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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB/A2
(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, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________to__________________
Commission File Number: 0-21142
NEMATRON CORPORATION
(Name of small business issuer in its charter)
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MICHIGAN 38-2483796
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
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5840 INTERFACE DRIVE, ANN ARBOR, MICHIGAN 48103
(Address of principal executive offices) (Zip Code)
(734) 214-2000
(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: $16,829,334
The aggregate market value of the voting stock held by non-affiliates
as of December 21, 1998, computed by reference to the closing price of such
stock on such date as quoted on the Nasdaq Stock Market National Market, was
approximately $2,856,000. 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 21, 1997 was 5,353,316.
DOCUMENTS INCORPORATED BY REFERENCE: NONE
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT [ ] Yes [ X ] No
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The Registrant hereby amends its Form 10-KSB for the fiscal year ended September
30, 1998 to amend Items 6 and 7 as set forth below:
PART II
ITEM 2 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 and in "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 of other entities 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.
FISCAL 1998 COMPARED TO FISCAL 1997
Net revenues were $16,829,000 in fiscal 1998 compared to $20,875,000 in
fiscal 1997. This represents a decrease of $4,046,000, or 19.4%, compared to
fiscal 1997. Software revenues increased to 23.9% of total sales in fiscal 1998
versus 16.3% in fiscal 1997, reflecting a full year of Paragon sales in 1998
compared to six months of sales of the Paragon software product after Intec was
acquired in March 1997. The decrease in sales of Industrial Workstations and
related parts and service as a percentage of total fiscal 1998 revenues resulted
primarily from the expiration at the end of fiscal 1997 of significant contracts
with a major customer. Additionally, when the Company experienced financial
difficulty in the third and fourth quarters of fiscal 1998, the customer order
rate decreased due to shipment uncertainty. Also, the Company was unable to
secure component parts for subsequent assembly into finished product due to the
lack of cash and available financing.
Foreign revenues decreased in fiscal 1998 by $759,000, or 12.7%, from
foreign revenues in fiscal 1997, due to a combination of higher software sales
but lower hardware sales due to the change in focus of the sales staff in
Europe. Domestic revenues decreased in fiscal 1998 by $3,287,000, or 22.1%,
compared to domestic revenues in fiscal 1997. This decrease is due primarily to
fewer sales personnel, the expiration of major a major contract in 1997 that was
not replaced in 1998, reluctance of customers to place orders in the third and
fourth quarters of fiscal 1998 and the lack of available cash or credit with
which to purchase component parts during that time.
Management expects that the working capital provided by the proceeds
from the issuance of $1 million of convertible promissory notes in December
1998, the additional private placement currently underway, borrowings under the
bank credit facility and borrowings under an additional credit facility from a
finance company entered into in December 1998 will permit the Company to
purchase the component parts needed to return the Company to more customary
production levels for the remainder of fiscal 1999. Also, assuming the Company
is able to fill the existing backlog and that the current order rate continues,
management expects that sales will increase in fiscal 1999 over 1998.
Additionally, management expects that sales will increase due to the recent
positive market response to the Company's Paragon and OpenControl software
products and to its ICC hardware products. If resources are available, the
Company intends to increase its marketing and sales efforts by hiring and
training new sales personnel in certain major metropolitan and industrial areas,
expanding its selling efforts in Europe and strengthening its sales management.
The Company's expectation of revenue growth in fiscal 1999 is also based on the
belief that the products introduced in the last several years and products
planned for release in fiscal 1999 are and will continue
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to be technologically more advanced than certain comparably priced competing
products, and also on the expectation that the expansion of the Company's
product line will result in the addition of new distributors and partnership
arrangements.
The Company's actual results of operations for fiscal 1999, however,
cannot be predicted with certainty and are subject to a number of risks. For
example, the Company may not close on its second traunch of a private placement,
or the amount of capital raised may not be sufficient to provide the Company
adequate working capital to sustain operations. Additionally, contracts may be
canceled or current purchase orders rescinded, 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.
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 as a percentage of total revenue. However, during
fiscal 1998, the Company provided significant reserves for obsolete materials
related to certain discontinued Industrial Workstation models. The net
realizable value of inventory was determined as of September 30, 1998 consistent
with prior years and based upon a lower of cost or market determination. The
Company prepared various analyses, on a part by part basis, and estimated each
part's usage compared to the physical quantities on hand. When the estimated
usage was less that the quantities on hand, a valuation reserve was recorded.
Monthly and quarterly provisions for obsolete inventory are also made based upon
1) analyses of recorded quantities on hand compared to future estimated uses, 2)
movements from the active storeroom to the inactive storeroom, 3) product end of
life determinations; and 4) sundry other factors as appropriate in the
circumstances. As a consequence of restricted cash resources and the price
competition causing decreasing margins on certain older products, together with
the success of ICC product models marketed to the automotive and machine tool
industries, the Company determined in the fourth quarter of fiscal 1998 to
discontinue certain families of products. Additionally, during the fourth
quarter of fiscal 1998 the Company determined to concentrate future sales
efforts on current models and future models of ICC products. Provisions for
excess and obsolete inventory totaled approximately $1.3 million, including
approximately $1,000,000 recorded in the fourth quarter of fiscal 1998. The
majority of the write-down in the fourth quarter related to the fact that during
that period two major customers switched to a new configuration of Industrial
Control Computers ("ICCs) and the Company was forced to absorb the cost of a
significant portion of its stock of certain motherboards and processors (both of
which were to be used in ICCs to be sold to such customers. Although the Company
will continue to search for uses of those products, there are no current
customers for ICCs configured with those component parts. All of the parts were
unique to units for those customers and the Company had either purchased or
committed to purchase significant quantities of such component parts. There is
no recourse for cost recovery from the customers. The configurations of certain
ICC products containing the excess quantities of the discontinued motherboards
and processors described above were discontinued as of September 30, 1998. The
Company will continue to supply the customers with ICC products containing other
component motherboards and processors. Management does not expect any decrease
in future revenues or net income relating to the discontinuance of the component
parts described above. Absent the special provision for inventory obsolescence
in fiscal 1998 and the special charges to cost of revenues recorded in fiscal
1997, the cost of sales as a percentage of total revenues was 62.5% in fiscal
1998, compared to 61.8% in fiscal 1997. During 1998, the Company initially
purchased inventory based on estimates of customer orders, and due to volume and
pricing issues, certain component parts were purchased in round lots, and
periodically the round lot purchases resulted in excess parts when anticipated
orders were not received. In the later part of 1998, purchasing practices were
altered so that the Company now, to the extent possible, purchases component
parts only after the receipt of customer orders. This practice is tempered in
instances of the need for short lead times for customer order fulfillment and
other customary competitive practices.
