-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TUWcjKdxo2OJYRLSYYwX1uL91r5QfbtyroUTScPzryrYfELTiO/iQpLX9/VfFfqw GqwcIm2Hs2/U1y3SOJnWiQ== 0000950152-01-505855.txt : 20020410 0000950152-01-505855.hdr.sgml : 20020410 ACCESSION NUMBER: 0000950152-01-505855 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FRONTSTEP INC CENTRAL INDEX KEY: 0000872443 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 311083175 STATE OF INCORPORATION: OH FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-19024 FILM NUMBER: 1788418 BUSINESS ADDRESS: STREET 1: 2800 CORPORATE EXCHANGE DR STREET 2: N/A CITY: COLUMBUS STATE: OH ZIP: 43231 BUSINESS PHONE: 6145237000 MAIL ADDRESS: STREET 1: 2800 CORPORATE EXCHANGE DR CITY: COLUMBUS STATE: OH ZIP: 43231 FORMER COMPANY: FORMER CONFORMED NAME: SYMIX SYSTEMS INC DATE OF NAME CHANGE: 19930328 10-Q 1 l91096ae10-q.txt FRONTSTEP, INC. 10-Q/QUARTER ENDED 9-30-01 ================================================================================ UNITED STATES 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 EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 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: 0-19024 ------------------- FRONTSTEP, INC. (Exact name of registrant as specified in its charter) OHIO 31-1083175 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 2800 CORPORATE EXCHANGE DRIVE 43231 COLUMBUS, OHIO (Zip Code) (Address of principal executive offices) (614) 523-7000 (Registrant's telephone number, including area code) NOT APPLICABLE. (Former name, former address and former fiscal year, if changed since last report) ------------------- 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 __ --- As of November 7, 2001, 7,568,218 shares of the issuer's common stock, without par value, were outstanding. ================================================================================ FRONTSTEP, INC. AND SUBSIDIARIES INDEX
PART I. FINANCIAL INFORMATION PAGE Item 1. Financial Statements Consolidated Balance Sheets as of September 30, 2001 (unaudited) and June 30, 2001...............3 Consolidated Statements of Operations (unaudited) for the Three Months Ended September 30, 2001 and 2000......................................................................4 Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended September 30, 2001 and 2000......................................................................5 Notes to Consolidated Financial Statements (unaudited)...........................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...........10 Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................14 PART II. OTHER INFORMATION Item 1. Legal Proceedings...............................................................................15 Item 2. Changes in Securities and Use of Proceeds.......................................................15 Item 3. Defaults Upon Senior Securities.................................................................15 Item 4. Submission of Matters to a Vote of Security Holders.............................................15 Item 5. Other Information...............................................................................15 Item 6. Exhibits and Reports on Form 8-K................................................................15 SIGNATURES ................................................................................................16 EXHIBIT INDEX ................................................................................................17
Page 2 PART I. - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. FRONTSTEP, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
SEPTEMBER 30, JUNE 30, 2001 2001 ----------------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents $ 3,493 $ 1,512 Trade accounts receivable, net 30,845 31,446 Prepaid expenses 4,135 3,756 Income taxes receivable 10 47 Deferred income taxes 1,907 2,026 Inventories 740 738 Other current assets 310 979 ------------ ------------ 41,440 40,504 Capitalized software, net 15,233 15,094 Goodwill, net 7,911 7,911 Property and equipment, net 6,882 7,646 Other assets 1,244 1,438 ------------ ------------ Total assets $ 72,710 $72,593 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 11,420 $15,610 Deferred revenue 17,052 19,067 Current portion of long-term obligations 6,106 1,967 ------------ ------------ 34,578 36,644 Noncurrent liabilities: Long-term debt 9,208 8,337 Deferred income taxes 2,643 2,891 Other 381 405 ------------ ------------ 12,232 11,633 Minority interest 2,105 2,102 Shareholders' equity: Series A Convertible Participating Preferred Stock, no par value; 1,000,000 shares authorized; 566,933 shares issued and outstanding at September 30, 2001 and June 30, 2001; liquidation preference $13,606 10,865 10,865 Common stock; no par value; 20,000,000 shares authorized; 7,872,418 shares issued at September 30, 2001 and June 30, 2001, at stated capital amounts of $0.01 per share 79 79 Additional paid-in capital 38,746 37,470 Treasury stock, at cost; 304,200 shares (1,320) (1,320) Retained deficit (21,418) (21,562) Accumulated other comprehensive loss (3,157) (3,318) ------------ ------------ 23,795 22,214 ------------ ------------ Total liabilities and shareholders' equity $ 72,710 $72,593 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. Page 3 FRONTSTEP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
THREE MONTHS ENDED SEPTEMBER 30, -------------------------- 2001 2000 ------------ ------------ (UNAUDITED) Revenue: License fees $ 9,329 $11,881 Service, maintenance and support 15,589 16,152 ------------ ------------ Total revenue 24,918 28,033 Cost of revenue: License fees 4,250 4,445 Service, maintenance and support 6,926 9,842 ------------ ------------ Total cost of revenue 11,176 14,287 ------------ ------------ Gross margin 13,742 13,746 Operating expenses: Selling, general and administrative 10,823 12,263 Research and development 1,691 3,718 Amortization of acquired intangibles 530 837 Restructuring and other charges - 2,163 ------------ ------------ Total operating expenses 13,044 18,981 ------------ ------------ Operating income (loss) 698 (5,235) Other income (expense), net (528) 73 ------------ ------------ Income (loss) before income taxes 170 (5,162) Provision for (benefit from) income taxes 26 (1,613) ------------ ------------ Net income (loss) $ 144 $ (3,549) ============ ============ Net income (loss) per common share: Basic $ 0.02 $ (0.47) ============ ============ Diluted $ 0.02 $ (0.47) ============ ============ Shares used in computing per share amounts: Basic 7,568 7,504 Diluted 7,661 7,504
