<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934.
For the quarterly period ended March 31, 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: 0-21992
------------------------
FOURTH SHIFT CORPORATION
(Exact name of Registrant as specified in its charter)
MINNESOTA 41-1437794
(state or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)
------------------------
7900 INTERNATIONAL DRIVE
SUITE 450
MINNEAPOLIS, MN 55425
(612) 851-1500
(Address, including zip code, of Registrant's
principal executive offices and telephone
number, including area code)
Indicate by check mark whether the Registrant (1) has 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.
Yes X No
----- -----
The number of shares outstanding of the Registrant's Common Stock on May 7th,
1998 was 9,900,653 shares.
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FOURTH SHIFT CORPORATION
INDEX
PART I - FINANCIAL INFORMATION PAGE
- ------------------------------ ----
Item 1. Financial Statements:
Consolidated Balance Sheets at 2
March 31, 1998 and December 31, 1997
Consolidated Statements of Operations 3
for the three months ended March 31, 1998
and 1997
Consolidated Statements of Cash Flows 4
for the three months ended March 31, 1998
and 1997
Notes to Interim Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial 7
Condition and Results of Operations
PART II - OTHER INFORMATION
- ----------------------------
Item 6. Exhibits and Reports on Form 8-K 12
SIGNATURE 13
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
FOURTH SHIFT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
ASSETS
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
<S> <C> <C>
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents..................... $ 5,230 $ 5,758
Accounts receivable, net...................... 13,216 14,001
Inventories................................... 609 482
Prepaid expenses.............................. 1,265 1,031
Royalty receivable............................ 68 650
--------- --------
Total current assets..................... 20,388 21,922
FURNITURE, FIXTURES AND EQUIPMENT, net............. 4,917 5,503
RESTRICTED CASH.................................... 715 715
SOFTWARE DEVELOPMENT COSTS, net.................... 3,289 3,289
--------- --------
TOTAL ASSETS $ 29,309 $ 31,429
--------- --------
--------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term obligations...... $ 1,155 $ 1,803
Revolving credit facility..................... 2,500 2,000
Accounts payable.............................. 3,492 3,964
Accrued expenses.............................. 5,654 8,001
Deferred revenue.............................. 11,432 10,315
--------- --------
Total current liabilities................ 24,233 26,083
LONG-TERM OBLIGATIONS.............................. 1,072 1,299
SHAREHOLDERS' EQUITY:
Common stock.................................. 99 98
Additional paid-in capital.................... 30,825 30,640
Other comprehensive losses.................... (222) (236)
Accumulated deficit........................... (26,698) (26,455)
--------- --------
Total shareholders' equity............... 4,004 4,047
--------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 29,309 $ 31,429
--------- --------
--------- --------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
2
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FOURTH SHIFT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
THREE MONTHS ENDED
MARCH 31
-------------------
1998 1997
-------- --------
(Unaudited)
<S> <C> <C>
REVENUE
Software license...................................... $ 5,333 $ 3,801
Service............................................... 8,197 6,416
Third-party software and other........................ 900 588
-------- -------
Total revenue.................................... 14,430 10,805
-------- -------
OPERATING EXPENSES:
Cost of licenses...................................... 954 525
Cost of services...................................... 3,963 3,122
Cost of third-party software and other................ 672 412
Selling, general and administrative................... 7,129 6,123
Product development................................... 1,808 2,073
-------- -------
Total operating expenses......................... 14,526 12,255
-------- -------
Operating loss............................................. (96) (1,450)
Interest expense, net...................................... (131) (68)
Other expense, net......................................... (49) (9)
-------- -------
LOSS FROM CONTINUING OPERATIONS
BEFORE PROVISION FOR INCOME TAXES........................ (276) (1,527)
Provision for (benefit from) income taxes............. 35 (31)
-------- -------
LOSS FROM CONTINUING OPERATIONS............................ (311) (1,496)
NET GAIN ON SALE OF DISCONTINUED OPERATIONS................ 68 201
-------- -------
NET LOSS................................................... $ (243) $ (1,295)
-------- -------
-------- -------
BASIC AND DILUTED EARNINGS (LOSS) PER
COMMON SHARE:
Continuing operations loss per share.................. $ (0.03) $ (0.15)
Discontinued operations income per share.............. 0.01 0.02
-------- -------
Net loss per share.................................... $ (0.02) $ (0.13)
