UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to _________________
Commission file No. 0-12969
TouchStone Software Corporation
(Exact name of registrant as specified in its charter)
California 95-3778226
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2124 Main Street, Huntington Beach, CA 92648
(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (714) 969-7746
Indicated by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities 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 _____
As of November 7, 1996 there were
7,769,735 shares of Common Stock outstanding
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
- ------------------------------
The accompanying financial statements and notes thereto do not contain all
information required by generally accepted accounting principles to be included
in a full set of financial statements.
In the opinion of management, the financial statements reflect all
adjustments necessary for a fair presentation of the registrant's financial
position and results of operations. However, the results of operations for the
three and nine months ended September 30, 1996 are not necessarily indicative of
the results to be expected for the full year. TouchStone Software Corporation
Consolidated Balance Sheet September 30, 1996 (Unaudited)
<TABLE>
<S> <C>
A S S E T S
Current assets:
Cash and cash equivalents ........................ $ 4,475,466
Investments ...................................... 5,800,012
Income tax refund receivable ..................... 307,900
Accounts receivable, net ......................... 484,536
Inventories ...................................... 329,237
Prepaid expenses and other current assets ........ 307,508
Employee advances ................................ 23,148
------
Total current assets ......................... 11,727,807
Investments ....................................... 4,212,551
Property, net ..................................... 395,608
Software development costs, net ................... 155,726
Other assets ...................................... 30,176
------
$ 16,521,868
============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................. $ 2,213,916
Accrued payroll and related expenses ............. 472,208
Accrued cooperative advertising costs ............ 575,664
Other accrued liabilities ........................ 960,911
-------
Total current liabilities .................... 4,222,699
Deferred compensation ............................. 72,000
Deferred lease obligation ......................... 42,996
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; 7,695,485 shares issued
and outstanding ................................. 7,695
Additional paid-in capital ....................... 18,568,687
Accumulated deficit ............................. (6,368,120)
Notes receivable from sale of common stock ....... (24,089)
-------
Net shareholders' equity ..................... 12,184,173
----------
$ 16,521,868
============
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
TouchStone Software Corporation
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three months Nine months
ended September 30, ended September 30,
1996 1995 1996 1995
-------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Revenues:
Product sales ......................... $ 2,366,084 $ 3,449,259 $ 4,641,210 $ 9,471,386
Royalty income ........................ 94,792 67,424 257,997 226,704
----------- ----------- ----------- -----------
Total revenues .................... 2,460,876 3,516,683 4,899,207 9,698,090
Cost of Sales .......................... 1,026,179 916,975 2,415,731 2,821,583
----------- ----------- ----------- -----------
Gross Profit ...................... 1,434,697 2,599,708 2,483,476 6,876,507
Operating expenses:
Sales and marketing ................... 1,250,996 1,306,320 3,449,287 3,147,055
General and administrative ............ 340,014 457,199 1,124,453 1,262,673
Research and development .............. 407,240 170,726 1,012,172 443,997
Litigation settlement and related costs -- -- 1,811,941 --
Total operating expenses ............... 1,998,250 1,934,245 7,397,853 4,853,725
----------- ----------- ----------- -----------
Income (loss) from operations ......... (563,553) 665,463 (4,914,377) 2,022,782
Other income, net ...................... 208,588 97,504 613,250 129,203
----------- ----------- ----------- -----------
Income (loss) before provision
for income taxes ...................... (354,965) 762,967 (4,301,127) 2,151,985
Provision for income taxes ............. -- 284,000 -- 812,300
----------- -----------
Net income (loss) ..................... ($ 354,965) $ 478,967 ($4,301,127) $ 1,339,685
=========== =========== =========== ===========
Net income (loss) per share of
common stock outstanding .............. ($ 0.05) $ 0.07 ($ 0.57) $ 0.19
=========== =========== =========== ===========
Weighted average shares ................ 7,669,000 7,267,000 7,507,000 6,909,000
=========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
