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d:\sec\10Q3Q97.doc 6:33 PM 8/4/98
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT of 1934.
For the quarterly period ended June 30,1998
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from ______, 19__, to_____, 19__.
Commission File Number: 0-22991
CUSIP NUMBER 64121L 10 3
NETWORK SYSTEMS INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Charter)
Nevada 87-0460247
(State or Other Jurisdiction of (I.R.S. Employer Identification
Incorporation or Organization) Number)
200 North Elm Street, Greensboro, North Carolina 27401
(Address of Principal Executive Offices,Including Zip Code)
(336) 271-8400
(Registrant's Telephone Number, Including Area Code)
AQUA AUSTRALIS, INC.
1901 East University, Suite 200, Mesa, AZ 85023
(Former Name, Former Address and Former Fiscal Year, if Changed)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the Registrant was required to
file such reports), and has been subject to such filing
requirements for the past 90 days.
X YES ___ NO
There were 7,577,179 shares of the Registrant's $.001 par value
common stock and 7,042 shares of Registrants $.001 par value
preferred stock outstanding as of June 30, 1998.
Transitional Small Business Format (check one) Yes __ No X
NETWORK SYSTEMS INTERNATIONAL, INC.
Contents
Part I - Financial Information Page
Item 1. Financial Statements
Consolidated Balance Sheet 3
Consolidated Statements of Income
Three and Nine months ended June 30, 1998 and 1997 4
Consolidated Statements of Cash Flow
Nine months ended June 30, 1998 and 1997 5
Consolidated Statement of Changes in Stockholders'
Equity 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 16
Part II
Item 5. Other matters 19
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 19
Exhibit Index 20
<TABLE>
PART I. FINANCIAL STATEMENTS
Network Systems International, Inc. and Subsidiaries
Consolidated Balance Sheet
June 30, 1998
<CAPTION>
(Unaudited)
<S> <C>
Assets
Current Assets:
Cash $1,422,394
Accounts receivable, trade, net of 4,087,281
allowance of $725,000
Note receivable, current portion 30,000
Accounts receivable, related parties 107,873
Other current assets 24,184
Total current assets 5,671,732
Property and equipment, net of accumulated 1,221,734
depreciation
Other Assets
Note receivable, net of current portion 118,420
Software development costs, net of 1,387,092
accumulated amortization
Other 103,769
1,609,281
$8,502,747
Liabilities and Stockholders' Equity
Current
Liabilities:
Note payable, current portion 31,000
Capital lease obligation, current portion 79,000
Accounts payable, trade 1,495,357
Other accrued liabilities 88,350
Income taxes payable 318,476
Deferred revenue 302,962
Total current liabilities $2,315,145
Long Term
Liabilities:
Deferred income taxes 375,000
Note payable, net of current maturities 331,485
Capital lease obligation, net of current 105,910
maturities
Total long term liabilities 812,395
Stockholders'Equity
Preferred Stock; $.001 par value;authorized 12,500 shares;
issued and outstanding 7,042 shares 7
Common Stock; $.001 par value; authorized 100,000,000
shares; issued and outstanding 7,577,179 shares 7,577
Capital in excess of par value 3,124,246
Retained Earnings 2,243,377
Total stockholders'equity 5,375,207
$8,502,747
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<TABLE>
Network Systems International, Inc. and Subsidiaries
Consolidated Statements of Income (Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
June 30 June 30
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Revenue:
Licensing and $1,718,295 $1,400,567 $5,559,667 $3,773,225
servicing revenue
Equipment revenue 1,703,906 1,572,619 4,288,249 2,537,575
Total revenue 3,422,201 2,973,186 9,847,916 6,310,800
Operating expenses:
Cost of sales and
services 1,897,514 1,659,309 5,034,722 3,212,494
Research and
development 118,211 49,375 333,786 210,611
General and
administrative 615,589 318,971 1,873,410 991,510
2,631,314 2,027,655 7,241,918 4,414,615
Operating income 790,887 945,531 2,605,998 1,896,185
Other income
(expenses):
Interest, net 17,309 (11,633) 31,037 (52,344)
Other, net 1,618 6,872 16,624 9,894
18,927 (4,761) 47,661 (42,450)
Income before income
tax provision 809,814 940,770 2,653,659 1,853,735
Income tax provision 263,100 297,000 918,600 601,000
Net income 546,714 643,770 1,735,059 1,252,735
Earnings per
common share .07 .08 .22 .17
Earnings per common
share -
assuming dilution .07 .08 .22 .17
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<TABLE>
NETWORK SYSTEMS INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited)
<CAPTION>
Nine Months Ended June 30
1998 1997
<S> <C> <C>
Operating activities
Net income $1,735,059 $1,252,735
Adjustments to reconcile net
income to net cash
provided by operating activities:
Depreciation and amortization 1,231,349 978,500
Promotional fees paid with
stock 72,000 -
Provision for bad debts 273,014 159,593
Change in operating assets and
liabilities:
Accounts receivable and (2,694,204) (1,514,826)
