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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB/A-2
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended SEPTEMBER 30, 1995
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to _________
Commission File Number: 0-21142
NEMATRON CORPORATION
(Name of small business issuer in its charter)
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<S> <C>
MICHIGAN 38-2483796
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
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5840 INTERFACE DRIVE, ANN ARBOR, MICHIGAN 48103
(Address of principal executive offices) (Zip Code)
(313) 994-0501
(Issuer's telephone number)
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, NO PAR VALUE
(Title of class)
Check whether the issuer (1) 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 (2) has been subject to such filing requirements for the
past 90 days. [X] Yes [ ] No
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. [ ]
Issuer's revenues for its most recent fiscal year: $17,576,305
The aggregate market value of the voting stock held by non-affiliates as
of December 8, 1995, computed by reference to the closing price of such stock
on such date as quoted on the NASD SmallCap Market, was approximately
$12,196,000.
The number of shares outstanding of the issuer's Common Stock on December 8,
1995 was 2,869,613.
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The Registrant hereby amends its Form 10-KSB for the fiscal year ended
September 30, 1995 to amend and restate Items 3, 6, 7 and 8 as set forth below:
ITEM 3. LEGAL PROCEEDINGS.
On September 20, 1995, Xycom, Inc. filed suit against the Company and UAI
in the Circuit Court for the County of Washtenaw, State of Michigan. The suit
alleges that UAI, a company acquired via merger into NemaSoft, Inc., a
wholly-owned subsidiary of the Company, disclosed confidential information of
Xycom to NemaSoft and the Company, and failed to notify Xycom of the transfer
of certain intellectual property to NemaSoft. In the complaint, Xycom contends
that, upon receipt of such notice, it would have been entitled to either
negotiate with NemaSoft for a royalty-free license to use the intellectual
property or to exercise a right of first refusal for the purchase of the
intellectual property. The suit also alleges that Nematron interfered with
Xycom's contractual relations with UAI. The suit seeks unspecified damages and
injunctive relief based on allegations of, among other things, breach of trade
secrets and tortuous interference with contractual relations. The suit also
seeks to enjoin the use of certain marketing, business and other non-technical
information which it alleges constitutes trade secrets and to unwind the merger
of UAI into NemaSoft. The Company and NemaSoft filed answers denying all
material allegations made by Xycom, and NemaSoft filed a countersuit against
Xycom. The Company and NemaSoft believe the allegations made by Xycom are
without merit. Although the Company cannot predict the likely outcome of the
lawsuit at this preliminary stage of proceedings, management believes that,
even if the Company does not prevail, the ultimate disposition of these matters
will not have a material adverse effect on the Company's business, financial
position or operations. The Company and NemaSoft intend to assert their
positions vigorously in litigation.
The Company is not involved in any other legal proceedings considered by
management to be other than routine litigation incidental to its business, and
management does not believe any such litigation to be material.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS
OVERVIEW
The Company generated net income in fiscal 1995 after incurring net losses
for each of the five fiscal years ended September 30, 1990 through 1994. The
return to profitable operations in fiscal 1995 was due to successful
implementation beginning in October 1994 of a turnaround plan that affected
virtually all areas of the Company. Due to cash required to fund losses
generated in the immediately preceding two years, by October 1994, the
Company's working capital had been eroded and the Company was generally unable
to generate sufficient funds with which to purchase required inventories and to
keep current with its vendor payments. A key component of the turnaround plan
was to obtain additional funds through an expansion of the Company's bank line
of credit and the incurrence of subordinated debt through a private placement.
The Company's turnaround plan also included, among other things, a reduction of
staff by over 20%, a wage freeze and/or salary decreases for all personnel,
implementation of improved financial and operating controls, entering into
extended payment terms with certain key vendors, strengthening its sales and
distribution network, upgrading its financial, engineering and marketing
staffs, and realigning corporate responsibilities. Later in fiscal 1995, the
Company replaced certain members of management, continued to improve operating
and financial controls, and implemented its corporate strategy to reduce
unprofitable product offerings, control its discounting policies, introduce
higher margin computers and hardware products, and shift its focus from relying
exclusively on computer and other hardware factory automation products to
increasing its revenues from sales of integrated hardware and software
solutions. In order to increase its revenues from integrated hardware and
software solution sales, the Company merged in March 1995 with Imagination
Systems, Inc. ("ISI") and acquired Universal Automation, Inc. ("UAI") in
September 1995, both of which companies develop and market software products.
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The turnaround plan described above has been substantially completed as of
mid - December, 1995, although adjustments of such actions will continue to
occur in the normal course of business. The Company intends to place
additional emphasis on foreign sales in fiscal 1996.
Management's continuing strategy is to incorporate software products
developed by ISI and UAI into the Company's product offerings and to vertically
integrate its product offerings to include both hardware and software products
related to industrial automation. The Company's marketing and sales efforts to
existing and new customers include stand-alone computers, software products and
bundled products. The Company intends to continue its shift of business away
from dominance by computer hardware sales, and will pursue the development of
existing and new software products. Additionally, the Company has identified
new markets for both hardware and software products, and will pursue new
business from customers which offer the greatest likelihood of large hardware
unit volume and/or large dollar volume from software products and licenses.
Management anticipates significant growth in the industrial software
marketplace and intends, through concentrated development and aggressive
marketing and sales efforts, to capture an increasing percentage of that
market.
The Company and its wholly owned subsidiary, NemaSoft, Inc., are defendants
in a lawsuit brought by one of its competitors, Xycom, Inc., seeking unspecified
damages based on allegations of, among other things, disclosure of trade secrets
and tortious interference with contractual relations. The suit also seeks to
enjoin the use of certain marketing, business and other non-technical
information which it alleges constitutes trade secrets and to unwind the merger
of UAI into NemaSoft. Although the Company cannot predict the likely outcome of
the lawsuit at this preliminary stage of the proceedings, management believes
that, even if the Company does not prevail, the ultimate disposition of these
matters will not have a material adverse effect on the Company's business,
financial condition or results of operations. There can be no assurance,
however, that the outcome of the litigation will not have a material adverse
effect on the Company's business, financial condition or results of operations.
The following discussion and analysis contains a number of "forward
looking statements" within the meaning of the Securities and Exchange Act of
1934, as amended, with respect to expectations for future periods which are
subject to various uncertainties explained herein.
FISCAL 1995 COMPARED TO FISCAL 1994
Net revenues were $17,576,000 in fiscal 1995 compared to $15,287,000 in
fiscal 1994. This represents an increase of $2,289,000, or 15.0%, compared to
fiscal 1994. Of the increase, $704,000, or 30.8%, was attributable to revenues
from the software sales, which were not material in fiscal 1994, and
$1,585,000, or 69.2% of the increase, was attributable to increases in sales of
Industrial Workstations(TM) and related parts and service. The increase in
sales of Industrial Workstations(TM) and related parts and service represented
an increase of 10.5% in fiscal 1995 over fiscal 1994, and resulted from both
price increases on several products and a reduction in discounts given to
certain distributors and direct sales accounts. Price increases, ranging from
1% to 20%, were made on a product by product basis and distributor discount
controls were established for specific accounts where needed. Both of these
activities were undertaken as part of the Company's turnaround plan initiated
in fiscal 1995. Foreign revenues increased in fiscal 1995 by $1,942,000, or
42.4%, over foreign revenues in fiscal 1994, reflecting the strong demand in
Europe and favorable customer response to increased marketing and sales efforts
expended by the Company over the last several years. Domestic revenues
increased in fiscal 1995 by $347,000, or 3.2%, over domestic revenues in fiscal
1994, due almost exclusively to revenues resulting from software sales.
Management expects that the growth in net revenues experienced in fiscal 1995
will continue at or near the fiscal 1995 rate as the initial response to the
Company's new products has been favorable, and the Company will continue to
place increased emphasis on marketing and sales efforts, especially to new
customers which have a the greatest likelihood for large hardware unit volume
and/or large dollar volume from software products and licenses. Also, software
sales from newly developed or acquired software products will be included in
Company revenues for a full year in fiscal 1996 versus being included for a
partial year in fiscal 1995. The Company's expectation of revenue growth is
also based on management's assumption and belief that the products introduced
in late fiscal 1995 and planned for release in fiscal 1996 are technologically
more advanced than certain comparably priced competing products and that the
expansion of the Company's product line will result in the addition of new
distributors to the Company's distribution network. The actual growth in net
revenues for fiscal 1996 is subject to a number of uncertainties, however. For
example, the marketplace may not respond favorably to the Company's sales and
marketing efforts, latent technological deficiencies in the new products may
reduce demand for the products, the anticipated interest of new distributors in
the Company's products may not come to fruition, or the technological advances
by competing products may reduce demand for the Company's products. The
occurrence of any of these events could result in the Company's net revenues
growing at a reduced rate or declining.