Product development expenses increased in fiscal 1998 by 2.1%, over the
fiscal 1997 level, primarily due to the development efforts on software
products. Product development expenses, which are a function of new product
research and development and existing product enhancement efforts, are expected
to remain relatively constant in fiscal 1999 compared to fiscal 1998. The actual
level of product development expense for fiscal 1999 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
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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 1998 increased
by $1,164,000, or 12.4%, over the fiscal 1997 level, due principally to the
effect of including the costs and expenses of the former Intec personnel and
other costs for a full year in fiscal 1998. Additionally, significant sales and
support efforts were expended to secure and support a large General Motors
contract under which ICC products will be supplied beginning in fiscal 1999. The
rate of increase in selling, general and administrative expenses in fiscal 1999
is expected to be less than in fiscal 1998 due to scheduled increases in
marketing activities and planned increases in sales staff levels and in sales
activities, offset by reductions in fixed costs, administrative personnel and
other discretionary costs which have been completed in the first quarter of
fiscal 1999. 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 cash resources are not available.
Other operating expenses in fiscal 1998 included a write down of
purchased intangible assets, including goodwill, totaling $1,320,000 and a
provision of $350,000 for payroll and other costs related to the shutting down
of three satellite offices in October and November 1998. Certain intangible
assets were acquired by the Company in the Intec merger in March 1997; in the
fourth quarter, due to personnel changes and changes in software development and
operating and marketing strategies, certain intangible assets, including
associated goodwill, were written down to net realizable value.
Sundry expense in fiscal 1998 was $17,000 compared to sundry income of
$104,000 in fiscal 1997. The decrease in sundry income (expense) is due to the
results from investing available funds in early fiscal 1997. In fiscal 1998, the
Company also recognized a loss of $55,000 on the disposal of property and
equipment.
Interest expense in fiscal 1998 increased by $373,000 due to high
average borrowing levels in fiscal 1998 than in fiscal 1997. The borrowing
levels were higher due to the capital leases entered into in fiscal 1998, as
well as the use of the bank line of credit to fund cash operating losses during
fiscal 1998.
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
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 supply its customers with the Y2K compliant software without
charge. 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
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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 not expended any 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 in fiscal 1998. The Company estimates total Y2K remediation
costs at $75,000 incrementally over the next four 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 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.
NEW ACCOUNTING PRONOUNCEMENTS
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. The Company will comply with the requirements of SOP 97-2 in fiscal
year 1999.
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LIQUIDITY AND CAPITAL RESOURCES
In August, 1998, the Company recruited Mr. Matthew S. Galvez to assist
the Company in its efforts to stem the significant ongoing losses being suffered
by the Company. At the direction of the Board of Directors, Mr. Galvez
entertained discussions to sell the Company as well as to take on additional
investors and financing.
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
prevent a complete closedown of the Company. 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 keeping the Company as
an ongoing entity, even if the existing shareholder's interests were materially
diluted, was a much better result than shutting down the business and risking
losing existing business with its significant customers, new business, the loss
of its management and employees, and other detrimental effects associated with a
shut-down.
The arrangement with the new investors called for the issuance of
convertible notes expiring March 31, 1999, in the aggregate of $1 million, with
the notes being convertible into options to acquire the Company's common stock
at $.25 per share. In addition, the investors were given the option to
contribute an additional $3 million in cash in exchange for convertible notes
also excersizable for options to purchase shares at $.25 per share. The
noteholders contribute the additional $3 million in exchange for convertible
notes expires January 31, 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. At September 30, 1998, approximately
$3.5 million was outstanding on the line, including a $900,000 overadvance which
the bank agreed to permit until October 31, 1998 in connection with the
extension of the expiration date of the line of credit to the same date. The
expiration date was subsequently extended to January 31, 1999. As of December
21, 1998, the amount outstanding was reduced to $2.2 million, and the amount
available under the formula was $.9 million. Amounts borrowed under the facility
bear interest at prime plus 2.0% (10.25% effective rate at December 21, 1998).
Prior to the expiration of the line of credit on January 31, 1999, the Company
plans to negotiate an extension of the expiration date of the line of credit.
Although management believes that by January 31, 1999 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.
As discussed above, on December 1, 1998, the Company closed on a
private placement of $1 million of convertible promissory notes. The notes bear
interest at 7% and are due on March 31, 1999. The notes are payable with and
convertible into the Company common stock (subject to shareholder approval)
valued at $.25 per share and grant the note holders options to acquire
additional convertible promissory notes in the amount of $3 million through
January 31, 1999. Shareholder approval is also required for the conversion of
the option shares. Management believes that the options will be exercised and an
additional $3 million in funding will be received prior to the option expiration
date. The board intends to call a meeting of the shareholders prior to the
expiration of the option on March 31, 1999 and seek to obtain shareholder
approval for the issuance of the shares pursuant to the convertible promissory
notes and the option agreement. See Note 2 to the Consolidated Financial
Statements.
