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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the Fiscal Year Ended December 31, 1995
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the Transition period from _____________ to _____________
Commission File Number 0-12969
TOUCHSTONE SOFTWARE CORPORATION
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(Exact name of Registrant as Specified in its Charter)
C A L I F O R N I A 95-3778226
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(State or other jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
2124 MAIN STREET, HUNTINGTON BEACH, CALIFORNIA 92648
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(Address of Principal Executive Offices) (Zip Code)
(Registrant's Telephone Number including Area Code): (714) 969-7746
----------------
Securities Registered Pursuant to Section 12(b) of the Act: NONE
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Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--------- ----------
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 1, 1996 COMMON STOCK, PAR VALUE OR $.001 PER SHARE -
$22,172,680 based upon the closing bid price for the Company's common stock at
March 1, 1996.
The issuer's revenues for the year ended December 31, 1995 were $9,355,745.
The number of shares outstanding of the registrant's classes of common stock as
of March 1, 1996: COMMON STOCK, PAR VALUE OF $.001 PER SHARE - 7,356,951 SHARES.
DOCUMENTS INCORPORATED BY REFERENCE: None
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PART I
This Annual Report on Form 10KSB contains forward-looking statements that
involve risks and uncertainties. TouchStone Software Corporation's
("TouchStone" or the "Company") actual future results could differ materially
from those statements. Factors that could cause or contribute to such
differences include, but are not limited to, those factors discussed in Item 1,
"Business" and elsewhere in this Report.
ITEM 1. BUSINESS
General
TouchStone Software Corporation (the "Company" or "TouchStone") is a
leading developer and publisher of utility software used to set up, maintain,
and manage personal computers. The Company's checkit family of products,
including WINCheckIt and CheckIt Diagnostic Kit, identifies and assists in the
resolution of system conflicts, facilitates the installation of upgrades and
accessories and substantially reduces the time and cost typically associated
with diagnosing personal computer problems. The Company's WINCheckIt product
for Windows-based personal computers was listed as the top selling utility
software product on Ingram Micro, Inc.'s ("Ingram Micro's") May, June, and July
1995 Retail Products Best Seller List, and the Company's SetUp Advisor product
was listed as the next best selling utility software product on the July, 1995
list. WINCheckIt was also awarded a Windows Magazine 1995 WIN 100 Award and a
Top 100 ranking in the June, 1995 issue of Home PC Magazine. In October, 1995,
the Company released WINCheckIt 4.0, TouchStone's latest version of its award-
winning Windows problem solver. WINCheckIt 4.0 provides a suite of diagnostic
tools, normally found in separate programs, that have been designed to work in
both Windows 95 and Windows 3.1 environments.
In November, 1995, TouchStone released PC-cillin 95. Designed for use with
Windows 95 and Internet, PC-cillin 95 provides complete protection from new
virus sources and increasingly sophisticated types of viruses. It automatically
adjusts protection levels based on the level of the threat, provides one-button
virus pattern updates, and intelligently scans for viruses when needed. In
addition, a powerful Clean Wizard automatically removes viruses step-by-step,
without harming system files. In July 1995 the Company released WIN'95 Advisor,
a utility software product that permits users to analyze their personal
computer's compatibility with Microsoft Corporation's ("Microsoft's") operating
system, Windows 95, which was released by Microsoft on August 24, 1995. WIN'95
Advisor was awarded a Windows Magazine 1995 WIN 100 Award. The Company's
FastMove! product, introduced in March, 1995, enables users of multiple personal
computers to transfer and synchronize data files between personal computers,
while simultaneously scanning for viruses.
The Company markets its products domestically primarily through software
distributors, including Ingram Micro, Merisel Americas, Inc. ("Merisel") and
Tech Data Corporation ("Tech Data"), for resale through the retail channel.
The Company's primary sales and marketing efforts in 1995 were directed at
increasing demand for products at the retail sales level and increasing the
number of mall stores, club stores, and warehouse stores that carry the
Company's products. Such efforts have included using outside representatives
to present the Company's products to retail store employees, and using
point-of-sale and other in-store displays in such retail stores as CompUSA,
Sam's Club, Micro Center, Egghead Software, Computer City, Fry's Electronics,
Office Depot, Best Buy and PriceCostco. The Company estimates that the
number of retail stores which carry the Company's products increased from
approximately 1,700 in 1993 to approximately 7,100 in 1995.
Organized in 1982, the Company is a California corporation whose principal
executive offices are located at 2124 Main Street, Huntington Beach, California,
92648, and its telephone number is (714) 969-7746.
INDUSTRY OVERVIEW
During the last decade, the personal computer industry has grown rapidly.
The Software Publisher Association estimates that worldwide utility software
sales were approximately $847 million in 1994. Technological advances and
increased functionality, combined with lower pricing, have made personal
computers common for use in both homes and businesses. A market for
sophisticated utility software has evolved in response to the popularity of
multimedia systems utilizing technologically advanced features such as CD-ROM
drives and enhanced video, storage, animation, and sound
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capability. In addition, each major change of the operating system that runs
a particular personal computer may lead to demand for the purchase of new
utility software to support a new operating system, such as Windows 95 or
Windows NT.
STRATEGY
The Company's strategy is to leverage the technological advances and
increased functionality of the personal computer to expand its position as a
leading developer and publisher of quality utility software products for use in
the home and in businesses. Key elements of the Company's business strategy are
as follows:
CAPITALIZE ON BRAND NAME RECOGNITION. The Company intends to leverage its
brand name recognition to introduce new products into its distribution channel
which supplies the retail market. The Company's merchandising strategy is
intended to encourage retailers to carry the Company's product lines by allowing
retailers to achieve relatively high revenues and margins from shelf space
allocated to the Company's products.
EXPLOIT SOFTWARE TECHNOLOGY EXPERTISE. The Company has dedicated
substantial time and effort in the development of its proprietary program
libraries from which most of its current products have been derived. These
efforts and the resulting "core" technology are critical in enabling the
Company to be competitive, improve quality and consistency, and bring
products to market quickly. The Company's product planning team is focused on
market research and the development of product specifications that will
enable the Company to exploit opportunities presented by technological and
other changes in the personal computer industry.
DEVELOP PRODUCTS FOR WINDOWS 95 AND WINDOWS NT. Many personal computer
users who upgrade to new operating systems will replace much of their current
utility software, as such software is not expected to be compatible with Windows
95 or Windows NT.
EXPAND INTERNATIONAL DISTRIBUTION. The Company believes that international
markets provide an opportunity for the Company to increase sales of its
products, and the Company is making a concerted effort to expand its
international operations. In July, 1995, the Company established a
wholly-owned subsidiary in the United Kingdom, TouchStone Europe Ltd., from
which its European sales and marketing efforts were directed. Subsequent to
December 31, 1995, the Company decided it was more cost-effective to delegate
sales of its products in the United Kingdom to The Roderick Manhattan Group,
a leading re-publisher and distributor. Management believes the operations
of TouchStone Europe Ltd. will be enhanced with this new relationship. In
June and July, 1995, the Company completed the translation of WINCheckIt into
the French, German, and Russian languages. Management is evaluating further
expansion into Asia, Latin America, and Australia.
TARGET CORPORATE CUSTOMERS. In November, 1995, the Company established an
Enterprise Sales Unit to expand the advertising and promotion of its products
directly to corporate customers and to provide product support through corporate
resellers like CompUSA and Egghead.
PURSUE STRATEGIC ALLIANCES AND ACQUISITIONS. The Company will continue to
pursue strategic alliances that, through the addition of development,
distribution, or financial resources, would allow the Company to develop,
publish, and market utility software products into broader markets. The Company
currently has a strategic alliance with Trend Micro Devices ("Trend"), an
international utility software developer and publisher. Trend developed the
Company's FastMove! product, and co-developed the Company's PC-cillin 95
product, which are currently published by TouchStone for domestic distribution.
Additionally, it is anticipated that the Company will seek to accelerate its
growth through strategic acquisition of complementary businesses, products, or
technologies.
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PRODUCTS
The following table sets forth selected products currently offered by the
Company:
<TABLE>
<CAPTION>
INITIAL RELEASE
PRODUCT TITLE DESCRIPTION DATE
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<S> <C> <C>
CheckIt For use with DOS, Windows 3.1 and Windows 95, this multi-utility March, 1996
Diagnostic Kit package is designed to meet the specific needs of both technicians and
technical users. It includes the new CheckIt 4 program, a
portable, self-booting DOS utility that provides extensive hardware
testing and configuration analysis features; the new WINCheckIt
Pro, an advanced version of WINCheckIt; Qualitas RAMexam, a
comprehensive PC memory test; plus a four-volume McGraw-Hill Technical
Reference Library on CD-ROM, computer screwdrivers, and a set of three
loopback plugs.
PC-cillin 95 Designed for use with Windows 95 and the Internet, PC-cillin provides November, 1995
complete protection from new virus sources and increasingly
sophisticated types of viruses. It automatically adjusts protection
levels based on the level of the threat, provides one-button virus
pattern updates, and intelligently scans for viruses when needed. In
addition, a powerful Clean Wizard automatically removes viruses
step-by-step, without harming system files.
WINCheckIt 4.0 This Windows-based utility provides a suite of diagnostic tools, October, 1995
normally found in separate programs, that have been designed to work in
both Windows 95 and Windows 3.1 environments. WINCheckIt now
includes a new uninstall utility, a modem test, a comprehensive CD-ROM
diagnostic utility, and a four-volume McGraw-Hill technical reference
library on CD-ROM.
WIN'95 Advisor This Windows-based utility tests a personal computer system for Windows July, 1995
95 suitability and generates a customized preparation checklist
identifying steps that must be taken, including hardware upgrades,
before Windows 95 is installed. WIN'95 Advisor also creates an
installation options batch file which automates the installation of
Windows 95 and includes other utilities used to prepare the system
ahead of time.
AutoHelp/ This utility is a diagnostic software package available only to May, 1995
CheckIt hardware manufacturers on an OEM basis and is 'bundled' as part of a
Diagnostics personal computer system. This product helps customers perform remote
diagnostics and upload the results to a manufacturer's technical
support staff. Hewlett-Packard was the first personal computer
manufacturer to license this product for use on the HP Multimedia 6100
line of home computers.
FastMove! This Windows and DOS-based file transfer utility is packaged with a March, 1995
cable to enable a user to quickly synchronize two personal computers
with up-to-date files while scanning for viruses at the same time.
</TABLE>
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PRODUCT DEVELOPMENT
The Company believes that significant investment in research and
development is required in order to remain competitive, accelerate the rate of
product introductions, incorporate new technologies, and sustain the quality of
its products. In addition to engineering and quality assurance, the Company's
research and development activities include the identification and validation of
a product's potential commercial success, as well as the incorporation of new
technologies in new products. The Company incurs significant expense in
preparing market research information and reviewing product specifications. In
addition, the Company works closely with hardware and software manufacturers to
anticipate user problems with new hardware and software. These efforts and the
resulting "core" technology are critical in enabling the Company to be
competitive, improve quality and consistency, and bring products to market
quickly.
The product planning and development process begins with research and
analysis by both the marketing and research and development groups. The project
team typically consists of six to ten people. The Company's products require
varying degrees of development time which frequently depend on the general
complexity of the product. The typical length of research and development time
ranges from six to 18 months. Prior to release, each product undergoes careful
quality assurance testing that involves usability testing with external
evaluators and a technical review of each component of the final product and
testing on various hardware platforms. The Company endeavors, with the
assistance of personal computer hardware, software, and peripheral suppliers, to
identify potential conflicts and other factors that could lead to problems with
personal computers due to incompatibility with evolving technology. The Company
then adapts its "core" technology to develop products, or enhance existing ones,
designed to assist the user in resolving the problem or adapting to new
technological environments. The Company's strategy for developing products
compatible with Windows and Windows 95, and future versions of Windows,
including Windows NT, is substantially dependent on its ability to gain pre-
release access to, and develop expertise in, such versions.
In early 1995, the Company introduced an enhanced version of SetUp Advisor,
which provides a number of additional features designed to assist Windows users
in upgrading their personal computer systems to attain multimedia and other
enhanced capabilities. In July, 1995, TouchStone released WIN'95 Advisor,
designed to assist current Windows users in determining if and how their current
systems must be modified if they anticipate installing and using Microsoft's new
Windows 95 operating system.
In October, 1995, the Company released WINCheckIt 4.0, TouchStone's
latest version of its award-winning Windows problem-solving utility software.
This product provides a suite of diagnostic tools that have been designed to
work in both Windows 95 and Windows 3.1 environments. WINCheckIt 4.0 also
includes a new uninstall utility, a modem test, a comprehensive CD-ROM
diagnostic utility, and a four-volume McGraw-Hill technical reference library
on CD-ROM.
