February 16, 1999
TAVA TECHNOLOGIES INC (TAVA)
Quarterly Report (SEC form 10-Q)
Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of operations for the three months ended December 31, 1998 compared to the three months ended December 31, 1997.
During June 1997, the Company announced its plans to develop its Plant Y2kOneTM suite of products and services. During the ensuing two quarters, the Company expended considerable time and resources to plan and develop these products. They became widely available for sale during the third quarter of the fiscal year ended June 30, 1998. Sales of these products and services have increased appreciably since that time. As a consequence of the manpower and resources that were expended to develop and introduce the Plant Y2kOneTM products, meaningful comparisons of the changes in the Company's operating results from its fiscal quarters ended December 31, 1998 and 1997 are difficult to make.
During the quarter ended December 31, 1998, the Company had net income in the amount of $5,901,000, compared to a net loss in the amount of $581,000 for the corresponding quarter of fiscal 1998. Revenue increased by $19,403,000 or 185% to $29,887,000 for the quarter ended December 31, 1998 compared to the same quarter of the preceding year. The growth in revenue is primarily attributed to sales of the Company's Plant Y2kOneTM products and services. Sales of these products and services were approximately $22,130,000 during the current quarter with minimal sales in the corresponding quarter of the preceding year. The gross margin during the quarter ended December 31, 1998 improved to 48% compared to 35% for the comparable period of the preceding year. Plant Y2kOneTM revenue is very labor intensive, with a considerably smaller portion of revenue derived from the resale of material and other lower margin non-labor elements, as compared to core system integration services revenue. Software product and license fee sales were $4,744,000 during the current quarter. These sales also contribute greater margins than revenue from core systems integration services. Management anticipates that gross margins will remain at these levels during the next several quarters.
Operating expenses increased by $4,681,000 to $8,862,000 for the quarter ended December 31, 1998 compared to the corresponding quarter of the preceding year. The increase is primarily attributable to higher sales and other administrative expenses, incurred to support growing operations. As a percentage of revenue, sales, marketing and administrative expenses decreased from 37% in the 1997 quarter to 26% in the current quarter. In addition, during the current quarter, the Company added 24 employees to its staff and also added contract employees, resulting in a total increase in staff to 61 during the quarter. Amortization expense increased by $771,000 or 299%. The increase is attributable to the amortization of software development costs associated with the Company's Plant Y2kOneTM products. Although management believes that the Company's Plant Y2kOneTM products may continue to be a valuable asset beyond December 1999, costs associated with their development are being amortized through that date. Management anticipates amortization expenses will increase in calendar year 1999. Total operating expenses, including amortization of goodwill and capitalized software costs, decreased as a percentage of sales from 40% to 30%.
TAVA TECHNOLOGIES, INC.
The Company capitalizes the cost of developing software products which have achieved technological feasibility, but are not yet ready for sale to customers, when it believes there is a market for future use of the technology or when enhancements are made to existing software products. During the quarter ended December 31, 1998, the Company capitalized $550,000 of software development costs, substantially all of which is related to its Plant Y2kOneTM products and database. This compares to $1,179,000 capitalized for the December 1997 quarter.
Earnings from the Company's investment in TAVA/Beck LLC were $467,000 during the current quarter. There were no operating results in the corresponding quarter of the preceding year. Interest expense increased by $89,000 during the current quarter. The increase is primarily due to interest associated with a term note borrowing incurred during March 1998.
During the current quarter, the Company recorded a current provision for state income and franchise taxes in the amount of $505,000 for taxable income in states that do not permit the filing of a consolidated income tax return. Additionally, the Company recognized a deferred tax benefit of $580,000 based on the realization of net operating loss carryforwards ("NOLs") to offset future taxable income. In recognizing a deferred tax asset, management believes that it is more likely than not that the deferred tax asset will be realized. As a result, the Company recorded an income tax benefit in the amount of $75,000 for the quarter ended December 31, 1998.
Results of operations for the six months ended December 31, 1998 compared to the six months ended December 31, 1997.
During the six month period ended December 31, 1998, the Company had net income in the amount of $9,347,000, compared to a net loss of $1,156,000 for the corresponding period of fiscal 1998. Revenue increased by $27,886,000 or 128% to $49,689,000 for the six months ended December 31, 1998 compared to the same period of the preceding year. Gross margin increased from 33% to 49% from 1997 to 1998. Sales of the Company's Plant Y2kOneTM products and services were approximately $35,626,000 during the current six month period. The net loss incurred during the first six months of fiscal 1998 is primarily attributed to the start-up costs associated with the Company's Plant Y2kOneTM products and services. These products and services became generally available for sale during the third quarter of fiscal year 1998.