unbilled receivables
Prepaid assets, other
receivables, and other
assets 264,280 (20,591)
Accounts payable and accrued
liabilities 1,462,686 313,860
Income tax payable 318,476 212,901
Unearned revenue 41,977 73,366
Deferred income taxes (226,300) 75,990
Net billings over (under)
costs uncompleted contracts - (462,843)
Total adjustments 743,278 (184,050)
Net cash provided by operating
activities 2,478,337 1,068,685
Investing activities
Acquisition of property and
equipment (354,957) (143,367)
Software development (897,550) (1,190,532)
Issuance of Note Receivable (200,000) -
Payment received on Note
Receivable 220,432 -
Increase in cash surrender value
of life insurance (34,473) (30,281)
Net cash (used in) investing
activities (1,266,548) (1,364,180)
Financing activities
Payment on notes payable, long-
term debt and capital leases (76,137) (93,289)
Net proceeds from issuance of - 856,689
preferred stock
Dividends paid (73,289) (33,053)
Net borrowings (payments) on line
of credit (131,382) 33,498
Net cash (used in) provided by
financing activities (280,808) 763,845
Net increase in cash 930,981 468,350
Cash at October 1 491,413 77,487
Cash at June 30 $1,422,394 $ 545,837
Supplemental disclosures of cash flow
information and noncash investing and
financing activities
Cash paid during the period for:
Interest $ 33,740 $ 52,344
Taxes $ 600,124 $ 308,700
</TABLE>
During the first quarter of 1998, the Company issued 56,250
shares of its common stock recorded at $132,000 as payment for
promotional expenditures of which $72,000 was recorded during the
first quarter of 1998 and $60,000 during fiscal 1997.
During the period ended June 30, 1998, 5,267 shares of
preferred stock were converted into 263,375 shares of common
stock.
The accompanying notes are an integral part of the financial
statements.
<TABLE>
Network Systems International, Inc. and Subsidiaries
Consolidated Statement of Changes in Stockholders' Equity
Nine months ended June 30, 1998 (Unaudited)
<CAPTION>
Common Stock Preferred
Stock
Capital
$0.001 $0.001 in
Number Par Number Par Excess Retained
of Value of Value of Par Earnings Total
Shares Shares Value
<S> <C> <C> <C> <C> <C> <C> <C>
Balance
September 30,
1997 7,257,554 $7,258 12,309 $12 $2,992,560 $581,607 $3,581,437
Issuance of
common stock 56,250 56 131,944 132,000
Conversion of
preferred 263,375 263 (5,267) (5) (258)
stock
Net income for
the nine month
period ended
June 30,1998 1,735,059 1,735,059
Dividends on
preferred
stock _________ __ ___ _____ ___ __________ (73,289) (73,289)
Balance June
30, 1998 7,577,179 $7,577 7,042 $ 7 $3,124,246 $2,243,377 $5,375,207
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
Network Systems International, Inc.
and Subsidiaries
Notes to Consolidated Financial Statements
For the Nine Months Ended June 30, 1998 and June 30, 1997
(Unaudited)
1. Background Information
Network Systems International, Inc. (the Company), was
incorporated on September 21, 1988 in the State of Nevada.
On April 22, 1996, the Company completed a merger whereby two of
its wholly owned subsidiary corporations merged with two North
Carolina corporations, with the North Carolina corporations being
the surviving corporations in the merger. Immediately
thereafter, the Company, with the approval of its shareholders,
caused its corporate charter to be amended to change its name to
Network Systems International, Inc. The newly named company is
now the parent company of two wholly owned subsidiary
corporations: Network Information Services, Inc. (NIS) and
Network Investment Group, Inc. (NIG), both North Carolina
corporations.
As a result of the merger, accounted for as a reverse acquisition
which is similar to the purchase method of accounting,
shareholders of NIS and NIG caused the transfer of all of their
shares of common stock in the companies, which had a total assets
value of approximately $3,800,000, to the Company in exchange for
6,562,720 shares of common stock of the Company.
NIS was incorporated under the laws of the State of North
Carolina on September 9, 1985 and develops, licenses, and
supports software products primarily for the textile, sewn
products and process manufacturing industries. Operations are
concentrated in North and South Carolina, however, NIS has
clients throughout the east coast of the United States. It
employs approximately 56 full-time associates. NIS is
headquartered in Greensboro, North Carolina and has satellite
offices in Greenville, S.C., Wilmington, N.C., Matthew's, N.C.
and Florence, S.C.
NIG was incorporated under the laws of the State of North
Carolina on April 7, 1993 and sells computer hardware to
manufacturing industries. Operations are concentrated in North
Carolina and South Carolina, however, it has clients throughout
the east coast of the United States. The corporate headquarters
of NIG are located in Greensboro, North Carolina and operates in
cooperation with its supply partners, IBM Corporation, REAL
Applications, Ltd., TEKLOGIX and PERLE Systems.
