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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended SEPTEMBER 30, 1997
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)
MICHIGAN 38-2483796
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5840 INTERFACE DRIVE, ANN ARBOR, MICHIGAN 48103
(Address of principal executive offices) (Zip Code)
(734) 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: $20,875,397
The aggregate market value of the voting stock held by non-affiliates
as of December 20, 1997, computed by reference to the closing price of such
stock on such date as quoted on the Nasdaq Stock Market National Market, was
approximately $17,220,000. For purposes of this computation only, all executive
officers, directors and beneficial owners of more than 5% of the outstanding
Common Stock are assumed to be affiliates.
The number of shares outstanding of the issuer's Common Stock on
December 20, 1997 was 5,339,538.
DOCUMENTS INCORPORATED BY REFERENCE
Part of Form 10-KSB Into
Document Which the Document is Incorporated
-------- ----------------------------------
Portions of Proxy Statement
for the 1998 Annual Meeting of Part III
Shareholders to be Held February 27, 1998
(the "1998 Proxy Statement")
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT [ ] Yes [ X ] No
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PART I
ITEM 1. BUSINESS.
This Business section contains forward looking statements that involve
uncertainties. Actual results could differ materially from those in the forward
looking statements due to a number of uncertainties, including, but not limited
to those discussed below and in "Management's Discussion and Analysis of
Operations Uncertainties Relating to Forward Looking Statements."
CORPORATE HISTORY
Nematron Corporation ("Nematron" or the "Company") was incorporated in
Michigan in October, 1983. In 1986, the Company became a wholly-owned subsidiary
of Interface Systems, Inc. ("Interface"). On February 26, 1993, the Company
became an independent publicly-traded company as a result of a spin-off from
Interface, which was effected by the distribution of 100% of the shares of the
Company on a pro rata basis to Interface's shareholders.
During the year ended September 30, 1995, the Company completed two
acquisitions, the merger of Imagination Systems, Inc., a Virginia corporation
("Imagination"), into the Company, and the merger of Universal Automation, Inc.
("UAI"), into the Company's wholly-owned subsidiary, NemaSoft, Inc.
("NemaSoft").
During the year ended September 30, 1996, the Company formed a new
wholly-owned subsidiary, Imagination Systems, Inc., a Michigan corporation
("ISI"), which remained a shell company until 1997.
During the year ended September 30, 1997, the Company completed two
acquisitions, the merger of Intec Controls Corp. into the Company's wholly-owned
subsidiary, NemaSoft, and the merger of Virtual-Time Software, Inc. into ISI.
The Company's principal executive offices are located at 5840 Interface
Drive, Ann Arbor, Michigan, and its telephone number is (734) 994-0501.
GENERAL
Nematron designs, manufactures and markets factory automation products,
including computer hardware and software products. Its industrial computers and
terminals are called Industrial Workstations(TM), which are "ruggedized"
computers with built-in displays, keyboards or other forms of operator input.
Industrial Workstations are used by operators in industrial processing and in
factory floor environments to monitor and control machine and cell level
operations. Nematron's software products, which have been sold under the trade
names of OpenControl(TM), Hyperkernel(TM), Paragon (TM), FloPro(R), and
PowerVIEW(TM), are sold to industrial users for operator interface, direct
machine control and supervisory control, and its AutoNet(TM) software product is
used in test and measurement environments.
The primary focus of Industrial Workstations is on applications where
the extremes of temperature, shock and vibration, high humidity, airborne
contaminants and physical abuse or hard use require the use of equipment that
has been specially designed to operate more reliably than commercial grade
equivalents. The Company's industrial computer products are used in industrial
manufacturing and process automation, specifically relating to operator-machine
interface and direct machine control applications. The Company incorporates
electronic technology and software in its Industrial Workstation products to
satisfy a broad variety of customer applications ranging from the replacement of
traditional hardwired push buttons, lights and gauges that can be used with a
single machine or local process, to advanced industrial computer-based systems
that provide supervisory control, direct control and networking capabilities
over a large number of machines.
The Company had six main software products used in the industrial and
factory automation workplace, all of which were developed by the Company or
acquired. These products are marketed under the trade names OpenControlTM,
Hyperkernel(TM), Paragon (TM), FloPro(R), PowerVIEW(TM) and AutoNet(TM).
Additionally, most of the Company's Industrial Workstations contain proprietary
software embedded in the products as firmware which is not
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sold separately. All six shrink-wrap products can be run on Nematron's computers
or those of most other manufacturers.
The Company's OpenControl software product allows operators to leverage
PC-based software packages, such as Windows NT and many popular Supervisory
Control and Data Acquisition ("SCADA") and Man-Machine Interface ("MMI")
programs. OpenControl allows the use of standard networking products and
connectivity to the Internet or corporate-wide Intranet systems using a modular
approach for open control architecture applications. Hyperkernel allows
software developers to integrate highly deterministic real-time applications
into the Microsoft's Windows NT operating system and enables devices such
as robots, process controllers and motion control systems to be configured
as application servers on any standard network system. The Company's
Paragon software product is a SCADA package which regulates control and
management of process information. Paragon was developed by Intec, which the
Company acquired through a merger of Intec into the Company's wholly-owned
NemaSoft subsidiary in March, 1997. The Company's FloPro software product is a
flowchart programming and direct machine control software product developed by
UAI, which the Company acquired through a merger of UAI into a wholly-owned
subsidiary in September, 1995. The Company's PowerVIEW product, first released
by the Company in 1996, is a powerful and comprehensive 32-bit Windows NT and
Windows `95-based application development system for factory floor operator
interface applications. The Company's AutoNet software product is a test and
measurement server which allows for data acquisition and real time processing of
data and for performing multiple functions at high speed while graphically
displaying such real time information through a wide variety of configurable
graphic instruments, trends and Cartesian plots. AutoNet was developed by
Imagination, which the Company acquired by merger in March, 1995.
The Company consists of three operating units at five locations.
The Company's headquarters are in Ann Arbor, Michigan and employees
located there are responsible for product development, administration, finance,
accounting, personnel, computer manufacturing, customer service, corporate
purchasing, corporate quality, corporate marketing, corporate-wide sales and
international business development.
The Company's software development and software manufacturing for its
Nematron and NemaSoft products are conducted primarily at its Walpole,
Massachusetts and Virginia Beach, Virginia offices, although certain development
activities are also performed at its Santa Clara, California and Hilliard, Ohio
facilities. Software engineers and other employees located at these facilities
are responsible for software product development, enhancement, maintenance, and
reproduction of shrink-wrapped software.
The Company's sales operations for the European marketplace are
conducted in Chichester, United Kingdom, through Nematron, Ltd., which was a
wholly-owned subsidiary of Intec which the Company acquired in March, 1997.
Located south of London, its principal functions are European sales,
distribution management, application engineering and customer service. Nematron,
Ltd. is primarily operated as a cost center since allocation of gross product
margins and operating and administrative expenses cannot be reasonably allocated
to that entity or by region.
The Company's sales and service operations for the European marketplace
were formerly conducted in Maarssenbroek, Netherlands through Nematron Europa,
BV ("NEBV"), which was a wholly-owned subsidiary of the Company. NEBV ceased
operations in March, 1997. Located near Amsterdam, its principal functions were
European sales, distribution management, application engineering and customer
service. In March, 1996, administrative personnel in Ann Arbor became directly
responsible for administrative activities of NEBV until these activities were
assumed first by the Company's regional sales managers located in Europe and
then by Nematron, Ltd.
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PRODUCTS, MARKET, AND COMPETITION
COMPUTERS AND HARDWARE PRODUCTS
The Company designs and manufactures operator terminals for reliable
performance in harsh industrial environments. Each operator terminal provides a
display that shows the status of the process and a keyboard or a touch screen
that allows personnel to control the process. These terminals all come in a
rugged package that withstands extremes of temperature, humidity, vibration,
shock, and electrical interference.
The Company offers a variety of Industrial Workstations to the
industrial automation marketplace. Each product class includes a range of
display options, prices, and capabilities.
Virtually all of the Company's smaller and newer products use "flat
panel" displays. Popularized by laptop personal computers, flat panels offer
considerable space savings over CRTs with increased reliability. These products
also provide immunity to shock, vibration, and electromagnetic interference.
They are particularly well suited for applications with hazardous environments
such as chemical plants, and in the presence of high electrical currents, such
as in aluminum and steel processing applications. In the near future, management
intends to convert virtually all of the Company's products to flat panel
technology.
While price and features can be important factors in a customer's
purchase decision, reliability consistently ranks the highest. As a result, the
Company expends significant effort on design verification and testing of new
products and purchased subassemblies. In addition, management believes the
Company is able to price its products competitively because of their higher
quality, and hence lower warranty and repair work is required to be performed
after the sale.
CHARACTER-BASED PLC WORKSTATIONS AND REMOTE MESSAGE UNIT PRODUCTS
Character-based PLC workstations and remote message unit products
economically replace as few as five electro-mechanical push buttons, while also
providing message display and alarm annunciation functions. All products in this
class include flat panel displays. The Company internally developed the
proprietary software for the products in the lower price range of this class of
product. Most of these products are used with small PLCs for simple machine
control, such as packaging equipment and small fabricating machines. Products in
this class range in price from less than $500 to $2,300.
Most of the Company's competitors in this segment are small companies
with limited resources and market share. A few competitors, such as
Allen-Bradley and Eaton IDT, have substantially greater resources than the
Company, and offer competitive products in the upper end of the price range.
Sales of low-end products in 1997 and 1996 amounted to 50% and 40%,
respectively, of the Company's unit volume and 14% and 14%, respectively, of its
dollar volume from unit sales. The Company expects a growth rate of 3 to 8% in
this market segment in the next year, largely because industry analysts project
similar growth in the
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small PLC market. To participate in this growth, the Company plans to maintain a
modest level of product development effort, both to enhance existing products
and to offer new models of character-based PLC workstations.
INDUSTRIAL GRAPHICS TERMINALS AND PROGRAMMABLE OPERATOR INTERFACE
PRODUCTS
Industrial graphics terminals and programmable operator interface
products include both CRT displays and keyboards. These products utilize the
Company's proprietary hardware and software designs, which support either remote
terminal operation with an intelligent host, or fully programmable operation to
support PLC operator interface applications.
Because several dozen large and small companies offer competing
products in this market, competition is intense. Every major PLC company
competes in this market, either with its own designs or with private-labeled
products. Significant competitors include Allen-Bradley, Siemens and Eaton IDT.
During 1997 sales of this class of product were comparable to fiscal 1996
levels, although since 1990, the Company's unit sales of mid-range products have
declined over 25% due to the increased competition and now relatively older
designs.
Sales of industrial graphics terminals and programmable operator
interface products in 1997 and 1996, amounted to 15% and 18%, respectively, of
the Company's unit volume and 14% and 15%, respectively, of its dollar volume
from unit sales. The Company expects a decrease of approximately 10% per year in
this market segment due to the availability in future years of more
sophisticated technology at lower costs.
INDUSTRIAL PC PRODUCTS AND INDUSTRIAL CONTROL COMPUTER PRODUCTS
Industrial PC products are fully integrated or modular rack-mount or
bench-top PCs which provide Intel 80X86 architecture with processors ranging
from 486DX-2/66 to Pentium 133, 166, 200 MHz or Pentium Pro 200 MHz processors,
and CRT or flat-panel displays. Many of the high-end workstations are "bundled"
with the Company's OpenControl, PowerVIEW, AutoNet or FloPro software products,
all of which are described in the "Software Products" section hereof. For the
remainder of the industrial PC products, customers run their systems with a
choice of several third-party industrial monitoring and control software
packages. Products in this class range in price from $2,000 to $10,000.
Industrial Control Computers ("ICCs") were designed and developed by
the Company beginning in 1995, and the Company began shipping them in late 1995.
ICC products offer a 486DX2/66, Pentium 133, 166, 200 MHz or Pentium Pro 200 MHz
or P24T Pentium Overdrive processors. They also are shipped with a variety of
display options and a single motherboard featuring local bus architecture for
integral SVGA video and IDE drive control circuits. The form of the units are
NEMA 4 (water tight) construction and include a rugged, front-panel
mouse-simulator or touch screen for cursor positioning. Many of the ICC products
are "bundled" with OpenControl, FloPro, PowerVIEW or AutoNet software products.
These units range in price from $2,000 to $7,000, varying primarily on the
choice of display and the bundled software.
Sales of these products in 1997 and 1996 amounted to 35% and
42%, respectively, of the Company's unit volume and 72% and 71%, respectively,
of its dollar volume from unit sales.
