-----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, AsO8C0WJXkBH5GyFt6qOMC0g+vlFOT1hShWQuTtzoKZdecLXDjBgQbOORRnTaVkW rOTF4Mf/BvnzPZBbi8BH2Q== 0000950124-99-002559.txt : 19990413 0000950124-99-002559.hdr.sgml : 19990413 ACCESSION NUMBER: 0000950124-99-002559 CONFORMED SUBMISSION TYPE: 10QSB/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990412 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NEMATRON CORP CENTRAL INDEX KEY: 0000892832 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRONIC COMPUTERS [3571] IRS NUMBER: 382483796 STATE OF INCORPORATION: MI FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10QSB/A SEC ACT: SEC FILE NUMBER: 000-21142 FILM NUMBER: 99591898 BUSINESS ADDRESS: STREET 1: 5840 INTEFACE DRIVE CITY: ANN ARBOR STATE: MI ZIP: 48103 BUSINESS PHONE: 7342142000 MAIL ADDRESS: STREET 1: 5840 INTERFACE DR CITY: ANN ARBOR STATE: MI ZIP: 48103 10QSB/A 1 AMENDMENT #1 TO FORM 10-Q 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB/A-1 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended DECEMBER 31, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to ____ Commission File Number: 0-21142 NEMATRON CORPORATION (Exact name of small business issuer as specified in its charter) MICHIGAN 38-2483796 (State or other jurisdiction of (I.R.S. Employer Identification No.) 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: 5,353,316 SHARES OUTSTANDING AS OF FEBRUARY 5, 1999 Transitional Small Business Disclosure Format: [ ] YES [X] NO ================================================================================ 2 The Registrant hereby amends its Form 10-QSB for the three-month period ended December 31, 1998 to amend Part I as set forth below. PART I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS NEMATRON CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS DECEMBER 31, 1998 AND SEPTEMBER 30, 1998
DECEMBER 31, SEPTEMBER 30, 1998 1998 (UNAUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 106,730 $ 357,724 Accounts receivable, net of allowance for doubtful accounts of $368,000 at December 31, 1998, and $381,000 at September 30, 1998 1,999,900 2,514,741 Inventories (Note 2) 1,884,335 2,103,434 Prepaid expenses and other current assets 305,310 295,321 ------------ ------------ Total Current Assets 4,296,275 5,271,220 PROPERTY AND EQUIPMENT, net of accumulated depreciation of $5,685,402 at December 31, 1998 and $5,475,815 at September 30, 1998 3,344,140 3,942,695 OTHER ASSETS: Software and related development costs, net of amortization of $2,557,639 at December 31,1998, and $2,314,845 at September 30, 1998 3,880,284 1,002,225 Other intangible assets, net of amortization of $2,225,842 at December 31, 1998 and $2,165,775 at September 30,1998 942,158 3,942,695 ------------ ------------ Net Other Assets 4,822,442 4,944,920 ------------ ------------ TOTAL ASSETS $ 12,462,857 $ 13,840,000 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Note payable to bank $ 2,715,457 $ 3,514,000 Accounts payable 1,409,645 1,414,417 Trade notes payable 1,123,956 1,545,956 Other accrued expenses 1,387,403 1,866,366 Convertible promissory notes payable (Note 3) 1,000,000 -0- Current maturities of long-term debt (Note 4) 1,576,492 1,832,791 ------------ ------------ Total Current Liabilities 9,212,953 10,173,530 LONG-TERM DEBT, less current maturities (Note 4) 2,182,783 2,084,346 DEFERRED TAX LIABILITY 178,200 189,000 ------------ ------------ Total Liabilities 11,573,936 12,446,876 STOCKHOLDERS' EQUITY: Common stock, no par value, 15,000,000 shares authorized; 5,353,316 shares issued and outstanding at December 31, 1998 and September 30, 1998 (Note 3) 24,664,809 21,664,809 Foreign currency translation adjustment (7,134) (6,080) Accumulated deficit (23,768,754) (20,265,605) ------------ ------------ Total Stockholders' Equity 888,921 1,393,124 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 12,462,857 $ 13,840,000 ============ ============
Page 1 3 ITEM 1. FINANCIAL STATEMENTS - CONTINUED NEMATRON CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS FOR THE QUARTERS ENDED DECEMBER 31, 1998 AND 1997
QUARTER QUARTER ENDED ENDED DECEMBER 31, DECEMBER 31, 1998 1997 (RECLASSIFIED) (UNAUDITED) (UNAUDITED) NET REVENUES $ 3,186,910 $ 4,351,308 COST OF REVENUES 2,084,915 3,037,120 ----------- ----------- Gross Profit 1,101,995 1,314,188 OPERATING EXPENSES: Product development costs 131,987 209,212 Selling, general and administrative expenses 1,323,945 2,300,862 ----------- ----------- Total Operating Expenses 1,455,932 2,510,074 ----------- ----------- Operating Loss (353,937) (1,195,886) OTHER INCOME (EXPENSE): Interest expense from use of funds (158,804) (143,487) Interest expense from issuance of convertible promissory notes (Note 3) (3,000,000) -0- Sundry income (expense), net (1,208) 1,154 ----------- ----------- Total Other Income (Expense) (3,160,012) (142,333) ----------- ----------- LOSS BEFORE INCOME TAXES (3,513,948) (1,338,219) INCOME TAXES BENEFIT (NOTE 5) 10,800 -0- ----------- ----------- NET LOSS $(3,503,149) $(1,338,219) =========== =========== BASIC LOSS PER SHARE (NOTE 6) $ (0.65) $ (0.25) =========== =========== DILUTED LOSS PER SHARE (NOTE 6) $ (0.65) $ (0.25) =========== =========== Weighted average shares outstanding - basic 5,353,316 5,335,168 =========== =========== Weighted average shares outstanding - diluted 5,353,316 5,335,168 =========== ===========