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Cost of revenues include costs related to raw materials and component
parts, direct labor, burden, amortization of capitalized software costs,
provisions for warranty expenses on products sold and provisions for excess and
obsolete inventory. There were no material changes in costs of raw materials,
direct labor or burden, but amortization of capitalized software costs
increased in relation to increases in software-related revenues in fiscal 1995
compared to fiscal 1994. In fiscal 1994 and 1995, the Company placed a
significantly increased emphasis on improving the overall quality of all
products assembled and shipped through improved manufacturing techniques,
placing higher quality standards on purchased materials, and improving shipping
and packaging methods. Additionally, in late fiscal 1994, the Company followed
industry trends and reduced its warranty period from an average of 30 months to
18 months. As a result of such actions, warranty expenses have decreased by
approximately $90,000 in fiscal 1995 compared to fiscal 1994, and the year-end
warranty reserve has decreased by approximately $110,000. As part of the
turnaround plan initiated in fiscal 1995, the Company altered its purchasing
practices and purchased raw materials in smaller quantities and more on a
"just-in-time" basis than in previous years. Also, the Company phased out its
product offerings only when it was economical to do so - i.e., when component
parts inventory for a potential phase-out product were minimal. As a result of
such actions, the need for a significant addition to the year-end provision for
excess and obsolete inventory was eliminated in fiscal 1995.
Gross profit increased in fiscal 1995 to $6,194,000, 35.2% of net
revenues, from $3,243,000, or 21.2% of net revenues in fiscal 1994. The
increase in gross profit in fiscal 1995 was due to implementation of the
Company's turnaround plan through increasing prices and/or decreasing discounts
for certain products and to certain major customers, the elimination of certain
low margin products from the Company's product offerings, and the increase in
sales of higher margin hardware and software products. In fiscal 1995, the
elimination of low margin products had the added benefit of reducing the number
of unique hardware components purchased and maintained in inventory. Further,
higher margin hardware and hardware bundled with software imbedded into the
product were emphasized in the Company's sales and marketing efforts. In
fiscal 1995 total gross profit improved due to the sales of such bundled
products and certain software products, primarily AutoNet software and the
related integration services resulting from the Company's merger with
Imagination Systems, Inc. ("ISI") in March 1995. Also, approximately $150,000
of revenue was recorded from sales of FloPro(R) software licenses resulting
from the Company's acquisition of Universal Automation, Inc. ("UAI") in
September 1995, and such sales of high margin software had a positive impact on
overall gross profit. The lower gross profit in fiscal 1994 was also the
result of increased provisions for warranty costs and for additional reserves
for excess and obsolete inventory; similar increases in provisions and reserves
were not required in fiscal 1995. Management expects that overall gross profit
will continue to improve, but at a slower rate than the growth rate experienced
in fiscal 1995. The expected increase in gross profit in fiscal 1996 is due to
the Company's continued shift away from lower margin hardware products, the
continued elimination of lower margin products and a favorable response to the
Company's marketing and sales efforts with respect to higher margin hardware
and software products. The actual gross profit growth rate for fiscal 1996 is
subject to various uncertainties, however. For example, the Company may be
unable to sustain product price increases implemented in fiscal 1995 if there
is a reduction in customer demand or a substantial decrease in competitors'
prices on comparable products, raw material prices may increase to an extent
that cannot be passed on to customers, or the Company's marketing efforts to
boost sales of higher margin products may not be successful. The occurrence of
any of these events would adversely affect the Company's gross profit.
Product development costs decreased in fiscal 1995 by $751,000, or 45.7%,
over the fiscal 1994 level, primarily due to write-offs of previously
capitalized software costs related to one major and several other smaller
projects in 1994, which were not required in fiscal 1995. A larger percentage
of the Company's software development efforts were capitalizable expenditures
in fiscal 1995 than in fiscal 1994. The most significant of these products was
the PowerVIEW(TM) product which was released in September 1995. Approximately
$494,000 more software development costs, primarily related to PowerVIEW(TM),
were capitalized in fiscal 1995 than in fiscal 1994. Included in the fiscal
1994 product development costs of $1,645,000 was a $440,000 write-off of
previously capitalized costs related to the abandonment in the fourth quarter
of fiscal 1994 of in-process software which was being developed in fiscal 1993
and fiscal 1994 and which was to be the basis for the Company's next generation
of industrial workstation products.
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In the fourth quarter of fiscal 1994 and prior to the issuance of its financial
statements, the Company completed its review and evaluation of its in-process
software. The Company determined that, although the in-process software would
accomplish its designed functions, it would be more economical and beneficial
to base the next generation of Company products on software that had been
developed by ISI. Consequently, the Company wrote off in the fourth quarter of
fiscal 1994 all costs associated with its internally developed software for the
applicable project. Product development expenses, which are a function of new
product research and development and existing product enhancement efforts, are
expected to increase over the fiscal 1995 level as a result of planned efforts
to update several existing products and plans to engage in additional research
efforts on new products and technologies. The actual level of product
development expense for fiscal 1996 is subject to various uncertainties,
including the Company's potential inability to attract and/or retain qualified
persons to perform the planned activities and the potential lack of available
cash to fund the planned activities. In addition, it is possible that research
and development efforts could proceed more quickly than anticipated and require
the Company to capitalize (rather than expense) the costs related to such
efforts.
Selling, general and administrative expenses in fiscal 1995 increased by
$397,000, or 9.2%, over the fiscal 1994 level, due principally to increased
marketing and sales efforts in the second half of the fiscal year undertaken to
achieve the sales growth discussed previously, including the sales and
marketing efforts needed for products acquired through the ISI merger and other
new product introductions, and for the expansion of the Company's sales force
and its distribution network. Also, the Company experienced certain increases
in general and administrative expenses due to the merger of the Company with
ISI in March 1995. The acquisition of UAI in September 1995 had an
insignificant impact on selling, general and administrative expenses in fiscal
1995. The Company's turnaround efforts included reductions early in fiscal
1995 of several selling, general and administrative personnel, and the
realization of certain efficiencies resulting from a realignment of
responsibilities. Additionally, the salaries of all officers and most middle
management personnel were reduced by between 5% and 20%, other salaries were
frozen, and to the extent practical, all non-essential spending was curtailed.
The rate of increase in selling, general and administrative expenses is
expected to approximate the growth rate in fiscal 1995. This expectation is
based upon planned increases in support staff and marketing staff, general cost
increases due to expanding marketing, sales and other activities and inclusion
of the cost of maintaining the Virginia facility for a full year in fiscal 1996
compared to a partial year in fiscal 1995. The actual rate of growth is
subject to various uncertainties, however. These include the Company's
potential inability to attract and retain qualified personnel as planned and
the potential need to curtail planned marketing and sales efforts and other
activities if the necessary funds are not available.
Interest expense in fiscal 1995 increased by $138,000 due to a combination
of higher borrowing levels which were necessary to fund fiscal 1994 losses and
the expansion of business in fiscal 1995. Average borrowings under the
Company's bank line of credit increased by $462,000 and the average interest
rate on such borrowings increased by 3.22%. Additionally, the Company
increased by $262,000 its borrowings under convertible subordinated notes for
most of fiscal 1995, borrowed $100,000 under a short term loan with a bank, and
borrowed $100,000 from former ISI shareholders for a portion of fiscal 1995.
In August 1995, the Company eliminated $200,000 of subordinated debt through
conversion of a convertible subordinated note into common stock, and entered
into a new term note collateralized by a mortgage. In September 1995, the
Company increased the amount of its available line of credit and has utilized a
portion of such increase. In November 1995 the Company repaid $444,000 of
convertible subordinated debt with proceeds of $1,800,000 of new subordinated
debt. The net effect of these transactions was an increase in total debt for
fiscal 1995 over fiscal 1994, and an increase in average debt outstanding for
fiscal 1996 is anticipated. Therefore, interest expense is expected to
increase in fiscal 1996.
