<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
EXCHANGE ACT
For the transition period from ________________ to _________________
Commission file No. 0-12969
TOUCHSTONE SOFTWARE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 95-3778226
-------- ----------
(State or other jurisdiction of (IRS 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
--------------
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 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 2, 1998 there were
7,963,060 shares of Common Stock outstanding
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PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
TouchStone Software Corporation
Consolidated Balance Sheet
September 30, 1998
(Unaudited)
<TABLE>
<CAPTION>
<S> <C>
A S S E T S
- ------------
Current assets:
Cash and cash equivalents $ 265,183
Restricted cash 500,000
Investments 7,805,866
Accounts receivable, net 148,297
Inventories 322,294
Prepaid expenses and other current assets 168,250
-----------
Total current assets 9,209,890
Investments 1,120,372
Property, net 166,617
Other assets 11,990
-----------
$10,508,869
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $ 359,027
Customer prepayments 842,456
Accrued payroll and related expenses 350,736
Accrued cooperative advertising expense 797,738
Accrued restructuring expense 481,115
Other accrued liabilities 270,116
Deferred revenue 10,929
-----------
Total current liabilities 3,112,117
Other liabilities 130,792
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, 7,963,060 shares 7,963
Additional paid-in capital 18,748,028
Accumulated deficit (11,490,031)
-----------
Total shareholders' equity 7,265,960
-----------
$10,508,869
===========
</TABLE>
See accompanying notes to consolidated financial statements
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TOUCHSTONE SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months Nine months
ended September 30, ended September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Product sales $ 724,295 $ 1,319,643 $ 3,322,651 $ 5,987,713
Royalty income 24,661 123,612 68,570 256,888
----------- ----------- ----------- -----------
Total revenues 748,956 1,443,255 3,391,221 6,244,601
Cost of sales 205,374 484,350 847,732 2,404,601
----------- ----------- ----------- -----------
Gross profit 543,582 958,905 2,543,489 3,840,000
Operating expenses:
Sales and marketing 624,776 1,066,253 2,269,137 3,665,711
General and administrative 480,420 315,271 1,218,120 1,034,527
Research and development 422,631 458,629 1,487,930 1,754,139
Restructuring expense 85,220 863,359
----------- ----------- ----------- -----------
Total operating expenses 1,613,047 1,840,153 5,838,546 6,454,377
----------- ----------- ----------- -----------
Loss from operations (1,069,465) (881,248) (3,295,057) (2,614,377)
Other income, net 134,260 167,588 459,171 534,573
----------- ----------- ----------- -----------
Net loss before income taxes (935,205) (713,660) (2,835,886) (2,079,804)
Income tax provision 800
-----------
Net loss $ (935,205) $ (713,660) $(2,836,686) $(2,079,804)
=========== =========== =========== ===========
Basic and diluted net loss per share $ (0.12) $ (0.09) $ (0.36) $ (0.27)
=========== =========== =========== ===========
Weighted average shares 7,948,000 7,847,000 7,920,000 7,833,000
=========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
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TOUCHSTONE SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine months Nine months
ended ended
Sept 30, 1998 Sept 30, 1997
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(2,836,686) $(2,079,804)
Adjustments to reconcile net loss to net cash flows
(used in) provided by
operating activities:
Depreciation and amortization 151,288 189,752
Stock options issued for consulting expense 8,764
Provision for doubtful accounts 14,846 44,817
Provision for obsolete inventories 68,317 206,550
Write-off of software development costs 151,073
Change in deferred lease obligation 21,086
Other 11,853
Changes in operating assets and liabilities:
Income tax refund receivable 32,790
Accounts receivable 459,005 181,332
Inventories (107,470) 329,940
Prepaid expenses and other current assets 62,162 99,401
Other assets 19,181 (995)
Accounts payable (300,817) (1,229,474)
Accrued restructuring expense 662,635
Accrued liabilities (200,801) 51,250
----------- -----------
