<PAGE>
SECURITIES & EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1999
[ ] TRANSITIONAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (No Fee Required)
Commission File No. 000-24637
JENKON INTERNATIONAL, INC.
----------------------------------------------
(Name of Small Business Issuer in its Charter)
Delaware 91-1890338
- -------------------------------------------------------------------------------
State or other jurisdiction of I.R.S. Employer
incorporation or organization Identification No.
7600 N.E. 41st Street, Suite 350, Vancouver, Washington 98662
- -------------------------------------------------------------------------------
Address of principal executive office Zip Code
Issuer's telephone number: (360) 256-4400
---------------
Check whether the issuer has (1) filed all reports required by Section 13 or
15(d) of the Exchange Act during the past 12 months, and (2) been subject to
such filing requirements for the past ninety (90) days. Yes X No
----- -----
As of March 31, 1999, [4,253,515] shares of Common Stock were outstanding.
<PAGE>
PART I -- FINANCIAL INFORMATION
JENKON INTERNATIONAL, INC. AND SUBSIDIARIES
ITEM 1. FINANCIAL STATEMENTS:
CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 1999 (UNAUDITED) AND JUNE 30,
1998 (AUDITED)
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THREE MONTHS ENDED
MARCH 31, 1999 AND 1998
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS FOR NINE MONTHS ENDED
MARCH 31, 1999 AND 1998
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED MARCH 31,
1999 AND 1998
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
-2-
<PAGE>
JENKON INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, June 30,
1999 1998
- ----------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $1,281,041 $200,557
Restricted cash - 200,000
Trade receivables, net of allowance for
doubtful accounts of $368,900 and $146,500 1,050,683 1,078,268
Prepaid and other assets 288,447 88,998
Refundable income taxes - 24,308
- ----------------------------------------------------------------------
Total current assets 2,620,171 1,592,131
PROPERTY AND EQUIPMENT, net of accumulated
depreciation of $793,400 and $474,100 1,078,778 1,088,926
CAPITALIZED SOFTWARE COSTS, net of
accumulated amortization of $527,212
and $442,278 160,526 226,486
PREPAID FUNDING AND OFFERING COSTS - 374,364
OTHER ASSETS 261,955 160,537
- ----------------------------------------------------------------------
Total assets $4,121,430 $3,442,444
- ----------------------------------------------------------------------
- ----------------------------------------------------------------------
</TABLE>
-3-
<PAGE>
JENKON INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, June 30,
1999 1998
- --------------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable $403,991 $563,924
Accrued vacation 150,544 152,077
Customer deposits 585,600 425,684
Other accrued liabilities 292,255 543,016
Bridge loans - 591,964
Notes payable - current portion 153,384 410,213
- --------------------------------------------------------------------------------------
Total current liabilities 1,585,774 2,686,878
NOTES PAYABLE, net of current portion 7,689 106,529
- --------------------------------------------------------------------------------------
Total liabilities 1,593,463 2,793,407
COMMITMENTS AND CONTINGENCIES
SERIES A, REDEEMABLE CONVERTIBLE PREFERRED STOCK,
$0.001 par value; 5,000,000 shares authorized;
Series A, 1,500,000 shares issued and outstanding - 2,310,174
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, par value $.001; 20,000,000 shares
authorized; 4,409,970 and 1,955,674 shares issued,
4,253,515 and 1,799,220 shares outstanding 4,410 1,956
Additional paid-in capital 7,389,263 601,483
Stock subscriptions receivable (8,500) (8,500)
Foreign currency translation adjustment (14,715) (28,190)
Accumulated deficit (4,502,491) (1,887,886)
Treasury stock, at cost, 156,454 shares (340,000) (340,000)
- --------------------------------------------------------------------------------------
Total stockholders' equity (deficit) 2,527,967 (1,661,137)
- --------------------------------------------------------------------------------------
Total liabilities and stockholders' equity (deficit) $4,121,430 $3,442,444
- --------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
-4-
<PAGE>
JENKON INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1999 1998
- ----------------------------------------------------------------------------
(Unaudited) (Unaudited)
<S> <C> <C>
NET SALES
Software license fees $293,460 $1,520,893
Equipment, software and supplies sales 140,424 283,485
Support and operations revenue 642,294 1,014,723
- ----------------------------------------------------------------------------
Total net sales 1,076,178 2,819,101
- ----------------------------------------------------------------------------
COST OF REVENUES
Cost of software license fees 28,312 32,943
Cost of equipment, software and supplies sold 71,142 201,638
Cost of support and operations 641,695 510,112
- ----------------------------------------------------------------------------
Total cost of revenues 741,149 744,693
- ----------------------------------------------------------------------------
GROSS PROFIT 335,029 2,074,408
OPERATING EXPENSES
Selling and marketing 229,035 191,124
Product research, development and enhancements 228,377 199,198
General and administration 1,391,914 871,781
- ----------------------------------------------------------------------------
Total operating expenses 1,849,326 1,262,103
- ----------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS (1,514,297) 812,305
OTHER INCOME (EXPENSE)
Interest, net 7,558 (13,801)
Other income (expense) (33,550) (42,323)
- ----------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAX (1,540,289) 756,181
PROVISION (BENEFIT) FOR INCOME TAX - 48,867
- ----------------------------------------------------------------------------
NET INCOME (LOSS) $(1,540,289) $707,314
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
NET INCOME (LOSS) PER SHARE
Basic $(0.36) $0.36
Diluted (0.36) 0.22
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
Basic 4,253,516 1,955,678
Diluted 4,253,516 3,202,289
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
-5-
<PAGE>
JENKON INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED MARCH 31, 1999 1998
- -------------------------------------------------------------------------------
(Unaudited) (Unaudited)
<S> <C> <C>
NET SALES
Software license fees $2,120,345 $3,090,640
Equipment, software and supplies sales 723,784 638,783
Support and operations revenue 2,207,591 3,318,211
- -------------------------------------------------------------------------------
Total net sales 5,051,720 7,047,634
- -------------------------------------------------------------------------------
COST OF REVENUES
Cost of software license fees 137,016 195,720
Cost of equipment, software and supplies sold 334,168 372,830
Cost of support and operations 1,950,945 1,816,168
- -------------------------------------------------------------------------------
Total cost of revenues 2,422,129 2,384,718
- -------------------------------------------------------------------------------
GROSS PROFIT 2,629,591 4,662,916
OPERATING EXPENSES
Selling and marketing 740,214 673,711
Product research, development and enhancements 569,177 643,439
General and administration 3,379,733 2,803,477
- -------------------------------------------------------------------------------
Total operating expenses 4,689,124 4,120,627
- -------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS (2,059,533) 542,289
OTHER INCOME (EXPENSE)
Interest, net (513,903) (87,044)
Other income (expense) (41,169) (28,118)
- -------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAX (2,614,605) 427,127
PROVISION (BENEFIT) FOR INCOME TAX - 15,577
- -------------------------------------------------------------------------------
NET INCOME (LOSS) $(2,614,605) $411,550
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NET INCOME (LOSS) PER SHARE
Basic $(0.67) $0.21
Diluted (0.67) 0.12
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
Basic 3,905,671 1,955,678
Diluted 3,905,671 3,358,744
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
-6-
<PAGE>
JENKON INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
<TABLE>
<CAPTION>
NINE MONTHS ENDED MARCH 31, 1999 1998
- --------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $(2,614,605) $411,550
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 417,915 288,494
Amortization of original issue discount 408,036 -
Provision for doubtful accounts 393,904 81,328
Foreign currency translation adjustment 13,475 (444)
Loss on disposal of fixed assets 11,408 -
Increase (decrease) from changes in operating
Assets and liabilities:
Trade receivables (366,319) (514,573)
Prepaid and other assets (199,449) (62,152)
Refundable income taxes 24,308 131,345
Other assets (186,352) -
Accounts payable (159,933) (225,839)
Accrued vacation (1,533) -
Customer deposits 159,916 (131,850)
Other accrued liabilities (250,761) 140,882
- --------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (2,349,990) 118,741
- --------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (267,341) (83,521)
Proceeds from sale of fixed assets 18,033 -
Additions to capitalized software costs (18,973) -
- --------------------------------------------------------------------------------------------
Net cash used in investing activities (268,281) (83,521)
- --------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Restricted cash 200,000 100,000
Additions to prepaid funding and offering costs (459,076) -
Repayment of Bridge Loans (1,000,000) -
Payments on notes payable (355,669) (184,470)
Net proceeds from initial public offering 5,313,500 -
- --------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 3,698,755 (84,470)
- --------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,080,484 (49,250)
CASH AND CASH EQUIVALENTS, beginning of period 200,557 132,736
- --------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of period $1,281,041 $83,486
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
-7-
<PAGE>
JENKON INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. STATEMENT OF In the opinion of management the accompanying
INFORMATION unaudited financial statements contain all
FURNISHED adjustments (consisting only of normal and
recurring accruals) necessary to present fairly
the financial position as of March 31, 1999, and
the results of operations and cash flows for the
nine month period ended March 31, 1999 and 1998.