The accompanying notes are an integral part of these consolidated financial statements. Page 4 FRONTSTEP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
THREE MONTHS ENDED SEPTEMBER 30, -------------------------- 2001 2000 ------------ ------------ (UNAUDITED) CASH FLOW FROM OPERATING ACTIVITIES: Net income (loss) $ 144 $ (3,549) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation 854 1,081 Amortization 1,608 1,925 Restructuring and other charges -- 2,163 Deferred income taxes (154) (716) Changes in operating assets and liabilities, net of restructuring and other charges: Accounts receivable 670 (1,647) Prepaid expenses and other assets 294 (1,744) Accounts payable and accrued expenses (4,207) (2,864) Deferred revenue (2,085) (1,111) Income taxes payable/receivable 269 (14) ----------- ----------- Net cash used in operating activities (2,607) (6,476) CASH FLOW FROM INVESTING ACTIVITIES: Purchases of property and equipment (73) (1,095) Additions to capitalized software (1,575) (1,395) ----------- ----------- Net cash used in investing activities (1,648) (2,490) CASH FLOW FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock, net -- 8 Proceeds from long-term obligations 21,548 3,814 Payments on long-term obligations (15,617) (2,660) ----------- ----------- Net cash provided by financing activities 5,931 1,162 Effect of exchange rate changes on cash 305 99 ----------- ----------- Net increase (decrease) in cash and cash equivalents 1,981 (7,705) Cash and cash equivalents at beginning of period 1,512 11,868 ----------- ----------- Cash and cash equivalents at end of period $ 3,493 $ 4,163 =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. Page 5 FRONTSTEP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2001 (unaudited) NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Description of Business. Frontstep, Inc. and its subsidiaries ("Frontstep" or the "Company"), is a leading global provider of business software and services for mid-sized manufacturing, distribution and other companies, including business units of larger companies. The Company offers a comprehensive suite of integrated, collaborative network-centric software and services that (1) support the traditional back office management and resources of an enterprise ("ERP"), (2) support customer relationship management ("CRM") and other front office business activities and (3) support an enterprise's supply chain management activities. Founded in 1979, Frontstep is headquartered in Columbus, Ohio. The Company has more than 4,400 customers that it serves from 28 sales and service offices in North America, Europe and the Pacific Rim, as well as through independent software and support business partners worldwide. The accompanying unaudited consolidated financial statements presented herein have been prepared by the Company and reflect all adjustments of a normal recurring nature that are, in the opinion of management, necessary for a fair presentation of financial results for the three months ended September 30, 2001 and 2000, in accordance with generally accepted accounting principles for interim financial reporting and pursuant to Article 10 of Regulation S-X. Certain footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These interim consolidated financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended June 30, 2001 ("Annual Report"). The results of operations for the three months ended September 30, 2001 are not necessarily indicative of the results to be expected for a full year. Comprehensive Income. The only item in addition to net income that is included in comprehensive income is the foreign currency translation adjustment. Comprehensive income (loss) for the three months ended September 30, 2001 and 2000 is as follows (in thousands):
THREE MONTHS ENDED SEPTEMBER 30, ----------------------- 2001 2000 -------- -------- Net income (loss) $144 $(3,549) Foreign currency translation adjustment 161 (368) -------- ------- Comprehensive income (loss) $305 $(3,917) ======== =======
Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. NOTE 2 - LONG-TERM DEBT In July 2001, the Company executed a new credit facility with Foothill Capital Corporation (the "Credit Facility"). The Credit Facility includes a $15,000,000, three-year term note and a $10,000,000 revolving credit facility. Availability under the Credit Facility is based on and secured by qualifying accounts receivable originating within the United States and Canada. The revolving credit facility bears interest either at the Federal Funds rate plus 1.5%, or at the Eurodollar market rate plus 3.0%. The term note bears interest at the rate of 10.5% plus 1.5% per annum added to principal. The term note is payable in monthly installments commencing October 1, 2001. The Credit Facility is subject to customary terms and conditions and includes financial covenants for maintenance of a minimum tangible net worth, a minimum level of earnings before interest, taxes, depreciation and amortization ("EBITDA") and a maximum ratio of debt to EBITDA. The proceeds from the Credit Facility were used to repay, in full, the Company's revolving credit facility with PNC Bank, National Association. As of September 30, 2001, Page 6 current and long-term debt included $13,830,000 outstanding on the term note and $378,000 drawn on the revolving credit facility. On November 9, 2001, the Company and Foothill Capital Corporation amended the Credit Facility to modify all financial covenants to give account to current global economic conditions. The modification of the financial covenants was effective commencing September 29, 2001. The amendment also modified the term note structure through January 15, 2002 to allow for increased borrowing capacity during that period. In connection with the Credit Facility, the Company issued to Foothill Capital Corporation a warrant to purchase 550,000 common shares of the Company with an exercise price per share based on the current market price per share of the Company's common shares as of the closing date for the transaction (which was $3.36 per share). The warrant expires in July 2006 and is subject to certain anti-dilution provisions as described in the warrant. The relative fair value of the warrant ($1,276,000) has been recorded as a debt discount and is being amortized as interest expense over the three-year term of the Credit Facility. As of September 30, 2001, the unamortized balance of the debt discount was $1,170,000. In connection with the issuance of the warrant to Foothill Capital Corporation in July, 2001 as discussed above, the exercise price of the outstanding warrants to purchase 