As a result of the Company's rapid growth, operating expenses increased by $7,357,000, or 90%, to $15,499,000 for the six months ended December 31, 1998. Sales expenses increased by 104% to $4,093,000 and general and administrative expenses increased by 69% to $9,465,000 from 1997 to 1998. During the six month period ended December 31, 1998, the Company hired 61 additional employees at all levels and in all disciplines, plus additional contract employees. Non-cash expenditures for the amortization of capitalized software, goodwill and depreciation amounted to $1,941,000 during the current six month period. This compares to $546,000 for the corresponding six month period of the previous year. Interest expense for the current period increased to $517,000 from $315,000 compared to the six months ended December 31, 1997. The increase is primarily due to interest associated with a term note borrowing incurred during March 1998.
During the six months ended December 31, 1998, the Company capitalized $1,146,000 of software development costs, substantially all of which is related to its Plant Y2kOneTM products and database. This compares to $1,842,000 capitalized for the six months ended December 31, 1997.
During the six months ended December 31, 1998, the Company recorded a provision for state income and franchise taxes in the amount of $580,000 for taxable income in states that do not permit the filing of a consolidated income tax return. Additionally, the Company recognized a deferred tax benefit of $580,000 based on the realization of net operating loss carryforwards ("NOLs") to offset future taxable income. In recognizing a deferred tax asset, management believes that it is more likely than not that the deferred tax asset will be realized. As a result, the Company recorded no income tax expense for the six months ended December 31, 1998. At December 31, 1998, the Company had NOLs of approximately $9,000,000 available for Federal income tax purposes that expire through 2019. Utilization of a portion of the NOLs is subject to an annual limitation as a result of Internal Revenue Code Section 382.
TAVA TECHNOLOGIES, INC.
Liquidity and capital resources.
During December 1998, the Company entered into a $3,000,000 revolving line of credit with a commercial bank. The credit facility was entered into to provide short-term financing of the Company's accounts receivable, which have grown significantly during the last six months. The facility is secured by the assets of TAVA Y2kOne, Inc. At December 31, 1998, $1,700,000 is outstanding under the line of credit.
As a result of the increase in accounts receivable and costs incurred to date in excess of billings to customers from the higher levels of revenue and anticipated revenue, the Company increased its allowance for doubtful accounts by $858,000 to $2,163,000 during the six months ended December 31, 1998. Management continually reviews the allowance for adequacy and believes that its current level will be sufficient to provide for any potential losses that may be incurred in the collection of the Company's accounts receivable and the ultimate recognition of costs incurred in excess of billings to customers. Management anticipates that the Company's accounts receivable and costs in excess of billings will continue to increase in the future in proportion to expected revenue growth.
During December 1998, the Company sold $2,058,000 of its accounts receivable under a factoring agreement with a commercial bank. Under the factoring agreement, the receivables are discounted at an interest rate of 9.75% per annum over the period from sale to collection of the receivables.
The Company's working capital position improved to $25,768,000 at December 31, 1998 from $17,322,000 at June 30, 1998. The Company's cash position at December 31, 1998 was $7,505,000, an increase of $2,512,000 from June 30, 1998.
The Company's convertible debenture agreements require principal repayments beginning June 1, 1999. If the debentures are not converted into the Company's common stock, the Company believes it will have adequate financial resources to comply with the repayment terms.
Subsequent to December 31, 1998, the Company was approved for an equipment lease facility with a financial institution. The facility permits the Company to enter into lease arrangements up to an aggregate amount of $500,000. The Company anticipates utilizing this facility during the next 12 months for acquiring additional computer equipment for anticipated additional employees.
In order to support the anticipated higher levels of future operations, management believes that the Company may require additional credit or financing facilities. Management believes that, if required, additional credit facilities will be available to the Company on commercial terms.
Capital expenditures and product development costs.
The Company is continuing with the implementation and installation of a project accounting and financial and operational reporting system. As of December 31, 1998, the Company has capitalized total costs of $776,000, which includes $367,000 capitalized during the current quarter in connection with this implementation. In addition, the Company has commitments of approximately $75,000 during the remainder of fiscal 1999 to complete the installation of this project.
During the six months ended December 31, 1998, the Company capitalized $1,146,000 of costs, substantially all of which is related to its Plant Y2kOneTM products and database. To date, $4,341,000 has been capitalized for software development. At December 31, 1998, the net book value of capitalized software costs of Plant Y2kOneTM was $3,143,000. All costs associated with the development of the Plant Y2kOneTM database will be fully amortized by December 1999, and, as a result, amortization of capitalized software costs will be higher over the next 12 month period.