Net cash used in operating activities (1,945,700) (2,044,305)
Cash flows from investing activities:
Purchase of investments (30,570,047) (24,137,657)
Maturity of investments 31,344,985 24,162,287
Purchases of property (65,917) (203,282)
Sale of property 2,342 30,350
----------- -----------
Net cash provided by (used in) investing activities 711,363 (148,302)
Cash flows from financing activities:
Proceeds from exercise of stock warrants and
options and repayment on notes receivable 65,659 39,641
----------- -----------
Net cash provided by financing activities 65,659 39,641
----------- -----------
Net decrease in cash and cash equivalents (1,168,678) (2,152,966)
Cash and cash equivalents, beginning of period 1,433,861 2,893,476
----------- -----------
Cash and cash equivalents, end of period $ 265,183 $ 740,510
=========== ===========
Supplemental cash flow information:
Interest paid $ 855 $ 1,483
=========== ===========
Income taxes paid $ 800 $ --
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
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TOUCHSTONE SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
1. GENERAL
-------
The consolidated financial statements of TouchStone Software Corporation
(the Company) include the financial statements of the Company's wholly owned
subsidiary, TouchStone Europe Ltd. These consolidated financial statements have
been prepared by the Company without audit and they 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, 1998
and 1997, the financial position at September 30, 1998, and the cash flows for
the nine months ended September 30, 1998 and 1997, 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. The results of operations for
the three and nine months ended September 30, 1998 are not necessarily
indicative of the results to be expected for the full year. These condensed
consolidated financial statements should be read in conjunction with the
TouchStone Software Corporation consolidated financial statements and notes
thereto included in the Company's Annual Report filed with the Securities and
Exchange Commission on Form 10-KSB for the year ended December 31, 1997.
Recently Issued Accounting Standards. In June 1997, the FASB issued SFAS
No. 130, Reporting Comprehensive Income, ("SFAS No. 130") (which was adopted by
the Company effective January 1, 1998). This statement establishes standards for
the reporting of comprehensive income and its components in a financial
statement that is displayed with the same prominence as other financial
statements. Comprehensive income, as defined, includes all changes in equity
(net assets) during a period from non-owner sources. Examples of items to be
included in comprehensive income, which are excluded from net income, include
foreign currency translation adjustments and unrealized gain/loss on
available-for-sale securities. There was no difference between comprehensive
income and net income as reported for the nine months ended September 30, 1998
and 1997.
In June 1997, the FASB issued SFAS No. 131, Disclosure about Segments of
an Enterprise and Related Information. SFAS No. 131 establishes standards for
the way public companies report financial information about operating segments.
The disclosures prescribed by SFAS No. 131 are effective in the year ended
December 31, 1998, but are not required for interim periods in the year of
adoption.
2. ACCOUNTS RECEIVABLE
-------------------
At September 30, 1998, accounts receivable is presented net of allowance
for doubtful accounts, reseller rebate reserves, and product return reserves of
approximately $77,000, $516,000, and $118,000, respectively. Certain
distributors' accounts resulted in credit balances and therefore were
reclassified to customer prepayments in the accompanying balance sheet.
3. FINANCING ARRANGEMENTS
----------------------
The Company has a bank line of credit, which provides for borrowings up
to $500,000, bears interest at the bank's prime rate (8.25% at September 30,
1998) and expires in September 1999. Borrowings are collateralized by a $500,000
certificate of deposit, which is recorded as restricted cash on the accompanying
consolidated balance sheet. There were no borrowings under this line of credit
at September 30, 1998. This line of credit prohibits acquisitions of other
entities without the prior approval of the bank and restricts the payment of
cash dividends.
