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, 2000
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 Number)
Incorporation or Organization)
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)
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 7,813,154 shares of the Registrant's $.001 par
value common stock and 3,455 shares of Registrant's $.001
par value preferred stock outstanding as of June 30, 2000.
Transitional Small Business Format (check one) Yes __ No X
NETWORK SYSTEMS INTERNATIONAL, INC.
Contents
Part I - Financial Information Page
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheet 3
Consolidated Statements of Operations
Three months ended June 30, 2000 and 1999 4
Nine months ended June 30, 2000 and 1999 5
Consolidated Statement of Changes in Stockholders' Equity 6
Consolidated Statements of Cash Flow
Nine months ended June 30, 2000 and 1999 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Part II
Item 1. Legal Proceedings 17
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
Exhibit Index 19
Item 1. Financial Statements
<TABLE>
Network Systems International, Inc. and Subsidiary
Consolidated Balance Sheet
(Unaudited)
<CAPTION>
June 30, 2000
<S> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 251,972
Accounts receivable, trade, net of allowance
of $250,000 1,108,399
Accounts receivable, related parties 129,997
Refundable income taxes 782,395
Deferred income taxes 126,688
Other current assets 163,790
Total current assets 2,563,241
Property and equipment, net of accumulated
depreciation and amortization 1,244,160
Intangible assets, net of accumulated amortization
of $827,354 5,267,448
Other 371,650
Total assets $9,446,499
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade $ 979,021
Note payable 298,324
Capital lease obligations 45,603
Other accrued liabilities 317,781
Unearned revenue 1,225,637
Revolving credit agreement 3,235,000
Total current liabilities 6,101,366
Deferred income taxes 126,688
Stockholders' Equity:
Preferred Stock; $.001 par value; authorized
12,500 shares; issued and outstanding 3,455,liquidation
preference of $345,500 3
Common Stock; $.001 par value; authorized 100,000,000
shares; issued and outstanding 7,813,154 7,813
Capital in excess of par value 3,930,923
Retained earnings (720,294)
Total stockholders' equity 3,218,445
Total liabilities and stockholders' equity $9,446,499
The accompanying notes are an integral part of the consolidated
financial statements.
</TABLE>
<TABLE>
Network Systems International, Inc. and Subsidiary
Consolidated Statements of Operations
(Unaudited)
<CAPTION>
Three Months Ended June 30,
2000 1999
<S> <C> <C>
Revenue:
Licensing revenue $ 21,783 $ 527,480
Servicing revenue 1,142,072 1,852,468
Equipment revenue 392,852 2,198,966
Total revenue 1,556,707 4,578,914
Operating expenses:
Cost of licensing 96,906 28,820
Cost of services 909,888 891,536
Cost of equipment 262,997 1,922,812
Research and development 303,120 444,583
Sales, general and administrative 1,216,448 1,477,067
Amortization of excess of cost
over net assets acquired 123,933 -
Total operating expenses 2,913,292 4,764,818
Operating loss (1,356,585) (185,904)
Other income (expenses)
Interest, net (74,195) 10,550
Loss before income tax provision
(benefit) (1,430,780) (175,354)
Income tax provision (benefit) (351,463) 58,114
Net loss $(1,079,317) $ (233,468)
Dividends on preferred shares 8,193 10,125
Net loss applicable to common shares (1,087,510) (243,593)
Loss per common share, basic and $ (.14) $ (.03)
diluted
The accompanying notes are an integral part of the
consolidated financial statements.
</TABLE>
<TABLE>
Network Systems International, Inc. and Subsidiary
Consolidated Statements of Operations
(Unaudited)
<CAPTION>
Nine Months Ended June 30,
2000 1999
<S> <C> <C>
Revenue:
Licensing revenue $ 142,090 $ 1,879,667
Servicing revenue 4,891,818 4,975,822
Equipment revenue 1,535,588 4,906,158
Total revenue 6,569,496 11,761,647
Operating expenses:
Cost of licensing 280,927 63,126
Cost of services 3,349,662 2,524,499
Cost of equipment 1,221,408 4,385,739
Research and development 927,343 648,111
Sales, general and administrative 3,769,085 2,546,896
Amortization of excess of cost
over net assets acquired 387,423 -
Gain on sale of fixed asset (1,670) -
Total operating expenses 9,934,178 10,168,371
Operating income (loss) (3,364,682) 1,593,276
Other income (expenses)
Interest, net (238,827) 28,280
Income (loss) before income tax
provision (benefit) (3,603,509) 1,621,556
Income tax provision (benefit) (1,080,729) 734,580
Net income (loss) $(2,522,780) $ 886,976
Dividends on preferred shares 25,485 39,468
Net income (loss) applicable to
common shares (2,548,265) 847,508
Earnings (loss) per common share,
basic and diluted $ (.33) $ .11
The accompanying notes are an integral part of the consolidated
financial statements.
