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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
[ ] TRANSITION REPORT UNDER 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
(Exact name of small business issuer as specified in its charter)
Michigan 38-2483796
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
5840 Interface Drive, Ann Arbor, Michigan 48103
(Address of principal executive offices) (Zip Code)
(734) 214-2000
(Issuer's telephone number, including area code)
Check whether the issuer (1) has filed all reports required to be filed by
section 13 or 15(d) of the Securities Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
[ X ] YES [ ] No
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: No par value Common Stock:
15,744,472 outstanding as of November 12, 2003
Transitional Small Business Disclosure Format: [ ] YES [X] NO
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PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Nematron Corporation and Subsidiaries
Consolidated Condensed Balance Sheets
September 30, 2003 and December 31, 2002
September 30,
2003 December 31,
(Unaudited) 2002
----------- ------------
Assets
------
Current assets:
Cash and cash equivalents $123,835 $103,802
Accounts receivable, net
of allowance for doubtful accounts
of $80,000 at September 30, 2003 and
$75,000 at at December 31, 2002 2,739,952 2,342,400
Inventories (Note3) 1,528,500 1,653,844
Prepaid expenses and other current assets 223,260 172,550
---------- -----------
Total current assets 4,615,547 4,272,596
Property and equipment, net of accumulated
depreciation of $7,768,202 at September 30,
2003 and $7,563,474 at December 31, 2002 1,647,320 1,850,392
Goodwill, net of amortization (Note 4) 2,922,122 2,922,122
Intangible assets (Note 5):
Software and related development costs,
net of amortization 488,088 574,407
Other intangible assets, net of amortization 254,539 404,159
---------- -----------
Total assets $9,927,616 $10,023,676
========== ===========
Liabilities and Shareholders' Deficit
Current liabilities:
Notes payable under lines of credit (Note 6) $ 1,625,426 $ 1,397,317
Accounts payable 1,547,156 1,582,958
Deferred revenue and other accrued expenses 2,371,802 1,748,594
Subordinated debt (Note 7) 4,511,500 3,179,000
Current maturities of long-term debt (Note 8) 172,479 169,255
---------- -----------
Total current liabilities 10,228,363 8,077,124
Long-term debt, less current maturities (Note 8) 2,382,659 2,522,740
---------- -----------
Total liabilities 12,611,022 10,599,864
Shareholders' deficit:
Common stock, no par value, 30,000,000 shares
authorized, 15,744,472 shares outstanding 33,343,288 33,246,346
Accumulated comprehensive income (1,013) 25,645
Accumulated deficit (36,025,681) (33,848,179)
---------- -----------
Total shareholders' deficit (2,683,406) (576,188)
---------- -----------
Total liabilities and
shareholders deficit $9,927,616 $10,023,676
========== ===========
2
Nematron Corporation and Subsidiaries
Consolidated Condensed Statements of Operations
For The Three-and Nine-Month Periods Ended
September 30, 2003 and 2002
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
---------------------------- ---------------------------
2003 2002 2003 2002
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
----------- ----------- ----------- -----------
Net revenues $3,347,276 $3,450,069 $9,770,157 $11,586,507
Cost of revenues 2,535,259 2,628,741 7,554,888 8,545,049
--------- --------- ----------- -----------
Gross profit 812,017 821,328 2,215,269 3,041,458
Operating expenses:
Software development costs 143,609 190,176 438,033 546,692
Selling, general and
administrative 1,076,424 1,229,776 3,190,783 3,774,827
--------- --------- ----------- -----------
Total operating expenses 1,220,033 1,419,952 3,628,816 4,321,519
--------- --------- ----------- -----------
Operating loss (408,016) (598,624) (1,413,547) (1,280,061)
Other income (expense):
Interest expense (303,362) (233,437) (779,459) (731,215)
Sundry income 4,611 (5,254) 15,510 19,851
--------- --------- ----------- -----------
Total other income (expense) (298,751) (238,691) (763,949) (711,364)
--------- --------- ----------- -----------
Loss before income taxes (706,767) (837,315) (2,177,496) (1,991,425)
Income taxes (Note 7) -0- -0- -0- -0-
--------- --------- ----------- -----------
Net loss $(706,767) $(837,315) $(2,177,496) $(1,991,425)
========= ========= =========== ===========
Per share amounts (Note 8):
Basic and diluted $(0.04) $(0.05) $(0.14) $(0.13)
========= ========= =========== ===========
Weighted average shares
outstanding (Note 8):
Basic and diluted 15,744,472 15,744,472 15,744,472 15,744,472
========== ========== ========== ==========
Nematron Corporation and Subsidiaries
Consolidated Condensed Statements of Comprehensive Loss
For The Three-and Nine-Month Periods Ended September 30, 2003 and 2002
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
---------------------------- ---------------------------
2003 2002 2003 2002
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
----------- ----------- ----------- -----------