TouchStone Software Corporation
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Nine months Nine months
ended ended
September 30, 1996 September 30, 1995
<S> <C> <C>
Cash flow from operating activities:
Net income (loss) ................................. ($ 4,301,127) $ 1,339,685
Adjustments to reconcile net income to net cash
flows provided by operating activities:
Depreciation and amortization .................... 236,756 267,138
Provision for doubtful accounts .................. 61,304 98,600
Provision for obsolete inventories ............... 103,858 124,800
Change in deferred lease obligation .............. 20,721 14,850
Amortization of investment premium ............... 5,096 --
Loss (gain) on disposal of assets ................ (1,382) 947
Issuance of common stock in litigation settlement 625,000 --
Changes in operating assets and liabilities:
Income tax refund receivable ..................... 690,990 --
Accounts receivable .............................. (320,787) 491,784
Inventories ...................................... (134,817) (186,801)
Prepaid expenses and other current assets ........ (190,491) (19,130)
Employee advances ................................ (3,723) (10,795)
Other assets ..................................... 2,501 (18,326)
Accounts payable ................................. 179,625 62,310
Accrued liabilities .............................. 291,626 206,854
------- -------
Net cash provided by (used in)
operating activities ......................... (2,734,850) 2,371,916
Cash flow from investing activities:
Sale of investments ............................... 7,530,560 --
Capitalized software development costs ............ (141,076) (284,316)
Purchase of investments ........................... (12,929,123) (2,006,530)
Purchases of property ............................. (254,517) (136,208)
Sale of property .................................. 7,800 --
-----
Net cash used in
investing activities .......................... (5,786,356) (2,427,054)
Cash flow from financing activities:
Principal payments on notes payable ............... -- (456,071)
Principal payments under capital
lease obligations ................................. -- (4,124)
Issuance of common stock, net ..................... -- 15,372,693
Other prepaid financing costs ..................... -- (1,000)
Proceeds from exercise of stock warrants and
options and repayment on notes receivable ......... 78,029 244,960
------ -------
Net cash provided by
financing activities .......................... 78,029 15,156,458
------ ----------
Net increase (decrease) in cash and cash equivalents (8,443,177) 15,101,320
Cash and cash equivalents, beginning of period ..... 12,918,643 1,298,201
---------- ---------
Cash and cash equivalents, end of period ........... $ 4,475,466 $ 16,399,521
============ ============
Supplemental cash flow information:
Interest paid .................................... -- $ 7,717
============
Income taxes paid ................................ -- $ 1,020,701
============
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
TouchStone Software Corporation
Notes to Consolidated Financial Statements
September 30, 1996
(Unaudited)
1. General
- ------------
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. These
consolidated financial statements have been prepared by the Registrant, without
audit, and include all adjustments which are, in the opinion of management,
necessary for a fair presentation of the results of operations for the three and
nine months ended September 30, 1996 and 1995, the financial position at
September 30, 1996, and the cash flows for the nine months ended September 30,
1996 and 1995, pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations, although the Registrant believes that the disclosures in such
financial statements are adequate to make the information presented not
misleading. These condensed consolidated financial statements should be read in
conjunction with the TouchStone Software Corporation financial statements and
notes thereto included in the TouchStone Software Corporation Annual Report
filed with the Securities and Exchange Commission on Form 10-KSB for the year
ended December 31, 1995.
Net income (loss) per share
Certain shares reserved for outstanding common stock purchase warrants and
options have been considered common stock equiva lents in computing net income
per share for the three and nine months ended September 30, 1995. Such common
equivalent shares were not included in the calculation of the net loss per share
for the three and nine months ended September 30, 1996 as their effect would
have been antidilutive.
2. Accounts Receivable
- ------------------------
At September 30, 1996, accounts receivable is presented net of allowance
for doubtful accounts, reseller rebate reserves, and product return reserves of
approximately $140,000, $484,500, and $435,800, respectively. Certain
distributors' accounts resulted in credit balances and therefore were
reclassified to accounts payable.