Management believes that while operator interface products will
eventually migrate to PC based control and operator interface solutions that
eliminate the PLC, the migration will not be complete for at least four to five
years, and the market for industrial PC products will expand significantly. In
response to this evaluation of the market, the Company will place substantial
emphasis on further enhancements to Industrial PC and ICC products as cost
effective replacements for existing, lower functionality, industrial
workstations that complement, rather than replace, PLCs.
Many competitors participate in the industrial PC product market, most
notably IBM, Allen-Bradley, and Siemens. Many segments in this market are highly
price-sensitive, especially in environments where commercial-grade products
perform adequately. As the market expands, numerous competitive offerings will
probably appear, putting downward pressure on prices and gross profit margins.
The Company intends to continue providing industrial PC products for reliable
operation in harsh environments.
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COMPUTER HARDWARE PARTS AND SERVICE
The Company maintains an inventory of spare parts and service stock and
dedicates approximately 25 service technicians and support personnel whose
functions include technical advice regarding product applications and service
and repair of returned computer and other hardware. With the increasing number
of units in service in the marketplace due to the products' wide acceptance and
long life, the shipment of spare parts and performing repair service on
out-of-warranty product continues to be a significant part of the business.
SOFTWARE PRODUCTS
The software products described below, all of which were acquired or
developed by the Company in the last three years, represent the cornerstone of
the Company's shift in its strategic focus from that of relying solely on sales
of Industrial Workstation products, which was the Company's strategy through
1994, to becoming a high value-added provider of bundled industrial PC
hardware and Microsoft operating system-based software solutions. With the
addition of the following products, plus the continued enhancement of existing
products and the development of new software products, the Company is
positioning itself to become a leading supplier of industrial automation
software. The Company will attempt use its software and proven reliable PC
hardware to help drive factory automation industry from PLC to PC based control.
The Company's six main software products are used in the industrial and
factory automation workplace. Additionally, most of the hardware products
discussed above contain proprietary software embedded in the products as
firmware which firmware is not sold as a separate product. All six shrink-wrap
products may be run on Nematron's computers or on computers of most other
manufacturers.
Sales of software products in 1997 and 1996 amounted to 16% and 8%,
respectively, of the Company's total revenue.
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OPENCONTROL(TM) SOFTWARE
The Company's software product suite for open architecture, direct
control of machines is called OpenControl(TM). OpenControl allows operators to
leverage PC-based software packages, such as Windows NT and many popular
Supervisory Control and Data Acquisition ("SCADA") and Man-Machine Interface
("MMI") programs, including the Company's proprietary Paragon SCADA product and
its PowerVIEW MMI product. OpenControl allows the use of standard networking
products and connectivity to the Internet or corporate-wide Intranet systems.
OpenControl provides a modular approach for open control architecture
applications. The product is comprised of a series of Visual Programming
languages for control, the FloPro for Windows NT run-time control engine, and
independent Device Network I/O servers. OpenControl's programming environment
is the Visual Flowchart Language ("VFL"), a graphical control language that
utilizes a structured development environment for machine control applications.
VFL provides a functional and graphical programming environment compared to the
aging ladder logic method by providing a wider variety of tools to graphically
create a program that maximizes machine control. VFL is capable of integrating
user created C programs and can generate IEC-1131 code as an output from
flowcharts. FloPro for Windows NT is OpenControl's run-time engine, and is a
32-bit version of the original field-proven FloPro technology described below.
FloPro for Windows NT is several times faster than its DOS-based predecessor
and is based on the Hyperkernel real-time Windows NT technology. FloPro for
Windows NT provides an advanced discrete manufacturing capability based on its
fast and efficient logic solve, inherent integrated diagnostics and coordinated
motion control capability. A variety of device networks and legacy PLC I/O
systems are supported.
HYPERKERNEL(TM)
Hyperkernel allows software developers to integrate highly
deterministic real-time applications into the Microsoft's Windows NT operating
system and enables devices such as robots, process controllers and motion
control systems to be configured as application servers on any standard network
system. The Hyperkernel product includes features such as high speed timers;
memory management; interrupt handlers; inter-process communication; file system
services; and task scheduling and prioritization. By using a standardized
development environment like Microsoft C and Visual C++, significant reductions
in software development time may be achieved.
In late 1993, ISI began work on an advanced 32-bit Windows development
framework that supported a traditional real-time microkernel target system for
runtime execution for industrial control. The present design of the core
technology is a greatly enhanced version of the original framework. The
technology has been expanded to provide true client/server capabilities for
complex software applications. The Hyperkernel RTSS for the Windows NT operating
system utilizes a sophisticated message-passing architecture for inter-process
communications, which is the key difference between Hyperkernel and similar
products developed to operate under DOS or Microsoft's Windows 3.1 operating
systems.
Traditionally, many developers have used custom or proprietary
operating systems and tools to gain high-speed determinism in their application
development work. This meant that they were not able to leverage the extensive
collection of tools and applications available for the desktop Windows/PC
marketplace. With the Hyperkernel product, development in a mainstream operating
system architecture is now practical.
PARAGON(TM) SOFTWARE
The Company's SCADA software is called Paragon (TM). Paragon was
developed by Intec, which the Company acquired through a merger in March, 1997.
Paragon is a software package which regulates control and management of process
information. The software delivers high performance and reliability in networked
applications with a scaleable database design. This open modular design and
dynamic connectivity simplify integration into enterprise-wide networks. Paragon
supports seamless cross-platform communication among operating systems from
Windows NT to Windows 95 and OS/2 on the same network.
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Paragon competes with other software product offerings from other
companies, most notably Wonderware and Intellution. However, the flexible
feature set of Paragon and its networking capabilities provide users with
advantages over competitive products. Paragon's built-in mechanisms allow data
exchange with third-party applications through DDE, standards or programming
languages. Paragon separates application functions into servers which acquire,
generate and store information. Peer-to-peer communication between any
client/server or server/server pair occurs without a central server.
FLOPRO(R) SOFTWARE
The Company's soft logic software is called FloPro(R). FloPro is a
flowchart programming system which executes from personal computers and which
was developed by UAI, which the Company acquired through a merger in September,
1995. FloPro is based upon the technology in Patent Number 4,852,047
"Continuous Flow Chart, Improved Data Format and Debugging System for
Programming and Operation of Machines." The programming system is used to
create, debug, document and execute control applications in an open
architecture environment. Its open system architecture allows operators to
interface it concurrently with many different input/output systems, motion
controllers, message units and RF tag/bar code systems. FloPro simplifies
machine control system development. The use of multiple flowcharts, each one
handling a relatively simple task, allows for the concurrent development of
applications by a team of control engineers. These flowcharts communicate
with each other in a multi-tasking environment, which means that the control
application is easy to create and understand. Additionally, FloPro is self
documenting in that it is a programming language based on the flowcharts; there
is no need to translate the flowcharts to ladder logic. The use of FloPro and a
PC replaces the need for PLCs and ladder logic for machine control
applications. FloPro is in use at several General Motors Corporation
manufacturing facilities. FloPro systems at GM's PowerTrain Group control over
2,000 machines used to manufacture engines and transmissions
FloPro competes with several products offered by companies of similar
or smaller size than Nematron in the soft logic marketplace. The soft logic
marketplace is an emerging market that is expected to grow significantly in the
next several years as PCs and soft logic software programs replace PLCs and
ladder logic software. Several of the Company's competitors license the
technology upon which FloPro is based. The advantages of the FloPro product as
compared to competing products is that the software is self documenting, thus
reducing programmer time; it costs less than many other products; it operates on
open PC architecture; and it reduces plant down time through diagnostic messages
and fast execution time.
During fiscal 1997, the Company devoted significant resources to the
upgrading of the current 16-bit version of FloPro to a 32-bit version of the
product which contains numerous and significant enhancements. However, due to
the technical success of the Company's Windows NT version of FloPro, which is
an integral part of the OpenControl software product, and the increasing market
acceptance of Windows NT, the Company abandoned the further development of the
32-bit DOS version in the fourth quarter of fiscal 1997 and did not release the
32-bit DOS version as a software product. All capitalized software development
costs related to the 32-bit DOS version of FloPro were charged against
operations in fiscal 1997. See "Management's Discussion and Analysis of
Operations Fiscal 1997 Compared to Fiscal 1996."
POWERVIEW(TM) SOFTWARE
The Company began the development of this 32-bit Windows-based
application development and run-time system in 1995 and released the product for
sale initially late in the fourth quarter of fiscal 1995. During fiscal 1996 and
1997, the Company performed substantial enhancements on the version initially
released in fiscal 1995 and released enhanced versions of PowerVIEW in fiscal
1996 and 1997. The application development system included in the PowerVIEW
system was developed to serve as a single point of control for building
graphical display panels and configuring hardware, I/O connections, process
variables, alarms, messages and all other events associated with the operation
of a machine. A high-speed run-time compliments the project manager portion of
the system, but operates on a 32-bit real-time preemptive multi-tasking
microkernel more naturally suited to high-speed, real-time process control. When
the application project is downloaded to the run-time system and the workstation
is plugged into a PLC or I/O network, it runs automatically and scans the I/O
network at rates higher than other commercially available workstations, updating
the screens and sending instructions to the PLC virtually instantaneously.
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PowerVIEW competes with other software product offerings from other
companies, most notably Allen Bradley and Eaton IDT. However, the product is
unique in that it runs on open architecture PC platforms and is a 32-bit
Windows-based application development system and its run time executes from
solid state memory.
The Company expects to substantially enhance PowerVIEW in fiscal 1998.
In anticipation thereof, the Company wrote off in the fourth quarter of fiscal
1997 a substantial portion of previously capitalized software development costs
in order to reduce the carrying value of the current PowerVIEW product to its
estimated net realizable value. See "Management's Discussion and Analysis of
Operations - Fiscal 1997 Compared to Fiscal 1996."
AUTONET(TM)
The Company's test and measurement software is called AutoNet(TM), and
is sold to commercial and industrial companies primarily for use in a test cell
environment. AutoNet allows for data acquisition and real time processing of
high speed data while performing multiple functions. AutoNet graphically
displays real time information through a wide variety of configurable graphic
instruments, trends and Cartesian plots. AutoNet performs real-time
mathematical, statistical and trigonometric calculations for control, test
sequencing, filtering and batch management of data. It features color coded
annunciation of alarm information, diagnostic files and automatic time stamps,
and presents stored data in report, historical graphics or ad hoc queries.
AutoNet competes with products offered by other companies, most notably
Hewlett Packard and National Instruments. The AutoNet product is unique in that
it is a real time operating system which operates in a performance region that
competitive products do not.
The Company expects to substantially enhance AutoNet in fiscal 1998. In
anticipation thereof, the Company wrote off in the fourth quarter of fiscal 1997
a substantial portion of previously capitalized software development costs in
order to reduce the carrying value of the current AutoNet product to its
estimated net realizable value. See "Management's Discussion and Analysis of
Operations - Fiscal 1997 Compared to Fiscal 1996."
SALES CHANNELS
The Company employs three forms of sales channels. A network of
high-tech industrial distributors is the Company's primary sales channel.
Private-label accounts that remarket Nematron's products primarily through their
own networks of industrial electrical distributors are a less significant sales
channel for the Company's products. In addition, the Company sells its products
to major original equipment manufacturers ("OEMs") of industrial processing
systems and machines and to other major end users.
Approximately 40% of the Company's total sales are to distributors, 20%
to private-label accounts and 40% to direct sales accounts. The Company believes
that it can increase its business as a result of increased marketing and sales
efforts for its OpenControl, Hyperkernel and Paragon software products and its
ICC hardware product lines. Additionally, with the significant enhancements
planned for its PowerVIEW and AutoNet software products in 1998, the Company
expects to introduce newer and more powerful versions of these products for sale
in late 1998. The Company presently markets OpenControl heavily to the
automotive manufacturing industry, and intends to expand that focus to other
discrete and process industries in fiscal 1998. The Company also intends to
increase its sales and marketing efforts for bundled hardware and software
products.
Two distributors accounted for 21% and 17% of the Company's total
fiscal 1997 and fiscal 1996 sales, respectively. These distributors resell
products primarily to the automotive industry and machine tool builders. No
other private label, direct customer, or distributor accounted for more than 5%
of total Company sales in 1997 or 1996. Furthermore, no single model or product
has accounted for more than 15% of the Company's sales during this time period.
