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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended _________
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from October 1, 1998 to December 31, 1998
Commission File Number: 0-21142
NEMATRON CORPORATION
(Exact name of small business issuer as specified in its charter)
<TABLE>
<S> <C>
MICHIGAN 38-2483796
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
</TABLE>
5840 INTERFACE DRIVE, ANN ARBOR, MICHIGAN 48103
(Address of principal executive offices) (Zip Code)
(734) 214-2000
(Issuer's telephone number, including area code)
Check whether the issuer (1) has filed all reports required to be filed
by section 13 or 15(d) of the Securities Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
[X] YES [ ] No
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date:
No par value Common Stock: 12,525,430 SHARES OUTSTANDING AS OF APRIL 23, 1999
Transitional Small Business Disclosure Format: [ ] YES [X] NO
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
DECEMBER 31, 1998 AND SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1998 1998
(UNAUDITED)
ASSETS
------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 106,730 $ 357,724
Accounts receivable, net of allowance for doubtful
accounts of $368,000 at December 31, 1998, and
$381,000 at September 30, 1998 1,999,900 2,514,741
Inventories (Note 2) 1,884,335 2,103,434
Prepaid expenses and other current assets 305,310 295,321
------------ ------------
Total Current Assets 4,296,275 5,271,220
PROPERTY AND EQUIPMENT, net of accumulated depreciation
of $5,685,402 at December 31, 1998 and $5,475,815
at September 30, 1998 3,344,140 3,942,695
OTHER ASSETS:
Software and related development costs, net of amortization
of $2,557,639 at December 31,1998, and $2,314,845 at
September 30, 1998 3,880,284 3,942,695
Other intangible assets, net of amortization of $2,225,842 at
December 31, 1998 and $2,165,775 at September 30, 1998 942,158 1,002,225
------------ -----------
Net Other Assets 4,822,442 4,944,920
------------ -----------
TOTAL ASSETS $ 12,462,857 $ 13,840,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Note payable to bank $ 2,715,457 $ 3,514,000
Accounts payable 1,409,645 1,414,417
Trade notes payable 1,123,956 1,545,956
Other accrued expenses 1,387,403 1,866,366
Convertible promissory notes payable (Note 3) 1,000,000 -0-
Current maturities of long-term debt (Note 4) 1,576,492 1,832,791
------------ -----------
Total Current Liabilities 9,212,953 10,173,530
LONG-TERM DEBT, less current maturities (Note 4) 2,182,783 2,084,346
DEFERRED TAX LIABILITY 178,200 189,000
------------ ------------
Total Liabilities 11,573,936 12,446,876
STOCKHOLDERS' EQUITY:
Common stock, no par value, 15,000,000 shares authorized;
5,353,316 shares issued and outstanding
at December 31, 1998 and September 30, 1998 (Note 3) 24,664,809 21,664,809
Foreign currency translation adjustment (7,134) (6,080)
Accumulated deficit (23,768,754) (20,265,605)
------------ -----------
Total Stockholders' Equity 888,921 1,393,124
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 12,462,857 $ 13,840,000
============ ============
</TABLE>
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ITEM 1. FINANCIAL STATEMENTS - CONTINUED
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
1998 1997
(RECLASSIFIED)
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
NET REVENUES $ 3,186,910 $ 4,351,308
COST OF REVENUES 2,084,915 3,037,120
----------- -----------
Gross Profit 1,101,995 1,314,188
OPERATING EXPENSES:
Product development costs 131,987 209,212
Selling, general and administrative expenses 1,323,945 2,300,862
----------- -----------
Total Operating Expenses 1,455,932 2,510,074
----------- -----------
Operating Loss (353,937) (1,195,886)
OTHER INCOME (EXPENSE):
Interest expense from use of funds (158,804) (143,487)
Interest expense from issuance of convertible promissory
notes (Note 3) (3,000,000) -0-
Sundry income (expense), net (1,208) 1,154
----------- -----------
Total Other Income (Expense) (3,160,012) (142,333)
----------- -----------
LOSS BEFORE INCOME TAXES (3,513,948) (1,338,219)
INCOME TAXES BENEFIT (NOTE 5) 10,800 -0-
----------- -----------
