UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended SEPTEMBER 30, 1998
------------------------------
OR
[ ] Transition Report Under Section 13 or 15(d)
of the Exchange Act
For the Transition Period From to
Commission File Number 1-10185
DOCUCON, INCORPORATED
(Exact name of small business issuer as specified in its charter)
Delaware 74-2418590
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
7461 Callaghan Road
San Antonio, Texas 78229
(Address of principal executive offices)
(210) 525-9221
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
State the number of shares outstanding of each of the issuer's classes of
common equity as of October 30, 1998. 3,308,716
<PAGE>
DOCUCON, INCORPORATED
INDEX
PAGE
PART I. FINANCIAL INFORMATION (UNAUDITED)
Item 1: Balance Sheets - September 30, 1998, and December 31, 1997 3
Statements of Operations - For the Three and Nine Months
Ended September 30, 1998 and 1997 5
Statements of Cash Flows - For the Nine Months Ended
September 30, 1998 and 1997 7
Notes to Financial Statements 8
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
PART II. OTHER INFORMATION 17
SIGNATURES 18
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<PAGE>
DOCUCON, INCORPORATED
BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
ASSETS (UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and temporary cash investments .............. $ 2,196,675 $ 4,597,183
Accounts receivable-trade, net of allowance for
doubtful accounts of $4,444-
U.S. Government ............................... 452,247 620,934
Commercial .................................... 131,607 335,300
Unbilled revenues, net of allowance of $800,000 at
September 30, 1998 ............................ 958,115 1,472,075
Other receivables ................................ 403,374 405,336
Prepaid expenses and other ....................... 97,523 77,044
Asset held for sale .............................. 1,682,517 --
------------ ------------
Total current assets .............. 5,922,058 7,507,872
------------ ------------
PROPERTY AND EQUIPMENT:
Conversion systems ............................... 4,754,223 4,589,473
Building and improvements ........................ -- 1,744,499
Land ............................................. -- 230,000
Furniture and fixtures ........................... 240,992 205,602
------------ ------------
Total property and equipment ...... 4,995,215 6,769,574
Less- Accumulated depreciation ................... (4,631,806) (4,680,368)
------------ ------------
Net property and equipment ........ 363,409 2,089,206
------------ ------------
OTHER, net ......................................... 481,314 472,490
------------ ------------
Total assets ...................... $ 6,766,781 $ 10,069,568
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
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<PAGE>
DOCUCON, INCORPORATED
BALANCE SHEETS (Continued)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
LIABILITIES AND STOCKHOLDERS' EQUITY (UNAUDITED)
------------ ------------
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable ................................. $ 296,828 $ 482,076
Accrued liabilities .............................. 695,427 616,615
Taxes payable .................................... 95,125 191,000
Preferred stock dividends payable ................ 88,815 --
Revolving term note .............................. -- 504,000
Current maturities of long-term debt ............. 1,492,735 30,722
Current maturities of capital lease obligations .. 20,830 15,798
Other current liabilities ........................ 56,469 --
Deferred revenues ................................ 149,351 --
------------ ------------
Total current liabilities .............. 2,895,580 1,840,211
------------ ------------
LONG-TERM DEBT ..................................... -- 1,485,079
------------ ------------
CAPITAL LEASE OBLIGATIONS .......................... 62,422 49,547
------------ ------------
OTHER LONG-TERM OBLIGATIONS ........................ 284,864 --
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value, 10,000,000
shares authorized-
Series A, 60 shares authorized, 7 and 12 shares
outstanding as of September 30, 1998, and
December 31, 1997, respectively ............... 7 12
Common stock, $.01 par value, 25,000,000 shares
authorized; 3,327,366 and 3,260,889 shares
outstanding as of September 30, 1998, and
December 31, 1997, respectively ................. 33,424 32,609
Additional paid-in capital ....................... 10,073,834 10,069,173
Accumulated deficit .............................. (6,558,798) (3,407,063)
Treasury stock, at cost, 15,100 shares and 0
shares as of September 30, 1998, and December 31,
1997, respectively .............................. (24,552) --
Total stockholders' equity ............. 3,523,915 6,694,731
------------ ------------
Total liabilities and stockholders'
equity ................................ $ 6,766,781 $ 10,069,568
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
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<PAGE>
DOCUCON, INCORPORATED
STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
OPERATING REVENUES ................................. $ 591,786 $ 1,317,352 $ 2,074,764 $ 5,903,083
----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Production ....................................... 600,404 855,515 1,957,368 3,818,692
Research and development ......................... 63,045 41,004 187,689 128,447
General and administrative ....................... 1,510,196 286,064 2,133,358 787,143
Marketing ........................................ 333,089 123,726 656,952 477,277
Depreciation and amortization .................... 84,873 104,688 256,270 327,361
----------- ----------- ----------- -----------
2,591,607 1,410,997 5,191,637 5,538,920
----------- ----------- ----------- -----------
OPERATING INCOME (LOSS) FROM CONTINUING
OPERATIONS ....................................... (1,999,821) (93,645) (3,116,873) 364,163
OTHER INCOME (EXPENSE):
Interest income .................................. 41,102 -- 155,430 --
Interest expense ................................. (40,433) (52,094) (112,538) (151,290)
Other, net ....................................... 5,935 10,152 22,061 39,430