Page 2 4 ITEM 1. FINANCIAL STATEMENTS - CONTINUED NEMATRON CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS FOR THE QUARTERS ENDED DECEMBER 31, 1998 AND 1997
QUARTER ENDED QUARTER ENDED DECEMBER 31, 1998 DECEMBER 31, 1997 (UNAUDITED) (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(3,503,149) $(1,338,219) Adjustments to reconcile net loss to net cash flows used in operating activities: Depreciation and amortization 544,013 547,968 Deferred income tax benefit (10,800) -0- Non-cash interest expense from issuance of convertible promissory note (Note 3) 3,000,000 -0- Changes in assets and liabilities that provided (used) cash: Accounts receivable 514,841 (98,142) Inventories 219,099 (243,645) Prepaid expenses and other current assets (9,989) (65,151) Accounts payable (4,772) (161,000) Accrued expenses (444,468) (188,560) ----------- ----------- Net Cash Provided By (Used In) Operating Activities 304,775 (1,546,749) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to capitalized software development costs (180,382) (638,214) Additions to property and equipment, net of minor disposals (8,723) (224,474) ----------- ----------- Net Cash Used In Investing Activities (189,105) (862,688) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of convertible promissory notes 1,000,000 -0- Proceeds from disposals of property and equipment 12,795 -0- Increase (decrease) in note payable to bank (798,543) 1,736,000 Payment of trade notes payable (422,000) -0- Payments of long-term debt (157,862) (165,306) Increase in other notes payable -0- 109,613 Proceeds from exercise of options and warrants -0- 41,491 ----------- ----------- Net Cash Provided By (Used In) Financing Activities (356,610) 1,721,798 ----------- ----------- FOREIGN CURRENCY TRANSLATION EFFECT (1,054) (584) ----------- ----------- Net Decrease In Cash and Cash Equivalents (250,994) (688,223) Cash and Cash Equivalents at Beginning of Period 357,724 1,142,988 ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 106,730 $ 454,765 =========== =========== NON-CASH FINANCING AND INVESTING ACTIVITIES: Increase in Common Stock due to issuance of convertible promissory notes at a conversion price at a discount to quoted market (Note 3) $ 3,000,000 $ -0- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest $ 142,255 $ 149,026 Cash paid for income taxes -0- -0-
Page 3 5 ITEM 1. FINANCIAL STATEMENTS - CONTINUED NEMATRON CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997 NOTE 1 - BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of Nematron Corporation (the "Company") and its wholly-owned subsidiaries, Nematron Ltd., a United Kingdom corporation; Nematron Europa BV, an inactive Netherlands corporation, and NemaSoft, Inc. ("NemaSoft") and Imagination Systems, Inc., ("ISI") both Michigan corporations. 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 S.E.C. 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 and amendments thereto Certain reclassifications have been made to the fiscal 1998 presentation to conform to classifications used in fiscal 1999. The results of operations for the three-month periods ended December 31, 1998 and 1997 are not necessarily indicative of the results to be expected for the full year. NOTE 2 - INVENTORIES Inventories consist of the following at December 31, 1998, and September 30, 1998:
DECEMBER 31, 1998 SEPTEMBER 30, 1998 Purchased parts and accessories $ 1,142,431 $ 1,100,202 Work in process 307,762 370,840 Finished goods, demo units and service stock 434,142 632,392 ------------- ------------- Total Inventory $ 1,884,335 $ 2,103,434 ============= =============