The Company's distributors are typically companies with non-exclusive
written agreements that purchase inventory and resell it to their customers. In
addition, distributors typically provide customer training, application
engineering, and support. The Company has approximately 100 domestic distributor
branches and approximately 150 distributor branches in more than 30 countries
internationally. The Company has over 20 regional sales managers covering major
geographic regions of the United States and Europe and several sales managers
who
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concentrate on key accounts nationwide. These managers are located in the
United States in California, Colorado, Illinois, Massachusetts, Michigan, North
Carolina, Ohio, Washington and Virginia, and in major business centers in the
Netherlands and the United Kingdom. In addition, direct sales accounts and
private label accounts are handled by both key account sales managers as well as
corporate executive management.
MANUFACTURING AND SUPPLY
The Company performs final assembly and testing for almost all hardware
products. The assembly process encompasses the assembly of sheet metal parts,
keyboards, displays, and electronic circuit boards into finished goods. In
addition, the Company performs some cable manufacturing, and also a limited
amount of circuit board assembly and wave soldering, as well as the repair and
engineering prototype assembly of surface mount technology components used on
various logic boards. The Company subcontracts the insertion and soldering of
components on circuit boards, and the fabrication of sheet metal, keyboards and
front panel bezels. The Company uses a number of independent firms for these
subcontracted services and is not materially dependent upon any third party that
performs these services. Selected models are built entirely to the Company's
design by vendors and purchased as complete products.
A network of personal computer-based engineering workstations supports
accounting, purchasing, production, scheduling and inventory, as well as the
computer-aided design and development of electronic circuitry, circuit board
layout, programming of programmable logic devices, mechanical design and
software development.
In addition, the Company has purchased and designed a variety of
assembly and test equipment to reduce the cost and ensure the quality of the
design and manufacturing process. The Company has made a substantial investment
in environmental chambers and electronic instrumentation used to certify that
the Company's products meet the severe industrial environments for which they
are intended.
Some components used in the Company's products are currently purchased
from single or limited sources of supply. The Company believes that the loss of
one or more suppliers would not have a material long-term impact on its
operations but could cause some production delays. As a result, the Company
typically maintains higher amounts of raw material inventory for certain
limited-source items than may be required for current production.
PRODUCT DEVELOPMENT
Since its inception, the Company has maintained an active product
development program and continues to supplement existing research and
development capabilities through active recruiting of technical personnel and
development of proprietary technology.
The Company currently has a total direct product development staff of
approximately 45 persons, including electrical and electronic design engineers,
mechanical design engineers, software design engineers, product managers,
application engineers and directly associated staff members involved in
technical documentation and product support. The Company also employs the
services of unrelated contract engineering companies on an as-needed basis. The
Company employs a separate group which is responsible for assuring the long term
quality and reliability of the Company's products. Within this quality assurance
group are quality, test, manufacturing and reliability engineers. Software
development activities are concentrated in the Walpole, Massachusetts and
Virginia Beach, Virginia offices but certain development is done by personnel in
Santa Clara, California and Hilliard, Ohio. Hardware development and quality
activities testing and control are concentrated in Ann Arbor, Michigan.
The Company emphasizes product development and quality and the
employment of highly skilled and motivated individuals in the product
development and quality assurance areas. Management believes that its product
development staff is an important factor in the Company's ability to compete in
the markets in which its products are sold. During the fiscal years 1997 and
1996, the Company expended approximately $4,600,000 and $2,600,000,
respectively, for direct hardware and software product development and product
design quality, including those costs capitalized under Statement of Financial
Accounting Standards No. 86. All of such costs were sponsored by the Company.
These amounts represented 22.0% and 8.8% of total revenues in fiscal 1997 and
1996, respectively.
10
<PAGE> 11
INTELLECTUAL PROPERTY
The Company's FloPro software product, which is sold as a separate
product and also the underlying technology of which is incorporated into the
Company's OpenControl product, is based upon the technology incorporated in a
patent for continuous flow chart, improved data formatting and a debugging
system for programming and operations of machines. This patent was issued in
1989 as a 17 year patent. The Company also was issued a patent in 1997 for a
chassis locking mechanism used on its Industrial Control Computer and certain
other products. The Company has no patents on other hardware products or
computer designs. The Company filed a patent application for its Hyperkernel
real-time extension to Windows NT during fiscal 1996. The Company has an active
patent committee to review patent potential on an ongoing basis.
In addition to trademarks on the trade names under which the Company
does or did business, including Nematron(R), NemaSoft, Imagination Systems and
Universal Automation, the Company also owns trademarks on certain of its
products, including Industrial Workstation(TM), ToolBox(TM), ToolBox Plus(TM),
OpenControl (TM), Hyperkernel (TM), Paragon(TM), FloPro(R), AutoNet(TM) and
PowerVIEW(TM).
The Company's software products are sold under licenses to use the
products as specified in the underlying contract. Certain of the licenses for
the use of the FloPro software product are site licenses for unlimited use of
the master copy of the product in a specified building, plant or group of
plants. To date, the revenue from these site licenses has not been a significant
source of revenue to the Company. Also, the Company has licensed its soft
logic technology to several unrelated companies under royalty arrangement;
these arrangements are not currently a significant source of revenue.
EMPLOYEES
The Company currently employs approximately 170 full time employees,
including 85 in Ann Arbor, Michigan, 30 in Walpole, Massachusetts, 25 in
Virginia Beach, Virginia, 7 in the United Kingdom, and 23 at other locations.
None of the Company's employees are represented by a collective bargaining unit,
and the Company believes its employee relations to be good.
ENVIRONMENTAL COMPLIANCE
The Company's products must comply with federal, state and/or local
laws and regulations that have been enacted or adopted relating to the discharge
of materials into the environment, or otherwise relating to the protection of
the environment. The Company believes that continuing efforts and expenditures
incurred to maintain compliance with such laws and regulations will not have a
material effect on capital expenditures, earnings or the competitive position of
the Company.
ITEM 2. PROPERTIES.
The Company's headquarters and principal manufacturing facilities are
located in Ann Arbor, Michigan, in a two-story building containing a total of
approximately 51,200 square feet of space. Of this space, approximately 6,400
square feet remain largely unfinished and are available for future office or
manufacturing expansion. This facility, located on approximately five acres of
land, has been designed such that further expansion of up to 20,000 square feet
may be accommodated. The Ann Arbor facility was designed and built to the
Company's specifications and is Company owned, subject to a first mortgage by
Chelsea State Bank, a second mortgage by KeyBank Leasing, a third position by
KeyBank, N.A., Michigan. The mortgage loan payable to Chelsea State Bank is in
the principal amount of approximately $2,160,000 at September 30, 1997, bears
interest at 9.5% per annum and is payable in monthly installments of $29,900
through September 2001, at which time the remaining balance of $1,491,000 is
due.
The Company's Walpole, Massachusetts facility consist of approximately
18,700 square feet of leased space in a multi-story historic office building.
Leasehold improvements consist of certain changes for specific office, service,
and storage requirements according to the Company's needs. The operating lease
for this facility is non-cancelable through August, 1999.
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<PAGE> 12
The Company's Virginia Beach, Virginia facility is a leased two story
office building consisting of approximately 5,800 square feet of space, with
leasehold improvements for office, service, and warehouse requirements according
to the Company's specifications. The operating lease for this facility is
non-cancelable through February, 1998, and the Company expects that the lease
will be re-negotiated and extended on substantially the same terms as in the
current lease.
The Company's European facilities are located in Chichester, United
Kingdom, and consist of approximately 5,000 square feet of leased space in a
20,000 square foot office complex. Leasehold improvements consist of certain
changes for specific office, service, and warehouse requirements according to
the Company's needs. The operating lease for this facility is non-cancelable
through December, 1998. Management expects to move to different facilities in
the Chichester area when the lease expires.
The Company's Hilliard, Ohio activities are conducted from a leased
facility in a large office complex and consist of approximately 4,600 square
feet. The operating lease for this facility is non-cancelable through April,
1998.
The Company believes that all of its facilities are adequate for its
present and anticipated operations.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not involved in any legal proceedings considered by
management to be other than routine litigation incidental to the business, and
management does not believe any such litigation to be material.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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<PAGE> 13
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Prior to October 5, 1995, the Company's Common Stock was traded in the
over-the counter market and was quoted on the NASD OTC Bulletin Board(SM) under
the symbol NEMA.U. In October, 1995, the Company's common stock was accepted for
listing on the NASDAQ SmallCap Market(SM) and began trading under the symbol
NEMA on the NASD SmallCap Market on October 5, 1995. Concurrent with the
Company's secondary stock offering on June 6, 1996, the Company's Common Stock
was accepted for listing on the Nasdaq Stock Market National Market (the
"National Market") and began trading under the symbol NEMA on the National
Market on June 6, 1996. The following table sets forth, for the periods
indicated, the closing price on the National Market for periods subsequent to
June 5, 1996, and the high and low bid as quoted by the National Association of
Securities Dealers through the NASD OTC Bulletin Board for periods prior to
June 6, 1996. The quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission, and may not represent actual transactions.
Fiscal 1996 High Bid/Close Low Bid/Close
----------- -------------- -------------
First Quarter $5.50 $4.25
Second Quarter $10.00 $4.50
Third Quarter $10.75 $7.75
Fourth Quarter $8.75 $6.44
Fiscal 1997 High Close Low Close
----------- ---------- ---------
First Quarter $8.63 $4.88
Second Quarter $7.38 $5.13
Third Quarter $6.75 $5.00
Fourth Quarter $8.75 $6.13
There are approximately 900 holders of record of the Company's Common
Stock as of December 20, 1997.
The Company has never paid cash dividends and does not expect to pay
cash dividends in the foreseeable future. Certain Company bank financing
covenants restrict the payment of dividends. See Note 8 of Notes to Consolidated
Financial Statements.
During fiscal 1996 and 1997, the Company issued the following
securities without registration of such securities:
<TABLE>
<CAPTION>
Securities
Act
Date Title Amount Consideration Exemption Terms of Conversion
<S> <C> <C> <C> <C> <C>
November 7, Warrants 237,214 Issued to lenders Section 4(2) of the Exercisable in whole or
1995 in connection Securities Act of 1933, in part after October
with subordinated as amended, and 31, 1996 through
debt issued on Regulation D October 21, 2002 at an
November 7, 1995 promulgated thereunder exercise price of $4.00
per share
March 13, Warrants 124,998 Issued to former Section 4(2) of the Exercisable in whole or
1997 Intec Securities Act of 1933, in part after March 31,
shareholders in as amended, and 1997 through February
connection with Regulation D 20, 2000 at an exercise
acquisition of promulgated thereunder price of $6.73 per share
Intec Controls
Corp. on March
13, 1997
</TABLE>
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<PAGE> 14
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS 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. See "Management's Discussion
and Analysis of Operations - Uncertainties Relating to Forward Looking
Statements."
OVERVIEW
Management's operating strategy is to incorporate software products
developed internally and those software products obtained through its
acquisitions, including its acquisitions of Intec, VTS, Imagination 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 new software
products and the enhancement of existing 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 unit volume. 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 has conducted a review of its internal computer systems
and of its software products offered for sale to its customers to identify
systems which could be affected by the Year 2000 issue. The Year 2000 issue is
the result of certain computer programs being written using two digits rather
than four digits to define the applicable year. The Company recently purchased
and installed a new enterprise-wide computer system which is Year 2000
compliant. Additionally, management believes that its software products sold
to third parties do not pose operational problems for its customers.
Accordingly, the Company believes that the Year 2000 issue will not have a
material effect on its operations.
FISCAL 1997 COMPARED TO FISCAL 1996
Net revenues were $20,875,000 in fiscal 1997 compared to $20,924,000 in
fiscal 1996. This represents a decrease of $49,000, or 0.2%, compared to fiscal
1996. Software revenues increased to 16.3% of total sales in fiscal 1997 versus
8.0% in fiscal 1996. The decrease in sales of Industrial Workstations and
related parts and service as a percentage of total fiscal 1997 revenues resulted
from both competitive pressures causing price declines as well as a decrease in
the number of units sold due to the fact the many of the Company's sales staff
were new to the Company and its products. Foreign revenues increased in fiscal
1997 by $1,206,000, or 25.2%, over foreign revenues in fiscal 1996, reflecting
the sales by Nematron, Ltd., the United Kingdom office of the former Intec
entity acquired in March, 1997. Revenues of the former Intec entity were
$1,730,000 from the date of acquisition to September 30, 1997. Additionally, the
Company increased its sales efforts in other parts of the world and dedicated
certain sales staff to foreign countries. Domestic revenues decreased in fiscal
1997 by $1,254,000, or 7.8%, compared to domestic revenues in fiscal 1996, due
to fewer sales personnel and inefficiencies of the sales processes. Management
expects relatively flat sales in the first half of fiscal 1998 compared to the
fourth quarter of fiscal 1997. Additionally, management expects that sales will,
for the second half of fiscal 1998, increase as a result of booked business and
the positive market response to its OpenControl and ICC hardware products.