These results have been determined on the basis
of generally accepted accounting principles and
practices applied consistently with those used in
the preparation of the Company's Annual Report on
Form 10-KSB for the fiscal year ended June 30,
1998.
The results of operations for the nine-month
period ended March 31, 1999 are not necessarily
indicative of the results to be expected for any
other period or for the entire year.
Certain information and footnote disclosures
normally included in financial statements
presented in accordance with generally accepted
accounting principles have been condensed or
omitted. The accompanying financial statements
should be read in conjunction with the Company's
audited financial statements and notes thereto
included in the Company's Annual Report on Form
10-KSB for the year ended June 30, 1998.
2. REVENUE RECOGNITION The Company adopted Statement of Position 97-2,
"Software Revenue Recognition", ("SOP 97-2")
effective July 1, 1998. In accordance with SOP
97-2, the Company recognizes revenue on sales of
internally-developed software and turnkey systems
when the following criteria are met; (i)
persuasive evidence of an arrangement exists,
(ii) delivery has occurred and the system is
functionable, (iii) the vendor's fee is fixed or
determinable and (iv) collectibility is probable.
Also in accordance with SOP 97-2, the Company
allocates the fee of a multiple element contract
to the various elements based on vendor-specific
objective evidence of fair value. Revenue
allocated to a specific element is recognized
when the basic revenue recognition criteria above
are met for that element. If sufficient
vendor-specific objective evidence for all
elements does not exist to allocate revenue to
the elements, all revenue from the arrangement
generally would be deferred until such evidence
does exist or until all elements have been
delivered. Revenues related to installation of
systems requiring substantial future performance
by the Company are recognized using the
percentage-of-completion method based on meeting
key milestone events over the terms of the
contract. Customization and training revenue is
recognized as revenue as the services are
performed. Future sales of the Company's existing
products may be contingent upon delivery of the
future software products. This would defer a
portion or all of the revenue, until the Company
has delivered all elements of the sales contract.
-8-
<PAGE>
JENKON INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. REVENUE RECOGNITION During the nine months ended March 31, 1999 two
(CONTINUED) customers accounted for 29% of total revenue.
The Company had no customers that accounted for
more than 10% of total revenue for the nine
months ended March 31, 1998. During the three
month period ended March 31, 1999 and 1998 two
customers accounted for 47.3% and 22.6% of total
revenue, respectively.
3. EARNINGS (LOSS) PER The Company computes loss per common share under
COMMON SHARE SFAS No. 128, "Earnings Per Share," which
requires presentation of basic and diluted
earnings (loss) per share. Basic earnings (loss)
per common share is computed by dividing income
or loss available to common shareholders by the
weighted average number of common shares
outstanding for the reporting period. Diluted
earnings (loss) per common share reflects the
potential dilution that could occur if securities
or other contracts, such as stock options, to
issue common stock were exercised or converted
into common stock. Common stock options and
convertible preferred stock were not included in
the computation of diluted loss per common share
for the three and nine months ended March 31,
1999, because the effect would be antidilutive.
4. INITIAL PUBLIC In August 1998, the Company completed an initial
OFFERING (IPO) public offering of 1,500,000 shares, of which
1,210,000 shares were offered by the Company and
290,000 shares by selling shareholders. Net
proceeds to the Company were approximately
$4,480,000 after deducting all offering-related
expenses of $1,570,000. The Company used a
portion of the proceeds to repay the outstanding
indebtedness of $1,000,000, which was incurred
with the 1998 private placement, and
approximately $272,500 related to other
indebtedness approximately $2,000,000 has been
used for general working capital, $500,000 for
product development, and $250,000 for sales and
marketing. The Company intends to use the
remaining proceeds for the development of new
products and upgrades, expansion of the Company's
sales and marketing efforts and general working
capital.
5. UNITED KINGDOM During the third quarter of 1998, the Company
OPERATIONS decided to close their United Kingdom office and
is winding up its international affairs.
6. COMPREHENSIVE Comprehensive income for the three months ended
INCOME March 31, 1999 and 1998 is comprised of net
income (loss) of $(1,540,289) and $707,314 and
foreign currency translation adjustment of
$19,166 and $(129).
Comprehensive income for the nine months ended
March 31, 1999 and 1998 is comprised of net income
(loss) of $(2,614,605) and $411,550 and foreign
currency translation adjustment of $13,475 and
$(445).
7. INCOME TAXES Due to the significant operating losses
incurred by the Company for the three and nine
month periods ended March 31, 1999, the Company
has recorded a 100% valuation allowance on its
net deferred tax asset since management cannot
determine whether it is more likely than not that
the deferred tax assets may be realized.
-9-
<PAGE>
JENKON INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. CONCENTRATION OF The Company is dependent on third-party equipment
SUPPLIERS manufacturers and distributors for all of its
supply of computer equipment and some of its
software accessories. During the nine month
periods ended March 31, 1999 and 1998, one
supplier accounted for 18% and 10% of total
purchases, respectively.
9. RELATED PARTY The Company has purchase arrangements with
TRANSACTIONS Jenetek, an entity wholly-owned by a related
party. Purchases from Jenetek amounted to
$80,239 and $0 for the nine months ended March
31, 1999 and 1998, respectively.
At March 31, 1999, the Company had receivables
due from two officers amounting to $146,563. At
March 31, 1998, the Company had a receivable due
from one officer of $21,563.
-10-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The following discussion and analysis should be read in conjunction
with the Company's Consolidated Financial Statements and notes thereto
included elsewhere in this Form 10-QSB. Except for the historical information
contained herein, the discussion in this Form 10-QSB contains certain
forward-looking statements that involve risks and uncertainties, such as
statements of the Company's plans, objectives, expectations and intentions.