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
18, 1998.
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 proceeds from the additional
convertible promissory notes described above and the Company must be able to pay
the principal and interest under all of its convertible notes with Common Stock
on March 31, 1999. If the Company is not successful
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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 DEVELOPMENT OF ACQUIRED IN-PROCESS RESEARCH AND
DEVELOPMENT
Intec Controls Corp.
On March 31, 1997, the Company completed its merger of its wholly-owned
subsidiary, NemaSoft, Inc., with Intec Controls Corp. ("Intec") a developer of
high-performance regulatory control software used primarily by process
industries. The Company recorded this transaction using the purchase method of
accounting. One asset the Company acquired from Intec was in-process research
and development ("IPR&D"), which represents, at estimated fair value using the
income approach, the present value of the projected cash flow that will be
generated by the IPR&D project if successfully completed.
The $1,644,000 of acquired IPR&D pursuant to the Intec transaction was
related to a synergistic product based upon a combination of technology
developed both by Intec and the Company. The product was identified but had not
yet reached the point of technological feasibility, and included features of
direct machine control, human-machine interface and process measurement. Also
included in the product are features concerning Windows NT compatibility,
flowchart programming and a PC-based programming environment. In determining the
value of the acquired IPR&D, the Company identified the components of an
existing product acquired from Intec, which needed to be revised or
substantially rewritten. Management then estimated the costs involved in the
process, including costs to complete the design, coding and testing, the
expected revenue less operating expenses and applicable taxes, and charges
related to fixed assets, technological updates, distribution, royalties and
other. At the date of acquisition, management expected that the products would
successfully be developed and estimated that first revenues would be achieved in
fiscal 1998. The Company successfully developed the product in fiscal 1998 and
began to realize net revenues from the efforts described above. Management
believes that resulting product is viable and that revenues in excess of costs
will continue to be received from the successful marketing of the product.
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 developer of real-time operating system products which provide for high-speed
deterministic performance to Microsoft's Windows(R) operating systems. The
Company recorded this transaction using the purchase method of accounting. One
asset the Company acquired from VTS was IPR&D, which represents, at estimated
fair value using the income approach, the present value of the projected cash
flow that will be generated by the IPR&D project if successfully completed.
The $400,000 of acquired IPR&D pursuant to the VTS transaction was related to a
synergistic product based upon a combination of technology developed both by VTS
and the Company. The product was identified but had not yet reached the point of
technological feasibility, and included features of direct machine control in a
Windows - based programming environment. In determining the value of the
acquired IPR&D, the Company identified the components of an existing product
acquired from VTS, which needed to be revised or substantially rewritten to
target a particular niche market. Management then estimated the costs involved
in the process, including costs to complete the design, coding and testing, the
expected revenue less operating expenses and applicable taxes, and charges
related to fixed assets, technological updates, distribution, royalties and
other. At the date of acquisition, management expected that the products would
successfully be developed and estimated that first revenues would be achieved in
fiscal 1999. However, in the fourth quarter of fiscal 1998, the Company decided
to abandon the contemplated project. In connection therewith, development
efforts were halted. Management believes that the effect on future results of
operations from the cessation of development efforts is not significant.
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
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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 the failure of the bank renew its line of credit agreement
when borrowings thereunder become due, the inability of the Company to pay the
principal and interest of the convertible promissory notes with Common Stock at
the March 31, 1999 maturity date, the failure of the Company to receive the
proceeds of the additional $3 million of convertible promissory notes described
above, 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, 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, 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, the inability to attract or retain sales and/or
engineering talent, changes in customer requirements, unexpected Y2K issues in
the Company's products or systems 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.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: /S/ DAVID P. GIENAPP Dated: February 12, 1999
-------------------------------------------
David P. Gienapp,
Executive Vice President - Finance and
Administration, Secretary and Treasurer
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NEMATRON CORPORATION AND SUBSIDIARIES
Table of Contents
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Page
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Report of Independent Certified Public Accountants 2
Consolidated Balance Sheet as of September 30, 1998 3
Consolidated Statements of Operations for the years ended
September 30, 1997 and 1998 4
Consolidated Statements of Stockholders' Equity for the years ended
September 30, 1997 and 1998 5
Consolidated Statements of Cash Flows for the years ended
September 30, 1997 and 1998 6
Notes to Consolidated Financial Statements 7
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F-1
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Report of Independent Certified Public Accountants
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THE BOARD Of DIRECTORS
Nematron Corporation:
We have audited the accompanying consolidated balance sheet of Nematron
Corporation and subsidiaries as of September 30, 1998, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years ended September 30, 1997 and 1998. 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, 1998, and the results of their operations
and their cash flows for the years ended September 30, 1997 and 1998, in
conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in note 2 to the
consolidated financial statements, the Company has suffered recurring losses
from operations, has experienced cash flow difficulties and is in default of its
loan agreements with its primary lenders. These matters raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
with respect to these matters are also discussed in note 2. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ Grant Thornton LLP
December 4, 1998
Detroit, Michigan
F-2
<PAGE> 12
NEMATRON CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheet
September 30, 1998
Assets (Notes 8 and 10)
-----------------------
<TABLE>
<CAPTION>
<S> <C>
Current assets:
Cash and cash equivalents $ 357,724
