurance that the Company will not be
subject to such claims in the future. A product liability claim brought against
the Company could have a material adverse effect upon the Company's business,
results of operations and financial condition.
The Company's operating results and financial condition could suffer if its if
unable to continue to secure significant sales of multiple licenses to
individual customers.
The Company has historically relied upon large sales transactions with
individual customers to achieve positive operating results. In fiscal 2000 and
1999, a single customer accounted for 12% and 10%, respectively, of the
Company's total revenue. There can be no assurance that the Company will
continue to obtain such large sales transactions on a consistent basis and, as
such, the Company's inability to obtain sufficient large sales could have a
material adverse effect on the Company's business, operating results and
financial position.
<PAGE> 12
Impact of Recently Issued Accounting Standards
In June 1999, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 is effective for
fiscal years beginning after June 15, 2000. SFAS No. 133 establishes standards
for accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. The accounting for changes in fair value of a
derivative depends on the intended use of the derivative and the resulting
designation. Adoption of SFAS No. 133 is not expected to impact the Company
because the Company does not have any derivative instruments.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation-an interpretation of APB
Opinion No. 25" ("FIN 44"). Among other issues, this interpretation clarifies
the definition of employee for purposes of applying APB Opinion No. 25,
Accounting for Stock issued to Employees ("APB 25"), the criteria for
determining whether a plan qualifies as a non compensatory plan, the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and the accounting for an exchange of stock compensation
awards in a business combination. This Interpretation was effective July 1,
2000, but certain conclusions in this Interpretation cover specific events that
occur after either December 15, 1998, or January 12, 2000. FIN 44 did not
affect the Company in fiscal 2000 and management believes that FIN 44 will not
have a material effect on the financial position or results of operations of
the Company in future fiscal years.
ITEM 7. FINANCIAL STATEMENTS
The financial statements required by this Item are set forth beginning on page
F1 hereof.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
-----------------
Part III
Information required in response to Items 9-12 shall appear in the Company's
definitive proxy statement to be filed pursuant to Regulation 14A within 120
days of the fiscal year end covered hereby, and shall be incorporated herein by
reference when filed.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits The following exhibits are included with this report; all
employment contracts and compensatory plans are marked with an asterisk (*):
Exhibit Name of Exhibit
------------------------------------------------------------------------------
3.1 Certificate of Incorporation of the Registrant, as amended,
incorporated herein by reference to Exhibit No. 3.1 to the
Registrant's Form 10K for the fiscal year ended August 31, 1995.
3.2 Bylaws of the Registrant, as amended on September 24, 1999.
10.1* Employee Stock Option Plan, incorporated herein by reference to
Exhibit No. 10.1 to the Registrant's Form 10 Registration Statement,
filed with the Commission on January 15, 1990 (the "Form 10").
10.2* Senior Employee Stock Option Plan, incorporated herein by reference
to Exhibit No. 10.2 to the Registrant's Form 10.
10.3* Employee Incentive Stock Option Plan, incorporated herein by
reference to Exhibit No. 10.3 to the Registrant's Form 10.
10.4* TMS, Inc. Employee Stock Purchase Plan, incorporated herein by
reference to Exhibit No. 10.9 to the Registrant's Form 10-KSB for
the fiscal year ended August 31, 1999.
10.5* TMS, Inc. 1996 Stock Option Plan, incorporated herein by reference
to Exhibit No. 99 to the Registrant's Form S-4 as filed with the
Commission on May 16, 1996.
10.6 Contract number F34601-98-C-0145 between the Registrant and the
Department of the Air Force, incorporated herein by reference to
Exhibit No. 10.11 to the Registrant's Form 10-KSB for the fiscal
year ended August 31, 1999.
10.7 Corporate Software License Agreement between the Registrant and The
Boeing Company, incorporated herein by reference to Exhibit No. 10.1
to the Registrant's Form 10-QSB for the quarterly period ended May
31, 2000.
10.8 Development Agreement between the Registrant and The Boeing Company,
incorporated herein by reference to Exhibit No. 10.2 to the
Registrant's Form 10-QSB for the quarterly period ended May 31,
2000.
10.9 Purchase Contract number W 311305 between the Registrant and The
Boeing Company, incorporated herein by reference to Exhibit No. 10.3
to the Registrant's Form 10-QSB for the quarterly period ended May
31, 2000.
23.1 Consent of KPMG LLP
27.0 Financial Data Schedule
(b) Reports on Form 8-K No Form 8-K Current Reports were filed by the Company
during the last quarter of fiscal 2000.
<PAGE> 13
---------------
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
REGISTRANT: TMS, INC.
-----------------------------------------------------------------------------
Date: 11/22/00 BY: /s/ Deborah D. Mosier
----------------------------------------------------
Deborah D. Mosier, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: 11/22/00 BY: /s/ Doyle E. Cherry
-----------------------------------------------------
Doyle E. Cherry, Director
Date: 11/22/00 BY: /s/ Deborah D. Mosier
-----------------------------------------------------
Deborah D. Mosier, President
Principal Executive Officer
Date: 11/22/00 BY: /s/ James R. Rau, M.D.