</TABLE>
<TABLE>
Network Systems International, Inc. and Subsidiary
Consolidated Statement of Changes in Stockholders' Equity
Nine Months Ended June 30, 2000
(Unaudited)
<CAPTION>
Common Stock Preferred Stock
Number of Number Capital in Retained
Shares of excess of Earnings
Shares Par Value
$.001 $.001 Common stock Total
Par Par subject to
Value Value redemption
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance
Oct.
1, 7,776,854 3,906 $3,531,426 $1,827,971
1999 $7,777 $ 4 $(1,896,000) $ 3,471,178
Conver-
sion of
prefer-
red 22,550 (451) (22) -
stock 23 (1) - -
Compen-
sation
related
to grant
of stock - - 257,814 -
options - - - 257,814
Compen-
sation
related
to
put - - 96,250 -
options - - - 96,250
Compen-
sation
related
to
common
stock
issued
to
Board
of
Direc- 13,750 - 45,455 -
tors 13 - - 45,468
Divi-
dends
on pre-
ferred - - - (25,485)
stock - - - (25,485)
Expira-
tion of
put
options
of
common
stock
subject
to re-
demp- - - - -
tion - - 1,896,000 1,896,000
Net loss
for the
nine
months
ended
June 30, - - - (2,522,780)
2000 - - - (2,522,780)
Balance
June
30, 7,813,154 3,455 $3,930,923 $ (720,294)
2000 $7,813 $ 3 $ - $3,218,445
The accompanying notes are an integral part of the
consolidated financial statements.
</TABLE>
<TABLE>
Network Systems International, Inc. and Subsidiary
Consolidated Statements of Cash Flow
(Unaudited)
<CAPTION>
Nine Months Ended June 30,
2000 1999
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) (2,522,780) 886,976
Adjustments to reconcile net
income (loss) to net cash
provided by operating activities:
Depreciation and amortization 745,930 171,333
Non-cash compensation expense 364,376 85,938
Provision for bad debts 617,055 250,000
Gain on sale of property and equipment (1,670) -
Increase in cash surrender
value of life insurance (6,331) (180,925)
Change in operating assets and liabilities:
Accounts receivable 1,139,938 (1,185,288)
Other current assets 28,102 (53,368)
Income taxes 50,374 (330,119)
Accounts payable and other
accrued liabilities (249,069) 1,146,137
Unearned revenue 612,644 428,668
Deferred income taxes (411,103) 508,725
Total adjustments 2,890,246 841,101
Net cash provided by operating activities 367,466 1,728,077
INVESTING ACTIVITIES
Acquisition of property and
equipment (139,830) (515,499)
Reimbursement of Vercom
acquisition escrowed funds 75,000 -
Acquisition of Vercom, net of
purchased research and development - (5,888,221)
Proceeds from sale of property and equipment 262,000 -
Net cash provided by (used in)
investing activities 197,170 (6,403,720)
FINANCING ACTIVITIES
Payment on notes payable and
capital lease obligations (85,467) (51,776)
Advances on (payment on) revolving
credit agreement (265,000) 3,700,000
Dividends paid (25,485) (39,468)
Net cash provided by (used in)
financing activities (375,952) 3,608,756
Net increase (decrease) in cash and
cash equivalents 188,684 (1,066,887)
Cash and cash equivalents at October 1: 63,288 1,228,894
Cash and cash equivalents at June 30: 251,972 162,007
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 208,845 $ 25,600
Taxes $ - $1,084,800
The accompanying notes are an integral part of the consolidated
financial statements.
</TABLE>
Network Systems International, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(Unaudited)
A. Organization and Basis of Preparation
Organization
Network Systems International, Inc. (the "Company"), a
Nevada corporation, is a vertical market company that is the
developer of the net collection(tm) and Primac software
systems. These products are suites of supply chain
management and enterprise-wide software products for the
textile, apparel, home furnishing, and printing industries.
The Company offers hardware products as well as consulting
and implementation services that provide a solution to its
customer's technology needs.
The Company and its wholly owned subsidiary Vercom Software,
Inc. ("Vercom") employ approximately 67 full-time
associates. The Company is headquartered in Greensboro,
North Carolina with offices in Dallas, Texas and Duncan,
South Carolina. All intercompany transactions have been
eliminated in consolidation.
The Company's common stock trades on the NASDAQ SmallCap
Exchange under the symbol NESI.
Basis of Preparation:
The financial statements consolidate the accounts of Network
Systems International, Inc. and its wholly owned subsidiary,
Vercom.