Net loss $(706,767) $(837,315) $(2,177,496) $(1,991,425)
Other comprehensive income (loss) -
equity adjustment from foreign
translation 5,501) 6,046 (26,658) 20,543
--------- --------- ----------- -----------
Comprehensive loss $(712,268) $(831,269) $(2,204,154) $(1,970,882)
========= ========= =========== ===========
3
Nematron Corporation and Subsidiaries
Consolidated Condensed Statements of Cash Flows
For The Nine-Month Periods Ended
September 30, 2003 and 2002
Nine Months Ended Sept. 30,
---------------------------
2003 2002
(Unaudited) (Unaudited)
----------- -----------
Cash flows from operating activities:
Net loss $(2,177,496) $(1,991,425)
Adjustments to reconcile net
loss to net cash flows used in
operating activities:
Depreciation 215,241 326,671
Amortization (Notes 4 and 5) 235,939 377,169
Non-cash interest expense for beneficial
conversion feature (Note 7) 96,942 192,257
Loss (gain) on disposal of equipment (948) 17,514
Changes in assets and liabilities that
provided (used) cash:
Accounts receivable (397,552) 657,155
Inventories 125,344 162,615
Prepaid expenses and other current assets (50,710) (5,982)
Accounts payable (35,798) 147,985
Deferred revenue and accrued expenses 623,204 (399,858)
--------- --------
Net cash used in operating activities (1,365,834) (515,899)
Cash flows from investing activities:
Additions to property and equipment (14,051) (91,328)
Proceeds from disposals of property
and equipment 2,824 1,253
--------- --------
Net cash used in investing activities (11,227) (90,075)
Cash flows from financing activities:
Proceeds from long-term debt agreement - 2,700,000
Proceeds from issuance of subordinated
notes and warrants (Note 7) 1,332,500 1,424,000
Increase (decrease) in notes payable under
lines of credit 228,109 (680,446)
Payments of long-term debt (136,857) (2,959,469)
Payment of deferred financing fees - (33,287)
--------- --------
Net cash provided by (used in)
financing activities 1,423,752 450,798
Foreign currency translation effect (26,658) 20,543
--------- --------
Net increase (decrease) in cash 20,033 (134,633)
Cash at beginning of period 103,802 291,726
--------- --------
Cash at end of period $ 123,835 $157,093
========= ========
Supplemental disclosures of cash flow information:
Cash paid for interest $272,811 $341,973
Cash paid for income taxes - -
4
Nematron Corporation and Subsidiaries
Notes To Consolidated Condensed Financial Statements
For The Three- and Nine-Month Periods Ended
September 30, 2003 and 2002
Note 1 - Basis of Presentation
The accompanying consolidated financial statements include the accounts of
Nematron Corporation (the "Company") and its wholly-owned subsidiaries, Nematron
Limited, a United Kingdom corporation, Nematron Canada Inc., a Canadian
corporation, A-OK Controls Engineering, Inc. ("A-OK Controls"), a Michigan
corporation, and Optimation, Inc. ("Optimation"), an Alabama corporation. All
significant intercompany transactions and balances have been eliminated in
consolidation.
In the opinion of management, all adjustments (consisting solely of normal
recurring adjustments) considered necessary for a fair presentation of the
consolidated financial statements for the interim periods have been included.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commissio's rules and regulations, although the Company believes that the
disclosures are adequate to make the information presented not misleading. It is
suggested that these condensed consolidated financial statements should be read
in conjunction with the consolidated financial statements and notes thereto
included in the Company's latest annual report on Form 10-KSB.
The results of operations for the three-month and nine month periods ended
September 30, 2003 and 2002 are not necessarily indicative of the results to be
expected for the full year.
Recent Accounting Pronouncements
- --------------------------------
In May 2003, the Financial Accounting Standards Board (FASB) issued
Statement 150, "Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity". This Statement establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). This Statement is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. The adoption of this statement did not impact the Company's financial
position.
Note 2 - Inventories
Inventories consist of the following at September 30, 2003
and December 31, 2002:
September 30, December 31,
2003 2002
----------- -----------
Purchased parts and accessories $1,012,654 $1,085,811
Work in process 243,873 247,730
Finished goods, demo units and service stock 271,973 320,303
---------- ----------
Total Inventories $1,528,500 $1,653,844
========== ==========
5
Note 3 - Goodwill
Goodwill was recorded in connection with the Companys acquisition of other
entities during the years 1995 through 2001, and prior to January 1, 2002, the
Company was amortizing goodwill over periods ranging from fifteen to twenty
years. Effective with the adoption of FASB Statement No. 142, Goodwill and Other
Intangible Assets, that the Company adopted on January 1, 2002, the Company
ceased amortizing goodwill in accordance with provisions of the pronouncement.
