ADAPTIVE SOLUTIONS INC (NASDAQ:ADSO) files SEC Form 10-Q
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIS REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS (IDENTIFIED WITH AN ASTERISK ("*")) THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH IN THIS "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS".
OVERVIEW
Adaptive Solutions, Inc., (the "Company"), incorporated in Oregon in 1988, designs and markets high performance automated data entry and image recognition solutions targeted at a range of applications. As of June 30, 1997, the Company had an accumulated deficit of $27,509,000. For the three months ended June 30, 1997, the Company incurred a net loss of $171,000.
During 1996 the Company made substantial changes to its strategy, and it has continued to refine the new strategy during 1997. Key elements of the strategy include: 1) a focus on applications requiring high performance automated data entry and image recognition in a range of industries, including medicine, transportation, and government; 2) development of high performance programmable image processing engine products for Windows NT and Intel CPU based server and embedded systems environments; 3) a gradual transition from the Company's proprietary CNAPS processor to parallel processing microprocessors being brought to market by Motorola, Inc.("Motorola") and Intel Corporation ("Intel"); and 4) development of relationships, through marketing agreements, investments or acquisitions, with other software and hardware companies with expertise in the image recognition area. The parallel processing chip to be produced by Motorola, the "VeComP" chip, uses architecture purchased from the Company. The company has developed software partnerships with two companies, Mitek Systems of San Diego, California ("Mitek"), and Mimetics S.A. of Paris, France ("Mimetics"), and is continuing to explore additional alliances that would further enhance the development of the Company's strategy.
In order to become profitable, the Company must successfully develop these new products, obtain market acceptance for the products, obtain design wins for incorporation of its board level products into developers' OEM systems, develop sufficiently higher sales volumes and manufacturing efficiencies, manage its operating expenses and capability.* There can be no assurance that the Company will meet any of these objectives or achieve profitability. The Company expects that operating losses will continue at least through the third quarter of 1997.
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REVENUES
Total revenue of $839,000 for the three months ended June 30, 1997 included $400,000 from the sale and license of technology to a major customer and $233,000 from the Company's agreement with Northrop Grumman, under which the two companies are jointly developing an advanced image processing architecture. The Northrop Grumman contract is expected to generate additional revenue in the third quarter of 1997, but the technology sales and license revenue is not expected to continue in the near future.* The remaining revenue for the quarter ended June 30, 1997 consisted primarily of the sale of CNAPS and PCI-XL boards and software. Revenue from the comparable period in 1996 was $1,483,000.
For the six months ended June 30, 1997, total revenue of $1,564,000 consisted of $700,000 from the sale and license of technology to the major customer, $282,000 from the Northrop Grumman contract, and sales of CNAPS and PCI-XL boards and software. Revenue from the comparable period in 1996 was $5,314,000.
The Company's future success and its ability to continue operations will depend in substantial part on its ability to significantly maintain and increase sales of its existing products and products being developed under its revised product strategy.* There can be no assurance that the Company will be able to generate significant additional sales or maintain sales at current or historical levels; failure to do so would have a material adverse effect on the Company's financial position and results of operations.
International sales totaled $9,000 (1% of total revenue) for the three months ended June 30, 1997 and $84,000(5% of total revenue) for the six months ended June 30, 1997. For the comparable periods in 1996, international sales were $147,000 (10% of total revenue) and $738,000 (14% of total revenue), respectively. The percentage of international revenues to total revenues has decreased as a result of the Company's decision to discontinue the PowerShop product in 1996.
Foreign regulatory bodies often establish technical standards different from those in the United States; while the Company tests its products to meet these standards, there can be no assurance that the Company's products will comply with such standards in the future. The Company's international sales and operations may also be materially adversely affected by the imposition of governmental controls, export license requirements, restrictions on the export of critical technology, political and economic instability, trade restrictions, changes in taxes, varying exchange rates, difficulties in establishing and managing international operations and general economic conditions. Compliance or noncompliance with international quality standards may also affect operating results. In this respect, the Company has not applied for and has no present plans to apply for ISO 9000 certification.