The interim financial information included herein is
unaudited. Certain information and footnote disclosures
normally included in the financial statements have been
condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission (SEC), although
the Company believes that the disclosures made are adequate
to make the information presented not misleading. These
consolidated financial statements should be read in
conjunction with the consolidated financial statements and
related notes contained in the Company's Form 10-KSB filed
with the SEC on January 13, 2000. In the opinion of
management, such unaudited information reflects all
adjustments, consisting of normal recurring accruals and
other adjustments, necessary for a fair presentation of the
unaudited information.
Results for interim periods are not necessarily indicative
of results expected for the full year.
Certain prior year amounts have been reclassified to conform
to the current year presentation.
Use of Estimates:
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 that affect the amounts
reported in the financial statements and accompanying notes.
Actual results could differ from these estimates.
B. Earnings Per Share:
The consolidated financial statements presents earnings
(loss) per common share, basic and diluted, 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.
The following data shows the amounts used in computing
earnings (loss) per share and the effect on income (loss)
and the weighted average number of shares of the potential
dilution from the exercise or conversion of securities into
common stock.
Three months ended June 30,
2000 1999
Net loss $ (1,079,317) $ (233,468)
Less preferred stock dividends (8,193) (10,125)
Loss applicable to common shares (1,087,510) (243,593)
Preferred stock dividends - -
Loss applicable to common shares
after assumed conversion of
dilutive securities (1,087,510) (243,593)
Weighted average number of common
shares used in basic EPS 7,805,544 7,757,260
Effect of dilutive convertible
preferred stock - -
Weighted average number of common
shares and dilutive potential
common shares used in diluted EPS 7,805,544 7,757,260
Nine months ended June 30,
2000 1999
Net income (loss) $(2,522,780) $ 886,976
Less preferred stock dividends (25,485) (39,468)
Income (loss) applicable to
common shares (2,548,265) 847,508
Preferred stock dividends - 39,468
Income (loss) applicable to
common shares after assumed
conversion of dilutive securities (2,548,265) 886,976
Weighted average number of common
shares used in basic EPS 7,799,027 7,700,320
Effect of dilutive convertible
preferred stock - 273,420
Weighted average number of common
shares and dilutive potential
common shares used in diluted EPS 7,799,027 7,973,740
The Company has 704,000 options and 3,455 shares of
preferred stock that were antidilutive and are not included
in the earnings per share calculation for the quarter and
period ended June 30, 2000.
C. Revolving Credit Agreement, Note Payable and Liquidity
At June 30, 2000, the Company was in default under certain
material provisions of the Revolving Credit Agreement
including the financial covenants related to (1)
Consolidated Cash Flow to Consolidated Funded Debt and (2)
Consolidated Liabilities to Consolidated Tangible Net Worth.
As a result, the debt under this agreement has been shown as
a current liability in the balance sheet. As of July 10,
2000, the Company and four of its majority stockholders
entered into a stock purchase agreement to raise adequate
funding to satisfy the terms of this revolving credit
agreement. See note H outlining the details of this
transaction. As of the filing, the bank has not exercised
its right under the default provisions of the agreement.
Note payable has been classified as a current liability due
to the cross default provision of the Revolving Credit
Agreement as discussed above.
D. Major Customers
For the three months ended June 30, 2000, there were no
significant sales to any one customer. For the three months
ended June 30, 1999, sales to two customers amounted to
approximately $2,946,000. For the nine months ended June
30, 2000 and 1999, sales to one customer amounted to
approximately $1,424,000 and $6,740,000, respectively.
E. Legal Proceedings
The Company is currently a party in a lawsuit in which the
plaintiff, "Canton Financial Services Corporation," is
seeking damages from the Company for an alleged breach of
contract. The Company contends that there was no contract
between the parties. The case is currently in the Circuit
Court for Hillsborough County, Florida. The Company is
defending the allegations and may exert counterclaims
against the plaintiff. The plaintiff is seeking 355,000
shares of the Company's stock and the potential damages are
not definite, as the total damages, if the plaintiff is
successful, depend on the stock price and the date on which
the resulting damages, if any, are determined. Management
believes the case is without merit, but, if the Company is
found in breach of contract, the damages could have a
material adverse effect on the Company.
The Company is currently involved in other routine legal
proceedings that are incidental to the business. In the
opinion of management, these other routine proceedings will
not have a material adverse effect on the Company's
financial position or overall trends in results of
operations.
The estimate of the potential impact on the Company's
financial position or overall results of operations for the
above legal proceedings could change in the future.
F. Common Stock Subject to Redemption
On May 1, 2000, the Company entered into a two-year
employment agreement with a former consultant of the
Company. Among other things, the employment agreement
terminated the prior consulting agreement between the
parties including the termination of the consultant's right
to put 10,000 shares of restricted stock owned by the
consultant back to the Company each quarter.
G. Segment Information
The Company's operations involve the design and development
of integrated software solutions for Enterprise Resource
Management ("ERP") and supply chain management for the
process manufacturing industry. The Company also offers
hardware products and technical consulting and
implementation services providing a complete solution to its
customer's technology needs.