However, goodwill is subject to certain impairment tests at least annually.
Note 4 - Software and Related Development Costs
Certain computer software development costs, primarily salaries, wages and
other payroll costs, and purchased software technology had been capitalized
prior to January 1, 2002. Capitalization of computer software development costs
began upon establishment of technological feasibility. The establishment of
technological feasibility and the ongoing assessment of recoverability of
capitalized computer software development costs required 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 annually reviews the
recoverability of capitalized software costs based on estimated cash flows.
Software costs are written off at the time a determination has been made that
the amounts are not recoverable.
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.
A summary of capitalized software and related development costs as of
September 30, 2003 is as follows:
Balance, January 1, 2003 $574,407
Additions --
Amortization (86,319)
--------
Total Capitalized Software $488,088
========
Note 5 - Other Intangible Assets
Intangible assets, which consist primarily of acquired intangible assets,
patent costs and deferred financing charges, are carried at cost less
accumulated amortization, which is calculated on a straight-line basis over the
estimated useful lives of the assets. The estimated useful lives of the assets
range from three to ten years.
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.
A summary of activity in the intangible asset account as of September 30,
2003 is as follows:
Balance, January 1, 2003 $404,159
Additions --
Amortization (149,620)
--------
Total Other Intangible Assets $254,539
========
6
Note 6 - Notes Payable Under Credit Lines
The Company and its subsidiary, A-OK Controls, were parties to two loan and
security agreements (the "Agreements") with LaSalle Business Credit, Inc. a
Wisconsin-based bank ("LBCI"). The Agreements, as amended through July 15 2003,
provided for a total of $1,225,000 as of June 30, 2003 and $900,000 beginning
July 15 through July 31, 2003 when the facility was terminated. Nematron repaid
a total of $500,000 of the amounts it had borrowed under the line of credit
facilities as of July 15, 2003 and repaid the remaining amounts on July 31,
2003. These funds were borrowed under a promissory note from North Coast
Technology Investors, LLP (the "Promissory Note"). Mr. Hugo Braun, a former
director of the Company, is a partner of North Coast.
Terms of the Promissory Note, under which the Company began borrowing on
July 15, 2003, provide for a maximum facility of $1,700,000 payable on demand.
The interest rate on amounts borrowed funds is 9.0% per annum. Borrowings under
the Promissory Note, which total $1,516,676 as of September 30, 2003, are
collateralized by substantially all assets of the Company and a second position
on the mortgage on the Company's Ann Arbor facility.
The Company's wholly owned subsidiary, Optimation, is party to a loan and
security agreement with Compass Bank, an Alabama-based bank (the "Optimation
Loan Agreement"). The Company and Compass Bank have been renewing the Optimation
Loan Agreement on consecutive 90 to 180 day revolving bases since the Company
acquired Optimation in March 2001. The Optimation Loan Agreement, last amended
as of October 3, 2003, provides for a total line of credit of $108,750 that
reduces in amount with all principal repayments made (the "Optimation credit
facility"). The amount available under the Optimation credit facility is limited
by a borrowing formula that allows for advances up to a maximum of the sum of a
specified percentage of eligible accounts receivable and a specified amount of
inventory. Amounts borrowed under the Optimation line of credit facility total
$108,750 at September 30, 2003, and such borrowings bear interest at the prime
rate plus .50% (5.0% effective rate at September 30, 2003), but not less than
5.0% per annum. The Optimation Loan Agreement requires monthly repayments of
$15,000 from October 2003 to March 2004 and a final payment of $18,750 on April
30, 2004 at which time the loan will be repaid in its entirety. The Optimation
Loan Agreement prohibits the transfer of funds from Optimation to the parent
company except for customary inter-company cost reimbursements. The Optimation
line of credit is collateralized by substantially all assets of Optimation and a
guaranty by Nematron.