NOTE 3 - INTEREST EXPENSE FROM ISSUANCE OF CONVERTIBLE PROMISSORY NOTE As of December 1, 1998, the Company executed and delivered convertible promissory notes (the "Notes") in the aggregate principal amount of $1 million to 18 investors in a private placement (collectively, the "Note Holders") as the first stage of a capital transaction, under which the Company plans to raise a total of not less than $4 million of equity. The Notes bear interest at the rate of seven percent (7%) per annum, are due and payable, with accrued interest, on March 31, 1999 (unless extended by mutual agreement of the Company and the Note Holders) and are not transferable without the Company's consent. The Notes may be paid by the Company, subject to the limitation described in the next sentence, with Common Stock valued at $.25 per share and are convertible by the Note Holders into Common Stock at $.25 per share (the "Conversion Price"). On the December 1, 1998, the closing sale price of the Company's common stock on the Nasdaq National Market was $1.00 per share. The Company is not required to issue more than 1,070,000 shares in connection with the payment and/or conversion of the Notes unless the issuance of any additional shares has been approved by the Company's shareholders to the extent required by applicable law, the Company's organizational documents or the rules of the Nasdaq Stock Market. Page 4 6 At period end, the Company's common stock was traded on the Nasdaq National Market, and as such, the Company was governed by rules of the Nasdaq Stock Market. Under such rules, on December 1, 1998 the Company was precluded from issuing common stock in excess of 20% of the outstanding shares of common stock unless the issuance was approved by the Company's shareholders. Because of this requirement, the Company was forced to structure the capital transaction as a sale of convertible promissory notes rather than common stock so that the Company could receive the proceeds currently but postpone the issuance of common stock until it had received the required shareholder approval. Accounting for the issuance of the Notes is governed by the SEC's Emerging Issues Task Force pronouncement D-60, Accounting for the Issuance of Convertible Preferred Stock and Debt Securities with a Nondetachable Conversion Feature, issued March 13, 1997 ("EITF D-60"). EITF D-60 states that a beneficial conversion feature should be recognized and measured by allocating a portion of the proceeds equal to the intrinsic value of that feature to additional paid -in capital. That amount is calculated at the date of issue as the difference between the conversion price and the fair value of the common stock into which the Notes are convertible, multiplied by the number of shares into which the Notes are convertible. EITF D-60 further states that if the common stock is traded in a public market, the SEC staff believes that the quoted market price is the best measure of the common stock's fair value. Additionally, EITF requires that any discount resulting from an allocation of the proceeds to a beneficial conversion feature increases the effective interest rate of the Notes and should be reflected as a charge to interest expense. Pursuant to EITF D-60, the Company has recorded interest expense of $3,000,000 on the date of issuance of $1,000,000 of the Notes to reflect the beneficial conversion feature of $0.25 per share compared to the quoted market price of $1.00 per share on the closing date of the transaction for the 4,000,000 shares Note Holders will receive when the Notes are converted into common stock. The Company intends to pay all of its obligations under the Notes with Common Stock if the Capital Transaction is approved by shareholders at the Company's 1999 Annual Shareholders Meeting. NOTE 4 - SHORT-TERM AND LONG-TERM DEBT On September 28, 1998, December 1, 1998 and January 31, 1999, the Company entered into amendments to the loan agreements and into a Repayment Agreement with the bank which provided, among other things, for a modification of certain terms of the Term Note, two Equipment Notes and the Revolving Credit Note. The Revolving Credit Note, as amended contains various affirmative and negative covenants. The Company is in violation of these covenants. Under the terms of the amended agreements, the amount available under the Revolving Credit Note is $5,000,000 and is limited by a borrowing formula which allows for advances up to a maximum of the sum of 80% of eligible domestic and foreign accounts, plus 35% of inventory, plus a Permitted Overadvance of $1,000,000 through April 15, 1999 . The interest rate on the credit line borrowings is at the bank's prime interest rate plus 2% (10.25% effective rate at December 31, 1998). Amounts borrowed under the line of credit are due in full on October 31, 1999. Long-term debt includes the following debt instruments at December 31, 1998, and September 30, 1998:
DECEMBER 31, 1998 SEPTEMBER 30, 1998 Mortgage loan payable to bank $ 1,956,474 $ 1,998,509 Term note payable 1,170,000 1,230,000 Capitalized lease obligations and other notes 632,801 688,628 ---------------- --------------- Total long-term debt 3,759,275 3,917,137 Less current maturities (1,576,492) (1,832,791) ---------------- --------------- Long-term debt, less current maturities $ 2,182,783 $ 2,084,346 ================ ===============