NET LOSS $(3,503,149) $(1,338,219)
=========== ===========
BASIC LOSS PER SHARE (NOTE 6) $ (0.65) $ (0.25)
=========== ===========
DILUTED LOSS PER SHARE (NOTE 6) $ (0.65) $ (0.25)
=========== ===========
Weighted average shares outstanding - basic 5,353,316 5,335,168
=========== ===========
Weighted average shares outstanding - diluted 5,353,316 5,335,168
=========== ===========
</TABLE>
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ITEM 1. FINANCIAL STATEMENTS - CONTINUED
NEMATRON CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
THREE THREE
MONTHS ENDED MONTHS ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(3,503,149) $(1,338,219)
Adjustments to reconcile net loss to net cash flows
used in operating activities:
Depreciation and amortization 544,013 547,968
Deferred income tax benefit (10,800) -0-
Non-cash interest expense from issuance of convertible
promissory note (Note 3) 3,000,000 -0-
Changes in assets and liabilities that provided (used) cash:
Accounts receivable 514,841 (98,142)
Inventories 219,099 (243,645)
Prepaid expenses and other current assets (9,989) (65,151)
Accounts payable (4,772) (161,000)
Accrued expenses (444,468) (188,560)
----------- -----------
Net Cash Provided By (Used In) Operating Activities 304,775 (1,546,749)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to capitalized software development costs (180,382) (638,214)
Additions to property and equipment, net of minor disposals (8,723) (224,474)
----------- -----------
Net Cash Used In Investing Activities (189,105) (862,688)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of convertible promissory notes 1,000,000 -0-
Proceeds from disposals of property and equipment 12,795 -0-
Increase (decrease) in note payable to bank (798,543) 1,736,000
Payment of trade notes payable (422,000) -0-
Payments of long-term debt (157,862) (165,306)
Increase in other notes payable -0- 109,613
Proceeds from exercise of options and warrants -0- 41,491
----------- -----------
Net Cash Provided By (Used In) Financing Activities (356,610) 1,721,798
----------- -----------
FOREIGN CURRENCY TRANSLATION EFFECT (1,054) (584)
----------- -----------
Net Decrease In Cash and Cash Equivalents (250,994) (688,223)
Cash and Cash Equivalents at Beginning of Period 357,724 1,142,988
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 106,730 $ 454,765
=========== ===========
NON-CASH FINANCING AND INVESTING ACTIVITIES:
Increase in Common Stock due to issuance of convertible
promissory notes at a conversion price at a discount to
quoted market (Note 3) $ 3,000,000 $ -0-
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 142,255 $ 149,026
Cash paid for income taxes -0- -0-
</TABLE>
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ITEM 1. FINANCIAL STATEMENTS - CONTINUED
NEMATRON CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997
NOTE 1 - BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Nematron Corporation (the "Company") and its wholly-owned subsidiaries, Nematron
Ltd., a United Kingdom corporation; Nematron Europa BV, an inactive Netherlands
corporation, and NemaSoft, Inc. ("NemaSoft") and Imagination Systems, Inc.,
("ISI") both Michigan corporations. All significant intercompany transactions
and balances have been eliminated in consolidation.
In the opinion of management, all adjustments (consisting solely of normal
recurring adjustments) considered necessary for a fair presentation of the
consolidated financial statements for the interim periods have been included.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to S.E.C. rules and regulations,
although the Company believes that the disclosures are adequate to make the
information presented not misleading. It is suggested that these condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
latest annual report on Form 10-KSB and amendments thereto.
Certain reclassifications have been made to the presentation as of and for the
period ended December 31, 1997 to conform to classifications used as of and for
the three months ended December 31, 1998.
The results of operations for the three-month periods ended December 31, 1998
and 1997 are not necessarily indicative of the results to be expected for the
full year.