----------- ----------- ----------- -----------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES ..................................... (1,993,217) (135,587) (3,051,920) 252,303
Income tax expense ............................... -- -- 11,000 12,000
----------- ----------- ----------- -----------
NET INCOME (LOSS) FROM CONTINUING OPERATIONS ....... (1,993,217) (135,587) (3,062,920) 240,303
Preferred stock dividend requirements ............ 6,149 11,688 22,649 36,439
----------- ----------- ----------- -----------
NET INCOME (LOSS) FROM CONTINUING OPERATIONS
APPLICABLE TO COMMON STOCKHOLDERS ................ (1,999,366) (147,275) (3,085,569) 203,864
Loss from discontinued operations ................ -- (281,983) -- (639,874)
----------- ----------- ----------- -----------
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS ......... $(1,999,366) $ (429,258) $(3,085,569) $ (436,010)
=========== =========== =========== ===========
Basic earnings (loss) from continuing
operations per common share ..................... $ (.60) $ (.05) $ (.94) $ .07
Basic loss from discontinued operations per
common share .................................... -- (.09) -- (.21)
----------- ----------- ----------- -----------
BASIC LOSS PER COMMON SHARE ........................ $ (.60) $ (.14) $ (.94) $ (.14)
=========== =========== =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING ...................................... 3,311,951 3,111,827 3,296,970 3,100,368
=========== =========== =========== ===========
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<PAGE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
-------------------------------- --------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
Diluted earnings (loss) from continuing
operations per common share and common share
equivalents ......................................... $ (.60) $ (.05) $ (.94) $ .06
Diluted loss from discontinued operations per
common share and common share equivalents ........... -- (.09) -- (.20)
------------- ------------- ------------- -------------
DILUTED LOSS PER COMMON SHARE AND COMMON SHARE
EQUIVALENTS .......................................... $ (.60) $ (.14) $ (.94) $ (.14)
============= ============= ============= =============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND
COMMON SHARE EQUIVALENTS OUTSTANDING ................. 3,311,951 3,111,827 3,296,970 3,208,521
============= ============= ============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
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<PAGE>
DOCUCON, INCORPORATED
STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) from continuing operations ........... $(3,062,920) $ 240,303
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities-
Depreciation and amortization ....................... 256,270 327,361
Allowance for unbilled revenues ..................... 800,000 --
Noncash compensation accrual ........................ 341,333 --
Changes in current assets and current liabilities-
Decrease in receivables and unbilled revenues ...... 88,302 915,340
(Increase) decrease in prepaid expenses and other .. (41,162) 26,579
Decrease in accounts payable and accrued liabilities (106,436) (959,844)
Decrease in taxes payable .......................... (95,875) (11,554)
Increase (decrease) in deferred revenues ........... 149,351 (20,300)
----------- -----------
Net cash provided by (used in) operating
activities ............................................... (1,671,137) 517,885
----------- -----------
NET CASH USED BY DISCONTINUED OPERATIONS ................. -- (591,878)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ................................... (172,386) (90,048)
----------- -----------
Net cash used in investing activities ........ (172,386) (90,048)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances under line of credit .......................... -- 2,408,500
Payments under line of credit .......................... (504,000) (2,433,500)
Principal payments under capital lease obligations ..... (10,969) (10,202)
Net proceeds from exercise of stock options ............ 5,602 7,882
Proceeds from issuing notes payable .................... -- 45,000
Principal payments on long-term debt ................... (23,066) (22,968)
Purchase of treasury stock ............................. (24,552) --
----------- -----------
Net cash used in financing activities ........ (556,985) (5,288)
----------- -----------
NET DECREASE IN CASH AND TEMPORARY CASH INVESTMENTS ...... (2,400,508) (169,329)
CASH AND TEMPORARY CASH INVESTMENTS, beginning of period . 4,597,183 198,152
----------- -----------
CASH AND TEMPORARY CASH INVESTMENTS, end of period ....... $ 2,196,675 $ 28,823
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Noncash investing and financing activities-
Capital lease obligations incurred .................... $ 28,877 $ 16,240
=========== ===========
Preferred stock dividends payable ..................... $ 88,815 $ --
=========== ===========
Cash paid during the period for-
Interest .............................................. $ 113,309 $ 163,953
=========== ===========
Income taxes .......................................... $ 106,875 $ 3,711
=========== ===========
</TABLE>
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<PAGE>
DOCUCON, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
NOTE 1
The financial statements included herein have been prepared by Docucon,
Incorporated (the Company), without audit, pursuant to the rules and regulations
of the Securities and Exchange Commission. However, all adjustments have been
made which are, in the opinion of the Company, necessary for a fair presentation
of the results of operations for the periods covered. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the disclosures are adequate to make the information presented not
misleading. It is recommended that these financial statements be read in
conjunction with the financial statements and the notes thereto included in the
Company's Annual Report on Form 10-KSB for the fiscal year ended December 31,
1997. Certain reclassifications have been made in the prior period financial
statements to conform with the current period presentation.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make certain 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 results could differ from those estimates.