Page 5 7 The mortgage loan agreement contains covenants that require the Company to maintain a minimum tangible net worth and a minimum debt-to-equity ratio. The Company was not in compliance with these covenants; however, the Company's lender has waived these defaults through October 1, 1999. The loan agreement with the bank regarding the term note and two equipment notes includes various affirmative and negative covenants, the most restrictive of which are (1) the prohibition of dividend payments, and (2) requirements to maintain (a) a specified ratio of current assets to current liabilities, (b) a specified ratio of liabilities to tangible net worth, (c) a specified debt coverage ratio, and (d) a specified level of tangible worth. These borrowings are due October 31, 1999 and as such these notes totaling $1,487,017 and $1,579,781 at December 31, 1998 and September 30, 1998, respectively, are included in current maturities of long-term debt. NOTE 5 - TAXES ON INCOME The current tax benefit computed for the three month period ended December 31, 1998 reflect the tax benefit associated with the amortization of non-deductible goodwill and other intangible assets during the same periods. There was no current tax benefit computed for the three month period ended December 31,1997 because of the uncertainty that the associated deferred tax asset could not be realized through future taxable income. The Company has NOLs of approximately $19,400,000, which may be applied against future taxable income. The NOLs expire beginning 2003 and run through 2013. Utilization of these carryforwards 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 net operating loss carryforwards. NOTE 6 - LOSS PER SHARE Basic earnings per share is based on the weighted average number of shares outstanding for each period presented because common stock equivalents are anti-dilutive. The weighted average number of shares outstanding for the three-month periods are as follows:
DECEMBER 31, 1998 DECEMBER 31, 1997 Weighted average shares outstanding 5,353,316 5,335,168
Diluted earnings per share is not presented because the amounts are anti-dilutive. NOTE 6 - CONTINGENCIES On May 8, 1998, a lawsuit was filed against the Company in the District Court for the Southern District of New York. The lawsuit names as defendants the Company, certain of its officers and directors, its former independent auditor and the underwriter for the Company's initial public offering. The plaintiff seeks to represent a class of shareholders who purchased the Company's common stock from January 31, 1996 through April 28, 1998. An amended complaint filed by the plaintiff in October 1998 claims violations of securities laws and common law based on allegations that defendants made untrue statements of material facts and that they omitted material facts necessary in order to make the statements not misleading. The complaint seeks unspecified damages and costs. In December 1998, the case was transferred to the United States District Court for the Eastern District of Michigan. In January 1999, the Company filed a motion for the dismissal of the lawsuit. Management believes that the outcome of this case will not have a material adverse effect on the Company. Page 6 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS THREE MONTHS ENDED DECEMBER 31, 1998 COMPARED WITH THREE MONTHS ENDED DECEMBER 31, 1997 Net revenues for the first quarter of fiscal 1999 decreased $1,164,000 (26.8%) to $3,187,000 compared to the same period last year. The decrease is attributable to decreases in sales of Industrial Workstations and Industrial Control Computers caused by component parts shortages due to the Company's working capital deficiency. Management expects that net revenues for the second quarter of fiscal 1998 will approximate second quarter fiscal 1998 net revenues and that net revenues will increase in the last two quarters of fiscal 1999 compared to year earlier periods. These net revenue changes are expected due to anticipated customer response to the Company's increases in sales and marketing efforts, existing scheduled production releases and expected shipments under existing contracts. Gross profit for the first quarter of fiscal 1999 decreased $212,000 (16.1%) to $1,102,000 compared to the same period last year. Gross profit as a percentage of sales in the first quarter of fiscal 1999 was 34.6% compared to 30.2% in the same period last year. The improvement in gross profit percentage is due primarily to a higher percentage of sales of higher margin bundled hardware/software products in the current period compared to the same