The Company conducts business primarily in the United
States. The Company's management uses an internal
management accounting system to make financial decisions and
allocate resources based on the revenues and operating
income (loss) before interest, amortization of certain
intangibles acquired and income taxes from these reports.
Based on the criteria set forth in SFAS No. 131, the Company
has three reportable segments: software licensing, technical
consulting and implementation services, and hardware product
sales.
In addition to the aforementioned operating segments, the
sales and marketing, research and development, and
administrative groups are allocated to the operating
segments and are included in the operating profit (loss)
reported below.
The Company's management does not identify or allocate
assets by operating segment, nor does management evaluate
each segment based on these criteria. Operating segments do
not sell products to each other, and accordingly, there are
no inter-segment revenues to be reported. The Company does
not allocate interest, amortization of certain intangibles
acquired or income taxes to operating segments. The
accounting policies for segment reporting are the same as
for the Company as a whole.
The following is a summary of segment information for the
nine-month period ended June 30, 2000 and 1999:
2000 1999
Revenues:
Software licensing $ 142,090 $ 1,879,667
Services 4,891,818 4,975,822
Hardware 1,535,588 4,906,158
Total $ 6,569,496 $11,761,647
Operating profit (loss):
Software licensing $(2,008,451) $ 531,706
Services (719,295) 923,185
Hardware (251,183) 138,385
Total $(2,978,929) 1,593,276
Reconciliation to net income (loss)
Interest, net $ (238,827) 28,280
Amortization of excess cost
over net assets acquired (387,423) -
Gain on sale of fixed assets 1,670 -
Income tax (provision) benefit 1,080,729 (734,580)
Net income (loss) $(2,522,780) 886,976
Depreciation and amortization of $745,930 for 2000 and
$171,333 for 1999 have been allocated to the segment
information above.
H. Subsequent Event
On July 10, 2000, the Company entered into a Stock Purchase
Agreement dated July 10, 2000 (the "Stock Purchase
Agreement") with Richard T. Clark, Joel C. Holt, D. Mark
White, George D. Gordon, Bryan John, John Signorello and
Steven Elias (the "Initial Investors"). Subject to the
terms and conditions of the Stock Purchase Agreement, the
Company issued 1,666,667 new, restricted shares of the
Company's common stock at $0.60 per share to the Initial
Investors in a private placement organized by Millennium
Holdings Group, Inc. ("Millennium"). The sale under the
Stock Purchase Agreement was subject to the satisfaction of
the following conditions, which are discussed in more detail
below: (i) certain of the Company's current management
shareholders must agree to sell 2,700,000 shares of the
Company's common stock to accredited investors arranged by
Millennium, (ii) these current management shareholders must
grant the Company a put option giving the Company the right
to require such management shareholders to purchase
substantially all of the assets associated with the
Company's business as currently conducted for $3,000,000,
(iii) all of the Company's current directors must resign and
a designated representative of the Initial Investors must be
appointed to replace the former directors effective as of
the closing date of the stock sale, and (iv) the Company
must receive the consent of its current revolving credit
lender, Wachovia Bank, N.A. ("Wachovia"). The sale under
the Stock Purchase Agreement closed on July 25, 2000.
As a condition to the Initial Investors' obligations
pursuant to the terms of the Stock Purchase Agreement, four
of the Company's current management shareholders, Robbie M.
Efird, E. W. "Sonny" Miller, Jr., David F. Christian and
James W. Moseley (collectively, the "Selling Shareholders")
entered into Stock Purchase Agreements dated July 21, 2000
(the "Investment Agreements") to collectively sell 2,700,000
shares to Herbert Tabin, a managing partner with Millennium,
for $1,500,000 (approximately $0.56 per share) in a second
private placement arranged by Millennium.
As a further condition to the Initial Investors' obligations
under the Stock Purchase Agreement, the Selling Shareholders
granted the Company a put option, expiring forty-five (45)
days after the closing date, giving the Company the right to
require the Selling Shareholders to purchase substantially
all of the Company's operating assets and liabilities (the
"Company Assets") and substantially all of the operating
assets and liabilities of Vercom Software, Inc., a wholly-
owned subsidiary corporation of the Company ("Vercom") (the
"Vercom Assets"; the Company Assets and the Vercom Assets
shall collectively be referred to as the "Assets") for
$3,000,000. The Assets include all of the operating assets
related to the Company's business as currently conducted.
During this 45-day period, the Company will determine the
value of the Assets and evaluate whether it is in the best
interests of the Company and its shareholders for the
Company to sell the Assets to the Selling Shareholders at
the put price, to sell the Assets to a third party, to
retain the Assets or to take other appropriate action.
