8 10Q1Q97.doc UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT of 1934. For the quarterly period ended December 31, 1996 OR __ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from ________, 19__, to _______, 19__. Commission File Number: 33-25308-D CUSIP NUMBER 64121L 10 3 NETWORK SYSTEMS INTERNATIONAL, INC. (Exact Name of Registrant as Specified in Charter) Nevada 87-0460247 (State or Other Jurisdiction of (I.R.S. Employer Identification Incorporation or Organization) Number) 200 North Elm Street, Greensboro, North Carolina 27401 (Address of Principal Executive Offices, Including Zip Code) (910) 271-8400 (Registrant's Telephone Number, Including Area Code) AQUA AUSTRALIS, INC. 1901 East University, Suite 200, Mesa, AZ 85023 (Former Name, Former Address and Former Fiscal Year, if Changed) 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 has been subject to such filing requirements for the past 90 days. X YES ___ NO There were 5,806,176 shares of the Registrant's .001 par value common stock outstanding as of February 13, 1997. Transitional Small Business Format (check one) Yes __ No X NETWORK SYSTEMS INTERNATIONAL, INC. Contents Part I - Financial Information Item 1. Financial Statements Consolidated Balance Sheet 3 Consolidated Statements of Operations Three months ended December 31, 1996 and 1995 4 Consolidated Statements of Cash Flow Three months ended December 31, 1996 and 1995 5 Consolidated Statement of Changes in Stockholder's Equity 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Part II Item 4. Submission of Matters to Vote of Security Holders 16 Item 5. Other matters 16 Item 6. Exhibits and Reports on Form 8-K 17 Signatures 18 Exhibit Index 19 PART I. FINANCIAL STATEMENTS Network Systems International, Inc. and Subsidiaries Consolidated Balance Sheet December 31, 1996 (Unaudited) Assets Current Assets Cash $ 3,564 Accounts receivable, trade, net of allowance of $121,594 1,777,718 Accounts receivable, related parties 13,139 Other current assets 30,110 1,824,531 Property and equipment, net of accumulated depreciation 991,617 Other Assets Software development costs, net of accumulated amortization 1,245,774 Other 53,528 1,299,302 $4,115,450 Liabilities and Stockholders' Equity Current Liabilities: Notes payable, current portion $ 275,134 Capital lease obligation, current portion 72,000 Accounts payable, trade 622,897 Other accrued liabilities 83,395 Income taxes payable 53,577 Deferred revenue 177,383 Billings in excess of costs and earnings on uncompleted contracts 18,240 Total current liabilities 1,302,626 Long Term Liabilities: Deferred income taxes 605,038 Notes payable, net of current maturities 370,714 Capital lease obligation, net of current maturities 215,382 Total long term liabilities 1,191,134 Stockholders' Equity Preferred Stock; $.001 par value; authorized 12,500 shares; issued and outstanding 0 shares Common Stock; $.001 par value; authorized 100,000,000 shares; issued and outstanding 5,806,176 shares 5,806 Capital in excess of par value 2,137,335 Accumulated Deficit (521,451) Total stockholders' equity 1,621,690 $4,115,450 The accompanying notes are an integral part of the consolidated financial statements. Network Systems International, Inc. and Subsidiaries Consolidated Statement of Operations (Unaudited) Three Months Ended December 31 1996 1995 Revenue: Licensing revenue $ 982,537 $ 632,769 Equipment revenue 403,226 1,262,607 Servicing revenue 47,100 493,958 Total revenue 1,432,863 2,389,334 Operating expenses Cost of sales and services 647,215 1,273,118 Research and development 89,749 128,549 General and administrative 234,416 413,759 971,380 1,815,426 Operating income 461,483 573,908 Other income (expenses) Interest (16,838) (5,703) Other income (expense) 174 (28,828) (16,664) (34,531) Income before income tax provision 444,819 539,377 Income tax provision 144,000 0 Net income $ 300,819 $ 539,377 Primary net income per common share $ .05 Weighted average common stock outstanding 5,806,176 Pro Forma Amounts Assuming Retroactive Application of Change In Subchapter S Status and Corporate Recapitalization Income before income tax provision $ 539,377 Income tax provision 210,600 Net income $ 328,777 Primary net income per common share $ .06 Weighted average common stock outstanding 5,756,176 The accompanying notes are an integral part of the consolidated financial statements. NETWORK SYSTEMS INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited) Three Months Ended December 31 1996 1995 Operating activities Net income 300,819 539,377 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 286,927 95,905 Loss on marketable securities 4,223 (Increase) in: Accounts receivable and unbilled (650,864) (1,419,523) receivables Prepaid assets, other receivables, and (1,104) (10,605) other assets Increase (decrease) in: Accounts payable and accrued liabilities 381,615 969,078 Income tax payable 53,577 Unearned revenue 41,875 4,797 