period last year. Management expects that gross profit margins will remain relatively constant throughout the year as the mix of sales in the remaining quarters of fiscal 1999 is expected to be similar to the sales mix experienced in the first quarter of the period. Product development expenses for the first quarter of fiscal 1999 decreased $77,000 (36.9%) to $132,000 compared to the same period last year. The decrease is due primarily to a decreased staff level and less development efforts in the current period compared to a year ago. Management expects that product development efforts will remain relatively constant in the remaining quarters of fiscal 1999. Selling, general and administrative expenses for the first quarter of fiscal 1999 decreased $977,000 (42.5%) to $1,324,000 compared to the comparable period of last year and decreased as a percentage of net revenue to 41.5% in the first quarter of fiscal 1999 from 52.9% in the comparable period of fiscal 1998. The decrease was primarily a result of lower staff levels, the effects of closing of satellite offices during the first quarter of fiscal 1999 and the effects of cost controls initiated during the current period. Management expects that selling, general and administrative expenses will increase marginally in the remaining quarters of fiscal 1999 due to expanded marketing and sales activities, and that such expenses will decrease as a percentage of net revenues as net revenues are expected to increase by a greater amount in the remaining quarters of fiscal 1999. Interest expense from use of funds for the first quarter of fiscal 1999 increased $15,000 (10.7%) to $159,000 compared to $143,000 for the comparable period last year due to higher average borrowing levels. Interest expense from the issuance of convertible promissory notes three months ended December 31, 1999 was $3,000,000, representing the charge to operations, with the offsetting increase in shareholders' equity, to reflect the beneficial conversion feature of $0.25 per share, compared to the quoted market price of $1.00 per share on the closing date of the transaction, for the 4,000,000 shares of common stock to be issued to Note Holders when the Notes are converted into common stock. That amount was calculated at the date of issue as the difference between the conversion price and the fair value of the common stock into which the Notes are convertible, multiplied by the number of shares into which the Notes are convertible. YEAR 2000 ISSUE The Year 2000 Issue ("Y2K") is the result of certain computer programs being written using two digits rather than four digits to define the applicable year. Computer systems with a Y2K problem will be unable to interpret dates beyond the years 1999, which could cause a system failure or other computer errors, leading to disruptions in operations. In 1997, the Company began to assess its Y2K readiness and adopted a three-phase program for Y2K information systems compliance. Phase I is the identification of systems and products with which the Company has exposures to Y2K issues. Phase II encompasses the development and implementation of action plans to be Y2K compliant in all areas by mid-1999. Phase III Page 7 9 includes final testing of each major area of exposure to ensure compliance. The Company has identified four major areas determined to be critical for successful Y2K compliance: (1) financial and information system applications; (2) software products currently sold; (3) third-party relationships and 4) non-information technology areas such as security, telephone systems and climate control systems. The Company is finishing Phase I of its program. The Company has contacted all significant software suppliers and, due to recent implementation of its major financial and operational software, believes that its financial and operational software is Y2K compliant. The Company has also reviewed for Y2K compliance its hardware and software products, including the firmware imbedded in certain hardware products, marketed and sold to third parties. The Company has used its employee engineers and others in its review and testing procedures. The Company has identified one older software product, used for monitoring and testing in a test cell environment (not related to machine control) which needs to be modified to correct a Y2K problem. The Company estimates that the cost to modify the product is approximately $50,000, all of which relates to the salary and benefits of software development employees of the Company, none of which has been expended to date. The Company intends to fix this Y2K issue and notify its customers when a solution is available. The Company intends to make the Y2K compliant software available to its customers