-----------------------------------------------------
James R. Rau, M.D., Director
Date: 11/22/00 BY: /s/ Russell W. Teubner
-----------------------------------------------------
Russell W. Teubner, Director
Date: 11/22/00 BY: /s/ Marshall C. Wicker
-----------------------------------------------------
Marshall C. Wicker, Director
Date: 11/22/00 BY: /s/ Kent E. Warkentin
-----------------------------------------------------
Kent E. Warkentin, Controller
Principal Financial Officer
<PAGE> 14
Index to Financial Statements and Financial Statement Schedule
------------------------------------------------------------------------------
PAGE
Independent Auditors' Report F1
Financial Statements
Balance Sheets: August 31, 2000
and 1999 F2 and F3
Statements of Operations: Years Ended
August 31, 2000 and 1999 F4
Statements of Shareholders' Equity:
Years Ended August 31, 2000 and 1999 F5
Statements of Cash Flows: Years Ended
August 31, 2000 and 1999 F6
Notes to Financial Statements:
August 31, 2000 and 1999 F7 through F14
Financial Statement Schedule
Schedule II -- Valuation and Qualifying Accounts:
Years Ended August 31, 2000 and 1999 F15
All other schedules are omitted as they are inapplicable or not required, or
the required information is included in the Financial Statements or Notes to
Financial Statements.
Independent Auditors' Report
The Board of Directors and Shareholders
TMS, Inc.:
We have audited the financial statements of TMS, Inc. (dba TMSSequoia) as
listed in the accompanying index. In connection with our audits of the
financial statements, we also have audited the financial statement schedule as
listed in the accompanying index. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of TMS, Inc. as of August 31,
2000 and 1999 and the results of its operations and its cash flows for the
years then ended in conformity with accounting principles generally accepted in
the United States of America. Also in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
KPMG LLP
Oklahoma City, Oklahoma
October 19, 2000
<PAGE> F1
Balance Sheets
August 31, 2000 and 1999
<TABLE>
<CAPTION>
TMS, Inc. (dba TMSSequoia) 2000 1999
----------------------------------------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $1,359,692 1,057,710
Trade accounts receivable, net of
allowance for doubtful accounts
of $54,032 in 2000 and
$395,069 in 1999 461,549 574,067
Contract service work in process 146,848 415,985
Deferred income taxes 64,007 242,701
Prepaid expenses and other current assets 54,285 55,317
----------------------------------------------------------------------
Total current assets 2,086,381 2,345,780
----------------------------------------------------------------------
Property and equipment:
Land 111,000 111,000
Building 747,634 747,634
Computer equipment 1,515,148 1,662,954
Furniture and fixtures 349,015 371,366
----------------------------------------------------------------------
2,722,797 2,892,954
Less accumulated depreciation and
amortization (1,649,589) (1,590,081)
----------------------------------------------------------------------
Net property and equipment 1,073,208 1,302,873
----------------------------------------------------------------------
Other assets:
Capitalized software development costs,
net of accumulated amortization of
$422,306 in 2000 and $645,004 in 1999 388,258 481,169
Deferred income taxes 420,493 241,799
Accounts receivable, long-term 77,406 --
Other assets 43,508 45,191
----------------------------------------------------------------------
Total other assets 929,665 768,159
----------------------------------------------------------------------
Total assets $4,089,254 4,416,812
----------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
<PAGE> F2
<TABLE>
<CAPTION>
2000 1999
-----------------------------------------------------------------------
<S> <C> <C>
Liabilities and Stockholders' Equity
Current liabilities:
Current obligations under capital leases $11,705 66,250
Current installments of long-term debt 28,943 27,313
Accounts payable 80,879 103,341
Accrued payroll expenses 301,107 236,070
Deferred revenue 287,512 115,642
-----------------------------------------------------------------------
Total current liabilities 710,146 548,616
-----------------------------------------------------------------------
Obligations under capital leases,
net of current installments -- 12,149
Long-term debt, net of current
installments 252,456 282,674
Other liabilities 10,375 --
-----------------------------------------------------------------------
Total liabilities 972,977 843,439
-----------------------------------------------------------------------
Shareholders' equity:
Preferred stock, $.01 par value.
Authorized 1,000,000 shares;
none issued -- --
Common stock, $.05 par value. Authorized
50,000,000 shares; 13,490,659
shares issued and 13,292,690
outstanding in 2000
and 13,820,622 shares issued and
13,578,659 outstanding in 1999 674,533 691,031
Additional paid-in capital 11,422,299 11,501,760
Unamortized deferred compensation (1,809) (20,072)
Accumulated deficit (8,884,719) (8,488,161)
Treasury stock, at cost,
197,969 shares in 2000
and 241,963 shares in 1999 (94,027) (111,185)
-----------------------------------------------------------------------
Total shareholders' equity 3,116,277 3,573,373
-----------------------------------------------------------------------
Commitments (Note 8)
-----------------------------------------------------------------------
Total liabilities and shareholders' equity $4,089,254 $4,416,812
-----------------------------------------------------------------------
</TABLE>
<PAGE> F3
Statements of Operations
Years Ended August 31, 2000 and 1999
<TABLE>
<CAPTION>
TMS, Inc. (dba TMSSequoia) 2000 1999
-----------------------------------------------------------------
<S> <C> <C>
Revenue:
Licensing and royalties $2,982,195 3,260,443
Software development services 363,615 1,204,403
Document conversion services 259,439 491,291
-----------------------------------------------------------------
3,605,249 4,956,137
-----------------------------------------------------------------
Operating costs and expenses:
Cost of licensing and royalties 555,713 630,847
Cost of software development services 463,807 1,022,769
Cost of document conversion services 137,569 274,815
Selling, general and administrative 2,279,734 3,337,818
Research and development 609,411 313,917
Restructuring charge -- 70,895
-----------------------------------------------------------------
4,046,234 5,651,061
-----------------------------------------------------------------
Operating loss (440,985) (694,924)
Other income, net 45,227 12,142
-----------------------------------------------------------------