Accounts receivable, net of allowance for doubtful accounts of $381,000 2,514,741
Inventories (Note 7) 2,103,434
Prepaid expenses and other current assets 295,321
------------
Total current assets 5,271,220
Property and equipment:
Land 117,000
Building and improvements 2,287,970
Equipment 6,694,705
------------
9,099,675
Less accumulated depreciation (5,475,815)
Net property and equipment 3,623,860
Other assets:
Software and related development costs, net of accumulated 3,942,695
amortization of $2,314,845 (Notes 3, 4 and 5)
Other intangible assets, net of accumulated amortization of $2,165,775 (Notes 3, 4 and 5) 1,002,225
------------
Net other assets 4,944,920
------------
Total assets $ 13,840,000
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
Note payable to bank (Note 8) $ 3,514,000
Accounts payable 1,414,417
Trade notes payable (Note 9) 1,545,956
Other accrued liabilities 1,866,366
Current maturities of long-term debt (Note 10) 1,832,791
------------
Total current liabilities 10,173,530
Long-term debt, less current maturities (Note 10) 2,084,346
Deferred tax liability (Note 11) 189,000
------------
Total liabilities 12,446,876
Commitments and contingencies (Note 14) -
Stockholders' equity:
Common stock, no par value; 15,000,000 shares authorized, 5,353,316 shares
issued and outstanding (Notes 2, 12 and 13) 21,664,809
Foreign currency translation adjustment (6,080)
Accumulated deficit (20,265,605)
------------
Total stockholders' equity 1,393,124
Total liabilities and stockholders' equity $ 13,840,000
============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 13
NEMATRON CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the years ended September 30, 1997 and 1998
<TABLE>
<CAPTION>
1997 1998
------------ -------------
<S> <C> <C>
Net revenues $ 20,875,397 $ 16,829,334
Cost of revenues (Note 5)
17,668,774 11,512,950
------------ ------------
Gross profit 3,206,623 5,316,384
Operating expenses:
Product development costs 2,151,698 2,196,390
Selling, general, and administrative expenses 9,357,460 10,521,663
Other charges (Note 5) 727,582 1,669,698
Write-off of in-process research and development costs relating to the
Intec Controls Corp. acquisition (Note 4) 1,655,000 -
Write-off of in-process research and development costs relating to the
Virtual-Time Software, Inc., acquisition (Note 4) 400,000 -
------------ ------------
Total operating expenses 14,291,740 14,387,751
------------ ------------
Operating loss (11,085,117) (9,071,367)
------------ ------------
Other income (expense):
Interest expense (361,894) (735,256)
Foreign currency gain (loss) (155,027) 2,900
Sundry income (expense), net 103,659 (17,105)
------------ ------------
Total other expense (413,262) (749,461)
------------ ------------
Loss before income taxes (11,498,379) (9,820,828)
Income taxes (tax benefit) (Note 11) - (811,000)
------------ ------------
Net loss $(11,498,379) $ (9,009,828)
============ ============
Loss per share - basic $ (2.33) $ (1.69)
============ ============
Weighted average shares outstanding - basic 4,933,939 5,345,889
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 14
NEMATRON CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
For the years ended September 30, 1997 and 1998
<TABLE>
<CAPTION>
Retained
Common Stock Foreign Earnings
----------------------------- Currency (Accumulated
Shares Amount Translation Deficit) Total
---------- ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance, October 1, 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
adjustment 77,947 77,947
Shares issued pursuant to
merger with Intec Controls 587,594 3,305,205 3,305,205
Corp. (Note 4)
Shares issued pursuant to
merger with Virtual-Time
Software, Inc. 67,301 403,806 403,806
(Note 4)
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
Net loss for the year ended
September 30, 1998 (9,009,828) (9,009,828)
Foreign currency translation
adjustment 1,491 1,491
Exercise of options, net of 850
shares redeemed 11,050 27,250 27,250
Exercise of warrants 12,328 48,146 48,146
------------ ------------ ------------ ------------ ------------
Balance, September 30, 1998 5,353,316 $ 21,664,809 $ (6,080) $(20,265,605) $ 1,393,124
============ ============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 15
NEMATRON CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the years ended September 30, 1997 and 1998
<TABLE>
<CAPTION>
1997 1998
------------ -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(11,498,379) $ (9,009,828)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 6,179,918 3,944,397
Write-off of in-process research and development costs (Note 4) 2,055,000 -
Loss on disposal of property and equipment - 54,711
Deferred income tax benefit - (811,000)
Debt retirement expense 122,340 -
Changes in assets and liabilities that provided (used) cash:
Accounts receivable 2,535,869 1,690,456
Inventories 143,617 2,295,992
Prepaid expenses and other current assets 248,403 233,150
Accounts payable (157,326) 1,490,242
Other accrued liabilities (224,832) 48,228
------------ ------------
Net cash used in operating activities (595,390) (63,652)
------------ ------------
Cash flows from investing activities:
Acquisition of Intec Controls Corp. (Note 4) 281,058 -
Acquisition of Virtual-Time Software, Inc., net of $6,327 cash acquired
(Note 4) (93,673) -
Additions to capitalized software development costs and other intangible
assets (2,512,111) (2,017,384)
Additions to property and equipment (827,861) (271,067)
Proceeds from sale of property and equipment - 60,921
------------ ------------
Net cash used in investing activities (3,152,587) (2,227,530)
------------ ------------
Cash flows from financing activities:
Borrowings under long-term debt agreements 1,800,000 -
Net proceeds of note payable to bank 1,141,000 2,373,000
Proceeds from exercise of options and warrants 307,588 75,396
Repayments of long-term debt (2,264,350) (702,164)
Repayments of trade notes payable - (241,805)
Additions to deferred financing fees (39,211) -
------------ ------------
Net cash provided by financing activities 945,027 1,504,427
------------ ------------
Foreign currency translation effect on cash 2,975 1,491
------------ ------------
Net decrease in cash and cash equivalents (2,799,975) (785,264)
Cash and cash equivalents at beginning of year 3,942,963 1,142,988
------------ ------------
Cash and cash equivalents at end of year $ 1,142,988 $ 357,724
============ ============
Supplemental disclosures of cash flow information:
Cash paid for interest, net of amounts capitalized $ 344,551 $ 687,023
Cash paid for income taxes $ - $ -
Supplemental disclosures of noncash financing and investing activities:
Conversion of trade accounts payable to trade notes payable (Note 9) $ - $ 1,787,761
Acquisition of equipment under capital lease obligations (Notes 10 and 14) $ 544,014 $ 342,692
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 16
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1997 and 1998
(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) GOING CONCERN MATTERS
The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. As shown in
the financial statements, during the years ended September 30, 1997 and
1998, the Company incurred losses of $11,498,379 and $9,009,828,
respectively. These losses have contributed to the Company's difficulties
in generating sufficient cash flow to finance operations. These factors,
among others, raise substantial doubt about the Company's ability to
continue as a going concern. The accompanying financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.