Since its inception, the Company has incurred cumulative net losses of
approximately $6.6 million. The cumulative net losses have been funded primarily
through the Company's public offering of common stock, issuances of preferred
stock, the exercise of warrants and options, debt financing and the sale of its
software division in the fourth quarter of 1997 for $6.5 million. The Company
has taken steps which it believes will improve its operating results including
selling its software division and focusing on the Company's document conversion
business. While the current quarter's operating loss is unsettling, management
believes that it has taken proper steps to significantly improve the Company's
operating results. Particularly encouraging to management are the initial
results from new marketing efforts in both the federal and commercial arenas.
Expansion of these efforts has been made to include a wide range of vertical
markets and partnering agreements within related industries. The Company's
management believes that it is likely that the Company's operating results for
the remainder of 1998 will improve and will generate sufficient working capital,
along with available cash, to sustain its operations throughout the year.
However, there can be no assurances that the Company's focus on marketing
efforts will improve its operating results.
NOTE 2
Discontinued operations-
In November 1997, the Company sold its software division to a third party for
$6.5 million. Included in other current receivables and in other, net, on the
accompanying balance sheets are escrowed amounts of approximately $400,000 each
related to the sale of the software division. These escrowed funds secure the
payment of any liability of the Company to the purchaser under the terms of the
purchase agreement and are scheduled to be released to the Company in the amount
of $400,000 in November 1998 and $400,000 in November 1999. Management of the
Company believes that the entire $800,000 held in escrow will be paid to
-8-
<PAGE>
DOCUCON, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (Continued)
the Company. Including the escrowed funds, net cash proceeds after expenses
relating to the sale were approximately $5.7 million. As a result of the sale,
the division has been accounted for as a discontinued operation and,
accordingly, the Company has restated its financial statements for all periods
presented in accordance with Accounting Principle Board Opinion No. 30. The
following table provides certain information related to the discontinued
operation:
THREE NINE
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1997
------------------ ------------------
Revenues ............................... $ 580,741 $ 1,880,621
=========== ===========
Loss from discontinued operations ...... $ (281,983) $ (639,874)
=========== ===========
NOTE 3
Substantially all of the Company's unbilled revenues at September 30, 1998, and
December 31, 1997, relate to conversion services performed for agencies of the
U.S. Government. The Company's ability to invoice these unbilled revenues is
dependent upon a number of factors including quality control acceptance and the
availability of funding to the respective agencies. The Company was contacted in
mid-1997 and informed that funding for certain conversion services being
performed had been depleted. Work that had been placed in production at that
time was completed despite the lack of assurance that funding would become
available. As a result, the Company has been unable to invoice approximately
$1.2 million of conversion services that were performed during 1997. The
conversion products associated with the $1.2 million of unbilled revenues have
been shipped to the customer and are in various stages of quality control
review. During the three and nine months ended September 30, 1998, the Company
recognized $0 and $370,000, respectively, in additional unbilled revenues
relating to additional conversion services performed through September 1998.
There can be no assurances that the customer will accept all of the work product
nor are there any assurances that sufficient funding will be made available to
enable the Company to invoice the unbilled revenues. Management of the Company,
based upon its past operating history and its ongoing discussions with various
governmental personnel regarding the availability of additional funding,
believes that all of such unbilled revenues totaling approximately $1.6 million
represent valid assets of the Company. However, due to the continued aging of
the unbilled revenues, the Company believed it was prudent to provide an
allowance on these unbilled revenues of $800,000 during the three months ended
September 1998. This allowance is reflected as a component of general and
administrative expense in the accompanying statements of operations. The
inability of the Company to realize its remaining unbilled revenues would have a
material adverse effect on the Company's future results of operations and its
financial position.