for purchase. The Company intends to fund the costs of this effort out of operating funds in fiscal 1999. If the product cannot be remedied in a cost efficient manner, the Company may determine to cease marketing and production of the product; such action, however, is not expected to have a material adverse effect on the Company's results of operations. The Company has relationships with, and is to varying degrees dependent upon, various third parties that provide funds, information, goods and services to the Company. These include the Company's bank lender, utility providers, stock transfer agent, and suppliers of components. The Company is attempting, through informal contacts, to assess the compliance of these third parties. While not all parties have informed the Company as to their status, the most significant of these third parties have represented that their systems and products are Y2K compliant. The Company will continue with this assessment in fiscal 1999. The Y2K compliance of the systems of these third parties is outside the Company's control and there can be no assurance that any of these third parties will not experience a systems failure due to Y2K. Because the Company expects that the systems within its control will be Y2K compliant before the end of 1999, the Company believes that the most reasonably likely worst case scenario is a compliance failure by one or more of the third parties described above. Such a failure would likely have an effect on the Company's business, financial condition and results of operations. The magnitude of that effect, however, cannot be quantified at this time because of variables such as the type and importance of the third party, the possible effect on the Company's operations and the Company's ability to respond. Thus, there can be no assurance that there will not be a material adverse effect on the Company if such third parties do not remediate their systems in a timely manner and in a way that is compatible with the Company's systems. As a result, the Company will develop contingency plans that assume some estimated level of noncompliance by, or business disruption to, these third parties. The Company intends to have contingency plans developed by the end of its third quarter of fiscal 1999 for third parties determined to be at high risk of noncompliance or business disruption or whose noncompliance or disruption, while not high risk, is considered likely to materially affect the Company. The contingency plans will be developed on a case-by-case basis, and may include plans for switching to Y2K compliant suppliers. Judgments regarding contingency plans are subject to many uncertainties and there can be no assurance that the Company will correctly anticipate the level, impact or duration of noncompliance or that its contingency plans will be sufficient to mitigate the impact of any noncompliance. Some material adverse effect to the Company may result despite such contingency plans. To date, the Company has expended approximately $10,000 incremental costs to remediate Y2K problems, in that all efforts have been expended by existing engineering and application support and other personnel These costs have been expensed as incurred. The Company estimates total Y2K remediation costs at $65,000 incrementally over the next three quarters. Estimates of time, cost and risks are based on currently available information. Developments that could affect estimates include, without limitation, the availability of trained personnel, the ability to locate and correct all noncompliant systems, cooperation and Page 8 10 remediation success of third parties material to the Company, and the ability to correctly anticipate risks and implement suitable contingency plans in the event of system failures at the Company or third parties. LIQUIDITY AND CAPITAL RESOURCES By the end of October 1998, the Company was overadvanced on its revolving credit facility, and was facing imminent foreclosure by the Company's lenders. In early November 1998, after unsuccessful attempts to sell the business or solicit working capital through other means, and when the Company was faced with imminent closing of its business, the Company negotiated an arrangement with a group of creditors that provided essential working capital to permit the Company to continue operations. The proposal was submitted to the bank, and precipitated a forbearance agreement from the Company's bank. Following receipt of support from the bank, the management and Board of Directors agreed to support the arrangement as an offer of last resort. It was the opinion of management and the Board of Directors that preserving the Company's ability to operate at the expense of diluting existing shareholders' interest