Foreign currency gain totaled $73,700 in fiscal 1995 compared to $40,000
in fiscal 1994. The gain resulted in each period primarily from translating
the intercompany balance between the Company and its Netherlands-based wholly
owned subsidiary at year end exchange rates of U.S. dollars to the Dutch
guilder. Only the portion of the intercompany balance planned or anticipated
to be settled in the foreseeable future is subject to foreign exchange gain or
loss. The foreign currency gain has no effect on near term liquidity. While
the foreign currency gain has been significant to operations in fiscal 1995,
management does not expect the effect of foreign currency transactions to be
significant in fiscal 1996 as
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the intercompany balance which is subject to translation is reduced from the
levels maintained in fiscal 1995.
FISCAL 1994 COMPARED TO FISCAL 1993
Net revenues increased in fiscal 1994 by $3,045,000, or 24.9%, compared to
fiscal 1993. Of this total, $1,669,000, or 54.8% of the increase, was
attributable to the acquisition of selected assets related to the industrial
computer business section of Action instruments, Inc. a California company, in
October, 1993 (the "Action Acquisition").
Foreign sales increased in fiscal 1994 by $1,827,000, or 66.6%, over
foreign sales in fiscal 1993, reflecting the strong demand in Europe and the
increase in marketing and sales efforts expended by the Company over the last
two years.
Domestic sales increased in fiscal 1994 by $1,218,000, or 12.8%, over
domestic sales in fiscal 1993. The increase was due almost exclusively to
revenues resulting from the Action Acquisition.
Gross margins continued to decrease in fiscal 1994, declining to 21.2% in
fiscal 1994 from 25.1% in fiscal 1993. The decrease in gross margin in fiscal
1994 was attributable primarily to increased provisions for warranty costs and
for additional reserves for excess and obsolete inventory. In the fourth
quarter of fiscal 1994, available information was analyzed which allowed the
Company to better estimate its required warranty reserves in the United States
and Europe. Company management conducted a thorough review of its inventory
and determined that an additional reserve for excess and obsolete inventory of
$675,000 was required at year end.
Product development costs in fiscal 1994 increased by $1,093,000, or
198.1%, over the fiscal 1993 level, primarily due to write-offs of previously
capitalized software costs related to one major and several other smaller
projects. Included in the fiscal 1994 amount of $1,645,000 is $440,000 of
costs related to software which was being developed in fiscal 1993 and fiscal
1994 which was to be the basis for the Company's next generation of industrial
workstation products. In June 1994 the Company had entered into several
commercial arrangements with Imagination Systems, Inc., a Virginia based
software company ("ISI"). Under one of the arrangements, ISI agreed to
continue development of the software underlying the next generation of products
by combining the Nematron product under development with a similar ISI product
under development. Nematron agreed to partially fund the development of that
product. After completing its review and evaluation in the fourth quarter of
fiscal 1994 of the Company's in-process product, prior to the issuance of its
1994 financial statements, the Company determined that, although the software
it had developed was on track to accomplish its designed functions, it would be
more economical and beneficial to base the next generation of Company products
on software that had been developed by ISI rather than on the Company's
internally developed software. Consequently, the Company wrote off in the
fourth quarter of fiscal 1994 all costs associated with its internally
developed software for the applicable project. The remaining $653,000 increase
in product development costs in fiscal 1994 was due to the Company's efforts to
update several product offerings.
Selling, general and administrative expenses increased in fiscal 1994 by
$420,000, or 10.8%, over the 1993 level, due principally to increased marketing
and sales efforts to achieve the sales growth discussed previously.
Other income in fiscal 1994 includes $100,000 realized from the sale to
ISI of a non-exclusive worldwide royalty free right to certain Company
proprietary technology for use in industrial workstations. A sale of this
nature is not expected in fiscal 1995.
Interest expense increased in 1994 by $59,000, or 32.3%, over fiscal 1993
due to higher interest rates on bank line of credit borrowings and higher
average borrowings which were used to finance working capital needs and to
partially finance the Company's acquisition of certain assets of Action
Instruments, Inc..
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NEW ACCOUNTING PRONOUNCEMENTS
In March, 1995, the Financial Accounting Standards Board (the "FASB")
issued Statement No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of." This statement is effective for
fiscal years beginning after December 15, 1995 and requires long-lived assets
and certain intangible assets to be carried at the lower of cost or fair value
to sell if recoverability is determined to be questionable. The Company does
not believe adoption of this statement will have a material impact on
operations.
In November, 1995, the FASB issued Statement No. 123, "Accounting for
Stock Based Compensation." This statement is effective for fiscal years
beginning after December 15, 1995. Companies have a choice to include a
reasonable estimate of expense for all stock-based compensation in the
operating statement, or to disclose the effect of adopting the provisions of
the statement on a pro forma basis in a footnote to the financial statements.
The Company anticipates that it will include the effects of the statement in a
pro forma disclosure, and it is unable to estimate the impact of the statement
at this time.
LIQUIDITY AND CAPITAL RESOURCES
During fiscal 1995, the Company increased its capital resources by
obtaining a new term note secured by a mortgage, $78,000 of equipment under
capital leases, $262,000 of proceeds under convertible subordinated notes, and
$500,000 under terms of an increased bank credit line. Additionally, the
Company has renegotiated the agreement underlying its bank line of credit, so
that the maximum borrowings available have increased to $3,250,000, which
represents an $800,000 increase over the amount available during fiscal 1995.
Although the maximum amount that can be drawn is limited by a formula, the
Company expects that the full $3,250,000 will be available for all of fiscal
1996.
In November 1995, the Company closed on a private placement of
subordinated debt. Under the terms of such agreement, the note holders
provided the Company with $1,800,000 of subordinated debt in return for 12%
notes which require interest only payments for three years. The net proceeds
from the sale of the notes of $1,208,000, after repayment of $444,000 of
convertible subordinated debt to a note holder and the payment of investment
banking fees, were added to working capital.
The Company's operating activities used $274,000 in cash in fiscal 1995,
compared to fiscal 1994 in which operating activities provided $154,000 in
cash. The use of cash in fiscal 1995 was incurred primarily the result of
increases in inventory and accounts receivable to fund the growth in business
activity, partially offset by an increase in accounts payable and the Company's
net income for the year. In fiscal 1996, the Company began implementing
measures to reduce its inventory levels and increase inventory turnover,
improve its cash collection procedures, and increase financial controls over
its spending. The Company intends to continue these efforts, although there
can be no assurance that such efforts will be successful. Working capital at
September 30, 1995 was $1,270,000, compared to $1,131,000 one year earlier.
The Company intends to acquire hardware and software to improve its
management information systems in fiscal 1996 at a cost estimated at $400,000,
which the Company may finance through either a capital lease or a term loan
from a local bank. Such expenditure is subject to funding availability and the
availability of suitable hardware and software.
Internally generated funds from operations, together with the existing
bank credit facilities or replacement facilities and the net proceeds from the
November 1995 subordinated debt placement, are expected to be sufficient for
the Company's operating and capital requirements for fiscal 1996.
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ITEM 7. FINANCIAL STATEMENTS
The financial statements filed herewith are set forth in the Index to
Consolidated Financial Statements (on page F-1) of the separate financial
section which follows this report, and are incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
PREVIOUS INDEPENDENT ACCOUNTANTS
On July 18, 1995, the Audit Committee of the Board of Directors of
Nematron Corporation (the "Company") informed the firm of Deloitte & Touche LLP
that the Company would not retain it to audit the Company's financial
statements for the year ended September 30, 1995. Deloitte & Touche LLP had
been the Company's principal accountants for the purpose of auditing its
financial statements since its fiscal year ended September 30, 1993.
The report of Deloitte & Touche LLP on the 1994 financial statements
contained no adverse opinion or disclaimer of opinion, nor were they modified
as to audit scope or accounting principles. However, Deloitte & Touche LLP's
report on the 1994 financial statements was modified as to uncertainty
regarding the Company's ability to continue as a going concern. The auditors'
report indicated in part that "The Company continued to experience significant
net losses in 1994, was unable to generate sufficient cash flows, and was not
in compliance with the terms and covenants of its line of credit agreement at
September 30, 1994. These matters raise substantial doubt about the Company's
ability to continue as a going concern.."