NOTE 4
Common stock and preferred stock-
Each share of the Company's preferred stock ($25,000 stated value) is
convertible into 8,334 shares of common stock and earns cash dividends of 11
percent per annum. Each share of preferred stock is entitled to vote 8,334
common shares. The Company has never paid cash dividends on its common stock and
does not anticipate the payment of cash dividends on its common stock in the
foreseeable future. The Company currently anticipates that any future earnings
will be retained to finance the Company's operations. Under
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<PAGE>
the terms of the Company's preferred stock, the Company cannot pay dividends on
its common stock until all accumulated but unpaid dividends on such preferred
stock have been paid. As of September 30, 1998, cumulative undeclared dividends
on the preferred stock approximated $243,000. The Company anticipates that it
will pay approximately $88,000 of cumulative dividends on preferred stock during
the fourth quarter of 1998. As the remainder of these dividends are undeclared,
they have not been recorded as a reduction of the Company's equity. Common stock
is subordinate to preferred stock in the event of liquidation.
Treasury stock-
On June 18, 1998, the Company announced the board of directors authorized the
repurchase of up to 500,000 shares of the Company's common stock in the open
market. As of September 30, 1998, the Company has acquired 15,100 treasury
shares for $24,552.
Reverse stock split-
In June 1998, the Company's board of directors approved a one-for-four reverse
common stock split. Accordingly, all common stock and share information has been
adjusted to reflect the reverse stock split.
NOTE 5
Time Accelerated Restricted Stock Award Plan
(TARSAP) and stock option grants-
In April 1998, the Company's board of directors granted options to certain
members of the Company's senior management, subject to shareholder approval, to
purchase 125,000 shares of the Company's common stock at an exercise price of $4
per share under a TARSAP. Additionally, in April 1998, the Company appointed a
new president and chief executive officer. The Company's board of directors
granted this employee options, subject to shareholder approval, to purchase
225,000 shares of the Company's common stock at an exercise price of $4 per
share under a TARSAP. Fifty thousand of the TARSAP options vest and become
exercisable in September 2001 while the remainder vest and become exercisable in
March 2005. Vesting and exercisability of the TARSAP options is accelerated, in
20,000 share increments, for each $2 per share incremental increase in the
quoted market price per share of the Company's common stock above $4 per share.
In April 1998, the Company's board of directors approved conditional stock
option grants to certain members of the Company's senior management. The
conditional grants provide that, for each $2 per share increase in the quoted
market value of the Company's common stock above $4 per share (up to $40 per
share), the employees shall receive options to purchase shares of the Company's
common stock as follows:
OPTIONS TO BE
GRANTED FOR
EMPLOYEE EACH $2 INCREASE TERM
-------- ---------------- ----
A 12,500 7 years
B 4,167 7 years
Each option will expire 10 years after date of grant. The conditions and option
price for each grant will be determined by a committee to be selected by the
Company's board of directors.
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<PAGE>
NOTE 6
Debt covenants and asset held for sale-
As a result of the disposition of the Company's software division in 1997, in
April 1998, certain of the affirmative covenants relating to the Company's
mortgage note payable to a financial institution were modified. The note
agreement contains various affirmative and negative covenants and requires the
Company to maintain (as modified and as defined in the note agreement): (i) a
current ratio of not less than 1:1, (ii) a debt-to-net worth ratio of not more
than .75:1, (iii) a quarterly debt coverage ratio of not less than 1.25:1
beginning in the quarterly period ended September 30, 1998, and (iv) a minimum
tangible net worth of $5.5 million. Based upon operating results in the third
quarter of 1998, the Company was unable to maintain compliance with certain
affirmative financial covenants. As a result, the lender has the right to demand
immediate repayment of the entire amount outstanding. Accordingly, all amounts
due this lender have been classified as a current liability at September 30,
1998. In connection with obtaining modifications to the note agreement, the
Company was required to reserve, out of its cash balances, one year's worth of
debt service payments of approximately $173,000. Subsequent to September 30,
1998, the Company obtained a waiver from its lender for additional indebtedness
that was incurred relating to a new capital lease. The mortgage note payable is
secured by substantially all of the Company's assets including the Company's
office building. Management of the Company has decided to sell the building and
believes that it will be sold during 1998 or early 1999 at an amount exceeding
net book value and, accordingly, the carrying value of the land, building and
associated improvements have been classified as a current asset held for sale at
September 30, 1998. The Company would be required to pay the mortgage note
payable with proceeds from the disposition of the building. In November 1998,
the Company entered into a contract to sell the building for an amount in excess
of its net book value and the related mortgage note payable. The contract
includes provisions for the buyer to lease the building back to the Company on a
short-term basis while the Company locates a replacement facility. Management of
the Company believes that suitable replacement facilities will be available.