In November, 1995, TouchStone released for shipment PC-cillin 95, an anti-
virus utility software that is fully compatible with Windows 95, Windows 3.1,
and DOS. PC-cillin 95 automatically adjusts virus protection levels, detects
and eliminates unknown viruses, scans Internet transfers and E-mail files, and
keeps the user's virus protection up-to-date with one-button virus pattern
updates.
The Company has worked with other, often smaller companies to develop
software that can be marketed and sold by the Company. These arrangements have
permitted the Company to expand its product offerings without incurring all of
the risks and costs of new product development. Typically, the agreements
between the Company and these third parties provide for joint development at
shared cost, or that the Company will reimburse the developer for costs incurred
through royalties to be paid by the Company as products are sold. The Company
also seeks to identify products developed by others that can be published by the
Company, for marketing and sale under the Company's name and trademarks and
through the Company's established channels of distribution. The FastMove!
product introduced by the Company in March, 1995 was originally developed by
Trend, and was subsequently modified by the Company. PC-cillin 95, released in
November, 1995, was co-developed with Trend. The Company will continue to
pursue strategic alliances that, through the addition of development,
distribution, or financial resources, will allow the Company to develop and
publish utility software products into broader markets.
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During 1995 and 1994, royalty expenses were $575,000 and $166,000,
respectively. Research and development expenses during 1995 and 1994 were
approximately $729,000 and $440,000, respectively. In addition, the Company
capitalized costs of approximately $360,000 and $169,000 in 1995 and 1994,
respectively, for the development of new software products and the enhancement
of existing products.
The Company's success is highly dependent on the continued widespread use
of Microsoft's Windows operating system for personal computers. Although the
Windows operating system is currently used by many personal computer users,
other companies, including International Business Machines Corporation, have
developed or are developing other operating systems which compete and will
compete with Microsoft's Windows. In the event that any of these alternative
operating systems become widely accepted in the personal computer marketplace,
demand for the Company's Windows-based products could adversely be affected,
thereby affecting the Company's operating results. On August 24, 1995,
Microsoft introduced a new operating system, Windows 95. In anticipation of
this introduction, the Company released WIN'95 Advisor, a new addition to its
CheckIt product line, designed to assist personal computer users in
determining whether their personal computers are compatible with Windows 95.
A lack of market acceptance to date of Windows 95 for personal computer
upgrades has limited sales of WIN'95 Advisor, leading to price reductions and
returns of unsold copies, which had an adverse effect on the Company's
operating results for the year ended December 31, 1995.
In addition, the Company's strategy of developing products based on the
Windows, Windows 95, and Windows NT operating systems, and releasing these
products immediately prior to or at the time of Microsoft's release of new and
upgraded Windows, Windows 95, and Windows NT products, is substantially
dependent on its ability to gain pre-release access to, and to develop expertise
in, current and future versions of Windows, Windows 95, and Windows NT. There
can be no assurance as to the ability of the Company to provide products
compatible with future Windows or Windows 95 releases on a timely basis without
the cooperation of Microsoft.
DISTRIBUTION, SALES, AND MARKETING
The Company markets its products domestically through software distributors
for resale to the retail sales channel. In 1994, one major customer, Ingram
Micro, accounted for approximately 59% of product sales. In 1995, Ingram Micro
and Tech Data accounted for approximately 58% and 17% of product sales,
respectively. The loss of or reduction in orders from either of these
distributors, but from Ingram particularly, could have a material adverse
effect on the Company's revenues and profitability. The Company depends upon
the continued viability and financial stability of these resellers and,
indirectly, on the personal computer industry. The Company's reseller
customers generally offer products of several different companies, including
products which compete with those of the Company. Accordingly, there is a
risk that these resellers may give higher priority to products of other
suppliers and reduce their efforts to sell the Company's products. In
addition, any special distribution arrangements and product pricing
arrangements that the Company may implement in one or more distribution
channels for strategic purposes could adversely affect gross profit margins
for its products.
The distribution channels through which consumer software products are sold
have been characterized by rapid change, including consolidations and financial
difficulties of certain distributors and retailers and the emergence of new
retailers such as general mass merchandisers. In addition, there are an
increasing number of companies competing for access to these channels.
Retailers of the Company's products typically have a limited amount of shelf
space and promotional resources, and there is intense competition for high
quality and adequate levels of shelf space and promotional support from the
retailers. To the extent that the number of software products available in the
marketplace increases, this competition for shelf space may also increase.
Since utility software typically constitutes a relatively small percentage of a
retailer's sales volume, there can be no assurance that retailers will continue
to purchase the Company's products or provide the Company's products with high
quality and adequate levels of shelf space and promotional support.
The Company's primary marketing and sales efforts in 1995 were directed at
increasing demand for products at the retail sales level, and increasing the
number of mall stores, club stores, and warehouse stores which carry the
Company's products. A key component of this strategy, which was begun in 1994,
includes using outside representatives to present the Company's products to
store
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employees in such retail stores as CompUSA, Sam's Club, Micro Center,
Egghead, Computer City, Fry's Electronics, Office Depot, Best Buy, and
PriceCostco. In addition, the Company engaged in a variety of merchandising
promotions, such as end-caps, shelf-talkers, in-store posters and rebate coupons
in order to increase sales. The Company has also improved its product packaging
to better attract attention of retail consumers to the Company's products
directly "on the shelf." Management estimates the number of retail stores which
carry the Company's products increased from approximately 1,700 in 1993 to
approximately 7,100 in 1995. Licensed end-users of the Company's products
include individual personal computer owners, government agencies, utilities,
educational institutions, software development companies, computer product
manufacturers, and others.
In November, 1995, TouchStone established an Enterprise Sales Unit. This
unit's focus is to promote TouchStone's products directly to Fortune 1000
companies and to provide product sales support through corporate resellers such
as CompUSA, Egghead, and Software Spectrum. The Company believes that this
focus on sales to corporate customers in multiple-user packages could increase
sales of its products and have a positive, long range impact on the future
growth of the Company, although no assurances may be given that this will
actually occur.
The Company also uses media advertising, direct mail, attendance at
industry trade shows, press releases, and direct contacts through its marketing
and sales force as other means of generating new sales. Additionally, the
Company participates in retail promotions to obtain sales and marketing
advantages at the retail level by providing allowances to certain distributors
which are passed through to the retailer. The Company also participates in
cooperative advertising programs directly with certain distributors and
retailers, whereby the Company receives marketing opportunities through
advertisements, brochures, and catalogs initially paid for by the
distributors. The Company provides for expenses related to these programs in
amounts established in the individual distributor agreements or in
modifications thereto.
Internationally, the Company markets its products through distributors
and/or co-publisher arrangements. Co-publisher arrangements usually provide
the Company with royalties based on sales of products by the co-publisher in
a specific geographical or foreign language market. The Company publishes
translated WINCheckIt products in French by A.B. Soft, in German by Markt Und
Technik, and in Russian by Connections East, and Trend publishes translated
versions of WIN'95 Advisor for distribution in China and Japan. The Company
also has independent sales representatives in Canada and Australia. The
Company's wholly-owned subsidiary, TouchStone Europe, Ltd., commenced
operations in July, 1995 and was responsible for sales of the Company's
products in the United Kingdom in 1995. The Company is also evaluating
further expansion into Asia, Latin America, and Australia.
The Company's sales force at March 1, 1996 consists of five people based in
the Company's office and one person at TouchStone Europe Ltd., all of whom
receive salaries, commissions, and/or incentive bonus compensation. In
addition, the Company maintains an in-house marketing department that handles
most of the design and development of the Company's product packaging,
advertisements, and promotional items.
DUPLICATION AND PACKAGING
The Company's product manuals are printed by United Business Systems, Inc.,
whose primary service is reproduction of manuals and brochures. Substantially
all of the Company's products are duplicated and packaged by Disk Copy Labs,
formerly Encryption Technology Corporation, a software manufacturing operation.
Promotion Distribution Services provided the fulfillment services for all of the
Company's mail order and upgrade offers in 1995. Subsequent to December 31,
1995, these services were transferred to Fortune 800. The Company believes its
relations with these suppliers are good. Although the Company believes that
alternative resources exist or can be obtained, a disruption of the Company's
relationship with any of these third-party contractors could adversely affect
the Company's results of operations until replacement sources are established.
In addition, any material changes in product and service quality and pricing by
these outside resources could adversely affect the Company's results of
operations. The Company has attempted to mitigate the risk of any such
disruption by maintaining certain levels of "safety stock" inventories and the
limited use of "second source" vendors.
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COMPETITION
The utility software industry is intensely competitive. Consumer demand
for particular software products may be adversely affected by the increasing
number of competitive products. The Company is aware of other companies which
have developed or are in the process of developing products which may compete in
whole or in part with the Company's products, including Microsoft, Symantec,
DiagSoft, Inc., CyberMedia, Quarterdeck, and others. In addition, there exist a
number of large, well-capitalized software development firms that could, should
they choose to do so, provide utility software in direct competition with the
Company, as well as a number of large companies which may be in the process of
developing products which compete, in whole or in part, with the Company's
products. Each of these firms and certain of the Company's existing competitors
have substantially greater financial, technical, and marketing resources than
the Company. Moreover, there are no proprietary barriers to entry that could
keep competitors from developing and selling competing products in the Company's
markets. There is no assurance that the Company will be able to successfully
compete with such concerns. Increased competition may result in loss of shelf
space and reduction in consumer demand, or sell-through of the Company's
products, any of which could have a material adverse effect on the Company's
operating results.
In addition, the Company may face increasing pricing pressures from current
and future competitors and, accordingly, there can be no assurance that
competitive pressures will not require the Company to reduce its prices. In
particular, over time, the average selling prices for the Company's products may
decline as the market for these products becomes more competitive. Any material
reduction in the price of the Company's products would negatively affect gross
margins and would require the Company to increase unit sales in order to
maintain historic levels of sales. In addition, to the extent that Microsoft or
other companies incorporate applications comparable, or perceived as comparable,
to those offered by the Company into Windows 95, Windows NT, or other products
(or separately offer such products), sales of the Company's products could be
materially adversely affected, and there can be no assurance that any such
action by Microsoft or others would not render the Company's Windows 95 or
Windows NT-based products noncompetitive or obsolete. There can be no
assurance that such competitors will not develop products that are superior
to the Company's products or that achieve greater market acceptance.
The Company believes that competition in the problem-solving computer
software utility market is somewhat fragmented, and largely based on adaptation
to a particular market segment, availability of an integrated set of products,
relationships with distributors and retailers, and selection of appropriate
distribution channels. The Company believes its focus on the utilities segment
of the market, emphasis on product quality and accuracy, its focus on the
Windows platform, the joint promotion of its products with software retailers
and sales to leading distributors make it competitive in each of these areas.
PROPRIETARY RIGHTS
The Company regards its software as proprietary and relies primarily on a
combination of copyright, trademark and trade secret laws, employee
confidentiality and nondisclosure agreements and third-party nondisclosure
agreements, and other methods of protection common in the industry. Despite
these precautions, it may be possible for an unauthorized third party to copy or
reverse-engineer certain portions of the Company's products or to obtain and use
information that the Company regards as proprietary.
Under existing law, software products have been difficult to patent,
and copyright laws offer limited protection. The Company has filed and
received federal trademark registrations for the Company's stylized logo and
"CHECKIT", "FASTMOVE!", "WINCHECKIT", "ROADTECH", "SETUP ADVISOR", and WIN'95
ADVISOR." Although the Company may file copyright applications with respect
to programs developed for the Company's software products, there can be no
assurance that any such copyrights will provide meaningful protection to the
Company or that the Company will be able to afford the expense of any
litigation which might be necessary to enforce its rights. However, the
Company believes that trademark and copyright protection are less significant
to the Company's success than factors such as knowledge, ability, and
experience of the Company's personnel, research and development, brand name
recognition, and product loyalty. The Company licenses its products
primarily under "shrink wrap" license agreements that are not signed by
licensees and, therefore, may be unenforceable under the laws of certain
jurisdictions. In addition, the laws of some foreign countries do not
protect the Company's proprietary rights to the same extent as do the laws of
the United States.
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The Company is aware that unauthorized copying by end-users affects many
companies within the software industry and if a significantly greater amount of
unauthorized copying were to occur, the Company's operating results could be
adversely affected. However, policing unauthorized use of the Company's
products is difficult. While the Company is unable to determine the extent to
which software piracy of its products exists, software piracy can be expected to
be a persistent problem.
The Company believes that its products, trademarks and other proprietary
rights do not infringe on the proprietary rights of third parties. As the
number of software products in the industry increases and the functionality of
these products further overlaps, software developers may become increasingly
subject to infringement claims. There can be no assurances that third parties
will not assert infringement claims against the Company in the future with
respect to current or future products or that any such assertion may not require
the Company to enter into royalty arrangements or result in costly litigation.