The cautionary statements made in this Form 10-QSB should be read as being
applicable to all related forward-looking statements wherever they appear in
this Form 10-QSB. The Company's actual results could differ materially from
those discussed here. Factors that could cause or contribute to such
differences include, without limitation, those factors discussed below under
"Additional Considerations and Risk Factors" herein and in the Company's
Annual Report on Form 10-KSB for the year ended June 30, 1998.
COMPARISON OF THREE MONTHS ENDED MARCH 31, 1999 TO MARCH 31, 1998
REVENUES. Total revenues decreased 61.8% to $1,076,000 for the three
months ended March 31, 1999 from $2,819,000 for the same period in 1998. The
decrease was primarily attributable to a significant reduction in software
license revenue and support and operations revenue as described below. During
the three month period ended March 31, 1999 two clients accounted for 47.3%
of total revenue. For the three month period ended March 31, 1998 two clients
accounted for 22.6% of total revenue.
As a result of increased competitive pressures, the Company has
accelerated the development of its next generation management information
system. The Company has incurred and will continue to incur significant
losses during the next six to twelve months due primarily to decreased demand
for its existing products, as well as the costs associated with the
development of this new product and delays in revenue recognition for sales
of existing products that are linked to or contingent upon delivery of the
new management information system. Such revenues would be recognized at such
time as the Company has completed its obligations under any such sales
contracts.
SOFTWARE LICENSE REVENUES. Software license revenues decreased 80.7%
to $293,000 for the three months ended March 31, 1999 from $1,521,000 for the
same period in 1998. The decrease in software license revenue was due to a
reduction in system sales and additional modules sold to new and existing
clients, as a result of increased competition in the marketplace and decreased
demand for older generation products.
EQUIPMENT, SOFTWARE, AND SUPPLIES REVENUES. Equipment, software and
supplies revenues decreased 50.5% to $140,000 for the three months ended
March 31, 1999 from $283,000 for the same period in 1998. The decrease was
primarily attributable to the decrease in resale of third party software
required to run the Company's software products. This decrease is directly
related to the decrease in software license revenues. The Company has reduced
its emphasis on selling computer hardware and makes exceptions only when the
margins on the overall contract are acceptable.
-11-
<PAGE>
SUPPORT AND OPERATIONS REVENUE. Support and operations revenue
decreased 36.7% to $642,000 for the three months ended March 31, 1999 from
$1,015,000 for the same period in 1998. The decrease is primarily
attributable to the lack of custom programming jobs during the recent period
compared to the same period last year which included two substantial custom
programming jobs. The decrease is partially offset by increased maintenance
contract revenues resulting primarily from an increase in the number of
customers paying maintenance for new and upgraded systems.
COST OF REVENUES. Total cost of revenues decreased by $4,000 or 0.5%
to $741,000 for the three months ended March 31, 1999 as compared to $745,000
for the same period in 1998. This decrease was primarily due to a decrease in
the cost of equipment, software and supplies described below which was
offset, in part by an increase in the costs of support and operations. As a
percentage of revenues, cost of revenues increased to 68.9% for the three
months ended March 31, 1999 from 26.4% for the same period in 1998 due
primarily to a significant decrease in revenues.
COST OF SOFTWARE LICENSES. The cost of software licenses consists
primarily of the cost of the third party provided supplies that are included
with the Company's systems and amortization of capitalized software costs.
The cost of software licenses remained relatively constant between the
periods totaling $28,000 for the three months ended March 31, 1999 from
$33,000 for the same period in 1998.
COST OF EQUIPMENT, SOFTWARE AND SUPPLIES SOLD. The cost of
equipment, software and supplies sold consists primarily of the cost of
computer hardware and third-party software and related peripheral equipment
purchased by the Company from various suppliers for resale as part of the
Company's turnkey systems. These costs decreased by 64.9% to $71,000 for the
three months ended March 31, 1999 from $202,000 for the same period in 1998,
primarily as a result of the decrease in the proportion of revenues derived
from resale of lower-margin third party software products.
COST OF SUPPORT AND OPERATIONS. The cost of support and operations
consists primarily of personnel costs, travel and materials associated with
providing implementation, education and training, consulting and technical
services. These costs increased by 25.9% to $642,000 for the three months
ended March 31, 1999 from $510,000 for the same period in 1998. The increase
in costs is related primarily to moving certain NOW! product programmers from
research and development to operations upon completion of development of the
NOW! product.
GROSS PROFIT. Gross profit decreased by 83.8% to $335,000 for the
three months ended March 31, 1999 from $2,074,000 for the same period in
1998. Overall gross profit as a percentage of total revenues decreased to
31.1% for the three months ended March 31, 1999 from 73.6% for the same
period in 1998, mainly as a result of the substantial decrease in support and
operations revenue and the relatively fixed cost of support and operations
during the quarter. The cost of support and operations were relatively fixed
during such period; however, the Company has taken steps to reduce personnel
costs subsequent to March 31, 1999. Gross profit on the Company's software
license revenues is significantly higher than on revenues from equipment,
services and maintenance. Gross profit on software licenses decreased for the
three
-12-
<PAGE>
months ended March 31, 1999 to 90.4% from 97.8% in 1998 primarily due to
competitive pressures. Gross profit on support and operations revenue
decreased to .09% for the three months ended March 31, 1999 from 49.7% for
the same period in 1998 mainly due to the significant reduction in support
and operations revenue and relatively fixed labor costs. The increase in
third party software and equipment gross profit to 49.3% for the three months
ended March 31, 1999 from 28.9% for the same period in 1998 was primarily due
to a change in mix of third party software sales with a greater portion of
higher margin sales occurring during the three months ended March 31, 1999.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses
increased 19.9% to $229,000 for the three months ended March 31, 1999 from
$191,000 for the same period in 1998. The increase was primarily attributable
to NOW! related marketing efforts.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
decreased 14.6% to $228,000 for the three months ended March 31, 1999 from
$199,000 for the same period in 1998. The increase is primarily related to
the acceleration of the development of its next generation management
information system, offset by the decrease of research and development
related to the NOW! product. The Company expects that research and
development expenses will increase substantially in future periods as the
Company increases its efforts to develop new products.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses increased 59.6% to $1,392,000 for the three months ended March 31,
1999 from $872,000 for the same period in 1998. The increase is primarily
related to an increase in professional service expense and an increase of
$200,000 in the allowance for potentially uncollectable accounts receivable
related to a contract dispute pertaining to a sale to one customer recorded
in fiscal year 1999.
COMPARISON OF NINE MONTHS ENDED MARCH 31, 1999 TO MARCH 31, 1998
REVENUES. Total revenues decreased 28.3% to $5,052,000 for the nine
months ended March 31, 1999 from $7,048,000 for the same period in 1998. The
decrease was primarily attributable to a significant reduction in software
license revenue and support and operations revenue as described below. During
the nine month period ended March 31, 1999 two clients accounted for 29.0% of
total revenue. The Company had no customers that accounted for more than 10%
of the Company's sales for the nine months ended March 31, 1998.
As a result of increased competitive pressures, the Company has
accelerated the development of its next generation management information
system. The Company has incurred and will continue to incur significant
losses during the next six to twelve months due primarily to decreased demand
for its existing products, as well as the costs associated with the
development of this new product and delays in revenue recognition for sales
of existing products that are linked to or contingent upon delivery of the
new management information system. Such revenues would be recognized at such
time as the Company has completed its obligations under any such sales
contracts.
