<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999 Commission File Number 0-12969
TOUCHSTONE SOFTWARE CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-3778226
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1538 TURNPIKE STREET
NORTH ANDOVER, MASSACHUSETTS 01845
(Address of principal executive offices) (Zip Code)
978.686.6468
(Registrant's telephone number, including area code)
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
Registrant had 7,990,060 shares of Common Stock outstanding at July 29, 1999.
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TOUCHSTONE SOFTWARE CORPORATION
INDEX
<TABLE>
<CAPTION>
Page Number
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements 3
a) Consolidated Balance Sheet as of June 30, 1999 (Unaudited) 3
b) Consolidated Statement of Income for the three months ended
June 30, 1999 and 1998, and six months ended June 30, 1999 and
1998 (Unaudited) 4
c) Consolidated Statement of Cash Flows for the
three months Ended June 30, 1999 and 1998 (Unaudited) 5
d) Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 8
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
</TABLE>
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ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Touchstone Software Corporation
Consolidated Balance Sheet
(Unaudited)
<TABLE>
<CAPTION>
June 30,
1999
------------
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,029,794
Investments 1,021,509
Restricted cash 3,120,000
Accounts receivable, net 1,879,666
Inventories, net 112,093
Prepaid expenses and other current assets 461,066
------------
Total current assets 7,624,128
Investments 568,524
Property, net 191,340
Other assets 57,799
Goodwill, net of accumulated amortization 3,634,291
------------
$ 12,076,082
============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 44,651
Accounts payable 247,230
Accrued payroll and related expenses 295,223
Accrued cooperative advertising expense 425,887
Accrued merger and acquisition costs 1,338,422
Deferred revenue 1,610,412
Deferred acquisition costs 2,077,000
Other accrued liabilities 308,912
------------
Total current liabilities 6,347,737
Long-term debt, net of current maturities 528,266
Other liabilities 189,893
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.001 par value, 3,000,000 shares
authorized; no shares issued or outstanding
Common stock, $0.001 par value, 20,000,000 shares
authorized; shares issued and outstanding,
7,990,060 (1999)
7,963,060 (1998) 7,990
Additional paid-in capital 19,109,306
Accumulated deficit (14,107,110)
------------
Total shareholders' equity 5,010,186
------------
$ 12,076,082
============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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Touchstone Software Corporation
Consolidated Statement of Income
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1999 1998 1999 1998
---------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Net revenues $1,849,033 $ 656,409 $ 3,184,231 $ 2,642,268
Cost of revenues 229,656 198,359 483,765 642,358
---------- ----------- ------------ -----------
Gross profit 1,619,377 458,050 2,700,466 1,999,910
Operating expenses:
Sales and marketing 453,798 924,420 562,335 1,791,390
General and administrative 684,458 296,453 1,422,512 590,672
Research and development 242,205 577,448 480,987 1,065,297
Amortization of goodwill
and other intangibles 1,187,190 - 1,187,325 -
Restructure - 778,140 1,502,624 778,140
---------- ----------- ------------ -----------
Total operating expenses 2,567,651 2,576,461 5,155,783 4,225,499
---------- ----------- ------------ -----------
Income (loss) from operations (948,274) (2,118,411) (2,455,317) (2,225,589)
Interest and other income, net 35,323 158,778 99,267 324,910
---------- ----------- ------------ -----------
Income before income taxes (912,951) (1,959,633) (2,356,050) (1,900,679)
Provision for income taxes - 800 800 800
---------- ----------- ------------ -----------
Net income (loss) $ (912,951) $(1,960,433) $ (2,356,850) $(1,901,479)
---------- ----------- ------------ -----------
Basic net income per share $ (0.11) $ (0.25) $ (0.30) $ (0.24)
========== =========== ============ ===========
Weighted average common shares 7,990,060 7,922,000 7,990,060 7,906,000
========== =========== ============ ===========
Diluted net income per share $ (0.11) $ (0.25) $ (0.30) $ (0.24)
========== =========== ============ ===========
Weighted average common and
common equivalent shares 7,990,060 7,922,000 7,990,060 7,906,000
========== =========== ============ ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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Touchstone Software Corporation
Consolidated Statement of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Six months ended
June 30,
1999 1998
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) (2,356,850) (1,901,479)
Adjustments to reconcile net loss to net cash
flows (used in) provided by operating activities:
Depreciation and amortization 1,222,650 122,995
Loss on Disposal of property - 148,767
Stock options issued for consulting expense - 7,276
Provision for doubtful accounts - 11,256
Provision for obsolete inventories - 66,793
Change in deferred lease obligation - 14,058
Income tax refund receivable - 32,790