In order to facilitate the Company's potential exercise of
the put option, the Company contributed the Company Assets
to a recently formed wholly-owned subsidiary corporation,
Network Systems International of North Carolina, Inc. on
July 20, 2000. As part of this process, the Company
assigned its rights and obligations under substantially all
of its current agreements (including its software license
agreements, service agreements and employment agreements) to
Network Systems International of North Carolina, Inc.
In order to satisfy a condition to the Initial Investors'
obligations under the Stock Purchase Agreement, all of the
Company's current directors resigned effective as of the
closing date, except for Mr. Efird. The current officers
of the Company also resigned as of the closing date.
Herbert Tabin has been appointed to the Company's Board of
Directors as of the closing date.
If the Company elects to exercise the put option and require
the Selling Shareholders to purchase the Assets for
$3,000,000, the Selling Shareholders will make an initial
cash payment of $1,500,000 to the Company. The Selling
Shareholders will deliver a non-recourse promissory note in
the principal amount of $1,500,000, payable in one hundred
twenty (120) days, for the remaining purchase price. The
Selling Shareholders will pledge all of their remaining
2,925,856 shares of the Company's common stock (the "Pledged
Shares") as security for the payment of the promissory note.
The Company's right to exercise the put option will be
conditioned upon the Company using $2,000,000 of the sales
price received for the Assets to reduce the obligation under
the revolving credit arrangement with Wachovia. The Company
plans to use $1,250,000 from the Selling Shareholders'
initial cash payment and $750,000 from the sale, if any, of
the Pledged Shares to reduce the outstanding indebtedness.
The sale of the Pledged Shares is discussed below. As a
further condition to the Company's right to exercise the put
option, the Company will also agree to change its name on
its corporate charter, to discontinue the use of the name
"Network Systems International" and to transfer all rights
to the name "Network Systems International" to the Selling
Shareholders.
The Company understands that Millennium will use its best
efforts to place the Pledged Shares with accredited
investors on behalf of the Selling Shareholders for at least
$1,500,000, or approximately $0.513 per share. Millennium
will remit the proceeds generated by the sale of the Pledged
Shares, up to $1,500,000, to the Company to satisfy the
remaining balance of the purchase price for the Assets.
If all of the Pledged Shares are sold for an amount greater
than $1,500,000, Millennium will retain the excess. If
Millennium cannot sell all of the Pledged Shares for at
least $1,500,000, Millennium will use its best efforts to
place as many of the Pledged Shares as possible with
accredited investors on behalf of the Selling Shareholders
for approximately $0.513 per share. Pursuant to the terms
of the put option, the Company will use the first $750,000
from the sale of the Pledged Shares to reduce the obligation
under the revolving credit arrangement with Wachovia. If
Millennium is unable to sell all of the Pledged Shares, the
Company will extinguish the promissory note at maturity and
retain any remaining shares in satisfaction of the
outstanding purchase price for the sale of the Subsidiaries
to the Selling Shareholders.
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
FORWARD LOOKING INFORMATION
THIS MD&A CONTAINS FORWARD LOOKING INFORMATION. EXCEPT FOR
HISTORICAL DATA, THE MATTERS DISCUSSED IN THIS FORM 10-QSB
CONTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISK AND
UNCERTAINTIES.
The Company would caution readers that in addition to the
important factors described elsewhere in this Form 10-QSB,
the following may contain forward looking statements that
involve risk and uncertainties, including, without
limitation, continued acceptance of the Company's products
and services, increased levels of competition, new products
and technological changes, the Company's dependency on
financing, third party suppliers, intellectual property
rights, material customers, business concentration risks
within the textile and printing industries, business
combinations, and other risks. The Company's actual
consolidated financial results during 2000, and beyond,
could differ materially from those expressed in any forward
looking statements made by, or on behalf of, the Company.
The Company undertakes no obligation to publicly revise
these forward-looking statements to reflect events and
circumstances that arise after the date hereof.
RESULTS OF OPERATIONS
Results of the Company's newly acquired subsidiary, Vercom
Software, Inc. are included in the financial statements
since its June 16, 1999 acquisition date.
Certain prior year amounts have been reclassified to conform
to the current year presentation.
Revenue. Net revenue for the three-month period ended June
30, 2000 was $1,556,707, a 66% decrease from the comparable
period in 1999. For the nine-month period ended June 30,
2000, revenues were $6,569,496 as compared to $11,761,647
for the same nine month period in fiscal 1999, a 44%
decrease. Software license revenues decreased between
periods as a result of a slowdown in demand for software
products like those offered by the Company. In addition,
services and hardware revenues are directly impacted by a
slowdown in software licensing, as most new customers
require implementation services and system upgrades.
Management believes the unique conditions created by the Y2K
phenomenon resulted in increased focus by companies ensuring
that their existing systems were compliant with requirements
related to the Year 2000, which directly resulted in a
postponement in purchasing decisions into the later part of
fiscal 2000.