-13-
<PAGE>
SOFTWARE LICENSE REVENUES. Software license revenues decreased 31.4%
to $2,120,000 for the nine months ended March 31, 1999 from $3,091,000 for
the same period in 1998. The decrease in software license revenue was due to
a reduction in system sales and additional modules sold to new and existing
clients, as a result of increased competition in the marketplace and decreased
demand for older generation products.
EQUIPMENT, SOFTWARE, AND SUPPLIES REVENUES. Equipment, software and
supplies revenues increased 13.3% to $724,000 for the nine months ended March
31, 1999 from $639,000 for the same period in 1998. The increase was
primarily attributable to the sale of third party software required to run
the Company's software products including the NOW! Internet product. The
Company has reduced its emphasis on selling computer hardware and makes
exceptions only when the margins on the overall contract are acceptable.
SUPPORT AND OPERATIONS REVENUE. Support and operations revenue
decreased 33.5% to $2,208,000 for the nine months ended March 31, 1999 from
$3,318,000 for the same period in 1998. The decrease is primarily
attributable to the lack of custom programming jobs during the recent period
compared to the same period last year which included two substantial custom
programming jobs. The decrease is partially offset by increased maintenance
contract revenues resulting primarily from an increase in the number of
customers paying maintenance for new and upgraded systems.
COST OF REVENUES. Total cost of revenues were consistent between the
periods totaling $2,422,000 for the nine months ended March 31, 1999 and
$2,385,000 for the same period in 1998. As a percentage of revenues, cost of
revenues increased to 47.9% for the nine months ended March 31, 1999 from
33.8% for the same period in 1998 due primarily to a significant decrease in
revenues.
COST OF SOFTWARE LICENSES. The cost of software licenses consists
primarily of the cost of the third party provided supplies that are included
with the Company's systems and amortization of capitalized software costs.
The cost of software licenses decreased 30.1% to $137,000 for the nine months
ended March 31, 1999 from $196,000 for the same period in 1998.
COST OF EQUIPMENT, SOFTWARE AND SUPPLIES SOLD. The cost of
equipment, software and supplies sold consists primarily of the cost of
computer hardware and third-party software and related peripheral equipment
purchased by the Company from various suppliers for resale as part of the
Company's turnkey systems. These costs decreased by 10.5% to $334,000 for the
nine months ended March 31, 1999 from $373,000 for the same period in 1998.
COST OF SUPPORT AND OPERATIONS. The cost of support and operations
consists primarily of personnel costs, travel and materials associated with
providing implementation, education and training, consulting and technical
services. These costs increased by 7.4% to $1,951,000 for the nine months
ended March 31, 1999 from $1,816,000 for the same period in 1998. The
increase primarily relates to the
-14-
<PAGE>
reclassification of NOW! programmers from research and development to
operations upon completion of development of such product.
GROSS PROFIT. Gross profit decreased by 43.6% to $2,630,000 for the
nine months ended March 31, 1999 from $4,663,000 for the same period in 1998.
Overall gross profit as a percentage of total revenues decreased to 52.1% for
the nine months ended March 31, 1999 from 66.2% for the same period in 1998,
mainly as a result of a decrease in operations revenue and relatively fixed
labor costs. The cost of support and operations were relatively fixed during
such period; however, the Company has taken steps to reduce personnel costs
subsequent to March 31, 1999. Gross profit on the Company's software license
revenues is significantly higher than on revenues from equipment, services
and maintenance. Gross profit on software licenses remained consistent for
the nine months ended March 31, 1999 at 93.5% and 93.7% in 1998. Gross profit
on support and operations revenue decreased to 11.6% for the nine months
ended March 31, 1999 from 45.3% for the same period in 1998 due mainly to
lower operations revenue and a fixed labor cost. The increase in third party
software and equipment gross profit to 53.9% for the nine months ended March
31, 1999 from 41.6% for the same period in 1998 was primarily due to a change
in mix of third party software sales with a greater portion of higher margin
sales occurring during the nine months ended March 31, 1999.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses
increased 9.8% to $740,000 for the nine months ended March 31, 1999 from
$674,000 for the same period in 1998. The increase was primarily attributable
to NOW! related marketing efforts.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
decreased 11.5% to $569,000 from $643,000 for the same period in 1998. The
decrease is primarily related to the completion of the NOW! suite of products
in the previous fiscal year. As a result, the expenses are lower in the
current period. The decrease is partially offset by the acceleration of the
development of the next generation management information system and expects
that research and development expenses will increase substantially in future
periods as the Company increases its efforts to develop new products.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses increased 20.6% to $3,380,000 for the nine months ended March 31,
1999 from $2,803,000 for the same period in 1998. The increase is primarily
related to an increase in professional service expense and an increase of
$200,00 in the allowance for potentially uncollectible accounts receivable
related to a contract dispute pertaining to a sale to one customer recorded
in fiscal year 1999, offset by lower overhead in the Company's United Kingdom
office which was closed during the period.
INTEREST EXPENSE. Interest expense increased 490.8% to $514,000 for
the nine months ended March 31, 1999 from $87,000 for the same period in
1998. The interest expense increase relates primarily to expense of the
original issue discount of $408,000 related to the June 1998 bridge loan. The
loan was paid in full on August 14, 1998.
-15-
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
In August 1998, the Company completed an initial public offering of
1,500,000 shares of common stock, of which 1,210,000 shares were sold by the
Company and 290,000 shares were sold by selling shareholders. Net proceeds to
the Company were approximately $4,480,000 after deducting all
offering-related expenses of $1,570,000. The Company used a portion of the
proceeds to repay the outstanding indebtedness of $1,000,000 which was
incurred with the 1998 private placement and approximately $272,000 related
to a note payable to a stockholder. The remaining proceeds are being used in
the development of new products and upgrades, expansion of the Company's
sales and marketing efforts and general working capital.
Prior to the initial public offering of common stock the Company
financed its operations primarily through cash flow from operations, private
sales of its equity, private debt placements and long-term equipment
financing. The Company does not have access to a line of credit. The
Company's $600,000 equipment lease requires the Company to maintain cash on
deposit with a bank affiliated with the lessor. The required cash balance was
initially $300,000 and reduces incrementally in proportion to the reduction
in the lease balance. At March 31, 1999 the principal balance of the lease
was $149,000 and the required cash balance was $0.
The Company has entered into employment agreements with four of its
executive officers as well as a Consulting and Non-Competition Agreement with
a director and former officer of the Company. The Company does not intend to
renew the one-year contracts upon their termination in August 1999. In
general, assuming the remaining agreements are not terminated such agreements
provide for total payments of not less than $2.0 million through the end of
the fiscal year ending June 30, 2002, including approximately $76,000 per
month during the fiscal year ending June 30, 1999.
For the nine months ended March 31, 1998, operating activities
provided net cash of approximately $119,000 primarily from income from
operations, net of depreciation and amortization, of approximately $700,000,
a decrease in refundable income tax of $132,000 and an increase in other
accrued liabilities of approximately $141,000 which were offset by an
increase in trade receivables of approximately $433,000, and a combined
decrease in accounts payable and customer deposits of approximately $358,000.
For the nine months ended March 31, 1998, financing activities used net cash
of approximately $84,000 primarily from principal payments on notes payable
and changes in restricted cash balance. For the nine months ended March 31,
1998 the Company's investing activities used net cash of approximately
$84,000 primarily to purchase equipment.