NOTE 7
Earnings (loss) per share-
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per
Share." SFAS No. 128 replaces the presentation of Primary Earnings Per Share
(EPS) with Basic EPS and requires dual presentation of Basic and Diluted EPS on
the face of the statements of operations. Basic EPS excludes dilution and is
computed by dividing income (loss) available to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
Company. SFAS No. 128 is effective for financial statements issued after
December 15, 1997, and, accordingly, the accompanying financial statements
reflect the adoption of SFAS No. 128. As the Company had a net loss from
continuing operations for the three months and nine months ended September 30,
1998, and the three months ended September 30, 1997, Diluted EPS equals Basic
EPS as potentially dilutive common stock equivalents are antidilutive in loss
periods. Prior period EPS data has been
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<PAGE>
restated as required by SFAS No. 128. The following table provides a
reconciliation of the denominator (weighted average number of common shares and
common share equivalents outstanding) used to compute Basic and Diluted EPS and
the number of common share equivalents relating to preferred stock that have
been excluded as a result of antidilution:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted average number of common
shares outstanding for Basic EPS 3,311,951 3,111,827 3,296,970 3,100,368
Weighted average incremental shares
outstanding upon assumed
conversion of dilutive options
and warrants .................... -- -- -- 108,153
Weighted average incremental shares
outstanding upon assumed
conversion of dilutive preferred
shares .......................... -- -- -- --
--------- --------- --------- ---------
Weighted average number of common
shares and common share
equivalents outstanding for
Diluted EPS ..................... 3,311,951 3,111,827 3,296,970 3,208,521
========= ========= ========= =========
Potential common shares from
assumed conversion of preferred
shares excluded as a result of
antidilution .................... 78,541 141,665 92,774 146,957
========= ========= ========= =========
</TABLE>
NOTE 8
Commitments-
In April 1998, the Company appointed a new president and chief executive
officer. The Company and the employee have entered into a seven-year employment
agreement providing for base compensation of $200,000 per year. The employment
agreement is terminable by either party with 30 days notice. In the event the
employee were to be terminated by the Company without cause, the Company would
be required to make a severance payment of $300,000.
In September 1998, the Company granted early retirement to a member of senior
management and terminated the related employment agreement. The employee will be
retained as a consultant to the Company for a period of two years following his
retirement in September 1998 at the rate of $2,500 per month. For the same
two-year period during the employee's consultancy, he will receive retirement
pay at the rate of $5,500 per month. For a 10-year period following the
employee's consultancy, he will receive retirement pay at the rate of $2,500 per
month. The consulting payments will be expensed as the services are provided.
The present value of the post-retirement payments, discounted at 5 percent,
resulted in noncash compensation expense of $341,333 during the three months
ended September 30, 1998. The present value of the post-retirement obligation is
being recorded as other long-term obligations on the accompanying balance sheet,
with the current portion of $56,469 included as other current liabilities.
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<PAGE>
DOCUCON, INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The Company's operations during the quarter ended September 30, 1998, resulted
in a net loss applicable to common stockholders of $1,999,366 compared to a net
loss applicable to common stockholders of $429,258 for the same quarter in 1997.
The 1997 quarter included a loss from discontinued operations of $281,983. In
November 1997, the Company sold its software division to a third party for $6.5
million. The Company incurred a net loss applicable to common shareholders of
$3,085,569 for the nine months ended September 30, 1998, as compared to a net
loss of $436,010 for the same period in 1997. The 1997 period included a loss
from discontinued operations of $639,874.
Revenues from continuing operations decreased 55 percent to $591,786 for the
quarter ended September 30, 1998, as compared to the same quarter in 1997.
Revenues from continuing operations decreased 65 percent to $2,074,764 for the
nine-month period ended September 30, 1998, as compared to the 1997 nine-month
period. The decrease in both periods is due to what management believes to be a
temporary discontinuation of funding for a specific project being performed
under a Department of Defense (DOD) contract.
Production costs from continuing operations decreased 30 percent and 49 percent,
respectively, for the quarter and nine months ended September 30, 1998, as
compared to the 1997 periods due to the decreased revenue levels.
Research and development costs from continuing operations increased 54 percent
and 46 percent, respectively, for the quarter and nine months ended September
30, 1998, compared to the same periods in 1997 as the Company continues to
devote resources to the development of new conversion capabilities.