The Company has had no disagreements with Deloitte & Touche LLP on any
matter of accounting principles or practices, financial statement disclosure,
or auditing scope or procedure which disagreements, if not resolved to the
satisfaction of Deloitte & Touche LLP, would cause it to make reference to the
subject matter of the disagreements in connection with its reports relating to
the auditing of the Company's 1993 and 1994 financial statements or during the
period October 1, 1994 to July 18, 1995.
In connection with Deloitte & Touche LLP's audits of the Company's
financial statements for both of the fiscal years ended September 30, 1994 and
1993, Deloitte & Touche LLP provided the Company's Audit Committee with reports
concerning matters involving its internal control structure and its operations
that Deloitte & Touche LLP considered to be reportable conditions under
standards established by the American Institute of Certified Public
Accountants. Reportable conditions involve matters coming to the attention of
the principal accountant that, in their judgment, could adversely affect the
Company's ability to record, process, summarize and report financial data
consistent with the assertions of management in the financial statements. The
reportable conditions were described in reports to management dated December 9,
1994 and December 15, 1993, and Deloitte & Touche LLP discussed such reports
with the Audit Committee after their issuance. The Company has authorized
Deloitte & Touche LLP to respond fully to the inquiries of the successor
accountant, KPMG Peat Marwick LLP, concerning the subject matter of each item
in the aforementioned reports.
NEW INDEPENDENT ACCOUNTANTS
On July 18, 1995, the Company engaged the accounting firm of KPMG Peat
Marwick LLP as its principal accountants to audit the Company's financial
statements for the fiscal year ending September 30, 1995. During the Company's
two most recently ended fiscal years and subsequent interim period prior to
engaging KPMG Peat Marwick LLP, the Company did not consult KPMG Peat Marwick
LLP regarding any matter relating to the Company's financial statements, and no
written report or oral advice was provided to the Company by KPMG Peat Marwick
LLP regarding any decision of the Company as to any accounting, auditing or
reporting issue, except as disclosed in the following paragraph.
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Subsequent to September 30, 1994, the Board of Directors of the Company
had given its tentative approval to a merger of the Company with Imagination
Systems, Inc. ("ISI"). In connection with the issuance of its financial
statements for the fiscal year ended September 30, 1994, the Company disclosed
in Note 11 to the financial statements the terms of the merger and a pro forma
balance sheet as of September 30, 1994 and a pro forma statement of operations
for the year then ended. Since the audit of ISI's financial statements for its
fiscal year ended September 30, 1994 performed by KPMG Peat Marwick LLP had not
been completed at the date of Deloitte & Touche LLP's auditors report, the
Company consulted with KPMG Peat Marwick LLP concerning the presentation of the
unaudited balance sheet and operating statement amounts in Note 11 to the
financial statements. KPMG Peat Marwick LLP's views of the presentation of
such information were that the information could be presented without
modification. Also, the Company filed a Form 8-K Current Report, received by
the Commission on March 20, 1995, concerning its acquisition of ISI as of March
3, 1995; in connection with such filing, the Company consulted with KPMG Peat
Marwick LLP as to the presentation of the unaudited pro forma financial
information presented in the Form 8-K. KPMG Peat Marwick LLP's views of the
presentation of such information were that the information could be presented
without modification.
Regarding the pro forma information presentation in Note 11 to the
financial statements and in the Form 8-K as discussed in the preceding
paragraph, Deloitte & Touche LLP was also consulted. Their views of the
presentation of such information were that the information could be presented
without modification. However, Deloitte & Touche LLP neither audited nor
reviewed the pro forma information in the financial statements and on Form 8-K
and expressed no opinion or any form of assurance regarding the accuracy or
propriety of such information.
9
<PAGE> 10
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
NEMATRON CORPORATION
By: /s/ David P. Gienapp Dated: May 20, 1996
-------------------------------------------
David P. Gienapp,
Vice President - Finance and Administration
and Chief Financial Officer
10
<PAGE> 11
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Financial Statements of Nematron Corporation and Subsidiaries:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report (KPMG Peat Marwick LLP).................................. F-2
Independent Auditors' Report (Deloitte & Touche LLP).................................. F-3
Consolidated Balance Sheet as of September 30, 1995................................... F-4
Consolidated Statements of Operations for the Years Ended September 30, 1994 and
1995................................................................................ F-5
Consolidated Statements of Stockholders' Equity for the Years Ended September 30, 1994
and 1995............................................................................ F-6
Consolidated Statements of Cash Flows for the Years Ended September 30, 1994 and
1995................................................................................ F-7
Notes to Consolidated Financial Statements............................................ F-8
</TABLE>
F-1
<PAGE> 12
PEAT MARWICK LOGO
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Nematron Corporation:
We have audited the accompanying consolidated balance sheet of Nematron
Corporation as of September 30, 1995, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated statements referred to above present
fairly, in all material respects, the financial position of Nematron Corporation
as of September 30, 1995, and the results of its operations and its cash flows
for the year then ended in conformity with generally accepted accounting
principles.
KPMG PEAT MARWICK LLP
Detroit, Michigan
December 15, 1995
F-2
<PAGE> 13
<TABLE>
<S> <C> <C>
Deloitte & Touche Logo
----------------------------------------------------------------
6th Floor Telephone: (313) 769-6200
101 North Main Street Facsimile: (313) 769-2612 or
Ann Arbor, Michigan 48104-1411 (313) 769-2178
</TABLE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
Nematron Corporation
Ann Arbor, Michigan
We have audited the accompanying consolidated statements of operations,
stockholders' equity, and cash flows of Nematron Corporation and subsidiary for
the year ended September 30, 1994. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statements presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the results of operations and cash flows of Nematron
Corporation and subsidiary for the year ended September 30, 1994 in conformity
with generally accepted accounting principles.
The accompanying financial statements referred to above have been prepared
assuming that the Company will continue as a going concern. The Company
continued to experience significant net losses in 1994, was unable to generate
sufficient cash flows and was not in compliance with the terms and covenants of
its line of credit at September 30, 1994. These matters raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
in regard to these matters are discussed in Notes 3, 6 and 7. The financial
statements referred to above do not include any adjustments that might result
from the outcome of these uncertainties.