7
Note 7 - Subordinated Debt
Subordinated debt consists of the following:
September 30, December 31,
2003 2002
---- ----
Convertible subordinated promissory notes, interest at 10% per
annum, due August 31, 2001. Accrued interest and the principal
of the note may be converted into common stock at the lower of
$0.09 per share or the lowest price of the underlying common
stock during the period the notes are outstanding. $1,200,000 $1,200,000
Convertible subordinated promissory notes, interest at 8% per
annum, due October 15, 2002. The notes may be converted into
preferred stock during the period the notes are outstanding, and the
terms of the preferred stock, if issued, would allow the holders to
convert the preferred stock into common stock on a one-for-one basis. 200,000 200,000
Convertible subordinated promissory notes, interest at 14% per
annum, due on demand. The notes may be converted into preferred
stock during the period the notes are outstanding, and the terms of the
preferred stock, if issued, would allow the holders to convert the
preferred stock into common stock on a one-for-one basis. 3,111,500 1,779,000
---------- ----------
Total $4,511,500 $3,179,000
========== ==========
The 10% Convertible Subordinated Promissory Notes
- -------------------------------------------------
The 10% convertible subordinated notes due August 31, 2001 (the "10%
Notes") included detachable warrants. The warrants, which are non-assignable,
initially allowed the holders to purchase Common Stock at $0.30 per share (the
"Per Share Warrant Price") at any time until March 31, 2006 (the "Warrants"). If
at any time prior to the exercise of the Warrants the daily closing price of the
Common Stock, as traded on the American Stock Exchange, falls below the Per
Share Warrant Price for five consecutive days, the Per Share Warrant Price will
be adjusted downward to the lowest price during such five trading day period. As
the lowest price per share has been $0.05, the Per Share Warrant Price has been
adjusted to that amount.
The 8% Subordinated Promissory Notes
- ------------------------------------
The 8% subordinated promissory notes due October 15, 2002 (the "8% Notes")
included detachable warrants. The warrants, which are non-assignable, initially
allowed the 8% Notes holders to purchase Common Stock at $0.22 per share (the
"Per Share Warrant Price) at any time until March 31, 2007 (the "Warrants").
The Company did not repay the 8% Notes when due and in connection with the
noteholders' forbearance, the conversion feature was modified to allow
conversion into the same securities and at the same price as that set forth in
the 14% Notes described below.
The 14% Subordinated Promissory Notes
- -------------------------------------
The 14% subordinated promissory notes due on demand (the "14% Notes") were
issued pursuant to an agreement initially dated in October 2001 and modified in
March and October 2002. The modified agreement allows the Company to draw up to
$3 million upon request and upon approval by the 14% Note holder upon its sole
discretion. In the event of any equity financing by the Company, the 14% Note
holder may convert any or all of the outstanding principal of the 14% Note and
accrued interest thereon into the securities offered in such financing at the
offering price per share. The modified agreement further provides that the
8
principal and accrued interest payable under the 14% Note may be converted in
whole or part into either shares of Common Stock or shares of Series A Preferred
Shares beginning on September 1, 2002 at $0.10 per share. Provisions of the
Series A Preferred Shares include: a) participation in dividends, if any, with
the Common Stock shareholders; b) a liquidation preference up to the initial
purchase price of the Series A Preferred Shares; c) a conversion feature
allowing conversion into Common Stock on a one-to-one basis; d) full voting
powers; e) the right to elect one person to the Board of Directors; f) the
consent of a majority in interest of the Series A Preferred will be required to
(i) purchase or redeem any Common or Preferred Stock, (ii) authorize or issue
any senior or parity securities, (iii) declare or pay dividends on or make any
distribution on account of the Common Stock, (iv) merge, consolidate or sell or
assign all or substantially all of the Company's assets, (v) increase or
decrease authorized Preferred Stock and (vi) amend Articles or Incorporation to
change the rights, preferences, privileges or limitations of any Preferred
Stock; g) the conversion price for the Series A Preferred shall be subject to
proportional antidilution protection for stock splits, stock dividends, etc. and
in the event that the Company issues additional shares of Common Stock or Common
Stock equivalents (other than shares issues to officers or employees of the
Company pursuant to plans approved by the Company's board of directors) at a
purchase price less than the applicable Series A Preferred conversion price, the
Series A Preferred Stock conversion price shall be adjusted to that same lower
purchase price; and h) each holder of Series A Preferred Stock shall have the
right to participate in any Company financing up to its pro-rata ownership.
The 14% Notes sold included detachable warrants. The warrants, which are
non-assignable, initially allowed the holders to purchase Common Stock at $0.10
per share (the "Per Share Warrant Price") in an amount of 20% of the principal
of the 14% Notes and accrued interest thereon for a period of five years from
the date of the advance (the "Warrants"). If at any time prior to the exercise
of the Warrants the daily closing price of the Common Stock, as traded on the
American Stock Exchange, falls below the Per Share Warrant Price for five
consecutive days, the Per Share Warrant Price will be adjusted downward to the
lowest price during such five trading day period. As the lowest price per share
has been $0.05, the Per Share Warrant Price has been adjusted to that amount. In
connection with the October 2002 modification the securities into which the
Warrants could be converted were allowed to be converted into either Series A
Preferred Stock as described above in addition to Common Stock.