The Company changed their year end from December 31 to September
30 in mid 1996.
In November of 1996, the Company set aside 625,000 shares of its
unissued common stock to be awarded to key associates of the
Company at a later date.
In December 1996 the Company entered into an agreement with an
underwriter to promote the sale of 15,625 shares of preferred
stock in a private placement stock offering. The Company sold
12,309 shares of Series A preferred stock at a purchase price of
$100 per share. Each share of preferred stock receives an annual
cumulative dividend of $12, payable monthly, and is convertible
into 50 shares of common stock at the holders discretion or upon
call by the Company. Upon liquidation of the Company, the
holders of this preferred stock are entitled to receive $100 per
share, plus an amount equal to all dividends accrued and unpaid
to the date of final distribution. The preferred stock is
redeemable for cash at the option of the company at any time
after January 12, 1998 based on a sliding payment scale over
time. Holders of the preferred stock have no voting privileges.
The Company raised $856,689 in connection with this private
placement offering which is net of offering expenses of $128,011.
On July 16, 1997, the Company entered into a six-month agreement
with a director of the Company to promote its stock. In exchange
for the promoters efforts, the Company agreed to issue common
stock for services rendered if the common stock achieved certain
minimum bid price levels. Through June 30, 1998, the promoter
had earned 56,250 shares of common stock under the terms of the
agreement. An additional 37,500 shares of the Company's common
stock became due to the promoter upon acceptance of the Company's
application for listing on NASDAQ as indicated below.
On January 12, 1998 the Board of Directors authorized a five for
four split on the outstanding common and preferred stock of the
Company for stockholders of record as of January 16, 1998. All
references in the accompanying financial statements to the number
of shares have been restated to reflect this transaction.
On July 10, 1998 the Company was officially approved for listing
on NASDAQ and the Company's common stock began trading on NASDAQ
Small Cap under the symbol NESI on that date.
2. Summaries of Significant Accounting Policies
Basis of Preparation:
The financial statements consolidate the Accounts of Network
Systems International, Inc. and its wholly owned subsidiaries
Network Information Services, Inc. and Network Investment Group,
Inc.
In the opinion of management, all adjustments, consisting only of
normal recurring adjustments necessary for a fair statement of
(a) the results of operations for the three and nine month
periods ended June 30, 1998 and 1997, (b) the financial position
at June 30, 1998, and (c) cash flows for the nine month periods
ended June 30, 1998 and 1997, have been made.
The preparation of financial statements in conformity with
generally accepted accounting principles 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 consolidated financial statements
and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those
estimates.
Financial Instruments:
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist primarily of trade
receivables. The Company performs on-going credit evaluations of
its customers' financial condition.
Cash deposits with two institutions are in excess of The Federal
Deposit Insurance Corporations average limit of $100,000.
Property and Equipment:
Property and equipment are recorded at cost. Depreciation is
computed using both straight-line and accelerated methods for
financial reporting and income tax purposes. Assets are
depreciated for financial reporting purposes based on estimated
useful lives as follows:
Building 39
Leasehold improvements 7-39
Furniture and fixtures 7
Office equipment 5-7
Computer equipment 5-7
Computer software 3-5
Computer software & equipment
under capital lease 3-5
Software Development Cost:
The Company capitalizes internally generated software development
costs in compliance with Statement of Financial Accounting
Standards No. 86, "Accounting for the Costs of Computer Software
to be Sold, Leased, or Otherwise Marketed". The Company
capitalizes the direct costs and allocated overhead associated
with the development of software products. Initial costs are
charged to operations as research and development prior to the
development of a detailed program design or a working model.
Capitalization of computer software development costs begins upon
the establishment of technical feasibility for the product.
Costs incurred subsequent to the product release are charged to
operations. Capitalized software development costs amounted to
$897,550 and $1,190,532 for the nine-month period ended June 30,
1998 and 1997, respectively. The Company capitalized software
development costs of $335,500 and $428,218 for the three-month
periods ended June 30, 1998 and 1997, respectively.
Amortization of capitalized computer software development costs
begins when the products are available for general release to
customers, and is computed on a product-by-product basis as the
greater of a) the ratio of current gross revenues for a product
to the total of current and anticipated future gross revenues for
the product or b) the straight-line method over the remaining
estimated economic life of the product. The Company has
estimated that the useful economic life of its products is two
years. Amortization expense of capitalized software cost
amounted to $1,102,251 and $843,348 for the nine month period
ended June 30, 1998 and 1997, respectively, and is included in
cost of sales. Amortization expense for the three-month periods
ended June 30, 1998 and 1997 totaled $367,532 and $326,434,
respectfully.