For the nine months ended March 31, 1999, operating activities used
net cash of approximately $2,350,000 primarily from a loss from operations,
net of depreciation and amortization, of approximately $1,789,000, a combined
increase in trade receivables, prepaids and other assets of approximately
$358,000 and a decrease in accounts payable
-16-
<PAGE>
other accrued liabilities of approximately $411,000 which were offset by a
decrease in customer deposits of approximately $160,000. For the nine months
ended March 31, 1999, financing activities provided net cash of approximately
$3,699,000 primarily from net proceeds from the sale of the Company's common
stock (approximately $4,480,000) which were offset by repayments of notes and
loans payable of approximately $1,356,000. For the nine months ended March
31, 1999 the Company's investing activities used net cash of approximately
$268,000 primarily to purchase equipment.
The Company's accounts receivable balance at June 30, 1998 and March
31, 1999 was $1,224,768 and $1,419,583, respectively. Accounts receivable in
the over 90-day category at June 30, 1998 was $308,292 or 25.2% of accounts
receivable compared to $459,301, or 32.4% of accounts receivable at March 31,
1999. The number of days sales in accounts receivable was 43 days and 72
days, respectively, for the year ended June 30, 1998 and nine months ended
March 31, 1999. The increase in accounts receivable and days sales in
accounts receivable was due to granting additional credit terms to larger
customers that have a strong payment history as well as granting extended
payment plans to three customers that have had financial trouble. Bad debt
expense as a percentage of sales for the year ended June 30, 1998 and the
nine months ended March 31, 1999 was 2% and 8%, respectively. A contract
dispute pertaining to a sale to one customer recorded in fiscal year 1999 has
increased the allowance for potentially uncollectible accounts receivable by
$200,000, which equates to 4% of the sales for the nine months ended March 31,
1999. At March 31, 1999, the Company had three customers which accounted for
approximately 39.8% of the accounts receivable balance.
At March 31, 1999 the Company had approximately $1,281,000 in cash.
The Company's current business plan calls for significant expenditures of
cash over the next six to twelve months in order to complete the development
and marketing of certain products. To the extent the Company is unable to
complete the development of these products on a timely basis or generate
significant cash flow from operations, the Company will need to rely on
outside financing sources for working capital. There can be no assurance that
the Company will be able to obtain sources of outside financing on favorable
terms, if at all. Any failure of the Company to obtain such financing if and
when needed would have a material adverse affect on the Company and its
ability to successfully operate.
ADDITIONAL CONSIDERATIONS AND RISK FACTORS
NEED FOR ADDITIONAL WORKING CAPITAL. The Company's business involves the
continued investment of funds towards the development of new products and
modifications of existing products. The Company's current business plan calls
for significant expenditures of cash over the next six to twelve months in
order to complete the development of the next generation of its back office
management information system to replace its current SUMMIT V product and to
continue the roll-out of its NOW! product. To the extent that the Company's
business plan is not implemented on a timely basis or at all and the Company
is not successful in generating significant cash flow from operations in
order to fund the expenses associated with the implementation of its business
plan, development expenses and other operating costs, the Company will need
to rely on outside financing sources for working capital. There can be no
-17-
<PAGE>
assurance that the Company will be able to obtain sources of outside
financing on favorable terms, if at all, in the event that such financing is
required in the future. Any failure of the Company to obtain such financing
if and when needed would have a material adverse affect on the Company and
its ability to successfully operate.
HISTORY OF LOSSES. The Company and its predecessors Summit V, Inc., a
Washington corporation and wholly-owned subsidiary of the Company, as well as
Redwood Technology, Inc., a Washington corporation formerly known as Jenkon
Data Systems, Inc. ("Redwood Technology" ), which operated certain assets of
the Company prior to selling them to Summit V, Inc. in 1995, have a history
of losses. The Company sustained net losses of approximately $265,000 and
$1,701,000 for the fiscal years ended June 30, 1996 and 1998, respectively
and a loss of $2,615,000 for the nine months ended March 31, 1999. Although
the Company operated profitably in fiscal 1998, there can be no assurance
that the Company will be able to operate profitably in the future.
As a result of increased competitive pressures, the Company has
accelerated the development of its next generation management information
system. The Company expects that it will incur significant losses during the
next six to twelve months due primarily to the costs associated with the
development of this new product and delays in revenue recognition for sales
of existing products that are linked to or contingent upon delivery of new
products. Such revenues would be recognized at such time as the Company has
completed its obligations under any such sales contracts.
RISK OF CREDITORS CLAIMS AND SUCCESSOR LIABILITY; RISKS OF PENDING
LITIGATION. In July 1995, Summit V, Inc. purchased and/or licensed
substantially all of the assets, and Summit V, Inc. assumed certain
contractual obligations and indebtedness from Redwood Technology, the
developer of a substantial portion of the Company's SUMMIT V software
technology. Because Redwood Technology may be deemed to have been rendered
insolvent by the sale and license of certain of its assets to Summit V, Inc.
and because of the commonality of ownership and management of Redwood
Technology and Summit V, Inc. and/or because Summit V continued operating the
business of Redwood Technology, the Company is or may be subject to claims by
unsatisfied creditors of Redwood Technology challenging the rights of the
Company to the SUMMIT V software technology or other assets acquired from
Redwood Technology or alleging successor liability or other similar bases for
liability. The Company believes that such claims could total as much as
$100,000. There can be no assurance that claims for successor liability will
not be made or that the Company's rights to the assets acquired from Redwood
Technology, including the SUMMIT V software technology, will not be
challenged. If any such claims or challenges are made and are successful, the
Company's business and results of operations would be materially and
adversely affected. Any payments made by the Company with respect to claims
against Redwood Technology may benefit certain officers and directors of the
Company who may be secondarily liable for such claims.
-18-
<PAGE>
The Company acquired from Redwood Technology a license to utilize
certain Ardent Software, Inc. products which were incorporated into the
Summit V software in connection with sales in certain portions of Asia,
including China. The grant of the license by Unidata, Inc., a predecessor of
Ardent Software, Inc., to Redwood Technology and the sublicense by Redwood
Technology to Avon Products or its affiliates have been challenged in a
lawsuit (the "U.S. Claim") filed in the United States District Court for the
Western District of Washington at Tacoma (Case No. C96-5459FDB) by Pacific
Unidata, Ltd., the Asia licensee of Unidata, Inc., as violating the terms of
such licensee's agreement with Unidata. In addition, Pacifica Unidata, Ltd.
brought an action (the "China Claim") against Guangzhou Avon Co., Ltd., a
Chinese subsidiary of Avon Products ("Avon China"), in the Guangdong Province
Supreme People's Court (the "Chinese Court") seeking damages against Avon
China for infringement of Pacific Unidata, Ltd.'s copyright and exclusive
rights to certain Unidata software in China. In June 1998, the Chinese Court
awarded damages in favor of Pacific Unidata, Ltd. in an amount of
approximately US $12 million plus costs. Avon China has informed the Company
that it has appealed the ruling and has indicated an intention to seek
indemnification against Redwood Technology and the Company in the event
it is unsuccessful in its appeal. Although the Company is not a party to the
China Claim, if Unidata, Inc. does not indemnify Redwood Technology and the
Company from damages resulting from the China Claim and the U.S. Claim and
the Company is required to (i) devote significant resources to protect its
interests and the interests of its sublicensees in Asia or (ii) if any
sublicensee successfully seeks indemnification against Redwood Technology or
the Company for damages suffered as a result of claims made by Pacific
Unidata, Ltd., and the Company is required to pay such indemnification
directly or as a successor to Redwood Technology, the Company's financial
condition and results of operations would be materially and adversely
affected.