Loss before income taxes (395,758) (682,782)
Income tax expense 800 3,702
-----------------------------------------------------------------
Net loss $(396,558) $ (686,484)
-----------------------------------------------------------------
Net loss per share
Basic $(0.03) (0.05)
Diluted $(0.03) (0.05)
-----------------------------------------------------------------
Weighted average shares:
Basic 13,364,352 13,570,605
Diluted 13,364,352 13,570,605
-----------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
<PAGE> F4
Statements of Shareholders' Equity
Years Ended August 31, 2000 and 1999
<TABLE>
<CAPTION>
ADDITIONAL UNAMORTIZED TOTAL
TMS, Inc. COMMON STOCK PAID-IN DEFERRED ACCUM. TREASURY SHAREHOLDERS'
(dba TMSSequoia) SHARES AMOUNT CAPITAL COMPENSATION DEFICIT STOCK EQUITY
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at August 31, 1998 13,466,109 $673,305 11,476,190 (23,967) (7,801,677) (78,885) 4,244,966
Exercise of stock options 354,513 17,726 25,570 -- -- -- 43,296
Issuance of common stock
held in treasury -- -- -- -- -- 2,700 2,700
Purchase of common stock
held in treasury -- -- -- -- -- (35,000) (35,000)
Amortization of deferred
compensation -- -- -- 3,895 -- -- 3,895
Net loss -- -- -- -- (686,484) -- (686,484)
------------------------------------------------------------------------------------------------------------------------
Balance at August 31, 1999 13,820,622 691,031 11,501,760 (20,072) (8,488,161) (111,185) 3,573,373
Exercise of stock options 16,000 800 1,200 -- -- -- 2,000
Issuance of common stock
to employees 4,037 202 1,022 -- -- -- 1,224
Sale of common stock
held in treasury -- -- -- -- -- 18,211 18,211
Issuance of common stock held
in treasury to employees -- -- 479 -- -- 2,787 3,266
Purchase of common stock
held in treasury -- -- -- -- -- (3,840) (3,840)
Purchase and retirement
of common stock (350,000) (17,500) (70,000) -- -- -- (87,500)
Amortization of deferred
compensation -- -- -- 6,101 -- -- 6,101
Forfeiture of stock options -- -- (12,162) 12,162 -- -- --
Net loss -- -- -- -- (396,558) -- (396,558)
-------------------------------------------------------------------------------------------------------------------------
Balance at August 31, 2000 13,490,659 $674,533 11,422,299 (1,809) (8,884,719) (94,027) 3,116,277
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
<PAGE> F5
Statements of Cash Flows
Years Ended August 31, 2000 and 1999
<TABLE>
<CAPTION>
TMS, Inc. (dba TMSSequoia) 2000 1999
----------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(396,558) (686,484)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization 509,272 660,604
Loss on disposal of equipment 20,626 65,218
Loss on write-off of software development costs 192,681 157,251
Employee stock-based compensation 10,591 3,895
Net change in:
Accounts receivable 35,112 719,854
Work in process 269,137 181,360
Prepaid expenses and other assets 183 34,656
Accounts payable (22,462) (44,503)
Accrued payroll expenses 75,412 (83,925)
Deferred revenue 171,870 15,895
----------------------------------------------------------------------------------
Net cash provided by operating activities 865,864 1,023,821
----------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (66,532) (72,011)
Proceeds from disposal of equipment 1,251 38,479
Capitalized software development costs (332,190) (350,626)
----------------------------------------------------------------------------------
Net cash used in investing activities (397,471) (384,158)
----------------------------------------------------------------------------------
Cash flows from financing activities:
Repayment of long-term debt (28,588) (23,630)
Repayment of capital lease (66,694) (61,015)
Sale of common stock 2,000 43,296
Sale of treasury stock, at cost 18,211 2,700
Purchase of treasury stock, at cost (91,340) (35,000)
----------------------------------------------------------------------------------
Net cash used in financing activities (166,411) (73,649)
----------------------------------------------------------------------------------
Net increase in cash and cash equivalents 301,982 566,014
Cash and cash equivalents at beginning of year 1,057,710 491,696
----------------------------------------------------------------------------------
Cash and cash equivalents at end of year $1,359,692 $1,057,710
----------------------------------------------------------------------------------
Supplemental cash flow information:
Cash paid for interest $21,161 31,793
Cash paid for income taxes 800 7,600
----------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
<PAGE> F6
Notes to Financial Statements August 31, 2000 and 1999
Note 1: Summary of Significant Accounting Policies
Organization
The Company is involved in the research, design, development, and marketing of
software tools and applications for document capture, image enhancement, image
viewing, forms processing, intranets and the Internet. The Company also
provides document conversion services to corporations and government
organizations to assist them in migrating from paper to electronic information
systems. The Company is also developing technologies to improve the overall
process of scoring large-scale assessments ("tests") for grades K-12 in the
educational marketplace. In fiscal 2000 the Company decided to transition out
of its professional service business model for which the Company had
historically offered a variety of services for analyzing business and
information management processes as well as integrating business solutions.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual amounts could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents consist primarily of highly liquid money market
accounts with an original maturity of three months or less and overnight
investments carried at cost plus accrued interest, which approximates fair
value.
Computer Software Costs
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs
of Computer Software to be Sold, Leased, or Otherwise Marketed" (SFAS No. 86),
requires capitalization of software development costs incurred subsequent to
establishment of technological feasibility and prior to the availability of the
product for general release to customers. The Company capitalized $332,190 and
$350,626 of software development costs, which primarily includes personnel
costs, in 2000 and 1999, respectively. Funding received from customers for the
development of products is first applied against the capitalized software
development costs and any remaining funding is recognized as revenue upon
product acceptance. In fiscal 2000, the Company applied approximately $43,000
of customer funding against capitalized software costs.