EMPLOYEES
On March 1, 1996, the Company had 53 employees, all full-time. None of the
Company's employees is covered by a collective bargaining agreement. The
Company considers its relationship with its employees to be good.
ITEM 2. PROPERTIES
The Company currently leases approximately 12,500 square feet of office
space in Huntington Beach, California. The square footage under lease will
increase to approximately 15,700 square feet over the five-year term of the
lease. The annual rent payments under this lease are currently $138,000.
ITEM 3. LEGAL PROCEEDINGS
On January 26, 1996, a purported class and derivative action entitled
DARRIN J. CARAMONTA v. LARRY W. DINGUS, ET AL, AND TOUCHSTONE SOFTWARE
CORPORATION, was filed in the United States District Court for the Central
District of California, in which Mr. Caramonta, on behalf of himself and all
others who purchased the Company's Common Stock between May 2, 1995 and December
21, 1995, alleges that the Company, and Larry W. Dingus, C. Shannon Jenkins,
Ronald Maas, Kenneth Welch III, Donald C. Watters, and Sigmund Fidyke III,
violated Section 10(b) and Rule 10b-5 promulgated under the Securities Exchange
Act of 1934, as amended, and various state statutes sounding in fraud, by
reporting earnings for the first three quarters of 1995 that allegedly were
knowingly inflated due to inadequate reserves for product returns, in part, in
order to assist the Company and the individual defendants in selling Common
Stock at an inflated price in the Company's August 25, 1995 public offering.
The derivative claims essentially assert that the allegations sounding in fraud
constituted a breach of the individual defendants' fiduciary duties . The
Company and each of the individual defendants have denied all allegations made
against them in the lawsuit. On March 11, 1996, the Company and the individual
defendants filed a motion to dismiss the lawsuit for failure to state a claim.
On March 13, 1996, a second purported class and derivative action entitled
JACK BODNER AND PAUL L. FRABER v. LARRY W. DINGUS, ET AL, AND TOUCHSTONE
SOFTWARE CORPORATION, was filed in the same court. This complaint essentially
repeats the allegations in the Caramonta lawsuit but also adds claims for an
alleged violation of Section 11 of the Securities Act of 1933, as amended,
against the Company and certain of the individual defendants, and against the
two managing underwriters of the Company's August 25, 1995 public offering,
Cruttenden Roth, Inc. and Punk, Ziegel & Knoell. The Company and the
individual defendants deny the allegations, and intend to move to dismiss this
lawsuit as well.
On February 28, 1996, a Complaint for Breach of Contract and Breach of the
Implied Covenant of Good Faith and Fair Dealing was filed by Personal Training
Systems in the Superior Court of California, County of San Mateo, in which the
plaintiff alleges that the Company broke a contract to purchase from plaintiff
specified quantities of a product produced and marketed by plaintiff, asserting
a claim for damages of not less than $185,000. The Company denies liability and
intends to defend the lawsuit vigorously.
9
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the quarter ended December 31, 1995, no matters were submitted for
vote to TouchStone's common stockholders.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's securities have been traded in the National Association of
Securities Dealers Automated Quotation (NASDAQ) system since May 19, 1995.
Prior to May 19, 1995, the Company's securities traded in the over-the-counter
market. The Company's securities are reported under the symbol "TSSW."
In 1995 and 1994, the high and low bid prices quoted for a share of common
stock were:
<TABLE>
<CAPTION>
1995 LOW HIGH
- ---- --- ----
<S> <C> <C>
Quarter ended December 31, 1995 $3.00 $10.00
Quarter ended September 30, 1995 5.00 16.38
Quarter ended June 30, 1995 1.06 5.88
Quarter ended March 31, 1995 .75 1.50
1994 LOW HIGH
- ---- --- ----
<CAPTION>
<S> <C> <C>
Quarter ended December 31, 1994 $.312 $1.56
Quarter ended September 30, 1994 .25 .40
Quarter ended June 30, 1994 .125 .375
Quarter ended March 31, 1994 .25 .625
</TABLE>
These market quotations reflect inter-dealer prices without retail mark-up,
mark-down, or commission and may not necessarily represent actual transactions.
The stock markets have experienced extreme price and volume fluctuations during
certain periods. These broad market fluctuations, and other factors, may
adversely affect the market price of the Company's Common Stock. Any shortfall
in revenue or earnings from levels expected by securities analysts could have an
immediate and significant adverse effect on the trading price of the Company's
common stock in any given period. Additionally, the Company may not learn of
such shortfalls until late in the fiscal quarter, which could result in an even
more immediate and adverse effect on the trading price of the Company's stock.
Finally, the Company participates in a highly dynamic industry, which often
results in significant volatility of the Company's common stock price.
As of March 1, 1996, there were approximately 3,334 holders of record of
TouchStone's common stock, including stock held by affiliates and excluding an
undetermined number of shareholders whose shares are held in "street" or
"nominee" names.
TouchStone has not paid cash dividends on its common stock since its
inception. TouchStone intends to employ all available funds for the development
of its business, and, accordingly, does not intend to declare or pay any cash
dividends in the foreseeable future. Additionally, the Company's line of credit
prohibits the payment of dividends without prior approval of the bank.
10
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company is a leading developer and publisher of utility software for
personal computers. The Company recognized significant increases in revenues
and profitability during 1994, attributable primarily to the April, 1994
release of SetUp Advisor, a Windows-based utility that helps users install
modems, fax cards, sound cards, CD-ROM drives, and other devices in their
personal computer systems. Following the August, 1994 introduction of
WINCheckIt, the "All-in-One Windows Problem Solver" for users of Microsoft's
Windows operating system, the Company's revenues and profitability grew at an
accelerated rate during the last five months of 1994 and the first quarter of
1995. In March, 1995, the Company introduced FastMove!, software packaged
with a cable to assist users of multiple personal computers in transferring
and synchronizing data files, while simultaneously scanning for viruses, and
a new version of SetUp Advisor that had been enhanced to address the needs of
personal computer users who intend to upgrade their personal computers to
multimedia systems. In July, 1995, the Company released WIN'95 Advisor, a
utility software product that permits users to analyze their personal
computer's compatibility with Microsoft's operating system, Windows 95, which
was released by Microsoft on August 24, 1995. WIN'95 Advisor was awarded a
Windows Magazine 1995 WIN 100 Award. In October, 1995, the Company released
WINCheckIt 4.0, TouchStone's latest version of its award-winning Windows
problem solver. WINCheckIt 4.0 provides a suite of diagnostic tools, normally
found in separate programs, that have been designed to work in both Windows
95 and Windows 3.1 environments. In November, 1995, TouchStone released
PC-cillin 95, an anti-virus utility software program that is fully compatible
with Windows 95 and Internet use.
The Company sells its products domestically, primarily through distributors
for resale to the retail channel. In 1994, three distributors accounted for
approximately 74% of the Company's product sales. In 1995, two distributors
accounted for approximately 75% of product sales.
Sales are recorded at the time products are shipped. However, the
Company's operations are subject to substantial risk of product returns from
distributors and retailers either through the exercise by the Company's
customers of contractual return rights or as a result of the Company's policy
of assisting customers in balancing and updating inventories. Although the
Company attempts to monitor and manage the volume of its sales to its
customers, large shipments in anticipation of demand which is subsequently
unrealized can lead to overstocking by the distributors and substantial
product returns. Furthermore, the risk of product returns may increase if the
demand for the Company's products declines. Although the Company maintains
allowances for projected returns, based upon historical experience, there can
be no assurance that actual levels of returns will not significantly exceed
amounts anticipated by the Company. Prior to the third quarter of 1995, the
Company based reserves on historical experience, and returns were within the
estimated reserve range. In the third and fourth quarters of 1995, due to
unanticipated slow sell-through of WIN'95 Advisor, the Company granted price
protections and recorded additional reserves based on revised estimates of
retail sell-through of that product. Certain of the Company's customer
agreements also provide for rebates to customers should the price of the
Company's products decline subsequent to shipment. The Company accrues for
such rebates when such price declines are known or become anticipated. The
Company's results of operations for the year ended December 31, 1995 were
adversely affected by actual and anticipated product returns of unsold
reseller inventories of WIN'95 Advisor, which was released in July, 1995, and
WINCheckIt 2.0, which required the booking of additional reserves for price
protection rebates, and product returns, of approximately $1.1 million and $2
million in the third and fourth quarters of 1995, respectively. The
sell-through rate of WIN'95 Advisor at the retail level dropped substantially
in the fourth quarter of 1995, in spite of price reductions implemented in
October and November, 1995. Management believes that market acceptance of
Windows 95 for upgrades has not materialized to the extent expected by most
industry analysts, which negatively affected sales of WIN'95 Advisor at the
retail level. Additionally, management believes that confusion in the
marketplace by personal computer users as to whether or not to upgrade their
operating system to Windows 95 also led to a reduction in sales of WINCheckIt
2.0 at the retail level. This confusion plus increased competition in the
utility software market-place has also led to lower sales than expected for
the first part of 1996. These factors, combined with legal expense incurred
with respect to the lawsuits
11
<PAGE>
described in Item 3,Legal Proceedings, are expected to adversely affect
profitability in the first quarter of 1996.
During 1995, approximately 51% of the Company's operating revenues were
attributable to sales of WINCheckIt which is designed for users of
Microsoft's Windows operating system. The Company anticipates that new
versions of WINCheckIt, PC-cillin 95, and the recently introduced
CheckIt Diagnostic Kit products will account for a substantial portion of the
Company's revenues during the current year. A decline in the demand for
these products, whether as a result of competition or other factors, could
have a material adverse effect on the Company's results of operations and
financial condition. In addition, the markets for the Company's products are
characterized by rapidly changing technology, short product life cycles,
extensive competition, eroding profit margins, frequent new product
introductions, and evolving industry standards. To meet these challenges, the
Company invests significant time and resources developing new products and
researching and testing their market acceptance. The length of time required
to develop the Company's products typically ranges from six to 18 months. In
the past, the Company has experienced delays in the introduction of new
products. The Company depends on the successful development of new products,
including adaptations to new platforms, to replace revenues from products
introduced in prior years which have begun to decline. The Company also
depends on upgrades of existing products to lengthen the life cycle of, and
increase the revenue attributable to, such products. If the Company does not
accurately anticipate and successfully adapt its products to emerging
personal computer platforms, environments and technologies, or new products
are not introduced when planned or do not achieve anticipated revenues, the
Company's operating results could be materially adversely affected. There
can be no assurance that the Company will be able to introduce new products
on schedule or that such new products will achieve market acceptance.
The Company's revenues consist of product sales and royalty income. Royalty
income is derived, for the most part, from international sales of the Company's
products under agreements with co-publishers, principally those who sell the
Company's products in Europe.
Most of the Company's operating expenses relate directly to sales volume.
Cost of sales includes the cost of blank diskettes, software duplication,
packaging materials and user manuals, in addition to amortization of software
development costs, royalties paid to other software development companies under
various agreements, and inventory obsolescence reserves. Sales and marketing
expense consists primarily of salaries and commissions paid to the Company's
sales, customer service, and technical support personnel and expenditures for
retail product merchandising and promotions. In addition to the base salaries
of employees in general administration, general and administrative expense
includes amounts paid to all of the Company's personnel under the Company's
annual bonus plans that are based upon the Company's overall levels of quarterly
net income. Certain of the Company's products can be expected to have short
product life cycles, characterized by decreases in retail prices as a given
product's life cycle advances. In order for the Company to maintain
satisfactory gross margins, the Company will need to introduce new products to
offset declining margins associated with older products. Research and
development expense consists primarily of salaries and related benefits paid to
computer programmers to research and design new software products. Research and
development expense during 1995 and 1994 was approximately $729,000 and
$440,000, respectively. In addition to amounts expensed for research and
development activities, salaries paid to the Company's software programmers and
fees paid to outside software development consulting firms for further
development and enhancement after technological feasibility of a product has
been established are capitalized in accordance with SFAS 86. During 1995 and
1994, approximately $360,000 and $169,000, respectively, of such costs were
capitalized. As described above, royalties paid to third-party software
developers ($575,000 in 1995 and $166,000 in 1994) are included in cost of
sales. When these expenditures are added to amounts expensed and capitalized in
connection with the Company's research and development activities, the resulting
totals represent 11.1% and 17.8% of total revenues in 1994 and 1995,
respectively.
As further discussed in "Results of Operations" below, the Company incurred
a net loss of $1,625,000 during the year ended December 31, 1995, as compared to
net income of $800,000 during the year ended December 31, 1994. In order to
return to profitability, the Company's plans include, but are not limited to,
the introduction of new software products in 1996 and the expansion of marketing
channels by the promotion of products directly to corporate and institutional
customers. No assurance may be given that the implementation of such plans will
result in profitable operating results.