Deferred income taxes 90,338 Billings in excess of costs and earnings on (252,460) (143,151) uncompleted contracts Total adjustments (50,096) (499,276) Net cash provided by operating activities 250,723 40,101 Investing activities Deposit on equipment (30,000) Acquisition of property and equipment (40,150) (16,541) Software development (390,488) (145,608) Proceeds on sale of marketable securities 3,557 Purchase of marketable securities (3,540) Increase in cash surrender value of life insurance (3,522) (2,016) Net cash (used) by investing activities (464,160) (164,148) Financing activities Payment received from stockholder advances 700 Payment on notes payable, long-term debt and capital leases (35,873) (6,990) Net proceeds on line of credit 175,387 97,578 Net cash provided by financing activities 139,514 91,288 Net (decrease) in cash (73,923) (32,759) Cash at October 1 77,487 94,517 Cash at December 31 $ 3,564 $ 61,758 Supplemental disclosures of cash flow information and noncash investing and financing activities Cash paid during the period for: Interest $ 17,567 $ 15,541 In April of 1996 the stockholders of Network Information Services, Inc. and Network Investment Group, Inc. exchanged all of their common shares of stock for controlling interest in Network Systems International, Inc. (formerly Aqua Australis, Inc.) The accompanying notes are an integral part of the financial statements. Network Systems International, Inc. and Subsidiaries Consolidated Statement of Changes in Stockholders' Equity Three months ended December 31, 1996 Retained $0.001 Capital in Earnings Number of Par Excess of (Accumulat Shares Value Par Value ed) Total (Deficit) Balance September 30, 1996 5,806,176 $ 5,806 $2,137,335 $(822,270) $1,320,871 Net income for the three month 300,819 300,819 period ended December 31, 1996 5,806,176 $ 5,806 $2,137,335 $(521,451) $1,621,690 The accompanying notes are an integral part of the consolidated financial statements. Network Systems International, Inc. and Subsidiaries Notes to Consolidated Financial Statements For the Three Months Ended December 31, 1996 and December 31, 1995 (Unaudited) 1. Background Information Network Systems International, Inc. (the Company), formerly Aqua Australis, Inc., was incorporated on September 21, 1988 in the state of Nevada. This corporation was considered a development stage company whose principal business activity was to seek potential business ventures and assets which would warrant involvement or purchase by the Company. On April 22, 1996, the Company completed a reverse triangular merger whereby two of its wholly owned subsidiary corporations merged with two North Carolina corporations, with the North Carolina corporations being the surviving corporations in the merger. Immediately thereafter, the Company, with the approval of its shareholders, caused its corporate charter to be amended to change its name to Network Systems International, Inc. The newly named company is now the parent company of two wholly owned subsidiary corporations: Network Information Services, Inc. (NIS) and Network Investment Group, Inc. (NIG), both North Carolina corporations. Immediately prior to the merger, the shareholders of the Company also approved a two for one reverse split of all issued and outstanding shares of the Company's common stock with a $.001 par value and Network Partners, LLC effectively merged into NIS. All per share data has been retroactively restated to show the effects of the two for one reverse split. In addition, immediately prior to the merger, the then controlling stockholders of the Company turned in approximately 17.5 million shares of the Company which were then canceled. As a result of the merger, accounted for as a reverse acquisition which is similar to the purchase method of accounting, shareholders of NIS and NIG caused the transfer of all of their shares of common stock in the companies, which had a total assets value of approximately $3,800,000, to the Company in exchange for 5,250,176 shares of common stock of the Company. NIS was incorporated under the laws of the state of North Carolina on September 9, 1985 and develops, licenses, and supports software products primarily for the textile, sewn products and process manufacturing industries. Operations are concentrated in North and South Carolina, however, NIS has clients throughout the east coast of the United States. It employs approximately 50 full-time employees. The corporate headquarters is located in Greensboro, North Carolina. NIG was incorporated under the laws of North Carolina on April 7, 1993 and sells computer hardware to manufacturing industries. Operations are concentrated in North Carolina and South Carolina, however, it has clients throughout the east coast of the United States. The corporate headquarters is located in Greensboro, North Carolina. The Company changed their year end from December 31 to September 30 in 1996. In December 1996 the Company entered into an agreement with an underwriter to promote the sale of a private placement preferred stock offering. The Company plans to sell 12,500 shares of Series A preferred stock at a purchase price of $100 per share. Each share of preferred stock will receive an annual dividend of $12 per share. The preferred stock is convertible into 50 shares of the Company's common stock at a conversion price of $2.00 per share, subject to the outcome of certain events. As of February 13, 1997 the Company has raised approximately $508,515 under the private placement offering. 