DELOITTE & TOUCHE LLP
December 9, 1994
F-3
<PAGE> 14
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
1995
-------------
<S> <C>
ASSETS (notes 6 and 7)
Current assets:
Cash.......................................................................... $ 78
Accounts receivable, net of allowance for doubtful accounts of $74............ 3,162
Inventories (note 5).......................................................... 4,123
Prepaid expenses and other current assets..................................... 269
-------
Total current assets.................................................. 7,632
Property and equipment
Land.......................................................................... 117
Building and improvements..................................................... 2,261
Equipment..................................................................... 3,276
-------
5,654
Less accumulated depreciation................................................. (2,692)
-------
Net property and equipment............................................ 2,962
Other assets:
Software and related development costs, net of accumulated amortization of
$569....................................................................... 4,327
Other intangible assets, net of accumulated amortization of $298.............. 283
-------
Net other assets...................................................... 4,610
-------
Total assets.......................................................... $15,204
=======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt (note 7)................................. $ 120
Notes payable to bank (note 6)................................................ 2,450
Accounts payable.............................................................. 2,744
Other accrued liabilities..................................................... 1,048
-------
Total current liabilities............................................. 6,362
Long-term debt, less current maturities (note 7)................................ 2,306
-------
Total liabilities..................................................... 8,668
Stockholders' equity:
Common stock, no par value, 8,000,000 shares authorized, 2,869,613 shares
issued and outstanding (note 12)........................................... 6,796
Foreign currency translation adjustment....................................... (51)
Accumulated deficit........................................................... (209)
-------
Total stockholders' equity............................................ 6,536
-------
Commitments and contingencies (note 10)
Total liabilities and stockholders' equity............................ $15,204
=======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 15
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
------------------
1994 1995
------- -------
<S> <C> <C>
Net revenues.............................................................. $15,287 $17,576
Cost of revenues.......................................................... 12,044 11,382
------- -------
Gross profit......................................................... 3,243 6,194
Operating expenses:
Product development costs............................................... 1,645 894
Selling, general and administrative expenses............................ 4,296 4,693
------- -------
Total operating expenses............................................. 5,941 5,587
------- -------
Operating income (loss)................................................... (2,698) 607
Other income (expense):
Sale of royalty rights.................................................. 100 --
Interest and other net.................................................. 4 3
Interest expense, net................................................... (243) (381)
Foreign currency gain (loss)............................................ 40 74
------- -------
Total other income (expense)......................................... (99) (304)
------- -------
Income (loss) before taxes on income...................................... (2,797) 303
Taxes on income (note 8).................................................. -- --
------- -------
Net income (loss).................................................... $(2,797) $ 303
======= =======
Earnings (loss) per share................................................. $ (1.75) $ 0.14
======= =======
Weighted average shares outstanding....................................... 1,600 2,180
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 16
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
RETAINED
COMMON STOCK FOREIGN EARNINGS
--------------- CURRENCY (ACCUMULATED
SHARES AMOUNT TRANSLATION DEFICIT) TOTAL
------ ------ ----------- ----------- -------
<S> <C> <C> <C> <C> <C>
Balance, October 1, 1993........................ 1,453 $3,351 $ (22) $ 2,285 $ 5,614
Shares issued pursuant to acquisition of product
line (note 4)................................. 160 276 276
Compensation related to restricted stock plan
(note 9)...................................... 16 16
Net loss for the year ended September 30,
1994.......................................... (2,797) (2,797)
Foreign currency translation.................... (11) (11)
----- ------ ---- ------- -------
Balance, September 30, 1994..................... 1,613 3,643 (33) (512) 3,098
Shares issued pursuant to merger with
Imagination Systems, Inc. (note 3)............ 971 1,699 1,699
Shares issued pursuant to merger with Universal
Automation, Inc. (note 3)..................... 200 1,112 1,112
Grant of stock in connection with separation
agreement..................................... 9 16 16
Shares issued in connection with conversion of
convertible subordinated note to common stock
(note 4)...................................... 102 200 200
Forfeiture of restricted stock upon termination
of employment................................. (25)
Compensation related to restricted stock plan
(note 9)...................................... 126 126
Net income for the year ended September 30,
1995.......................................... 303 303
Foreign currency translation.................... (18) (18)
----- ------ ---- ------- -------
Balance, September 30, 1995..................... 2,870 $6,796 $ (51) $ (209) $ 6,536
===== ====== ==== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 17
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
-----------------
1994 1995
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss).................................................................. $(2,797) $ 303
Adjustments to reconcile net income (loss) to net cash flow provided by (used in)
operating activities:
Depreciation and amortization.................................................... 905 731
Gain on disposal of property and equipment....................................... (5) --
Sale of royalty rights for note receivable....................................... (100) --
Non-cash compensation related to restricted stock................................ 16 125
Write-off of software projects in process........................................ 246 --
Changes in assets and liabilities that provided (used) cash:
Accounts receivable............................................................ (228) (677)
Inventories.................................................................... 655 (597)
Prepaid expenses and other current assets...................................... (37) (265)
Accounts payable............................................................... 1,186 593
Other accrued liabilities...................................................... 313 (487)
------- -------
Net cash provided by (used in) operating activities......................... 154 (274)
------- -------
Cash flows from investing activities:
Additions to capitalized software development costs................................ (76) (469)
Additions to property and equipment................................................ (213) (245)
Acquisitions, net of cash acquired................................................. -- (105)
Cash portion of purchase price of Action product line.............................. (290) --
Proceeds from disposals of property and equipment.................................. 15 --
------- -------
Net cash used in investing activities....................................... (564) (819)
------- -------
Cash flows from financing activities:
Borrowings under mortgage note..................................................... -- 1,900
Increase in notes payable to bank.................................................. 500 730
Proceeds from exercise of common stock options and warrants........................ -- --
Borrowings under subordinated and other notes...................................... -- 200
Payments of long-term debt......................................................... (188) (1,696)
Additions to deferred financing fees............................................... -- (23)
------- -------
Net cash flows provided by financing activities 312 1,111
------- -------
Foreign currency translation effect on cash.......................................... 2 (1)
------- -------
Net increase (decrease) in cash...................................................... (96) 17
Cash at beginning of year............................................................ 157 61
------- -------
Cash at end of period................................................................ $ 61 $ 78
======= =======
Supplemental disclosures of cash flow information:
Cash paid for interest............................................................. $ 210 $ 457
Cash paid for income taxes......................................................... -- --
Supplemental disclosures of noncash financing and investing activities:
Additions to various assets and liabilities in connection with the acquisition of
Imagination Systems, Inc. for common stock (note 3).............................. -- 1,498
Additions to various assets and liabilities in connection with the acquisition of
Universal Automation, Inc. for common stock (note 3)............................. -- 1,112
Issuance of common stock in exchange for noncompete agreement
(note 3)......................................................................... -- 218
Issuance of common stock in connection with conversion of a subordinated note (note
4)............................................................................... -- 200
Acquisition of equipment under capital lease obligations........................... 79
Noncash portion of Action product line purchase of inventories, product designs,
and note payable (note 4)........................................................ 443 --
Addition to license fees through issuance of note.................................. 295 --
Purchase of inventories through issuance of note................................... 215 62
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE> 18
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BUSINESS
Nematron Corporation (the "Company") designs, manufactures and markets
environmentally ruggedized computers and computer displays known as industrial
workstations, and designs, develops and markets software for use worldwide in
factory automation and control and in test and measurement environments.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries -- Nematron Europa BV, a
Netherlands corporation formed in 1990, and NemaSoft, Inc., a Michigan
corporation formed in 1995. All significant intercompany transactions and
balances have been eliminated in consolidation.
During the fiscal year ended September 30, 1995, the Company acquired two
software design and manufacturing companies. Imagination Systems, Inc. ("ISI")
was acquired on March 3, 1995 and Universal Automation, Inc. ("UAI") was
acquired on September 20, 1995. The consolidated operations of Nematron for 1995
include the results of ISI and UAI since the dates of their respective
acquisitions. (See note 3.)
(2) SUMMARY OF ACCOUNTING PRINCIPLES
Inventories
Inventories are carried at the lower of cost or market. Cost is determined
by the first in, first out method. Provision is made to reduce inventories to
net realizable value for excess and/or obsolete inventories based upon an item
by item review of quantities on hand compared to estimated usage for sales and
service.
Property and Equipment
Property and equipment are stated at cost. Capital leases are recorded at
the present value of future minimum lease payments and are amortized over their
primary term. Depreciation is provided over the estimated useful lives of the
assets, ranging from 3 years for certain factory and office equipment to 33
years for the Company's manufacturing facility. Depreciation is computed using
the straight-line method for financial reporting purposes and accelerated
methods as promulgated by the IRS for tax reporting purposes.
Software and Related Development Costs
In accordance with Statement of Financial Accounting Standards No. 86,
Accounting for the Costs of Computer Software To Be Sold, Leased or Otherwise
Marketed, certain computer software development costs and purchased software
technology have been capitalized. Capitalization of computer software
development costs begins upon establishment of technological feasibility. The
establishment of technological feasibility and the ongoing assessment of
recoverability of capitalized computer software development costs requires
considerable judgment by management with respect to certain external factors,
including, but not limited to, anticipated future gross revenues, estimated
economic life, and changes in software and hardware technology.
During the year ended September 30, 1995, capitalized software and related
development costs, net of amortization, increased by approximately $4,066,000,
including approximately $470,000 relating to salaries and other costs incurred
during the year, and approximately $2,140,000 and $1,622,000 relating to the
acquisitions of ISI and UAI, respectively (see note 3), offset by approximately
$166,000 of amortization of capitalized costs.
Amortization of capitalized computer software development costs is provided
on a product-by-product basis using the greater of the amount computed using (a)
the ratio that current gross revenues for each product bear to the total of
current and anticipated future gross revenues for that product, or (b) the
straight-line
F-8
<PAGE> 19
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
method over the remaining estimated economic lives of the respective products,
ranging from two to five years. Amortization amounted to $402,745 and $166,256
for the years ended September 30, 1994 and 1995, respectively, and is included
in cost of revenues in the accompanying consolidated statements of operations.
Foreign Currency Translation
In accordance with Statement of Financial Accounting Standards No. 52,
Foreign Currency Translation, the assets and liabilities of the Company's
foreign subsidiary, Nematron Europa BV, denominated in foreign currency, are
translated at exchange rates in effect on the balance sheet date, and revenue
and expenses are translated using a weighted average exchange rate during the
year. Gains or losses resulting from translating foreign currency financial
statements are recorded in a separate component of shareholders' equity. Gains
or losses resulting from foreign currency transactions are included in net
income.