12
<PAGE>
The Company's quarterly operating results may fluctuate
significantly due to a variety of factors, including changes in the Company's
product and customer mix, the number and timing of new product introductions
by the Company or its competitors, pricing pressures, general economic
conditions, and other factors. Products are generally shipped as orders are
received and, accordingly, the Company has historically operated with
relatively little backlog. As a result, quarterly revenue will depend on the
volume and timing of orders received during a particular quarter, both of
which are difficult to forecast. In addition, the Company will continue to
incur product development, marketing, and promotional expenses based upon
management's expectations as to future sales. Since many of these expenses
are committed in advance, the Company generally is unable to adjust spending
in a timely manner to compensate for any unexpected shortfall in sales. If
operating revenues do not meet the Company's expectations in any given
quarter, operating results may be adversely affected. There can be no
assurance that the Company will be profitable in any particular quarter.
In addition, the software industry has seasonal elements. In recent
years the software industry has experienced decreased demand for software
products in the second and third quarters. These seasonal elements, together
with the other factors which impact quarterly results, can cause revenues and
net income to vary. The Company's business may be affected by these seasonal
elements in the future.
The Company's business has grown rapidly during the past two years
and such growth has placed and, if sustained, will continue to place
significant demands on the Company's management and resources. It is likely
that the Company will be required to hire and train additional technical,
marketing, and administrative personnel, implement additional operating and
financial controls, install additional reporting and management information
systems for order processing, system monitoring, customer service and
financial reporting, and otherwise improve coordination between the design,
development, duplication and packaging, marketing, sales, and finance
functions. The Company's future operating results will depend on
management's ability to manage future growth, and there can be no assurance
that efforts to manage future growth will be successful.
The success of the Company in accelerating its growth through strategic
acquisitions will depend upon the Company's ability to identify and acquire
complementary businesses, products, or technologies. There can be no assurance
that the Company will be able to locate appropriate candidates that can be
acquired, outright or pursuant to product or technology licenses or other
arrangements, on favorable terms, if at all, or that acquired operations or
products will be integrated efficiently or prove profitable. The completion of
acquisitions may require sizable amounts of capital and is likely to involve the
diversion of management's attention from other business concerns. Moreover,
unexpected problems encountered in connection with any such acquisition could
have a material adverse effect on the Company. The Company could be forced to
alter its strategy in the future, if appropriate candidates prove unavailable or
too costly.
The following information should be read in conjunction with the
audited financial statements included herein. All dollar amounts presented
have been rounded to the nearest thousand, and all percentages are
approximate.
13
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of
operations data as a percentage of total revenues for the years ended
December 31:
<TABLE>
<CAPTION>
1995 1994
------ ------
<S> <C> <C>
Revenues:
Product sales 96.6% 95.7%
Royalty income 3.4 4.3
------ ------
Total revenues 100.0 100.0
Cost of sales 46.0 32.2
------ ------
Gross profit 54.0 67.8
Sales and marketing 48.8 31.5
General and administrative 15.3 17.3
Research and development 7.8 6.1
------ ------
Income (loss) from operations (17.9) 12.8
Other income (expense), net 3.5 (.3)
------ ------
Income (loss) before taxes (14.4) 12.5
Provision for income taxes 2.9 1.4
------ ------
Net income (loss) (17.3)% 11.1%
------ ------
------ ------
</TABLE>
COMPARISON OF YEARS ENDED DECEMBER 31, 1995 AND 1994
REVENUES. Total revenues for the year ended December 31, 1995 were
$9,356,000, an increase of $2,154,000, or 29.9%, compared to $7,202,000 for
the year ended December 31, 1994. This increase was attributable to increased
sales of the Company's WINCheckIt product which was first released in August
1994, and sales of FastMove! and PC-cillin 95, released in March 1995 and
November 1995, respectively. The revenue for 1995 is reported net of reserves
that were accrued for price protection (price reduction on resellers'
inventories), reseller rebates, and expected returns, aggregating
approximately $3,100,000. The Company expects that sales of an upgraded
version of WINCheckIt and PC-cillin 95 will contribute a substantial portion
of total revenues during 1996.
For the year ended December 31, 1995, royalty income was $320,000, an
increase of $12,000, or 3.9%, compared to $308,000 for the year ended December
31, 1994. Royalty income continued to decline as a percentage of total
revenues, from 4.3% during the year ended December 31, 1994 to 3.4% during the
year ended December 31, 1995.
GROSS PROFIT. Gross profit for the year ended December 31, 1995 was
$5,053,000, an increase of $167,000, or 3.4%, compared to $4,886,000 for the
year ended December 31, 1994. Although the amount of gross profit increased,
gross profit as a percentage of total revenues declined from 67.8% in 1994 to
54.0% in 1995. This decrease was primarily attributable to increased customer
price protection, and product returns without corresponding decreases in cost,
and inventory obsolescence reserves ($563,000 in 1995, compared to $73,000 in
1994), which were required in connection with product returns of WIN'95
Advisor and CheckIt 2.0. Additionally, royalty costs paid to other software
development companies increased from $166,000 in 1994 to $575,000 in 1995,
primarily incurred in connection with sales of the Company's FastMove! and
PC-cillin 95 products. Other costs which increased in 1995 from 1994 levels
included freight ($276,000, as compared to $85,000 in the year ended December
31, 1994), resulting from increases in units shipped and higher freight-in
costs for certain product components, and amortization of software
development costs ($446,000, as compared to $367,000 in 1994), which included
a one-time charge of $70,000 in 1995 to write off costs capitalized to
develop WIN'95 Advisor.
SALES AND MARKETING EXPENSE. Sales and marketing expense for the year
ended December 31, 1995 was $4,570,000, an increase of $2,297,000, or 101.0%,
compared to $2,273,000 for the year ended December 31, 1994. This increase was
primarily attributable to increased promotional and merchandising expenditures
for the Company's products associated with its enhanced retail strategy.
Additional promotional costs were incurred with the release of new products,
primarily FastMove! in March, 1995, WIN'95 Advisor in July, 1995, and PC-cillin
95 in November, 1995. Further, in order to support the substantial increase in
sales volume experienced in the first nine months of 1995, the Company was
required to add sales, customer service, and technical support personnel. Sales
and marketing expense in 1995 also includes costs aggregating $125,000 in
connection with sales and marketing activities of the
14
<PAGE>
Company's wholly-owned subsidiary, TouchStone Europe Ltd., which commenced
operations in the United Kingdom in July, 1995. Due to these additional
expenditures, sales and marketing expenses increased as a percentage of
total revenues from 31.5% in 1994 to 48.8% in 1995.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative
expense for the year ended December 31, 1995 was $1,430,000, an increase of
$185,000, or 14.9%, compared to $1,245,000 for the year ended December 31,
1994. As a result of the Company's secondary public offering of common stock
and subsequent listing on the Nasdaq National Market ("NASDAQ exchange"),
accounting, legal and investor relations costs increased. Additionally,
compensation costs increased as the number of administrative staff increased
in 1995. These increased costs were somewhat offset by a decrease in
profit-sharing bonuses ($276,000, compared to $376,000 in the year ended
December 31, 1994). As a percentage of total revenues, general and
administrative expenses declined from 17.3% to 15.3% during the year ended
December 31, 1994 to the year ended December 31, 1995, respectively.
RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense
for the year ended December 31, 1995 was $729,000, an increase of $289,000,
or 65.7%, compared to $440,000 during the year ended December 31, 1994. The
increase was attributable primarily to the hiring of additional programmers
during 1995 to develop new products. Research and development expense also
increased as a percentage of total revenues, from 6.1% for the year ended
December 31, 1994 to 7.8% for the year ended December 31, 1995.
INCOME (LOSS) FROM OPERATIONS. Due to expenses increasing more than
revenue in the fourth quarter of 1995, as discussed above, the Company incurred
a loss from operations of $1,676,000 during the year ended December 31, 1995, as
opposed to net income from operations of $928,000 for the year ended December
31, 1994.
OTHER INCOME (EXPENSE), NET. During the year ended December 31,
1994, the Company's interest expense exceeded its interest revenue by
approximately $28,000. As the Company's cash resources improved in 1995,
primarily as a result of the successful completion of its secondary public
offering of common stock, the Company's interest revenue exceeded interest
expense in the year ended December 31, 1995, by approximately $327,000, as
the Company was able to reduce debt and increase interest-bearing investments
in 1995.
PROVISION FOR INCOME TAXES. The Company's effective tax rate for
the year ended December 31, 1994 was 11%. The difference between the
provision for income taxes by applying the federal statutory tax rate to
pre-tax income and the actual provision for income taxes results primarily
from the elimination of valuation allowances on deferred tax assets and the
utilization of net operating loss carryforwards which were previously
available to the Company.
The Company's provision for taxes of $276,000 in 1995 relates
primarily to the change in valuation allowances on net deferred tax assets.
COMPARISON OF YEARS ENDED DECEMBER 31, 1994 AND 1993
REVENUES. Total revenues for the year ended December 31, 1994 were
$7,202,000, an increase of $2,277,000, or 46.2%, compared to $4,925,000 for
the year ended December 31, 1993. This increase was attributable to sales
during the last five months of the year of WINCheckIt, which was released in
August 1994. As a result, product sales for the year ended December 31, 1994
increased by $2,200,000, or 46.9%, over 1993 product sales despite declining
sales of older products.
Royalty income was $308,000 for the year ended December 31, 1994, an
increase of $76,000, or 32.8%, compared to $232,000 for the year ended December
31, 1993. However, the 1994 increases in royalty income did not match the rate
of growth in product sales (most of which are domestic) experienced during the
year. Consequently, royalty income decreased as a percentage of total revenues
from 4.7% in 1993 to 4.3% in 1994.
GROSS PROFIT. Gross profit for 1994 was $4,886,000, an increase of
$1,625,000, or 49.8%, compared to $3,261,000 for the year ended December 31,
1993. The increase in gross profit as a percentage of product sales realized
during the past year, from 69.5% in 1993 up to 70.9% in 1994, was
attributable primarily to a change in sales mix resulting from the release of
WINCheckIt in late 1994. WINCheckIt has lower materials and software costs
per unit than does CheckIt PRO:Deluxe which
15
<PAGE>
comprised a larger portion of the Company's product sales during the first
nine months of 1994. Gross profits also increased as a percentage of total
revenues from 66.2% in 1993 to 67.8% in 1994. Included in cost of sales are
amortization of software development costs ($367,000 in 1994, as compared to
$296,000 in 1993) and royalties paid to other software development companies
($166,000 in 1994 and $139,000 in 1993) under various agreements.
SALES AND MARKETING EXPENSE. Sales and marketing expense for 1994
was $2,273,000, an increase of $400,000, or 21.4%, compared to $1,873,000 for
1993. This increase was attributable primarily to the promotional and
merchandising expenditures incurred in connection with the release of
WINCheckIt. In addition, salaries and related costs increased during 1994 as
the Company decided to perform certain marketing functions in-house, as
opposed to using outside services. These increased costs were partially
offset by reductions in consulting and other fees paid to third party service
providers. Sales and marketing expense, however decreased as a percentage of
total revenues from 38.0% in 1993 to 31.6% in 1994. This decrease was
attributable primarily to the significant increase in revenue in 1994
resulting from sales during the last five months of 1994 of WINCheckIt.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative
expense for 1994 was $1,245,000 an increase of $432,000, or 53.1%, compared
to $813,000 for 1993. The 1994 expenses included the accrual of the minimum
of $50,000 in license royalties payable in connection with the Company's
Superhuman Samurai Computer Safety Fun Kit, a product whose sales have not
materialized as anticipated and are not expected to contribute significantly
to future sales. Excluding the effect of this accrual, general and
administrative expenses in 1994 increased by 46.8% over the 1993 level.
Similarly, general and administrative expense increased as a percentage of
total revenues from 16.5% in 1993 to 17.3% in 1994. The primary reason for
this increase was higher profit sharing bonuses ($406,000 for the year ended
December 31, 1994, compared to $134,000 for the year ended December 31, 1993)
which were paid as a result of the significant increase in profits in 1994.
Additionally, as sales increased significantly in 1994, the provision for
doubtful accounts increased above amounts provided for the year ended
December 31, 1993.
RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense
for 1994 was $440,000, an increase of $182,000 or 70.5%, compared to $258,000
for 1993. Research and development expense also increased as a percentage of
total revenues from 5.2% in 1993 to 6.1% in 1994. This increase reflects the
hiring of additional programmers and management personnel in 1994 in order to
assist in the development and release of new products. The additional
payroll costs were somewhat offset by a decline in consultant's fees in 1994
from 1993 levels.