Although OpenControl was released for sale in the fourth quarter of fiscal 1997,
sales were modest due to the selling cycle which generally requires a somewhat
extended evaluation period of the product after the initial sale before a
customer commits itself to a full program based on the OpenControl product. With
the introduction of the OpenControl and Hyperkernel products in 1997, together
with the acquisition of the Paragon software product mid year in fiscal 1997,
the percentage of revenue from software is expected to increase significantly
over the approximate 16% that software products contributed to total net
revenues in fiscal 1997. Also, the Company intends to continue to increase its
marketing and sales efforts in the United States as well as to increase such
efforts internationally; this will include the hiring and training of new sales
personnel in certain major metropolitan and industrial areas, the expansion of
its selling efforts in Europe, and the strengthening of its sales management.
The Company's expectation of revenue growth for the full fiscal year 1998 is
also based on the belief that the products introduced in the last several years
and products planned for release in fiscal 1998 are technologically more
advanced than certain comparably priced competing products, and also on the
belief that the expansion of the Company's product line will result in the
addition of new distributors to the Company's current distribution network. The
actual growth in net revenues for fiscal 1998 is subject to a number of
uncertainties, however. For example, the marketplace may not respond favorably
to the Company's marketing and sales efforts, the Company may be unable to
attract and retain qualified sales staff and management, 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
materialize, and technological advances by competing companies and 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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<PAGE> 15
Cost of revenues include costs related to raw materials and component
parts, direct labor, overhead, amortization of capitalized software costs,
provisions for warranty costs on products sold and provisions for excess and
obsolete inventory. There were no material changes in costs of raw materials,
direct labor or overhead; however, during fiscal 1997, the Company provided
significant reserves for obsolete materials related to certain discontinued
Industrial Workstation models and wrote off certain capitalized software
development costs. With the positive introduction of Industrial Control
Computers late in fiscal 1996 and the success of selling ICC models into major
automotive and other companies on a program basis, the Company determined in the
fourth quarter of fiscal 1997 to discontinue certain models of products.
Additionally, as the sales staff has changed over the last several years, the
Company has determined that future sales efforts will concentrate on current
models and future models of ICC products. Consequently, the Company wrote off
over $700,000 of obsolete and excess inventory in the fourth quarter of fiscal
1997, as well as recording provisions and other write offs of approximately
$350,0000 during the year. During the fourth quarter of fiscal 1997, the Company
secured a major award with General Motors to supply bundled products on a
program basis. The products included in the program will include ICC products
bundled with OpenControl and Paragon software. This contract culminates the
Company's efforts during the last two fiscal years to obtain a cornerstone
account for its vertically integrated bundled ICC and direct machine control
product. Significant selling and marketing efforts were expended for this
contract in particular and for the marketing of the Company's changing strategy
in general. As a result of this success and management's expectations regarding
the success of the bundled concept with other significant customers and other
markets, management determined that selling and future development efforts on
other commercial software products would decrease, and the resulting net
realizable value of projected revenues would be less than capitalized software
development costs. Additionally, management has determined that the AutoNet and
PowerVIEW software products will undergo a major enhancement in 1998. Therefore,
in the fourth quarter, the Company recorded a write down of capitalized software
development costs relating to its AutoNet, PowerVIEW, Hyperkernel and unreleased
NT Real Time projects, resulting in a fourth quarter charge to operations of
$4,061,000.
Gross profit decreased in fiscal 1997 to $3,207,000, or 15.4% of net
revenues, from $8,733,000, or 41.7% of net revenues, in fiscal 1996. The
decrease in gross profit in fiscal 1997 was due to primarily to the increase in
reserves for excess and obsolete inventory and the write off of capitalized
software development costs discussed in the previous paragraph. Management
expects that the gross profit percentage in fiscal 1998 will return to or
surpass the 1996 percentage due to the absence of the non-recurring charges
experienced in fiscal 1997.
Product development costs increased in fiscal 1997 by $703,000 to
$2,152,000, or 48.5%, over the fiscal 1996 level, primarily due to research and
developments efforts on new ICC and other hardware products and the development
efforts on advanced technology software products. With the addition of software
developers from the former Intec and VTS entities, the Company was able to
devote additional personnel to research and development activities. Product
development expenses, which are a function of new product research and
development and existing product enhancement efforts, are expected to increase
in fiscal 1998 over the fiscal 1997 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 Company expects to have more
personnel devoted to research and development activities in 1998 as the software
development staffs of Intec and VTS will be available to the Company for the
entire fiscal 1998 versus being employees of the Company for only a partial year
in fiscal 1997. The actual level of product development expense for fiscal 1998
is subject to various uncertainties, including the ability of the Company to
attract and/or retain qualified persons to perform the planned activities. In
addition, it is possible that research and development efforts could proceed
differently than anticipated or the Company may be required to expense, rather
than to capitalize, the costs related to such efforts.
Selling, general and administrative expenses in fiscal 1997 increased
by $2,978,000, or 46.7%, over the fiscal 1996 level, due principally to
increased marketing and sales efforts throughout the year to introduce its new
hardware and software products and to increased provisions for uncollectable
accounts receivable. Additionally, significant sales efforts were expended to
secure the large General Motors contract discussed previously. Also, in the
later half of fiscal 1997, the Company increased its sales and support staffs
significantly to support the expected ramp up of sales activities and to
increase the capabilities of the application engineering and technical support
groups to assist in the total sales and after sales activities. Also, the
Company experienced certain increased general and administrative expenses due
to the merger of the Company with Intec in March, 1997 and with VTS in June,
1997.
Other operating expenses in fiscal 1997 included write-offs of
in-process research and development costs of $1,655,000 and $400,000 relating
to the acquisitions in fiscal 1997 of Intec and VTS, respectively. Acquired
in-process research and development includes the value of products in the
development stage and not considered to have reached technological feasibility.
In accordance with applicable accounting rules, acquired in-process research
and development costs are required to be expensed. Accordingly, $2,055,000 of
such costs were recorded to operating expense at the acquisition dates of Intec
and VTS.
Non-recurring operating charges in fiscal 1997 totaled $728,000. The
acquisition of Intec's United Kingdom office in March, 1997 allowed for the
closure of the
15
<PAGE> 16
Company's sales and service office in the Netherlands, accounting for $246,000
of non-recurring charges, and allowed the European operations to be
headquartered in England while providing an upgrade in personnel, service levels
and operating structure. The refinancing of 12% subordinated debt with 8.5% term
debt in 1997 resulted in a charge to operations of previously unamortized debt
issuance costs of $122,000. Certain intangible assets were acquired by the
Company in the UAI merger in March, 1995; in the fourth quarter, due to
personnel changes and changes in software development and operating strategy,
such intangible assets were charged against operations and written off to zero
value, resulting in a fourth quarter charge of $360,000.
The rate of increase in selling, general and administrative expenses in
fiscal 1998 is expected to be less than in fiscal 1997 due the absence of
non-recurring charges in fiscal 1998 as were experienced in fiscal 1997 and the
lack of the unexpected increases in reserves for uncollectable accounts
receivable. Also, the Company expects to consolidate selling, general and
administrative functions of the merged-in companies in fiscal 1998 and to reduce
certain redundancies which occurred in the second half of fiscal 1997 as a
result of the acquisitions of VTS and Intec. This expectation is based upon
planned increases in sales personnel and support staff offset by efficiencies
and the elimination of redundancies, only modest increases in marketing
activities and modest general cost increases in advance of net revenue
increases. The actual rate of growth is subject to various uncertainties,
however. These include difficulties in attracting and retaining qualified
personnel as planned, the ability of management to effect operational
improvement, and the potential need to curtail planned marketing and sales
efforts and other activities if the potential profit improvement anticipated is
not realized.
Interest expense in fiscal 1997 decreased by $151,000 due to lower
average borrowing levels in fiscal 1997 than in fiscal 1996.
Foreign currency losses totaled $155,000 in fiscal 1997 compared to
losses of $10,000 in fiscal 1996. The losses resulted in each period primarily
from translating the intercompany balance between the Company and its foreign
subsidiaries at year end exchange rates of U.S. dollars to the local foreign
currency.
Interest income in fiscal 1997 increased by $33,000 to $104,000, or
47%, over the fiscal 1996 level. The increase is due to higher average cash
balances in interest bearing accounts in fiscal 1997 compared to fiscal 1996.
FISCAL 1996 COMPARED TO FISCAL 1995
Net revenues were $20,924,000 in fiscal 1996 compared to $17,576,000 in
fiscal 1995. This represents an increase of $3,348,000, or 19.0%, compared to
fiscal 1995. Of the increase, $903,000, or 27.0%, was attributable to net
revenues from software sales, and $2,445,000 of the increase, or 73.0%, was
attributable to increases in sales of Industrial Workstations and related parts
and service. The increase in revenues from software and software services
represented an increase of 128.4% in fiscal 1996 over fiscal 1995 and resulted
from sales of the AutoNet, FloPro and PowerVIEW software products for the entire
year versus a partial year in fiscal 1995, and also from increased unit volume.
The increase in revenues from Industrial Workstations and related parts and
service represented an increase of 10.5% in fiscal 1996 over fiscal 1995, and
resulted from increased unit volume as a result of increased sales efforts by an
increased number of regional sales managers. Foreign revenues decreased in
fiscal 1996 by $1,735,000 to $4,777,000, or 26.6%, over foreign sales in fiscal
1995, reflecting a lower level of purchases from a major European customer and a
decreased emphasis on international markets. Additionally, the Company's
emphasis on new hardware and software products was limited to the domestic
marketplace. Domestic revenues increased in fiscal 1996 by $5,082,000 to
$16,146,000 or 45.9%, over domestic revenues in fiscal 1995 due to the
introduction of new hardware and software products and the ability of the
Company to secure several new customers for certain programs at a major
automotive company. Additionally, the Company expanded its domestic sales force
significantly in fiscal 1996.
16
<PAGE> 17
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 to date and provisions for
excess and obsolete inventory. There were no material changes in costs of any
components of costs of revenues, although certain costs did decrease moderately.
Gross profit increased in fiscal 1996 to $8,733,000, or 41.7% of net
revenues, from $6,194,000, or 35.2% of net revenues, in fiscal 1995. The
increase in gross profit in fiscal 1996 was due fairly equally to the
introduction and sale of higher margin hardware products in fiscal 1996 and the
effect of an increasing percentage of software sales, which are higher margin
products. Additionally, material costs have decreased slightly due to falling
parts prices offered by certain component vendors, and the greater management
resources devoted to the Company's purchasing function.
Product development costs increased in fiscal 1996 by $555,000 to
$1,449,000, or 62.1%, over the fiscal 1995 level, primarily due to efforts to
develop and introduce new products, including the ICC products, in fiscal 1996.
Additionally, the Company formed a product development department in fiscal 1996
and increased its resources devoted to research and development activities
Selling, general and administrative expenses in fiscal 1996 increased
by $1,687,000 to $6,380,000, or 35.9%, over the fiscal 1995 level, due
principally to increased marketing activities and to increased sales personnel
and their sales efforts to achieve the net revenue 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 these expenses due to the merger of the Company
with ISI in March, 1995 and the acquisition of UAI in September, 1995.
Additionally, the Company incurred approximately $215,000 of expenses in 1996
related to the termination of its managing director at NEBV.
Interest expense in fiscal 1996 increased by $132,000 to $513,000, or
34.7%, due to higher borrowing levels for the first two quarters of fiscal 1996
until a portion of the proceeds of the Company's secondary stock offering were
used to repay all borrowings under the Company's line of credit in June, 1996.
Higher borrowing levels were required to fund the Company's growth and were
incurred as a result of the negotiation and generally full use of a higher bank
credit line, the private placement in November, 1995 of $1,800,000 of
subordinated debt, and an increase in amounts borrowed under a mortgage note.
Concurrent with the repayment of all outstanding borrowings under the available
bank credit line, total average borrowings decreased, and will continue to
decrease as the mortgage note is paid monthly.
Foreign currency losses totaled $10,000 in fiscal 1996 compared to
foreign currency gains of $74,000 in fiscal 1994. The gain or loss 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.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share. The Company intends
to adopt this standard during the first quarter of fiscal 1998. The adoption of
this standard is not expected to have a material effect on the Company's
reported earnings per share.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, Reporting Comprehensive Income. The
Company intends to adopt this standard during the first quarter of fiscal 1998.
The adoption of this standard is not expected to have a material effect on the
Company's reported operations.