NOTE 2 - INVENTORIES
Inventories consist of the following at December 31, 1998, and September 30,
1998:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 SEPTEMBER 30, 1998
<S> <C> <C>
Purchased parts and accessories $1,142,431 $1,100,202
Work in process 307,762 370,840
Finished goods, demo units and service stock 434,142 632,392
---------- ----------
Total Inventory $1,884,335 $2,103,434
========== ==========
</TABLE>
NOTE 3 - INTEREST EXPENSE FROM ISSUANCE OF CONVERTIBLE PROMISSORY NOTE
As of December 1, 1998, the Company executed and delivered convertible
promissory notes (the "Notes") in the aggregate principal amount of $1 million
to 18 investors in a private placement (collectively, the "Note Holders") as the
first stage of a capital transaction, under which the Company plans to raise a
total of not less than $4 million of equity. The Notes bear interest at the rate
of seven percent (7%) per annum, are due and payable, with accrued interest, on
March 31, 1999 (unless extended by mutual agreement of the Company and the Note
Holders) and are not transferable without the Company's consent. The Notes may
be paid by the Company, subject to the limitation described in the next
sentence, with Common Stock valued at $.25 per share and are convertible by the
Note Holders into Common Stock at $.25 per share (the "Conversion Price"). On
the December 1, 1998, the closing sale price of the Company's common stock on
the Nasdaq National Market was $1.00 per share. The Company is not required to
issue more than 1,070,000 shares in connection with the payment and/or
conversion of the Notes unless the issuance of any additional shares has been
approved by the Company's shareholders to the extent required by applicable law,
the Company's organizational documents or the rules of the Nasdaq Stock Market.
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At December 31, 1998, the Company's common stock was traded on the
Nasdaq National Market, and as such, the Company was governed by rules of the
Nasdaq Stock Market. Under such rules, on December 1, 1998 the Company was
precluded from issuing common stock in excess of 20% of the outstanding shares
of common stock unless the issuance was approved by the Company's shareholders.
Because of this requirement, the Company structured the capital transaction as a
sale of convertible promissory notes rather than common stock so that the
Company could receive the proceeds currently but postpone the issuance of common
stock until it had received the required shareholder approval.
Accounting for the issuance of the Notes is governed by Emerging Issues
Task Force pronouncement D-60, Accounting for the Issuance of Convertible
Preferred Stock and Debt Securities with a Nondetachable Conversion Feature,
issued March 13, 1997 ("EITF D-60"). EITF D-60 states that a beneficial
conversion feature should be recognized and measured by allocating a portion of
the proceeds equal to the intrinsic value of that feature to additional paid -in
capital. That amount is calculated at the date of issue as the difference
between the conversion price and the fair value of the common stock into which
the Notes are convertible, multiplied by the number of shares into which the
Notes are convertible. EITF D-60 further states that if the common stock is
traded in a public market, the SEC staff believes that the quoted market price
is the best measure of the common stock's fair value. Additionally, EITF
requires that any discount resulting from an allocation of the proceeds to a
beneficial conversion feature increases the effective interest rate of the Notes
and should be reflected as a charge to interest expense. Pursuant to EITF D-60,
the Company has recorded interest expense of $3,000,000 on the date of issuance
of $1,000,000 of the Notes to reflect the beneficial conversion feature of $0.25
per share compared to the quoted market price of $1.00 per share on the closing
date of the transaction share for the 4,000,000 shares Note Holders will receive
when the Notes are converted into common stock.
In April 1999, the Company paid all of its obligations under the
Notes with Common Stock.
NOTE 4 - SHORT-TERM AND LONG-TERM DEBT
On September 28, 1998, December 1, 1998 and January 31, 1999, the Company
entered into amendments to the loan agreements and into a Repayment Agreement
with the bank which provided, among other things, for a modification of certain
terms of the Term Note, two Equipment Notes and the Revolving Credit Note. The
Revolving Credit Note, as amended contains various affirmative and negative
covenants. The Company is in violation of these covenants.