3. Financing Arrangements
- ---------------------------
In September 1996, the Company negotiated a bank line of credit which
allows for borrowings up to $500,000 and which expires September 1997.
Borrowings will bear interest at the bank prime rate, and are collateralized by
a $500,000 certificate of deposit. The prime rate was 8.25% at September 30,
1996. There were no borrowings under this line of credit at September 30, 1996.
This borrowing facility requires the Company to maintain minimum shareholders'
equity of $10,000,000 and minimum aggregate cash, cash equivalents and
investments of $12,000,000. This line of credit also prohibits acquisitions of
other entities without the prior approval of the bank.
4. Litigation Settlement
- --------------------------
In June 1996 the Company reached an agreement to settle three shareholder
class action and derivative suits against the Company and certain of its
officers and directors. Under the principal terms of the agreement, the Company
established a settlement fund consisting of $500,000 and 200,000 newly- issued
shares of the Company's common stock. See Part II, Item 1 Legal Proceedings.
<PAGE>
TouchStone Software Corporation
Notes to Consolidated Financial Statements
September 30, 1996
(Unaudited)
5. New Accounting Pronouncement
- ---------------------------------
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation," which becomes effective for the Company beginning December 31,
1996. SFAS No. 123 requires expanded disclosures of stock-based compensation
arrangements with employees and encourages (but does not require) compensation
cost to be measured based on the fair value of the equity instrument awarded.
Companies are permitted, however, to continue to apply APB Opinion No. 25, which
recognizes compensation cost based on the intrinsic value of the equity
instrument awarded. The Company will continue to apply APB Opinion No. 25 to its
stock-based compensation awards to employees and will disclose the required pro
forma effect on net income or loss and earnings per share in its financial
statements for the year ended December 31, 1996.
6. Shareholder Rights Plan
- ----------------------------
In September 1996 the Board of Directors approved the adoption of a
Shareholder Rights Plan. The Rights Plan provides for the distribution to
TouchStone Software Corporation's stockholders of one preferred stock purchase
"Right" for each outstanding share of TouchStone common stock. The Rights have
an exercise price of $15 per Right, subject to subsequent adjustment. Initially,
the Rights will trade with the Company's common stock, and will not be
exercisable until the occurrence of certain takeover-related events.
The Rights Plan provides that if a person or group acquires 15 percent or
more of the Company's common stock without the approval of the Board, the
holders of the Rights, other than the acquiring person or group, would, under
certain circumstances, have the right to purchase additional shares of the
Company's common stock having a market value equal to two times the exercise
price of the Right. In addition, if the Company is thereafter merged into
another entity, or if 50 percent or more of the Company's consolidated assets or
earning power are sold, then the Right will entitle its holder, other than the
acquiring person or group, to buy common shares of the acquiring entity having a
market value equal to two time the exercise price of the Right.
The Rights were distributed to holders of the Company's common stock of
record on October 4, 1996, as a dividend, and will expire, unless earlier
redeemed, on September 26, 2006.
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
This quarterly report on Form 10-QSB contains forward-looking statements
that involve risks and uncertainties. The Company's actual results may differ
materially from the results discussed in the forward-looking statements. Factors
that might cause such a difference include, but are not limited to those
discussed under the caption "Business Risks" contained herein.
General
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.
Product revenues are recorded at the time products are shipped less
estimated reserves for product returns. Currently the Company uses historical
experience and retail sell-through information to establish these reserves.
Shipments of the Company's products into the domestic market are reserved until
there is reasonable information that the product has been sold at the retail
level. 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. The Company maintains allowances for projected returns; however there
can be no assurance that actual levels of returns will not significantly exceed
amounts anticipated by the Company. 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.
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. 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. 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.