General and administrative expenses, net of charges of approximately $340,000
related to the buyout of an employment agreement and $800,000 related to an
allowance for doubtful collection associated with unbilled revenues, increased
32 percent and 26 percent, respectively, for the three- and nine-month periods
ended September 30, 1998, as compared to the same periods in 1997. The increases
are due to increased expenses associated with the transition to new management,
and the northeast U.S. corporate office presence discussed below, as well as the
Company's annual shareholder meeting and the related proxy solicitation.
Marketing expenses from continuing operations increased 169 percent and 38
percent for the quarter and nine months ended September 30, 1998, respectively,
as compared to the same periods in 1997. The increase in expense is due to
extensive new marketing efforts aimed at rebuilding the federal market and
developing a commercial market. The Company developed a federal marketing
organization in Washington, D.C., during the second quarter of 1998 and began
building its commercial organization headquartered in Wayne, PA, during the
third quarter of 1998.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company's operations have been primarily supplemented
through borrowings, capital lease agreements, an initial public offering of the
Company's common stock in 1989, the exercise of warrants and options, private
preferred stock placements and the sale of its software division in the fourth
quarter of 1997. As of September 30, 1998, the Company had positive working
capital of approximately $3.0 million and expects to fund its remaining 1998
operations and marketing activities through utilization of cash on hand.
-13-
<PAGE>
DOCUCON, INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Substantially all of the Company's unbilled revenues at September 30, 1998, and
December 31, 1997, relate to conversion services performed for agencies of the
U.S. Government. The Company's ability to invoice these unbilled revenues is
dependent upon a number of factors including quality control acceptance and the
availability of funding to the respective agencies. The Company was contacted in
mid-1997 and informed that funding for certain conversion services being
performed had been depleted. Work that had been placed in production at that
time was completed despite the lack of assurance that funding would become
available. As a result, the Company has been unable to invoice approximately
$1.2 million of conversion services that were performed during 1997. The
conversion products associated with the $1.2 million of unbilled revenues have
been shipped to the customer and are in various stages of quality control
review. During the three and nine months ended September 30, 1998, the Company
recognized $0 and $370,000, respectively, in additional unbilled revenues
relating to additional conversion services performed through September 1998.
There can be no assurances that the customer will accept all of the work product
nor are there any assurances that sufficient funding will be made available to
enable the Company to invoice the unbilled revenues. Management of the Company,
based upon its past operating history and its ongoing discussions with various
governmental personnel regarding the availability of additional funding,
believes that all of such unbilled revenues totaling approximately $1.6 million
represent valid assets of the Company. However, due to the continued aging of
the unbilled revenues, the Company believed it was prudent to provide an
allowance on these unbilled revenues of $800,000 during the three months ended
September 1998. This allowance is reflected as a component of general and
administrative expense in the accompanying statements of operations. The
inability of the Company to realize its remaining unbilled revenues would have a
material adverse effect on the Company's future results of operations and its
financial position.
In 1998, the Company has performed services under two DOD contracts. One
contract was awarded in 1996 and extended through April 1998. The other contract
was awarded in December 1997 for a term of one year with four additional option
years. The contracts have a potential value of $77.8 million. However, there can
be no assurances that the full potential value of the contracts will be realized
or that the terms of the latest contract will extend through the optional years.
In March 1998, the General Services Administration (GSA) awarded a Federal
Supply Schedule to the Company which is effective until September 30, 2002.
Federal Supply Schedules are centralized contracts established by the GSA for
the use of all government agencies. There are no limitations to order size or
cumulative order value under such contracts. Under the Federal Supply Schedule
awarded to the Company, any government agency can buy a wide variety of document
conversion services directly from the Company. The Company began providing
services under the GSA during the second quarter of 1998. The DOD and GSA
contracts referred to herein enable the Company to act as an approved vendor
within Federal Government markets. They do not, in and of themselves, represent
purchase orders for work to be completed nor do they receive direct funding. The
Company markets directly to customers within the Federal Government to obtain
such funded orders.
In March 1994, the Company purchased the assets and assumed certain liabilities
of J. Feuerstein Systems. In November 1997, the Company sold the assets of the
division to Bowne & Co., Inc., for $6.5 million. A total of $800,000 was placed
in an escrow account as security for certain representations and warranties made
to the buyer. Management does not anticipate any material claims to be made
against the representations and warranties and expects the funds will be
released from escrow on November 25, 1998, and November 25, 1999, in two amounts
of $400,000 each. Including the escrowed funds, net cash proceeds after expenses
relating to the sale were approximately $5.7 million. Cash proceeds were used to
pay down the Company's $504,000 line-of-credit balance after the 1997 year-end
and to fund continuing operations. The Company plans to invest excess proceeds
in short-term securities which would be available for capital or operational
needs.
-14-
<PAGE>
DOCUCON, INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
In October 1996, the Company obtained long-term financing to replace the
existing mortgage note for its office building with a December 1996 maturity.