Software development costs at June 30, 1998 consist of the
following:
Software Development Costs 3,598,371
Less Accumulated
Amortization (2,211,279)
1,387,092
Revenue:
The Company generates several types of revenue which are
accounted for as follows:
Revenue from the sale of software licenses is recognized after
shipment and fulfillment of all major obligations under the terms
of the licensing agreements. The licensing agreements are
typically for the use of company products and are usually
restricted by the number of copies, the number of users and the
term.
Revenue from "time and materials" contracts is recognized when
the services are performed. Services performed that have been
authorized but may not be currently billable are classified as
unbilled account receivables.
Revenues from fixed price contracts are recognized using the
percentage-of-completion method, measured by direct hours.
Contract costs include direct labor combined with allocations of
operational overhead and other direct costs. Provisions for
estimated losses on uncompleted contracts are made in the period
in which such losses are determined. Changes in job performance,
job conditions and estimated profitability which may result in
revisions to costs and revenue are recognized in the period in
which the revenues are determined.
Support agreements generally call for the Company to provide
technical support and certain software updates to customers.
Revenue on support and software update rights is recognized
ratably over the term of the support agreement.
The Company provides consulting and educational services to its
customers. Revenue from such services is generally recognized as
the services are performed.
Hardware revenue is recognized when the product is shipped to the
customer.
In October, 1997, the American Institute of Certified Public
Accountants issued Statement of Position Number 97-2 "Software
Revenue Recognition". This statement provides recognition and
measurement guidance in accounting for revenue from selling,
leasing or licensing of software and is effective for
transactions entered into in fiscal years beginning after
December 15, 1997. The Company has elected to adopt this
statement. The adoption of this statement does not have a
material effect on the Company's financial statements.
Advertising Costs:
Advertising costs, except for costs associated with direct
response advertising, are charged to operations when incurred.
The costs of direct response advertising are capitalized and
amortized over the period during which future benefits are
expected to be received. Advertising expense amounted to $35,669
and $72,694 for the nine-month periods ended June 30, 1998 and
June 30, 1997, respectively. Advertising expense for the three-
month periods ended June 30, 1998 and 1997 totaled $14,418 and
$22,010, respectively. No material amounts were capitalized
during the nine-month period ended June 30, 1998. Advertising
costs of $25,673 were capitalized during the nine-month period
ended June 30, 1997.
Income Tax:
Prior to the merger on April 22, 1996, the principal operating
subsidiary of the Company (NIS) was treated as an S corporation
for tax purposes. As such, income and deductions attributable to
NIS were reported by its shareholders, and no tax expense or
liability was recorded by the Company up until such date.
Activities of the Company and its other subsidiary prior to that
date did not give rise to a material liability for income taxes.
Beginning in April, 1996, income taxes are provided for
transactions reported in the financial statements.
Deferred income taxes are provided for when transactions are
reflected in income for financial reporting purposes in a year
other than the year of their inclusion in taxable income.
Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or
settled. 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.
Earnings Per Share:
The consolidated financial statements are presented in accordance
with Statement of Financial Accounting Standards No. 128 (SFAS
128), "Earnings Per Share". Basic earnings per share is
computed using the weighted average number of common shares
outstanding during the period. Diluted earnings per share
reflect the potential dilution from the exercise or conversion of
securities into common stock. All earnings per share amounts for
all periods presented have been restated to give effect to the
application of SFAS 128.
3. Accounts Receivable, Related Parties.
Accounts Receivable from related parties at June 30, 1998,
consist of amounts due from three (3) shareholders of the Company
that bear interest at five percent, are due on demand, and
collateralized by their common stock in the Company.
4. Note Receivable
Note receivable at June 30, 1998 consists of the following:
Note receivable, 60 monthly principle and
interest payments of $3,563 until
September 1, 2002, remaining balance due
at that time, secured by work in progress,
inventory, accounts receivable and
personal property $148,420
Less current maturities 30,000
$118,420
5. Property and Equipment
Property and equipment at June 30, 1998 consists
of the following:
Land 150,000
Building 569,000
Leasehold improvements 100,043
Furniture and fixtures 124,006
Office equipment 114,771
Computer equipment and software 466,204
Computer equipment and software under
capital lease 324,931
1,848,955
Less accumulated depreciation (441,349)
Less accumulated amortization on computer
equipment and software under capital lease (185,872)
$1,221,734
6. Note Payable
Note payable at June 30, 1998 consists of the following:
Mortgage note payable:
Monthly principal payments of $2,612 plus
interest at the prime rate plus 0.25%
through February 2000 with the remaining
balance due March 2000; collateralized by
building; personally guaranteed by certain
stockholders $362,485
Less current maturities 31,000
$331,485
Aggregate maturities of note payable as of June 30, 1998 were
as follows: 1999 - $31,000; 2000 - $331,485.