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<PAGE> 18
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, Disclosures About Segments of an
Enterprise and Related Information. The Company intends to adopt this standard
during the first quarter of fiscal 1998. The adoption of this standard is not
expected to have a material effect on the Company's reporting.
On October 27, 1997, the AICPA Accounting Standards Executive
Committee issued Statement of Position 97-2 (SOP 97-2), Software Revenue
Recognition. SOP 97-2 is effective for fiscal years commencing after December
15, 1997, and is not expected to impact the Company's financial position or
results of operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company is in the process of upgrading its management information,
telephone and network systems. Although most equipment needed in connection with
these activities has been acquired and financed in fiscal 1997, management
expects that additional equipment required will be financed through operating
leases. It is expected that capital required for software and product
development in 1998 will increase over the fiscal 1997 level, and amounts to be
expended for marketing and sales efforts will increase as well.
The Company's bank line of credit remains at $6,000,000, limited in
amount by availability formulas pertaining to accounts receivable and inventory.
A total of $1,141,000 was outstanding, and $3,500,000 was available under this
facility at September 30, 1997. The line of credit includes certain
affirmative and negative covenants. The Company was in violation of certain of
the covenants as of September 30, 1997, and obtained a waiver of such
violations from the bank. Amounts borrowed under the facility bear interest
at LIBOR plus 2.5% (8.5% at September 30, 1997). The line of credit expires on
February 28, 1998, and management believes it will be able to renew the
facility at or prior to that date on terms and conditions comparable to those
contained in the current facility. See Note 7 to Notes to Consolidated
Financial Statements. Management anticipates that additional amounts will be
borrowed under the line in the first half of fiscal 1998 before reductions of
the line usage will materialize.
Internally generated funds from operations, together with the existing
cash resources and available bank credit facilities and amounts available
through leases are expected to be sufficient for the Company's operating and
capital requirements for fiscal 1998.
UNCERTAINTIES RELATING TO FORWARD LOOKING STATEMENTS
"Item 6. Management's Discussion and Analysis of Operations" and other
parts of this Form 10-KSB contain certain "forward-looking statements" within
the meaning of the Securities Act of 1934, as amended, based on current
management expectations. Actual results could differ materially from the
forward-looking statements due to a number of uncertainties, including, but not
limited to, those discussed in this section and in "Business - Products, Market
and Competition" above.
Factors that could cause future results to differ from these
expectations include general economic conditions particularly related to
automotive manufacturing, demand for the Company's products and services, the
ability of the Company to successfully implement its strategy to lead the
industrial automation market migration from closed architecture PLCs to open
architecture PC-based solutions, changes in Company strategy, product life
cycles, competitive factors (including the introduction or enhancement of
competitive products), pricing pressures, raw material price increases, delays
in introduction of planned hardware and software products, software defects and
latent technological deficiencies in new products, changes in operating
expenses, fluctuations in foreign exchange rates, inability to attract or retain
sales and/or engineering talent, changes in customer requirement and evolving
industry standards.
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
Not applicable.
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PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information required by this item is incorporated by reference to
the Company's 1998 Proxy Statement under the captions "Election of Directors,"
"Board of Directors Meetings and Committees" and "Executive Officers."
ITEM 10. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to
the Company's 1998 Proxy Statement under the caption "Executive Compensation."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to
the Company's 1998 Proxy Statement under the caption "Security Ownership of
Certain Beneficial Owners and Management."
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference to
the Company's 1998 Proxy Statement under the caption "Certain Relationships and
Related Transactions."
ITEM 13. EXHIBITS REPORTS ON FORM 8-K.
(a) The exhibits filed herewith are set forth in the Index to Exhibits
(on the first page of the separate exhibit section which follows
the financial section of this report) and are incorporated herein
by reference. The following are the Company's management contracts
and compensatory plans and arrangements which are required to be
filed as Exhibits to this Form 10-KSB:
Exhibit
Number Description of Exhibit
------- ----------------------
10.01 Nematron Corporation Restricted Stock Plan, filed as
Exhibit 10.01 to the Registrant's Form 10-Q for the
quarterly period ended June 30, 1993 and incorporated
herein by reference.
10.02 Nematron Corporation 1993 Stock Option Plan, as amended,
filed as Exhibit 10.1 to the Registrant's Form 10-Q for
the quarterly period ended March 31, 1997 and incorporated
herein by reference.
10.03 Nematron Corporation 1993 Directors Option Plan filed as
Exhibit 10.2 to the Registrant's Form 10-Q for the
quarterly period ended March 31, 1997 and incorporated
herein by reference.
10.04 Nematron 401(k) Plan filed as Exhibit 10.04 to the
Registrant's Form 10-KSB for the year ended September 30,
1995 and incorporated herein by reference
10.06 Employment and Non-Competition Agreement, dated as of
March 31, 1997, between NemaSoft, Inc. and Thomas Kraus
filed as Exhibit 10.4 to the Registrant's Form 10-QSB for
the quarterly period ended March 31, 1997 and incorporated
herein by reference
10.07 Non-Competition Agreement dated as of March 2, 1995
between the Registrant and Frank G. Logan, III, filed as
Exhibit 99(a) to the Registrant's Form 8-K dated as of
March 3, 1995 and incorporated herein by reference.
(b) The Company was not required to and did not file any current
report on Form 8-K during the fourth quarter of the Company's
fiscal year ended September 30, 1997.
19
<PAGE> 20
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized
NEMATRON CORPORATION
By: /s/Frank G. Logan, III Dated: December 23, 1997
----------------------------------------------- -----------------
Frank G. Logan, III, President and CEO
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
Signature Title
Date
<S> <C> <C>
/s/ Frank G. Logan, III Chairman of the Board, President, CEO December 23, 1997
- --------------------------------- and a Director -----------------
Frank G. Logan, III (Principal Executive and Financial Officer)
/s/ David P. Gienapp Executive Vice President - Finance and December 23, 1997
- --------------------------------- Administration(Principal Accounting Officer) -----------------
David P. Gienapp Secretary, Treasurer and a Director
/s/ Hugo E. Braun Director December 23, 1997
- --------------------------------- -----------------
Hugo E. Braun
/s/ Joseph J. Fitzsimmons Director December 23, 1997
- --------------------------------- -----------------
Joseph J. Fitzsimmons
/s/ Garnel F. Graber Director December 23, 1997
- --------------------------------- -----------------
Garnel F. Graber
/s/ Michael L. Hershey Director December 23, 1997
- --------------------------------- -----------------
Michael L. Hershey
/s/ Douglas B. Juanarena Director December 23, 1997
- --------------------------------- -----------------
Douglas B. Juanarena
</TABLE>
20
<PAGE> 21
NEMATRON CORPORATION AND SUBSIDIARIES
Consolidated Financial Statements
As of September 30, 1997
(With Independent Auditors' Report Thereon)
<PAGE> 22
NEMATRON CORPORATION AND SUBSIDIARIES
Table of Contents
<TABLE>
<CAPTION>
Page(s)
-------
<S> <C>
Independent Auditors' Report F-2
Consolidated Balance Sheet as of September 30, 1997 F-3
Consolidated Statements of Operations for the years ended
September 30, 1996 and 1997 F-4
Consolidated Statements of Stockholders' Equity for the years ended
September 30, 1996 and 1997 F-5
Consolidated Statements of Cash Flows for the years ended
September 30, 1996 and 1997 F-6
Notes to Consolidated Financial Statements F-7 to F-26
</TABLE>
<PAGE> 23
Independent Auditors' Report
The Board of Directors
Nematron Corporation:
We have audited the accompanying consolidated balance sheet of Nematron
Corporation and subsidiaries as of September 30, 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years ended September 30, 1996 and 1997. 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 audits.
We conducted our audits 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 audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Nematron
Corporation and subsidiaries as of September 30, 1997, and the results of their
operations and their cash flows for the years ended September 30, 1996 and
1997, in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
Detroit, Michigan
December 12, 1997
F-2
<PAGE> 24
NEMATRON CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheet
September 30, 1997
<TABLE>
<CAPTION>
Assets (Notes 7 and 8)
---------------------
<S> <C>
Current assets:
Cash and cash equivalents $ 1,142,988
Accounts receivable, net of allowance for doubtful accounts of $410,000 4,205,196
Inventories (note 6) 4,399,426
Prepaid expenses and other current assets 528,471
-------------
Total current assets 10,276,081
Property and equipment:
Land 117,000
Building and improvements 2,279,598
Equipment 5,732,795
-------------
8,129,393
Less accumulated depreciation (3,865,092)
-------------
Net property and equipment 4,264,301
Other assets:
Software and related development costs, net of accumulated amortization of $1,619,919
(note 4) 2,724,819
Other intangible assets, net of accumulated amortization of $516,168 (note 4) 3,008,547
-------------
Net other assets 5,733,366
-------------
Total assets $ 20,273,748
=============
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
Note payable to bank (note 7) $ 1,141,000
Current maturities of long-term debt (note 8) 681,231
Accounts payable 1,711,936
Other accrued liabilities 1,818,138
-------------
Total current liabilities 5,352,305
Deferred tax liability (notes 3 and 9) 1,000,000
Long-term debt, less current maturities (note 8) 3,595,378
-------------
Total liabilities 9,947,683
Stockholders' equity:
Common stock, no par value; 15,000,000 shares authorized, 5,329,938 shares issued and
outstanding (notes 10 and 11) 21,589,413
Foreign currency translation adjustment (7,571)
Accumulated deficit (11,255,777)
-------------
Total stockholders' equity 10,326,065
-------------
Commitments and contingencies (note 12)
Total liabilities and stockholders' equity $ 20,273,748
=============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 25
NEMATRON CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the years ended September 30, 1996 and 1997
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Net revenues $ 20,923,613 $ 20,875,397
Cost of revenues, including non-recurring charges of $4,768,687 in 1997
(note 4) 12,190,759 17,668,774
------------- --------------
Gross profit 8,732,854 3,206,623
Operating expenses:
Product development costs 1,448,540 2,151,698
Selling, general, and administrative expenses 6,379,718 9,357,460
Write-off of in-process research and development costs relating to the
Intec Controls Corp. acquisition (note 3) 1,655,000
Write-off of in-process research and development costs relating to the
Virtual-Time Software, Inc., acquisition (note 3) 400,000
Non-recurring charges (note 4) 727,582
------------- --------------
Total operating expenses 7,828,258 14,291,740
------------- --------------
Operating income (loss) 904,596 (11,085,117)
------------- --------------
Other income (expense):
Interest and other income, net 70,189 103,659
Interest expense (512,896) (361,894)
Foreign currency loss (10,199) (155,027)
------------ --------------
Total other expense (452,906) (413,262)
------------ --------------
Income (loss) before income taxes 451,690 (11,498,379)
Income taxes (note 9) 0 0
------------- --------------
Net income (loss) $ 451,690 $ (11,498,379)
============= ==============
Income (loss) per share:
Primary $0.13 $(2.33)
===== ======
Fully diluted $0.12
=====
Weighted average shares outstanding - primary 3,580,057 4,933,939
============= ==============
Weighted average shares outstanding - fully diluted 3,797,490
=============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 26
NEMATRON CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
For the years ended September 30, 1996 and 1997
<TABLE>
<CAPTION>
Retained
Common Stock Foreign Earnings
------------------------- Currency (Accumulated
Shares Amount Translation Deficit) Total
------ ------ ----------- -------- -----
<S> <C> <C> <C> <C> <C>
Balance, October 1, 1995 2,869,613 $6,796,193 $ (50,947) $ (209,088) $6,536,158
Net income for the year ended
September 30, 1996 451,690 451,690
Foreign currency translation effect (34,571) (34,571)
Shares issued pursuant to secondary
stock offering, net of expenses 1,200,000 9,551,604 9,551,604
Exercise of options 13,416 36,968 36,968
Exercise of warrants 475,219 1,188,049 1,188,049
----------- --------- ---------- ----------- ---------
Balance, September 30, 1996 4,558,248 17,572,814 (85,518) 242,602 17,729,898
Net loss for the year ended
September 30, 1997 (11,498,379) (11,498,379)
Foreign currency translation effect 77,947 77,947
Shares issued pursuant to merger with
Intec Controls Corp. (note 3) 587,594 3,305,205 3,305,205
Shares issued pursuant to merger with
Virtual-Time Software, Inc.