Accounts receivable (686,138) 234,973
Inventories 73,194 (87,371)
Prepaid expenses and other current assets (294,079) 59,645
Deferred revenue 367,378 1,700
Other assets 659
Accrued merger, acquisitions and restructuring charges 958,294 613,736
Accounts payable (384,416) 18,468
Accrued liabilities 160,273 (124,226)
----------- -----------
Net cash used in operating activities (939,035) (780,619)
Cash flows from investing activities:
Purchase & sale of investment, net 2,057,453 304,657
Purchases of property - -
Capitalized software development costs (950,000) (58,438)
----------- -----------
Net cash provided by (used in) investing activities 1,107,453 246,219
Cash flows from financing activities:
Principal repayment of long-term debt 22,321 -
Proceeds from exercise of stock warrants and options - -
and repayment on notes receivable 13,800 58,612
----------- -----------
Net cash provided by financing activities 36,121 58,612
----------- -----------
Net increase (decrease) in cash and cash equivalents 204,539 (475,788)
Cash and cash equivalents, beginning of period 825,255 1,433,861
----------- -----------
Cash and cash equivalents, end of period 1,029,794 958,073
=========== ===========
Supplemental cash flow information:
Interest paid $ 9,810 $ 409
=========== ===========
Income taxes paid - $ 800
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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TOUCHSTONE SOFTWARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying consolidated financial statements of Touchstone Software
Corporation (the "Company") as of June 30, 1999 and for the three and six
months ended June 30, 1999 and 1998 are unaudited. The consolidated financial
statements reflect all adjustments, consisting only of normal recurring
adjustments, which in the opinion of management are necessary for a fair
presentation of the financial position, operating results and cash flows for the
periods presented. The consolidated financial statements have been prepared
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. These
condensed consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto for the year
ended December 31, 1998 included in the Annual Report on Form 10-KSB filed by
the Company on April 14, 1999.
The results of operations for the interim periods presented are not
necessarily indicative of the results to be expected for the full year or for
any future period.
2. COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." 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 is defined as the change in
equity of a company from transactions, other events and circumstances excluding
transactions resulting from investments by owners and distributions to owners.
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 loss and net loss as reported for the three and six months ended
June 30, 1999 and 1998.
3. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 ("SFAS No. 131"), "Disclosures About
Segments of an Enterprise and Related Information." SFAS No. 131 supersedes
SFAS No. 14 and requires segment information to be reported on the basis that is
used entirely for evaluating segment performance and deciding how to allocate
resources to segments in quarterly and annual reports. SFAS No. 131 is
effective for annual reports for fiscal years beginning after December 15, 1997,
and is applicable to interim financial statements beginning with the second year
of application. The Company believes that the effect of adopting the new
standards will not be material to its consolidated financial statements.
4. 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 of 7.75% at June 30, 1999 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 June 30, 1999. This line of credit prohibits acquisitions of other entities
without the prior approval of the bank and restricts the payment of cash
dividends.
5. EARNINGS (LOSS) PER YEAR
The Company has adopted Statement of Financial Accounting Standards No. 128,
"Earnings per Share," ("EPS") which replaces the presentation of "primary"
earnings per share with "basic" earnings per
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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. The number
of shares used in computing EPS is as follows:
<TABLE>
<CAPTION>
For the Three Months
Ended June 30,
1999 1998
---- ----
<S> <C> <C>
Weighted average number of shares outstanding:
Basic 7,990,060 7,922,000
<CAPTION>
For the Six Months
Ended June 30,
1999 1998
---- ----
<S> <C> <C>
Weighted average number of shares outstanding:
Basic 7,990,060 7,906,000
</TABLE>
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This quarterly report contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21A of the
Securities Exchange Act of 1934, as amended, which involve risks and
uncertainties. The forward-looking statements are made as of the date hereof,
and the Company assumes no obligation to update these statements. The Company's
actual results could differ materially from those anticipated in these forward-
looking statements as a result of certain factors, including those set forth
below and those discussed in the Company's Annual Report on Form 10-KSB, for the
year ended December 31, 1998 on file with the Securities and Exchange
Commission.