INCOME FROM OPERATIONS. As a result of the foregoing, income from
operations for 1994 was $928.000, an increase of $611,000, or 192.7%, compared
to $317.000 in 1993.
PROVISION (BENEFIT) FOR INCOME TAXES. The effective tax rate for
1994 was 11% compared to a benefit of 7% in 1993. The 1994 effective rate
was less than the statutory rate primarily due to the elimination of the
valuation allowance on deferred tax assets resulting from current taxable
income and the expected utilization of net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
During the year ended December 31, 1995, the Company used its cash
resources primarily for investments in debt securities totaling $4,505,000.
The Company also repaid debt and capital lease obligations aggregating
$460,000, invested $360,000 in software development and purchased equipment
totaling $215,000. These expenditures were funded primarily from proceeds
from sales of common stock and repayments on notes receivable aggregating
$15,612,000, and cash generated from operating activities of $1,550,000.
During the year ended December 31, 1994, the Company used its cash
resources primarily to invest $169,000 in software development.
Additionally, the Company repaid debt aggregating $77,000 and purchased
office equipment totaling $14,000. The Company used cash generated from
operations of $1,268,000 to fund these expenditures, as well as borrowings
under its bank line of credit of $210,000. The Company also received $45,000
from common stock issuances and subscriptions in 1994.
On August 30, 1995, the Company completed a secondary public
offering of common stock which resulted in net proceeds to the Company of
$15,272,000, after deducting underwriter's commission
16
<PAGE>
and offering costs. As a result, the Company's working capital has
increased from $1,446,000 at December 31, 1994, to $15,373,000 at
December 31, 1995. Cash and cash equivalents has increased from
$1,298,000 at December 31, 1994 to $12,919,000 at December 31, 1995.
In addition to its cash and working capital resources, the Company
also has a bank line of credit which provides for borrowings up to $300,000,
bears interest at the prime rate (8.5% at December 31, 1995), plus 1.5%, and
matures May 5, 1996. Borrowings are collateralized by substantially all
Company assets and guaranteed by three of the Company's executive officers.
The borrowing facility contains certain financial covenants which require,
among other things, the Company to be profitable on an annual basis, minimum
levels of tangible net worth, and maintaining certain financial ratios, as
defined. This line of credit also prohibits payment of dividends without
prior approval of the bank, and limits annual capital expenditures to
$75,000. The Company was either in compliance with these covenants or had
received applicable waivers at December 31, 1995. There were no borrowings
under this line of credit at December 31, 1995. The Company intends to renew
this line of credit when it matures.
Management believes that the Company's existing cash resources and
anticipated cash flows from operations, and periodic borrowings under the
line of credit, will be sufficient to fund the Company's operations at
currently anticipated levels through December 31, 1996. The Company plans to
use its cash resources to finance new product development and existing
product enhancements, expand internationally, establish a direct sales force
for corporate customers, and for general corporate purposes. The execution
of such plans may include strategic acquisitions of or investments in
complementary businesses, products, or technologies.
17
<PAGE>
ITEM 7. FINANCIAL STATEMENTS PAGE
Index to Financial Statements:
1. Independent Auditors' Report 19
2. Financial Statements:
Balance Sheet as of December 31, 1995. 20
Statements of Operations for the years ended
December 31, 1995 and 1994. 21
Statements of Shareholders' Equity for
the years ended December 31, 1995 and 1994. 22
Statements of Cash Flows for
the years ended December 31, 1995 and 1994. 23
Notes to Financial Statements. 24
18
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
TouchStone Software Corporation:
We have audited the accompanying balance sheet of TouchStone Software
Corporation as of December 31, 1995 and the related consolidated statements
of operations, shareholders' equity and cash flows for each of the two years
in the period then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of TouchStone Software Corporation
as of December 31, 1995 and the results of its operations and its cash flows
for each of the two years in the period then ended, in conformity with
generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Costa Mesa, California
March 13, 1996
19
<PAGE>
TouchStone Software Corporation
Consolidated Balance Sheet
December 31, 1995
<TABLE>
<CAPTION>
A S S E T S
Current assets:
<S> <C>
Cash and cash equivalents $12,918,643
Investments 4,505,096
Income tax refund receivable 998,890
Accounts receivable, net 225,053
Inventories 298,278
Prepaid expenses and other current assets 117,017
Employee advances 19,425
-------------
Total current assets $19,082,402
Investments 114,000
Property, net 248,608
Software development costs, net 149,974
Other assets 33,010
-----------
$19,627,994
-------------
-------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,034,291
Accrued payroll and related expenses 260,703
Accrued cooperative advertising costs 834,269
Other accrued liabilities 580,185
-----------
Total current liabilities 3,709,448
Deferred compensation 114,000
Deferred lease obligation 22,275
Shareholders' equity:
Preferred stock, $.001 par value, 3,000,000
shares authorized, none issued or outstanding
Common stock, $.001 par value; 20,000,000 shares
authorized; issued and outstanding, 7,341,118 shares
7,341
Additional paid-in capital 17,866,012
Accumulated deficit (2,066,993)
Notes receivable from sale of common stock (24,089)
------------
Net shareholders' equity 15,782,271
------------
$19,627,994
------------
------------
</TABLE>
See accompanying notes to consolidated financial statements
20
<PAGE>
TouchStone Software Corporation
Consolidated Statements of Operations
Years ended December 31, 1995 and 1994
<TABLE>
<CAPTION>
1995 1994
---- ----
<S> <C> <C>
Revenues :
Product sales $9,035,620 $6,893,447
Royalty income 320,125 308,054
---------- ----------
Total revenues 9,355,745 7,201,501
Cost of sales 4,303,217 2,315,740
--------- ---------
Gross profit 5,052,528 4,885,761
Operating expenses:
Sales and marketing 4,569,990 2,273,188
General and administrative 1,430,283 1,244,516
Research and development 728,624 440,477
---------- ----------
Total costs and expenses 6,728,897 3,958,181
---------- ---------
Income (loss) from operations (1,676,369) 927,580
Other income (expense), net 326,852 (28,005)
---------- ----------
Income (loss) before
provision for income taxes (1,349,517) 899,575
Provision for income taxes 275,500 99,500
---------- ----------
Net Income (loss) ($1,625,017) $800,075
----------- ----------
----------- ----------
Net Income (loss) per share of common
stock outstanding ( $0.26) $0.14
----------- ----------
----------- ----------
Weighted average shares 6,367,000 5,576,000
----------- ----------
----------- ----------
</TABLE>
See accompanying notes to consolidated financial statements.
21
<PAGE>
TOUCHSTONE SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995 AND 1994
<TABLE>
<CAPTION>
NOTES
RECEIVABLE TOTAL
FROM SALE SHARE-
COMMON STOCK PAID-IN ACCUMULATED OF COMMON HOLDERS'
------------
SHARES AMOUNT CAPITAL DEFICIT STOCK EQUITY
------ ------ ------- ------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Balances at
December 31, 1993 4,446,304 $ 2,071,150 ($1,242,051) ($74,175) $754,924
Recapitalization (2,066,704) $2,066,704
Collection of notes receivable 36,309 36,309
Interest accrued (2,361) (2,361)
Issuance of shares for
services received 17,930 18 4,487 4,505
Stock options exercised 61,966 62 13,092 13,154
Notes received for options and
warrants exercised 1,307,269 1,307 239,828 (232,376) 8,759
Net income 800,075 800,075
--------- ------ ----------- ------------ --------- ------------
Balances at
December 31, 1994 5,833,469 5,833 2,324,111 (441,976) (272,603) 1,615,365
Stock options exercised 207,649 208 94,243 94,451
Collections of notes receivable 245,137 245,137
Issuance of common stock in
secondary offering, net
of costs 1,300,000 1,300 15,270,838 15,272,138
Tax benefit from stock option
exercises 176,820 176,820
Forgiveness of note in lieu of fees 3,377 3,377
Net loss (1,625,017) (1,625,017)
--------- ------ ----------- ------------ --------- ------------
Balances at
December 31, 1995 7,341,118 $7,341 $17,866,012 ($2,066,993) ($24,089) $15,782,271
--------- ------ ----------- ------------ --------- ------------
--------- ------ ----------- ------------ --------- ------------
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE>
TOUCHSTONE SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995 AND 1994
<TABLE>
<CAPTION>
1995 1994
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ($1,625,017) $800,075
Adjustments to reconcile net income (loss) to net
cash flows provided by operating activities:
Depreciation and amortization 506,679 404,897
Change in deferred income taxes 218,400 (201,100)
Provision for doubtful accounts 118,598 72,600
Provision for obsolete inventories 562,553 72,600
Change in deferred lease obligation 22,275 (6,871)
Issuance of stock for compensation
and interest 4,505
Interest expense in connection with
stock issuances 8,759
Loss on sale of assets 947
Changes in operating assets and liabilities:
Income tax refund receivable (998,890)
Accounts receivable 1,337,961 (861,715)
Inventories (471,651) (222,794)
Prepaid expenses and other current assets (85,677) (2,131)
Employee advances (967) (3,477)
Other assets (18,324) (540)
Accounts payable 1,330,767 392,114
Accrued liabilities 652,842 810,588
------------ -----------
Net cash provided by operating activities 1,550,496 1,267,510
Cash flows from investing activities:
Capitalized software development costs (360,160) (168,730)
Purchase of investments (4,505,096)
Purchases of property (215,329) (14,380)
------------ -----------
Net cash used in investing activities (5,080,585) (183,110)
Cash flows from financing activities:
Net (repayments) borrowings under bank
line of credit (300,000) 210,179
Principal payments on notes payable (156,071) (66,783)
Principal payments under capital
lease obligations (4,124) (10,468)
Proceeds from exercise of stock warrants and
options and repayment on notes receivable 245,137 45,463
Interest accrued on notes receivable (2,361)
Issuance of common stock, net 15,366,589
Other prepaid financing costs (1,000) (6,234)
------------ -----------
Net cash provided by financing activities 15,150,531 169,796
------------ -----------
Net increase in cash and cash equivalents 11,620,442 1,254,196
Cash and cash equivalents, beginning of period 1,298,201 44,005
------------ -----------
Cash and cash equivalents, end of period $12,918,643 $1,298,201
------------ -----------
------------ -----------
Supplemental cash flow information:
Interest paid $7,966 $26,153
------------ -----------
------------ -----------
Income taxes paid $1,170,701 $22,555
------------ -----------
------------ -----------
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE>
TOUCHSTONE SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS. TouchStone Software Corporation ("TouchStone"
or the "Company") designs, develops, markets, and supports a line of computer
problem-solving utility software and supporting products which simplify personal
computer (PC) installation, support, and maintenance. The Company markets its
products domestically through software distributors, for resale through the
retail channel which includes approximately 7,100 stores. Ongoing customer
evaluations are performed with respect to the Company's receivables, and
collateral is generally not required.
CONSOLIDATION. The consolidated financial statements of the Company
include the financial statements of the Company's wholly-owned subsidiary,
TouchStone Europe Ltd., which commenced operations in the United Kingdom in
July, 1995. All intercompany transactions and balances have been eliminated.
CASH EQUIVALENTS. Cash equivalents consist of highly liquid investments
with original maturities of three months or less.
INVENTORIES. Inventories are stated at the lower of cost, using the first-
in, first-out method, or market, and consist mainly of finished goods and
packaging supplies.
PROPERTY. Property is stated at cost and depreciated using the straight-
line method based on the estimated useful lives of the assets (three to five
years). Leasehold improvements are amortized over the shorter of the useful
life or the life of the related lease.
SOFTWARE DEVELOPMENT COSTS. Research and development expenses resulting
from the design, development, and testing of new software and software
maintenance and enhancement costs are expensed as incurred, until technological
feasibility has been established. Thereafter, certain costs such as coding and
testing are capitalized in accordance with the Statement of Financial Accounting
Standards No. 86, Accounting for Costs of Computer Software to be Sold, Leased
or Otherwise Marketed, until the product is available for sale. Capitalized
expenses were approximately $360,000 and $169,000 for the years ended December
31, 1995 and 1994, respectively.
Capitalized software development costs are amortized using the straight-
line method, or based on unit sales as compared to total projected unit sales,
commencing when the related products are available for sale, over the estimated
useful lives of the related products which range from 12 to 24 months.
Amortization of software development costs was approximately $446,000 and
$367,000 for the years ended December 31, 1995 and 1994, respectively.
Software development costs are presented in the accompanying balance sheet
net of accumulated amortization of approximately $1,063,000 at December 31,
1995.