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4. EARNINGS (LOSS) PER SHARE
-------------------------
The Company has adopted SFAS No. 128, Earnings per Share (EPS), which
replaces the presentation of "primary" earnings per share with "basic" earnings
per share and the presentation of "fully diluted" earnings per share with
"diluted" earnings per share. All previously reported EPS amounts have been
restated based on the provisions of the new standard. Basic EPS amounts are
based upon the weighted average number of common shares outstanding. Diluted EPS
amounts are based upon the weighted average number of common and common
equivalent shares outstanding. Common equivalent shares include stock options
using the treasury stock method. Common equivalent shares are excluded from the
calculation of diluted EPS in loss years, as the impact is anti-dilutive. There
was no difference between basic and diluted EPS for each period presented.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
---------------------------------------------------------
Statements contained in this Quarterly Report on Form 10-QSB that are
not purely historical are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Such statements include but are not limited to statements
regarding the Company's expectations, hopes, beliefs, intentions or strategies
regarding the future. Actual results could differ materially from those
projected in any forward-looking statements due to a number of factors including
those detailed in this "Management's Discussion and Analysis" section and
elsewhere herein, and in the Company's Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1997. The forward-looking statements are made as
of the date hereof, and the Company assumes no obligation to update the
forward-looking statements, or to update the reasons why actual results could
differ materially from those projected in the forward-looking statements.
GENERAL
The Company's revenues consist of product sales and royalty income.
Royalty income is derived from international sales of the Company's products
under agreements with co-publishers, and OEM customers in the U.S.
Product revenues are recorded at the time products are shipped, less
estimated reserves for product returns. Currently the Company uses historical
experience for international shipments and retail sell-through information for
domestic shipments to establish these reserves. 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. 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, compact disks,
software duplication, packaging materials and user manuals, in addition to
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.
The utility software business is part of a fast changing industry and
the ability of the Company to grow or to predict future revenue is dependent to
a large extent on the ability of the Company to develop new products and new
versions of existing products. Given the results of the last two years, and the
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competitive factors affecting this industry, as discussed elsewhere in this
report, management is unable to predict at this time whether the Company can be
successful at designing and developing products that can compete profitably in
this industry. Furthermore, several of the products currently under
consideration involve complicated diagnostic technologies which are
significantly more complex than those previously encountered in the development
of the Company's products. This may result in significant delays and greater
expense than normally encountered by the Company in the development of its
products.
In addition, in order for the Company to achieve satisfactory gross
margins, the Company will need to introduce new products to offset declining
margins associated with older products. All product development efforts include
the risk that products under development prove more difficult to develop than
currently anticipated, resulting in delays in reaching the market, significantly
greater development costs, or even in planned products 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. In addition, rapid change and technological
advancement characterize the software industry, 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 product or
technology currently under development
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,
enhancement, and translation to foreign languages after technological
feasibility of a product has been established may be capitalized in accordance
with Statement of Financial Accounting Standards (SFAS) No. 86. During the nine
months ended September 30, 1998, technological feasibility was not reached for
any products under development. Accordingly, the Company did not capitalize any
software development costs during the nine months ended September 30, 1998.
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. Many of these expenses are committed in advance, therefore the Company
generally is unable to adjust spending in a timely manner to compensate for any
unexpected shortfall in sales.
Management recognizes the difficulty of competing solely in the retail
distribution channel, and believes that the Company must embark on a more
balanced strategy of developing PC support solutions that can be delivered to
home and small office users through multiple channels. Currently, the company is
focused on development efforts for its utility products with product releases
planned for the first and second quarter of 1999. The Company will continue to
develop products for and market through the retail distribution channel in order
to maintain its current revenue levels while this more balanced strategy
continues to develop.
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In regards to the strategy to broaden the Company's distribution
channels, the Company will endeavor to develop new marketing partnerships and
new technologies and, in so doing will compete against other companies having
greater resources and greater name recognition in the marketplace. There is a
risk that the Company will not be able to develop these partnerships, but will
nonetheless incur sales and administrative expenses in attempting to do so, as
well as research and development costs to develop the new technologies. To a
large extent, the Company's success in this regard will be a function of the
Company's ability to market its products to prospective partners as well as
consumers, along with its ability to successfully deploy its new technologies in
support of this expanded distribution strategy.