Revenue Recognition
Revenues from product sales are recognized upon shipment. Revenues from
service and repair of computers are recognized as the services are performed.
Revenues from software and engineering development are recognized as the Company
performs the services, in accordance with the contract terms. Revenues from
extended warranty agreements covering software are recognized ratably over the
terms of the agreement with the customer. Revenues from license agreements are
recognized upon delivery of the software and performance of all obligations
under the applicable agreement. The Company has established programs which,
under specified terms and limited conditions, enable its distributors to return
limited amounts of product. The effect of these programs is estimated and
current period revenues and cost of revenues are reduced accordingly.
Research and Development Costs
Research and development costs are expensed when incurred. These costs,
representing engineering salaries, fringe benefits, and a portion of the
Company's overhead, are included in the accompanying consolidated statements of
operations as a component of product development costs. Research and development
costs expensed were $888,700 and $704,800 for the years ended September 30, 1994
and 1995, respectively.
Reserve for Self-Insurance
The Company has elected to retain a significant portion of expected medical
claims for Ann Arbor-based personnel expenses through the use of deductibles
which total $30,000 per employee and $1,000,000 aggregate. Provisions for losses
under the medical program are recorded based upon the Company's estimates of
claims incurred but not reported as provided by its third party administrator.
The total estimated liability for medical claim expenses, both reported as well
as for incurred but not reported, at September 30, 1995, was approximately
$45,000 and is included in other accrued liabilities.
Warranty Costs
The Company provides for estimated warranty costs as products are shipped.
Estimated warranty reserves are adjusted currently based upon projected levels
of warranty repairs and estimated costs of materials, labor, and overhead costs
to be incurred in meeting warranty obligations.
Income Taxes
The Company accounts for taxes under the provisions of Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS No.
109"), which requires an asset and liability approach for
F-9
<PAGE> 20
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
financial accounting and reporting of income taxes. Under SFAS No. 109, deferred
income tax assets and liabilities are computed annually for differences between
the financial statement and tax bases of assets and liabilities that will result
in taxable or deductible amounts in the future. Such deferred income tax asset
and liability computations are based on enacted tax laws and rates. A valuation
allowance is established when necessary to reduce deferred income tax assets to
the amount expected to be realized. Income tax expense is the tax payable or
refundable for the period, plus or minus the change during the period in
deferred tax assets and liabilities.
Earnings Per Share
Primary earnings per share are calculated using the weighted average number
of shares of common stock and common stock equivalents outstanding. Fully
diluted earnings per share are calculated using the treasury method, assuming
conversion of convertible subordinated notes and warrants having conversion
prices less than the average market price of the common stock.
Fair Value
Financial instruments of the Company, consisting principally of cash,
accounts receivable, accounts payable and debt, are recorded at estimated fair
value. The estimated fair value amounts have been determined by the Company,
using available market information and available valuation methodologies.
(3) ACQUISITIONS
Merger with Imagination Systems, Inc.
On March 3, 1995, the Company purchased all of the outstanding shares of
Imagination Systems, Inc., a Virginia Beach, Virginia-based developer of
industrial data acquisition, networking, and other software, and recorded this
transaction using the purchase method. The total purchase price was
approximately $1,830,000, including expenses of approximately $300,000. Under
terms of the merger agreement, the Company issued 825,526 shares of its common
stock to the former ISI shareholders in exchange for 100 percent of the
outstanding common stock of ISI. The ISI stock was retired, and the Company is
the surviving entity. In connection with the merger, the Company also issued
120,000 shares of its common stock in return for a noncompetition agreement with
ISI's president, who became the Company's president, and 25,000 shares of its
common stock to certain employees of ISI who became employees of the Company as
a result of the merger. A total of 970,526 shares of Company common stock were
issued in this transaction.
In addition to the common stock issued, the Company issued warrants to
purchase Company common stock at $2.50 per share for every two shares issued in
the merger. The warrants expire three years from the date of the merger. (See
note 12.)
Merger with Universal Automation, Inc.
On September 20, 1995, the Company completed its merger of its wholly owned
subsidiary, NemaSoft, Inc., with Universal Automation, Inc., a Hudson, New
Hampshire-based developer of industrial software for machine control that
executes on Intel-based personal computers, and recorded this transaction using
the purchase method. UAI is the holder of a patent for a continuous flow chart,
improved data format and debugging system for the programming and operation of
machines. The total purchase price was approximately $1,530,000, including
expenses of approximately $400,000. Under terms of the merger agreement, the
Company issued 200,000 shares of its common stock and $100,000 to the former UAI
shareholders in exchange for 100 percent of the outstanding common stock of UAI.
The UAI stock was retired, and NemaSoft is the surviving entity. In connection
with the merger, NemaSoft also entered into two-year
F-10
<PAGE> 21
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
employment and noncompetition agreements with UAI's president and vice
president, who became employees of NemaSoft as a result of the merger.
In addition to the common stock issued, the Company also issued 137,000
warrants to purchase Nematron common stock at $4.81 per share. The warrants
expire November 20, 1997. (See note 12.)
The preliminary allocation of the total purchase price to assets acquired
and liabilities assumed as of the respective purchase dates was as follows:
<TABLE>
<CAPTION>
ISI UAI
---------- ----------
<S> <C> <C>
Current assets...................................... $ 268,000 $ --
Software and related development costs.............. 2,140,000 1,622,000
Other intangible assets............................. 218,000 --
Property and equipment.............................. 81,000 5,000
Liabilities......................................... (877,000) (97,000)
---------- ----------
Total purchase price...................... $1,830,000 $1,530,000
========== ==========
</TABLE>
The allocation of the total purchase price among the fair value of the
acquired assets and liabilities is subject to adjustment as certain estimates
are finalized, but is not expected to materially differ from preliminary
estimates.
The following unaudited pro forma information presents a summary of
consolidated results of operations of the Company, ISI and UAI as if the
acquisitions had occurred as of the beginning of 1994, with pro forma
adjustments to give effect to amortization of software, interest expense on
additional borrowings and certain other adjustments, together with related
income tax effects.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
1994 1995
----------- -----------
(UNAUDITED)
<S> <C> <C>
Net revenues........................................... $17,728,000 $18,578,000
Net income (loss)...................................... $(3,061,000) $ 37,000
Net earnings (loss) per share.......................... $ (1.10) $ .01
</TABLE>
(4) RELATED PARTY TRANSACTIONS
In October 1993, the Company purchased certain inventories, product designs
and equipment from Action Instruments ("Action"). The total cost of such assets
was $743,130, and consideration paid was 160,000 shares of common stock, valued
at closing at $276,000, a subordinated convertible note of $167,000, and cash of
$291,130. During the remainder of fiscal 1994 and in fiscal 1995, the Company
purchased additional inventory from Action in exchange for subordinated notes of
$215,000 and $62,000, respectively. In November 1995, the Company repaid all of
the subordinated notes. See note 7 for a description of the subordinated notes.
Interest expense related to the subordinated notes totaled $14,595 and $37,656
for the years ended September 30, 1994 and 1995, respectively.
On December 8, 1994, the Company issued a convertible subordinated note in
the amount of $200,000, payable to the Company's then-president and board
member. The note required interest-only payments due quarterly for three years,
at which time the note was due in 24 equal monthly installments. Interest was
payable at the prime rate. The note contained terms under which the noteholder
could convert the note into common stock at any time prior to maturity. On
August 16, 1995, the noteholder exercised the conversion feature of the note,
and on that date the note was converted at book value per share into 102,564
shares of common stock. Interest expense on the note was $12,020 for the year
ended September 30, 1995.
F-11
<PAGE> 22
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company leases its Virginia Beach, Virginia office building from a
partnership in which the president and CEO of the Company is a partner. Total
lease payments made for the lease period from March 3, 1995, through September
30, 1995, under the terms of the lease, which commenced on March 3, 1995, were
$45,262.