Management's plans with respect to these matters include the following:
On December 1, 1998, the Company's primary lender extended the maturity
date of the line of credit and the term loan to January 31, 1999. The
lender also granted an adjustment to the borrowing base to allow a
permitted over-advance of $1 million. The line of credit note was
partially repaid with a portion of the proceeds from a private placement
completed on December 1, 1998. As a result of the paydown and the
operating activity subsequent to year end, the Company has returned to
compliance with the limits of its adjusted borrowing formula.
On December 1, 1998, the Company completed a $1 million private placement
of convertible promissory notes to a group of private investors. The
notes are convertible into common stock of the Company at $0.25 per
share, bear interest at 7% per annum and become due on March 31, 1999.
The notes grant the note holders an option through January 31, 1999 to
purchase additional convertible notes totaling $3 million, which are
convertible into common stock at $0.25 per share. Management believes
that the options will be exercised and an additional $3 million in
funding will be received prior to the option expiration date. Issuance of
shares in excess of 20% of the number of shares currently outstanding
will require shareholder approval, which the Board of Directors will seek
at the 1999 annual meeting of shareholders in March 1999.
A portion of the proceeds from the private placement was used to pay
delinquent vendor notes. When these notes became delinquent in the first
quarter of fiscal 1999, certain vendors ceased product delivery to the
Company. Upon the payment of the past due notes, the Company's vendors
agreed to resume the shipment, on a COD basis, of component parts for
subsequent assembly and sale to customers. Component parts have been
purchased in sufficient quantities so that management believes the
Company will be able to ship the current customer order backlog in a
timely manner and keep current with the anticipated order rate. Based
upon the actual and anticipated component purchases and subsequent
forecasted sales of finished product, management expects that current
operations and available credit facilities will be sufficient to pay its
costs and expenses as they become due.
F-7
<PAGE> 17
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(2) GOING CONCERN MATTERS, CONTINUED
Management plans to close on the private placement of the additional $3
million convertible notes by the expiration of the bank agreement, and to
use a portion of the additional proceeds to further pay down the credit
line. After this anticipated paydown, management expects borrowings to be
below the basic borrowing base (exclusive of the permitted overadvance).
Further, management intends to negotiate with its bank lender a longer
term extension of the expiration date of the financing agreement.
Management believes that an extension of the credit line is possible,
assuming that accounts receivable and inventory levels increases to
reduce or eliminate the amount of the overadvance as a result of the
anticipated sales increases, and assuming that the Company is able to
complete the additional placement of $3 million of its convertible
promissory notes prior to January 31, 1999.
Management believes successful implementation of the plans set forth
above will enable the Company to continue as a going concern. If the
Company is not successful in executing these plans, the Company maybe
forced to curtail its operations and either sell the Company or seek
protection under federal bankruptcy laws.
(3) 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; 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 4).
F-8
<PAGE> 18
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(3) SUMMARY OF ACCOUNTING PRINCIPLES, CONTINUED
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.
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
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.
F-9
<PAGE> 19
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(3) SUMMARY OF ACCOUNTING PRINCIPLES, CONTINUED
Software and Related Development Costs, Continued
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 4 and 5).
During the year ended September 30, 1998, capitalized software and
related development costs, net of amortization, increased by
approximately $1,218,000, primarily relating to the capitalization of
approximately $1,988,000 of salaries and other costs incurred during the
year, offset by approximately $770,000 of amortization of capitalized
costs.
Amortization of capitalized computer software development costs is
provided on a product-by-product basis using the greater of the amount
computed using (a) the ratio that current gross revenues for each product
bear to the total of current and anticipated future gross revenues for
that product, or (b) the straight-line method over the remaining
estimated economic lives of the respective products, ranging from two to
five years.
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. For
the year ended September 30, 1997, amortization was approximately
$636,900. For the year ended September 30, 1998, amortization was
approximately $2,035,900, including a provision for impairment of
approximately $1,319,700 relating to the write down of certain purchased
intangible assets (See Note 5).
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
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 compensation 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 (See Note 12).
F-10
<PAGE> 20
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(3) SUMMARY OF ACCOUNTING PRINCIPLES, CONTINUED
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 the net loss.
Revenue Recognition
Revenues from hardware product sales are recognized upon delivery and
when collection is probable. 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
software license agreements and from bundled products (hardware products
pre-loaded with software covered by applicable license agreements) are
deferred until all conditions in SOP 91-1, "Software Revenue
Recognition", are met; such conditions include the delivery of the
product, the performance of all obligations so that remaining obligations
are no longer significant, and collectibility is probable. 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 were approximately $1,615,000 and
$1,287,000 for the years ended September 30, 1997 and 1998, 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-11
<PAGE> 21
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(3) 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.
Loss Per Share
Loss per share is 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 net losses were incurred in
1997 and 1998, no conversion of dilutive stock options and warrants was
assumed in the loss per share calculation in either year, as the effect
would be anti-dilutive.
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 the allowance for doubtful accounts, obsolete and
slow moving inventory, capitalized software and related development
costs, intangible assets, warranty costs, and deferred tax assets and
liabilities.
Other Recent Pronouncements
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.