Systematic amortization of capitalized costs begins when a product is
available for general release to customers and is computed on a
product-by-product basis at a rate not less than straight-line over the
product's remaining estimated economic life. The Company amortized $232,420 and
$332,744 of software development costs in 2000 and 1999, respectively. The
Company compares the unamortized capitalized software development costs to the
estimated net realizable values of its products on a periodic basis. If the
estimated net realizable values fall below the unamortized costs, the excess
costs are charged directly to operations. During fiscal 2000, the Company
charged approximately $118,000 to cost of revenue and $75,000 to research and
development to write-down the unamortized development costs for SpectrumFix,
ScanFix Twain, and Prizm Image Server. During fiscal 1999, the Company charged
approximately $157,000 to cost of revenue to write-down unamortized development
costs.
Property and Equipment
Property and equipment are stated at cost. Depreciation on the building is
calculated using the straight-line method over thirty-nine years. Depreciation
on equipment and furniture, which includes amortization for equipment held
under capital leases, is calculated using the straight-line method over periods
ranging from three to ten years, but not less than the estimated useful life of
the leased property.
The Company reviews long-lived assets and certain identifiable intangibles
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future net cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceeds the fair value of
the assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.
Patent Costs
Included in other assets at August 31, 2000 and 1999, are $33,020 and $35,552,
respectively, of unamortized capitalized costs associated with obtaining patent
rights for certain software products. Various patents were approved during
fiscal 1996 through 1998 and the capitalized costs are amortized using the
straight-line method over the seventeen-year life of the patents.
<PAGE> F7
Revenue
Statement of Position (SOP) 97-2 "Software Revenue Recognition" requires
software licensing and royalties revenue to be recognized only after the
software is delivered, all significant obligations of the Company are
fulfilled, and all significant uncertainties regarding customer acceptance have
expired. SOP 97-2 also requires the unbundling of multiple elements in software
transactions and the allocation of 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. At August 31, 2000 and
1999, deferred technical support and product maintenance revenue was $166,277
and $78,070, respectively. 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. At August 31, 2000 and 1999, the Company had deferred revenue of
$6,991 and $1,591, respectively, representing software products and/or
enhancements expected to be delivered in the Company's fiscal year 2001 and
2000, respectively. The Company also deferred $49,936 and $18,482 of software
product revenue at August 31, 2000 and 1999, respectively, because of
uncertainties surrounding customer payment.
Funding received from customers for the development of products is first
applied against the capitalized software development costs and any remaining
funding is recognized as revenue upon product acceptance. In fiscal 2000, the
Company recognized revenue of approximately $23,000 that represented the excess
of customer funding over the cost of the product development.
Revenue for software development services and document conversion services
is recognized as the services are performed using the percentage-of-completion
method and is deferred to the extent that customer billings or payments exceed
the percentage complete. Deferred revenue under service contracts was $64,307
and $17,500 at August 31, 2000 and 1999, respectively. Contract service work in
process of $146,848 and $415,985 at August 31, 2000 and 1999, respectively,
represented costs and related profits recognized on a percentage-of-completion
basis in excess of customer billings. Contract costs primarily include direct
labor. Provisions for losses on contracts are recorded at the time such losses
are known. Amounts for contracts in process at August 31, 2000, will be billed
pursuant to contractual terms and are expected to be collected during fiscal
2001.
Net Loss Per Share
Basic EPS is computed by dividing net income available to common shareholders
by the weighted-average number of shares of common stock outstanding during the
period. Diluted EPS recognizes the potential dilutive effects of the future
exercise of common stock options.
Stock-based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation" (SFAS No. 123), encourages, but does not require companies
to record compensation cost for stock-based employee compensation plans at fair
value. The Company has chosen to continue to account for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" APB
No. 25), and related Interpretations. Accordingly, compensation cost for stock-
based awards is expensed in an amount equal to the excess of the quoted market
price on the grant date over the exercise price. Such expense is recognized at
the grant date for awards fully vested. For awards with a vesting period, the
expense is deferred and recognized over the vesting period. The amount of
expense recognized in 2000 and 1999 related to employee stock-based awards was
$10,591 and $3,895, respectively. Compensation cost is not required to be
recorded for the employee stock purchase plan (see Note 4), as it is non-
compensatory under the provisions of APB No. 25.
Income Taxes
The Company accounts for income taxes using the asset and liability method.
Under the asset and liability method, deferred tax assets and liabilities are
recognized at the enacted tax rates for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.
Allowance for Doubtful Trade Accounts Receivables
The Company extends credit to customers in accordance with normal industry
standards and terms. Credit risk arises as customers default on trade accounts
receivable owed to the Company. The Company has established an allowance for
doubtful accounts based on known factors surrounding the credit risk of
specific customers, historical trends and other information.
Under certain circumstances, the Company requires that a portion of the
estimated billings be paid prior to delivering products or performing services.
In addition, the Company may revoke customer contracts if outstanding amounts
are not paid.
<PAGE> F8
Fair Value of Financial Instruments
The carrying value of cash and cash equivalents, trade accounts receivable,
contract service work in process, accounts payable, accrued expenses and other
liabilities approximate fair value because of the short maturity of these
financial instruments. The carrying value of notes payable and long-term debt
approximates fair value because the current rates approximate market rates
available on similar instruments.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" (SFAS No. 130), establishes standards for reporting and display of
"comprehensive income" and its components in a set of financial statements. It
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed at the same prominence as other financial
statements. The Company currently does not have any components of comprehensive
income that are not included in net loss.