2. Summaries of Significant Accounting Policies Basis of Preparation: The financial statements as of December 31, 1996 and for the three month period then ended Consolidate the Accounts of Network Systems International, Inc. and its wholly owned subsidiaries Network Information Services, Inc. and Network Investment Group, Inc. The financial statements for the three months ended December 31, 1995 combine the accounts of Network Information Services, Inc., Network Investment Group, Inc. and Network Partners, LLC. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary for a fair statement of (a) the results of operations for the three-month periods ended December 31, 1996 and 1995, (b) the financial position at December 31, 1996, and (c) cash flows for the three-month periods ended December 31, 1996 and 1995, have been made. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Financial Instruments: Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade receivables. The Company performs on-going credit evaluations of its customers' financial condition. Property and Equipment: Property and equipment are recorded at cost. Depreciation is calculated by the declining-balance and straight-line methods over the estimated useful lives of the assets, ranging generally from 5 to 39.5 years. Additions to and major improvements of property and equipment are capitalized. Maintenance and repair expenditures are charged to expense as incurred. As property is sold or retired, the applicable cost and accumulated depreciation are eliminated from the accounts and any gain or loss is recorded. For income tax purposes, the Company uses accelerated methods of depreciation for certain assets. Software Development Cost: The Company capitalizes internally generated software development costs in compliance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed". The Company capitalizes the direct costs and allocated overhead associated with the development of software products. Initial costs are charged to operations as research and development prior to the development of a detailed program design or a working model. Costs incurred subsequent to the product release are charged to operations. Capitalization of computer software development costs begins upon the establishment of technical feasibility for the product. Capitalized software development costs amounted to $390,488 and $145,608 for the three month period ended December 31, 1996 and 1995, respectively. Amortization of capitalized computer software development costs begins when the products are available for general release to customers, and is computed on a product-by-product basis as the greater of 1) the ratio of current gross revenues for a product to the total of current and anticipated future gross revenues for the product or 2) the straight-line method over the remaining estimated economic life of the product. The Companies have estimated that the useful economic life of its products is two years. Amortization expense of capitalized software cost amounts to $240,494 and $75,790 for the three month period ended December 31, 1996 and 1995, respectively, and is included in cost of sales. Software development costs at December 31, 1996 consist of the following: Software Development Costs $ 2,212,945 Less Accumulated Amortization (967,171) $ 1,245,774 Revenue: The Company generates several types of revenue which are accounted for as follows: Revenue from the sale of software licenses is recognized after shipment and fulfillment of all major obligations under the terms of the licensing agreements. The licensing agreements are typically for the use of company products and are usually restricted by the number of copies, the number of users and the term. Revenue from "time and materials" contracts are recognized when the services are performed. Services performed which have been authorized but may not be currently billable are classified as unbilled accounts receivable. Revenues from fixed price contracts are recognized using the percentage-of-completion method, measured by direct hours. Contract costs include direct labor combined with allocations of operational overhead and other direct costs. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability which may result in revisions to costs and revenue are recognized in the period in which the revenues are determined. Support agreements generally call for the Company to provide technical support and certain software updates to customers. Revenue on support and software update rights is recognized ratably over the term of the support agreement. The Company provides consulting and educational services to its customers. Revenue from such services is generally recognized as the services are performed. Hardware revenue is recognized when the product is shipped to the customer. Advertising Costs: Advertising costs, except for costs associated with direct response advertising, are charged to operations when incurred. The costs of direct response advertising are capitalized and amortized over the period during which future benefits are expected to be received. Advertising expense amounted to $30,489 and $-0- for the periods ended December 31, 1996 and December 31, 1995, respectively. No material amounts were capitalized during the 3 month period ended December 31, 1996 and 1995, respectively. Income Tax: Prior to the merger on April 22, 1996, the principal operating subsidiary of the Company (NIS) was treated as an S corporation for tax purposes. As such, income and deductions attributable to NIS were reported by its shareholders, and no tax expense or liability was recorded by the Company up until such date. Activities of the Company and its other subsidiary prior to that date did not give rise to a material liability for income taxes. Beginning in April, 1996, income taxes are provided for transactions reported in the financial statements. Deferred income taxes are provided for when transactions are reflected in income for financial reporting purposes in a year other than the year of their inclusion in taxable income. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Earnings Per Share: Primary earnings per common share are computed using the weighted average number of shares outstanding of the Company for the period ended December 31, 1996. Pro forma Presentation: The consolidated financial statement of operations for the 3 month period ended December 31, 1995 includes a pro forma presentation, as specified by the Securities and Exchange Commission, for income taxes which would have been recorded had the operating subsidiary been a C corporation, based on the tax laws in effect during those periods. Pro forma earnings per share have been calculated to include the adjustment for income taxes had the operating subsidiary been a C corporation during the periods ended December 31, 1995. Weighted average number of shares outstanding have been calculated to reflect the number of equivalent shares received by the acquiring company during the reverse acquisition. 3. Uncompleted Contracts Information with respect to uncompleted contracts at December 31, 1996 is summarized as follows: Earned contract revenue $ 429,760 Less billings to date 448,000 Billings in excess of costs and earnings on uncompleted contracts $ (18,240) 4. Property and Equipment Property and equipment at December 31, 1996 consist of the following Land $ 150,000 Building 300,000 Leasehold improvements 89,426 Furniture and fixtures 118,229 Office equipment 93,364 Computer equipment 229,507 Computer software 50,693 Computer equipment and software under capital lease 324,933 1,356,152 Less accumulated depreciation and amortization (304,706) Accumulated amortization on computer equipment and software ( 59,829) under capital lease $ 991,617 5. Notes Payable Notes payable at December 31, 1996 consist of: Bank line of credit: $250,000 maximum line; interest payable monthly at prime plus .5%; principal due February 26, 1997; collateralized by accounts receivable, equipment, and a $200,000 life insurance policy; personally guaranteed by certain $ 195,134 stockholders Bank note payable: interest at prime plus 1.0%; monthly payments of $4,729; due July 1, 1997; collateralized by accounts receivable, equipment, and a $200,000 life insurance policy; personally guaranteed by certain stockholders 35,566 Mortgage note payable: interest at prime plus 0.25%; monthly principal payments of $2,612 plus interest; balloon payment due March 10, 2000; collateralized by building; personally guaranteed by certain stockholders 415,148 645,848 Less amounts currently due 275,134 $ 370,714 The following is a schedule by year of the principal payments required on these notes payable and long-term debts: 1997 $275,134 1998 31,344 1999 31,344 2000 308,026 6. Obligations Under Capital Leases The Company has capitalized rental obligations under three leases of software and equipment. The obligations, which mature in 2000 and 2001, represent the total present value of future rental payments discounted at the interest rates implicit in the leases. Future minimum lease payments under the capital leases are: Period Ending December 31 1997 $ 92,197 1998 90,432 1999 90,432 2000 42,812 2001 14,600 Total minimum lease payments 330,473 Less amount representing interest 43,091 Present value of net minimum lease payments $ 287,382 Less current portion 72,000 $ 215,382 7. Retirement Benefit Plan Effective January 1, 1993, the Company established a retirement plan which allows participants to make contributions by salary reduction under Section 401(k) of the Internal Revenue Code. The Company did not make matching contributions to the plan during 1996 or 1995. 