During the second quarter, the Company restructured its operations. In
the third quarter, that restructuring continued with the hiring of a new Chief
Executive Officer, a further reduction in its workforce by approximately 30% and
the retirement of certain fixed assets. The restructuring costs incurred in the
third quarter amount to $85,000, which includes severance packages related to
the reduction in workforce and the expensing of capital assets.
As part of the Company's plan to increase focus on the development of
CheckIt products, Trend Micro, Inc. assumed responsibility for the PC-cillin
anti-virus product. Trend Micro will provide service and support for current and
future PC-cillin customers. Additionally, the Company transferred all PC-cillin
inventory in the sales channel and in the Company's third-party warehouse
locations to Trend Micro which became solely responsible for the inventory.
Trend Micro agreed to pay the inventory carrying costs to the Company for the
inventory. The transfer took effect on September 30, 1998. The Company and Trend
Micro have co-developed the PC-cillin line of products since 1995.
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PRODUCTS
The following table sets forth the products currently marketed by the Company:
<TABLE>
<CAPTION>
INITIAL RELEASE
PRODUCT TITLE DESCRIPTION DATE
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
CheckIt A utility with new technology that optimizes and troubleshoots May 1998
NetOptimizer(tm) users' Internet connections and modems
for maximum performance. The product's Internet Tune-Up program
optimizes modem, port and Windows settings for maximum
efficiency and speed, increasing throughput and download speeds
on all analog modems. The CheckIt Internet Monitor automatically
tracks download and connection speeds, total on-line time by day
or month, and notifies surfers when connecting at below-average
rates. CheckIt Redial is available to continually redial an ISP
until a connection at average or above-average speed is
obtained. NetOptimizer also includes Active Update allowing
users to receive free program updates and enhancements.
CheckIt 98(R) CheckIt 98 for Windows 95/98 collects detailed system August 1998
information, tests system components, pinpoints
problems, locates hidden conflicts, and restores critical system
files for fast and easy PC troubleshooting. CheckIt
automatically detects problems, identifies exactly what isn't
working, and guides the user directly to the information and
tests needed to fix it.
CheckIt98 The CheckIt 98 Diagnostic Suite features the portable, August 1998
Diagnostic self-booting diagnostics of CheckIt for DOS,
Suite(R) CheckIt 98 for Windows 95/98, FastMove file
synchronization and a reference manual on PC hardware repair.
Professional technicians use this product to troubleshoot PC
problems, test hardware components, diagnose setup conflicts,
optimize modem configuration, calibrate video components,
benchmark PC performance, and conduct burn-in and certification
tests. The CheckIt 98 Diagnostic Suite includes a year of free
program upgrades via the Internet.
FastMove!(R) A file synchronization and transfer program with ZIPSync that March 1995
keeps the files and directories on desktop PCs, (last update
laptops, networks and Zip drives, synchronized and October 1996)
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! Includes an Ultra Flex Parallel Transfer
Cable.
</TABLE>
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RESULTS OF OPERATIONS
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.