-------- -------
-------- -------
SHARES USED IN BASIC AND DILUTED PER COMMON SHARE
COMPUTATION............................................... 9,901 9,674
-------- -------
-------- -------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
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FOURTH SHIFT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
THREE MONTHS ENDED
MARCH 31
--------------------------
1998 1997
----------- -----------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (243) $ (1,295)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 655 614
Gain on sale of discontinued operations (68) (201)
Other 16 (5)
Change in current operating items:
Accounts receivable, net 785 2,293
Inventories (127) 31
Prepaid expenses (234) (71)
Accounts payable (472) (1,715)
Accrued expenses (2,114) (1,083)
Deferred revenue 1,117 (112)
---------- ----------
Net cash used in operating activities (685) (1,544)
---------- ----------
INVESTING ACTIVITIES:
Purchase of furniture, fixtures and equipment (69) (280)
Proceeds from sale of discontinued operations 650 196
Capitalized software development costs - (1,220)
---------- ----------
Net cash provided by (used in) investing activities 581 (1,304)
---------- ----------
FINANCING ACTIVITIES:
Payments of long-term obligations (924) (138)
Borrowings on equipment facility - 195
Borrowings on line of credit 500 -
Proceeds on issuance of common stock - 60
---------- ----------
Net cash provided by (used in) financing activities (424) 117
---------- ----------
Net change in cash and cash equivalents (528) (2,731)
CASH AND CASH EQUIVALENTS:
Beginning of period 5,758 5,935
---------- ----------
End of period $ 5,230 $ 3,204
---------- ----------
---------- ----------
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during each period for-
Income taxes $ - $ 19
Interest 192 107
---------- ----------
---------- ----------
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Capitalized leases $ 51 $ 496
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
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FOURTH SHIFT CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
1. The accompanying interim consolidated financial statements have been
prepared by Fourth Shift Corporation (the "Company"), without audit, in
accordance with generally accepted accounting principles for interim financial
information and pursuant to the rules and regulations of the Securities and
Exchange Commission.
The unaudited consolidated financial statements as of March 31, 1998 and
1997 and for the three month periods then ended include, in the opinion of
management, all adjustments, consisting solely of normal recurring adjustments,
necessary for a fair presentation of the financial results for the respective
interim periods. The results of operations for the three month period ended
March 31, 1998 are not necessarily indicative of results of operations to be
expected for the entire fiscal year ending December 31, 1998. The accompanying
interim consolidated financial statements have been prepared under the
presumption that users of the interim consolidated financial information have
either read or have access to the audited consolidated financial statements for
the year ended December 31, 1997. Accordingly, certain footnote disclosures
which would substantially duplicate the disclosures contained in the December
31, 1997 audited consolidated financial statements have been omitted from these
interim consolidated financial statements. It is suggested that these interim
consolidated financial statements be read in conjunction with the audited
consolidated financial statements for the year ended December 31, 1997 and the
notes thereto.
2. In the quarter ended March 31, 1998, the Company recognized a gain of
$68,000 in conjunction with the receipt of a royalty payment in April 1998
related to the sale of its former subsidiary, Just In Time Enterprise Systems,
Inc.
3. In the fourth quarter of 1997 the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 128 "Earnings per Share" and, retroactively,
restated the earnings (loss) per share (EPS) for all prior periods. SFAS No.
128 requires presentation of basic and diluted EPS. Basic EPS is computed by
dividing net income by the number of weighted average common shares outstanding.
Diluted EPS reflects potential dilution from outstanding stock options, using
the treasury stock method. For the quarters ending March 31, 1998 and 1997
options were excluded from the diluted EPS calculation as the options were
anti-dilutive.
4. The Financial Accounting Standards Board has released SFAS 130, "Reporting
Comprehensive Income," effective for years beginning after December 15, 1997.
SFAS No. 130 establishes standards for reporting in the financial statements the
non-income components of all nonowner changes in equity. Other comprehensive
income (losses) were $14,000 and ($27,000) for the three months ending March 31,
1998 and 1997, respectively. These amounts result from translation losses from
the Company's foreign operations. Other comprehensive losses are reclassified
on a cumulative basis from accumulated deficit in the attached Consolidated
Balance Sheets.