Under the terms of the amended agreements, the amount available under the
Revolving Credit Note is $5,000,000 and is limited by a borrowing formula which
allows for advances up to a maximum of the sum of 80% of eligible domestic and
foreign accounts, plus 35% of inventory, plus a Permitted Overadvance of
$1,000,000 through April 15, 1999 . The interest rate on the credit line
borrowings is at the bank's prime interest rate plus 2% (10.25% effective rate
at December 31, 1998). Amounts borrowed under the line of credit are due in full
on October 31, 1999.
Long-term debt includes the following debt instruments at December 31, 1998, and
September 30, 1998:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 SEPTEMBER 30, 1998
<S> <C> <C>
Mortgage loan payable to bank $1,956,474 $1,998,509
Term note payable 1,170,000 1,230,000
Capitalized lease obligations and other notes 632,801 688,628
---------- ----------
Total long-term debt 3,759,275 3,917,137
Less current maturities (1,576,492) (1,832,791)
---------- ----------
Long-term debt, less current maturities $2,182,783 $2,084,346
========== ==========
</TABLE>
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The mortgage loan agreement contains covenants that require the Company to
maintain a minimum tangible net worth and a minimum debt-to-equity ratio. The
Company was not in compliance with these covenants; however, the Company's
lender has waived these defaults through October 1, 1999.
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. These borrowings
are due October 31, 1999 and as such these notes totaling $1,487,017 and
$1,579,781 at December 31, 1998 and September 30, 1998, respectively, are
included in current maturities of long-term debt.
NOTE 5 - TAXES ON INCOME
The current tax benefit computed for the three month period ended December 31,
1998 reflect the tax benefit associated with the amortization of non-deductible
goodwill and other intangible assets during the same periods.
There was no current tax benefit computed for the three month period ended
December 31,1997 because of the uncertainty that the associated deferred tax
asset could not be realized through future taxable income.
The Company has NOLs of approximately $19,400,000, which may be applied against
future taxable income. The NOLs expire beginning 2003 and run through 2013.
Utilization of these carryforwards is subject to annual limitations under
current Internal Revenue Service 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.
NOTE 6 - LOSS PER SHARE
Basic earnings per share is based on the weighted average number of shares
outstanding for each period presented because common stock equivalents are
anti-dilutive. The weighted average number of shares outstanding for the
three-month periods are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
<S> <C> <C>
Weighted average shares outstanding 5,353,316 5,335,168
</TABLE>
Diluted earnings per share is not presented because the amounts are
anti-dilutive.
NOTE 6 - CONTINGENCIES
On May 8, 1998, a lawsuit was filed against the Company in the District
Court for the Southern District of New York. The lawsuit names as defendants the
Company, certain of its officers and directors, its former independent auditor
and the underwriter for the Company's initial public offering. The plaintiff
seeks to represent a class of shareholders who purchased the Company's common
stock from January 31, 1996 through April 28, 1998. An amended complaint filed
by the plaintiff in October 1998 claims violations of securities laws and common
law based on allegations that defendants made untrue statements of material
facts and that they omitted material facts necessary in order to make the
statements not misleading. The complaint seeks unspecified damages and costs. In
December 1998, the case was transferred to the United States District Court for
the Eastern District of Michigan. In January 1999, the Company filed a motion
for the dismissal of the lawsuit. Management believes that the outcome of this
case will not have a material adverse effect on the Company.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 1998 COMPARED WITH THREE MONTHS ENDED DECEMBER
31, 1997
Net revenues for the three months ended December 31, 1998 decreased
$1,164,000 (26.8%) to $3,187,000 compared to the same period last year. The
decrease is attributable to decreases in sales of Industrial Workstations and
Industrial Control Computers caused by component parts shortages due to the
Company's working capital deficiency. Management expects that net revenues for
the three months ended March 31, 1999 will approximate net revenues for the
three months ended December 31, 1998, and that net revenues will increase in the
period April 1, 1999 to December 31, 1999 compared to year earlier periods.
These net revenue changes are expected due to anticipated customer response to
the Company's increases in sales and marketing efforts, existing scheduled
production releases and expected shipments under existing contracts.