The following table sets forth certain statement of operations data as a
percentage of total revenues for the three and nine months ended September 30,
1998 and 1997:
<TABLE>
<CAPTION>
Three months Nine months
ended September 30, ended September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Product sales 96.7% 91.4% 98.0% 95.9%
Royalty income 3.3 8.6 2.0 4.1
------ ----- ----- -----
Total revenue 100.0 100.0 100.0 100.0
Cost of sales 27.4 33.6 25.0 38.5
------ ----- ----- -----
Gross profit 72.6 66.4 75.0 61.5
------ ----- ----- -----
Sales and marketing 83.4 73.9 66.9 58.7
General and administrative 64.1 21.8 35.9 16.6
Research and development 56.4 31.8 43.9 28.1
Restructuring expense 11.4 -- 25.5 --
------ ----- ----- -----
Total operating expenses 215.3 127.5 172.2 103.4
------ ----- ----- -----
Loss from operations (142.7) (61.1) (97.2) (41.9)
Other income, net 17.9 11.6 13.5 8.6
------ ----- ----- -----
Loss before income taxes (124.8) (49.5) (83.6) (33.3)
Provision for income taxes -- -- -- --
------ ----- ----- -----
Net loss (124.8)% (49.5)% (83.6)% (33.3)%
====== ===== ===== =====
</TABLE>
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
Revenue. Product sales decreased from 1997 to 1998 primarily due to a
decline in the sales of the Company's PC-cillin anti-virus product, which the
Company discontinued at the end of the quarter. The decision to discontinue this
product was caused, in part, by fierce competition in the anti-virus market,
which drove prices down severely. The overall slowdown in the software utility
market caused by the release of Windows 98 affected revenues for the Company's
diagnostic products during the first part of the quarter. Sales of CheckIt
NetOptimizer, which had its first full quarter of sales in the retail market,
and CheckIt 98 and CheckIt Diagnostic Suite, both released in August, have not
attained a volume sufficient to offset the reduced sales of other products.
There can no assurance that the sales of CheckIt 98 and CheckIt Diagnostic Suite
will compensate for the decline and cessation in PC-cillin sales.
Royalty income declined from 1997 to 1998 primarily because of a decline
in the Company's OEM sales. Royalty income decreased as a percentage of total
revenues, from 8.6% in 1997 to 3.3% in 1998.
Gross Profit. Gross profit as a percentage of total revenues increased
from 66.4% in 1997 to 72.6% in 1998. The increase was primarily due to reduced
royalty expense as the mix of products sold during 1998 included more
Company-developed products. In addition, CheckIt NetOptimizer, which has a lower
unit cost relative to the Company's other products, was more prominent in the
Company's product mix.
Sales and Marketing Expense. The decrease in sales and marketing expense
was primarily attributable to a decrease in the number of customer service and
marketing personnel in 1998 as compared to 1997. In addition, retail promotion
costs and media advertising expenses were slightly lower in 1998 in conjunction
with the decision to discontinue selling PC-cillin. Due to the decrease in
product sales, sales and marketing expenses increased as a percentage of total
revenues from 73.9% in 1997 to 83.4% in 1998.
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General and Administrative Expense. The increase in general and
administrative expense from 1997 to 1998 was primarily due to incurring a charge
of approximately $150,000 to establish a reserve related to accounts receivable
from customers in Europe. In addition, some employees who previously performed
sales and marketing functions assumed general and administrative roles. Due to
the decrease in product sales, general and administrative expenses, as a
percentage of total revenues, increased from 21.8% in 1997 to 64.1% in 1998.
Research and Development Expense. Research and development expense
remained constant in 1998 from 1997. Due to the decrease in product sales,
research and development expense, as a percentage of total revenues, increased
from 31.8% in 1997 to 56.4% in 1998.
Restructuring Expense. During the quarter, the Company finalized the
majority of its restructuring of operations. The loss in the third quarter
includes $85,000 of restructuring charges, which includes $45,000 related to
severance pay for terminated employees, $33,000 of expenses related to the
write-off of capital assets and $7,000 related to one-time recruitment fees.
Other Income. Other income is comprised primarily of interest earned on
the Company's investments. Investment income declined in 1998 compared to 1997
as the Company reduced investment holdings in 1998 to fund operations.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
Revenue. Product sales decreased from 1997 to 1998 primarily due to a
decline in the sales of the company's PC-cillin anti-virus product, which was
discontinued at the end of September. During the year, anti-virus sales were
subjected to price erosion due to severe competition. In addition, the utility
market in general experienced an overall slowdown in part because of the release
of Windows 98. CheckIt NetOptimizer, introduced in June and CheckIt 98 and
CheckIt Diagnostic Suite, both released in August have not been in the market
long enough to compensate for the decline in PC-cillin sales. There can no
assurance that the sales of CheckIt 98 and CheckIt Diagnostic Suite will
compensate for the decline and cessation in PC-cillin sales.