In June 1996 the Company reached an agreement to settle three shareholder
class action and derivative suits against the Company and certain of its
officers and directors. Under the principal terms of the agreement, the Company
established a settlement fund consisting of $500,000 and 200,000 newly-issued
shares of common stock in June 1996. The Company recorded an expense of
$1,375,000 in the second quarter of 1996 related to such settlement.
The Company's performance during the last half of 1995 and the first nine
months of 1996 was adversely affected by an unanticipated slowdown in the sale
of some of its Windows 95 related products. As a result of that slowdown and its
experience with returned products, the Company not only had to make large
adjustments to revenue in the fourth quarter of 1995, but had to increase the
calculation for the required reserves on all shipment of products in the three
and nine months ended September 30, 1996. The slowdown in sales and the
Company's reserve policy combined with increased selling and research and
development expenses as reflected in the accompanying unaudited, consolidated
financial statements, have adversely affected profitability and resulted in net
losses of $355,000 and $4,301,000 during the three and nine months ended
September 30, 1996, respectively, as compared to net income of $479,000 and
$1,340,000 during the three and nine months ended September 30, 1995,
respectively. In order to improve operating results, the Company's plans
include, but are not limited to, the introduction of new software products in
the fourth quarter of 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.
The following information should be read in conjunction with the unaudited,
consolidated financial statements included herein. All dollar amounts presented
have been rounded to the nearest thousand and all percentages are approximate.
Products
The following table sets forth selected products currently offered by the
Company:
Initial Release
Product Title Description Date
- ------------- ---------------------------------- ----------------------
e.support e.support is an electronic support October, 1996
system which allows millions of users
to communicate with thousands of
vendors from one simple user interface
on the user's system. e.support allows
the user to send a Problem Report,
Information Request, Registration,
"How To" Request or Feedback to a
vendor electronically via a modem, LAN
or Internet connection, and to
optionally include system diagnostic
information, up to 5 user-attached
files and/or up to 5 vendor-specified
files.
Check-It For use with DOS, Windows 3.1 and March, 1996
Diagnostic Windows 95, this multi-utility package
Kit is designed to meet the specific needs
of both technicians and technical
users. It includes the new Check3It 4
program, a portable, self-booting DOS
utility that provides extensive
hardware testing and configuration
analysis features; the new WINCheck3It
Pro, an advanced version of
WINCheck3It; 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 Designed for use with Windows 95 and November, 1995
95 the Internet, PC-cillin 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.
WINCheck-It This Windows-based utility provides a October,1995
4.0 suite of diagnostic tools, normally
found in separate programs, that have
been designed to work in both Windows
95 and Windows 3.1 environments.
WINCheck3It 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.
FastMove! A file synchronization and transfer March, 1995
2.0 program with ZIPSync that keeps the
files and directories on desktop PCs,
laptops, networks and Zip drive,
synchronized and up-to-date with the
click of a button. ZIPSync is the
first utility of its kind to
synchronize and catalog files on a Zip
drive. FastMove! Is also available
with the Ultra Flex Parallel Transfer
Cable.
AutoHelp/ This utility is a diagnostic software May, 1995
Check-It package available only to hardware
Diagnostics manufacturers on an OEM basis and is
"bundled" as part of a 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.