(note 3) 67,301 403,806 403,806
Exercise of options, net of 13,083
shares redeemed 72,148 136,667 136,667
Exercise of warrants 44,647 170,921 170,921
----------- ----------- ---------- ----------- -----------
Balance, September 30, 1997 5,329,938 $21,589,413 $ (7,571) (11,255,777) $10,326,065
=========== =========== ========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 27
NEMATRON CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the years ended September 30, 1996 and 1997
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 451,690 $ (11,498,379)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization 837,666 6,179,918
Write-off of in-process research and development costs (note 3) 2,055,000
Debt retirement expense 122,340
Changes in assets and liabilities that provided (used) cash:
Accounts receivable (2,828,082) 2,535,869
Inventories (397,915) 143,617
Prepaid expenses and other current assets (481,638) 248,403
Accounts payable (1,083,280) (157,326)
Other accrued liabilities (376,418) (224,832)
-------------- --------------
Net cash used in operating activities (3,877,977) (595,390)
-------------- --------------
Cash flows from investing activities:
Acquisition of Intec Controls Corp. (note 3) 281,058
Acquisition of Virtual-Time Software, Inc., net of $6,327 cash acquired
(note 3) (93,673)
Additions to capitalized software development costs and other
intangible assets (1,171,827) (2,512,111)
Additions to property and equipment (929,730) (827,861)
-------------- --------------
Net cash used in investing activities (2,101,557) (3,152,587)
-------------- --------------
Cash flows from financing activities:
Borrowings under long-term debt agreements 2,266,081 1,800,000
Net proceeds (repayments) of note payable to bank (2,450,000) 1,141,000
Proceeds from sale of common stock and exercise of options and warrants 10,776,621 307,588
Repayments of long-term debt (540,245) (2,264,350)
Additions to deferred financing fees (173,647) (39,211)
-------------- --------------
Net cash provided by financing activities 9,878,810 945,027
-------------- --------------
Foreign currency translation effect on cash (34,571) 2,975
-------------- --------------
Net increase (decrease) in cash and cash equivalents 3,864,705 (2,799,975)
Cash and cash equivalents at beginning of year 78,258 3,942,963
-------------- --------------
Cash and cash equivalents at end of year $ 3,942,963 $ 1,142,988
============== ==============
Supplemental disclosures of cash flow information:
Cash paid for interest, net of amounts capitalized $ 519,456 $ 344,551
Cash paid for income taxes 0 0
Supplemental disclosures of noncash financing and investing activities:
Acquisition of equipment under capital lease obligations (notes 8 and $ 544,014
12)
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 28
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1996 and 1997
(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
worldwide use in factory automation and control and in test and
measurement environments.
(2) Summary of Accounting Principles
Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries Nematron Europa BV
("NEBV"), an inactive Netherlands corporation; Nematron Ltd., a United
Kingdom corporation acquired in the Intec acquisition; and NemaSoft, Inc.
("NemaSoft"), and Imagination Systems, Inc. ("ISI"), Michigan
corporations formed in 1995 and 1996, respectively. All significant
intercompany transactions and balances have been eliminated in
consolidation.
During the fiscal year ended September 30, 1997, the Company acquired two
software design and manufacturing companies. Intec Controls Corp.
("Intec"), a Massachusetts corporation, was acquired on March 31, 1997,
and Virtual-Time Software, Inc. ("VTS"), a California corporation, was
acquired on June 20, 1997. The consolidated operations of the Company
for 1997 include the results of Intec and VTS since the dates of their
respective acquisitions (see note 3).
Cash Equivalents
The Company considers all highly liquid debt instruments with original
maturities of three months or less at the date of purchase to be cash
equivalents.
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 (including demonstration units) to net realizable
value for excess and/or obsolete inventories based upon an item-by- item
review of quantities on hand compared to estimated future usage for sales
and service.
F-7
<PAGE> 29
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Summary of Accounting Principles, Continued
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. The Company continually
reviews the recoverability of capitalized software costs based on
estimated cash flows. Software costs are written off, as amortization
expense, at the time a determination has been made that the amounts are
not recoverable.
During the year ended September 30, 1996, capitalized software and
related development costs, net of amortization, increased by
approximately $1,125,000, primarily relating to salaries and other costs
incurred during the year, offset by approximately $47,000 of amortization
of capitalized costs. During the year ended September 30, 1997,
capitalized software and related development costs, net of amortization,
decreased by approximately $1,701,000. The decrease was due to the
capitalization of approximately $2,435,000 of salaries and other costs
incurred during the year, the acquisition of approximately $478,000 of
costs pursuant to the Intec and VTS acquisitions, offset by approximately
$553,000 of amortization of capital costs, and the write-off of
approximately $4,061,000 related to abandoned software projects (see
notes 3 and 4).
F-8
<PAGE> 30
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Summary of Accounting Principles, Continued
Software and Related Development Costs, Continued
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 method over the remaining
estimated economic lives of the respective products, ranging from two to
five years. Amortization for ongoing software projects amounted to
approximately $47,000 and $553,000 for the years ended September 30, 1996
and 1997, respectively, and is included in cost of revenues in the
accompanying consolidated statements of operations.
Intangible Assets
Other intangible assets are carried at cost less accumulated
amortization, which is calculated on a straight-line basis over the
estimated useful lives of the assets, ranging from five to ten years.
Amortization was approximately $100,500 and $636,900 for the years ended
September 30, 1996 and 1997, respectively.
The carrying value of intangible assets is periodically reviewed, and
impairments are recognized when the expected future cash flows derived
from such intangible assets are less than their carrying value.
Stock Option Plan
Prior to October 1, 1996, the Company accounted for its stock option plan
in accordance with the provisions of Accounting Principles Board ("APB")
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. As such, compensation expense was recorded on the
date of grant only if the current market price of the underlying stock
exceeded the exercise price. On October 1, 1996, the Company adopted
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation ("SFAS 123"), which permits entities to
recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS No. 123
also allows entities to continue to apply the provisions of APB Opinion
No. 25 and provide pro forma net income and pro forma earnings per share
disclosures for employee stock option grants as if the fair-value-based
method defined in SFAS No. 123 had been applied. The Company has elected
to continue to apply the provisions of APB Opinion No. 25 and provide the
pro forma disclosure provisions of SFAS No. 123.
F-9
<PAGE> 31
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Summary of Accounting Principles, Continued
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 subsidiaries, NEBV and Nematron Ltd., 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 stockholders' equity. Gains or losses resulting
from foreign currency transactions are included in net income (loss).
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 approximately $1,087,000 and
$1,615,000 for the years ended September 30, 1996 and 1997, respectively.
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.
F-10
<PAGE> 32
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Summary of Accounting Principles, Continued
Income Taxes
Income taxes are accounted for under the asset-and-liability method.
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.
Earnings (Loss) Per Share
Earnings (loss) per share are calculated using the weighted average
number of common shares outstanding during the year, adjusted for the
assumed conversion of dilutive stock options and warrants. Since a net
loss was incurred in 1997, no conversion of dilutive stock options and
warrants was assumed in the loss per share calculation in 1997. In
computing the per-share effect of assumed conversion in 1996, funds
which would have been received from the exercise of options and warrants
are considered to have been used to purchase common shares at an average
market price for primary earnings per share and at the year-end market
price for fully diluted earnings per share. The resulting net
additional common shares are included in the calculation of average
shares outstanding.
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.
Use of Estimates
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these consolidated financial
statements in conformity with generally accepted accounting principles.
Actual results could differ from those estimates. Estimates are used in
the determination of allowance for doubtful accounts, obsolete and slow
moving inventory, capitalized software and development costs, intangible
assets, and warranty costs.
Other Recent Pronouncements
In 1997, Statement of Financial Accounting Standards No. 128 ("SFAS
128"), Earnings Per Share, was issued, and is effective for fiscal years
commencing after December 15, 1997. The future adoption of SFAS 128 is
not expected to have a material effect on the Company's reported earnings
per share.
F-11
<PAGE> 33
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Summary of Accounting Principles, Continued
Other Recent Pronouncements, Continued
In 1997, Statement of Financial Accounting Standards No. 130 ("SFAS
130"), Reporting Comprehensive Income, was issued, and is effective for
fiscal years commencing after December 15, 1997. The Company will comply
with the requirements of SFAS 130 in fiscal year 1999.
In 1997, Statement of Financial Accounting Standards No. 131 ("SFAS
131"), Disclosures About Segments of an Enterprise and Related
Information, was issued, and is effective for fiscal years commencing
after December 15, 1997. The Company will comply with the requirements
of SFAS 131 in fiscal year 1999.
On October 27, 1997, the AICPA Accounting Standards Executive Committee
issued Statement of Position 97-2 (SOP 97-2), Software Revenue
Recognition. SOP 97-2 is effective for fiscal years commencing after
December 15, 1997, and is not expected to impact The Company's financial
position or results of operations.
(3) Acquisitions
Merger with Intec Controls Corp.
On March 31, 1997, the Company completed a merger of its wholly owned
subsidiary, NemaSoft, Inc., with Intec Controls Corp. ("Intec"), a
Walpole, Massachusetts-based developer of high-performance regulatory
control software solutions used primarily by process industries. The
Company recorded this transaction using the purchase method. The total
purchase price was approximately $3,735,000, including expenses of
approximately $430,000. Under terms of the merger agreement, the Company
issued 587,594 shares of its common stock to the former Intec
shareholders in exchange for 100Epercent of the outstanding common stock
of Intec. The Intec stock was retired, and NemaSoft is the surviving
entity.
In addition to the common stock issued, the Company issued warrants to
the former Intec shareholders to purchase an additional 124,998 shares of
Company common stock at $6.73 per share. The warrants expire February
20, 2000.
F-12
<PAGE> 34
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Acquisitions, Continued
Merger with Virtual-Time Software, Inc.
On June 20, 1997, the Company completed a merger of its wholly owned
subsidiary, Imagination Systems, Inc., with Virtual-Time Software, Inc.
("VTS"), a Santa Clara, California-based developer of real-time operating
system products which provide high-speed deterministic performance to
MicroSoft's Windows (R) operating systems. The Company recorded this
transaction using the purchase method. The total purchase price was
approximately $694,000, including expenses of approximately $190,000.
Under terms of the merger agreement, the Company issued 67,301 shares of
its common stock and $100,000 to the former VTS shareholders in exchange
for 100 percent of the outstanding common stock of VTS. The VTS stock
was retired, and ISI is the surviving entity. In connection with the
merger, ISI also entered into two-year employment and noncompetition
agreements with VTS's president, who became an employee of ISI as a
result of the merger.
The allocation of total purchase price to assets acquired and liabilities
assumed as of the respective purchase dates was as follows:
<TABLE>
<CAPTION>
Intec VTS
----- ---
<S> <C> <C>
Current assets $1,005,000 $ 6,000
Software and related development costs 2,058,000 475,000
Other intangible assets 2,352,000 216,000
Property and equipment 305,000 16,000
Deferred tax liability (1,000,000) 0
Other liabilities (985,000) (19,000)
-------- -------
Total purchase price $3,735,000 $ 694,000
========== =========
</TABLE>
Software and related development costs include acquired in-process
research and development (R&D). Acquired in-process R&D includes the
value of products in the development stage and not considered to have
reached technological feasibility. In accordance with applicable
accounting rules, acquired in-process R&D is required to be expensed.
Accordingly, charges of $1,655,000 and $400,000 were recorded at the
acquisition dates related to the acquisitions of Intec and VTS,
respectively.
F-13
<PAGE> 35
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Acquisitions, Continued
The following unaudited pro forma information presents a summary of
consolidated results of operations for fiscal 1996 and 1997 of the
Company, Intec, and VTS as if the acquisitions had occurred as of the
beginning of 1996, 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,
------------------------
1996 1997
---- ----
(Unaudited) (Unaudited)
<S> <C> <C>
Net revenues $ 25,317,404 $ 22,825,183
Net loss $ (2,034,301) $ (9,200,075)
Net loss per share $ (.51) $ (1.74)
</TABLE>
(4) Non-Recurring Charges
Non-recurring charges consist of the following:
<TABLE>
<S> <C>
Charged to cost of revenues:
Write-down of software and related development costs $ 4,061,304
Write-down of inventories 707,383
---------------
$ 4,768,687
===============
Charged to operating expenses:
Write-down of other intangible assets $ 359,406
Loss on closing of Netherlands office 245,836
Debt retirement expense 122,340
---------------
$ 727,582
===============
</TABLE>
In September 1997, the Company wrote down certain software and related
development costs, inventories and other intangible assets. In
conjunction with the Company's strategic planning process, analyses were
prepared to determine if any asset impairment existed as a result of
changes to the Company's long-term strategic plan. These analyses
indicated impairment existed due to lower or no planned revenues from
certain products, and accordingly, assets related to these products were
written off.