OVERVIEW
Touchstone Software Corporation (the "Company") develops and publishes
utility software packages designed to perform Personal Computer ("PC") hardware
diagnostics, Internet access optimization, and PC to PC file transfer. The
functionality of these packages assists in the set up, maintenance, optimization
and management of personal computers and networks.
Effective as of the close of business on March 8, 1999, TouchStone Software
Corporation (the "Company") acquired all of the issued and outstanding capital
stock of Unicore Software, Inc., a Massachusetts corporation ("Unicore"). At
the time of the acquisition, Unicore was privately owned by Pierre A. Narath,
the Company's President and Chief Executive Officer and a member of the
Company's Board of Directors, and Jason K. Raza, who became a Vice President of
the Company in connection with the acquisition. Unicore is a leading provider
of system management software, including BIOS upgrades, PC Diagnostics and Year
2000 Solutions, whose customers consist of a majority of Fortune 500
corporations, government agencies, and major educational and financial
institutions. The original Unicore was founded by Mr. Narath in 1989, and sold
to Award Software International, Inc. ("Award") in 1997. On October 27, 1998,
following the merger of Award with and into Phoenix Technologies Ltd.
("Phoenix"), Messrs. Narath and Raza formed Unicore as a new Massachusetts
corporation and used it to purchase all of the assets of the original Unicore
from Phoenix.
Pursuant to the terms and conditions of a definitive Agreement and Plan of
Acquisition ("Acquisition Agreement"), the acquisition of Unicore was
accomplished through the merger of Unicore with and into a newly formed and
wholly owned subsidiary of the Company. Immediately prior to the acquisition,
the Company contributed all of the assets, products and operations of its
personal computer diagnostic software business to this newly formed corporation.
As a consequence, since the closing of the Unicore acquisition the Company has
served as a holding company with a single, wholly-owned subsidiary that
currently conducts the business and activities that previously were separately
conducted by both the Company and Unicore. The Company is accounting for the
acquisition as a purchase.
At the closing of the acquisition of Unicore by the Company, the former
shareholders of Unicore, Messrs. Narath and Raza, received an aggregate of
$1,205,000 in cash. The balance of the purchase price was paid through the
issuance of an aggregate of 3,350,000 shares of the Company's Common Stock
immediately following stockholder approval of the issuance of these shares at
the 1999 Annual Meeting of the Company's stockholders (the "Annual Meeting"),
held on July 30, 1999 in Ipswich, Massachusetts.
In connection with the acquisition, each of Messrs. Narath and Raza entered
into a three-year employment agreement with the Company. Under the terms of his
employment agreement, Mr. Narath is to serve as the President and Chief
Executive Officer of the Company, and as a member of its Board of Directors, and
as the President, Chief Executive Officer and a director of Unicore which
currently operates as a wholly-owned subsidiary of the Company. The employment
agreement has an initial term of three years commencing March 1, 1999, and will
automatically renew for an additional one-year period on each March 1 unless
terminated by either party on six months prior written notice. For the year
ending December 31, 1999, Mr. Narath is to be paid a base salary of $200,000,
with his base salary to increase to $210,000 for the year ending December 31,
2000 and to $225,000 for the year ending December 31, 2001. In addition to this
base salary, Mr. Narath is to be paid a bonus equal to 3.5% of all consolidated
net sales in excess of $6,000,000 generated by the Company during the year
ending December 31, 1999, plus such other bonuses as the Company's Board of
Directors may determine. Mr. Narath's employment agreement also provides that
he is entitled to receive certain specified supplemental health and life
insurance and all
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costs of a motor vehicle to be selected by him, in addition to reimbursement for
all of his reasonable business expenses, and to participate in all of the
Company's existing benefit plans.