Related Party Notes and Accrued Interest
- ----------------------------------------
A total of $750,000 of the 10% Notes and all of the 8% Notes and 14% Notes
were issued to individuals or affiliates who were members of the Board of
Directors at the date of issuance. On July 31, 2003, Mr. Hugo Braun, a partner
of North Coast, resigned as a Board member. At September 30, 2003, a total of
$756,698 of interest has been accrued for convertible subordinated promissory
notes, including $643,739 related to notes due to related parties.
Note 8 - Long-Term Debt
Long-term debt includes the following debt instruments at September 30,
2003 and December 31, 2002:
September 30, December 31,
2003 2002
---- ----
Variable rate term loan payable to a bank,
interest at prime plus 3.5% per annum (7.5%
effective rate at September 30, 2003), payable
in monthly installments of $31,000 through
October 2005, at which time the remaining
principal and interest is due. The term loan
is collateralized by a mortgage on the Ann
Arbor facility. $2,536,044 $2,663,056
Other notes, secured by equipment 19,094 28,939
Total long-term debt 2,555,138 2,691,995
Less current maturities (172,479) (169,255)
---------- ----------
Long-term debt, less current maturities $2,382,659 $2,522,740
========== ==========
9
Note 9 - Income Taxes
The Company has net operating loss carryforwards ("NOLs") of approximately
$26.9 million as of December 31, 2002 that may be applied against future taxable
income. The NOLs expire in varying amounts from 2004 and through 2022.
Utilization of certain of these NOLs is subject to annual limitations under
current Internal Revenue Service regulations. The Company has established a
valuation allowance for the estimated amount of the total limitation on the
utilization of the NOLs. Realization of net deferred tax assets associated with
the NOLs is dependent upon generating sufficient taxable income prior to their
expiration.
Note 10 - Stock Based Compensation
The Company has stock-based employee and director compensation plans, which
are described more fully in Note 11 to the Company's December 31, 2002 financial
statements. The Company accounts for those plans under the recognition and
measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based employee compensation
cost is reflected in net loss, as all options granted under those plans had an
exercise price greater than or equal to the market value of the underlying
common stock on the date of grant. The following table illustrates the effect on
net loss and loss per share if the Company had applied the fair value
recognition provisions of FASB Statement No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation.
Three Months Ended Sept. 30,
----------------------------
2003 2002
---- ----
Net loss, as reported $(706,767) $(837,315)
Deduct: Total stock-based employee
compensation expense determined under
fair value-based method for all awards,
net of tax (26,714) (54,787)
--------- ---------
Pro forma net loss $(733,481) $(892,102)
========= =========
Loss per share:
Basic and diluted, as reported $(0.04) $(0.05)
Basic and diluted, pro forma $(0.05) $(0.06)
Nine Months Ended Sept. 30,
---------------------------
2003 2002
---- ----
Net loss, as reported $(2,177,496) $(1,991,425)
Deduct: Total stock-based employee
compensation expense determined under
fair value-based method for all awards,
net of tax (126,671) (188,540)
----------- -----------
Pro forma net loss $(2,304,167) $(2,179,965)
=========== ===========
Loss per share:
Basic and diluted, as reported $(0.14) $(0.13)
Basic and diluted, pro forma $(0.15) $(0.14)
Note 11 - Loss Per Share
The weighted average shares outstanding used in computing loss per share
were 15,744,472 for the three- and nine-month periods ended September 30, 2003
and 2002.
10
For the three- and nine-month periods ended September 30, 2003 and 2002,
outstanding options and warrants were not included in the computation of diluted
loss per share because the inclusion of such securities is antidilutive.