was preferable to ceasing operations in view of the Company's significant backlog and the risk of losing its existing customers if it were t cease operations. As a result, the Company determined to enter into the capital transaction described below (the "Capital Transaction"). As of December 1, 1998, the Company executed and delivered convertible promissory notes (the "Notes") in the aggregate principal amount of $1 million to 18 investors in a private placement (collectively, the "Note Holders") as the first stage of the Capital Transaction. The Notes bear interest at the rate of seven percent (7%) per annum, are due and payable, with accrued interest, on March 31, 1999 (except as described below) and are not transferable without the Company's consent. The Notes may be paid by the Company, subject to the limitation described in the next sentence, with Common Stock valued at $.25 per share and are convertible by the Note Holders into Common Stock at $.25 per share (the "Conversion Price"). The Company is not required to issue more than 1,070,000 shares in connection with the payment and/or conversion of the Notes unless the issuance of any additional shares has been approved by the Company's. If the entire principal and accrued interest amount of the Notes is converted into or paid with Common Stock, the Company would be required to issue 4,093,333 million shares of Common Stock. Amounts due under the Notes which are not paid with or converted into Common Stock must be paid in cash on or before their due date. The Company intends to pay all of its obligations under the Notes with Common Stock if the Company receives shareholder approval. In contemplation of the second stage of the Capital Transaction in which the Company was to raise an additional $3 million, five of the Note Holders, including Mr. Nichols, Mr. Globus and two of his affiliates and Mr. Hershey (on behalf of J. Eric May), expressed a willingness to invest additional funds in the Company's Common Stock and were granted, in connection with their purchase of Notes as of December 1, 1999, options to acquire additional Notes with an aggregate principal amount of $1,250,000 on or before January 31, 1999 (the "Options"). As of January 12, 1999, the terms of the Options were amended to provide that (i) the Options expire on the earlier of April 30, 1999 and the fifth business day after receipt of shareholder approval of the issuance of the shares, (ii) the Option holders together have the right to purchase a total of 1,250,000 shares of Common Stock, rather than Notes convertible into Common Stock (subject to receipt of the shareholder approval) and (iii) the exercise price of the Options is $1.00 per share, rather than $.25. The Notes held by these five investors were also amended to extend the maturity of the Notes from March 31, 1999 to coincide with the termination of the Options -- the earlier of April 30, 1999 and the fifth business day after receipt of shareholder approval. The Option holders have indicated that they intend to exercise the Options in full if shareholder approval is received. The Company is also in the process of receiving subscription agreements from other accredited investors to purchase an additional 1,750,000 shares as part of the second stage of the Capital Transaction at $1.00 per share, subject to receipt of shareholder approval. As consideration for its efforts as placement agent in connection with the sale of such shares and the sale of $250,000 principal amount of the Notes, the Company will issue to Gregory J. Schwartz & Co. ("Schwartz") upon the sale of the shares in the second stage of the Capital Transaction an option to purchase 80,000 shares at $.25 per share and 140,000 shares at $1.00 per share (the "Schwartz Option"). The Schwartz Option expires on June 30, 1999. The Company is party to a bank line of credit which permits borrowing up to $5,000,000, subject to an availability formula based upon a percentage of eligible accounts receivable and inventory and a permitted overadvance. At December 31, 1998, $2,715,457 was outstanding on the line. The expiration Page 9 11 date of the underlying Agreement has been extended to October 31, 1999. Amounts borrowed under the facility bear interest at prime plus 2.0% (10.25% effective rate at December 31, 1998). Prior to the expiration of the line of credit on October 31, 1999, the Company plans to negotiate an extension of the expiration date of the line of credit. Additionally, the Company plans to reduce borrowings on the credit line with a portion of the proceeds from the Capital Transaction described above. Although management believes that by the set expiration date of the credit line the receivable and inventory levels, upon which