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data as a
percentage of total revenues for the three and nine- month periods ended
September 30:
<TABLE>
<CAPTION>
Three months Nine months
ended September 30, ended September 30,
1996 1995 1996 1995
<S> <C> <C> <C> <C>
Revenues:
Product sales ....................... 96.1% 98.1% 94.7% 97.7%
Royalty income ...................... 3.9 1.9 5.3 2.3
Total revenues ................... 100.0 100.0 100.0 100.0
Cost of sales ......................... 41.7 26.1 49.3 29.1
Gross profit ..................... 58.3 73.9 50.7 70.9
Sales and marketing ................... 50.8 37.1 70.4 32.4
General and administrative ............ 13.8 13.0 22.9 13.0
Research and development .............. 16.5 4.9 20.7 4.6
Litigation settlement and related costs -- -- 37.0 --
Total operating expenses ......... 81.1 55.0 151.0 50.0
Income (loss) from operations ......... (22.8) 18.9 (100.3) 20.9
Other income .......................... 8.5 2.8 12.5 1.3
Income (loss) before taxes(14.3) ...... 21.7 (87.8) 22.2
Provision for income taxes ............ -- 8.1 -- 8.4
Net income (loss) ................ (14.3)% 13.6% (87.8)% 13.8%
</TABLE>
Comparison of Three Months Ended September 30, 1996 and 1995
Revenues
Total product sales for the three months ended September 30, 1996 were
$2,366,000, a decrease of $1,083,000, or 31.4%, compared to $3,449,000 for the
three months ended September 30, 1995, primarily due to the lower sales of the
WINCheckIt product line. Additionally, revenues for the third quarter of 1995
included sales of WIN 95 Advisor. Sales of the current leading products,
PC-cillin and CheckIt Diagnostic Kit, did not offset the declining sales of the
WINCheckIt products.
For the three months ended September 30, 1996, royalty income was $95,000,
an increase of $28,000, or 40.6%, compared to $67,000 for the three months ended
September 30, 1995. This increase was primarily due to royalties earned from
sales of PC-cillin during the third quarter of 1996. Royalty income increased as
a percentage of total revenues, from 1.9% during the three months ended
September 30, 1995 to 3.9% for the three months ended September 30, 1996.
Gross Profit
Gross profit for the three months ended September 30, 1996 was $1,435,000,
a decrease of $1,165,000, or 44.8%, compared to $2,600,000 for the three months
ended September 30, 1995. Gross profit as a percentage of total revenues
declined from 73.9% in the third quarter of 1995 to 58.3% in the third quarter
of 1996. This decrease was primarily attributable to increased royalty costs
paid to other software companies in relation to product sales, primarily
incurred in connection with sales of the Compa ny's PC-cillin product ($361,000
in the three months ended September 30, 1996, compared to $8,000 in the three
months ended September 30, 1995). Additionally, the gross profit percentage
declined due to the lower sales volume in relation to certain fixed costs that
were established for higher sales volumes. Such increased costs were offset
somewhat by a decline in amortization of software development costs, which
decreased from $90,000 in the three months ended September 30, 1995 to $52,000
in the three months ended September 30, 1996, and by lower freight costs
($91,000 in the three months ended September 30, 1995 as compared to $24,000 in
the three months ended September 30, 1996).
Sales and Marketing Expense
Sales and marketing expense for the three months ended September 30, 1996
was $1,251,000, a decrease of $55,000, or 4.2%, compared to $1,306,000 for the
three months ended September 30, 1995. Increases in salaries and related costs
due to additional customer service, technical support and marketing personnel in
1996 as compared to 1995 were more than offset by a decline in retail
promotional expenditures. Due to the decline in product sales, sales and
marketing expenses increased as a percentage of total revenues from 37.1% in the
third quarter of 1995 to 50.8% in the third quarter of 1996. The Company
continues to make investment in sales and marketing to support future revenue
growth, but such revenue growth may lag the expense level.
General and Administrative Expense
General and administrative expense for the three months ended September 30,
1996 was $340,000, a decrease of $117,000, or 25.6%, compared to $457,000 for
the three months ended September 30, 1995. This decrease is primarily
attributable to a decline in profit-sharing bonuses paid to employees ($165,000
in the three months ended September 30, 1995, as compared to none in the three
months ended September 30, 1996). The decline in profit-sharing bonuses was
somewhat offset by an increase in salaries, legal and accounting expense. As a
percentage of total revenues, general and administrative expenses increased from
13.0% to 13.8% during the three months ended September 30, 1995 to the three
months ended September 30, 1996, respectively.