REVENUE RECOGNITION. Revenues are recognized upon the later of shipment
of the related product or transfer of title and are in accordance with Statement
of Position 91-1, SOFTWARE REVENUE RECOGNITION, as there are no significant
vendor obligations or post-contract support at the time of delivery. The
Company offers its distributors certain rights of return, price protection, and
exchange privileges on sales. The Company records estimates for such rights of
return, price protection, and exchange privileges at the time of product sale,
based on historical experience and, or sell-through information obtained from
its distributors and certain retailers. Royalties are recognized as income when
minimum payments specified in the royalty agreements become due, or as the
related products are sold by the licensee.
COOPERATIVE ADVERTISING. The Company offers cooperative advertising
programs to its distributors whereby the Company's products receive market
visibility through ads, brochures, and catalogs paid for by the distributors.
Approved expenditures can be deducted by the distributors from amounts due to
the Company. Cooperative advertising costs are accrued at the maximum rates
allowed under the respective distribution agreements and are charged to expense
when product sales are recognized as revenue.
24
<PAGE>
TOUCHSTONE SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME (LOSS) PER SHARE. Net income per share was computed in 1994
using the weighted average common and common equivalent shares outstanding.
Common equivalent shares included warrants and options to purchase common stock.
Such common equivalent shares were not included in the calculation of the net
loss per share in 1995 as their effect would have been antidilutive.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles requires TouchStone management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the periods then ended. Actual results, including those related to sales
returns, could differ from those estimates.
During the fourth quarter of 1995, the Company recorded additional reserves
for price protection, product returns, and obsolete inventory aggregating
approximately $2,000,000.
RECENT ACCOUNTING PRONOUNCEMENT. In October of 1995, the Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards No. 123 (SFAS 123), ACCOUNTING FOR STOCK-BASED COMPENSATION, which
became effective for fiscal years beginning after December 15, 1995. SFAS 123
establishes new financial accounting and reporting standards for stock-based
compensation plans. Entities will be allowed to measure compensation expense
for stock-based compensation under SFAS 123 or APB Opinion No. 25 ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES. Entities electing to remain with the accounting in
APB Opinion No. 25 will be required to make pro-forma disclosures of net income
and earnings per share as if the provisions of SFAS 123 had been applied. The
Company is in the process of evaluating the impact of SFAS 123, and the
potential impact on the Company adopting the new standard has not been
quantified at this time. The Company must adopt SFAS 123 no later than December
1, 1996.
2. BALANCE SHEET DETAIL
INVESTMENTS. Investments classified as current assets at December 31,
1995 consist of investments in municipal debt securities, all maturing within
one year and classified as held-to maturity securities, and stocks, rights,
and warrants classified as available for sale securities. Such investments
are recorded at cost if held-to maturity and at fair market value for all
other investments.
Current investments at December 31, 1995 consist of the following:
<TABLE>
<CAPTION>
Cost of Fair Market Value
Investments of Investments
----------- --------------
<S> <C> <C>
Municipal bonds $ 1,005,096 $ 1,006,680
Stocks, rights, and warrants 3,500,000 3,500,000
----------- -------------
$ 4,505,096 $ 4,506,680
----------- -------------
----------- -------------
</TABLE>
Investments classified as non-current assets at December 31, 1995 consist
primarily of money funds held by the Company as custodian for certain executive
officers under a deferred compensation plan. Such investments are reported at
cost, which approximated market value.
ACCOUNTS RECEIVABLE. At December 31, 1995, accounts receivable is
presented net of allowance for doubtful accounts, reseller rebate reserves, and
product return reserves of approximately $139,300, $150,900, and $2,760,700,
respectively.
25
<PAGE>
TouchStone Software Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 1995 and 1994
2. BALANCE SHEET DETAIL (CONTINUED)
PROPERTY. At December 31, 1995, property consists of the following:
<TABLE>
<CAPTION>
<S> <C>
Office equipment and furniture $485,547
Automobiles 104,794
Leasehold improvements 24,533
--------
$614,874
Less accumulated depreciation and amortization (366,266)
--------
$248,608
--------
--------
</TABLE>
3. FINANCING ARRANGEMENTS
At December 31, 1995, the Company had a bank line of credit which provides
for borrowings up to $300,000, bears interest at the prime rate (8.5% at
December 31, 1995) plus 1.5%, and matures May 5, 1996. Borrowings are
collateralized by substantially all Company assets and guaranteed by three of
the Company's executive officers. The borrowing facility contains certain
financial covenants which require, among other things, the Company to be
profitable on an annual basis, minimum levels of tangible net worth, and
maintaining certain financial ratios, as defined. This line of credit also
prohibits payment of dividends without prior approval of the bank, and limits
annual capital expenditures to $75,000. There were no borrowings under this
line of credit at December 31, 1995.
The Company was not in compliance with certain of these covenants at
December 31, 1995. The Company received a waiver for the covenant violations.
4. COMMITMENTS AND CONTINGENT LIABILITIES
COMMITMENTS. At December 31, 1995, the Company was obligated under non-
cancelable operating leases for its office facility and office equipment as
follows:
Year ending
December 31,
- ------------
1996 $226,000
1997 209,000
1998 189,000
1999 178,000
2000 44,000
--------
$846,000
--------
--------
In 1994, the Company sublet a portion of its office space. This sublease
required monthly payments of $700 and was canceled March 31, 1995. Rent
expense, net of sublease income, totaled approximately $204,000 and $141,000 for
the years ended December 31, 1995 and 1994, respectively.
The Company has entered into various agreements with outside consulting
firms for the development of specialized applications utilized in the Company's
software products. Generally, the Company agrees to pay the software developers
a percentage royalty based on actual product sales. One royalty agreement
executed in 1994 provided that TouchStone pay minimum royalties of $50,000,
which the Company accrued at December 31, 1994. The Company recorded total
royalty expense of approximately $575,000 and $166,000 for the years ended
December 31, 1995 and 1994, respectively.
CONTINGENT LIABILITIES. On January 26, 1996, a purported class and
derivative action entitled DARRIN J. CARAMONTA v. LARRY W. DINGUS, ET AL, AND
TOUCHSTONE SOFTWARE CORPORATION, was filed in the United States District Court
for the Central District of California, in which Mr. Caramonta, on behalf of
himself and all others who purchased the Company's Common Stock between May 2,
1995 and December 21, 1995, alleges that the Company, and Larry W. Dingus, C.
Shannon Jenkins, Ronald Maas, Kenneth Welch III, Donald C. Watters, and Sigmund
Fidyke III, violated Section 10(b) and Rule
26
<PAGE>
TouchStone Software Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 1995 and 1994
4. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
10b-5 promulgated under the Securities Exchange Act of 1934, as amended,
and various state statutes sounding in fraud, by reporting earnings for the
first three quarters of 1995 that allegedly were knowingly inflated due to
inadequate reserves for product returns, in part, in order to assist the
Company and the individual defendants in selling Common Stock at an inflated
price in the Company's August 25, 1995 public offering. The derivative claims
essentially assert that the allegations sounding in fraud constituted a breach
of the individual defendants' fiduciary duties . The Company and each of the
individual defendants have denied all allegations made against them in the
lawsuit. On March 11, 1996, the Company and the individual defendants filed a
motion to dismiss the lawsuit for failure to state a claim.
On March 13, 1996, a second purported class and derivative action entitled
JACK BODNER AND PAUL L. FRABER v. LARRY W. DINGUS, ET AL, AND TOUCHSTONE
SOFTWARE CORPORATION, was filed in the same court. This complaint essentially
repeats the allegations in the Caramonta lawsuit but also adds claims for an
alleged violation of Section 11 of the Securities Act of 1933, as amended,
against the Company and certain of the individual defendants, and against the
two managing underwriters of the Company's August 25, 1995 public offering,
Cruttenden Roth, Inc. and Punk, Ziegel & Knoell. The Company and the
individual defendants deny the allegations, and intend to move to dismiss this
lawsuit as well.
On February 28, 1996, a Complaint for Breach of Contract and Breach of the
Implied Covenant of Good Faith and Fair Dealing was filed by Personal Training
Systems in the Superior Court of California, County of San Mateo, in which the
plaintiff alleges that the Company broke a contract to purchase from plaintiff
specified quantities of a product produced and marketed by plaintiff, asserting
a claim for damages of not less than $185,000. The Company denies liability and
intends to defend the lawsuit vigorously.
Based on its current knowledge, the Company does not believe that the
referenced matters are likely to have a material adverse effect on the financial
condition of the Company.
5. SHAREHOLDERS' EQUITY
1983 INCENTIVE STOCK OPTION PLAN. During 1983, the Company adopted an
incentive stock option plan (the 1983 ISOP "Plan") which provides for the
granting of options to purchase up to 329,399 shares of the Company's common
stock at not less than fair market value at the date of grant. In addition,
stock appreciation rights may be granted under the Plan. Options granted under
the Plan vest immediately and are for periods not exceeding 10 years from date
of grant.
1988 NON-QUALIFIED STOCK OPTION PLAN. On August 5, 1988, the Company's
Board of Directors adopted a Non-Qualified Stock Option Plan (the "1988 NQ-
Plan"). The 1988 NQ-Plan authorizes the issuance of up to a total of 166,667
shares of Common Stock designed as an incentive for non-employee directors,
technical advisors, vendors and consultants of the Company. The 1988 NQ-Plan is
administered by the Non-Qualified Stock Option Committee of the Board of
Directors which determines the recipients of options, the exercise price of the
options, and the number of shares subject to each option. This plan expires
August 5, 1998. At December 31, 1995, there were no shares available under the
1988 NQ-Plan for future grant.
THE 1991 INCENTIVE STOCK OPTION AND NON-QUALIFIED STOCK OPTION PLANS. In
January, 1992, the Company's stockholders approved additional incentive stock
option and non-qualified stock option plans (the "1991 ISOP-Plan" and the "1991
NQ-Plan") which provide for additional grants of options to purchase up to an
aggregate of 1,175,000 shares of the Company's common stock. These plans expire
December 13, 2000. At December 31, 1995, there were no shares available for
grant under these plans.
27
<PAGE>
TouchStone Software Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 1995 and 1994
5. SHAREHOLDERS' EQUITY (CONTINUED)
THE 1994 STOCK OPTION PLAN. In 1994, the Company's Board of Directors
adopted a 1994 Stock Option Plan (the "1994 Plan") pursuant to which options to
purchase up to 550,000 shares of the Company's common stock may be granted.
Unless and until the 1994 Plan is approved by the Company's shareholders, only
non-qualified options can be granted under the 1994 Plan to employees, including
executive officers, non-employee directors, consultants, vendors, customer, and
others expected to provide significant services to the Company. On October 31,
1994, the Company granted options under the 1994 Plan to purchase an aggregate
of 435,000 shares of common stock, at $.50 per share, to a total of 15 key
employees, including executive officers. In 1995, options to purchase an
additional 110,000 shares of the Company's common stock, at prices ranging from
$.85 to $1.85 per share, were granted under the 1994 Plan, including options to
purchase 10,000 shares, at $1.00 per share, for each of the Company's two
outside directors.
All options under the above plans were granted at fair market value at the
date of issuance. Stock option activity for these plans, along with common
stock warrant activity, for the years ended December 31, 1995 and 1994 was as
follows:
<TABLE>
<CAPTION>
1983 1988 1991 1991 1994
PLAN PLAN PLAN PLAN PLAN WARRANTS
<S> <C> <C> <C> <C> <C> <C>
Options outstanding,
December 31, 1993 15,668 44,167 901,000 243,666 14,169
Granted 97,000 9,000 435,000 442,633
Lapsed (11,667) (41,667) (3,334)
Exercised (20,000) (883,000) (173,000) (16,667)
Canceled (15,668) (75,000)
------ ------ ------- ------- ------- ------
Balance,
December 31, 1994 0 12,500 40,000 37,999 435,000 436,801
Granted 39,000 30,000 1,000 110,000
Exercised (10,000) (20,000) (29,666) (91,150) (56,833)
Canceled (5,000) (50,000)
------ ------ ------- ------- ------- ------
Balance,
December 31, 1995 0 41,500 50,000 9,333 448,850 329,968
------ ------ ------- ------- ------- -------
------ ------ ------- ------- ------- -------
Options exercisable,
December 31, 1995 0 12,500 20,000 8,333 398,850 329,968
------ ------ ------- ------- ------- -------
------ ------ ------- ------- ------- -------
Price range of
outstanding options, $ .20 to $.19 to $ .30 to $ .50 to $ .20 to
December 31, 1995 n/a $5.00 $2.66 $5.00 $1.85 $ .50
------ ------ ------- ------- ------- -------
</TABLE>
1994 grants under the 1991 ISOP-Plan and the 1991 NQ-Plan included 16,000
options to various officers and directors in connection with their guarantee of
borrowings under the Company's bank line of credit.