(5) INVENTORIES
Inventories are summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1995
----------
<S> <C>
Purchased parts and accessories..................................... $2,622,872
Finished goods...................................................... 829,465
Work-in-process..................................................... 160,382
Demo units.......................................................... 236,564
Service stock....................................................... 273,739
----------
Total inventories......................................... $4,123,022
==========
</TABLE>
(6) NOTES PAYABLE TO BANK
As of September 30, 1995, $2,450,000 was outstanding under a $2,450,000
line of credit agreement which is subject to renewal in February 1996. The
amount available under this facility is limited by a borrowing formula which
allows for advances up to 75 percent of eligible domestic accounts receivable
plus 80 percent of eligible foreign accounts receivable plus a maximum of
$1,000,000 against certain inventory categories plus $400,000. Based upon the
borrowing formula, the entire amount of the available line was eligible for
advance. The line of credit is secured by substantially all assets of the
Company and a second mortgage on the Company's Ann Arbor facility. The note
bears interest at 2 percent above the bank's prime interest rate (10.75 percent
at September 30, 1995).
The line of credit includes various affirmative and negative covenants. The
Company was in compliance with all covenants at September 30, 1995.
On October 6, 1995, the Company negotiated an expansion of its credit
facility to a maximum availability of $2,850,000.
F-12
<PAGE> 23
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1995
-------------
<S> <C>
Mortgage loan payable to a bank, interest at 10.5% per annum, payable in
monthly installments of $23,260 through August 2000, at which time the
remaining principal and any interest thereon is due. The loan is
collateralized by a first mortgage of the Company's land and building
in Ann Arbor, Michigan................................................ $ 1,893,919
Convertible subordinated notes payable to Action. The notes require
quarterly interest-only payments for three years, at which time the
notes and interest thereon are due in 24 equal monthly installments.
The notes are subordinated to the notes payable to the bank. In
November 1995, the notes were repaid by the Company in their
entirety.............................................................. 444,000
Other notes, repaid in October 1995..................................... 11,477
Capitalized lease obligations (note 10)................................. 76,417
-----------
Total long-term debt.......................................... 2,425,813
Less current maturities................................................. (119,706)
-----------
Total long-term debt, less current maturities................. $ 2,306,107
===========
</TABLE>
The mortgage loan payable to a bank contains a covenant that requires the
Company to maintain a minimum debt-to-equity ratio. The Company was in
compliance with this covenant at September 30, 1995.
The aggregate amounts of long-term debt maturities at September 30, 1995,
are as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------------
<S> <C>
1996................... $ 119,706
1997................... 205,589
1998................... 352,437
1999................... 251,850
2000................... 1,496,231
----------
Total long-term debt........ $2,425,813
==========
</TABLE>
In November 1995, the Company obtained a total of $1,800,000 of
subordinated debt under a term loan and warrant purchase agreement (the
"Subordinated Note Agreement") with a consortium of five lenders. All of the
notes are collateralized by substantially all assets, other than real property,
of the Company, and the Company has granted to one note holder, representing
$500,000 of the total subordinated debt, a third mortgage on the Company's Ann
Arbor facility. The subordinated notes bear interest at 12 percent per annum and
require monthly interest-only payments totaling $18,000 for three years and
monthly principal payments of $50,000, plus interest, beginning October 1997.
Total principal due under the subordinated notes is $600,000 in each of the
fiscal years ending September 30, 1998, 1999 and 2000. The Subordinated Note
Agreement includes various affirmative and negative covenants, the most
restrictive of which are (1) the prohibition of dividend payments, and (2)
requirements to maintain (a) a specified ratio of current assets to current
liabilities, (b) a specified ratio of total liabilities less subordinated debt
to the sum of tangible net worth plus subordinated debt, and (c) a specified
level of tangible net worth. A total of 237,214 warrants were issued to purchase
stock at $4 a share which expire October 31, 2002. (See note 12.)
F-13
<PAGE> 24
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) TAXES ON INCOME
The provisions for taxes on income in fiscal 1994 and 1995, including both
the current and deferred portions, are zero. Deferred income taxes result from
temporary differences in the recognition of income and expenses for financial
and income tax reporting purposes. Deferred income taxes are primarily due to
the use of accelerated methods of depreciation for tax purposes versus
principally straight-line methods for financial reporting purposes, the
capitalization of software development costs for financial reporting purposes
versus the expensing of these items as incurred for tax purposes, the required
capitalization of certain inventory items for tax purposes, inventory reserves
deductible for tax purposes when disposed of versus directly expensing them for
financial reporting purposes, and employee benefit accruals deductible for tax
purposes when paid.
The following reconciles the statutory federal income tax rate to the
Company's effective tax rate:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
---------------
1994 1995
----- -----
<S> <C> <C>
Income tax expense (benefit) based on the federal statutory
rate....................................................... (34.0)% 34.0%
Increase (decrease) in taxes resulting from generation
(utilization) of net operating losses...................... 34.0% (34.0)%
----- -----
Effective tax rate................................. 0.0% 0.0%
===== =====
</TABLE>
The domestic and foreign components of income (loss) before taxes on income
are as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
1994 1995
----------- --------
<S> <C> <C>
Domestic............................................ $(2,592,997) $368,057
Foreign............................................. (203,966) (64,988)
----------- --------
Total income (loss) before taxes on
income.................................. $(2,796,963) $303,069
=========== ========
</TABLE>
Temporary differences and carryforwards which give rise to the net deferred
tax position at September 30, 1995, are as follows:
<TABLE>
<S> <C>
Deferred tax assets:
Accounts receivable........................................... $ 15,000
Inventories................................................... 124,000
Property and equipment........................................ 62,000
Noncompetition agreement...................................... 19,000
Accrued compensation.......................................... 50,000
Accrued self-insurance........................................ 14,000
Accrued warranty.............................................. 31,000
Net operating loss carryforwards.............................. 1,711,000
-----------
Total deferred tax assets............................. 2,026,000
Less: Valuation allowance....................................... (405,000)
-----------
Net deferred tax assets............................... 1,621,000
-----------
Deferred tax liability -- capitalized software development
costs......................................................... (1,621,000)
-----------
Net deferred tax position............................. $ --
===========
</TABLE>
At September 30, 1995, the Company has net operating loss carryforwards of
approximately $4,750,000 which expire at various dates between 2003 and 2010.
Utilization of these carryforwards are subject to annual limitation under
current IRS regulations. The Company has established a valuation allowance for
the deferred tax assets, as it is unlikely that they will be fully utilized.
F-14
<PAGE> 25
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) EMPLOYEE BENEFIT PLANS
Restricted Stock Plan
The Company has a Restricted Stock Plan which provides for the granting of
up to 75,000 shares of the Company's common stock to key employees. In July
1993, all 75,000 shares were granted by action of the Compensation Committee of
the Board of Directors, and no further grants will be made under this plan.
Shares of common stock subject to the awards ("Restricted Stock") are
subject to transfer restrictions and forfeiture. Recipients of Restricted Stock
are not required to provide consideration other than the rendering of services.
Subject to the restrictions described below, a participant has, with respect to
all Restricted Stock, all of the rights of a stockholder of the Company,
including the right to vote the shares and the right to receive dividends, if
any.
Restricted Stock is subject to forfeiture and may not be transferred, and a
certificate is not delivered, until certain restrictions lapse. The shares
subject to an award under the Restricted Stock Plan become vested and
transferable at the rate of 10 percent per year, contingent upon continuous
employment with the Company. Recognition of income to the employee and expense
to the Company takes place coincident with the annual lapse of restrictions,
with income and expense determined by the fair market value of unrestricted
shares at that time. Unvested shares are forfeited upon termination of
employment, except termination of employment by reason of death or disability.
Upon a change in control, all shares subject to an award shall automatically
vest. The merger of the Company with ISI constituted a change in control. By
action of the Board of Directors, the Restricted Stock not previously vested as
of August 16, 1995, was 100 percent vested as of that date.
During 1994 and 1995, 7,000 and 42,750 shares of Restricted Stock,
respectively, became vested, and 25,250 shares were forfeited due to
terminations. Compensation expense in 1994 and 1995 related to the Restricted
Stock plan was $15,968 and $125,579, respectively.
1993 Stock Option Plan
The Company's 1993 Stock Option Plan (the "1993 Plan") provides for the
granting of options to purchase a total of 455,000 shares, increased 350,000
shares by the shareholders in 1995, of common stock to key employees. The
exercise price for each option granted under the 1993 Plan cannot be less than
the fair market value of the common stock on the date of the grant.