Royalty income decreased in 1998 as the product mix changed from royalty
based sales to direct product sales. Royalty income decreased as a percentage of
total revenues from 4.1% in 1997 to 2.0% in 1998.
Gross Profit. Gross profit as a percentage of total revenues increased
from 61.5% in 1997 to 75.0% in 1998. The primary reason for this increase was
due to reduced royalty expense as the mix of products sold during 1998 included
more Company-developed products.
Sales and Marketing Expense. The decrease in sales and marketing expense
from 1997 to 1998 was primarily attributable to a decrease in the number of
customer service and marketing personnel and a reduction in media advertising
expense in 1998 as compared to 1997. Retail promotion costs remained relatively
constant between 1997 and 1998. Due to the decrease in product sales, sales and
marketing expenses increased as a percentage of total revenues from 58.7% in
1997 to 66.9% in 1998.
General and Administrative Expense. The increase in general and
administrative expense from 1997 to 1998 was primarily due to incurring a charge
of approximately $150,000 to establish a reserve related to accounts receivable
from customers in Europe. In addition, some employees who previously performed
sales and marketing functions assumed general and administrative roles. Due to
the decrease in product sales, general and administrative expenses, as a
percentage of total revenues, increased from 16.6% in 1997 to 35.9% in 1998.
Research and Development Expense. Included in research and development
expense during the nine months ended September 30, 1997 was a one-time charge of
$151,000 to
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write-off previously capitalized costs incurred to develop the Company's
e.Support product. In addition, the company reduced its use of outside
consultants. Due to the decrease in product sales, research and development
expense, as a percentage of total revenues, increased from 28.1% in 1997 to
43.9% in 1998.
Restructuring Expense. The Company's restructuring charges included
$778,000 during the second quarter and $85,000 for the third quarter for a total
of $863,000 for the year. These restructuring charges included the previously
reported 2nd quarter restructuring charges as well as severance expense for
several employees and the write-off of fixed assets during the 3rd quarter.
Other Income. Other income is comprised primarily of interest earned on
the Company's investments. Investment income declined in 1998 compared to 1997
as the Company reduced investment holdings in 1998 to fund operations.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 1998 the Company used cash
resources of $1,946,000 for operating activities and purchased equipment
totaling $66,000. The Company sold investments in debt securities totaling
$31,344,000, and purchased similar securities aggregating $30,570,000. The
Company also received proceeds from exercises of common stock options
aggregating $66,000.
The Company's cash, cash equivalents, restricted cash, and investments
totaled $9,691,000 at September 30, 1998. Working capital decreased from
$8,401,000 at December 31, 1997 to $6,098,000 at September 30, 1998. Cash and
cash equivalents decreased from $1,434,000 at December 31, 1997 to $265,000 at
September 30, 1998. The decline in cash and cash equivalents and working capital
was due primarily to the net loss incurred by the Company in the nine months
ended September 30, 1998.
The Company's restructuring activities began in June 1998 and will be
completed during the quarter ending September 30, 1998 with an expected impact
of approximately $525,000 on cash over the 15 months following the period ending
September 30, 1998.
The Company has a bank line of credit, which allows for borrowings up to
$500,000 and was renewed in September 1998 for an additional year. Borrowings
bear interest at the bank prime rate, and are collateralized by a $500,000
certificate of deposit. The bank prime rate at September 30, 1998 was 8.5%.
There were no borrowings under the bank line of credit at September 30, 1998.
This line of credit prohibits acquisitions of other entities without the prior
approval of the bank, and restricts the payments of cash dividends.
Management believes that the Company's existing cash, investments, and
periodic borrowings under the line of credit will be sufficient to fund the
Company's operations at currently anticipated levels through September 30, 1999.