5. Statement of Position (SOP) 97-2, "Software Revenue Recognition," issued in
October 1997, is effective for transactions entered into beginning in January
1998. This statement supersedes SOP 91-1 and provides guidance on applying
generally accepted accounting principles in recognizing revenue on software
transactions. The company has implemented SOP 97-2 in January 1998 and the
implementation did not have a material impact on the Company's financial
condition or results of operations.
5
<PAGE>
6. In accordance with Statement of Financial Accounting Standards (SFAS)
No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed," certain software development costs are capitalized upon
the establishment of technological feasibility. Costs incurred prior to the
establishment of technological feasibility and development costs incurred to
improve and enhance existing software are charged to expense as incurred. In
the quarter ended March 31, 1997, the Company capitalized $1,220,000 of
development costs related to the development of its next generation product,
Fourth Shift OBJECTS Enterprise Software-TM-.
In conjunction with a December 1997 restructuring of the Company's product
development operations, the Company reevaluated its OBJECTS development
activities and product strategy. As a result of this evaluation, the Company
identified ways to combine some of the OBJECTS technology with the functionality
of the current MSS product, and redirected its development activities
accordingly. Because of this redirection, components of the previously
developed OBJECTS product will not be incorporated into planned future product
releases. As such, $1,630,000 of previously capitalized costs related to these
components, net of accumulated amortization, were charged to restructuring
expense in December 1997.
As of March 31, 1998, Fourth Shift is not marketing a product using the
OBJECTS technology. As such, the remaining capitalized asset will not be
amortized until such time as the underlying technology is incorporated into a
product that is available for general release. Upon releasing such a product,
the remaining capitalized costs will be amortized to expense over the product's
estimated economic life. In the three months ended March 31, 1998, no
additional software development costs were capitalized.
6
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis of financial condition and results of
operations has been prepared under the presumption that users of the interim
consolidated financial statements have either read or have access to the
Company's annual report for the year ended December 31, 1997.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. The following Management's
Discussion and Analysis contains various "forward looking statements" within the
meaning of federal securities laws which represent management's expectations or
beliefs concerning future events, including statements regarding anticipated
sales, marketing and research and development expenditures, growth in revenue,
capital requirements and the sufficiency of cash to meet operating expenses.
These, and other forward looking statements made by the Company, must be
evaluated in the context of a number of factors that may affect the Company's
financial condition and results of operations, including the following:
- - The ability of the Company to continually enhance the Manufacturing
Software System for OBJECTS (MSS) product to meet ever changing market
demands for both functionality and new technology;
- - Fluctuations in quarterly operating results caused by changes in the
computer industry, buying patterns and general economic conditions;
- - The ability of the Company to successfully develop its MSS product to meet
European Monetary Union requirements;
- - The dependence of the Company on revenue from licensing of its MSS product;
- - The effects of changes in technology and standards in the computer
industry;
- - The significant competition among developers and marketers of industrial
software;
- - The ability of the Company to retain key employees;
- - The ability of the Company to continue to integrate complementary
applications with its MSS product to meet functionality demands;
- - The increasing size of the Company's international operations, particularly
in Asia;
- - The ability of the Company to manage expansion of international
distribution channels;
- - The dependence of the MSS product line on a third-party database management
system; and
- - Evolving standards regarding intellectual property protection for software
products in general.
RESULTS OF OPERATIONS
NET LOSS. The Company recorded a net loss of $243,000 or $.02
per share for the quarter ended March 31, 1998, compared to a net
loss of $1,295,000 or $.13 per share for the quarter ended March
31, 1997.
7
<PAGE>
TOTAL REVENUE increased 34% to $14,430,000 during the three months ended
March 31, 1998 from $10,805,000 during the comparable period in 1997, as
outlined below.
SOFTWARE LICENSE REVENUE are fees paid by customers for the right to use
the Company's software systems. Software license revenue increased 40% to
$5,333,000 from $3,801,000 during the same quarter in 1997. At the regional
level, the Americas and Europe posted increases of 56% and 90%, respectively
over the comparable period in 1997. These increases were partially offset by a
decline in Asia software revenue of 44% from the same quarter in 1997.