Information relative to the excluded options and warrants is as follows:
Outstanding Options Outstanding Warrants
------------------- --------------------
Expiration Expiration
Quarter Ended Amount Dates Amount Dates
------------- ------ ----- ------ -----
September 30, 2003 1,795,850 2005 to 2011 7,423,000 2006 to 2008
September 30, 2002 2,162,942 2003 to 2011 2,286,882 2002 to 2006
Nine Months Ended
-----------------
September 30, 2003 1,795,850 2005 to 2011 7,423,000 2006 to 2008
September 30, 2002 2,162,942 2003 to 2011 1,887,822 2002 to 2006
11
Item 2. Management's Discussion and Analysis of Results of Operations
Three- and Nine Month Periods Ended September 30, 2003 Compared With The
Three- and Nine-Month Periods Ended September 30, 2002
- ------------------------------------------------------
Net revenues for the three- and nine-month periods ended September 30, 2003
decreased $103,000 (3.0%) and $1,816,000 (15.7%), respectively, to $3,347,000
and $9,770,000, respectively, compared to the same periods last year. The net
revenue decrease in the three-month period ended September 30, 2003 compared to
the prior year period results from lower sales of all product lines except
bundled Industrial Control Computers ("ICCs"), which increased 416.6% and
application services which increased 12.0%. The net revenue decrease in the
nine-month period ended September 30, 2003 compared to the prior year period
results from lower sales of all product lines except bundled ICCs, which
increased 229.9%. Generally, revenues from non-bundled ICCs and other hardware
control products, system integration services, repair services and software
licenses for the current periods ended September 30, 2003 were below the prior
year periods as customers have continued to restrict their capital spending. In
addition, revenues from software licenses in the nine-month period ended
September 30, 2002 included a significant sale of software licenses to one
customer/end user pursuant to a program that was not extended by the customer
beyond 2002. Finally, revenues from system integration services in the
nine-month period ended September 30, 2002 included revenue recognized from one
customer for certain application services performed in 2001 and 2000, the
revenue from which was previously not recorded pending certainty of collection.
Management expects that net revenues for the last three months of 2003 will be
comparable to the year earlier period based on the current order rate and
scheduled deliveries.
Gross profit for the three- and nine-month periods ended September 30, 2003
decreased $9,000 (1.1%) and $826,000 (27.2%), respectively, to $812,000 and
$2,215,000, respectively, compared to the same periods last year. Gross profit
as a percentage of net revenues for the three- and nine-month periods ended
September 30, 2003 was 24.3% and 22.7% respectively, compared to 23.8% and 26.2%
in the same periods last year. The increase in gross profit percentage in the
three-month period ended September 30, 2003 results from lower material costs,
lower software amortization costs and lower personnel costs in the current
period compared to the year ago period. The decrease in gross profit percentage
in the nine-month period ended September 30, 2003 results primarily from the
effect of the profit margin on the FloPro license sold in the 2002 nine-month
period and the profit margin from the revenue recorded from the system
integration services for which the costs were incurred in 2001 and prior
periods, as discussed in the first paragraph above. Management expects that
gross profit margins will remain relatively constant with the margin realized in
the third quarter of 2003 as the mix of sales in the remaining quarter of 2003
is expected to be similar to the sales mix experienced in the first nine months
of the year, based on the current backlog and forecasts.
Software development costs for the three- and nine-month periods ended
September 30, 2003 decreased $47,000 (24.5%) and $109,000 (19.9%), respectively,
to $144,000 and $438,000, respectively, compared to the same periods last year.
The decreases are attributable to smaller development staffs and lower overhead
and other fixed costs. Management expects that product development expenses will
not increase in the remaining quarter of 2003.
Selling, general and administrative expenses for the three- and nine-month
periods ended September 30, 2003 decreased $153,000 (12.5%) and $584,000 (15.5%)
to $1,076,000 and $3,191,000, respectively, compared to the comparable periods
last year. The decreases result primarily from more efficient marketing and
sales initiatives during the current periods compared to the comparable periods
last year and the effects of cost reduction initiatives implemented over the
last two years. Management expects that selling, general and administrative
expenses will increase moderately in the remaining quarter of 2003 because of an
expansion of its marketing and sales initiatives compared to current activities.
Interest expense for the three- and nine-month periods ended September 30,
2003 increased $70,000 (30.0%) and $48,000 (6.6%), respectively, to $303,000 and
$779,000, respectively, compared to the comparable periods last year. Interest
expense for the three- and nine-month periods ended September 30, 2003 includes
12
$60,000 and $97,000, respectively, of non-cash interest expense related to the
beneficial conversion feature of warrants sold in 2003 wherein the exercise
price of the warrants was below the market price of the common stock into which
the warrants may be converted. The sale of the warrants and convertible
subordinated debt raised $1,322,500. Interest expense for the three- and
nine-month periods ended September 30, 2002 includes $39,000 and $192,000,
respectively, of non-cash interest expense related to the beneficial conversion
feature of warrants sold in 2002. Absent the non-cash charges for the beneficial
conversion features described above, interest expense for the three- and
nine-month periods ended September 30, 2003 would have increased $49,000 and
$143,000, respectively, compared to the comparable 2002 periods, resulting from
higher borrowing levels in 2003 compared to 2002. Management expects that
interest expense will increase in the remaining quarter of 2003 because of
projected higher borrowing levels.