Gross profit for the three months ended December 31, 1998 decreased
$212,000 (16.1%) to $1,102,000 compared to the same period last year. Gross
profit as a percentage of sales in the three months ended December 31, 1999 was
34.6% compared to 30.2% in the same period last year. The improvement in gross
profit percentage is due primarily to a higher percentage of sales of higher
margin bundled hardware/software products in the current period compared to the
same period last year. Management expects that gross profit margins will remain
relatively constant throughout 1999 as the mix of sales is expected to be
similar to the sales mix experienced in the three months ended December 31,
1998.
Product development expenses for the three months ended December 31,
1998 decreased $77,000 (36.9%) to $132,000 compared to the same period last
year. The decrease is due primarily to a decreased staff level and less
development efforts in the current period compared to a year ago. Management
expects that product development efforts will remain relatively constant
throughout 1999.
Selling, general and administrative expenses for the three months ended
December 31, 1998 decreased $977,000 (42.5%) to $1,324,000 compared to the
comparable period of last year and decreased as a percentage of net revenue to
41.5% in the three months ended December 31, 1998 from 52.9% in the comparable
period of fiscal 1998. The decrease was primarily a result of lower staff
levels, the effects of closing of satellite offices during the three months
ended December 31, 1998 and the effects of cost controls initiated during the
current period. Management expects that selling, general and administrative
expenses will increase marginally throughout 1998 due to expanded
marketing and sales activities, and that such expenses will decrease as a
percentage of net revenues as net revenues are expected to increase by a greater
amount in the remaining throughout 1999.
Interest expense from use of funds for the three months ended December
31, 1998 increased $15,000 (10.7%) to $159,000 compared to $143,000 for the
comparable period last year due to higher average borrowing levels.
Interest expense from the issuance of convertible promissory notes
three months ended December 31, 1998 was $3,000,000, representing the charge to
operations, with the offsetting increase in shareholders' equity, to reflect the
beneficial conversion feature of $0.25 per share, compared to the quoted market
price of $1.00 per share on the closing date of the transaction, for the
4,000,000 shares of common stock to be issued to Note Holders when the Notes are
converted into common stock. That amount was calculated at the date of issue as
the difference between the conversion price and the fair value of the common
stock into which the Notes are convertible, multiplied by the number of shares
into which the Notes are convertible.
YEAR 2000 ISSUE
The Year 2000 Issue ("Y2K") is the result of certain computer programs
being written using two digits rather than four digits to define the applicable
year. Computer systems with a Y2K problem will be unable to interpret dates
beyond the years 1999, which could cause a system failure or other computer
errors, leading to disruptions in operations. In 1997, the Company began to
assess its Y2K readiness and adopted a three-phase program for Y2K information
systems compliance. Phase I is the identification of systems and products with
which the Company has exposures to Y2K issues. Phase II encompasses the
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development and implementation of action plans to be Y2K compliant in all areas
by mid-1999. Phase III includes final testing of each major area of exposure to
ensure compliance. The Company has identified four major areas determined to be
critical for successful Y2K compliance: (1) financial and information system
applications; (2) software products currently sold; (3) third-party
relationships and 4) non-information technology areas such as security,
telephone systems and climate control systems.
The Company is finishing Phase I of its program. The Company has
contacted all significant software suppliers and, due to recent implementation
of its major financial and operational software, believes that its financial and
operational software is Y2K compliant. The Company has also reviewed for Y2K
compliance its hardware and software products, including the firmware imbedded
in certain hardware products, marketed and sold to third parties. The Company
has used its employee engineers and others in its review and testing procedures.
The Company has identified one older software product, used for
monitoring and testing in a test cell environment (not related to machine
control) which needs to be modified to correct a Y2K problem. The Company
estimates that the cost to modify the product is approximately $50,000, all of
which relates to the salary and benefits of software development employees of
the Company, none of which has been expended to date. The Company intends to fix
this Y2K issue and notify its customers when a solution is available. The
Company intends to make the Y2K compliant software available to its customers
for purchase. The Company intends to fund the costs of this effort out of
operating funds in fiscal 1999. If the product cannot be remedied in a cost
efficient manner, the Company may determine to cease marketing and production of
the product; such action, however, is not expected to have a material adverse
effect on the Company's results of operations.