Reclassifications
Certain 1999 amounts have been reclassified to conform to the 2000 financial
statement presentation. In 2000, certain distribution expenses, which had been
previously reported in "Selling, general and administrative" expenses, are now
presented in "Cost of licensing and royalties" on the statements of operations.
In addition, certain expenses related to the research and development of the
Company's component products and assessment products, which had been previously
reported in "Cost of licensing and royalties", are now presented separately on
the statements of operations.
Note 2: Note Payable and Long-Term Debt
At August 31, 1999, the Company had an $800,000 operating line of credit with a
bank that bore interest at .75% above prime (9.00% at August 31, 1999) and
expired on November 3, 1999. The Company renewed this line of credit at an
interest rate of 1% above prime and it expired on March 31, 2000. The Company
chose not to renew this line of credit at that time. No balance was outstanding
against the line of credit at August 31, 1999. The Company had $281,399 and
$309,987 outstanding under a long-term note payable to a bank, at August 31,
2000 and 1999, respectively. The note bore interest at 5.57% at August 31, 2000
and 1999 and is due January 1, 2009. The interest rate is based on an Oklahoma
small business program and may be adjusted at the end of each two-year period,
beginning on June 30, 1996. The aggregate maturities of long-term debt for each
of the five years subsequent to August 31, 2000, and thereafter, are as
follows: 2001, $28,943; 2002, $30,620; 2003, $32,395; 2004, $34,245; 2005,
$36,257; thereafter, $118,939. The line of credit (prior to its expiration) and
long-term note are secured by all accounts receivable, equipment, furniture and
fixtures, and real property of the Company.
Note 3: Income Taxes
Income tax expense for fiscal 2000 was $800. The significant components of the
2000 expense include: deferred tax benefit, $146,404; increase in the valuation
allowance for deferred tax assets, $147,567; state income tax paid, $800; and
benefit for correction of prior year estimates, $1,163. Income tax expense for
fiscal 1999 was $3,702. The significant components of the 1999 benefit include:
deferred tax benefit, $255,370; increase in the valuation allowance for
deferred tax assets, $260,634; state income tax refund, $2,943; and expense for
correction of prior year estimates, $1,381. Income tax expense for 2000 and
1999 differed from the amounts computed by applying the U.S. Federal income tax
rate of 34% to pretax income from operations as a result of the following:
2000 1999
----------------------------------------------------------------------------
Computed "expected" tax benefit (34.0%) (34.0%)
Change in the tax assets valuation allowance 37.0% 38.0%
State income tax, net of Federal income tax benefit (4.0%) (4.0%)
Other 1.0% 1.0%
----------------------------------------------------------------------------
Effective income tax expense 0.0% 1.0%
----------------------------------------------------------------------------
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at August 31, 2000 and 1999
are presented in Table 3a.
________________
Table 3a
2000 1999
------------------------------------------------------------------------------
Deferred tax assets:
Tax operating loss carryforwards $1,636,823 1,554,621
Tax credit carryforwards 79,152 79,152
Accounts receivable 20,511 149,968
Other 44,246 43,821
------------------------------------------------------------------------------
Total gross deferred tax assets 1,780,732 1,827,562
Less valuation allowance 1,130,030 1,114,267
------------------------------------------------------------------------------
Net deferred tax assets 650,702 713,295
------------------------------------------------------------------------------
Deferred tax liabilities:
Property and equipment (18,819) (46,143)
Capitalized software costs (147,383) (182,652)
------------------------------------------------------------------------------
Net deferred tax assets $ 484,500 484,500
------------------------------------------------------------------------------
<PAGE> F9
Deferred tax assets are recognized when it is more likely than not that
benefits from deferred tax assets will be realized. The Company had recognized
a net deferred tax asset of $484,500 at August 31, 2000. The ultimate
realization of this deferred tax asset is dependent upon the Company's ability
to generate future taxable income during the periods in which those temporary
differences become deductible. Management considered the scheduled reversal of
deferred tax liabilities, projected future taxable income, past earnings
history, sales backlog, and net operating loss and tax credit carryforward
expiration dates in determining the amount of deferred tax asset to recognize.
In order to fully realize the deferred tax asset, the Company will be required
to generate future taxable income of approximately $1,275,000 prior to the
expiration of the net operating loss and tax credit carryforwards. Taxable loss
for the year ended August 31, 2000 approximated $552,000 compared to a
financial loss of approximately $397,000. Taxable loss for the year ended
August 31, 1999 approximated $388,000 compared to a financial loss of
approximately $682,000. In fiscal 2000 and 1999, the differences in the tax and
financial losses primarily resulted from timing differences associated with the
deductibility of capitalized software and bad debt estimates compared to the
recognition of related expenses in accordance with generally accepted
accounting principles ("GAAP").
The $1,130,030 valuation allowance provides for net operating loss and tax
credit carryforwards that, as of August 31, 2000, are not expected to be
realized prior to expiration. At August 31, 2000 the Company's tax net
operating loss carryforwards, investment tax credit carryforwards, and research
and experimental tax credit carryforwards approximated $4,312,000, $39,000 and
$40,000, respectively. These carryforwards expire during the years 2001 through
2015. Approximately $2,160,000, or 50%, of the net operating loss carryforwards
expire by the end of fiscal year 2001. The benefits from these carryforwards
could also be limited under Internal Revenue Service Code Section 382 due to
changes in ownership.