Sundry income was not significant in any of the periods reported herein.
Liquidity and Capital Resources
- -------------------------------
Primary sources of liquidity are advances under subordinated debt
agreements, the Optimation line of credit and the North Coast Promissory Note.
As of September 30, 2003, the Company had borrowed $108,750 under its Optimation
line of credit and $1,516,676 under the $1,700,000 Promissory Note to North
Coast. Subsequent to the end of the quarter, the maximum amount of borrowings
under the North Coast Promissory Note was increased to $1,800,000. The Company
has additional borrowing capacity under the North Coast Promissory Note, as
amended through October 30, 2003, of approximately $283,000. The Company's
operations used $1,366,000 in cash during the first nine months of 2003 as a
result of the net loss and the effects of changes in working capital and the
noncash depreciation, amortization and interest charges. During the first nine
months of 2003, the Company also used $14,000 for property additions, $137,000
for payments of long-term debt and increased its borrowings under its lines of
credit by $228,000. Primary sources of cash in the period were $1,332,500 from
proceeds from sales of subordinated promissory notes and warrants.
Management believes that the Company will incur net cash losses during the
last quarter even if it continues to defer payment of the principal amount of
subordinated debt and the accrued interest thereon. Based upon this projection,
management believes that the Company will need to borrow additional amounts on
its North Coast line of credit to sustain operations. In the short term, in
addition to having to fund its projected net cash losses over the next quarter,
the Company will be required to repay term debt of approximately $18,000 per
month, plus interest. Additionally, all of the subordinated debt, $4,311,500 as
of September 30, 2003, plus accrued interest thereon is due currently.
The Company has filed a preliminary proxy statement with the Securities and
Exchange Commission seeking shareholder approval to sell substantially all of
the assets of the Company to its subordinated debt lenders (the "Purchaser') who
will also assume the Company's liabilities. The Board of Directors has approved
and is recommending the sale of substantially all of the Company's tangible and
intangible assets, including its real estate, accounts, equipment, intellectual
property, inventory, goodwill, and other intangibles (the "Net Asset Sale") to
the Purchaser. The Net Asset Sale will also include the assumption by Purchaser
of all of the Company's liabilities, including the Company's subordinated debt
and convertible subordinated notes. The Net Asset Sale would be completed as
soon as practical after approval of the transaction by the Company's
shareholders and the negotiation and execution of a satisfactory Asset Purchase
Agreement, but in any event, no later than December 31, 2003 (the "Agreement").
The total consideration for the Net Asset Sale will be equal to or greater than
the total amount of all of the Company's liabilities. As of September 30, 2003,
the Company's liabilities were in the amount of $12,611,000, which includes
$4,511,500 of subordinated debt. This price would exceed the total value of the
Company's assets, when valued at book value, by approximately $2,683,000 which
is equal to the Company's shareholder's deficit as of September 30, 2003. If
consummated, the Net Asset Sale will result in the Company remaining a public
company owned by its existing shareholders. The Company will not, however, own
any assets except the $30,000 in cash the Company expects to retain and certain
intangible assets consisting of the Company's net operating loss carry forward
and its value as a public shell entity. The Company will not, however, have any
liabilities, all of them will be assumed by the Purchaser. In effect, the
13
Company will become a public shell with no established business. It is
anticipated that all of the Company's employees will be hired by the Purchaser
to carry on the Company's existing businesses.
The near term financial projections prepared by management of the Company,
based on known trends, backlog, order rates and revenue and expense projections,
indicate that the Company will require additional capital infusions for the
foreseeable future until operations become cash positive, and the Company will
require continuing forbearance by all of its lenders to further delay the
repayment of the Company's debt. Though management is optimistic that operations
can become cash positive within the next twelve months, management does not
believe it is possible to project the exact timing of the Company's cash needs.
Despite the best efforts of the Company's management, no lender or investor has
been identified that is willing to fund the Company's ongoing cash requirements
within the current structure of the Company. The sole providers of capital,
other than senior debt, to the Company during the past three years have been the
holders of the Company's subordinated debt. The holders of the Company's
subordinated debt have indicated to the Company that they are not willing to
provide further financing to the Company within the current structure of the
Company. To avoid dilution of the existing shareholders and the possible
foreclosure on the Company's assets, the Company would have to repay the
subordinated debt. Funds to make this payment would be required from other
equity or debt sources, but despite the Company's efforts over the last three
years, management has been unable to attract investor interest. All of the
capital that has been raised over the last three years has been secured solely
from the subordinated noteholders. Management estimates that the Company will
not generate funds internally through operations in the foreseeable future to
repay the subordinated debt and accrued interest thereon.