8. Income Taxes As a result of the reverse acquisition on April 22, 1996, the Subchapter S status of one of the Company's subsidiaries was terminated. After that date, the financial statements of the Company provide for the income tax effect of earnings reported in the financial statements, including taxes currently due and taxes deferred because of different accounting methods used for financial and income tax reporting. Prior to the change in tax status, earnings and losses were included in the personal tax returns of the stockholders and taxed depending on their personal tax situations and the Company did not record an income tax provision. The change in tax status necessitated the recognition of the cumulative deferred income existing as of the date of the termination of the S status which resulted in a one-time charge to deferred tax expense of $435,200. Net income from operations before income taxes totaled $444,819 for the three months ended December 31, 1996. The provision for income taxes from continuing operations consist of the following components: Current tax expense $ 107,400 Deferred tax expense 65,800 Research and development credit (29,200) $ 144,000 The significant temporary differences which gave rise to deferred tax assets and liabilities as of December 31, 1996 are as follows: Deferred tax asset Bad debt revenue $ 199,600 Deferred tax liabilities Software development cost $1,245,800 Book basis of property & equipment in excess of tax basis 71,200 Change in tax status 553,900 $1,870,900 The Company has loss carryforwards totaling $149,900 that may be offset against future taxable income and research and development credit totaling $26,600 that may be offset against future federal income taxes. If not used, the carryforwards will expire as follows: Research & development Operating losses credits 2003 $ 92,800 - 2009 49,300 - 2010 7,800 - 2011 - 6,300 2012 - $20,300 $149,900 $26,600 No valuation allowance has been recorded against the deferred tax assets or operating loss or tax credit carryforwards because recognition of the cumulative deferred income arising from the change in tax status should be sufficient to offset the remaining tax assets. The difference between the provision for income taxes and the amounts obtained by applying the statutory U.S. Federal income tax rate to income before taxes for the three months ended December 31, 1996 is as follows: Tax expense at U.S. statutory rates $ 151,200 34.0% State and local income tax 5,600 1.3% Research & development credit and other (12,800) (2.9%) $ 144,000 32.4% 9. Major Customer For the three month period ended December 31, 1996, sales to four customers amounted to approximately $833,000. For the three month period ended December 31, 1995, sales to two customers amounted to approximately $1,488,000. 10. Lease Commitments The following is a schedule by year of future minimum rental payments required under operating leases that have an initial or remaining noncancelable lease term in excess of one year as of December 31, 1996: 1997 $44,986 1998 $35,417 1999 $19,032 2000 $ 2,449 Rent expense amounted to $9,658 and $52,754 for the three months ended December 31, 1996 and 1995, respectively. 11. Commitments The Company entered into 20 year employment agreements with five of its officers calling for annual salaries totaling no less than $195,000. ____________________________________________________________________ Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ___________________________________________________________________ This MD&A Contains Some Forward Looking Information Results of Operations Revenue. Although Network's first quarter software sales increased from $632,769 to $982,577 during first period 1996 over the comparable period 1995, a 55% increase, the Company's total first quarter revenues decreased 40% to $1,432,863 compared to the first quarter of the prior year. This decrease resulted from the sale of approximately one million dollars of hardware to a single customer during the comparable period in 1995. Software sales contributed 68.6% of the net revenues of the Company; implementation services 3.3% and hardware sales 28.1% for the quarter ended 12/31/96. The Company intends to continue to provide periodic upgrades to its software packages during the balance of the year. During first quarter, 1997, the Company issued an upgrade to its software package to its customers who were eligible to receive the enhancement. Additionally, the Company currently intends to introduce a third generation