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COST OF PRODUCT REVENUE
The cost of product revenue for the three months and six months ended June 30, 1997 was $167,000 and $407,000, respectively. For 1996, the cost of product revenue for the similar periods was $1,262,000 and $3,396,000, respectively.
The cost of product revenue consists of direct manufacturing costs, overhead costs associated with the manufacturing operations in Beaverton, Oregon, provisions for warranty costs, and reserves for inventory obsolescence and return. The decrease in cost for the three months and six months ended June 30, 1997, as compared to the similar periods in the prior year, was due mainly to the decrease in revenues versus the prior year, the reduced overhead associated with the shutdown of the California manufacturing site, and the inventory reserves associated with the Company's restructuring in the second quarter of 1996.
Cost of product revenue could be negatively affected in future periods due to a number of factors, including problems with component supplies, variability of component cost, product quality or reliability problems or other factors.
Additionally, the shutdown of the Company's Sunnyvale, California manufacturing site which manufactured the Company's proprietary CNAPS processors from silicon wafer has led the Company to outsource the testing of the CNAPS processors. The transition of this part of the manufacturing process may lead to increased processor costs. In addition, the Company purchases many of its components from Japanese manufacturers and pricing for these components is generally in yen.
When the value of the yen increases relative to the dollar, the cost to the Company of these components increases correspondingly. Accordingly, future increases in the value of the yen relative to the dollar could adversely affect the Company's gross margins or make the prices of the Company's products less competitive.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses of $370,000 and $654,000 for the three months and six months ended June 30, 1997 were associated with the development of high performance image recognition applications for the automated data entry market and the development of image processing and recognition engines for server and embedded systems environments. Research and development expenses were $880,000 and $1,811,000 for the comparable periods in 1996. The research and development focus has been shifted toward automated data entry solutions utilizing application software developed by the Company and its partners. The reduction in expenses for the three months and six months ended June 30, 1997, as compared to the same periods in 1996, was a result of decreased compensation and development expenses associated with reduced R & D headcount and the termination of the development of the Company's next generation processor. This has allowed the Company to focus its R & D expenditures on its revised product strategy, the development of its automated data entry solutions and image recognition and processing engines.
The Company believes that a significant investment in research and development is critical to its future success. To the extent permitted by its liquidity position, the Company plans to continue to invest substantial resources in research and development. If resource constraints cause the Company to allocate resources away from its research and development activities, the Company's future financial position and results of operations could be adversely affected.
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SALES AND MARKETING EXPENSES
Sales and marketing expenses for the three months and six months ended June 30, 1997 were $246,000 and $448,000, respectively, as compared to $538,000 and $1,350,000 for the same periods a year earlier. Sales and marketing expenses are primarily comprised of salary costs, sales commissions, advertising and promotion, and customer literature. Commissions generally vary with sales volume. The level of spending for promotion and literature costs is largely dependent on the level of promotion for new products. The decrease in sales and marketing expenses from the prior year consists of decreases in advertising, promotion, personnel, travel, sales samples, and commission related to lower sales levels.
The Company believes that effective sales and marketing activities are critical to any future growth in sales; accordingly, if resource constraints cause the Company to continue to allocate resources away from these activities, the Company's future financial position and results of operations could be adversely affected.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses for the three months and six months ended June 30, 1997 were $257,000 and $542,000 as compared to $1,740,000 and $2,227,000 for the same period in 1996. The primary components of these expenses are salaries, insurance and fees related to legal, accounting and consulting services. The decreased level of expense from the prior year was primarily due to costs associated with the Company's restructuring in the second quarter of 1996, as well as, reductions in financial personnel and the use of consulting services.