453,546 common shares of the Company related to the private placement of preferred shares of the Company in fiscal 2000 was reduced from $15.00 per share to $3.36 per share pursuant to the terms of the warrants. No amount was recorded in the Company's financial statements as a result of this transaction since the original contractual terms of the warrant remain unchanged. NOTE 3 - RESTRUCTURING AND OTHER CHARGES Fiscal 2001 Restructuring. In April 2001, the Company announced a broad restructuring plan to reduce operating costs by reducing its worldwide workforce by approximately 20%; discontinuing certain product development and other non-essential activities, including terminating activities related to its SyteCentre product and exiting certain license agreements; and closing certain office facilities in Arizona, California, Canada and Asia. In relation to this restructuring plan, the Company also wrote-off certain accounts receivable and other non-performing assets. The accounts receivable writedowns were recorded to reflect accounts deemed to be uncollectible due to economic and other situations that occurred subsequent to the recording of the sales related to those receivables. As a result of this restructuring plan, the Company recorded pre-tax restructuring and other charges of $8,493,000 and $4,500,000 in the three months ended March 31, 2001 and June 30, 2001, respectively. The aggregate restructuring and other charges of $12,993,000 is comprised of $2,182,000 in employee separation costs, $1,978,000 in exit costs for contract terminations, $6,840,000 in accounts receivable writedowns and $1,993,000 of product asset writedowns. The following table displays a rollforward of the accruals established for the restructuring and other charges from June 30, 2001 to September 30, 2001 (in thousands):
ACCRUAL AT AMOUNTS ACCRUAL AT JUNE 30, USED IN SEPTEMBER 30, 2001 FISCAL 2002 2001 ------------- ------------- ----------------- Employee separation costs $ 412 $ 400 $ 12 Exit costs 1,658 359 1,299 ------------- -------------- ------------- Total $ 2,070 $ 759 $ 1,311 ============= ============== =============
The amounts used of $759,000 reflects cash payments. The remaining accrual of $1,311,000, which is included in accounts payable and accrued expenses in the Consolidated Balance Sheets, represents cash payments expected to be completed during the current year ended June 30, 2002. Fiscal 2000 Restructuring. In July 2000, the Company announced several structural changes to discontinue certain business operations, write off non-performing assets and to restructure the Company to better focus on its core business strategy. These changes included divesting the Company's FieldPro subsidiary, discontinuing operations of the Company's e-Mongoose subsidiary, consolidating the Company's product development organizations and restructuring the Company's sales channels. In connection with this announcement, the Company Page 7 recorded a non-recurring charge of $3,011,000, pre-tax, in the three months ended June 30, 2000 and an additional non-recurring charge of $2,163,000, pre-tax, in the three months ended September 30, 2000. The non-recurring charge of $2,163,000 incurred in the three months ended September 30, 2000 primarily related to severance payments made to employees associated with the discontinued operations discussed above. All severance payments were paid during the year ended June 30, 2001 and no accruals remain for these costs as of September 30, 2001. NOTE 4 - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):
THREE MONTHS ENDED SEPTEMBER 30, --------------------------- 2001 2000 --------------------------- Numerator for basic and diluted income (loss) per share - net income (loss) $ 144 $ (3,549) ============= ============= Denominator for basic income (loss) per share - weighted average common shares outstanding 7,568 7,504 Effect of dilutive warrants 93 - ------------- ------------- Denominator for diluted income (loss) per share - adjusted weighted average common shares and assumed conversions 7,661 7,504 ============= ============= Basic net income (loss) per share $ 0.02 $ (0.47) ============= ============= Diluted net income (loss) per share $ 0.02 $ (0.47) ============= =============
During the three months ended September 30, 2001, 1,983,404 shares related to employee stock options were outstanding, but were not included in the computation of diluted net income per share because the options' exercise price was greater than the average market price of the common shares for the period and, therefore, the effect would be antidilutive. During the three months ended September 30, 2000, common share equivalents related to warrants and employee stock options were outstanding, but were not included in the computation of diluted net income per share because the Company reported a net loss for the period and, therefore, the effect would be antidilutive. NOTE 5 - INTANGIBLE ASSETS In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets, which requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually. The Company has adopted the provisions of SFAS No. 142 effective on July 1, 2001. As of September 30, 2001, the Company had unamortized intangible assets consisting only of goodwill of $7,911,000. The Company's amortizable intangible assets include only purchased software. The gross carrying amount of purchased software as of September 30, 2001 was $2,696,000 and accumulated amortization of purchased software was $1,851,000. In accordance with the provisions of SFAS No. 142, the Company performed the appropriate transitional impairment tests related to its stated goodwill and determined that there is no transitional impairment loss as of July 1, 2001. Also in accordance with the provisions of SFAS No. 142, the Company reassessed the useful lives of all purchased software and determined that no adjustments were necessary. Page 8 The following table illustrates what reported net income (loss) and net income (loss) per share would have been in the periods presented exclusive of amortization expense recognized in those periods related to goodwill (in thousands, except per share data):
THREE MONTHS ENDED SEPTEMBER 30, --------------------------- 2001 2000 ------------- ------------- Net income (loss) $ 144 $ (3,549) Goodwill amortization, net of tax - 198 ------------- ------------- Adjusted net income (loss) $ 144 $ (3,351) ============= ============= Basic and diluted net income (loss) per share: Net income (loss) $ 0.02 $ (0.47) Goodwill amortization, net of tax - 0.02 ------------- ------------- Adjusted net income (loss) $ 0.02 $ (0.45) ============= =============