version of its original software package during the calendar year 1997. However, there are no assurances that the Company will not experience difficulties that could delay or prevent the successful completion, introduction and marketing of the new program, its product enhancements or that they will adequately meet the requirements of either the marketplace or achieve market acceptance. In addition, the Company's revenues in future periods could be adversely affected by a significant change in general manufacturing environments or as it relates to their desire to computerize the manufacturing process. Cost of Sales and Services. Cost of sales and services as a percentage of revenue decreased in the first quarter of fiscal 1997 to 45% from 53% in the first quarter of the prior fiscal year. This decrease is attributable to a shift of the Company's focus into software licensing and a resultant decrease in equipment sales. Since equipment revenues carry a higher percentage of costs as compared to software licensing fees, an anticipated decrease in cost of sales and services was achieved. Included in cost of sales and services is $240,494 of amortized software costs. Software Development Costs. Software development costs, both capitalized and expensed as research and development, amounted to approximately $480,000 for the three months ended 12/31/96, as compared to approximately $274,000 for the three months ended 12/31/95; a 75% increase. Of these amounts, approximately $390,000 and $146,000 were capitalized for the three months ended December 31, 1996 and 1995, respectively. More software development costs were capitalized in 1996 versus 1995 since technological feasibility of more products was achieved in fiscal year 1996. This increase is principally attributable to the Company's continued commitment to develop new and improved software modules. The Company would anticipate that research and development expenses will overall, increase in 1997 due to the Company's continuing efforts to launch its third generation software package. Additionally, the Company intends to continue recruiting and hiring experienced software developers and to consider the acquisition of complementary software technologies. However, there can be no assurances that the Company will achieve these goals. General and Administrative. General and administrative expenses were 16.4% of revenue in the first quarter of 1997 as compared to 17.3% in the same quarter of 1996. This decrease in general and administrative expenses is principally due to the Company's assignment of certain associates out of the administrative area into more product focused issues of the Company's business. Provisions for Income Taxes. Prior to the merger on April 21, 1996 the principal operating subsidiary of the Company (NIS) was treated as a subchapter S corporation for tax purposes. As such income and deductions attributable to NIS were reported by its shareholders and no tax expense or liability was recorded by the Company up until such date. Activities of the Company and its other subsidiary prior to April 21, 1996 did not give rise to a material liability for income taxes and therefore no taxes were recorded prior to the second quarter of 1996. Income taxes are provided for transactions reported in the financial statements beginning on April 21, 1996, and consist of taxes currently due plus deferred income taxes. The change in tax status resulted in a one time charge of approximately $435,000. Quarterly Results. Net income for the three month period ended 12/31/96 was $300,819. Assuming a retroactive application of change in Subchapter S status, pro forma net income for the comparable period ended 12/31/95 amounted to $328,777. This decrease is directly attributable to the sale of approximately one million dollars of hardware to a single customer during the 1995 period. On a per share basis, earnings were $.05 for the three months ended 12/31/96 as compared to pro forma $.06 for the comparable period of 1995. This per share data has been computed using the weighted average of the common stock outstanding for Network Systems International, Inc., the former development stage company, for all periods presented versus the 5,806,176 shares outstanding as of 12/31/96. Net income before income taxes was $444,819 in the quarter ended December 31, 1996 compared to an income before income taxes of $539,377 for the comparable period ended 12/31/95. This decrease is primarily due to the sale of approximately one million dollars of hardware to a single customer during the period in 1995. The Company believes that in the future its results may reflect quarterly fluctuations resulting from such factors as order deferrals in anticipation of new product releases, delays in the release of new products, a slower growth rate in the overall manufacturing industry or adverse general economic and manufacturing conditions in the industries in which