The Company has available a $300,000 bank line of credit to
provide additional short-term working capital. This line of
credit is at prime plus .5% and is collateralized by accounts
receivable and equipment. Additionally, the line is personally
guaranteed by certain stockholders. At June 30, 1998, there were
no amounts outstanding.
7. Obligations Under Capital Leases
The Company has capitalized rental obligations under three leases
of software and equipment. The obligations, which mature in
fiscal 2000 and 2001, represent the total present value of future
rental payments discounted at the interest rates implicit in the
leases. Future minimum lease payments under the capital leases
are:
Period Ending June 30
1999 $ 90,532
2000 82,839
2001 21,900
2002 7,300
Total minimum lease payments 202,571
Less amount representing interest 17,661
Present value of net minimum lease
payments 184,910
Less current portion 79,000
$105,910
8. Retirement Benefit Plan
Effective January 1, 1993, the Company established a retirement
plan which allows participants to make contributions by salary
reduction under Section 401(k) of the Internal Revenue Code. The
Company made matching contributions to the plan of $14,009 and
$5,713 for the nine months ended June 30, 1998 and 1997,
respectively. The Company made matching contributions to the
Plan of $5,577 and $4,297 for the three months ended June 30,
1998 and 1997.
9. Income Taxes
As a result of the reverse acquisition on April 22, 1996, the
Subchapter S status of one of the Company's subsidiaries was
terminated. After that date, the financial statements of the
Company provide for the income tax effect of earnings reported in
the financial statements, including taxes currently due and taxes
deferred because of different accounting methods used for
financial and income tax reporting. Prior to the change in tax
status, earnings and losses were included in the personal tax
returns of the stockholders and taxed depending on their personal
tax situations and the Company did not record an income tax
provision. The change in tax status necessitated the recognition
of the cumulative deferred income existing as of the date of the
termination of the S status which resulted in a one-time charge
to deferred tax expense of $435,200.
Net income from operations before income taxes totaled $2,653,659
and $1,853,735 for the nine months ended June 30, 1998 and 1997,
respectively. The provision for income taxes for the nine months
ended June 30, 1998 and 1997 consists of the following
components:
1998 1997
Current tax expense $1,240,600 $642,300
Deferred tax expense (226,300) 76,000
Credit for research and
development activities (95,700) (117,300)
$ 918,600 $601,000
The significant temporary differences which gave rise to deferred
tax assets and liabilities as of June 30, 1998 and 1997 are as
follows:
1998 1997
Deferred tax asset
Bad debts $725,000 $229,700
Deferred tax liabilities
Software development cost 1,387,100 1,443,000
Book basis of property &
equipment in excess
of tax basis 105,800 70,900
Change in tax status 227,400 409,300
$1,720,300 $1,923,200
As of June 30, 1998, the Company has federal loss carryforwards
totaling $77,700 that may be offset against future federal
taxable income. If not used, the carryforward will expire as
follows:
Operating
losses
2003 $ 20,600
2009 49,300
2010 7,800
2011 -
2012 -
$ 77,700
No valuation allowance has been recorded against the deferred tax
assets or operating loss or tax credit carryforwards because
recognition of the cumulative deferred income arising from the
change in tax status should be sufficient to offset the remaining
tax assets.
The difference between the provision for income taxes and the
amounts obtained by applying the statutory U.S. Federal income
tax rate to income before taxes for the nine months ended June
30, 1998 and 1997 are as follows:
1998 1997
Tax expense at U.S.
statutory rates $902,200 34.0% $629,100 34.0%
State and local income
tax 65,100 2.5% 43,000 2.3%
Non-deductible expense
and other 22,600 .9% - -
Credit for increasing
research activities (71,300) (2.7%) (71,100) (3.8%)
$918,600 34.7% $601,000 32.5%
10. Earnings Per Share
<TABLE>
The following data shows the amounts used in computing earnings
per share and the effect on income and the weighted average
number of shares of dilutive potential common stock.
<CAPTION>
Three Months Ended Nine Months Ended
June 30 June 30
1998 1997 1997 1996
<S> <C> <C> <C> <C>
Net income 546,714 643,770 1,735,059 1,252,735
Less preferred stock
dividends (18,388) (28,146) (73,289) (42,925)
Income available to
common stockholders
used in basic EPS 528,326 615,624 1,661,770 1,209,810
Preferred stock
dividends 18,388 28,146 73,289 42,925
Income available to
common stockholders
after assumed
conversion of dilutive
securities 546,714 643,770 1,735,059 1,252,735
Weighted average number
of common shares used
in basic EPS 7,545,553 7,257,720 7,398,110 7,257,720
Effect of dilutive
convertible preferred
stock 383,701 585,600 515,485 299,250
Weighted average number
of common shares and
dilutive potential
common stock used in
diluted EPS 7,929,254 7,843,320 7,913,595 7,556,970
</TABLE>
11. Major Customer
For the three-month period ended June 30, 1998, sales to two
customers amounted to approximately $1,907,000. For the three-
month period ended June 30, 1997, sales to two customers amounted
to approximately $1,435,700. For the nine-month period ended
June 30, 1998, sales to two customers amounted to approximately
$4,041,000. For the nine-month period ended June 30, 1997, sales
to three customers amounted to approximately $2,749,600.