RISK OF ACCEPTANCE OF NEW PRODUCT. The future success and growth of the
Company, if any, will depend in large part upon the success and acceptance of
the Company's Internet-based product, NOW! and the ability of the Company to
develop and sell a next generation back office product to replace Summit V.
Although the Company has completed initial testing of the product, there can
be no assurance that the NOW! product will be without defects. In addition,
the Company has generated only limited sales from NOW! and there can be no
assurance that the Company will be able to successfully market such product
to its existing client base or to new customers. The failure of the Company
to generate significant sales of the NOW! product would have a material
adverse effect on the Company's prospects for future growth.
NEW PRODUCTS AND RAPID TECHNOLOGICAL CHANGE. The markets for the
Company's products are characterized by rapid technological advances,
evolving industry standards, changes in end-user requirements and frequent
new product introductions and enhancements. The introduction of products
embodying new technologies and the emergence of new industry standards could
render the Company's existing products and products currently under
development obsolete and unmarketable. The Company has experienced decreased
demand for its SUMMIT V product, as a result of the introduction of
competing products which more effectively embody these new technologies. The
Company's future success will depend upon its ability to enhance its current
products and develop
-19-
<PAGE>
and successfully introduce and sell new products that keep pace with
technological developments and respond to evolving end-user requirements. Any
failure by the Company to anticipate or respond adequately to technological
developments or end-user requirements, or any significant delays in product
development or introduction, could damage the Company's competitive position
in the marketplace and reduce revenues. The Company may need to increase the
size of its product development staff in the near term to meet these
challenges. There can be no assurance that the Company will be successful in
hiring and training adequate product development personnel to meet its needs.
In the past, the Company has occasionally experienced delays in the
introduction of new products and product enhancements. There can be no
assurance that the Company will be successful in developing and marketing new
products or product enhancements on a timely basis or that the Company will
not experience significant delays in the future. Any failure to successfully
develop and market new products and product enhancements would have a
material adverse effect on the Company's results of operations.
RISKS OF SOFTWARE DEVELOPMENT IN GENERAL. The success of the Company is
dependent upon its ability to deliver reliable, easy-to-use and
technologically up-to-date software products. Any failure of the Company's
existing or new products to meet client specifications or expectations will
have a material adverse effect on the Company's reputation and the demand for
the Company's products. There can be no assurance that the software will
consistently meet such specifications or expectations. In addition, continued
demand for the Company's products and services will depend on its ability to
successfully anticipate customer demand and to integrate new and emerging
technologies, features and standards into its software on a timely basis. Any
failure by the Company to anticipate customer demand and to successfully
integrate new features and standards into its software on a timely basis
could adversely affect the Company's reputation, demand for its products and,
as a result, its financial condition and results of operations.
DEPENDENCE ON SALES OF EXISTING SOFTWARE PRODUCTS. Substantially all of
the Company's revenues have been derived from sales of its SUMMIT V and
TOUCHTALK information systems and software and related support services. The
demand for such products has decreased in recent periods due to increased
competition through the introduction of new technology and products by the
Company's competitors. In addition, the initial demand for the Company's NOW!
product will be highly dependent on customers and companies who utilize such
information systems and software. Accordingly, any event that adversely
affects fees derived from the sale of such systems, such as competition from
other products, significant flaws in the Company's software products or
incompatibility with third party hardware or software products, negative
publicity or evaluation, or obsolescence of the hardware platforms or
software environments in which the systems run, would have a material adverse
effect on the Company's results of operations. The Company's future financial
performance will depend, in substantial part, on the continued development
and introduction of new and enhanced versions of its management information
systems and customer acceptance of such new and enhanced products.
-20-
<PAGE>
RISK OF EXPANSION INTO NEW BUSINESSES. Part of the Company's business
plan involves the possible acquisition or development of complementary but
alternative sources of revenues such as credit card processing. There can be
no assurance that the Company will be successful in identifying and acquiring
or developing any alternate sources of revenues. Moreover, to the extent that
the Company acquires or begins operations of a business other than the
development of software products, the Company's lack of experience and track
record in such business may result in an inability of the Company to
effectively compete, potential operating losses and loss of standing in the
direct sales industry, any of which would have a material adverse effect on
the Company, its operations and financial condition.
SIGNIFICANT FLUCTUATIONS IN QUARTERLY RESULTS. The Company has
experienced and expects to continue to experience significant fluctuations in
its quarterly results. Such fluctuations may be caused by many factors,
including, but not limited to: the size and timing of individual orders;
seasonality of revenues; lengthy sales cycle; delays in introduction of
products or product enhancements by the Company or other providers of
hardware, software and components for the Company's systems; competition and
pricing in the software industry; market acceptance of new products;
reduction in demand for existing products and shortening of product life
cycles as a result of new product introductions by competitors; foreign
currency exchange rates; mix of products sold; conditions or events in the
direct sales industry; and general economic conditions. The Company does not
typically maintain a significant backlog and therefore the revenue results
for each quarter depend substantially on orders received and delivered in
that quarter. As a result of the relatively high revenue amount per order and
relatively low unit volume, any lost or delayed sales will have a
disproportionately greater effect on the Company's revenues and quarterly
results relative to companies that have higher unit sales volumes and less
revenue associated with each sale. The Company's sales cycle is typically
three to nine months from the time initial sales contact is made with a
qualified prospect, making the timing of the Company's license fees difficult
to predict and the Company's quarterly results difficult to forecast. The
Company's expense levels are based in part on its forecasts of future
revenues. Accordingly, since the majority of the Company's expenses are fixed
in nature, the Company would not be able to quickly curtail expenses in
response to a decline in revenues, and operating results for a given quarter
would be adversely affected. As a result, revenues for any quarter are
subject to significant variation and the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future
performance. To the extent that the Company's Common Stock is publicly
traded, fluctuations in operating results may also result in volatility in
the market price of the Company's Common Stock.
DEPENDENCE ON DIRECT SALES INDUSTRY; LEGISLATIVE RISKS. The Company's
business depends substantially upon the capital expenditures of direct sales
companies, which in part depends upon the demand for such companies products.
A recession, new laws or
-21-
<PAGE>
regulations of the activities of direct sales companies, or other adverse
event affecting the direct sales industry in the United States, the United
Kingdom, Asia or other markets served by the Company could affect such
demand, forcing companies in the Company's targeted markets to curtail or
postpone capital expenditures on business information systems. Any such
change in the amount or timing of capital expenditures in its targeted
markets would have a material adverse effect on the Company's financial
condition and results of operations. The Peoples Republic of China recently
announced laws restricting the ability of multi-level marketing companies to
operate in China. To date, the Company has not derived significant revenues
from The Peoples Republic of China. Accordingly, the Company does not believe
that such laws will adversely affect the Company's current operations or
financial condition. However, similar restrictions, if adopted by other
countries, could have a materially adverse effect on the Company's business,
results of operations and prospects.