The Company's operations are classified into three principal
segments for reporting purposes. They are: (1) software
licensing revenue, (2) consulting and implementation
services and (3) hardware sales. Revenues from licensing
software amounted to $21,783 for the three-month period
ended June 30, 2000 compared to $527,480 for the same period
in 1999. During the nine-month period ended June 30, 2000
and 1999, licensing revenue decreased to $142,090 from
$1,879,667, respectively. Though licensing revenue
decreased during the Company's third fiscal quarter 2000
compared to the first and second fiscal quarters, the
Company, however, signed new software deals in the fiscal
third quarter amounting to approximately $170,000 in which
the software products will be delivered and implementation will begin in the
Company's fiscal forth quarter. The Company,
however, recognizes that licensing
continues to be slow to rebound to the prior year levels due
to the post Year 2000 purchasing decisions from the
Company's current prospects. For the three months ended
June 30, service revenues decreased from $1,852,468 in 1999
to $1,142,072 in 2000 representing a decrease of 38%. For
the nine months ended June 30, 2000 and 1999, the decrease
was 2% from $4,975,822 to $4,891,818. The decrease in
service revenues was directly related to the decreased
demand of implementation services in 2000 as compared to
1999 due to the slowdown in software sales. The inclusion
of service revenue from Vercom in fiscal 2000 of $1,586,408
further highlights the decrease in implementation service
revenue during 2000. In the hardware segment of the
business, revenues for the three-month period ended June 30,
2000 totaled $392,852 as compared to $2,198,966 for the
comparable period ended June 30, 1999. For the nine-month
period ended June 30, 2000 and 1999, hardware revenues
amounted to $1,535,588 and $4,906,158, respectively. The
decrease is primarily related to the reduction in software
licenses to new customers and the postponement of purchases
related to businesses that focused on the readiness of their
existing hardware and software systems for Year 2000.
Current fiscal year hardware revenue is being derived from
hardware accessories which complement the base systems which
run the Company's products compared to entire base system
sales in the prior year to new and existing customers for
Year 2000 readiness.
Cost of Licensing, Services and Equipment. Cost of software
licensing consists of the costs of software reproductions
and delivery, media, packaging, documentation and other
related costs and the amortization of purchased software.
For the three-month period ended June 30, 2000, costs
associated to licensing amounted to $96,906 in 2000 compared
to $28,820 in 1999. The costs associated with the nine-
month period ended June 30, 2000 and 1999 were $280,927 and
$63,126, respectively. The increase is attributable to the
amortization of purchased software from the acquisition of
Vercom amounting to $70,000 for the three-month period ended
June 30, 2000 and $210,000 for the nine-month period ended
June 30, 2000. Cost of services increased to $909,888 or
80% of service revenues for the three months ended June 30,
2000 compared to $891,536 or 48% in 1999. For the nine-month
period ended June 30, 2000 cost of services increased to
$3,349,662 or 68% of service revenue compared with
$2,524,499 and 51% in 1999. The primary increase in cost of
services was the addition of Vercom, which has a lower
percentage of servicing revenue compared to the Company in
the prior year. In addition, the progressive increase in
the cost of service percentage for fiscal 2000 is directly
related to the slowdown in software license sales and the
subsequent implementation services. Due to these factors,
the Company has reduced its workforce approximately 50%
during fiscal 2000 in order to bring service expenses in
line with sales. Cost of equipment as a percent to revenue
was 67% or $262,997 in 2000 compared to 87% or $1,922,812 in
1999 for the three-month period ended June 30. For the nine-
month period ended June 30, 2000 and 1999, cost of equipment
percentage was 80% and 89%. The overriding factor for the
increase in profit margin is the inclusion of equipment
sales at Vercom, which carry a higher profit margin
percentage.
Sales, General and Administrative. Sales, general and
administrative expense for the three-month period ended June
30, 2000 was $1,216,448 compared to $1,477,067 for the same
period ended in 1999. The nine-month period ended June 30,
2000 and 1999 was $3,769,085 and $2,546,896. The increase in
sales, general and administrative expenses for the nine-
month period is directly related to the inclusion of sales,
general and administrative expenses of Vercom amounting to
$870,443. In addition, the Company incurred approximately
$364,000 in non-cash compensation during the nine months
ended June 30, 2000 not charged in fiscal 1999. After
taking the aforementioned items into consideration, sales,
general and administrative expenses decreased slightly for
the nine-month and three-month periods ended June 30, 2000
as compared to the same period in 1999.
Research and Development Costs. Research and development
costs amounted to $303,120 for the three-month period ended
June 30, 2000 compared to $444,583 in 1999 which included
$300,000 of purchased in-process research and development.