NOTE 6 - BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION The Company designs, develops, markets and supports business software and services for mid-sized manufacturing, distribution and other companies, including business units of larger companies. The Company operates exclusively in this market and, therefore, only reports on one primary segment. Summarized financial information attributable to each of the Company's geographic areas is shown in the following table (in thousands):
NORTH ASIA/ AMERICA EUROPE PACIFIC ------- ------ ------- THREE MONTHS ENDED SEPTEMBER 30, 2001 Total revenue $18,740 $3,553 $2,625 Operating income before amortization of intangibles 943 195 90 Operating income 509 99 90 THREE MONTHS ENDED SEPTEMBER 30, 2000 Total revenue $21,606 $3,308 $3,119 Operating income (loss) before amortization of intangibles and special charges (2,327) 125 (33) Operating income (loss) (5,190) 5 (50)
NOTE 7 - SUBSEQUENT EVENTS On October 30, 2001, the Company offered the participants of its Non-Qualified Stock Option Plan for Key Employees and its 1999 Non-Qualified Stock Option Plan for Key Employees (collectively, "the Plans") the opportunity to participate in a voluntary stock option exchange program. The program generally allows a participant to return options currently held to the Company in exchange for new options to be granted at a future date which is at least six months and one day after the date of cancellation of the old options by the Company. As of the date of the offer, options to purchase 1,586,054 shares of the Company were outstanding pursuant to the Plans. The offer is expected to expire on November 30, 2001, subject to extension by the Company. New options are expected to be issued for exchanged options on or about June 2, 2002 with an exercise price per share equal to the market price per share of the Company's common shares on the date of grant. The new options will have other terms and conditions substantially the same as the old options. The exchange program is not expected to result in any additional compensation charges or variable plan accounting. Page 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. This Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on current beliefs, plans, objectives and expectations of the Company's management. The words "expect," "anticipate," "intend," "plan," "believe," "estimate," "would" and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Such risks and uncertainties are set forth herein and in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2001. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's opinions only as of the date hereof. The Company undertakes no obligation to revise or update or publicly release the results of any revision or update to these forward-looking statements. Readers should carefully review the risk factors set forth in each of the Company's reports or documents filed from time to time with the Securities and Exchange Commission. The following information should be read in conjunction with the unaudited Consolidated Financial Statements and related notes included elsewhere in this Form 10-Q. The following information should also be read in conjunction with the Company's audited Consolidated Financial Statements and related notes and Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended June 30, 2001, as contained in the Annual Report. OVERVIEW The Company is a leading provider of integrated ERP software and services for mid-market manufacturing and distribution companies and business units of larger companies. Current Financial Results and Events. After nearly two years of difficult economic and market conditions, during which the Company undertook to significantly enhance its product capabilities, the Company reported positive financial results for the quarter ended September 30, 2001 (the "current fiscal quarter" or "fiscal 2002 quarter"). Throughout the quarter, the Company believed that it was on track to become profitable and to maintain a positive cash flow primarily as a result of the cost savings achieved from the restructuring program initiated in April 2001 as discussed below. The Company reported operating income of $0.7 million and net income of $0.1 million for the current fiscal quarter. On September 11, 2001, the United States was violently attacked by terrorists. The widespread uncertainty related to the events of September 11, 2001 and the ensuing war against terrorism waged by the United States and its allies appears to have caused our customers and potential customers to elect to defer their buying decisions, particularly near the end of the current fiscal quarter. In spite of these tragic events, the Company believes it was able to achieve positive results in the current fiscal quarter primarily due to the cost reductions initiated and the careful management of the Company's costs since that time. In the months that have followed since this event, there have been significant indications of a broad and possibly lasting impact of this event on our economy and the economy of other countries around the world. Although there are many indications that the country has already entered into a recession, it is not yet clear whether a recession or further slowdown of the economy will occur. Further economic slowdown and lessening of demand or a continuation of the uncertainty created by the war against terrorism could have a negative impact on the Company. Prior Financial Results and Events. Since the second quarter of fiscal 2000, the Company has experienced changing market conditions resulting from a recession in many manufacturing industries and a lessening of demand for ERP systems. Well before these market changes began to affect results of operations, the Company began to enhance its product offerings beyond traditional ERP systems to participate in higher growth market segments. These enhancements include a comprehensive suite of integrated software and services that (1) support the management and resources of an enterprise, (2) support customer relationship management and other front office business activities and (3) support an enterprise's supply chain management activities. Page 10 While the enterprise applications software industry has generally been experiencing weak demand and fluctuating economic conditions for software spending since early in 1999, the Company did experience significantly improved license fees revenues and heightened demand for its products in the December 2000 quarter. This increase in revenues and heightened overall demand