Management can offer no assurance that the shareholders will approve the
Net Asset Sale. If the efforts to finalize the Net Asset Sale are not
successful, the Company will not have sufficient liquidity to satisfy its
liabilities and obligations as they become due and it may be forced to curtail
operations, sell product lines or sell the Company to a third party.
Uncertainties Relating to Forward Looking Statements
- ----------------------------------------------------
"Item 2. Management's Discussion and Analysis of Operation" and other parts
of this Form 10-QSB contain certain "forward-looking statements" within the
meaning of the Securities Act of 1934, as amended. While the Company believes
any forward-looking statements it has made are reasonable, actual results could
differ materially since the statements are based on current management
expectations and are subject to risks and uncertainties. These risks and
uncertainties include, but are not limited to the following:
|X| Uncertainties discussed elsewhere in "Management's Discussion and Analysis
of Operation" above;
|X| The approval by the shareholders of the Net Asset Sale and the ability of
the Company to finalize the Net Asset Sale;
|X| The potential inability to raise additional equity or debt financing in a
sufficient amount to sustain operations and allow management to execute its
strategies;
|X| Continued forbearance by the subordinated debt holders in exercising their
right to demand immediate payment of all subordinated debt and accrued
interest thereon;
|X| Continued cooperation of the Company's vendors in accepting payment beyond
such vendors' normal payment terms;
|X| A further decline of economic conditions in general and conditions in the
automotive manufacturing industry in particular;
|X| Delays in introduction of planned hardware and software product offerings;
|X| Reductions in product life cycles;
14
|X| Changes in customer requirements or reductions in demand for the Company's
products and services;
|X| The inability of the Company to successfully implement its strategy to
participate effectively in the industrial automation market migration from
closed architecture PLCs to open architecture PC-based solutions or to
effectively change its corporate strategy to capitalize on market changes.
Item 3. Controls and Procedures
Our Chief Executive Officer and Chief Accounting Officer have concluded,
based on their evaluation within 90 days of the filing date of this report, that
our disclosure controls and procedures are effective for gathering, analyzing
and disclosing the information we are required to disclose in our reports filed
under the Securities Exchange Act of 1934. There have been no significant
changes in our internal controls or in other factors that could significantly
affect these controls subsequent to the date of the previously mentioned
evaluation.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits included herewith are set forth on the Index to Exhibits, which is
incorporated herein by reference.
(b) During the quarter ended September 30, 2003, the Company filed a report on
Form 8-K concerning its press release dated August 19, 2003 concerning its
second quarter ended June 30, 2003 operating results.
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Nematron Corporation
November 13, 2003 /s/ Matthew S. Galvez
- ----------------- ------------------------------------------
Date Matthew S. Galvez, Chief Executive Officer
November 13, 2003 /s/ Tina M. Raiford
- ----------------- ------------------------------------------
Date Tina M. Raiford, Controller
15
CERTIFICATION
Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
I, Matthew S. Galvez, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Nematron
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based upon such evaluation; and
c) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial
reporting;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors:
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
Date: November 13, 2003
/s/ Matthew S. Galvez
- -----------------------
Matthew S. Galvez
Chief Executive Officer
See also the certification pursuant to Section 906 of the Sarbanes Oxley Act of
2002, which is also attached to this report as an exhibit.
16
CERTIFICATION
Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
I, Tina M. Raiford, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Nematron
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based upon such evaluation; and
c) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial
reporting;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors:
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
Date: November 13, 2003
/s/ Tina M. Raiford
- ---------------------------------------
Tina M. Raiford
Controller and Chief Accounting Officer
See also the certification pursuant to Section 906 of the Sarbanes Oxley Act of
2002, which is also attached to this report as an exhibit.
17
INDEX TO EXHIBITS
Exhibit
Number Description of Exhibit
- ------ ----------------------
4.1 Loan Modification Agreement and Amendment to Loan Documents between
Compass Bank and Optimation, Inc. dated October 3, 2003.
4.2 Security Agreement between North Coast Technology Investors, L.P.
("NCTI") and Nematron Corporation dated July 31, 2003 pursuant to
which Nematron grants to NCTI a continuing security interest in
Collateral to secure payment of the liabilities.
4.3 Mortgage between North Coast Technology Investors, L.P. and
Nematron Corporation dated July 31, 2003.
4.4 Promissory Note between North Coast Technology Investors, L.P. and
Nematron Corporation dated July 16, 2003 in the amount of $1,700,000
payable on demand with interest at 9.0% per annum.
99.1 Certification of Chief Executive Officer and Chief Accounting Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
18