Research and Development Expense
Research and development expense for the three months ended September 30,
1996 was $407,000, an increase of $236,000, or 138.5%, compared to $171,000
during the three months ended September 30, 1995. The increase was attributable
primarily to the hiring of additional programmers and increased use of outside
programmers to develop new products, and to salary increases for existing
programmers. Research and development expense also increased as a percentage of
total revenues, from 4.9% for the three months ended September 30, 1995 to 16.5%
for the three months ended September 30, 1996.
Other Income
During the three months ended September 30, 1995, the Company's interest
income exceeded its interest expense by approximately $98,000. Interest income
exceeded interest expense in the three months ended September 30, 1996, by
approximately $209,000, as interest-bearing investments increased.
Comparison of Nine Months Ended September 30, 1996 and 1995
Revenues
Total product sales for the nine months ended September 30, 1996 were
$4,641,000, a decrease of $4,830,000, or 51.0%, compared to $9,471,000 for the
nine months ended September 30, 1995, as sales of WINCheckIt 4.0 in 1996 were
significantly less than expected. Although sales of PC-cillin and CheckIt
Diagnostic Kit met management's expectations, sales of these products did not
offset declining sales of the WINCheckIt product line. Additionally, product
sales for the nine months ended September 30, 1995 included sales of WIN 95
Advisor.
For the nine months ended September 30, 1996, royalty income was $258,000,
an increase of $31,000, or 13.8%, compared to $227,000 for the nine months ended
September 30, 1995. The increase in royalty income was primarily due to
royalties earned from sales of PC-cillin in the third quarter of 1996. Royalty
income increased as a percentage of total revenues, from 2.3% during the nine
months ended September 30, 1995 to 5.3% for the nine months ended September 30,
1996.
Gross Profit
Gross profit for the nine months ended September 30, 1996 was $2,483,000, a
decrease of $4,394,000, or 63.9%, compared to $6,877,000 for the nine months
ended September 30, 1995. Gross profit as a percentage of total revenues
declined from 70.9% in 1995 to 50.7% in 1996. This decrease was primarily
attributable to increased royalty costs paid to other software companies
($884,000 in the nine months ended September 30, 1996, compared to $282,000 in
the nine months ended September 30, 1995), primarily incurred in connection with
sales of the Company's PC- cillin product. Additionally, the gross profit
percentage was lower because the sales volume is low in relation to certain
fixed costs. Such increased costs were offset somewhat by a decline in
amortization of software development costs, which decreased from $228,000 in the
nine months ended September 30, 1995 to $135,000 in the nine months ended
September 30, 1996, and by lower freight costs ($237,000 in the nine months
ended September 30, 1995 as compared to $98,000 in the nine months ended
September 30, 1996).
Sales and Marketing Expense
Sales and marketing expense for the nine months ended September 30, 1996
was $3,449,000, an increase of $139,000, or 9.6%, compared to $3,147,000 for the
nine months ended September 30, 1995. This increase was primarily attributable
to an increase in the number of customer service, technical support and
marketing personnel in 1996 as compared to 1995. Additionally, direct mail and
media advertising costs increased in 1996 as compared to 1995. Further, the
Company's consulting costs increased in 1996 from 1995 levels to support the
Company's attempts to increase sales internationally. Such increased costs were
offset somewhat by a decline in retail promotional expenditures. Due to these
additional expenditures and the decline in product sales, sales and marketing
expenses increased as a percentage of total revenues from 32.4% in the nine
months ended September 30, 1995 to 70.4% in the nine months ended September 30,
1996.
General and Administrative Expense
General and administrative expense for the nine months ended September 30,
1996 was $1,124,000, a decrease of $139,000, or 11.0%, compared to $1,263,000
for the nine months ended September 30, 1995. This decrease is primarily
attributable to a decline in profit-sharing bonuses paid to employees ($466,000
in the nine months ended September 30, 1995, as compared to none in the nine
months ended September 30, 1996). Such decreased costs were partially offset by
compensation expense related to a stock buy- back agreement incurred in
connection with the resignation of a Company officer. Additionally, investor
relations, audit, rent, and depreciation costs increased in 1996. As a
percentage of total revenues, general and administrative expenses increased from
13.0% to 22.9% during the nine months ended September 30, 1995 to the nine
months ended September 30, 1996, respectively.