28
<PAGE>
TouchStone Software Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 1995 and 1994
5. SHAREHOLDERS' EQUITY (CONTINUED)
NOTES RECEIVABLE FROM SALE OF COMMON STOCK. Amounts due from sale of
common stock or exercise of options consisted of the following at December 31,
1995:
<TABLE>
<CAPTION>
<S> <C>
Notes receivable, bearing
interest at 3.5% per annum $23,906
Notes receivable, non-interest
bearing 183
-------
24,089
-------
-------
</TABLE>
During 1994, the due date of notes receivable aggregating $48,484 plus
accrued interest was extended from August, 1995 to August, 1998. All amounts
due under these notes were repaid in 1995.
RECAPITALIZATION. During 1994, the Company amended its Articles of
Incorporation to change its common stock from no par to a $.001 value.
PUBLIC OFFERING OF COMMON STOCK. On August 30, 1995, the Company completed
a secondary public offering of 2,300,000 shares of the Company's common stock,
including 1,000,000 shares sold by certain shareholders of the Company. The net
proceeds of the offering, after deducting the underwriter's commission and
offering costs, were approximately $15,272,000.
6. SEGMENT INFORMATION AND CONCENTRATION OF CREDIT RISK
The Company operates primarily in the U.S. in a single segment that is the
design, development, manufacture, and sale of computer-related software
products. Its customers generally consist of large software distributors as
well as PC end-users. Amounts receivable from customers are generally not
secured.
In 1994, one customer who is a distributor accounted for approximately 59%
of product sales. Two customers who are distributors accounted for
approximately 58%, and 17% of product sales during the year ended December 31,
1995. International product sales were approximately $1,031,000 and $670,000
during the years ended December 31, 1995 and 1994, respectively, and accounted
for approximately 9.7% and 11.4% of total product sales, respectively.
7. INCOME TAXES
Effective January 1, 1993, the Company adopted the Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). This
statement requires the recognition of deferred tax assets and liabilities for
the future consequences of events that have been recognized in the Company's
financial statements or tax returns. The measurement of the deferred items is
based on enacted tax laws. In the event the future consequences of differences
between financial reporting bases and the tax bases of the Company's assets and
liabilities result in a deferred tax asset, SFAS 109 requires an evaluation of
the probability of being able to realize the future benefits indicated by such
asset. A valuation allowance related to a deferred tax asset is recorded when it
is more likely than not that some portion or all of the deferred tax asset will
not be realized.
29
<PAGE>
TOUCHSTONE SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994
7. INCOME TAXES (CONTINUED)
The provision for income taxes consists of:
<TABLE>
YEAR ENDED DECEMBER 31,
------------------------
1995 1994
---- ----
<S> <C> <C>
Current:
Federal $16,200 $129,000
State 40,800 171,600
-------- ---------
57,000 300,600
Deferred:
Federal 368,400 (113,700)
State (149,900) (87,400)
-------- ---------
218,500 (201,100)
-------- ---------
Total provision $275,500 $99,500
-------- ---------
-------- ---------
</TABLE>
A reconciliation of the provision for income taxes compared to the U.S.
statutory rate of 34% for the years ended December 31, 1995 and 1994 is as
follows:
<TABLE>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1994
---- ----
<S> <C> <C>
Income taxes at statutory rates ($458,800) $314,900
State taxes, net of federal benefit (72,000) 55,700
Loss of unconsolidated foreign subsidiary 34,400
Deductible temporary differences
for which no benefit was
previously recognized (68,600)
Change in valuation allowance 792,500 (196,100)
Other (20,600) (6,400)
-------- ---------
Provision for income taxes $275,500 $99,500
-------- ---------
-------- ---------
</TABLE>
30
<PAGE>
TOUCHSTONE SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994
7. INCOME TAXES (CONTINUED)
Deferred tax assets (liabilities) consist of the following at December 31, 1995:
State taxes $(52,500)
Research and development (76,000)
Net non-current
deferred tax liabilities (128,500)
---------
Accrued vacation 27,400
Inventory and bad debt
reserves 221,900
Deferred rent and compensation 62,200
Depreciation 18,600
Sales returns reserve 739,800
Credit carryforwards 17,000
---------
Deferred tax assets 1,086,900
Deferred tax valuation
allowance (958,400)
---------
128,500
---------
Net deferred tax asset $0
---------
---------
The net change in the valuation allowance for the deferred tax asset was a
decrease of $196,100 for the year ended December 31, 1994, related to benefits
arising primarily from the utilization of net operating loss carryforwards. For
the year ended December 31, 1995, the net change in the valuation allowance was
an increase of $792,500, related to significant increases in deferred tax
assets, and the reversal of net deferred tax assets in 1994, and the uncertainty
of the realization of such deferred tax assets in the near term. At December
31, 1995, the Company had general business tax credit carryforwards for federal
purposes of approximately $17,000, of which $11,400 expire in 2000 and $5,600
expire in 2004.
In the year ended December 31, 1995, the Company decreased its taxes
payable and increased additional paid-in capital by $176,820, as a result of tax
benefits arising from certain non-qualified stock option and warrant exercises.
8. STATEMENTS OF CASH FLOWS
Supplemental information concerning significant non-cash investing and
financing activities for the years ended December 31, 1995 and 1994 are
presented below.
In March, 1995, the Company purchased property for $48,475 by exchanging
cash of $11,415 and executing a note payable in the amount of $37,060.
In 1995 and 1994, the Company forgave notes receivable from sale of common
stock and related interest receivable aggregating $3,377 and $4,000,
respectively, due from a consultant to the Company in lieu of fees.
In 1994, the Company issued 1,307,269 shares of the Company's common stock
in exchange for notes receivable of $232,376.
In 1994, the Company issued 2,000 shares of the Company's common stock to
an officer of the Company in lieu of cash compensation of $1,000.
31
<PAGE>
TOUCHSTONE SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994
8. STATEMENTS OF CASH FLOWS (CONTINUED)
In 1994, two Company officers who held approximately $22,550 of the
Company's subordinated debt received a total of 15,930 shares of the Company's
common stock in lieu of interest payments aggregating approximately $3,500.
9. TRANSACTIONS WITH RELATED PARTIES
The Company paid royalties to a software programming company whose majority
shareholder is a TouchStone officer aggregating approximately $27,000 and
$67,000 during the years ended December 31, 1995 and 1994, respectively.
The Company incurred interest expense in connection with notes payable to
related parties of $1,741 and $8,578 for the years ended December 31, 1995 and
1994, respectively.
The Company recorded interest income in connection with notes receivable
from related parties of $9,032 and $1,890 for the years ended December 31, 1995
and 1994, respectively.
In April, 1995, the Company made a $23,000 loan to a member of the Board of
Directors. This loan bore interest at 8% per annum, and was repaid in December,
1995.
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's balance sheet includes the following financial instruments:
cash and cash equivalents, investments, accounts receivable, and accounts
payable. The Company considers the carrying amounts in the financial statements
to approximate fair value for the financial instruments because of the
relatively short period of time between origination of the instruments and their
expected realization.
32
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
NONE
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, AND KEY EMPLOYEES
The directors and executive officers of the Company at March 1, 1996
are as follows:
N A M E A G E T I T L E
- ------------------------- ----- -----------------------------------------
Larry W. Dingus 51 Chairman of the Board
C. Shannon Jenkins 48 Chief Executive Officer and Director
Larry Jordan 52 President and Chief Operating Officer
Richard W. Brail 54 Director
Ronald R. Maas 49 Executive Vice President, Chief Financial
Officer, Director, and Secretary
Kenneth C. Welch III 39 Director
Mr. Dingus has served as Chairman of the Company's Board of Directors since
the Company was founded in September, 1982, and served as Secretary of the
Company from 1989 to October, 1995. He resigned as President of the Company on
February 15, 1988, and as Chief Executive Officer of the Company on February 16,
1989, posts he had held since September, 1982.
Ms. Jenkins has served as Chief Executive Officer of the Company since
February, 1989. She served as the Company's President from March, 1988 until
January, 1996. She served as the Company's Vice President of Marketing from
September, 1982 until January, 1986, when she became the Company's Executive
Vice President, and since September, 1982, she has also served as a Director.
Mr. Jordan joined the Company in January, 1996 as President and Chief
Operating Officer. Prior to joining the Company Mr. Jordan was with FileNet
Corporation, a leading developer of workflow and document imaging software, from
1984 to 1996, holding the position of Senior Vice President of Sales since
1992.
Mr. Maas joined the Company in 1991 as Vice President of Finance and
Operations and Chief Financial Officer. In 1993, Mr. Maas was promoted to
Executive Vice President of the Company, and was elected to the Company's Board
of Directors. In October, 1995 he was elected Corporate Secretary. Prior to
joining the Company, Mr. Maas served from March, 1990 through January, 1991 as
the Controller of Bell & Howell Quintar Company, a manufacturer of computer
peripheral equipment.
33
<PAGE>
Mr. Welch has been a Director of the Company since August 1993. From
September, 1985 to the present, he has worked as an independent software
consultant in the Washington D.C. area. From September, 1982 to May, 1985 he
served as the Company's Vice President of Development, and was a Director of the
Company from September, 1982 to August, 1986
Mr. Brail joined the Company's Board of Directors in April, 1995. He has
been the President and Chief Executive Officer of Best Golf, Inc. since
September 1994. From July, 1991 to May, 1994, Mr. Brail served as the President
of Helio Computers, Inc. of Irvine, California. From 1985 until 1991, he
provided services to the Company and other computer companies as the owner of a
computer sales and marketing company.
In addition to its executive officers, the following individuals are
considered to be key employees of the Company:
Mr. Fidyke joined the Company in December, 1993 as the Vice President of
Development. From 1985 until December, 1993, he was the majority owner and had
served as the President of Custom Software, Inc., a software development firm
with which the Company contracted from time to time.
Mr. Watters joined the Company in July, 1992 as the Director of Sales and
was promoted to Vice President of Sales on January 1, 1994. From January, 1992
to July, 1992, Mr. Watters was the Regional Territory Manager for Certus
International. From 1987 to 1992, he was employed as the Manager of Distributor
Sales for California Software Products, Inc. Mr. Watters has advised management
of his intention to leave the Company and pursue other interests.
Ms. Bartlett joined the Company as Director of Operations in May of 1995.
In January of 1996, she was promoted to Vice President of Operations. From 1992
to May, 1995 Ms. Bartlett was self-employed as a business broker in Arizona.
Ms. Bartlett held upper management positions for various companies in the
computer software industry between 1982 and 1992.
Ms. Kennedy joined the Company in August, 1995 as Director of Marketing and
was promoted to Vice President of Marketing in February, 1996. From June 1994
to March, 1995 Ms. Kennedy was a founder and Director of Marketing at Rememory
Corporation, a developer of NetWare backup systems. Rememory Corporation was
acquired by Stac Electronics in March 1995. From March to August 1995, she held
various marketing management positions at Conner Peripherals (previously Archive
Corp.).
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, and persons who own more than 10 percent of the
Company's common stock to file reports of ownership and changes in ownership
with the Securities and Exchange Commission (SEC). Officers, directors, and
greater than 10 percent shareholders are required by SEC regulations to furnish
the Company with copies of all Section 16(a) forms they file. Management
believes all such individuals were in compliance with Section 16(a) at December
31, 1995, and that none were delinquent.
34
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth information regarding compensation for
services in all capacities paid or accrued for the fiscal years indicated by the
Company to each of the officers identified above.
<TABLE>
<CAPTION>
OTHER RESTRICTED
NAME & ANNUAL STOCK ALL OTHER
PRINCIPAL COMPEN- AWARDS OPTIONS/ LTIP COMPEN-
POSITION YEAR SALARY ($) BONUS ($) SATION ($) ($) SAR (#) PAYOUTS SATION
<S> <C> <C> <C> <C> <C> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------------------------
C.S. Jenkins 1995 125,750 88,911 0 0 0 0 0
CEO, AND 1994 112,400 89,657 0 0 138,300 0 0
DIRECTOR 1993 100,000 17,641(1) 0 0 80,000 0 0
- --------------------------------------------------------------------------------------------------------------------------
L.W. Dingus
CHAIRMAN OF THE 1995 71,489 73,289 0 0 0 0 0
BOARD OF 1994 95,333 78,683 0 0 138,883 0 0
DIRECTORS 1993 86,000 15,370(2) 0 0 80,000 0 0
- --------------------------------------------------------------------------------------------------------------------------
R.R. Maas 1995 85,862 43,444 0 0 0 0 0
EXEC. V.P. AND 1994 83,800 47,449 0 0 92,467 0 0
DIRECTOR 1993 78,300 8,376(3) 0 0 78,000 0 0
- --------------------------------------------------------------------------------------------------------------------------
D.C. Watters 1995 73,408 100,313 0 0 0 0 0
V.P. OF SALES 1994 62,200 84,046 0 0 63,500 0 0
1993 58,200 42,668(4) 0 0 70,000 0 0
- --------------------------------------------------------------------------------------------------------------------------
S. Fidyke III 1995 88,188 24,392 0 0 0 0 0
V.P. OF DEVELOP. 1994 81,000 30,679 0 0 63,750 0 0
1993 6,125(5) 0 0 0 75,000 0 0
</TABLE>
(1) Amount reported for 1993 excludes $20,960 representing a bonus paid in
1994.