The Company has relationships with, and is to varying degrees dependent
upon, various third parties that provide funds, information, goods and services
to the Company. These include the Company's bank lender, utility providers,
stock transfer agent, and suppliers of components. The Company is attempting,
through informal contacts, to assess the compliance of these third parties.
While not all parties have informed the Company as to their status, the most
significant of these third parties have represented that their systems and
products are Y2K compliant. The Company will continue with this assessment in
fiscal 1999. The Y2K compliance of the systems of these third parties is outside
the Company's control and there can be no assurance that any of these third
parties will not experience a systems failure due to Y2K.
Because the Company expects that the systems within its control will be
Y2K compliant before the end of 1999, the Company believes that the most
reasonably likely worst case scenario is a compliance failure by one or more of
the third parties described above. Such a failure would likely have an effect on
the Company's business, financial condition and results of operations. The
magnitude of that effect, however, cannot be quantified at this time because of
variables such as the type and importance of the third party, the possible
effect on the Company's operations and the Company's ability to respond. Thus,
there can be no assurance that there will not be a material adverse effect on
the Company if such third parties do not remediate their systems in a timely
manner and in a way that is compatible with the Company's systems.
As a result, the Company will develop contingency plans that assume
some estimated level of noncompliance by, or business disruption to, these third
parties. The Company intends to have contingency plans developed by the end of
its third quarter of fiscal 1999 for third parties determined to be at high risk
of noncompliance or business disruption or whose noncompliance or disruption,
while not high risk, is considered likely to materially affect the Company. The
contingency plans will be developed on a case-by-case basis, and may include
plans for switching to Y2K compliant suppliers.
Judgments regarding contingency plans are subject to many uncertainties
and there can be no assurance that the Company will correctly anticipate the
level, impact or duration of noncompliance or that its contingency plans will be
sufficient to mitigate the impact of any noncompliance. Some material adverse
effect to the Company may result despite such contingency plans.
To date, the Company has expended approximately $10,000 incremental
costs to remediate Y2K problems, in that all efforts have been expended by
existing engineering and application support and other personnel These costs
have been expensed as incurred. The Company estimates total Y2K remediation
costs at $65,000 incrementally over the next three quarters. Estimates of time,
cost and risks are based on currently available information. Developments that
could affect estimates include, without limitation, the availability of trained
personnel, the ability to locate and correct all noncompliant systems,
cooperation and
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remediation success of third parties material to the Company, and the ability to
correctly anticipate risks and implement suitable contingency plans in the event
of system failures at the Company or third parties.
LIQUIDITY AND CAPITAL RESOURCES
By the end of October 1998, the Company was overadvanced on its
revolving credit facility, and was facing imminent foreclosure by the Company's
lenders. In early November 1998, after unsuccessful attempts to sell the
business or solicit working capital through other means, and when the Company
was faced with imminent closing of its business, the Company negotiated an
arrangement with a group of creditors that provided essential working capital to
permit the Company to continue operations. The proposal was submitted to the
bank, and precipitated a forbearance agreement from the Company's bank.
Following receipt of support from the bank, the management and Board of
Directors agreed to support the arrangement as an offer of last resort. It was
the opinion of management and the Board of Directors that preserving the
Company's ability to operate at the expense of diluting existing shareholders'
interest was preferable to ceasing operations in view of the Company's
significant backlog and the risk of losing its existing customers if it were to
cease operations. As a result, the Company determined to enter into the capital
transaction described below (the "Capital Transaction").
As of December 1, 1998, the Company executed and delivered convertible
promissory notes (the "Notes") in the aggregate principal amount of $1 million
to 18 investors in a private placement (collectively, the "Note Holders") as the
first stage of the Capital Transaction. The Notes bear interest at the rate of
seven percent (7%) per annum, are due and payable, with accrued interest, on
March 31, 1999 (except as described below) and are not transferable without the
Company's consent. The Notes may be paid by the Company, subject to the
limitation described in the next sentence, with Common Stock valued at $.25 per
share and are convertible by the Note Holders into Common Stock at $.25 per
share (the "Conversion Price"). The Company is not required to issue more than
1,070,000 shares in connection with the payment and/or conversion of the Notes
unless the issuance of any additional shares has been approved by the Company's.