F-12
<PAGE> 22
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(3) SUMMARY OF ACCOUNTING PRINCIPLES, CONTINUED
Other Recent Pronouncements (Continued)
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. The Company will comply with the
requirements of SOP 97-2 in fiscal year 1999.
(4) 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 100 percent 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.
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.
F-13
<PAGE> 23
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(4) ACQUISITIONS (CONTINUED)
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) -
Other liabilities (985,000) (19,000)
----------- ---------
$ 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.
The $1,655,000 of acquired in-process R&D pursuant to the Intec
transaction in March 1997 was related to a synergistic product based upon
a combination of technology developed both by Intec and the Company. The
product was identified but had not yet reached the point of technological
feasibility, and included features of direct machine control,
human-machine interface and process measurement. Also included in the
product are features concerning Windows NT compatibility, flowchart
programming and a PC-based programming environment. In determining the
value of the acquired in-process R&D, the Company identified the
components of an existing product acquired from Intec, which needed to be
revised or substantially rewritten. Management then estimated the costs
involved in the process, including costs to complete the design, coding
and testing, the expected revenue less operating expenses and applicable
taxes, and charges related to fixed assets, technological updates,
distribution, royalties and other costs.
F-14
<PAGE> 24
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(4) ACQUISITIONS, CONTINUED
The $400,000 of acquired in-process R&D pursuant to the VTS transaction
in June 1997 was related to a synergistic product based upon a
combination of technology developed both by VTS and the Company. The
product was identified but had not yet reached the point of technological
feasibility, and included features of direct machine control in a Windows
- based programming environment. In determining the value of the acquired
in-process R&D, the Company identified the components of an existing
product acquired from VTS, which needed to be revised or substantially
rewritten to target a particular niche market. Management then estimated
the costs involved in the process, including costs to compete the design,
coding and testing, the expected revenue less operating expenses and
applicable, taxes, and charges related to fixed assets, technological
updates, distribution, royalties and other costs.
The following unaudited pro forma information presents a summary of
consolidated results of operations for fiscal 1997 of the Company, Intec,
and VTS as if the acquisitions had occurred as of the beginning of 1997,
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>
1997
------------
(Unaudited)
<S> <C>
Net revenues $ 22,825,183
Net loss $(11,255,075)
Net loss per share $ (2.28)
</TABLE>
(5) WRITE-DOWNS AND OTHER CHARGES
Write downs and other charges consist of the following:
<TABLE>
<CAPTION>
Year Ended September 30
1997 1998
------------ ----------
<S> <C> <C>
Charged to cost of revenues:
Write-down of software and related development $ 4,061,304 $ -
costs
Write-down of inventories 707,383 1,001,742
------------ ----------
$ 4,768,687 $1,001,742
============ ==========
Charged to operating expenses:
Write-down of other intangible assets $ 359,406 $1,319,698
Provision for loss on closing U.S. offices
- 350,000
Loss on closing of Netherlands office 245,836 -
Debt retirement expense 122,340 -
------------ ----------
$ 727,582 $1,669,698
============ ==========
</TABLE>
F-15
<PAGE> 25
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(5) WRITE-DOWNS AND OTHER CHARGES (CONTINUED)
In the fourth quarters of fiscal 1997 and 1998, 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 plans.
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.
In the fourth quarter of fiscal 1997 and in the third and fourth quarters
of 1998, the Company wrote down certain purchased parts and accessories
and finished goods inventories related to discontinued 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.
During the fourth quarter of fiscal 1998, the Company announced that it
had elected to close its software development offices in Virginia, Ohio
and California and to consolidate the software development activities in
its Massachusetts office. A provision for closing costs of $350,000 was
recorded in connection with costs expected to occur resulting from such
office closings.
(6) RELATED PARTY TRANSACTIONS
The Company leased its Virginia Beach, Virginia, office building from a
partnership in which the former president and CEO of the Company is a
partner. Total lease expense for the years ended September 30, 1997 and
1998, under the terms of the lease were $79,600 and $82,600,
respectively.
(7) INVENTORIES
Inventories are summarized as follows:
<TABLE>
<CAPTION>
September 30,
1998
--------------
<S> <C>
Purchased parts and accessories $ 1,100,202
Finished goods 158,472
Work-in-process 370,840
Demonstration units 357,456
Service stock 116,464
-----------
Total inventories $ 2,103,434
===========
</TABLE>
F-16
<PAGE> 26
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(8) NOTE PAYABLE TO BANK
The Company had a credit facility (the "Loan Agreement") with a bank
providing for a Term Note, two Equipment Notes and a Revolving Credit
Note. The Revolving Credit Note provided for a maximum borrowing by the
Company of $6,000,000. The amount available under the line of credit was
limited by a borrowing formula which allowed for advances up to a maximum
of the sum of 80% of eligible domestic and foreign accounts, plus 35% of
inventory. Based upon the borrowing formula, approximately $2,607,000 of
the available line was eligible for advance at September 30, 1998,
resulting in an over-advance position of $907,000 at that date. 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 borrowings bore
interest at the bank's prime interest rate (effective rate of 8.25% at
September 30, 1998).
On September 28, 1998, and December 1, 1998 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 January 31, 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 1, 1998).
Amounts borrowed under the line of credit are due in full on January 31,
1999.
(9) TRADE NOTES PAYABLE
Trade notes payable consist of short-term notes payable to certain of the
Company's creditors. The notes arose from the conversion in 1998 of
$1,787,761 of trade notes payable and the payment against the notes in
1998 of $241,805. The notes range in terms from six to twelve months in
duration and generally are interest bearing at 12% per annum. The notes
are classified as a current liability.