INTEREST INCOME AND EXPENSE
Interest income for the three months and six months ended June 30, 1997 was $32,000 and $66,000 respectively. Interest income for the same periods in 1996 was $53,000 and $80,000, respectively. Interest income varies depending upon the cash balances and prevailing interest rates from period to period. Interest expense for the three months and six months ended June 30, 1997 decreased to $2,000 and $19,000, respectively, from $21,000 and $62,000 for the three months and six months ended June 30, 1996, respectively. In 1997 interest expense was mainly due to the Company's capital lease obligations, while in 1996 interest expense was primarily attributable to the Company's line of credit and capital lease obligations. The Company has not entered into additional capital lease obligations in the current year.
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INCOME TAXES
The completion of the initial public offering in November 1993 constituted a change in ownership that will limit the net operating loss carryforwards that can be used to offset taxable income in future years. See Notes to Condensed Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
To date, the Company has funded its operations primarily through (i) sales of its equity and convertible debt securities with venture capital and other investors, (ii) equipment leases, (iii) revenues from technology development agreements and government research contracts and (iv) revenues from the sales of its CNAPS development systems, boards and software products and PowerShop products.
Although the Company has not established any new capital leases in 1997, as of June 30, 1997, the Company had outstanding capital leases with two major equipment leasing companies at effective interest rates ranging from 10% to 21%.
The aggregate principal amount outstanding under these capital leases, including the current portion, totaled $451,000 at June 30, 1997. Although the Company has no material commitments to purchase capital equipment, the Company may need to expend significant additional amounts for capital equipment in connection with its change in product strategy. The Company's cash and cash equivalents at June 30, 1997 were $2,752,000, a decrease of $860,000 from the cash and cash equivalents balance of $3,612,000 at December 31, 1996. The Company's working capital at June 30, 1997 was $3,382,000, an increase of $554,000 from the working capital balance of $2,828,000 at December 31, 1996. The Company expects that it may need additional funding in the future, although it is unable to predict the precise amount or date that such funding will be required.
The Company will continue considering alternative sources for expected future funding, including equity or debt financings, corporate partnering relationships involving up-front payments and/or equity investments, sales of technology and other alternatives. The Company has not yet identified which, if any, of these courses it will pursue, nor has it received commitments from any such sources for any funding of any kind. Accordingly, there can be no assurance that any such funding can be obtained. If adequate funds are not available as required, the Company's ability to fulfill product orders, as well as the Company's financial position and results of operations, will be adversely affected. In particular, the Company could be required to significantly reduce or suspend its operations, seek a merger partner or sell additional securities on terms that are highly dilutive to existing stockholders. The Company's future capital needs will depend upon numerous factors, including the success of the Company's revised product strategy, the progress of the Company's research and development activities, the extent and timing of the acceptance of the Company's products, the cost of the Company's sales, marketing and manufacturing activities and the amount of revenues generated from operations, none of which can be predicted with certainty, and, therefore, there can be no assurance that the Company will not require additional funding earlier than anticipated.
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The Company has 1,680,764 outstanding warrants entitling the holders to purchase 2,286,319 shares of the Company's common stock at an exercise price of $6.393.
In addition, there are 75,000 warrants outstanding which entitle the holders to purchase 75,000 shares of the Company's common stock at an exercise price of $3.375.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS) No. 128 "Earnings per Share". This statement establishes a different method of computing net income per share than is currently required under the provisions of Accounting Principles Board Opinion No. 15. Under SFAS No. 128, the Company will be required to present both basic net income per share and diluted net income per share. Basic net income per share is expected to be comparable or slightly higher than the currently presented net income per share as the effect of dilutive stock options will not be considered in computing basic net income per share. Diluted net income per share is expected to be comparable or slightly lower than the currently presented net income per share.
The Company plans to adopt SFAS No. 128 in the fourth quarter of 1997 and at that time all historical net income per share data presented will be restated to conform to the provisions of this Statement.
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