The new note bears interest at a fixed rate of 9.5 percent, payable monthly to a
commercial bank, and is being amortized over a 20-year term with a 5-year
maturity. The note is secured by the Company's building, other fixed assets,
accounts receivable and inventory. Approximately $68,000 of debt issuance costs
were incurred in connection with this refinancing. In April 1998, certain of the
affirmative covenants relating to this note were modified. Based upon operating
results in the third quarter of 1998, the Company was unable to maintain
compliance with certain affirmative financial covenants. As a result, the lender
has the right to demand immediate repayment of the entire amount outstanding.
Accordingly, all amounts due this lender have been classified as a current
liability at September 30, 1998. In connection with obtaining modifications to
the note agreement, the Company was required to reserve, out of its cash
balances, one year's worth of debt service payments of approximately $173,000.
During 1998, management of the Company decided to list the building for sale.
Although the current facility is satisfactory, management believes that certain
production efficiencies can be achieved by utilizing single- or double-level
production space as opposed to the existing high-rise configuration. Management
of the Company believes that the building will be sold during 1998 or early 1999
at an amount exceeding net book value and, accordingly, the carrying value of
the land, building and associated improvements have been classified as a current
asset held for sale at September 30, 1998. The Company would be required to pay
the mortgage note payable with proceeds from the disposition of the building. In
November 1998, the Company entered into a contract to sell the building for an
amount in excess of its net book value and the related mortgage note payable.
The contract includes provisions for the buyer to lease the building back to the
Company on a short-term basis while the Company locates a replacement facility.
Management of the Company believes that suitable replacement facilities will be
available.
On March 31, 1998, the Company received notice that it was subject to delisting
on the NASDAQ SmallCap Market System because the Company's average closing bid
price per share had not exceeded $1.00 during the prior 30-day period. The
Company effected a one-to-four reverse split of its common stock on June 12,
1998. On June 29, 1998, the Company received notification that the Company was
deemed to be in compliance with the new bid requirement for continued listing on
The Nasdaq Stock MarketSM. On June 18, 1998, the Company announced the board of
directors authorized the repurchase of up to 500,000 shares of its common stock
in the open market. Through October 28, 1998, the Company had repurchased 33,500
such shares at prices varying from $29/32 to $2-1/16.
The efficient operations of the Company's business is dependent on its computer
software programs and operating systems (collectively, Programs and Systems).
These Programs and Systems are used in several key areas of the Company's
business, including information management services and financial reporting, as
well as in various administrative functions. The Company has been evaluating its
Programs and Systems to identify potential year 2000 compliance problems, as
well as manual processes, external interfaces with customers and services
supplied by vendors to coordinate year 2000 compliance and conversion. The year
2000 problem refers to the limitations of the programming code in certain
existing software programs to recognize data-sensitive information for the year
2000 and beyond. Unless modified prior to the year 2000, such systems may not
properly recognize such information and could generate erroneous data or cause a
system to fail to operate properly.
-15-
<PAGE>
DOCUCON, INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Based on current information, the Company expects to attain year 2000 compliance
and institute appropriate testing of its modifications and replacements in a
timely fashion and in advance of the year 2000 date change. It is anticipated
that modification or replacement of the Company's Programs and Systems will be
performed in-house by Company personnel. The Company believes that, with
modifications to existing software and conversions to new software, the year
2000 problem will not pose a significant operational problem for the Company.
However, because most computer systems are, by their very nature,
interdependent, it is possible that noncompliant third-party computers may not
interface properly with the Company's computer systems. The Company could be
adversely affected by the year 2000 problem if it or unrelated parties fail to
successfully address this issue. Management of the Company currently anticipates
that the expenses and capital expenditures associated with its year 2000
compliance project will not have a material effect on its financial position or
results of operations.
-16-
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders -
Item 5. Other Matters - None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 11 - Computation of Earnings Per Share
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K - None
-17-
<PAGE>
SIGNATURES
Pursuant to the requirements 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.