The growth in the Americas and Europe was due to improved
sales strategies and management changes initiated in the second and
third quarters of 1997. In addition, increased feet on the street
in the Americas have positively impacted sales. The decline in Asia
is primarily attributable to economic problems in Asia that have
softened the demand for enterprise software solutions.
Additionally, the Company has experienced increased competition in
Asia.
SERVICE REVENUE includes customer support fees, training, consulting,
installation and project management. Service revenue increased 28% to
$8,197,000 from $6,416,000 during the same quarter in 1997. Service revenue
showed strong growth due to sustained license revenue growth beginning in the
third quarter of 1997 that has continued through the first quarter of 1998. A
major portion of professional services are purchased in the three to six months
following the licensing of the software. In addition, service revenue continues
to benefit from the Company's ongoing efforts to expand, standardize and promote
its professional services offerings.
THIRD-PARTY SOFTWARE REVENUE is derived from the resale of third-party
software licenses (complementary applications). These complementary
applications have been integrated to function with the MSS software and extend
the functionality of MSS. Third-party software and other revenue increased 53%
to $900,000 in the first quarter of 1998 from $588,000 during the same quarter
in 1997. This increase is primarily attributable to the increase in MSS
software license revenue, as a significant portion of third-party software is
licensed in conjunction with the MSS product. Additional revenues were also
generated though the introduction of certain complementary applications that
were added to the product line.
COST OF LICENSES increased to $954,000 in the first quarter of 1998 from
$525,000 in the same period of 1997. As a percentage of total license revenue,
cost of licenses was 18% in the first quarter of 1998 compared to 14% for the
prior year comparable period. The increase in the cost of licenses as a
percentage of license revenue is primarily due to increases in royalty costs
paid to third-party software suppliers whose products are embedded in and
distributed with the MSS product. Additionally, in the first quarter the
Company began licensing at near cost a migration tool to its customers that
allows them to migrate to a newer version of a supplier's database, impacting
the cost of licenses.
COST OF SERVICES increased to $3,963,000 for the three months ended March
31, 1998 from $3,122,000 for the same period of 1997. As a percentage of
service revenue, cost of services was 48% for the first quarter of 1998 and 49%
for the first quarter of 1997.
COST OF THIRD-PARTY SOFTWARE AND OTHER increased to $672,000 or 75% of
third-party software and other revenue in the first quarter of 1998 from
$412,000 or 70% of third-party software and other revenue in the same period of
1997. The increase in cost of third-party software as a percentage of
third-party software revenue is due to changes in the mix of software products
sold in the quarter.
8
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE increased to $7,129,000 for the three
month period ended March 31, 1998, up from $6,123,000 for the three month period
ended March 31, 1997. As a percentage of total revenue, selling, general and
administrative expense decreased to 49% of total revenue compared to 57% for the
same period in 1997. The increase in terms of absolute dollars reflects the
increased size of the Company resulting from second half 1997 growth and market
penetration. Fixed selling, general and administrative costs for the first
quarter of 1998 decreased $150,000 from the fourth quarter 1997 results
demonstrating the Company's commitment to cost containment. Variable selling,
general and administrative costs consisting primarily of commissions and certain
incentive plans increased in absolute dollars and as percentage of total revenue
in the first quarter of 1998 over fourth quarter 1997 totals. This growth
partially resulted from special provisions in commission plans to encourage
first quarter sales.
PRODUCT DEVELOPMENT expense for the three months ended March 31, 1998
decreased to $1,808,000 from $2,073,000 for the three months ended March 31,
1997. As a percentage of total revenue, product development declined to 13%
from 19% during the same period in 1997. Further, in the first quarter of
1997, the Company capitalized $1,220,000 of development costs for the
Company's object-oriented, communications-centric technology (OBJECTS) while
no costs were considered capitalizable in the first quarter of 1998. The
$1,485,000 reduction in product development spending results from the
execution of a product development restructuring plan that was implemented in
the fourth quarter of 1997.