F-17
<PAGE> 27
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(10) LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
September 30,
1998
-----------
<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 $ 1,998,509
Term note payable to a bank, interest at LIBOR plus 2.5% per annum
(effective rate of 8.25% at September 30, 1998) payable in monthly
installments of $30,000 plus interest through January 31, 1999. The
note is collateralized by substantially all assets, other than real 1,230,000
property, and a third mortgage on the Company's real estate
Capitalized lease obligations and other 688,628
-----------
Total long-term debt 3,917,137
Less current maturities (1,832,791)
-----------
Total long-term debt, less current maturities $ 2,084,346
===========
</TABLE>
The mortgage loan agreement contains covenants that require the Company
to maintain a minimum tangible net worth and a minimum debt-to-equity
ratio. As of September 30, 1998, 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. The Company was in violation of certain of these
covenants at September 30, 1998 and as such these notes totaling
$1,579,781 are included in current maturities of long-term debt.
The aggregate amounts of long-term debt maturities at September 30, 1998,
are as follows:
<TABLE>
<CAPTION>
Year ended September 30:
<S> <C>
1999 $ 1,832,791
2000 279,652
2001 1,690,569
2002 49,881
2003 54,643
2004 9,601
-----------
Total long-term debt $ 3,917,137
===========
</TABLE>
F-18
<PAGE> 28
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(11) TAXES ON INCOME
The following reconciles the statutory federal income tax rate to the
Company's effective tax rate:
<TABLE>
<CAPTION>
Year ended September 30,
1997 1998
------- --------
<S> <C> <C>
Income tax benefit based on the federal statutory rate (34.0)% (34.0)%
Generation of net operating loss carryforwards 34.0% 34.0%
Effect of impairment and amortization of intangible assets
0.0% 8.3%
------- -------
Effective tax rate 0.0% 8.3%
======= =======
</TABLE>
The domestic and foreign components of income (loss) before taxes on
income are as follows:
<TABLE>
<CAPTION>
Year ended September 30,
1997 1998
----------- ----------
<S> <C> <C>
Domestic loss $(11,220,617) $(9,879,752)
Foreign income (loss) (277,762) 58,924
------------ -----------
Total loss before tax benefit $(11,498,379) $(9,820,828)
============ ===========
</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, 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.
Temporary differences and carryforwards which give rise to the net
deferred tax position are as follows:
<TABLE>
<CAPTION>
September 30,
1998
-----------
<S> <C>
Deferred tax assets:
Inventories $ 814,000
Accounts receivable 129,000
Property and equipment 101,000
Other 119,000
Net operating loss carryforwards 6,588,000
-----------
Total deferred tax assets 7,751,000
Less valuation allowance against deferred tax assets (6,284,000)
Net deferred tax assets 1,467,000
Deferred tax liability - capitalized software development costs
and other intangible assets (1,656,000)
Net deferred tax position $ (189,000)
===========
</TABLE>
F-19
<PAGE> 29
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(11) TAXES ON INCOME (CONTINUED)
During the years ended September 30, 1997 and 1998, the valuation
allowance increased by $3,786,000 and $2,112,000, respectively. At
September 30, 1998, the Company has net operating loss carryforwards of
approximately $19,400,000, which expire at various dates between 2003 and
2013. Utilization of these carryforwards is subject to annual limitations
under current IRS regulations. The Company has established 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.
(12) EMPLOYEE BENEFIT PLANS
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 1993 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.
Options remaining unexercised on the tenth anniversary of the date of the
grant will expire. No options may be granted after February 26, 2003.
As of September 30, 1998, an additional 56,503 options may be issued
under the 1993 Plan.
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.
F-20
<PAGE> 30
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(12) EMPLOYEE BENEFIT PLANS, CONTINUED
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. As of September 30, 1998, an additional 24,680 options may be
issued under the Directors Option Plan.
Special Option Grants
The Board of Directors, in fiscal 1995, 1996 and 1997, awarded special
option grants to a former chairman and a former Board member. The awards
were made separate from either of the two qualified plans specified
above.
Information with respect to options under the 1993 Stock Option Plan, the
1993 Directors Option Plan, and special option grants for the two years
ended September 30, 1998, is as follows:
<TABLE>
<CAPTION>
Outstanding Exercisable
--------------------------- ---------------------
Wtd. Ave. Wtd. Ave. Number
Number Exercise Number Exercise Available
Outstanding Price Exercisable Price For Grant
----------- -------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C>
Balance, October 1, 1996 518,884 $4.63 253,032 $4.33 267,700
Increase in authorized
shares:
1993 Plan 200,000
Directors Option Plan 100,000
Granted 501,570 $5.82 (496,820)
Exercisable 118,397 $4.87
Exercised (85,231) $2.57 (85,231) $2.57
Forfeited (80,219) $5.19 (58,204) 80,219
-------- -------- --------
Balance, September 30, 1997 855,004 $5.48 227,994 $5.05 151,099
Granted 269,700 $3.39 (269,700)
Exercisable 251,507 $5.59
Exercised (11,900) $2.70 (11,900) $2.70
Forfeited (199,684) $5.45 (8,187) 199,684
-------- -------- --------
Balance, September 30, 1998 913,120 $4.89 459,414 $5.24 81,083
========= ======== ========
</TABLE>
F-21
<PAGE> 31
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(12) EMPLOYEE BENEFIT PLANS, CONTINUED
Information concerning outstanding options at September 30, 1998 is as follows:
<TABLE>
<CAPTION>
Outstanding Exercisable
-------------------------------------------- --------------------------
Weighted
Number of Average Weighted Number of Weighted
Range of Options Remaining Average Options Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices At 9-30-98 Life Price At 9-30-98 Price
------ ---------- ---- ----- ---------- -----
<S> <C> <C> <C> <C> <C>
$2.00 to $3.00 251,550 8.4 years $2.19 98,850 $2.50
$3.01 to $5.00 84,750 7.2 $4.20 73,747 $4.12
$5.01 to $7.00 547,820 8.5 $6.05 263,484 $6.28
$7.01 to $8.75 29,000 7.7 $8.41 23,333 $8.66
-------- --------
913,120 8.4 $4.89 459,414 $5.24
======== ========
</TABLE>
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>
1997 1998
------------- -------------
<S> <C> <C>
Net loss
As reported $(11,498,379) $(9,009,828)
Pro forma $(12,029,150) $(9,570,278)
Net loss per share
As reported $ (2.33) $ (1.69)
Pro forma $ (2.44) $ (1.79)
</TABLE>
The fair values of options granted during 1997 and 1998 were determined
using the Black-Scholes option-pricing model based on the following
assumptions:
<TABLE>
<CAPTION>
1997 1998
------------ ------------
<S> <C> <C>
Risk-free interest rate 6.6% 5.8%
Dividend yield 0% 0%
Expected life 3 to 6 years 3 to 6 years
Expected volatility 61.7% 74.1%
</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, the Company may
make a basic contribution and a discretionary contribution to the plan.