The Company has no other material commitments for capital expenditures. However, the Company recently expanded the office space it leases for its corporate office and has recently announced the opening of a new engineering and sales office in Walnut Creek, California. Together with anticipated staff additions, management believes that the Company will be acquiring telephone systems, computer equipment and furniture to accommodate future growth.
TAVA TECHNOLOGIES, INC.
Cash flow.
During the six months ended December 31, 1998, cash increased by $2,512,000. Funds provided by operations were $2,782,000, an increase of $7,838,000 over the corresponding period of the preceding year. The increase is attributable to the higher levels of operating activity and additional financing activities. Operating funds were used to finance accounts receivable, which increased by $7,136,000 and costs in excess of billings, which increased by $5,016,000, during the six month period. During the first two quarters of fiscal 1999, investments were made in capital equipment, $937,000, and in capitalized software development costs, $1,146,000. Financing activities provided $1,813,000 of cash proceeds, primarily from borrowings in the amount of $1,700,000. In addition, the Company made debt principal repayments in the amount of $238,000, and received cash in the amount of $323,000 from the exercise of stock options and stock purchase warrants.
Impact of recently issued accounting standards.
Effective July 1, 1998, the Company adopted Statement of Position 97-2, "Software Revenue Recognition" which modifies the revenue recognition criteria for software products and supersedes Statement of Position 97-1, "Software Revenue Recognition." This statement requires, among other things, that the individual elements of a contract for the sale of software products be identified and accounted for separately. The effect of the adoption of this pronouncement was not material to the Company's financial position, results of operations or its cash flows.
Statement of Financial Accounting Standards 131 "Disclosures About Segments of an Enterprise and Related Information." Statement 131 supersedes Statement of Financial Accounting Standards 14 "Financial Reporting for Segments of a Business Enterprise." Statement 131 establishes standards on the way that public companies report financial information about operating segments in annual financial statements and requires reporting of selected information about operating segments in interim financial statements issued to the public. It also establishes standards for disclosures regarding products and services, geographic areas and major customers. Statement 131 defines operating segments as components of a company about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
The additional disclosures required by Statement 131 are effective for annual financial statements for periods beginning after December 15, 1997 and require comparative information for earlier years to be restated. Statement 131 will not affect the Company's financial position, results of operations or its cash flows.
Statement of Financial Accounting Standards 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." Statement 134 established accounting and reporting standards for certain activities of mortgage banking enterprises and other enterprises that conduct operations that are substantially similar to the primary operations of a mortgage banking enterprise. Statement 134 is effective for the first fiscal quarter beginning after December 15, 1998. Management believes the adoption of this statement will have no material impact on TAVA's consolidated financial statements.
Year 2000 assessment.
The following disclosure is made pursuant to the Year 2000 Information and Readiness Disclosure Act. The following disclosure originated from the Company and concerns (1) assessments, projections, or estimates of Year 2000 processing capabilities; (2) plans, objectives, or timetables for implementing or verifying Year 2000 processing capabilities; (3) test plans, dates, or results; and/or (4) reviews and comments concerning Year 2000 processing capabilities as defined by the Act.
The Company has recently appointed a senior level executive to assess and monitor its internal and external exposure to Year 2000 compliance. The Company has assessed Year 2000 compliance matters and has determined that it has potential for exposure regarding Year 2000 compliance in three areas of its internal and external business activities. These areas include (1) its own internal hardware and software systems which are utilized to process and provide the Company's accounting and operational information, (2) the hardware and software systems it has historically designed and installed in its clients' control systems, and (3) Year 2000 inventory, assessment and remediation services it is providing to assist its customers in identifying their own
TAVA TECHNOLOGIES, INC.
potential exposure in their manufacturing and control systems under the Company's Plant Y2kOneTM product and service offering. The following discusses management's assessment of those risks and the steps it is taking to mitigate them.
Internal hardware and software. During the past two years, the Company has replaced or added new equipment to its inventory of network and systems computers. The Company has committed approximately $1,350,000 for this hardware replacement, which has been financed with its cash resources and with lease financing. This hardware includes the Company's organization-wide network system and servers, telephone systems and personal computer equipment. The Company has tested Year 2000 compliance on new hardware as it has been accepted. In addition, the Company is presently implementing the installation of a new organization-wide accounting and management information computer software. This new software will operate the Company's accounting and operational information systems and will be functional at each of its facility locations. The vendor has warranted that the software is Year 2000 compliant. Customization of the software has been completed and staff training has begun. It is estimated that the system will be installed and functional by February 1999. The cost of this system is expected to be approximately $850,000, including software, hardware and implementation expense. The primary purpose of acquiring this system is to provide improved functionality in the area of consolidated financial reporting, financial project control and management reporting. In addition, the Company is reviewing its telecommunication systems and analyzing various options to purchase and install a central telecommunication system that would provide increased functionality associated with multiple office communication requirements. This evaluation is expected to be complete by March 1999 with a resulting installation expected by July 1999. Until this evaluation is complete, it is not possible to estimate costs associated with a new telecommunication system. However, it is not anticipated that this program will be a significant capital expenditure. Management intends to develop a contingency plan by March 31, 1999 if the planned implementation program is delayed.