Research and Development Expense
Research and development expense for the nine months ended September 30,
1996 was $1,012,000, an increase of $568,000, or 128.0%, compared to $444,000
during the nine months ended September 30, 1995. The increase was attributable
primarily to the hiring of additional programmers and increased use of outside
programmers to develop new products, and to salary increases for existing
programmers. Research and development expense also increased as a percentage of
total revenues, from 4.6% for the nine months ended September 30, 1995 to 20.7%
for the nine months ended September 30, 1996.
Litigation Settlement and Related Costs
In June 1996 the Company reached an agreement to settle three shareholder
class action and derivative suits against the Company and certain of its
officers and directors. Under the principal terms of the agreement, the Company
established a settlement fund consisting of $500,000 and 200,000 newly-issued
shares of common stock in June 1996.
Other Income
During the nine months ended September 30, 1995, the Company's interest
income exceeded its interest expense by approximately $129,000. Interest income
exceeded interest expense in the nine months ended September 30, 1996, by
approximately $613,000, as interest-bearing investments increased.
Liquidity and Capital Resources
During the nine months ended September 30, 1996, the Company used its cash
resources primarily for investments in debt securities totaling $12,929,000.
Additionally, the Company used $2,735,000 for operating activities. The Company
also invested $141,000 in capitalized software development and purchased
equipment totaling $255,000. These expenditures were funded primarily by cash
received from sale of investments of $7,531,000. The Company also received
proceeds from sales of common stock aggregating $78,000.
The Company's working capital has decreased from $15,373,000 at December
31, 1995 to $7,505,000 at September 30, 1996. Cash and cash equivalents
decreased from $12,919,000 at December 31, 1995 to $4,475,000 at September 30,
1996. The declines in working capital and cash and cash equivalents were caused
primarily by increased holdings of long-term investments and the net loss
incurred by the Company in the nine months ended September 30, 1996, as
discussed above.
In September 1996 the Company negotiated a bank line of credit which allows
for borrowings up to $500,000 and which expires September 1997. Borrowings will
bear interest at the bank prime rate, and are collateralized by a $500,000
certificate of deposit. The bank prime rate at September 30, 1996 was 8.25%.
There were no borrowings under the bank line of credit at September 30, 1996.
This borrowing facility requires the Company to maintain minimum shareholders'
equity of $10,000,000 and minimum aggregate cash, cash equivalents and
investments of $12,000,000. This line of credit also prohibits acquisitions of
other entities without the prior approval of the bank.
Management believes that the Company's existing cash resources and
anticipated cash flows from operations, and periodic borrow ings under the line
of credit, will be sufficient to fund the Company's operations at currently
anticipated levels through September 30, 1997. The Company plans to use its cash
resources to finance new product development and existing product enhancements,
expand internationally, expand the direct sales force for corporate customers,
and for general corporate customers. The execution of such plans may include
strategic acquisitions of or investments in complementary businesses, products
or technologies.
Business Risks
This quarterly report on Form 10-QSB contains forward-looking statements
that involve risks and uncertainties. The actual future results of TouchStone
Software Corporation ("Company") could differ materially from those statements.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed below and elsewhere in this report, as well as those
factors discussed in the Company's Annual Report on Form 10-KSB for the year
ended December 31, 1995.