At June 30, 1998 and 1997 accounts receivable balance included
$2,109,000 and $783,000 due from two and one customers,
respectfully.
12. Lease Commitments
The following is a schedule by year of future minimum rental
payments required under operating leases that have an initial or
remaining noncancelable lease term in excess of one year as of
March 31, 1998:
1999 55,541
2000 21,134
2001 3,667
2002 3,056
2003 -
Rent expense amounted to $16,805 and $15,731 for the three months
ended June 30, 1998 and 1997, respectively. Rent expense
amounted to $56,420 and $37,512 for the nine months ended June
30, 1998 and 1997, respectively.
13. Commitments
The Company entered into 20-year employment agreements with five
of its officers calling for annual salaries totaling no less than
$195,000.
14. Segment Information
In June 1997, the Financial Accounting Standards Board issued
FASB #131 "Disclosures about Segments of an Enterprise and
Related Information". This statement establishes standards for
the way that public companies report information about operating
segments in annual financial statements and is required for
periods beginning after December 15, 1997; however earlier
application is encouraged. The Company has elected to adopt this
statement.
The Company's operations are classified into two principal
industry segments: Hardware sales and sales of Software Licenses
and related service fees.
The accounting policies of the segments are the same as those
described in the summary of significant accounting policies
except that general and administrative expenses are recognized
and measured on the ratio of salaries of the segment to total
salaries.
All intercompany transactions are eliminated for financial
reporting purposes.
The Company's reportable segments are strategic business units
that offer different product of services. They are managed
separately because each business requires different technology
and marketing strategies.
<TABLE>
The following is a summary of segment information for the quarter
ended June 30:
<CAPTION>
1998 1997
Software Corporate Software Corporate
And Hardware And Hardware
Service Total Service Total
Fees Fees
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues from
external customers
$1,718,295 $1,703,906 - $3,422,201 $1,400,567 $1,572,619 - $2,973,186
Interest
revenue 6,228 - 18,121 24,349 1,514 - 5,358 6,872
Interest
expense 7,040 - - 7,040 11,633 - - 11,633
Depreciation
and 412,337 - 456 412,793 370,473 489 - 370,962
amortization
Segment
profit 740,601 111,643 (61,357) 790,887 721,798 286,363 (62,630) 945,531
Expenditures
for
segment 42,565 - - 42,565 50,100 - - 50,100
assets
</TABLE>
<TABLE>
The following is a summary of segment information for the nine
months ended June 30:
<CAPTION>
1998 1997
Software Corporate Software Corporate
And Hardware Total And Hardware Total
Service Servic
Fees Fees
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue from
external customers
$5,559,667 $4,288,249 - $9,847,916 $3,773,225 $2,537,575 - $6,310,800
Interest
revenue 15,657 - 49,120 64,777 2,545 - 7,349 9,894
Interest
expense 33,740 - - 33,740 52,344 - - 52,344
Depreciation
and 1,229,982 - 1,422 1,231,404 977,034 1,466 - 978,500
amortization
Segment profit
2,556,874 270,140 (221,016) 2,605,998 1,785,509 325,699 (215,023) 1,896,185
Expenditures
for
segment 85,957 - 269,000 354,957 143,367 - - 143,367
assets
</TABLE>
<TABLE>
The following is a summary of identifiable assets for each
segment as of June 30,:
<CAPTION>
1998 1997
Software Software
And Hardware And Hardware
Service Corporare Service Corporate
Fees Total Fees Total
<C> <C> <C> <C> <C> <C> <C> <C>
4,734,777 2,104,946 1,663,024 8,502,747 4,651,729 568,231 568,231 5,878,646
</TABLE>
_________________________________________________________________
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
_________________________________________________________________
This MD&A contains some forward looking information. Except for
historical data, the matters discussed in this form 10-QSB
contain forward-looking statements that involve risk and
uncertainties.
Network would caution readers that in addition to the important
factors described elsewhere in the Form 10-QSB, the following
important factors, among others, sometimes have affected, and in
the future could affect, the Company's actual results and could
cause the Company's actual consolidated results during 1998, and
beyond, to differ materially from those expressed in any forward
statements made by, or on behalf of Network.
Results of Operations
Revenue. Total revenue for the three-month period ended June 30,
1998 was $3,422,201. This revenue represents a 15% increase over
the Company's revenues for the three-month comparable period in
1997. For the nine-month period ended June 30, 1998, revenues
were $9,847,916 as compared to $6,310,800 for the same nine-month
period in fiscal 1997, a 56% increase. The increase in revenue
is attributable to the Company's increase in customer base during
the first quarter; its resultant increase in service related
income and an upgrading of independent software products to the
Company's integrated net collection package.