the Company does business. Rapid technological change and the Company's ability to develop and market products that successfully adapt to that change may also have an impact on the results of operations. Further, increased competition in the design and distribution of manufacturing software products could also negatively impact the Company's results of operations. Due to the factors stated above, the Company's future earnings and stock price may be subject to significant volatility, particularly on a quarterly basis. Any shortfall in revenues or earnings from levels expected by securities analysts could have an immediate and significant adverse effect on the trading price of the Company's stock. Liquidity and Capital Resources. Cash totaled $3,564 on December 31, 1996. Cash provided by operating activities amounted to approximately $250,700 for the three months ended 12/31/96 compared to $40,100 in the comparable period of 1995. This increase in cash provided by operations is principally due to additional collections of accounts receivables over the prior period. Long term cash requirements, other than normal operating expenses, are anticipated for development of new software products and enhancements of existing products; financing anticipated growth; adding additional personnel; and the possible acquisition of software products or technologies complimentary to the Company's business. The Company believes that its existing cash, cash equivalents, available lines of credit and anticipated cash generated from continuing operations will be sufficient to satisfy its currently anticipated cash requirements for the 1996 fiscal year. Additionally, the Company anticipates increasing its cash availability by way of a private placement of some of its shares of common stock and a secondary offering of its stock by calendar year end. However, there are no assurances as to the timing or success of these anticipated offerings. As previously stated, current sales of preferred stock in a private placement offering as of February 13, 1997 amounted to a net cash position of $508,515. Assuming the balance of the private placement offering is successful, the total net cash to be received by the Company will amount to $1,087,500. The Company will pay a $12.00 per share dividend on each share of preferred stock until, (1) the preferred shareholder exercises the right to convert the preferred shares to common stock of the Company at a conversion rate of $2.00 per share, or (2) the Company exercises its right to call the shares on the basis of a declining premium from $3.00 to $0 over the nine month period beginning February 12, 1998. Part II _______________________________________________________________________ Item 4. Submission of Matters to a Vote of Security Holders _______________________________________________________________________ All matters submitted to a vote of security holders during the period covered by this report has been previously reported by the Company in its Form 10-KSB for the period ending September 30, 1996 and filed with the Securities and Exchange Commission on January 10, 1997. Exhibits contained therein set forth the details of all matters submitted to a vote of security holders, therefore, specific reference is made thereto. ______________________________________________________________________ Item 5. Other Matters ______________________________________________________________________ (1) On December 12, 1996 the Company initiated a plan to issue up to $1,250,000 in Series A Convertible Preferred Stock in a private placement offering. Palm State Equities, Inc. will act as underwriter in the offering which anticipates that the offering will be completed by the close of the Company's second quarter ending March 31, 1997. (2) Although the Company previously believed that it would acquire a sufficient asset level by the end of its second quarter to qualify for its submission of an application for NASDAQ Small Cap Market status, such asset level was not achieved due to the failure of the Company to close pending business prior to the end of the quarter. Therefore, application for NASDAQ Small Cap Market status is currently held in abeyance until such time as the Company increases its asset base to the levels required. _______________________________________________________________________ Item 6 Exhibits and Reports on Form 8-K _______________________________________________________________________ (a)Exhibits included herewith are: (3)(i) Articles of Incorporation (4) Investments defining the rights of holders including indentures (27) Financial Data Schedule SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereto duly authorized. NETWORK SYSTEMS INTERNATIONAL, INC. Date: 2/14/97 /s/ Robbie M. Efird Robbie M. Efird, President and acting as CFO Date: 2/14/97 /s/ William C. Ray William C. Ray, Vice President EXHIBIT INDEX Exhibit Page (3)(i) 20 (4) 26 (27) 29