the borrowing base is calculated, will increase, and the amount of over-advance from the bank will decrease, there can be no assurance that the credit line will be extended. Consequently, if negotiations to extend the credit line fail, management will seek financing from other financing sources, which may not materialize, or if such sources are available, the cost of such arrangement may be significantly higher than the current bank agreement. The Company also successfully negotiated the conversion of $1.7 million of trade accounts payable into short-term trade notes payable. Although the Company was delinquent on the terms of these notes at September 30, 1998, the Company has paid or received extensions of all past due payments as of December 31, 1998, and is current with the revised terms of such trade notes payable. In order for the Company to have sufficient short-term liquidity to continue operations for the remainder of fiscal 1999, the line of credit must be renewed or replaced, the Company must receive the remaining proceeds from the Capital Transaction described above and the Company must be able to pay the principal and interest under all of its convertible notes with Common Stock as described above. If the Company is not successful in accomplishing these goals, the Company would be forced to curtail its operations and either sell the Company to a third party or seek protection under federal bankruptcy laws. UNCERTAINTIES RELATING TO FORWARD LOOKING STATEMENTS "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" includes "forward-looking statements" (as defined in the federal securities laws) based on current management expectations. Factors that could cause future results to differ from these expectations include the failure of the bank to renew its line of credit agreement when borrowings thereunder become due, the failure of the Company to complete the second stage of the Capital Transaction, the inability of the Company to pay the principal and interest of the Notes with common stock at their maturity dates, the decline of economic conditions in general and conditions in the automotive manufacturing industry in particular, a reduction in demand for the Company's products and services, decreases in orders under existing contracts, the inability of the Company to successfully implement its strategy to lead the industrial automation market migration from closed architecture PLCs to open architecture PC-based solutions, changes in Company strategy, reductions in product life cycles, competitive factors (including the introduction or enhancement of competitive products), pricing pressures which result in materially reduced selling prices for the Company's products, shifts in sales mix to less profitable products, raw material price increases or unavailability, delays in introduction of planned hardware and software products, software defects and latent technological deficiencies in new products, changes in operating expenses, fluctuations in foreign exchange rates, the inability to attract or retain sales, marketing and engineering talent, changes in customer requirements, unexpected Y2K issues in the Company's products or systems, evolving industry standards, and any additional factors described in the Company's other reports filed with the Securities and Exchange Commission. Page 10 12 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. (b) The Company filed no reports on Form 8-K during the quarter ended December 31, 1998. Page 11 13 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this amendment to this report to be signed on its behalf by the undersigned thereunto duly authorized. NEMATRON CORPORATION BY: APRIL 12, 1999 /s/ MATTHEW S. GALVEZ - ----------------------- --------------------------------------------- DATE MATTHEW S. GALVEZ, PRESIDENT & COO (DULY AUTHORIZED OFFICER) APRIL 12, 1999 /s/ DAVID P. GIENAPP - ----------------------- --------------------------------------------- DATE DAVID P. GIENAPP, EXECUTIVE VICE PRESIDENT - FINANCE &ADMINISTRATION (CHIEF ACCOUNTING OFFICER) Page 12 14 INDEX TO EXHIBITS Exhibit Number Description of Exhibit 10.1 Second Amendment to Repayment Agreement and Fifth Amendment to Loan Agreement dated as of January 31, 1999 by and between KeyBank National Association and the Company (filed with initial filing) 27 Financial Data Schedule, as amended Page 13 EX-27 2 FINANCIAL DATA SCHEDULE
5 3-MOS SEP-30-1998 DEC-31-1998 106,730 0 1,999,900 368,000 1,884,335 4,296,275 9,029,542 (5,685,402) 12,462,857 9,212,953 2,182,783 0 0 21,664,809 (7,134) 12,462,857 3,186,910 3,186,910 2,084,915 1,455,932 1,208 0 3,158,804 (3,513,948) 10,800 (3,503,149) 0 0 0 (503,149) (0.65) (0.65)
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