led the Company to believe that its strategy would lead it to more successful financial results, with improvements each quarter over comparable periods in the prior year. However, in the latter portion of the March 2001 quarter, customers and potential customers appeared to react to the slowing economy by electing to defer their buying decisions. As a result, the Company, the information technology industry in general and many other enterprise software providers experienced significant shortfalls in revenue levels and incurred net losses for the March and June 2001 quarters as compared to an expectation of continued improvements as were demonstrated in the December 2000 quarter. Consequently, in April 2001, the Company initiated a broad restructuring program in order to reduce operating costs. The Company's worldwide workforce was reduced by approximately 20%, certain product development and other non-essential activities were discontinued and certain offices around the world were closed. In the March and June 2001 quarters, the Company recorded an aggregate of approximately $13.0 million, pre-tax, in related restructuring charges and write-downs of related product assets and accounts receivable. In July 2000, the Company made several structural changes to discontinue certain business operations, write off non-performing assets and to restructure the Company to better focus on its core business strategy. In connection with these changes, the Company recorded a $3.0 million, pre-tax, non-recurring charge in the June 2000 quarter and an additional $2.2 million, pre-tax, non-recurring charge in the September 2000 quarter. GENERAL The Company's total revenue is derived primarily from licensing software, providing related services, including installation, implementation, training, consulting and systems integration and providing maintenance and support on an annual basis. Revenue is accounted for in accordance with Statement of Position 97-2, Software Revenue Recognition, as amended and interpreted from time to time. License fees revenue is generally recognized when the software product is shipped. Services revenue is recognized as the services are performed and revenues from maintenance agreements are billed periodically, deferred and recognized straight-line over the term of the agreements. Cost of license fees revenue includes royalties, amortization of capitalized software development costs and software delivery expenses. Cost of service, maintenance and support revenue includes the personnel and related overhead costs for implementation, training and customer support services, together with fees paid to third parties for subcontracted services. Selling, general and administrative expenses consist of personnel, facilities and related overhead costs, together with other operating costs of the Company, including advertising and marketing costs. Research and development expenses include personnel and related overhead costs for product development, enhancement, upgrades, quality assurance and testing. The amount of such expenses is dependent on the nature and status of the development process for the Company's products. Development costs capitalized in a given period are dependent upon the nature and status of the development process. Upon general release of a product, related capitalized costs are amortized over three to five years and recorded as license fees cost of revenue. Page 11 RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2000 Revenue. Total revenue decreased $3.1 million, or 11.1%, to $24.9 million in the current fiscal quarter from $28.0 million in the three months ended September 30, 2000 (the "prior year fiscal quarter" or "fiscal 2001 quarter"). The total revenue mix is shown in the table below (in thousands, except percentage data):
THREE MONTHS ENDED SEPTEMBER 30, --------------------------------------------- 2001 2000 --------------------- --------------------- License fees revenue $9,329 37.4% $11,881 42.4% Service, maintenance and support revenue 15,589 62.6% 16,152 57.6% --------------------- --------------------- Total revenue $24,918 100.0% $28,033 100.0% ===================== =====================
License fees revenue decreased 21.5% in the fiscal 2002 quarter from the fiscal 2001 quarter. The Company believes that the decrease in license fees revenue in the fiscal 2002 quarter is due to the current economic climate that is causing the Company's customers and potential customers to defer their buying decisions related to large capital investments, particularly information technology investments. The Company expects that license fees revenues will remain stable in the short-term but will not begin to significantly grow again until the current economic climate improves and demand for our product improves as a result. Service, maintenance and support revenue decreased 3.5% in the fiscal 2002 quarter from the fiscal 2001 quarter. The decrease is primarily the result of a decrease in service revenues resulting from the sluggish license fees revenue experienced by the Company in the last few quarters. Service revenues in particular are directly dependent on new license purchases by new and existing customers. Maintenance and support contracts and the related revenue from these contracts have been steadily improving over the last few years as the base of customers under such programs has continued to grow. Cost of Revenue. Total cost of revenue as a percentage of total revenue decreased to 44.9% for the fiscal 2002 quarter from 51.0% for the fiscal 2001 quarter. Cost of license fees revenue decreased $0.2 million, or 4.4%, to $4.3 million in the fiscal 2002 quarter from $4.4 million in the fiscal 2001 quarter and as a percentage of license fees revenue, increased to 45.6% in the fiscal 2002 quarter from 37.4% in the fiscal 2001 quarter. The percentage increase is primarily attributable to lower license fees revenue affecting certain fixed and related costs, an increase in the number of third party product vendors included in the Company's expanded product offerings and discounting as a result of weakened demand. Cost of service, maintenance and support revenue decreased $2.9 million, or 29.6%, to $6.9 million in the fiscal 2002 quarter from $9.8 million in the fiscal 2001 quarter and as a percentage of service, maintenance and support revenue, decreased to 44.4% in the fiscal 2002 quarter from 60.9% in the fiscal 2001 quarter. The decrease in cost is attributable to a decline in service revenue as compared to the year earlier period. The percentage decrease is primarily due to improvements in gross margin for maintenance and support and services as a result of the cost management efforts of the Company since the April 2001 restructuring and continued growth of maintenance and support revenues which have higher margins than services revenues. Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $1.4 million, or 11.7%, to $10.8 million in the fiscal 2002 quarter from $12.3 million in the fiscal 2001 quarter. Such expenses as a percentage of total revenue remained relatively constant: 43.4% in the fiscal 2002 quarter and 43.7% in the fiscal 2001 quarter. The decrease in costs is attributable to the restructuring that was undertaken during the June 2001 quarter. The Company expects that these costs will decrease as a percentage of total revenue when total revenue increases since many of these costs are fixed in nature. Research and Development. Total research and development costs, including amounts capitalized, decreased $1.8 million or 36.1%, to $3.3 million for the fiscal 2002 quarter from $5.1 million for the fiscal 2001 quarter and decreased as a percentage of total revenue to 13.1% in the fiscal 2002 quarter from 18.2% in the fiscal 2001 quarter. Although total research and development spending decreased from the fiscal 2001 quarter, the Company is Page 12 continuing to spend a substantial portion of total revenue on development of future releases of the Company's ERP software and development of its expanded product offerings and product capabilities. The Company believes that these investments are critical to the success and market acceptance of its new product offerings and total suite of integrated collaborative business systems. The Company capitalized research and development costs of $1.6 million during the fiscal 2002 quarter and $1.4 million during the fiscal 2001 quarter. Restructuring and Other Charges. The restructuring program undertaken by the Company in July 2000 and its related costs recorded are discussed above. Provision for (Benefit from) Income Taxes. The provision for (benefit from) income taxes for the fiscal 2002 and 2001 quarters reflects an effective tax rate of 15% and (31)%, respectively. The effective tax rate in both periods differs from the expected corporate tax rate primarily due to valuation allowances recorded against deferred tax assets related to net operating losses incurred domestically, foreign losses incurred in countries where no tax benefits will be received for the losses, the non-deductibility of the amortization of certain intangibles and the application of prior net operating losses carried forward to offset current pre-tax income. QUARTERLY RESULTS The Company's results of operations have fluctuated on a quarterly basis. The Company's expenses, with the principal exception of sales commissions and certain components of cost of revenue, are generally fixed and do not vary with revenue. As a result, any shortfall of actual revenue in a given quarter would adversely affect net earnings for that quarter. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2001, the Company had cash and cash equivalents of $3.5 million and working capital of $6.9 million. During the current fiscal quarter, the Company used $2.6 million of cash for operating activities, including the restructuring and other charges described above. The Company purchased $0.1 million of property and equipment and used $1.6 million in relation to capitalized software. Cash was also used for the payment of $0.6 million on certain debt payments relating to previous acquisitions. Net borrowings on the term note and revolving credit facility under the Credit Facility as of September 30, 2001 were $13.8 million and $0.4 million, respectively In July 2001, the Company executed a new credit facility with Foothill Capital Corporation (the "Credit Facility"). The Credit Facility includes a $15.0 million, three-year term note and a $10.0 million revolving credit facility. Availability under the Credit Facility is based on and secured by qualifying accounts receivable originating within the United States and Canada. The revolving credit facility bears interest either at the Federal Funds rate plus 1.5%, or at the Eurodollar market rate plus 3.0%. The term note bears interest at the rate of 10.5% plus 1.5% per annum added to principal. The term note is payable in monthly installments commencing October 1, 2001. The Credit Facility is subject to customary terms and conditions and includes financial covenants for maintenance of a minimum tangible net worth, a minimum level of earnings before interest, taxes, depreciation and amortization and a maximum ratio of debt to earnings before interest, taxes, depreciation and amortization. The proceeds from the Credit Facility were used to repay, in full, the Company's revolving credit facility with PNC Bank, National Association. On November 9, 2001, the Company and Foothill Capital Corporation amended the Credit Facility to modify all financial covenants to give account to current global economic conditions. The modification of the financial covenants was effective commencing September 29, 2001. The amendment also modified the term note structure through January 15, 2002 to allow for increased borrowing capacity during that period. In connection with the Credit Facility, the Company issued to Foothill Capital Corporation a warrant to purchase 550,000 common shares of the Company with an exercise price per share based on the current market price per share of the Company's common shares as of the closing date for the transaction (which was $3.36 per share). The warrant expires in July 2006 and is subject to certain anti-dilution provisions as described in the warrant. The Company anticipates that cash on hand, cash flow from operations and available borrowings from the Credit Facility, as amended, will be sufficient to satisfy expected cash needs for the next 12 months. Page 13 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Foreign Exchange. Frontstep's revenues originating outside of North America were 25% and 23% of total revenue for the current and prior year fiscal quarters, respectively. By geographic region, revenues originating in Europe were 14% and 12% of total revenue for the current and prior year fiscal quarters, respectively. Revenues originating in Asia Pacific were 11% of total revenue for both the current and prior year fiscal quarters. International sales are made mostly from the Company's foreign sales subsidiaries in the local countries and are typically denominated in the local currency of each country. These subsidiaries also incur most of their expenses in the local