The plan gives the Compensation Committee of the Board of Directors
latitude to decide the vesting period. Except for the March 4, 1995, grant of
18,750 options which vested one-third immediately and one-third on each
successive anniversary date of the award, all other stock options granted under
the 1993 Plan are exercisable at the rate of one-third per year beginning on the
day after the first anniversary of the date of the award. Under provisions of
the 1993 Plan, shares subject to an option award will become immediately
exercisable upon a change in control of the Company. A "change in control" has
the same definition in the 1993 Stock Option Plan as this term has in the
Restricted Stock Plan. Accordingly, 67,150 options became immediately
exercisable in 1995. Options remaining unexercised on the tenth anniversary of
the date of the grant will expire. No options may be granted after February 26,
2003.
During fiscal 1995, the Company granted 239,250 options at exercise prices
of $2.50 to $3.87 per share, 73,400 options became exercisable, and 32,850
options were forfeited. During fiscal 1994, 43,650 options were granted at an
option price of $2.50 per share, 16,900 exercisable, and 21,100 options
forfeited. As of September 30, 1995, an additional 168,900 options may be issued
under the 1993 Plan.
The Company's 1993 Directors Stock Option Plan (the "Directors Option
Plan") provides for the granting of options to purchase a total of 20,000 shares
of common stock. The exercise price for each option
F-15
<PAGE> 26
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
granted under the Directors Option Plan is equal to the greater of the fair
market value or book value of the Company's common stock on the date of the
grant.
The Directors Option Plan provides that each director will be granted
annually an option to purchase 1,000 shares of common stock. Options will be
exercisable at any time beginning six months after the date of the grant;
options expire five years from the date of grant. During fiscal 1995, the
Company granted options to purchase 4,000 shares of common stock at exercise
prices of $1.87 to $2.12 per share, and in fiscal 1994, the Company granted
options to purchase 3,000 shares of common stock at an exercise price of $4.55
per share and 1,000 options were forfeited. As of September 30, 1995, an
additional 11,000 options may be issued under the Directors Option Plan.
Special Option Grant
In July 1995, the Board of Directors awarded a special option award to the
former chairman of the Board of Directors. This award of 10,000 options to
purchase common stock at $2.50 per share was a grant made separate from either
of the two qualified plans specified above.
Information with respect to options under the 1993 Stock Option Plan, the
1993 Directors Stock Option Plan, and the special option grant for the two years
ended September 30, 1995, is as follows.
<TABLE>
<CAPTION>
OPTION
PRICE AVAILABLE
PER SHARE OUTSTANDING EXERCISABLE FOR GRANT
-------------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
Balance, October 1, 1993......................... $2.50 - $4.89 60,150 3,000 64,850
Granted.......................................... $2.50 - $4.55 46,650 -- (46,650)
Exercisable...................................... $2.50 - $4.55 -- 19,900 --
Forfeited........................................ $2.50 - $4.89 (22,100) -- 22,100
------- ------ --------
Balance, September 30, 1994...................... $2.50 - $4.89 84,700 22,900 40,300
Increase in authorized shares.................... -- -- 350,000
Special option grant............................. $2.50 10,000 -- --
Granted.......................................... $1.87 - $3.87 243,250 -- (243,250)
Exercisable...................................... $1.87 - $2.50 -- 74,400 --
Forfeited........................................ $2.50 (32,850) -- 32,850
------- ------ --------
Balance, September 30, 1995...................... $1.87 - $4.89 305,100 97,300 179,900
======= ====== ========
</TABLE>
401(k) Plan and Trust
The Company has established a defined contribution retirement plan for all
eligible employees. Participants may make basic contributions, from 2 percent to
4 percent of their compensation, pursuant to section 401(k) of the Internal
Revenue Code. Under terms of the 401(k) plan, the Company makes a basic
contribution of 50 percent of each employee's contribution, and it may make
additional contributions as approved by the Board of Directors. A participant
becomes vested in the Company's contribution on his or her behalf at a rate of
20 percent for each year of service after the effective date of the 401(k) plan.
Notwithstanding the foregoing, a participating employee will be fully vested in
the Company's contributions to his or her account in the event of death, or in
the event of disability or normal retirement, as those terms will be defined in
the 401(k) plan. Employees may make additional voluntary contributions of up to
5 percent of their compensation.
The Company's contributions to the 401(k) plan were approximately $92,000
and $38,000 for the years ended September 30, 1994 and 1995, respectively.
F-16
<PAGE> 27
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) LEASE COMMITMENTS
The Company leases its software development office, its Netherlands
facility, other facilities, and certain vehicles and office equipment under
operating leases, and leases certain office and production equipment under
capital leases. Terms of the software development office lease with a
partnership which includes the Company's president as a partner, include monthly
rent of $6,466 for a 24-month period ending February 1997. The lease for the
Netherlands facility requires quarterly payments of $53,243; the other
facilities' lease requires monthly payments of $1,150 through March 1996; the
vehicle leases collectively require lease payments totaling $4,640 through
various dates between April 1997 and March 1998; and the office equipment
operating lease requires monthly payments of $147 through April 1998.
The Company leases certain computer and test equipment under two capital
leases which had an initial term of three years and which collectively require
monthly payments, including interest, of $2,642 through August 1998. The net
book value of equipment leased under the two capital leases is $76,262 at
September 30, 1995.
A summary of commitments under noncancelable leases as of September 30,
1995 is as follows:
<TABLE>
<CAPTION>
CAPITAL LEASES OPERATING LEASES TOTAL
-------------- ---------------- --------
<S> <C> <C> <C>
1996..................................... $ 31,700 $195,200 $226,900
1997..................................... 31,700 132,100 163,800
1998..................................... 28,200 64,300 92,500
1999..................................... -- 53,200 53,200
2000..................................... -- 17,700 17,700
-------- -------- --------
Total minimum obligation................. $ 91,600 $462,500 $554,100
======== ========
Less amounts representing interest....... (15,183)
--------
Present value on minimum lease
payments............................... $ 76,417
========
</TABLE>
Total rental expense in fiscal 1994 and 1995 was $117,900, and $161,300,
respectively.
(11) FOREIGN REVENUES AND MAJOR CUSTOMER
Net revenues include export sales to various countries. A summary of both
foreign and domestic revenues is as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30
--------------------------
1994 1995
----------- -----------
<S> <C> <C>
Foreign:
France........................................... $ 1,048,740 $ 2,330,183
Other European................................... 1,752,214 2,399,158
Canada........................................... 1,040,050 837,543
South America.................................... 257,911 539,209
Asia and South Pacific........................... 436,320 346,244
Africa........................................... 35,541 59,949
----------- -----------
Total foreign revenues................... 4,570,776 6,512,286
Domestic revenues.................................. 10,716,520 11,064,019
----------- -----------
Total.................................... $15,287,296 $17,576,305
=========== ===========
</TABLE>
During the years ended September 30, 1994 and 1995, revenues from one
unaffiliated customer totaled 7 percent and 15 percent of total revenues,
respectively.
F-17
<PAGE> 28
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONCLUDED)
(12) WARRANTS
The Company has outstanding warrants for the purchase of its Common Stock
as follows:
<TABLE>
<CAPTION>
ISI UAI SUBORDINATED
ACQUISITION ACQUISITION DEBT TOTAL
----------- ----------- ------------ --------
<S> <C> <C> <C> <C>
Exercise price.................................... $2.50 $4.81 $4.00 --
Expiration date................................... 3/3/98 11/20/97 10/31/02 --
Balance, September 30, 1994....................... -- -- -- --
Issued in connection with ISI Acquisition....... 485,258 485,258
Issued in connection with UAI Acquisition....... -- 137,000 -- 137,000
------- ------- ------- --------
Balance, September 30, 1995....................... 485,258 137,000 -- 622,258
======= ======= ======= ========
</TABLE>
F-18
<PAGE> 29
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION PAGE NO.
----------- ----------- --------
23.1 Consent of KPMG Peat Marwick LLP
<PAGE> 1
EXHIBIT 23.1
The Board of Directors
Nematron Corporation:
We consent to incorporation by reference in the registration statements
(Numbers 333-1138, 333-1136, and 333-1140) on Form S-8 of Nematron Corporation
of our report dated December 15, 1995, relating to the consolidated balance
sheet of Nematron Corporation as of September 30, 1995, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the year then ended, which report appears in the September 30, 1995, annual
report on Form 10-K of Nematron Corporation.
KPMG PEAT MARWICK LLP
Detroit, Michigan
May 20, 1996