F-14
<PAGE> 36
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(4) Non-Recurring Charges, Continued
In September 1997, the Company wrote down certain purchased parts and
accessories and finished goods inventories related to discounted product
models, pursuant to results of the Company's strategic planning process.
During the second quarter of fiscal 1997, the Company elected to close
its Netherlands office and incurred closure costs of $245,836. Also in
the second quarter, the Company obtained bank financing in order to repay
its higher cost subordinated debt. A noncash charge of $122,340 was
recorded, which relates to the write-off of deferred financing fees on
the refinanced subordinated debt.
(5) Related Party Transactions
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 years ended September 30, 1996 and
1997, under the terms of the lease were $77,600 and $79,600,
respectively.
(6) Inventories
Inventories are summarized as follows:
<TABLE>
<CAPTION>
September 30,
1997
----
<S> <C>
Purchased parts and accessories $ 2,928,277
Finished goods 320,671
Work-in-process 349,069
Demonstration units 532,099
Service stock 269,310
--------------
Total inventories $ 4,399,426
==============
</TABLE>
F-15
<PAGE> 37
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Note Payable to Bank
The Company has a credit facility with a bank providing for a maximum
amount available of $6,000,000. A total of $1,141,000 was outstanding on
this facility as of September 30, 1997. The amount available under this
facility is limited by a borrowing formula which allows for advances up
to a maximum of the sum of 80 percent of eligible domestic accounts
receivable plus a maximum of $2,000,000 of eligible foreign receivables,
plus a maximum of $2,500,000 against certain inventory categories. Based
upon the borrowing formula, approximately $3,500,000 of the available
line was eligible for advance at September 30, 1997. 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
the bank's prime interest rate (8.5 percent at September 30, 1997). The
line of credit includes various affirmative and negative covenants. The
Company was in violation of certain covenants as of September 30, 1997,
and obtained a waiver of such violations from the bank.
(8) Long-term Debt
Long-term debt consists of the following:
<TABLE>
<CAPTION>
September 30,
1997
----
<S> <C>
Mortgage loan payable to a bank, interest at 9.5% per annum; payable in monthly
installments of $29,900 through September 2001, 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
$ 2,156,481
Term note payable to a bank, interest at LIBOR plus 2.5% per annum; payable in
monthly installments of $30,000 plus interest through February 2002. The note
is collateralized by substantially all assets, other than real property, and a
third mortgage on the Company's real estate 1,590,000
Capitalized lease obligations - computer equipment (note 12) 474,265
Capitalized lease obligations - production equipment (note 12) 26,536
Other notes 29,327
-----------
Total long-term debt 4,276,609
Less current maturities (681,231)
-----------
Total long-term debt, less current maturities $ 3,595,378
===========
</TABLE>
F-16
<PAGE> 38
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(8) Long-term Debt, Continued
The mortgage loan agreement contains a covenant that requires the Company
to maintain a minimum tangible net worth and a minimum debt-to- equity
ratio. The loan agreement with the bank regarding the term note and two
equipment notes 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 liabilities to tangible
net worth, (c) a specified debt coverage ratio, and (d) a specified level
of tangible worth. The Company was in violation of certain of these
covenants at September 30, 1997, and obtained a waiver of such violations
from the bank.
The aggregate amounts of long-term debt maturities at September 30, 1997,
are as follows:
Year ended September 30:
1998 $ 681,231
1999 686,213
2000 697,804
2001 2,061,361
2002 150,000
---------------
Total long-term debt $ 4,276,609
===============
F-17
<PAGE> 39
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(9) Taxes on Income
The provisions for taxes on income in fiscal 1996 and 1997, including
both the current and deferred portions, are zero. The following
reconciles the statutory federal income tax rate to the Company's
effective tax rate:
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------
1996 1997
---- ----
<S> <C> <C>
Income tax expense (benefit) based on the federal statutory rate 34.0% (34.0)%
Generation (utilization) of net operating loss carryforwards (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,
------------------------
1996 1997
---- ----
<S> <C> <C>
Domestic $ (9,100) $(11,220,617)
Foreign 460,790 (277,762)
---------- ------------
Total income (loss) before taxes on income $ 451,690 $(11,498,379)
========== ============
</TABLE>
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, employee
benefit accruals deductible for tax purposes when paid, and net operating
loss carryforwards.
F-18
<PAGE> 40
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(9) Taxes on Income, Continued
Temporary differences and carryforwards which give rise to the net
deferred tax position at September 30, 1997, are as follows:
<TABLE>
<CAPTION>
<S> <C>
Deferred tax assets:
Inventories $ 374,000
Property and equipment 101,000
Other 219,000
Net operating loss carryforwards 3,934,000
-----------
Total deferred tax assets 4,628,000
Less: Valuation allowance (4,172,000)
-----------
Net deferred tax assets 456,000
Deferred tax liability - capitalized software development costs
and other intangible assets (1,456,000)
-----------
Net deferred tax position $(1,000,000)
===========
</TABLE>
During the years ended September 30, 1996 and 1997, the valuation
allowance decreased by $18,000 and increased by $3,786,000, respectively.
At September 30, 1997, the Company has net operating loss carryforwards
of approximately $11,570,000, which expire at various dates between 2003
and 2012. Utilization of these carryforwards is subject to annual
limitations under current IRS regulations. The Company has established a
valuation allowance for the estimated amount of the total limitation on
the utilization of the net operating loss carryforwards. Realization of
net deferred tax assets associated with the net operating loss
carryforwards is dependent upon generating sufficient taxable income
prior to their expiration. Although realization is not assured for the
net deferred tax assets, management believes it is more likely than not
that they will be realized through future taxable earnings or alternative
tax strategies. However, the net deferred tax assets could be reduced in
the near term if management's estimates of future taxable income are no
longer viable.
F-19
<PAGE> 41
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(10) 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. Under terms of the plan, upon change in
control all shares subject to an award shall automatically vest. The
merger of the Company with ISI in 1995 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.
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 950,000 shares 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 in deciding the vesting period. Options generally vest one
third immediately and one third on each successive anniversary date of
the award, or 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 in the Restricted Stock Plan. 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 1996, the Company granted 225,500 options at exercise
prices of $4.50 to $9.00 per share, 151,448 options became exercisable,
and 18,300 options were forfeited. During fiscal 1997, 412,500 options
were granted at option prices of $5.00 to $7.12 per share, 101,980
options became exercisable, and 80,219 options were forfeited. As of
September 30, 1997, an additional 127,419 options may be issued under the
1993 Plan.
F-20
<PAGE> 42
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(10) Employee Benefit Plans, Continued
Directors Option Plan
The Company's 1993 Directors Stock Option Plan (the "Directors Option
Plan") provides for the granting of options to purchase a total of
120,000 shares of common stock. The exercise price for each option
granted beginning April 1997 under the Directors Option Plan is equal to
110 percent of the closing price of the stock on the grant date. The
exercise price for options granted prior to April 1997 was 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 beginning April 1997, each
qualified director will be granted annually an option to purchase 4,500
shares of common stock. Prior to April 1997, each qualified director was
granted annually an option to purchase 1,000 shares of common stock.
Options granted in April 1997 or thereafter will be exercisable in
one-third increments beginning on the date of the grant. Options granted
prior to April 1997 are exercisable at any time beginning six months
after the date of the grant. Options expire five years from the date of
the grant. During fiscal 1996, the Company granted options to purchase
3,000 shares of common stock at an exercise price of $8.75 per share, and
in fiscal 1997, the Company granted options to purchase 84,320 shares of
common stock at exercise prices of $5.00 to $7.00 per share. As of
September 30, 1997, an additional 23,680 options may be issued under the
Directors Option Plan.
Special Option Grants
The Board of Directors has awarded special option awards to its former
chairman and a former Board member. As of September 30, 1997, these
awards total 34,750 options to purchase common stock at $2.50 to $8.75
per share which per share prices equaled or exceeded the fair value of
the common stock at the date of the awards. The awards totaled 20,000 and
4,750 options in 1996 and 1997, respectively. The awards were made
separate from either of the two qualified plans specified above.
F-21
<PAGE> 43
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(10) Employee Benefit Plans, Continued
Information with respect to options under the 1993 Stock Option Plan, the
1993 Directors Option Plan, and special option grants for the two years
ended September 30, 1997, is as follows:
<TABLE>
<CAPTION>
Option Price Available
Per Share Outstanding Exercisable for Grant
--------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
Balance, October 1, 1996 $1.87 - $4.89 305,100 97,300 179,900
Increase in authorized shares - 1993
Plan 295,000
Special option grant $8.75 20,000
Granted $4.50 - $9.00 225,500 (225,500)
Exercisable $2.50 - $8.75 187,448
Exercised $1.87 - $2.50 (13,416) (13,416)
Forfeited $2.50 (18,300) (18,300) 18,300
------- ------- -----------
Balance, September 30, 1996 $1.87 - $8.75 518,884 253,032 267,700
Increase in authorized shares:
1993 Plan 200,000
Directors option plan 100,000
Special option grant $4.75 4,750
Granted $5.00 - $7.12 496,820 (496,820)
Exercisable $2.50 - $9.00 101,980
Exercised $2.12 - $5.00 (85,231) (85,231)
Forfeited $2.50 - $9.00 (80,219) (80,219) 80,219
------- ------- -------
Balance, September 30, 1997 855,004 189,562 151,099
======= ======= =======
</TABLE>
F-22
<PAGE> 44
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(10) Employee Benefit Plans, Continued
The Company applies APB Opinion 25 in accounting for its stock option
plans. Accordingly, no compensation cost has been recognized in the
Company's financial statements. Had compensation cost been determined
based on the fair value of such awards at the date of grant consistent
with the provisions of SFAS No. 123, the Company's total and per share
net income (loss) would have been as follows:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Net income (loss)
As reported $ 451,690 $ (11,498,379)
Pro forma $ 328,302 $ (12,029,150)
Net income (loss) per share
As reported $0.13 $(2.33)
Pro forma $0.09 $(2.44)
</TABLE>
The fair values of options granted during 1996 and 1997 were determined
using the Black-Scholes option-pricing model based on the following
assumptions:
<TABLE>
1996 1997
---- ----
<S> <C> <C>
Risk-free interest rate 6.1% 6.6%
Dividend yield 0 0
Expected life 6 years 3 to 6 years
Expected volatility 6.25% 61.7%
</TABLE>
401(k) Plan and Trust
The Company has established a defined-contribution retirement plan for
all eligible employees. Participants may make basic contributions of up
to 15 percent of their compensation, pursuant to section 401(k) of the
Internal Revenue Code. Under terms of the 401(k) plan, effective October
1, 1996, the Company makes a basic contribution of 100 percent of each
employee's contribution up to the first 5 percent of the employee's base
salary contributed by the employee. Prior to October 1, 1996, the
Company made a basic contribution of 50 percent of each employee's
contribution up to the first 4 percent of the employee's base salary
contributed by the employee. The Company may also 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
F-23
<PAGE> 45
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(10) Employee Benefit Plans, Continued
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. The Company's contributions to the 401(k) plan were
approximately $68,000 and $158,000 for the years ended September 30, 1996
and 1997, respectively.
(11) Warrants
The Company has outstanding warrants for the purchase of its common stock
as follows:
<TABLE>
<Capiton>
ISI UAI Subordinated Intec
Acquisition Acquisition Debt Acquisition Total
----------- ----------- ---- ------------- -----
<S> <C> <C> <C> <C> <C>
Exercise price $2.50 $4.81 $4.00 $6.73
Expiration date 3/03/98 11/20/97 10/31/02 2/20/00
Balance, October 1, 1995 485,258 137,000 622,258
Issued in connection with
subordinated debt 237,214 237,214
Exercised (475,219) (475,219)
-------- ------- ------- -------
Balance, September 30,
1996 10,039 137,000 237,214 384,253
Issued in connection with
the Intec acquisition 124,998 124,998
Exercised (5,111) (39,536) (44,647)
-------- ------- ------- ------- -------
Balance September 30, 1997 4,928 137,000 197,678 124,998 464,604
======== ======= ======= ======= =======
</TABLE>
F-24
<PAGE> 46
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(12) Lease Commitments
The Company leases its Virginia, Massachusetts, Ohio, United Kingdom, and
certain regional facilities, as well as certain vehicles and office
equipment, under operating leases, and leases certain computer and
production equipment under capital leases. The leases on the facilities
expire at various dates through August 1999, and the equipment operating
leases expire at various dates through June 2001.
The Company leases certain production equipment from finance companies
under two capital leases. The leases had an initial term of three years
beginning in 1995 and collectively require monthly payments, including
interest, of $2,642 through August 1998. The unpaid balance of these
capital leases was $26,536 at September 30, 1997 (note 8). The net book
value of equipment leased under the two capital leases is approximately
$26,000 at September 30, 1997.