MANAGEMENT OF GROWTH. Management believes that the Company's existing
internal controls are sufficient for the current size and level of
operations; however, to manage its growth effectively, the Company will be
required to continue to implement and improve its operating and financial
systems and to expand, train and manage its employee base. There can be no
assurance that the management skills and systems currently in place will be
adequate if the Company continues to grow. In addition, although no
acquisitions of companies or products are currently being negotiated, the
Company may make acquisitions in the future. The Company's management has
only limited experience with acquisitions, which involve numerous risks,
including difficulties in the assimilation of acquired operations and
products, the diversion of management's attention from other business
concerns and the potential loss of key employees of the acquired companies.
INTERNATIONAL OPERATIONS AND RISK OF INTERNATIONAL SALES. The Company
derived approximately 1.9% and 7.3% of its total revenues from its United
Kingdom operations for the nine months ended March 31, 1999 and 1998,
respectively. International business is subject to various risks common to
international activities, including exposure to currency fluctuations,
political and economic instability, the greater difficulty of administering
business abroad, and the need to comply with a wide variety of foreign import
and United States export laws and regulatory requirements. The Company does
not currently engage in foreign currency hedging transactions. Any
significant adverse change in the international business climate could have a
material adverse effect on the Company, its financial condition and results
of operations.
DEPENDENCE ON THIRD PARTY SOFTWARE AND HARDWARE. The Company's products
incorporate and use software products and computer hardware and equipment
developed by other entities. The fourth generation language ("4GL") set of
development tools used by the Company as well as the relational database
management system used in the Company's products are provided by Ardent
Software, Inc. (a successor to Unidata, Inc.) or its affiliates. The
operating systems on which the Company's products can function (UNIX, NT)
have been developed or are owned by
-22-
<PAGE>
Novell Corporation and Microsoft Corporation. The computer hardware and
equipment sold as part of the Company's turnkey system are manufactured by
Hewlett-Packard Company, International Business Machines Corporation, and
others. There can be no assurance that all of these entities will remain in
business, that their product lines will remain viable or that these products
will otherwise continue to be available to the Company. If any of these
entities ceases to do business, or abandons or fails to enhance a particular
product line, the Company may need to seek other suppliers. This could have a
material adverse effect on the Company's results of operations. In addition,
there also can be no assurance that the Company's current suppliers will not
significantly alter their pricing in a manner adverse to the Company.
RISK OF FIXED PRICE CONTRACTS. The Company has and expects to derive
significant revenues pursuant to software maintenance contracts that provide
for fixed annual fees in exchange for the Company's commitment to provide
technical assistance and customer support. Because the total compensation
payable to the Company pursuant to such contracts is fixed in the event of
cost over-runs, price increases, unanticipated problems, inefficient
management, inaccurate estimates of customer needs or disputes over the terms
and specifications of contracted performance, the Company's business and
financial condition could be materially adversely affected.
YEAR 2000 COMPLIANCE RISK. The Company believes that its principal
software products (SUMMIT V and NOW!) are Year 2000 compliant. However,
because the Company's products are designed to work with relational database
and other software products developed and sold by third parties, any failure
of these third party software products to be Year 2000 compliant could result
in the failure of the Company's software products to effectively operate. Any
such failure could harm the Company's reputation in the market and could have
an adverse effect on sales of the Company's products and its financial
performance.
POSSIBLE ADVERSE IMPACT ON MARKET PRICE OF FUTURE SALES OF RESTRICTED
SHARES. Sales of a substantial number of shares of Common Stock into the
public market in the future could materially adversely affect the prevailing
market price for the Common Stock. The Company has outstanding an aggregate
of 4,253,515 shares of Common Stock of which approximately 2,750,000 are
"restricted securities" (the "Restricted Shares") pursuant to Rule 144
promulgated under the Securities Act. Beginning on the expiration of
applicable lock-up agreements (a substantial majority of which expire in
August 1999), the Restricted Shares subject to such lock-up agreements will
become eligible for sale in the public market pursuant to Rule 144, some of
which will be not be subject to the volume limitations and other restrictions
under Rule 144.
MAINTENANCE CRITERIA FOR NASDAQ; RISK OF LOW-PRICED SECURITIES. The
Company's Common Stock is currently listed for trading on the Nasdaq SmallCap
Market. To maintain inclusion on the Nasdaq SmallCap Market, the Company's
Common Stock must continue to be registered under Section 12(g) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the
Company must continue to have net
-23-
<PAGE>
tangible assets of at least $2,000,000, a public float of at least 500,000
shares with a market value of at least $1,000,000, at least 300 stockholders,
a minimum bid price of $1.00 per share and at least two market makers. While
the Company has initially satisfied these maintenance standards, there is no
assurance that the Company will be able to maintain the standards for Nasdaq
SmallCap Market inclusion with respect to its Common Stock. If the Company
fails to maintain Nasdaq SmallCap Market listing, the market value of the
Common Stock likely would decline and stockholders likely would find it more
difficult to dispose of, or to obtain accurate quotations as to the market
value of, the Common Stock.
If the Common Stock ceases to be included on the Nasdaq SmallCap
Market, the Common Stock could become subject to Rule 15a-9 under the
Exchange Act, which imposes additional sales practice requirements on
broker-dealers which sell such securities. If the Common Stock becomes
subject to the penny stock rules, the ability of broker-dealers to make a
market in or sell the Company's securities may be adversely affected and the
market liquidity for the Company's securities could be severely adversely
affected.
PART II - OTHER INFORMATION.
ITEM 1. LEGAL PROCEEDINGS.
The Company has acquired from Redwood Technology a license to
utilize certain Ardent Software, Inc. products incorporated into the SUMMIT V
software in connection with sales in certain portions of Asia, including
China. The grant of the license by Unidata, Inc., a predecessor of Ardent
Software, Inc., to Redwood Technology and the sublicense by Redwood
Technology to Avon Products, a New York corporation, have been challenged in
a lawsuit (the "U.S. Claim") filed in the United States District Court for
the Western District of Washington at Tacoma (Case No. C96-5459FDB) by
Pacific Unidata, Ltd., the Asia licensee of Unidata, Inc., as violating the
terms of such licensee's agreement with Unidata. In addition, Pacific
Unidata, Ltd. brought an action (the "China Claim") against Guangzhou Avon
Co., Ltd., a Chinese subsidiary of Avon Products ("Avon China"), in the
Guangdong Province Supreme People's Court (the "Chinese Court") seeking
damages against Avon China for infringement of Pacific Unidata, Ltd.'s
copyright and exclusive rights to certain Unidata software in China. In June
1998, the Chinese Court awarded damages in favor of Pacific Unidata, Ltd. in
an amount of approximately US$12 million plus costs. Avon China has informed
the Company that it intends to appeal the ruling. Although the Company is not
a party to the China Claim or the U.S. Claim, if Unidata, Inc. does not
indemnify Redwood Technology from damages resulting from the China Claim and
the U.S. Claim and the Company is required to (i) devote significant
resources to protect its interests and the interests of its sublicensees in
Asia or (ii) if any sublicensee successfully seeks indemnification against
Redwood Technology for damages suffered as a result of claims made by Pacific
Unidata, Ltd. and the Company is required to pay such indemnification as a
successor to Redwood Technology, the
-24-
<PAGE>
Company's financial condition and results of operations could be materially
adversely affected. Moreover, in the event that a court rules that the
Company's license of the Unidata, Inc. software is invalid, the Company's
ability to expand its sales into China will be materially adversely affected.