The Company plans to use its cash resources to finance new product development
and existing product enhancements, expand internationally, and expand the direct
sales force for corporate customers. The execution of such plans may include
strategic acquisitions of, or investments in, businesses, products or
technologies.
BUSINESS RISKS
All product development efforts include the risk that products under
development prove more difficult to develop than currently anticipated,
resulting in delays in reaching the market, significantly greater development
costs, or even in planned products 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. In addition, rapid change and technological advancement
characterize the software industry, 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 product or
12
<PAGE> 13
technology currently under-development.
The utility software business is part of a fast changing industry and
the ability of the Company to grow or to predict future revenue is dependent to
a large extent on the ability of the Company to develop new products and new
versions of existing products. Given the results of the last two years, and the
competitive factors affecting this industry, as discussed elsewhere in this
report, management is unable to predict at this time whether the Company can be
successful at designing and developing products that can compete profitably in
this industry. Furthermore, several of the products currently under
consideration involve complicated diagnostic technologies which are
significantly more complex than those previously encountered in the development
of the Company's products. This may result in significant delays and greater
expense than normally encountered by the Company in the development of its
products.
With respect to statements regarding the strategy to broaden the
Company's distribution channels, the Company intends on entering new markets
and, in so doing, will compete against other companies having greater resources
and greater name recognition. 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, as well as research and
development costs. To a large extent, the Company's success in this regard will
be a function of the Company's ability to develop new products or new versions
of existing products.
Management has assessed the impact of the transition to the year 2000 on
its products and the software applications that are used internally. Management
believes that all current versions of the Company's products are, and future
releases will be, year 2000-compliant. Management has received confirmation from
vendors of certain purchased software used internally by the Company that
current releases or upgrades eliminate any year 2000-related issues. The Company
believes that becoming year 2000-compliant has not had a significant impact on
the financial position or results of operations of the Company. If the Company
has failed to become year 2000-compliant with respect to any of its products,
such failure could have a material adverse effect on the Company.
13
<PAGE> 14
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
-----------------
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, Contra Costa 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. Eight other software companies have been named as defendants in
identical lawsuits in three different counties; all of the actions have been
coordinated in the San Francisco Superior Court (No. 4006). The Court sustained
the Company's demurrer to the complaint without leave to amend on January 23,
1998 and entered judgment in the case on behalf of the defendants. The plaintiff
has filed a notice of appeal. The Company will continue to defend itself
vigorously. Based on its current knowledge, the Company does not believe that
this matter will have a material adverse effect on the financial condition or
results of operations of the Company.
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
Exhibit 27 - Financial Data Schedule.
b. Reports on Form 8-K
None
14
<PAGE> 15
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/ Kenneth S. Forbes, III
- --------------------------------------------------- Chief Executive Officer
Kenneth S. Forbes, III Dated: November 12, 1998 and Director
/s/ Ronald R. Maas Executive Vice President,
Ronald R. Maas Dated: November 12, 1998 Chief Financial Officer,
Principal Accounting
Officer and Director
15
<PAGE> 16
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
27 Financial Data Schedule.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 265,183
<SECURITIES> 8,305,866
<RECEIVABLES> 148,297
<ALLOWANCES> 0
<INVENTORY> 322,294
<CURRENT-ASSETS> 9,209,890
<PP&E> 166,617
<DEPRECIATION> 0
<TOTAL-ASSETS> 10,508,869
<CURRENT-LIABILITIES> 3,112,117
<BONDS> 0
0
0
<COMMON> 7,963
<OTHER-SE> 7,257,997
<TOTAL-LIABILITY-AND-EQUITY> 10,508,869
<SALES> 0
<TOTAL-REVENUES> 748,956
<CGS> 205,374
<TOTAL-COSTS> 1,818,421
<OTHER-EXPENSES> (134,260)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (935,205)
<INCOME-TAX> 0
<INCOME-CONTINUING> (935,205)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (935,205)
<EPS-PRIMARY> (0.12)
<EPS-DILUTED> (0.12)
</TABLE>