In fiscal 1997 and through March 1998, the Company contributed 100% of
each employee's contribution up to the first 5% of the employee's base
salary contributed by the employee. In April and May, the Company reduced
its contribution to 3%, and beginning in June, contributions were
discontinued. A participant becomes vested in the Company's contribution
on his or
F-22
<PAGE> 32
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(12) EMPLOYEE BENEFIT PLANS, CONTINUED
her behalf at a rate of 20 percent for each year of service after the
effective date of the 401(k) plan.
Notwithstanding the foregoing, a participating employee will be fully
vested in the Company's contributions to his or her account in the event
of death, or in the event of disability or normal retirement, as those
terms will be defined in the 401(k) plan. The Company's contributions to
the 401(k) plan were approximately $158,000 and $38,000 for the years
ended September 30, 1997 and 1998, respectively.
(13) WARRANTS
The Company has outstanding warrants for the purchase of its common stock
as follows:
<TABLE>
<CAPTION>
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,
1996 10,039 137,000 237,214 - 384,253
Issued in connection
with the Intec 124,998 124,998
acquisition
Exercised (5,111) - (39,536) - (44,647)
-------- -------- -------- -------- --------
Balance
September 30,
1997 4,928 137,000 197,678 124,998 464,604
Exercised (4,828) (7,500) - - (12,328)
Expired (100) (129,500) - - (129,600)
-------- -------- -------- -------- --------
Balance
September 30, 1997
- - 197,678 124,998 322,676
======== ======== ======== ======== ========
</TABLE>
(14) COMMITMENTS AND CONTINGENCIES
The Company leases its Massachusetts, Ohio, Virginia, California and the
United Kingdom facilities, as well as certain office equipment, under
operating leases, and leases certain computer, phone, network 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 2003.
F-23
<PAGE> 33
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(14) COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 $349,781 at September 30, 1998 (note 10). The net
book value of equipment leased under the two capital leases is
approximately $305,000 at September 30, 1998.
The Company leases certain computer equipment under a capital lease from
a finance company. The lease has an initial term of three years beginning
December 1997 and requires monthly payments, including interest, of
$3,898 through December 2000. The unpaid balance of this capital lease
totaled $87,085 at September 30, 1998 (note 10). The net book value of
equipment leased under the capital lease is approximately $83,000 at
September 30, 1998.
The Company leases certain telephone and network equipment under a
capital lease from a finance company. The lease has an initial term of
five years beginning November 1998 and requires monthly payments,
including interest, of $4,856 through November 2003. The unpaid balance
of this capital lease totaled $233,079 at September 30, 1998 (note 10).
The net book value of equipment leased under the capital lease is
approximately $233,000 at September 30, 1998.
A summary of commitments under noncancelable leases as of September 30,
1998, is as follows:
<TABLE>
<CAPTION>
Capital Leases Operating Leases Total
-------------- ---------------- -----
<S> <C> <C> <C>
Year ending September 30,
1999 $ 417,210 $ 132,116 $ 549,326
2000 82,593 85,002 167,595
2001 56,869 55,959 112,828
2002 49,881 4,152 54,033
2003 54,643 1,730 56,373
2004 9,601 9,601
--------- --------- ---------
Total minimum lease
obligation $ 670,797 $ 278,959 $ 949,756
========= =========
Less amounts representing
interest (114,256)
Present value of minimum
lease payments $ 556,541
=========
</TABLE>
Total rental expense in fiscal 1997 and 1998 was approximately $308,000
and $245,000, respectively.
F-24
<PAGE> 34
NEMATRON CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
September 30, 1997 and 1998
(14) COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 shareholder 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 Michigan District. Management
believes that the outcome of this case will not have a material adverse effect
on the Company.
(15) SEGMENT INFORMATION
The Company operates in one market segment - factory automation.
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,
------------------------
1997 1998
---- ----
<S> <C> <C>
Foreign:
France $ 1,687,171 $ 1,795,275
Other countries 4,296,205 3,429,303
----------- -----------
Total foreign revenues 5,983,376 5,224,578
United States revenues 14,892,021 11,604,756
----------- -----------
Total revenues $20,875,397 $16,829,334
=========== ===========
</TABLE>
Long-lived assets include property and equipment, capitalized software
development costs and other intangible assets. A summary of both foreign
and domestic long-lived assets at depreciated or amortized cost is as
follows:
<TABLE>
<CAPTION>
September 30, 1998
------------------
<S> <C>
Foreign countries $ 72,440
United States 8,496,341
-----------
$ 8,598,781
</TABLE>
(16) SIGNIFICANT CUSTOMER
The Company has one significant customer to which it sold $1,045,000 and
$1,795,000 in fiscal 1997 and 1998, respectively. Accounts receivable
from this customer approximated $783,000 and $442,000 at September 30,
1997 and 1998, respectively.
F-25