In July 1995, Summit V, Inc. purchased and/or licensed substantially
all of the assets and assumed certain liabilities of Redwood Technology, the
developer of certain of the Company's software technology. Because Redwood
Technology may be deemed to have been rendered insolvent by the sale and
license of certain of its assets to Summit V, Inc. and because of the
commonality of ownership and management of Redwood Technology and Summit V,
Inc., the Company is or may be subject to claims by unsatisfied creditors of
Redwood Technology challenging the Company's rights to the acquired assets
(including the SUMMIT V software technology) or alleging successor liability
or other similar claims. Whether or not litigation ensues, such claims could
result in a disruption of the Company's business which would have material
adverse effect on the Company and its financial performance. The Company
recently settled a claim for the unpaid portion of payroll taxes of Redwood
Technology in exchange for a payment by the Company of $135,000. The Company
may elect or be required to settle other obligations of Redwood Technology.
In the event that the Company were required to pay all or a significant
portion of the claims of creditors of Redwood Technology, the Company's
business and financial conditions and its ability to achieve its business
plan could be materially and adversely affected.
In the ordinary course of business, the Company is subject to
various legal proceedings and claims. In the opinion of management, the
amount of ultimate liability with respect to these proceedings will not
materially affect the financial position, results of operations or cash flow
of the Company.
See also "Additional Considerations and Risk Factors -- RISK OF
CREDITORS CLAIMS AND SUCCESSOR LIABILITY; RISKS OF PENDING LITIGATION" in
Part I, Item 2 of this Form 10-QSB.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Quotation of the Company's Common Stock, $0.001 par value, commenced
on The Nasdaq Small Cap Market on August 11, 1998 under the symbol "JNKN."
On August 14, 1998 the Company and certain selling stockholders of
the Company completed an underwritten public offering of an aggregate of
1,500,000 shares of Common Stock, $0.001 par value, 1,210,000 of which were
sold by the Company and 290,000 shares of which were sold by selling
stockholders. The managing underwriters of the initial public offering were
Meridian Capital Group, Inc., Trautman Kramer & Company Incorporated, and
W.J. Nolan & Company Inc.
-25-
<PAGE>
The shares of Common Stock sold in the offering were registered
pursuant to a Registration Statement on Form SB-2 (Commission File No.
333-56023) which was declared effective at 5:30 p.m. E.D.T. on August 10,
1998. The offering price to the public was $5.00 per share. The registration
statement covered (i) 1,210,000 shares sold by the Company in the offering
(aggregate offering price registered and sold of $6,050,000), (ii) 290,000
shares sold by certain selling stockholders in the offering (aggregate
offering price registered and sold of $1,450,000), (iii) 225,000 additional
shares of Common Stock for the sole purpose of covering an over-allotment
option granted to the underwriters by the Company and two executive officers
of the Company (aggregate offering price registered of $850,000 for the
executive officers and $275,000 for the Company; none of which were sold),
(iv) 1,034,296 additional shares of Common Stock registered on the account of
certain stockholders of the Company but which were not underwritten or sold
in the offering (aggregate offering price registered of $5,171,480; none of
which were sold), (v) warrants to purchase up to 150,000 shares of Common
Stock granted to the managing underwriters at $8.25 per share (aggregate
offering price registered and sold of $150), and (vi) the 150,000 shares of
Common Stock underlying the underwriters' warrants (aggregate offering price
registered of $1,237,500; none of which have been sold). The underwriters'
over-allotment option expired without being exercised in September 1998.
The initial public offering resulted in gross proceeds to the
Company of $6,050,000. After deducting total offering costs (including
underwriter discounts and commissions) of $1,570,000, the net proceeds to the
Company from the offering were $4,480,000. The total offering costs consisted
of (i) $605,000 in underwriter discounts and commissions, (ii) $181,500 in
expenses paid to or for the underwriters, (iii) a $100,000 fee payable to
Anthony Soich for advisory and consulting services, and (iv) $683,500 in
other offering expenses (including filing fees, printing and distribution
costs, and legal and accounting fees), none of which were direct or indirect
payments to directors, officers or 10% stockholders of the Company.
Of the $4,480,000 in net offering proceeds to the Company,
approximately $1.3 million was used for the repayment of indebtedness,
approximately $2,000,000 was used for general working capital (including
$91,000 for payments under a Non-Compete/Consulting Agreement with Dan
Jensen, a director and stockholder of the Company, and $50,000 for the
purchase of certain software products from an affiliate of Dan Jensen),
$500,000 for product development, $250,000 for sales and marketing, The
remaining approximately $430,000 of the offering proceeds has not yet been
applied and is being held in a short-term interest bearing account for the
Company.
The Company has not paid any dividends since its inception and has
no current plans to pay dividends on the Common Stock in the foreseeable
future. The Company intends to reinvest future earnings, if any, in the
development and expansion of its business. Any future determination to pay
dividends will depend upon the Company's results of operations, financial
condition and capital requirements and such other factors deemed relevant by
the Company's Board of Directors.
-26-
<PAGE>
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
Effective April 8, 1999, John Tefft resigned from the Company's Board
of Directors in order to devote his full time and energy to the formation of
a new consulting company. In addition, effective May 17, 1999, Steve McKeag
resigned as the Company's Chief Financial Officer in order to pursue other
business opportunities. David Edwards will serve as the Company's Interim
Chief Financial Officer until such time as a new Chief Financial Officer has
been named.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
<S> <C>
3.1 Articles of Incorporation of the Company, as amended*
3.2 Bylaws of the Company, as amended*
4.1 Form of Representatives' Warrant Agreement, including form of
Representatives' Warrant.*
4.2 Dealer Manager's Warrant Agreement, dated as of July 1, 1996
between the Company and The Boston Group, L.P.*
4.3 Form of Warrant to purchase Common Stock issued in connection
with the 1998 Private Placement*
4.4 Subscription Supplement and Registration Rights Agreement with
respect to 1996 private placement*
27 Financial Data Schedule
</TABLE>
- -------------------
* Incorporated by reference to the referenced document filed as an
exhibit to the Company's Registration Statement on Form SB-2,
Commission File No. 333-56023, filed on June 4, 1998, and amended on
July 15, 1998 and August 3, 1998).
(b) Reports on Form 8-K.
No reports on Form 8-K were filed in the last quarter of
the period covered by this Report.
-27-
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
JENKON INTERNATIONAL, INC.
Date: May 17, 1998 /s/ STEVE MCKEAG
--------------------------------------
Chief Financial Officer and Principal
Accounting Officer
-28-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 1,281,041
<SECURITIES> 0
<RECEIVABLES> 1,419,583
<ALLOWANCES> (368,900)
<INVENTORY> 0
<CURRENT-ASSETS> 2,620,171
<PP&E> 1,872,151
<DEPRECIATION> (793,373)
<TOTAL-ASSETS> 4,121,430
<CURRENT-LIABILITIES> 1,585,774
<BONDS> 0
0
0
<COMMON> 4,410
<OTHER-SE> 2,523,557
<TOTAL-LIABILITY-AND-EQUITY> 4,121,430
<SALES> 5,051,720
<TOTAL-REVENUES> 5,051,720
<CGS> 2,422,129
<TOTAL-COSTS> 2,422,129
<OTHER-EXPENSES> 4,689,124
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 513,903
<INCOME-PRETAX> (2,614,605)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,614,605)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,614,605)
<EPS-PRIMARY> (.67)
<EPS-DILUTED> (.67)
</TABLE>