In the area of licensing and servicing revenues, the Company
experienced an increase of approximately 23% to $1,718,295 at the
June 30, 1998 quarter end as compared to $1,400,567 in the same
period ending 1997. During the nine-month period, licensing and
servicing revenues increased 47% from $3,773,225 in fiscal 1997
to $5,559,667 during the same period in fiscal 1998. This
increase in the licensing and servicing sectors of the Company's
business is a result of the factors indicated above.
Hardware sales for the three-month period ended June 30, 1998 was
$1,703,906 as compared to $1,572,619 or an 8% increase over the
same period in 1997. For the nine-month period ended June 30,
1998, the Company experienced a 69% increase in hardware sales
over the comparable period in 1997 from $2,537,575 to $4,288,249.
This increase in hardware sales is directly attributable to
customer upgrades and additional equipment purchases in response
to Year 2000 issues.
Licensing and service revenues represented 50.2% of total
revenues for the quarter ended and 56.5% for the first nine
months of the fiscal year. Hardware sales were 49.8% of total
revenues for the quarter and 43.5% for the first nine months of
fiscal 1998.
Cost of Sales and Services. Cost of sales and services amounted
to $1,897,514 and 55% of total revenue during the third quarter
of fiscal 1998 as compared to $1,659,309 and 55% of total revenue
for the comparable period in fiscal 1997. Cost of sales and
services for the first nine months of the year amounted to
$5,034,722 and 51% of total revenue as compared to $3,212,494 and
51% of total revenue for the comparable 1997 period. The
increases in cost of sales and services are primarily
attributable to the increases in hardware sales for the periods.
On a percentage basis to total revenue, the 1998 cost of sales
and services remained consistent with that of 1997, hardware
sales, however carry a higher percentage of costs than do
licensing and service fees.
Software Development Costs. Software development costs
capitalized amounted to approximately $336,000 and $428,000 for
the quarters ended June 30, 1998 and 1997, respectively.
Approximately $898,000 and $1,191,000 were capitalized for the
nine months ended June 30, 1998 and 1997 respectively. Less
software development costs were capitalized in the comparable
periods 1998 versus 1997 due to the Company's strategic decision
to address its third generation product as add-on modules rather
than continued development as a stand-alone product. Research
and development costs increased approximately $118,000 from
$49,000 in the current quarter versus the prior year quarter and
to approximately $334,000 for the nine month period ended June
30, 1998 from $211,000 for the nine months ended June 30, 1997.
It is anticipated that the Company will experience an increase in
software development costs both capitalized and expensed, as its
efforts to accommodate specific customer needs escalates.
Additionally, the Company intends to continue recruiting and
hiring additional software programmers and to consider additional
complementary software technologies. Whether or not the Company
will successfully achieve these goals cannot be assured since
competition to hire programmers appears to be at an all time high
and new technologies are uncertain.
General and Administrative. General and administrative expenses
were 18% of revenue in the third quarter of fiscal 1998 as
compared to 11% in the comparable period 1997. For the nine
months ended June 30, 1998 general and administrative expenses
were 19% of revenue and 16% in the comparable period in the prior
year. The percentage increases are directly attributable to
increases in Company personnel as well as utilizing the
additional personnel in the administrative sector as opposed to
development of the Company's software.
Provisions for Income Taxes. The income tax provision for the
nine months ended June 30, 1998 and June 30, 1997 was $918,600
and $601,000, respectively. This represents 34.7% and 32.5% of
income before taxes.
Quarterly Results. Net income for the three and nine-month
periods ended June 30, 1998 were $546,714 and $1,735,059
respectively. Net income for the comparable period ended June
30, 1997 amounted to $643,770 and $1,252,735, respectively. The
decrease in net income for the comparable three months is
attributable to utilization of Company personnel in the administrative
sector as opposed to utilization of such personnel primarily in
the Company's development area. Also, amortization of software
development costs exceeded amounts capitalized for the three
month period ended June 30, 1998 contrary to June 30, 1997.
Additionally, the increase in net income for the nine-month
period ended June 30, 1998 versus the comparable prior period is
partly attributable to the increase in sales of hardware.
On a per share basis, earnings were $.07 and $.22 for the three
and nine months ended June 30, 1998. These per share amounts are
down from the net income per common share amounts of $.08 for the
three month period ended June 30, 1997 and up from $.17 for the
nine month period ended June 30, 1997 for the reasons explained
above.
The Company believes that in the future its results may reflect
quarterly fluctuations resulting from such factors as order
deferrals in anticipation of new product releases, delays in the
release of new products, a slower growth rate in the overall
manufacturing industry or adverse general economic and
manufacturing conditions in the industries in which the Company
does business. Rapid technological change and the Company's
ability to develop and market products that
successfully adapt to that change may also have an impact on the
results of operations. Further, increased competition in the
design and distribution of manufacturing software products could
also negatively impact the Company's results of operations.