(2) Amount reported for 1993 excludes $18,340 representing a bonus paid in
1994.
(3) Amount reported for 1993 excludes $11,480 representing a bonus paid in
1994.
(4) Amount reported for 1993 excludes $7,765 representing a bonus paid in
1994.
(5) Hired December 1, 1993
OPTION GRANTS IN 1995
The Company did not grant stock options or stock appreciation rights in
1995 to any of the executive officers named above.
35
<PAGE>
AGGREGATED OPTION EXERCISES IN 1995 AND OPTION VALUES AS OF DECEMBER 31,
1995
None of the executive officers named above exercised any stock options in
1995. The value of unexercised options at December 31, 1995, for each of the
officers named above are:
<TABLE>
<CAPTION>
NUMBER OF VALUE OF
UNEXERCISED UNEXERCISED
OPTIONS/SARS AT IN-THE-MONEY
12/31/95 (#) OPTIONS/SARS AT
SHARES 12/31/95 ($)
ACQUIRED ON VALUE
EXERCISE REALIZED
NAME (#) ($) ALL EXERCISABLE ALL EXERCISABLE
<S> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------------
C.S. Jenkins 0 0 134,300 $ 445,507
L.W. Dingus 0 0 134,883 $ 447,542
R.R. Maas 0 0 88,467 $ 295,150
D.C. Watters 0 0 63,500 $ 212,815
S. Fidyke III 0 0 63,750 $ 213,688
</TABLE>
The value of unexercised in-the-money options is determined by using the
difference between the exercise price and the average bid price at December 31,
1995.
BOARD OF DIRECTORS
During 1995, the Company's Board of Directors held two regular and two
special meetings and, otherwise took action by written consent. The Board has
established an Executive Committee comprised of Mr. Dingus, Ms. Jenkins, Mr.
Jordan and Mr. Maas. Among other things, the Executive Committee determines the
persons entitled to participate in stock option, bonus, and other similar plans.
The Board has also established an Audit Committee comprised of Messrs. Dingus,
Welch, and Brail, which meets to consult with the Company's independent auditors
concerning their engagement and audit plan, and thereafter concerning the
auditors' report and management letter and with the assistance of the
independent auditors, also monitors the adequacy of the Company's internal
accounting controls. The Board has not established separate compensation or
nominating committees. Rather, the Board of Directors meets as a whole to
determine the compensation of corporate officers and nominate the individuals to
be proposed by the Board of Directors for election as directors of the Company.
Each non-employee director is paid an annual retainer of $1,200 plus $300
per each board meeting attended and each board committee meeting attended for
each committee of which he/she is a member. The Company has and will continue
to pay the expenses incurred by its non-employee directors in attending Board
meetings. In October, 1995, the Company issued warrants to purchase 10,000
shares of Common Stock, at the exercise price of $1.00 per share, to each of Mr.
Welch and Mr. Brail for serving on the Company's Board of Directors. No
additional compensation is paid to any of the employee directors.
EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement with each of its three
executive officers, Ms. Jenkins, Mr. Jordan, and Mr. Maas, that automatically
renews on January 1 of each year and provides that, upon termination of
employment with the Company for any reason other than "cause," the executive
officer will continue to receive compensation at the level in effect on the date
of termination of employment for the remainder of the year or nine months,
whichever is longer. In the event that the termination of employment of any of
the executive officers occurs following a change in control of the Company, the
exercisability of all stock options and warrants held by the terminated officer
will automatically be accelerated, and the purchase price of all shares of the
Company's Common Stock
36
<PAGE>
issuable upon exercise of such options and warrants can
be paid by the terminated executive pursuant to a promissory note due and
payable in two years.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of March 1, 1996, certain information
concerning ownership of the Company's common stock by each director and all
officers and directors as a group. At March 1, 1996, no other person nor entity
owns more than 5% of the Company's outstanding shares, as indicated by the
Company's securities transfer agent.
NAME AND ADDRESS OF NUMBER OF SHARES PERCENTAGE
BENEFICIAL OWNER BENEFICIALLY OWNED (*) OF CLASS
- --------------------------- ------------------------ ------------
Larry W. Dingus 487,490(1) 6.5%
2124 Main Street
Huntington Beach, CA 92648
C. Shannon Jenkins 712,351(2) 9.5%
2124 Main Street
Huntington Beach, CA 92648
Larry Jordan 80,000 1.1%
2124 Main Street
Huntington Beach, CA 92648
Ronald R. Maas 335,610(3) 4.5%
2124 Main Street
Huntington Beach, CA 92648
Kenneth C. Welch III 228,574(4) 3.1%
2124 Main Street
Huntington Beach, CA 92648
Richard W. Brail 0 0%
2124 Main Street
Huntington Beach, CA 92648
All Officers and Directors as 2,161,819(5) 27.4%
a Group (10 persons at
March 1, 1996)
(*) Excludes options that do not vest within 60 days after the Company's fiscal
year end.
(1) Includes options for 134,833 shares.
(2) Includes options for 134,300 shares.
(3) Includes options for 88,467 shares.
(4) Includes options for 42,000 shares.
(5) Includes options for 526,850 shares.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In 1995 and 1994, the Company paid royalties aggregating approximately
$27,000 and $67,000 to Custom Software, Inc., a software programming company
whose majority stockholder is Sigmund A. Fidyke III, a TouchStone officer.
In 1991, Mr. Dingus participated in the Company's $200,000 subordinated
debt financing, providing the Company with a personal loan of $10,000 for two
years at 15% interest and receiving options to purchase a total of 3,334 shares
of the Company's Common Stock at an average price of $.20
37
<PAGE>
per share. In 1992, Mr. Dingus, a member of his family, and Mr. Maas
participated in the Company's $45,000 subordinated note financing, lending
the Company $15,000, $20,000, and $10,000, respectively. In consideration of
these loans, Messrs. Dingus and Maas were granted warrants to purchase 5,000
and 3,333 shares of Common Stock, respectively, at $.30 per share.
Additionally, in connection with the Company's bank line of credit, Mr.
Dingus and Mr. Maas were required to accept only payments of interest from
November, 1993 until May 1, 1994 by virtue of the subordination provisions of
their subordinated notes. In consideration for the Company's failure to make
principal payments when due, Mr. Dingus was issued 11,120 shares of Common
Stock and Mr. Maas was issued 4,810 shares of Common Stock. At December 31,
1994, the principal amounts due Messrs. Dingus and Maas under these
subordinated notes were approximately $15,800 and $6,800, respectively. All
of these amounts were paid in March, 1995.
During the years ended December 31, 1993 and 1994, Mr. Dingus, Ms. Jenkin,
and Mr. Maas were each granted options to purchase a total of 34,000 of the
Company's Common Stock in consideration for their guarantees of borrowings under
the Company's bank line of credit.
In August, 1994, three-year warrants to purchase an aggregate of 56,733
shares of Common Stock at $.26 per share were issued to holders of outstanding
stock options who agreed to exercise their options at an earlier date than
otherwise required, including warrants to purchase 14,883, 14,300, 8,467, and
2,000 shares issued to Mr. Dingus, Ms. Jenkins, Mr. Maas, and Mr. Welch,
respectively.
During the year ended December 31, 1994, Mr. Dingus, Ms. Jenkins, and Mr.
Maas gave the Company promissory notes in the respective principal amounts of
$46,357, $43,349, and $28,244 as payment of the purchase price for 297,668,
286,000, and 169,333 shares of the Company's Common Stock, respectively,
acquired upon exercise of stock options. Certain of these notes originally bore
interest at the rate of 8% per annum and were due and payable in August, 1995,
while others bore interest at the annual rate of 3.5% and were not payable until
August, 1998. Prior to the end of 1994, the interest rate on the 8% notes was
reduced to 3.5% per annum, and the maturity of those notes was extended to
August 1998. Each of these promissory notes was paid in full in August, 1995.
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED WITH REPORT
1. Financial Statements.
The financial statements listed in the index to financial statements
at Item 7 are filed as part of this report.
2. Exhibits.
The Exhibits listed on the accompanying Index to Exhibits are filed as
part of this report.
(b) REPORTS ON FORM 8-K
1. Item reported: None
(c) EXHIBITS
See Item 13 (a) 2 above.
38
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has caused this report to be signed on its
behalf by the under-signed, thereunto duly authorized.
TouchStone Software Corporation
By /s/ Ronald R. Maas
-----------------------------
Ronald R. Maas,
Executive Vice President, Secretary,
Chief Financial Officer, and Director
(Principal Accounting Officer)
Dated: March 28, 1996
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ Larry W. Dingus Chairman of the Board of Directors
- --------------------------------
Larry W. Dingus
/s/ C. Shannon Jenkins Chief Executive Officer and Director
- --------------------------------
C. Shannon Jenkins
/s/ Larry Jordan President and Chief Operating Officer
- --------------------------------
Larry Jordan
/s/ Kenneth C. Welch III Director
- --------------------------------
Kenneth C. Welch III
/s/ Richard W. Brail Director
- --------------------------------
Richard W. Brail
39
<PAGE>
TouchStone Software Corporation
INDEX TO EXHIBITS
3.1 Articles of Incorporation of Registrant. (1)
3.2 By-Laws of Registrant. (1)
3.3 Amended Articles of Incorporation.(5)
10.1 Incentive Stock Option Plan. (1)
10.1 A Amended Incentive Stock Option Plan. (2)
10.1 B Non-Qualified Stock Option Plan. (2)
10.1 C 1991 Stock Option Plan. (3)
10.1 D Employee Stock Purchase Agreement. (5)
10.1 E 1994 Non-Qualified Stock Option Plan. (6)
10.2 Line of Credit Agreement dated April 27,1995. (6)
10.3 Office Lease dated February 7,1995. (6)
10.5 Loan Agreement dated April 27, 1995. (6)
21. Subsidiaries of the Registrant. (6)
23. Consent of Independent Auditors.
27. Financial Data Schedule.
(1) Incorporated by reference to the Exhibits to the Registration
Statements on Form S-18, as amended, Registration Number 2-92450-LA as
filed with the Securities and Exchange Commission.
(2) Incorporated by reference to the Company's filing on Form S-8 with the
Securities and Exchange Commission, Registration Number 33-25989.
(3) Incorporated by reference to the Exhibits to the Company's Form 10-KSB
for the year ended December 31, 1992 as filed with the Securities and
Exchange Commission.
(4) Incorporated by reference to the Exhibits to the Company's 10KSB for the
year ended December 31, 1993 as filed with the Securities and Exchange
Commission.
(5) Incorporated by reference to the Exhibits to the Company's 10KSB for the
year ended December 31, 1993 as filed with the Securities and Exchange
Commission.
(6) Incorporated by reference to the Exhibits to the Registration Statement
on Form SB-2, as amended; Registration number 33-94 352 as filed with
the Securities and Exchange Commission.
40
<PAGE>
Exhibit 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
33-25989 of Touchstone Software Corporation on Form S-8 of our report dated
March 13, appearing in the Annual Report on Form 10-KSB of Touchstone
Software Corporation for the year ended December 31, 1995.
/s/ Deloitte & Touche LLP
Costa Mesa, California
March 28, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> DEC-31-1995
<CASH> 12,918,643
<SECURITIES> 4,505,096
<RECEIVABLES> 225,053
<ALLOWANCES> 0
<INVENTORY> 298,278
<CURRENT-ASSETS> 19,082,402
<PP&E> 248,608
<DEPRECIATION> 0
<TOTAL-ASSETS> 19,627,994
<CURRENT-LIABILITIES> 3,709,448
<BONDS> 0
0
0
<COMMON> 7,341
<OTHER-SE> 15,774,930
<TOTAL-LIABILITY-AND-EQUITY> 19,627,994
<SALES> 0
<TOTAL-REVENUES> 9,355,745
<CGS> 4,303,217
<TOTAL-COSTS> 11,032,114
<OTHER-EXPENSES> (326,852)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,349,517)
<INCOME-TAX> 275,500
<INCOME-CONTINUING> (1,625,017)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,625,017)
<EPS-PRIMARY> (0.26)
<EPS-DILUTED> 0
</TABLE>