currency. Accordingly, all foreign subsidiaries use the local currency as their functional currency. The Company's exposure to foreign exchange rate fluctuations arises in part from intercompany accounts in which costs of software, including certain development costs, incurred in the United States are charged to the Company's foreign sales subsidiaries. These intercompany accounts are typically denominated in the functional currency of the foreign subsidiary in order to centralize foreign exchange risk with the parent company in the United States. The Company is also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. Foreign currency gains and losses will continue to result from fluctuations in the value of the currencies in which the Company conducts its operations as compared to the U.S. dollar and future operating results will be affected by gains and losses from foreign currency exposure. The Company does not currently hedge against losses arising from its foreign currency exposure. The Company has considered the potential impact of a 10% adverse change in foreign exchange rates and it believes that such a change would not have a material impact on financial results or financial condition in the coming fiscal year. Interest Rates. The Company invests its surplus cash in financial instruments such as short-term marketable securities and interest-bearing time deposits. The Company also incurs interest at variable rates, dependent upon the prime rate or LIBOR rate that may be in effect from time to time. The Company has considered the potential impact of an adverse change in interest rates of one hundred basis points and it believes that such a change would not have a material impact on financial results or financial condition in the coming fiscal year. Page 14 PART II. - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. The Company is subject to legal proceedings and claims which arise in the normal course of business. While the outcome of these matters cannot be predicted with certainty, management does not believe the outcome of any of these legal matters will have a material adverse effect on the Company's business, financial condition or results of operations. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. In July 2001, the Company entered into a new credit facility arrangement with Foothill Capital Corporation. In connection with the new credit facility arrangement, the Company issued to Foothill Capital Corporation a warrant to purchase 550,000 common shares at an initial exercise price of $3.36 per share, which was the average of the closing bid price for common shares of the Company for the 10 trading days immediately preceding the closing date for the new credit facility. The exercise price of the warrant and the number of common shares issuable upon exercise of the warrant are subject to adjustments from time to time under the anti-dilution provisions contained in the warrant. The warrant expires in July 2006 and is exercisable at any time prior to its expiration. The warrant was issued in reliance upon an exemption from registration under Section 4(2) of the Securities Act of 1933 (the "Act") and Rule 506 promulgated under the Act. As required by the Company's agreement with Foothill Capital Corporation, the Company has filed with the Securities and Exchange Commission (the "Commission") a registration statement on Form S-3 to register 687,500 common shares of the Company for possible issuance upon exercise of the warrant. The registration statement has not been declared effective by the Commission as of the date hereof. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. ITEM 5. OTHER INFORMATION. None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) See Index to Exhibits filed with this Quarterly Report on Form 10-Q following the Signature Page. (b) Reports on Form 8-K. None Page 15 SIGNATURES 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. FRONTSTEP, INC. Dated: November 12, 2001 By: /s/ Daniel P. Buettin ----------------- ------------------------------------------------ Daniel P. Buettin Vice President, Finance, Chief Financial Officer and Secretary (on behalf of the Registrant and as Principal Financial Officer) Page 16 INDEX TO EXHIBITS
Exhibit No. Description Page - ----------- ----------- ---- 3(a)(1) Amended Articles of Incorporation of Incorporated herein by reference to Frontstep, Inc. (f/k/a "Symix Systems, Exhibit 3(a)(1) to the Registrant's Annual Inc.") (the "Company") (as filed with the Report on Form 10-K for the fiscal year Ohio Secretary of State on February 8, ended June 30, 1997 (File No. 0-19024) 1991) 3(a)(2) Certificate of Amendment to the Amended Incorporated herein by reference to Exhibit 3(a)(2) Articles of Incorporation of the Company to the Registrant's Annual Report on Form 10-K (as filed with the Ohio Secretary of for the fiscal year ended June 30, 1997 State on July 16, 1996) (File No. 0-19024) 3(a)(3) Certificate of Amendment to the Amended Incorporated herein by reference to Articles of Incorporation, as amended of Exhibit 3(a)(3) to the Registrant's Quarterly the Company (as filed with the Ohio Report on Form 10-Q for the fiscal quarter ended Secretary of State on May 10, 2000) March 31, 2000 (File No. 0-19024) 3(a)(4) Certificate of Amendment to the Amended Incorporated herein by reference to Articles of Incorporation, as amended of Exhibit 3(a)(4) to the Registrant's Quarterly the Company (as filed with the Ohio Report on Form 10-Q for the fiscal quarter ended Secretary of State on November 8, 2000) September 30, 2000 (File No. 0-19024) 3(a)(5) Amended Articles of Incorporation, as Incorporated herein by reference to amended of the Company (reflecting Exhibit 3(a)(5) to the Registrant's amendments through November 8, 2000 for Quarterly Report on Form 10-Q for the purposes of Securities and Exchange fiscal quarter ended September 30, 2000 Commission reporting compliance only) (File No. 0-19024) 3(b) Amended Regulations of the Company Incorporated herein by reference to Exhibit 3(b) to the Registrant's Registration Statement on Form S-1, as filed with the Securities and Exchange Commission on February 12, 1991 (Registration No. 33-38878) 4(a)(1) Amended Articles of Incorporation of the Incorporated herein by reference to Company (as filed with the Ohio Secretary Exhibit 3(a)(1) to the Registrant's Annual of State on February 8, 1991) Report on Form 10-K for the fiscal year ended June 30, 1997 (File No. 0-19024) 4(a)(2) Certificate of Amendment to the Amended Incorporated herein by reference to Articles of Incorporation of the Company Exhibit 3(a)(2) to the Registrant's Annual (as filed with the Ohio Secretary of Report on Form 10-K for the fiscal year ended State on July 16, 1996) June 30, 1997 (File No. 0-19024) 4(a)(3) Certificate of Amendment to the Amended Incorporated herein by reference to Articles of Incorporation, as amended of Exhibit 3(a)(3) to the Registrant's Quarterly the Company (as filed with the Ohio Report on Form 10-Q for the fiscal quarter ended Secretary of State on May 10, 2000) March 31, 2000 (File No. 0-19024)