For the nine months ended June 30, 2000 and 1999, research
and development cost increased $279,232 to $927,343 from
$648,111, respectively. The primary increase is due to the
inclusion of research and development expenses incurred by
Vercom since the acquisition date.
Provisions for Income Taxes. Income taxes are provided for
transactions reported in the financial statements and
consist of taxes currently due, plus deferred income taxes.
The income tax provision (benefit) for the three-month
period ended June 30, 2000 and 1999 was $(351,463) and
$58,114, respectively. For the nine-month period ended
June 30, 2000 and 1999 the income tax provision (benefit)
was $(1,080,729) and $734,580, respectively. The effective
tax rate for the three and nine month periods ended June 30,
were (25%) and (30)% in 2000, respectively, and 33% and 45%
in 1999, respectively.
Liquidity and Capital Resources. Cash and Cash Equivalents
were $251,972, representing a increase of $89,965 from the
same period ended June 30, 1999. Currently, the Company is
in default under certain of the material provisions of the
revolving credit agreement, including the financial
covenants related to 1) Consolidated Cash Flow to
Consolidated Funded Debt, 2) Consolidated Liabilities to
Consolidated Tangible Net Worth. On July 10, 2000, the
Company entered into a Stock Purchase Agreement dated July
10, 2000 (the "Stock Purchase Agreement") with Richard T.
Clark, Joel C. Holt, D. Mark White, George D. Gordon, Bryan
John, John Signorello and Steven Elias (the "Initial
Investors"). Subject to the terms and conditions of the
Stock Purchase Agreement, the Company issued 1,666,667 new,
restricted shares of the Company's common stock at $0.60 per
share generating $1,000,000 which was used to pay down the
revolving credit agreement. In addition, on July 10, 2000,
certain of the Company's current management shareholders
have sold 2,700,000 shares of the Company's common stock to
accredited investors arranged by Millennium and these
current management shareholders have granted the Company a
put option giving the Company the right to require such
management shareholders to purchase substantially all of the
assets associated with the Company's business as currently
conducted for $3,000,000. If the Company elects to exercise
the put option and require the Selling Shareholders to
purchase the Assets for $3,000,000, the Selling Shareholders
will make an initial cash payment of $1,500,000 to the
Company. The Selling Shareholders will deliver a non-
recourse promissory note in the principal amount of
$1,500,000, payable in one hundred twenty (120) days, for
the remaining purchase price. The Selling Shareholders will
pledge all of their remaining 2,925,856 shares of the
Company's common stock (the "Pledged Shares") as security
for the payment of the promissory note. The Company's right
to exercise the put option will be conditioned upon the
Company using $2,000,000 of the sales price received for the
Assets to reduce the obligation under the revolving credit
arrangement with Wachovia. The Company plans to use
$1,250,000 from the Selling Shareholders' initial cash
payment and $750,000 from the sale, if any, of the Pledged
Shares to reduce the outstanding indebtedness. These
transactions will reduce the Company's indebtedness on the
revolving credit arrangement to approximately $400,000 net
of related bank and legal fees. In addition, the Company's
other primary sources of liquidity are funds generated by
operations. Based on the transactions described above, the
Company has adequate resources and liquidity to fund
operations of the Company. However, if one or all of the
transactions do not materialize, along with the slowdown in
software license sales, doubt is raised about the ability of
the Company to continue as a going concern as well as the continuing
carrying value of the assets.
Quarterly Results. Net loss for the three-month period
ended June 30, 2000 and 1999 was $(1,079,317) and
$(233,468), respectively. For the nine months ended June
30, 2000 and 1999, net income (loss) was $(2,522,780) and
$886,976, respectively. On a per share basis, losses were
$(.14) and $(.03) for the three months ended June 30, 2000
and 1999, respectively. For the nine months ended June 30,
2000 and 1999 earnings (loss) per share amounted to $(.33)
and .11, respectively. The decrease in earnings was
directly impacted by a reduction in software license,
services and hardware revenues due to post Year 2000
software slowdown.
Recent Accounting Pronouncements:
In June 1998, the Financial Accounting Standards Board
issued SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." The Statement establishes
accounting and reporting standards for derivative
instruments and hedging activities. The Statement is
effective for fiscal years beginning after June 15, 1999.
The Financial Accounting Standards Board issued SFAS No. 137
"Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB
Statement No. 133" deferring the effective date to all
fiscal quarters of all fiscal years beginning after June 15,
2000. Due to the Company's limited use of derivative
financial instruments, adoption of Statement 133 is not
expected to have a significant effect on the Company's
consolidated results of operations, financial position, or
cash flows.
The Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement
of Position 98-9 ("SOP 98-9") "Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain
Transactions. SOP 98-9 amends paragraphs 11 and 12 of SOP
97-2 to require revenue recognition using the "residual
method" when certain vendor-specific objective evidence is
met. This SOP is effective for fiscal years beginning
after March 15, 1999. The Company has adopted the
provisions of SOP 98-9 during the fiscal quarter ended
December 31, 1999 and the financial statements have not been
impacted due to this adoption.
OTHER MATTERS
Some of the key variables and other qualitative and
quantitative factors which might be deemed necessary to an
understanding and valuation of the Company's business and
risks associated therewith are as follows:
Rapid Technological Changes. The computer software industry
is characterized by rapid technological change and
uncertainty as to the impact of emerging software solutions
and services to the general process manufacturing industry.
The Company's success will depend upon its ability to
enhance its current products and develop new products that
address technological and market developments. Major
changes and/or additional competition could negatively
impact the Company's future performance.
Long-term Investment Cycle. Developing software is
expensive and the investment in software development often
involves a long payback cycle. The Company plans to
continue to make significant investments in software
development. Expenditure of funds for research and
development may not generate anticipated revenues in the
event the final product developed does not meet market
expectations and acceptance.
Sales Cycle. Traditionally, the Company experiences a
significant period between the time a customer is introduced
to the Company's products and services and the final date
upon which actual contracts are signed. The period to
complete these efforts often takes up to twelve months or
longer. As a result, it is difficult to build a firm
foundation for predicting revenues over an extended period
of time. Additionally, by the time prospects become
customers, time is usually of the essence and proper
predictions for staffing needs must be made well in advance
of the time implementation services are required. The
uncertainties stated above could ultimately create a
negative impact on the overall revenues and profitability of
the Company
Material Customers. The Company could potentially face the
risks related to loss of material customers. Such loss of
customers would have an immediate negative impact on the
profitability of the Company.
Business Concentration Risk. The Company develops
enterprise-wide software products for complex manufacturers
to be utilized in all process manufacturing industries.
However, the Company's current customer base is
predominately with companies in the textiles, apparel, home
fashions, and printing industries. A downturn in these
industries could cause a negative impact on the Company's
operating results.
Year 2000 Issues. Prior to December 31, 1999, the Company
took what it believes as the appropriate steps to prevent
Y2K related compliance issues with its proprietary software
and internal software and systems. As of June 30, 2000, the
Company is not aware of any Y2K related occurrences with its
proprietary software or internal software and systems that
have or may have caused some unknown or unanticipated event
related to Y2K compliance for the Company or its business
partners.
General. 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
global economy, a loss of significant associates to
competition 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.
Lastly, it appears that the ERP software industry segment
has experience a slowdown in overall business activities as
customer demands for products and services have lessened
after Year 2000 compliance has been achieved.
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.
Part II
Item 1. Legal Proceedings
The Company is currently a party in a lawsuit in which the
plaintiff, "Canton Financial Services Corporation," is
seeking damages from the Company for an alleged breach of
contract. The Company contends that there was no contract
between the parties. The case is currently in the Circuit
Court for Hillsborough County, Florida. The Company is
defending the allegations and may exert counterclaims
against the plaintiff. The plaintiff is seeking 355,000
shares of the Company's stock and the potential damages are
not definite, as the total damages, if the plaintiff is
successful, depend on the stock price and the date on which
the resulting damages, if any, are determined. Management
believes the case is without merit, but, if the Company is
found in breach of contract, the damages could have a
material adverse effect on the Company.
The Company is currently involved in other routine legal
proceedings that are incidental to the business. In the
opinion of management, these other routine proceedings will
not have a material adverse effect on the Company's
financial position or overall trends in results of
operations.
The estimate of the potential impact on the Company's
financial position or overall results of operations for the
above legal proceedings could change in the future.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits included herewith are:
(11) Schedule of Computation of Net Income Per Common Share
(27) Financial Data Schedule
(b) Reports on Form 8-K
1. Form 8-K filed with the Securities and Exchange
Commission January 13, 2000 announcing 1999 earnings, one-
time charges, and results of a change in the application of
an accounting standard.
2. Form 8-K filed with the Securities and Exchange
Commission July 10, 2000 announcing that the Company
entered into a Stock Purchase Agreement dated July 10,
2000 with Richard T. Clark, Joel C. Holt, D. Mark
White, George D. Gordon, Bryan John, John Signorello
and Steven Elias.
SIGNATURES
In accordance with the requirements of the Securities
and Exchange Act, the registrant has caused this report to
be signed on its behalf by the undersigned, thereto duly
authorized.
NETWORK SYSTEMS INTERNATIONAL, INC.
Date: 08/14/00 /s/ Herbert Tabin
Herbert Tabin, President
Date: 08/14/00 /s/ Robbie Efird
Robbie Efird, Director
EXHIBIT INDEX
Exhibit
(11) Schedule of Computation of Net Income Per Share (Unaudited)
(27) Financial Data Schedule