These risks include, but are not limited to, the risk that the products
under development prove more difficult to develop than currently anticipated,
resulting in delays in reaching the market or even in the planned product having
to be abandoned. Moreover, with or without delays in bringing new products to
market, it is possible that the Company's competitors will bring to market
successful competing products which reduce the size of, or eliminate altogether,
the market for the Company's planned products. Furthermore, several of the
products under consideration involve complicated communication systems, which is
an area where the Company has little experience, and thus it may find that the
technological problems are more difficult than presently anticipated. In
addition, the software industry is characterized by rapid change and
technological advancement, including a trend by hardware manufacturers to
feature pre-loaded software packages in computers. This could reduce demand for
the Company's products, if such pre-loaded software performs many of the same
functions as the Company's currently marketed or currently under-development
software.
With respect to statements regarding the sales force and the hope to
broaden the Company's customer base, the Company intends on entering markets
that are new for it and in so doing will compete against other companies with
greater resources. There is a risk that the Company will not be able to
penetrate these new markets successfully, but will nonetheless incur sales and
administrative expenses in attempting to do so. With regard to the hoped for
expansion of the Company's presence at retail chains, the Company competes
against many other software vendors both directly, in the form of directly
competing products, and indirectly, with even non-competing products for limited
shelf space at retailers and distributors. To a large extent, the Company's
success in this regard will be a function of the Company's ability to develop
successfully the planned products identified in this report, along with market
acceptance of the Company's products currently being sold at retail. Other risks
are detailed in the Company's Securities and Exchange Commission filings,
including form 10-KSB for the year ended December 31, 1995.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
- ---------------------------
On January 26, 1996, a purported class and derivative action entitled
DARRIN J. CARAMONTA v. LARRY W. DINGUS, ET AL. was filed in 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 certain
of its officers 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.
On March 13, 1996, and on March 21, 1996, substantially similar purported
class and derivative actions entitled JACK BODNER v. Larry W. Dingus, et al. and
MARC JAFFE v. LARRY W. DINGUS, ET AL., respectively, were also filed in the same
Court.
On March 11, 1996, defendants moved to dismiss the Caramonta action
pursuant to Fed. R. Civ. P. 12(b) (6) and Rule 9(b). A ruling on the motion to
dismiss was pending at the time the parties reached an agreement-in-principle to
settle the litigation.
Under the principal terms of the agreement, the Company established a
settlement fund consisting of $500,000 and 200,000 newly-issues shares of common
stock. The Company also adopted a written policy on insider trading.
The Court has granted preliminary approval to the terms of the settlement
and has authorized the mailing of notice of the terms of the settlement to the
class. The Company is informed by counsel for the class that the notice has been
mailed. A final approval hereby has been scheduled for December.
On October 9, 1996 an entity known as Intervention, Incorporated
("Intervention") filed an action against the Company in the Superior Court of
the State of California, Santa Clara County (C 96-04476). Intervention claims
that it is a non-profit corporation bringing an action for the interests of the
general public. In essence, Intervention claims that the Company is engaged in
unfair competition and is violating California's Fair Packaging and Labeling Act
by filling the Software packages to "substantially less than their capacities."
Intervention seeks injunctive relief, unspecified attorneys' fees and damages of
$1,000,000. The Company understands that eight other software companies have
been named as defendants in identical lawsuits in three different counties. A
response to the action will not be filed until approximately November 25, 1996.
The Company believes this suit is without merit and intends to defend itself
vigorously.
ITEM 2. Changes in Securities
Not applicable.
ITEM 3. Defaults Upon Senior Securities
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 5. Other Information
None
ITEM 6. Exhibits and Reports on Form 8-K
a. Exhibits
None
b. Reports on Form 8-K
On September 20, 1996 the Company filed a current report on Form 8-K
announcing a dividend of Preferred Share Purchase Rights in connection with the
adoption of a shareholder rights plan.
S I G N A T U R E S
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TouchStone Software Corporation
(Registrant)
/s/Larry S. Jordan President, Chief Executive
Larry S. Jordan Dated: November 13, 1996 Officer and Director
/s/Ronald R. Maas Executive Vice President,
Ronald R. MaasDated: November 13, 1996 Chief Financial Officer,
Principal Accounting
Officer and Director
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