The restructuring plan merged two development operations into one and
resulted in staff and contractor reductions and allowed the Company to close
development offices in San Jose. The implementation of this plan has reduced
the product development costs in absolute dollars and as a percentage of
revenue.
As of March 31, 1998, Fourth Shift is not marketing a product using the
OBJECTS technology. As such, the remaining capitalized asset will not be
amortized until such time as the underlying technology is incorporated into a
product that is available for general release. Upon releasing such a product,
the remaining capitalized costs will be amortized to expense over the product's
estimated economic life. In the three months ended March 31, 1998, no
additional software development costs were capitalized.
PROVISION FOR INCOME TAXES. The provision for income taxes for the three
months ended March 31, 1998 and 1997 was comprised of state and foreign income
taxes. The Company does not provide for U.S. federal taxes as a result of
operating losses and a significant net operating loss carryforward.
LIQUIDITY AND CAPITAL RESOURCES
During the three months ended March 31, 1998, the Company's cash and cash
equivalents decreased $528,000 to $5,230,000.
The Company used $685,000 cash in operating activities during the first quarter
of 1998. Although the Company incurred a small net loss in the quarter, the loss
was more than offset
9
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by noncash items (depreciation and amortization) and by a gain recognized in
the quarter from the sale of the Company's former subsidiary, Just In Time
Enterprise Systems (JIT), in 1995. The normal seasonal reduction in sales
from fourth quarter to first quarter resulted in a corresponding decrease in
receivables as they were collected in the first quarter, generating $785,000
of cash. The Company also collected seasonally high customer support
payments in the first quarter (which are recorded as deferred revenue and
recognized as income over the period of the support services) and augmented
payments in the first quarter by offering a discount for customers who
prepaid two years of support services, generating $1,117,000 of cash. The
Company paid down seasonally high accounts payable resulting in use of
$472,000 of cash, and paid severance and other costs associated with the
restructuring discussed above, resulting in a reduction in accrued expenses
and use of $2,114,000 of cash.
Investing activities provided $581,000 of cash for the three months ending
March 31, 1998. The primary source of cash was $650,000 of royalty
payments received in connection with the sale of JIT. This was partially offset
by purchases of furniture, fixtures and equipment totaling $69,000. The
Company's purchases of furniture, fixtures, and equipment for the comparable
period in 1997 was $280,000. The sharp decline is a direct result of the
restructuring plan initiated in December 1997 that reduced headcount in the
development area.
Financing activities used $424,000 of cash during the three
months ended March 31, 1998. The primary use of cash was payments
of $924,000 for the early settlement of a certain equipment debt
facility and principal payments on the Company's capital lease
obligations. This was partially offset by additional borrowings of
$500,000 under the Company's line of credit agreement.
The Company does not have any material scheduled commitments for capital
expenditures. The Company believes that the $5,230,000 of cash and cash
equivalents on hand at March 31, 1998, together with the Company's available
line of credit and anticipated cash flows from operations will be sufficient to
fund operating cash needs over the next twelve months. At March 31, 1998, and
the Company was in compliance with all related financial performance covenants
under the bank line of credit. If the above sources of cash are not sufficient
to fund operations, the Company may need to seek additional funds through equity
or debt financing.
OTHER
The Company has analyzed the potential affect of the year 2000 issue on its
application products and application software it uses in its internal
operations. The Information Technology Association of America (ITAA) has
certified that Fourth Shift enterprise software solutions are year 2000
compliant. Additionally, the Company has requested and received documentation
from vendors currently supplying third party products addressing year 2000
compliance. In most cases, vendors responses indicated that their applications
were either currently year 2000 compliant or that they would be compliant by the
end of 1998. In certain instances, vendors have not made a commitment to become
year 2000 compliant by the end of 1998. The Company is evaluating alternative
courses of action relating to these certain vendors and anticipates resolution
by the end of 1998. Based on this review, the Company does not anticipate any
material effect on its future operating results or financial position.
10
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PART II - OTHER INFORMATION
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
No exhibits will be filed.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three months ended
March 31, 1998.
11
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Fourth Shift Corporation
May ___, 1998
/s/ DAVID G. LATZKE
------------------------------------------
David G. Latzke
Vice President and Chief Financial Officer
(principal financial officer)
12