If the entire principal and accrued interest amount of the Notes is converted
into or paid with Common Stock, the Company would be required to issue 4,093,333
million shares of Common Stock. Amounts due under the Notes which are not paid
with or converted into Common Stock must be paid in cash on or before their due
date. In April 1998, the Company paid all of its obligations under the Notes
with Common Stock.
In contemplation of the second stage of the Capital Transaction in
which the Company was to raise an additional $3 million, five of the Note
Holders, including Mr. Nichols, Mr. Globus and two of his affiliates and Mr.
Hershey (on behalf of J. Eric May), expressed a willingness to invest additional
funds in the Company's Common Stock and were granted, in connection with their
purchase of Notes as of December 1, 1998, options to acquire additional Notes
with an aggregate principal amount of $1,250,000 on or before January 31, 1999
(the "Options"). As of January 12, 1999, the terms of the Options were amended
to provide that (i) the Options expire on the earlier of April 30, 1999 and the
fifth business day after receipt of shareholder approval of the issuance of the
shares, (ii) the Option holders together have the right to purchase a total of
1,250,000 shares of Common Stock, rather than Notes convertible into Common
Stock (subject to receipt of the shareholder approval) and (iii) the exercise
price of the Options is $1.00 per share, rather than $.25. The Notes held by
these five investors were also amended to extend the maturity of the Notes from
March 31, 1999 to coincide with the termination of the Options -- the earlier of
April 30, 1999 and the fifth business day after receipt of shareholder approval.
The Option holders have indicated that they intend to exercise the Options in
full if shareholder approval is received.
The Company is also in the process of receiving subscription agreements
from other accredited investors to purchase an additional 1,750,000 shares as
part of the second stage of the Capital Transaction at $1.00 per share, subject
to receipt of shareholder approval. As consideration for its efforts as
placement agent in connection with the sale of such shares and the sale of
$250,000 principal amount of the Notes, the Company will issue to Gregory J.
Schwartz & Co. ("Schwartz") upon the sale of the shares in the second stage of
the Capital Transaction an option to purchase 80,000 shares at $.25 per share
and 140,000 shares at $1.00 per share (the "Schwartz Option"). The Schwartz
Option expires on June 30, 1999.
The Company is party to a bank line of credit which permits borrowing
up to $5,000,000, subject to an availability formula based upon a percentage of
eligible accounts receivable and inventory and a permitted overadvance. At
December 31, 1998, $2,715,457 was outstanding on the line. The expiration
Page 9
<PAGE> 11
date of the underlying Agreement has been extended to October 31, 1999. Amounts
borrowed under the facility bear interest at prime plus 2.0% (10.25% effective
rate at December 31, 1998).
Prior to the expiration of the line of credit on October 31, 1999, the
Company plans to negotiate an extension of the expiration date of the line of
credit. Additionally, the Company plans to reduce borrowings on the credit line
with a portion of the proceeds from the Capital Transaction described above.
Although management believes that by the set expiration date of the credit line
the receivable and inventory levels, upon which the borrowing base is
calculated, will increase, and the amount of over-advance from the bank will
decrease, there can be no assurance that the credit line will be extended.
Consequently, if negotiations to extend the credit line fail, management will
seek financing from other financing sources, which may not materialize, or if
such sources are available, the cost of such arrangement may be significantly
higher than the current bank agreement.
The Company also successfully negotiated the conversion of $1.7 million
of trade accounts payable into short-term trade notes payable. Although the
Company was delinquent on the terms of these notes at September 30, 1998, the
Company has paid or received extensions of all past due payments as of December
31, 1998, and is current with the revised terms of such trade notes payable.