Note 4: Stock-Based Compensation
Stock Options
In 1985, the Company's board of directors approved an employee incentive stock
option plan ("1985 Plan"). Options to purchase 1,000,000 shares of the
Company's common stock at a price of $.125 per share were granted under this
plan. The options are exercisable after one year of continued employment with
the Company following the grant date, and expire ten years after the grant
date.
In 1989, the Company adopted an employee stock option plan and a senior
employee stock option plan. Options to purchase 1,150,000 shares of the
Company's common stock at $.125 per share were granted under the employee stock
option plan and options to purchase 850,000 shares of the Company's common
stock at $.125 per share were granted under the senior employee stock option
plan. The options become exercisable over a five-year period, beginning one
year after the grant date. No options were outstanding at August 31, 2000 and
1999 under the senior employee stock option plan.
________________
Table 4a
<TABLE>
<CAPTION>
WEIGHTED WEIGHTED
AVERAGE OPTION AVERAGE
SHARES EXERCISE PRICE PRICE RANGE FAIR VALUE
<S> <C> <C> <C> <C>
-----------------------------------------------------------------------------------------------
Shares under option:
-----------------------------------------------------------------------------------------------
At August 31, 1998 1,495,209 $ 0.32 $ 0.13-$0.75
Options granted 385,000 $ 0.54 $ 0.40-$0.75 $ 0.16
Options exercised (354,513) $ 0.13 $ 0.13
Options cancelled (776,982) $ 0.44 $ 0.13-$0.75
-----------------------------------------------------------------------------------------------
At August 31, 1999 748,714 $ 0.41 $ 0.13-$0.75
-----------------------------------------------------------------------------------------------
Options granted 275,000 $ 0.28 $ 0.27-$0.29 $ 0.23
Options exercised (16,000) $ 0.13 $ 0.13
Options cancelled (266,740) $ 0.58 $ 0.13-$0.75
-----------------------------------------------------------------------------------------------
At August 31, 2000 740,974 $ 0.30 $ 0.13-$0.40
-----------------------------------------------------------------------------------------------
</TABLE>
_________________
Table 4b
<TABLE>
<CAPTION>
OPTIONS WEIGHTED AVERAGE WEIGHTED OPTIONS WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
OPTION PRICES AT 8/31/00 CONTRACT LIFE EXERCISE PRICE AT 8/31/00 EXERCISE PRICE
<S> <C> <C> <C> <C> <C>
-----------------------------------------------------------------------------------------------------------------------
$0.13-$ 0.31 600,500 4.5 Years $0.28 350,400 $0.29
-----------------------------------------------------------------------------------------------------------------------
$0.38-$ 0.75 140,474 4.6 Years $0.39 90,474 $0.39
-----------------------------------------------------------------------------------------------------------------------
$0.13-$ 0.75 740,974 4.5 Years $0.30 440,874 $0.31
-----------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE> F10
Pursuant to the Company's merger with Sequoia Data Corporation (Sequoia) in
fiscal 1996, the Company adopted a 1996 stock option plan ("1996 Plan") for all
Sequoia employee, officer and director options (Sequoia options) in effect at
the time of the merger to be converted into options for the right to purchase
1,164,651 shares of the Company's common stock. The Sequoia options were
converted to TMS options at a rate of 2.837:1 and a price of 35.24% of the
original Sequoia option price. The conversion factors resulted in Sequoia
option holders receiving TMS common stock options of corresponding value at the
time of the plan of merger. No options under this plan were outstanding at
August 31, 2000.
Pursuant to resolutions by the board of directors, options to purchase the
Company's common stock have been issued to certain directors and key employees
of the Company. Such options are generally exercisable at a price equal to or
greater than the market price of the stock at the date of the grant. See Table
4a for a summary of stock option transactions. Table 4b summarizes information
about stock options outstanding at August 31, 2000.
Employee Stock Purchase Plan
On January 21, 2000, the shareholders approved the TMS, Inc. Employee Stock
Purchase Plan ("ESPP"). The ESPP allows eligible employees the right to
purchase common stock on a quarterly basis at the lower of 85% of the market
price at the beginning or end of each three-month offering period. Employee
contributions to the ESPP were approximately $19,300 for fiscal 2000. Pursuant
to the ESPP, 52,031 shares were issued in fiscal 2000 from common shares held
in treasury by the Company. As of August 31, 2000, 197,969 shares are available
for future issuances under the plan.
Fair Value Disclosures
The Company has adopted the disclosure only provisions of SFAS No. 123.
Accordingly, compensation cost has been recognized using the intrinsic value
method prescribed in APB No. 25, and related Interpretations. Had compensation
cost for the Company's stock option grants and ESPP in fiscal years 2000 and
1999 been based on the fair value method prescribed by SFAS No. 123, net loss
would have been increased by $31,096 and $16,118 in 2000 and 1999,
respectively, with no effect on loss per share. The fair values of each option
grant was estimated using the Black-Scholes option-pricing model with the
following weighted-average assumptions: dividend yield of 0%; expected
volatility of 95.96% and 76.95% in 2000 and 1999, respectively; risk-free
interest rate of 6% and 5.4% for the stock option grants and the ESPP,
respectively; expected lives of approximately 6 to 8 years in 2000 and 3.5 to 6
years in 1999 for the stock option grants; and expected lives for the ESPP of
approximately .25 years in fiscal 2000.
Pro forma net earnings reflects only options granted after September 1,
1995. Therefore, the full impact of calculating compensation cost for stock
options under SFAS No. 123 is not reflected in the pro forma net earnings
amounts presented above because compensation cost is reflected over the
options' vesting period and compensation cost for options granted prior to
September 1, 1995 is not considered.