Due to the factors stated above, the Company's future earnings
and stock price may be subject to significant volatility,
particularly on a quarterly basis. Any shortfall in revenues or
earnings from levels expected by securities analysts could have
an immediate and significant adverse effect on the trading price
of the Company's stock.
Liquidity and Capital Resources. Cash totaled $1,422,394 on June
30, 1998. Cash provided by operating activities amounted to
approximately $2,478,337 for the nine months ended June 30, 1998
compared to $1,068,685 in the comparable period of 1997. This
increase in cash provided by operations is principally due to
increases in the Company's operating liabilities and increased
profits, generally.
Long term cash requirements, other than normal operating
expenses, are anticipated for development of new software
products and enhancements of existing products; financing
anticipated growth; adding additional personnel; and the possible
acquisition of software products or technologies complimentary to
the Company's business. The Company believes that its existing
cash, cash equivalents, available lines of credit and anticipated
cash generated from continuing operations will be sufficient to
satisfy its currently anticipated cash requirements for the 1998
fiscal year.
Historically, accounts receivable for the Company has been
generally high due to a number of factors. A primary contributor
is the nature of how the Company's customer base pays for the
software licensing fee of the Company's product. The Company
records revenues from software
license fees after shipment of the product and the fulfillment of
all major obligations under the terms of the licensing agreement.
Therefore, the Company often establishes a payment schedule for
its customers. The payment schedules have resulted in a slow
turnaround time in the collection of receivables. Additionally,
the textile industry as a whole tends to experience flat periods
which make it difficult to fully fund major management
information systems projects.
For the nine month period ended June 30, 1998, the average
collection days on accounts receivables was 95.1 days compared to
77.2 days for the comparable period in fiscal year 1997. This
increase in collection days is attributable to a major version
release of the Company's software towards the latter part of the
quarter. The Company has a continued focus on collecting
accounts and scheduling customer payments on a more time
sensitive basis.
As a result of the above, the Company monitors its accounts
receivable closely and attempts to make adequate provisions for
potentially uncollectable receivables.
Year 2000 Compliance. In 1993 the Company developed the
trademark software net collection1TM. All databases, user
screens, application programs, and date sensitive algorithms were
re-engineered to include the century within all date fields. All
new products introduced by the Company are developed to include
the century format. In addition, the Company has upgraded most
3rd party software used during the day to day operations of the
Company and believes that this software meets the year 2000
requirements.
Part II
_________________________________________________________________
Item 5. Other Matters
(1) The Company received approval for listing on NASDAQ Small
Cap effective July 10, 1998.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits included herewith are:
(27) Financial Data Schedule
(b) Reports on Form 8-K
1. Form 8-K filed with the Securities and Exchange Commission
June 1, 1998 announcing the forty-five day extension of its
letter of intent with Innovative Control Concepts, Inc. This
Form 8-K is incorporated by reference.
2. Form 8-K filed with the Securities and Exchange Commission
July 23, 1998 announcing that the Company had received NASDAQ
Small Cap approval effective July 10, 1998 and termination of
merger negotiations with Innovative Control Concepts, Inc. This
Form 8-K is incorporated by reference.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange
Act of 1934, the registrant has caused this report to be signed
on its behalf by the undersigned, thereto duly authorized.
NETWORK SYSTEMS INTERNATIONAL, INC.
Date: 8/7/98 /s/ Robbie M. Efird
Robbie M. Efird, President
Date: 8/7/98 /s/ Michael T. Spohn
Michael T. Spohn, Chief Financial Officer
EXHIBIT INDEX
Exhibit Page
(27) Financial Data Schedule 21
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> JUN-30-1998
<CASH> 1,422,394
<SECURITIES> 0
<RECEIVABLES> 4,812,281
<ALLOWANCES> (725,000)
<INVENTORY> 0
<CURRENT-ASSETS> 5,671,732
<PP&E> 1,848,955
<DEPRECIATION> (627,221)
<TOTAL-ASSETS> 8,502,747
<CURRENT-LIABILITIES> 2,315,145
<BONDS> 0
0
7
<COMMON> 7577
<OTHER-SE> 5,367,623
<TOTAL-LIABILITY-AND-EQUITY> 8,502,747
<SALES> 9,847,916
<TOTAL-REVENUES> 9,847,916
<CGS> 5,034,722
<TOTAL-COSTS> 2,207,196
<OTHER-EXPENSES> 16,624
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 31,037
<INCOME-PRETAX> 2,653,659
<INCOME-TAX> 918,600
<INCOME-CONTINUING> 1,735,059
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,735,059
<EPS-PRIMARY> 0.22
<EPS-DILUTED> 0.22
</TABLE>