DOCUCON, INCORPORATED
(Registrant)
By /s/ DOUGLAS P. GILL
Douglas P. Gill,
President and Chief
Executive Officer
By /s/ LORI TURNER
Lori Turner,
Chief Financial Officer
and Treasurer
Dated: November 12, 1998
-18-
EXHIBIT 11
DOCUCON, INCORPORATED
COMPUTATION OF EARNINGS PER SHARE
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
------------------------------------ -----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
COMPUTATION OF BASIC EARNINGS (LOSS) PER
SHARE:
Net income (loss) from continuing operations $(1,993,217) $ (135,587) $(3,062,920) $ 240,303
Less- Preferred stock dividend requirements (6,149) (11,688) (22,649) (36,439)
----------- ----------- ----------- -----------
Net income (loss) from continuing
operations applicable to common
stockholders ............................. (1,999,366) (147,275) (3,085,569) 203,864
Loss from discontinued operations ......... -- (281,983) -- (639,874)
----------- ----------- ----------- -----------
Net income applicable to common
stockholders ............................. $(1,999,366) $ (429,258) $(3,085,569) $ (436,010)
=========== =========== =========== ===========
WEIGHTED AVERAGE NUMBER OF SHARES OF
COMMON STOCK OUTSTANDING ..................... 3,311,951 3,111,827 3,296,970 3,100,368
=========== =========== =========== ===========
Basic earnings (loss) from
continuing operations per common
share ..................................... $ (.60) $ (.05) $ (.94) $ .07
Basic loss from discontinued
operations per common share ............... -- (.09) -- (.21)
----------- ----------- ----------- -----------
BASIC EARNINGS (LOSS) PER COMMON SHARE ......... $ (.60) $ (.14) $ (.94) $ (.14)
=========== =========== =========== ===========
COMPUTATION OF DILUTED EARNINGS (LOSS)
PER SHARE:
Net income (loss) from continuing
operations .................................. $(1,993,217) $ (135,587) $(3,062,920) $ 240,303
Preferred stock dividend requirements ........ (6,149) (11,688) (22,649) (36,439)
Increase applicable to common stock
for preferred stock dividends not
incurred upon assumed conversion of
preferred stock ............................. 6,149 11,688 22,649 36,439
----------- ----------- ----------- -----------
Net income (loss) from continuing
operations applicable to common
stockholders used for computation ......... (1,993,217) (135,587) (3,062,920) 240,303
Net (loss) from discontinued operations
applicable to common stockholders ........... -- (281,983) -- (639,874)
----------- ----------- ----------- -----------
Net income (loss) applicable to common
stockholders used for computation ........... $(1,993,217) $ (417,570) $(3,062,920) $ (399,571)
=========== =========== =========== ===========
Weighted average number of shares of
common stock outstanding .................... 3,311,951 3,111,827 3,296,970 3,100,368
Weighted average incremental shares
outstanding upon assumed conversion of
options and warrants ........................ -- 74,981 17,694 108,153
Weighted average incremental shares
outstanding upon assumed conversion of
the preferred stock ......................... 78,541 141,665 92,774 146,957
----------- ----------- ----------- -----------
WEIGHTED AVERAGE NUMBER OF SHARES OF
COMMON STOCK AND COMMON STOCK
EQUIVALENTS OUTSTANDING USED FOR
COMPUTATION .................................. 3,390,492 3,328,473 3,407,438 3,355,478
=========== =========== =========== ===========
Diluted earnings (loss) from
continuing operations per common
share and common share equivalents ........ $ (.59) $ (.04) $ (.90) $ .07
Diluted loss from discontinued
operations per common share and
common share equivalents .................. -- (.08) -- (.19)
----------- ----------- ----------- -----------
DILUTED EARNINGS (LOSS) PER COMMON SHARE
AND COMMON SHARE EQUIVALENTS ................. $ (.59)(a) $ (.12)(a) $ (.90)(a) $ (.12)
=========== =========== =========== ===========
</TABLE>
(a) This calculation is submitted in accordance with Item
601(b)(11) of Regulation S-K although it is not required by
SFAS No. 128 because it is antidilutive.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM DOCUCON,
INCORPORATED'S CONDENSED BALANCE SHEET AS OF SEPTEMBER 30, 1998, AND ITS
CONDENSED STATEMENT OF OPERATIONS FOR THE NINE MONTHS THEN ENDED AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,196,675
<SECURITIES> 0
<RECEIVABLES> 2,749,787
<ALLOWANCES> (804,444)
<INVENTORY> 0
<CURRENT-ASSETS> 5,922,058
<PP&E> 4,995,215
<DEPRECIATION> (4,631,806)
<TOTAL-ASSETS> 6,766,781
<CURRENT-LIABILITIES> 2,895,580
<BONDS> 347,286
0
7
<COMMON> 33,424
<OTHER-SE> 3,490,484
<TOTAL-LIABILITY-AND-EQUITY> 6,766,781
<SALES> 2,074,764
<TOTAL-REVENUES> 2,074,764
<CGS> 1,957,368
<TOTAL-COSTS> 5,191,637
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 112,538
<INCOME-PRETAX> (3,051,920)
<INCOME-TAX> 11,000
<INCOME-CONTINUING> (3,062,920)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,085,569)
<EPS-PRIMARY> (.94)
<EPS-DILUTED> (.94)
</TABLE>