The Company leases certain computer equipment under two capital leases
from a finance company. The leases have an initial term of four years
beginning March 1997 and collectively require monthly payments, including
interest, of $13,267 through February 2001. The unpaid balance of these
capital leases totaled $474,265 at September 30, 1997 (note 8). The net
book value of equipment leased under the two capital leases is
approximately $479,000 at September 30, 1997.
A summary of commitments under noncancelable leases as of September 30,
1997, is as follows:
<TABLE>
<CAPTION>
Capital Leases Operating Leases Total
--------------- ---------------- -----
<S> <C> <C> <C>
1998 $ 188,000 $ 258,400 $ 446,400
1999 159,200 180,700 340,100
2000 159,200 15,800 175,000
2001 69,100 8,400 77,300
------------- ------------- -----------
Total minimum lease obligation $ 575,500 $ 463,300 $ 1,038,800
============= ===========
Less amounts representing interest (74,700)
-------------
Present value of minimum lease
payments $ 500,800
=============
</TABLE>
Total rental expense in fiscal 1996 and 1997 was $172,500 and $308,000,
respectively.
F-25
<PAGE> 47
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(13) Foreign Revenues and Major Customers
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,
------------------------
1996 1997
---- ----
<S> <C> <C>
Foreign:
France $ 2,019,177 $ 1,687,171
Other European countries 1,307,856 2,395,361
Canada 670,832 1,363,529
South America 285,892 182,442
Asia and South Pacific 471,539 309,701
Africa 22,061 45,172
------------- -------------
Total foreign revenues 4,777,357 5,983,376
Domestic revenues 16,146,256 14,892,021
------------- -------------
Total $ 20,923,613 $ 20,875,397
============= =============
</TABLE>
Approximately 30 percent and 23 percent of revenues were from three
unaffiliated customers during the years ended September 30, 1996 and
1997, respectively. Accounts receivable from these customers were
approximately $1,700,500 and $1,148,500 at September 30, 1996 and 1997,
respectively.
F-26
<PAGE> 48
NEMATRON CORPORATION
AND SUBSIDIARIES
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Sequential
Number Description of Exhibit Page No.
------- ----------------------
<S> <C> <C>
2.01 Asset Purchase Agreement dated October 29, 1993 between the
Registrant and Action Instruments, Inc., filed as Exhibit 2.01 to
the Registrant's Form 10-KSB for the fiscal year ended September
30, 1993 and incorporated herein by reference.
2.02 Merger Agreement dated February 2, 1995 between the Registrant and Imagination
Systems, Inc., filed as Exhibit 2 to the Registrant's Form 8-K dated as of
March 3, 1995 and incorporated herein by reference.
2.03 Merger Agreement dated August 30, 1995 between the Registrant and
Universal Automation, Inc. Ronald J. Lavallee and Thomas Peacock,
the Shareholders, filed as Exhibit 2 to the Registrant's Form 8-K
dated as of September 20, 1995 and incorporated herein by
reference.
2.04 Agreement and Plan of Merger, dated as of June 13, 1997, by and among the
Company. Imagination Systems, Inc., Virtual-Time Software, Inc. and certain VTS
shareholders, filed as Exhibit 2.1 to the Registrant's Form 10-QSB for the
quarterly period ended June 30, 1997 and incorported herein by
reference.
2.05 Agreement and Plan of Merger, dated as of February 20, 1997, by
and among the Company, NemaSoft, Inc., Thomas Kraus and Robert O.
Mick, as amended March 28, 1997, filed as Exhibit 2.1 to the
Registrant's Form 8-K filed April 10, 1997 and incorporated
herein by reference.
3.01 Amended and Restated Articles of Incorporation, filed as Exhibit 4 to the
Registrant's Form 10-QSB for the quarterly period ended June 30, 1995 and
incorporated herein by reference.
3.02 Amended and Restated Bylaws, as amended, filed as Exhibit 3.02 to the
Registrant's Form 10-KSB for the fiscal year ended September 30, 1994 and
incorporated herein by reference.
4.01 Specimen form of Stock Certificate, filed as Exhibit 4.01 to the Registrant's
Form 10-Registration Statement filed on January 27, 1993 and incorporated
herein by reference.
4.02 First Amended and Restated Loan Agreement dated October 6, 1995
between the Registrant and Society Bank, Michigan filed as
Exhibit 4.02 to the Registrant's Form 10-KSB for the fiscal year
ended September 30, 1995 and incorporated herein by reference.
4.03 Mortgage Note dated August 8, 1995 between the Company and
Chelsea State Bank, filed as Exhibit 4.03 to the Registrant's
Form 10-KSB for the fiscal year ended September 30, 1995 and
incorporated herein by reference.
4.04 Mortgage Note dated September 19, 1996 between the Registrant
and Chelsea State Bank, filed as Exhibit 4.04 to the Registrant's
Form 10-KSB for the fiscal year ended September 30, 1996 and
incorporated herein by reference.
4.05 Term Loan and Warrant Purchase Agreement dated as of November 7,
1995 between the Registrant and Onset BIDCO, The Capital Fund,
Joseph Krinski Trust U/A Dated 6/20/91, Emily Krinski Trust U/A
Dated 6/20/91, and Urban A. MacDonald filed as Exhibit 4.04 to
the Registrant's Form S-2 Registration Statement dated June 6,
1996 and incorporated herein by reference.
4.06 Second Amended and Restated Loan Agreement dated March 29, 1996
between the Company and KeyBank National Association (formerly
Society Bank, Michigan), together with Master Demand Business
Loan Note and affirmations of guarantees, filed as Exhibit 4.05
to the Registrant's Form S-2 Registration Statement dated June 6,
1996 and incorporated herein by reference.
</TABLE>
<PAGE> 49
<TABLE>
<CAPTION>
Exhibit Sequential
Number Description of Exhibit Page No.
------- ----------------------
<S> <C> <C>
4.07 Mortgage, dated November 16, 1995, between the Company and The
Capital Fund, Inc., filed as Exhibit 4.07 to the Registrant's
Form S-2 Registration Statement dated June 6, 1996 and
incorporated herein by reference.
4.08 Revolving Credit Note entered into as of February 12, 1997,
between the Company and KeyBank National Association, filed as
Exhibit 4.1 to the Registrant's Form 10-QSB for the quarterly
period ended March 31, 1997 and incorporated herein by reference
4.09 Term Note entered into as of February 12, 1997, between the Company and KeyBank
National Association, filed as Exhibit 4.2 to the Registrant's Form 10-QSB for
the quarterly period ended March 31, 1997 and incorporated
herein by reference
4.10 Revolving Credit Note (Equipment Line of Credit) entered into as
of February 12, 1997, between the Company and KeyBank National
Association, filed as Exhibit 4.3 to the Registrant's Form 10-QSB
for the quarterly period ended March 31, 1997 and incorporated
herein by reference
4.11 Form of Warrant issued as of March 31, 1997 to Intec shareholders, filed as
Exhibit 4.1 to the Registrant's Form 8-K filed April 10, 1997 and incorporated
herein by reference
10.01 Nematron Corporation Restricted Stock Plan, filed as Exhibit
10.01 to the Registrant's Form 10-QSB for the quarterly period
ended June 30, 1993 and incorporated herein by reference
10.02 Nematron Corporation 1993 Stock Option Plan, as amended and
restated March 1997, filed as Exhibit 10.1 to the Registrant's
Form 10-QSB for the quarterly period ended March 31, 1997 and
incorporated herein by reference.
10.03 Nematron Corporation 1993 Directors Option Plan, as amended and
restated March 1997, filed as Exhibit 10.2 to the Registrant's
Form 10-QSB for the quarterly period ended June 30, 1993 and
incorporated herein by reference.
10.04 Nematron 401(k) Plan filed as Exhibit 10.04 to the Registrant's
Form 10-KSB for the year ended September 30, 1995 and
incorporated herein by reference
10.05 Registration Rights Agreement, dated as of March 31, 1997, between the Company
and former stockholders of Intec Controls Corp., filed as Exhibit 10.3 to the
Registrant's Form 10-QSB for the quarterly period ended March 31, 1997 and
incorporated herein by reference
10.06 Employment and Non-Competition Agreement, dated as of March 31, 1997, between
NemaSoft, Inc. and Thomas Kraus filed as Exhibit 10.4 to the Registrant's Form
10-QSB for the quarterly period ended March 31, 1997 and incorporated herein
by reference.
10.07 Non-competition Agreement dated as of March 2, 1995 between the Registrant and
Frank G. Logan, III, filed as Exhibit 99(a) to the Registrant's Form 8-K dated
as of March 3, 1995 and incorporated herein by reference.
11.01 Statement re Computation of Per Share Earnings
21.01 Subsidiaries of Nematron Corporation
23.01 Consent of Independent Public Accountants
27.00 Financial Data Schedule
</TABLE>
UNDERTAKING
The Company will furnish to any shareholder a copy of any of the exhibits listed
above upon written request and upon payment of a specified reasonable fee, which
fee shall be equal to the Company's reasonable expenses in furnishing the
exhibit to the shareholder. Requests for exhibits and information regarding the
applicable fee shall be direct to: Mr. David P. Gienapp, Executive Vice
President - Finance and Administration, at the address of the principal
executive offices set forth on the cover of this Report on Form 10-KSB.
<PAGE> 1
EXHIBIT 11.01
-------------
<TABLE>
<CAPTION>
Year Ended September 30
1997 1996
PRIMARY
<S> <C> <C>
Weighted average common shares outstanding 4,933,939 3,360,213
Dilutive stock options and warrants - based on the Treasury
Stock Method using the average market price N/A 219,844
--------------- ----------------
Adjusted weighted average common shares outstanding 4,933,939 3,580,057
--------------- ----------------
Net income (loss) $ (11,498,379) $ 451,690
--------------- ----------------
Income (loss) per common share $ (2.33) $ 0.13
--------------- ----------------
FULLY DILUTED
Weighted average common shares outstanding 4,933,939 3,360,213
Dilutive stock options and warrants - based on the Treasury
Stock Method using the average market price N/A 437,277
--------------- ----------------
Adjusted weighted average common shares outstanding 4,933,939 3,797,490
--------------- ----------------
Net income (loss) $ (11,498,379) $ 451,690
--------------- ----------------
Income (loss) per common share $ (2.33) $ 0.12
--------------- ----------------
</TABLE>
1
<PAGE> 1
EXHIBIT 21.01
-------------
SUBSIDIARIES OF NEMATRON CORPORATION
------------------------------------
- - Imagination Systems, Inc.
- - NemaSoft, Inc.
- - Nematron, Ltd.
- - Nematron Europa, B.V.
1
<PAGE> 1
EXHIBIT 23.01
The Board of Directors
Nematron Corporation:
We consent to incorporation by reference in the regisration statements (Numbers
333-1136, 333-1138, 333-1140, and 333-12379) on Form S-8 and in the
registration statements (Numbers 333-1314 and 333-15959) on Form S-3 of
Nematron Corporation of our report dated December 12, 1997, relating to the
consolidated balance sheet of Nematron Corporation as of September 30, 1997,
and the related consolidated statements of operations, stockholders' equity,
and cash flows for the years ended September 30, 1997 and 1996, which report
appears in the September 30, 1997, annual report on Form 10-KSB of Nematron
Corporation.
/s/ KPMG Peat Marwick LLP
Detroit, Michigan
December 29, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-END> SEP-30-1997
<CASH> 1,142,988
<SECURITIES> 0
<RECEIVABLES> 4,205,196
<ALLOWANCES> 410,000
<INVENTORY> 4,399,426
<CURRENT-ASSETS> 10,276,081
<PP&E> 8,129,393
<DEPRECIATION> 3,865,092
<TOTAL-ASSETS> 20,273,748
<CURRENT-LIABILITIES> 5,352,305
<BONDS> 3,595,378
0
0
<COMMON> 21,589,413
<OTHER-SE> (7,571)
<TOTAL-LIABILITY-AND-EQUITY> 20,273,748
<SALES> 20,875,397
<TOTAL-REVENUES> 20,875,397
<CGS> 17,668,774
<TOTAL-COSTS> 12,236,740
<OTHER-EXPENSES> 2,210,027
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 361,894
<INCOME-PRETAX> (11,498,379)
<INCOME-TAX> 0
<INCOME-CONTINUING> (11,498,379)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,498,379)
<EPS-PRIMARY> (2.33)
<EPS-DILUTED> (2.33)
</TABLE>