Note 5: Earnings Per Share
Table 5a is a reconciliation of the numerators and the denominators of the
basic and diluted per-share computations for income available to common
shareholders.
Options to purchase approximately 182,000 and 401,000 shares of common stock
at prices ranging from $.38-$.75 per share were outstanding at August 31, 2000
and 1999, but were not included in the computation of EPS because the options'
exercise price was greater than the average market price of common shares.
Additionally, approximately 114,000 options to purchase common stock at prices
ranging from $.125-$.310 were excluded from the per share computation for
fiscal 2000, because of their anti-dilutive effect. All options expire during
periods through the year 2008.
----------------
Table 5a
<TABLE>
<CAPTION>
FISCAL YEAR 2000 FISCAL YEAR 1999
------------------------------------------------------------------------------------------------
INCOME SHARES PER-SHARE INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS: $(396,558) 13,364,352 $(0.03) $(686,484) 13,570,605 $(0.05)
Effect of Dilutive Securities:
Common stock options -- --
-----------------------------------------------------------------------------------------------------------------------------------
Diluted EPS: $(396,558) 13,364,352 $(0.03) $(686,484) 13,570,605 $(0.05)
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE> F11
Note 6: Reportable Segments
The Company's reportable segments are determined by its products and services
and include: Component Product Technologies ("CPT"), Assessment Product
Technologies ("APT"), Professional Services ("PS") and Document Conversion
("DC") Services. The CPT segment develops the Company's core product
technologies. These products include core image viewing, image enhancement and
forms processing software products (toolkits) that are necessary for developing
new software applications or enhancing existing software applications. In
addition, the CPT segment develops software products (applications) that may
function independently from any other software package or may be closely
associated with other software packages. The toolkits 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 utilizes the product. The applications install
directly on a user's system or on a server in a client/server environment. The
applications are primarily licensed to entities that require the capability to
view and manipulate images through their Internet or intranet web browsers. The
APT segment was created during fiscal 2000 to focus on developing technologies
to improve the overall process of scoring large-scale assessments ("tests") for
grades K-12 in the educational marketplace. The technologies being developed
within this segment leverage the Company's existing core competencies in forms
recognition, image processing, viewing and enhancement. The APT segment created
a Digital Mark Recognition ("DMR") software product prototype designed to
replace the need for hardware based Optical Mark Recognition ("OMR"). The APT
segment also began design and development of a new product called Virtual
Scoring Center ("VSC"). The VSC provides the ability for qualified raters to
score student responses to open-ended test questions in a web-enabled
environment. In fiscal 2000 the Company decided to transition out of its
existing professional service business model. The PS segment offered a variety
of consulting and integration services for business and information management
processes. In general, the professional service projects focused on an entity's
need for document imaging solutions. The Company charged for projects on a time
and materials or fixed fee basis. The DC 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.
Direct costs are charged to the segments and 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. Financial results are measured in
accordance with the manner in which management assesses segment performance and
allocates resources. Except for capitalized software development costs,
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.
Revenue for the PS segment includes a fiscal 1999 fourth quarter adjustment of
approximately $105,000 to reflect cost overruns on two fixed fee contracts that
represented 44% of fiscal 1999 PS revenue. See Table 9a for the results of
operations for each reportable segment for fiscal years ending 2000 and 1999.
All revenue and expenses are from unaffiliated sources.
Table 6b is a reconciliation of segment operating loss to the total company
fiscal 2000 and 1999 net loss.
_______________
Table 6b
2000 1999
---------------------------------------------------------------
Operating loss for
reportable segments (90,969) (245,628)
Unallocated corporate
expenses (350,016) (449,296)
Interest income 60,531 25,971
Interest expense (21,161) (31,793)
Other, net 5,857 17,964
Income tax expense (800) (3,702)
---------------------------------------------------------------
Net loss $(396,558) (686,484)
---------------------------------------------------------------
Note 7: Employee Benefit Plan
The Company sponsors a defined contribution benefit plan for substantially
all employees for the purpose of accumulating funds for retirement.
Participation in the plan is based on one year of service and a minimum of
1,000 hours of annual service. The Company matches 50% of employee
contributions in an amount up to 6% of employees' total compensation. The cost
of employer matching approximated $48,000 and $62,000 in 2000 and 1999,
respectively. Employees vest in employer matching contributions at a rate of
20% per year after two years of service.