In addition to the above activities, the Company is in the final process of completing a full inventory and assessment of its computer hardware, software systems and embedded devices using its proprietary Plant Y2kOneTM product. Management intends to identify any remaining remediation effort that may be required to ensure its internal hardware and software systems are Year 2000 compliant.
Prior customer installations. The Company and its subsidiaries have provided systems integration hardware and software for use by clients in their process control systems. Generally, the hardware is purchased from a vendor and used without further customization. Hardware vendor warranties pass to the Company's clients. Software may be purchased from a third party vendor and further customized, or be completely designed by the Company. During 1997, the Company undertook a program of notifying many of its customers that it is aware that hardware and software it provided may not be Year 2000 compliant and should be assessed for Year 2000 compliance. To date, the Company has received various inquires from its clients to provide information regarding Year 2000 compliance on systems it has developed and has responded to these requests. Management is not aware of any claims by any customers to provide remediation services under any warranty agreement (stated or implied) for systems it has developed and delivered, nor is it aware of any systems it has developed that may be in violation of any Year 2000 compliance contractual agreements. To the extent any such claims may be made, the Company intends to address these issues on a case by case basis.
Year 2000 compliance services and products and remediation services. In late June 1997, TAVA launched a major business initiative to address Year 2000 compliance problems in process control, factory automation and facility management systems. The Company determined that addressing the Year 2000 issue in these systems was a logical extension of its current business. The Company developed a proprietary package of products and services, Plant Y2kOneTM, as the foundation of its approach. PlantY2kOneTM includes a methodology, system inventory support tool, access to a Company developed database of Year 2000 compliance information, specific code search engines and a remediation project management tool, all packaged on CD ROM.
The methodology includes assessment, analysis, planning and remediation phases. In the assessment phase, the overall project is defined and organized. An inventory of all process control hardware and software is then completed using the Company's inventory builder tool. In the analysis phase, that inventory is examined, component by component, using the Company's database of vendor Year 2000 compliance statements. Custom code is analyzed with the Company's search engines to reveal date usage. The conversion planning stage applies the results of the analysis to develop a plan for bringing the client's system into Year 2000 compliance. The final stage is to develop and execute the remediation plan and conduct system and enterprise wide training.
TAVA TECHNOLOGIES, INC.
The Company supplies complete Year 2000 project consulting services. They are built upon the methodology and use of the database and tools; the licensing of the methodology, tools and database access which are packaged on CD ROM and supported by internet access to the client for self execution, or provides a combination of both approaches.
The Company has employed three general strategies to monitor and limit risk in performing Year 2000 engagements. These include: proper assignment of skilled employees; delineation and limitation of liability through contractual terms; and purchasing professional liability insurance in amounts and on terms considered appropriate by Company management. The Company believes that this business is a logical extension of its historical business and as such, it has the appropriate employee skill sets to execute its Year 2000 engagements. Service projects are managed by experienced project managers who assume the role of managing the overall customer engagement. Service engagements are generally conducted under a standard professional services agreement that delineates deliverables and liability. The Company has worked diligently in its contractual agreements to attempt to limit liability, in most cases to no more than the total amount of fees paid by the client. Further, the Company has secured professional liability insurance to address professional liability that may arise from Year 2000 customer engagements. The Company's standard contracts specifically disclaim any Year 2000 compliance warranty or guarantees, or the success of its Year 2000 activities in addressing client compliance, except when it has been contracted to develop and implement new systems. The Company has relied on external legal counsel to assist in developing specific contractual terms to disclaim any legal liability associated with insuring, or guaranteeing Year 2000 compliance as a result of its activities. To the knowledge of management, the Company has not been associated with any liability for work it conducted in providing Year 2000 products and services.
Item 3. Quantitative and qualitative disclosures about market risk.
Market risk represents the risk of loss that may impact the financial position, results of operations, or cash flows of the Company due to adverse changes in financial market prices, including interest rate risk. The Company is subject to interest rate risk through a short-term line of credit, which bears interest at prime plus 1/2% and other fixed rate term debt. The Company does not consider this potential interest rate risk to be significant to the financial statements as a whole. The Company manages its interest rate risk generally through short-term financing arrangements and long-term fixed rate borrowings.
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