In order for the Company to have sufficient short-term liquidity to
continue operations for the remainder of fiscal 1999, the line of credit must be
renewed or replaced, the Company must receive the remaining proceeds from the
Capital Transaction described above and the Company must be able to pay the
principal and interest under all of its convertible notes with Common Stock as
described above. If the Company is not successful in accomplishing these goals,
the Company would be forced to curtail its operations and either sell the
Company to a third party or seek protection under federal bankruptcy laws.
UNCERTAINTIES RELATING TO FORWARD LOOKING STATEMENTS
"Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations" includes "forward-looking statements" (as defined in
the federal securities laws) based on current management expectations. Factors
that could cause future results to differ from these expectations include the
failure of the bank to renew its line of credit agreement when borrowings
thereunder become due, the failure of the Company to complete the second stage
of the Capital Transaction, the inability of the Company to pay the principal
and interest of the Notes with common stock at their maturity dates, the decline
of economic conditions in general and conditions in the automotive manufacturing
industry in particular, a reduction in demand for the Company's products and
services, decreases in orders under existing contracts, the inability 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, reductions in product life cycles,
competitive factors (including the introduction or enhancement of competitive
products), pricing pressures which result in materially reduced selling prices
for the Company's products, shifts in sales mix to less profitable products, raw
material price increases or unavailability, 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, the inability to attract or retain sales, marketing and
engineering talent, changes in customer requirements, unexpected Y2K issues in
the Company's products or systems, evolving industry standards, and any
additional factors described in the Company's other reports filed with the
Securities and Exchange Commission.
Page 10
<PAGE> 12
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits included herewith are set forth on the Index to Exhibits, which
is incorporated herein.
(b) The Company filed no reports on Form 8-K during the quarter ended
December 31, 1998.
ALL OTHER ITEMS OMITTED ARE NOT APPLICABLE OR THE ANSWERS THERETO ARE NEGATIVE.
Page 11
<PAGE> 13
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this amendment to this report to be signed on its
behalf by the undersigned thereunto duly authorized.
NEMATRON CORPORATION
BY:
APRIL 27, 1999 /S/ MATTHEW S. GALVEZ
- ----------------------------- -----------------------------------------------
DATE MATTHEW S. GALVEZ, PRESIDENT & COO
(DULY AUTHORIZED OFFICER)
APRIL 27, 1999 /S/ DAVID P. GIENAPP
- ----------------------------- -----------------------------------------------
DATE DAVID P. GIENAPP, EXECUTIVE VICE PRESIDENT -
FINANCE & ADMINISTRATION
(CHIEF ACCOUNTING OFFICER)
Page 12
<PAGE> 14
INDEX TO EXHIBITS
Exhibit Number Description of Exhibit
- -------------- ----------------------
10.1 Second Amendment to Repayment Agreement and Fifth
Amendment to Loan Agreement dated as of January 31,
1999 by and between KeyBank National Association and
the Company, filed as Exhibit 10.1 to the
Registrant's Form 10-QSB for the quarterly period
ended December 31, 1998 and incorporated herein by
reference
27 Financial Data Schedule
Page 13
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> DEC-31-1998
<CASH> 106,730
<SECURITIES> 0
<RECEIVABLES> 1,999,900
<ALLOWANCES> 368,000
<INVENTORY> 1,884,335
<CURRENT-ASSETS> 4,296,275
<PP&E> 9,029,542
<DEPRECIATION> (5,685,402)
<TOTAL-ASSETS> 12,462,857
<CURRENT-LIABILITIES> 9,212,953
<BONDS> 2,182,783
0
0
<COMMON> 21,664,809
<OTHER-SE> (7,134)
<TOTAL-LIABILITY-AND-EQUITY> 12,462,857
<SALES> 3,186,910
<TOTAL-REVENUES> 3,186,910
<CGS> 2,084,915
<TOTAL-COSTS> 1,455,932
<OTHER-EXPENSES> 1,208
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,158,804
<INCOME-PRETAX> (3,513,948)
<INCOME-TAX> 10,800
<INCOME-CONTINUING> (3,503,149)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,503,149)
<EPS-PRIMARY> (0.65)
<EPS-DILUTED> (0.65)
</TABLE>