<PAGE> F12
________________
Table 6a
<TABLE>
<CAPTION>
COMPONENT ASSESSMENT
PRODUCT PRODUCT PROFESSIONAL DOCUMENT
2000 TECHNOLOGIES TECHNOLOGIES SERVICES CONVERSION TOTALS
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenue to external customers 2,982,195 3,000 360,615 259,439 3,605,249
-----------------------------------------------------------------------------------------------------------------------------
Depreciation and amortization 86,853 11,132 31,937 81,418 211,340
-----------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 649,007 (420,978) (318,092) (906) (90,969)
-----------------------------------------------------------------------------------------------------------------------------
Other significant noncash items:
Amortization of capitalized software
development costs 232,420 -- -- -- 232,420
-----------------------------------------------------------------------------------------------------------------------------
Write-off of capitalized software
development costs 192,681 -- -- -- 192,681
-----------------------------------------------------------------------------------------------------------------------------
Identifiable segment assets:
Capitalized software development costs, net 388,258 -- -- -- 388,258
-----------------------------------------------------------------------------------------------------------------------------
Expenditures for capitalized software
development costs 332,190 -- -- -- 332,190
-----------------------------------------------------------------------------------------------------------------------------
COMPONENT ASSESSMENT
PRODUCT PRODUCT PROFESSIONAL DOCUMENT
1999 TECHNOLOGIES TECNOLOGIES SERVICES CONVERSION TOTALS
-----------------------------------------------------------------------------------------------------------------------------
Revenue to external customers 3,260,443 -- 1,204,403 491,291 4,956,137
-----------------------------------------------------------------------------------------------------------------------------
Depreciation and amortization 100,314 -- 66,744 98,475 265,533
-----------------------------------------------------------------------------------------------------------------------------
Restructuring charge -- -- -- 70,895 70,895
-----------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 382,417 -- (441,757) (186,288) (245,628)
-----------------------------------------------------------------------------------------------------------------------------
Other significant noncash items:
Amortization of capitalized software
development costs 332,744 -- -- -- 332,744
Write-off of capitalized software
development costs 157,251 -- -- -- 157,251
-----------------------------------------------------------------------------------------------------------------------------
Identifiable segment assets:
Capitalized software development costs, net 481,169 -- -- -- 481,169
-----------------------------------------------------------------------------------------------------------------------------
Expenditures for capitalized software
development costs 350,626 -- -- -- 350,626
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE> F13
Note 8: Leases
The Company leases office space and equipment under operating leases. Rent
expense was approximately $51,000 and $77,000 for 2000 and 1999, respectively.
The Company has non-cancelable future minimum lease obligations of $80,864 in
fiscal 2000. In November 1997, the Company entered into two capital lease
agreements for scanning equipment and related software. The leases have a three-
year term and provide for the Company to either relinquish the equipment and
software to the leasing company at the end of the lease or purchase the
equipment and software at fair market value. Assets under capital leases are
included in the Company's balance sheet as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
2000 1999
--------------------------------------------------------------------------------
Computer equipment $ 165,003 $165,003
Less: accumulated amortization (154,043) (102,569)
--------------------------------------------------------------------------------
$ 10,960 $62,434
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
Future minimum payments, by year and in the aggregate, under
capital leases follow:
---------------------------------------------------------------------
2001 14,236
---------------------------------------------------------------------
Less: estimated executory costs
included in capital leases 2,181
---------------------------------------------------------------------
Net minimum lease payments 12,055
under capital leases
---------------------------------------------------------------------
Less: amount representing interest 350
---------------------------------------------------------------------
Present value of net minimum
lease payment under capital lease 11,705
---------------------------------------------------------------------
</TABLE>
During fiscal 2000 and 1999, depreciation expense included $51,474 and
$53,237, respectively for amortization of assets held under capital lease. In
fiscal 1999, the Company entered into an operating sublease for certain
computer equipment and software held under capital lease. The Company received
$29,000 and $19,000 in rental payments under the sublease in fiscal 2000 and
1999, respectively. The initial $100,000 cost of the subleased computer
equipment and software differed from the August 31, 1999, $26,000 carrying
amount due to a $21,000 write-down of the assets to fair value and accumulated
depreciation of $53,000. The $21,000 write-down occurred in conjunction with
the restructuring of the Company's Document Conversion segment and was based on
the present value of discounted future cash flows expected to be received under
the operating sublease. The operating sublease expires the earlier of 30 days
written notice or November 1, 2000.
Note 9: Business and Credit Concentrations
In 2000, one customer accounted for 12% and 38% of the Company's total
revenue and trade accounts receivable, respectively. In 1999, the Tinker Small
Business Innovation Research Grant Services contract accounted for 10% of the
Company's total revenue. Information regarding the Company's operations by
geographic area as of and for the years ended August 31, 2000 and 1999,
follows:
Revenue: 2000 1999
------------------------------------------------------------------
United States $3,053,608 4,317,397
Europe (export sales) 359,684 381,398
Asia (export sales) 89,096 104,330
Australia (export sales) 28,238 50,281
Canada (export sales) 20,606 83,602
Other (export sales) 54,017 19,129
------------------------------------------------------------------
$3,605,249 4,956,137
------------------------------------------------------------------
Accounts receivable (gross): 2000 1999
------------------------------------------------------------------
United States $525,001 922,984
Europe 52,951 20,807
Asia (2,273) 872
Australia 17,308 18,223
Canada 6,250
------------------------------------------------------------------
$592,987 969,136
Note 10: Restructuring
In October of fiscal 1999, the Company restructured DC operations to support
only customer relationships that primarily relate to electronic publishing
activities and for which there are contractual obligations. The restructuring
charge of $70,895 incurred in fiscal 1999 included approximately $53,000 of
equipment write-downs, $15,000 of employee severance costs, and $3,000 for
closing down the leased DC facility. At August 31, 2000 and 1999, there were no
outstanding liabilities associated with the restructuring of DC.
<PAGE> F14
_______________
Schedule II
Valuation and Qualifying Accounts
TMS, Inc. (dba TMSSequoia)
<TABLE>
BALANCE AT ADDITIONS CHARGED TO DEDUCTIONS-- BALANCE AT
BEGINNING COSTS & RECOVERY/WRITE-OFF END
Classification OF PERIOD EXPENSES OF ACCOUNTS OF PERIOD
<S> <C> <C> <C> <C>
--------------------------------------------------------------------------------------------------------------------------------
Year ended August 31, 2000:
Allowance for doubtful accounts $ 395,069 66,178 407,215 $ 54,032
Year ended August 31, 1999:
Allowance for doubtful accounts $ 190,000 267,131 62,062 $ 395,069
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE> F15