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Exhibit No. Description Page - ---------- ----------- ---- 4(a)(4) Certificate of Amendment to the Amended Incorporated herein by reference to Articles of Incorporation, as amended of Exhibit 3(a)(4) to the Registrant's the Company (as filed with the Ohio Quarterly Report on Form 10-Q for the Secretary of State on November 8, 2000) fiscal quarter ended September 30, 2000 (File No. 0-19024) 4(a)(5) Amended Articles of Incorporation, as Incorporated herein by reference to amended of the Company (reflecting Exhibit 3(a)(5) to the Registrant's amendments through November 8, 2000 for Quarterly Report on Form 10-Q for the purposes of Securities and Exchange fiscal quarter ended September 30, 2000 Commission reporting compliance only) (File No. 0-19024) 4(b) Amended Regulations of the Company Incorporated herein by reference to Exhibit 3(b) to the Registrant's Registration Statement on Form S-1, as filed with the Securities and Exchange Commission on February 12, 1991 (Registration No. 33-38878) 4(c) Share Exchange Agreement, dated Incorporated herein by reference to January 9, 1997 Exhibit 99 to the Registrant's Current Report on Form 8-K, as filed with the Securities and Exchange Commission on January 24, 1997 (File No. 0-19024) 4(d) Investor Rights Agreement, dated as of Incorporated herein by reference to May 10, 2000, among the Company, the Exhibit 4(c) to the Registrant's Quarterly Investors identified therein and Lawrence Report on Form 10-Q for the fiscal quarter J. Fox ended March 31, 2000 (File No. 0-19024) 4(e) Amendment to Investor Rights Agreement Incorporated herein by reference to Exhibit 4(c) to the Registrant's Current Report on Form 8-K, as filed with the Securities and Exchange Commission on August 30, 2000 (File No. 0-19024) 4(f) Warrant for the Purchase of Shares of Incorporated herein by reference to Common Stock of the Registrant issued to Exhibit 4(e) to the Registrant's Annual Morgan Stanley Dean Witter Venture Report on Form 10-K for the fiscal year Partners IV, L.P. and Exhibit A, ended June 30, 2001 (File No. 0-19024) identifying other identical warrants issued to the Investors identified on Exhibit A, for the number of common shares listed on Exhibit A, on the dates indicated 4(g) Assignment and Assumption Agreement, by Incorporated herein by reference to and between Morgan Stanley Dean Witter Exhibit 4(g) to the Registrant's Quarterly Equity Funding, Inc. and the Originators Report on Form 10-Q for the fiscal quarter Investment Plan, L.P., dated November 24, ended December 31, 2000 (File No. 0-19024) 2000 4(h) Common Share Purchase Warrant, dated July Incorporated herein by reference to 17, 2001, issued to Foothill Capital Exhibit 4(g) to the Registrant's Annual Corporation Report on Form 10-K for the fiscal year ended June 30, 2001 (File No. 0-19024)
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Exhibit No. Description Page - ----------- ----------- ---- 4(i) Registration Rights Agreement, dated July Incorporated herein by reference to 17, 2001, by and between the Registrant Exhibit 4(h) to the Registrant's Annual and Foothill Capital Corporation Report on Form 10-K for the fiscal year ended June 30, 2001 (File No. 0-19024) 10(a) Loan and Security Agreement, by and among Incorporated herein by reference to the Registrant, Frontstep Solutions Exhibit 10(u) to the Registrant's Annual Group, Inc., brightwhite solutions, inc. Report on Form 10-K for the fiscal year and Frontstep Canada, Inc., as Borrowers, ended June 30, 2001 (File No. 0-19024) and the Lenders signatory thereto, as Lenders, and Foothill Capital Corporation, as Arranger and Administrative Agent 10(b) Common Share Purchase Warrant, dated July Incorporated herein by reference to 17, 2001, issued to Foothill Capital Exhibit 10(v) to the Registrant's Annual Corporation Report on Form 10-K for the fiscal year ended June 30, 2001 (File No. 0-19024) 10(c) Registration Rights Agreement, dated July Incorporated herein by reference to 17, 2001, by and between the Registrant Exhibit 10(w) to the Registrant's Annual and Foothill Capital Corporation Report on Form 10-K for the fiscal year ended June 30, 2001 (File No. 0-19024) 10(d) Pledge and Security Agreement (Foreign), Incorporated herein by reference to dated July 17, 2001, made by the Exhibit 10(x) to the Registrant's Annual Registrant and Frontstep Solutions Group, Report on Form 10-K for the fiscal year Inc., in favor of Foothill Capital ended June 30, 2001 (File No. 0-19024) Corporation, as agent for certain Lenders 10(e) Pledge and Security Agreement (Domestic), Incorporated herein by reference to dated July 17, 2001, made by the Exhibit 10(y) to the Registrant's Annual Registrant and Frontstep Solutions Group, Report on Form 10-K for the fiscal year Inc., in favor of Foothill Capital ended June 30, 2001 (File No. 0-19024) Corporation, as agent for certain Lenders 10(f) Copyright Security Agreement, dated July Incorporated herein by reference to 17, 2001, made by the Registrant, Exhibit 10(z) to the Registrant's Annual Frontstep Solutions Group, Inc. and Report on Form 10-K for the fiscal year brightwhite solutions, inc., in favor of ended June 30, 2001 (File No. 0-19024) Foothill Capital Corporation, as agent for certain Lenders 10(g) Trademark Security Agreement, dated July Incorporated herein by reference to 17, 2001, made by the Registrant, Exhibit 10(a)(a) to the Registrant's Frontstep Solutions Group, Inc. and Annual Report on Form 10-K for the fiscal brightwhite solutions, inc., in favor of year ended June 30, 2001 (File No. 0-19024) Foothill Capital Corporation, as agent for certain Lenders 10(h) Intercompany Subordination Agreement, Incorporated herein by reference to dated July 17, 2001, made among the Exhibit 10(a)(b) to the Registrant's Registrant, Frontstep Solutions Group, Annual Report on Form 10-K for the fiscal Inc., brightwhite solutions, inc., year ended June 30, 2001 (File No. 0-19024) Frontstep Canada, Inc., and other future obligors, and Foothill Capital Corporation, as agent for certain Lenders
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