Should his employment with the Company be terminated for any reason other
than "cause" as defined therein, Mr. Narath would be entitled to receive, in one
payment, an amount equal to one year's base salary at the level then in effect,
plus an amount equal to any bonuses earned during the previous calendar year.
However, if Mr. Narath's employment is terminated for any reason within one year
following a specified change in control of the Company which is not approved by
the Company's Board of Directors, with Mr. Narath voting in favor thereof, the
Company would be obligated to pay Mr. Narath, in one payment, an amount equal to
200% of one year's salary at the level then in effect, plus 200% of any bonuses
earned during the previous calendar year and an additional amount equal to all
taxes payable by Mr. Narath on the full amount of such payment. In the event
that there is a change in control of the Company which has been approved by the
Company's Board of Directors, with Mr. Narath voting in favor thereof, he would
nevertheless be entitled to terminate his employment agreement for "good cause"
if his duties were substantially diminished within 12 months thereafter, in
which case the Company would be obligated to pay him, in one payment, an amount
equal to one year's base salary at the level then in effect, plus an amount
equal to any bonuses earned during the previous calendar year.
Mr. Raza's employment agreement provides that he is to be employed as a
Vice President of both the Company and Unicore for a three-year period
commencing March 1, 1999, subject to the same provision for additional one-year
extensions. During each year of the initial term, Mr. Raza is to be paid a
base salary of not less than $110,000 and shall be entitled to receive such
bonuses as the Company's Board of Directors may determine. In the event that his
employment with the Company is terminated for any reason other than "cause" as
defined therein, Mr. Raza would be entitled to receive, in one payment, an
amount equal to one year's base salary at the level then in effect, plus an
amount equal to any bonuses earned during the previous calendar year.
As a condition to the closing of the Unicore acquisition, the Company
deposited the sum of $620,000 in cash with Lawrence Savings Bank of
Massachusetts, in order to obtain the release of Mr. Narath from his personal
guarantee of approximately $620,000 of indebtedness owed by Unicore to Lawrence
Savings Bank that was incurred in connection with the purchase of Unicore from
Phoenix.
In connection with the acquisition, each of Messrs. Narath and Raza also
was granted "piggy-back" registration rights with respect to any and all shares
of the Company's Common Stock owned by them.
On November 6, 1998, Unicore and Phoenix, through its subsidiary Award,
entered into a Software License Agreement ("License Agreement") for the
licensing of certain Award Software by Unicore and the licensing of certain
Unicore Software by Phoenix (both as defined in the License Agreement).
On January 21, 1999, the NASDAQ Stock Market, Inc. ("NASDAQ") notified the
Company that the NASDAQ Staff had conducted a review of the price data for the
Company's shares during the preceding thirty trading days and had determined
that such data showed a failure to maintain a $1.00 minimum closing price as
required by the Marketplace Rule 4450(a)(5) under Maintenance Standard 1 ("Rule
4450(a)(5)"). The notice further stated that the Company would be provided
ninety calendar days in which to regain compliance with Rule 4450(a)(5), during
which if the closing bid price of the Company's shares was equal to or greater
than $1.00 for a minimum of ten consecutive trading days, then the NASDAQ Staff
would verify compliance with the continued listing requirements. Commencing on
March 22, 1999, and on every trading day thereafter through May 12, 1999, the
closing bid price of the Company's shares had been at or above $1.00. The
Company reported to the NASDAQ staff that the requirement specified in the
notice has been met and requested a hearing with the NASDAQ staff regarding the
bid price issue.
On March 5, 1999, Unicore and Phoenix entered into an Agreement Regarding
Change in Control pursuant to which Phoenix gave its consent to the merger of
Unicore with and into a wholly-owned subsidiary of the Company, and Unicore
agreed to incorporate certain additional events into the License Agreement, each
of which is a material breach giving Phoenix the right to terminate the licenses
granted by Phoenix thereunder.
On March 5, 1999, an Addendum "A" to the License Agreement ("Addendum")
between Unicore and Phoenix was signed and made effective as of October 1, 1998.
The Addendum adds the Phoenix CardWare product to the list of products Unicore
is licensed to market and sell. The Addendum specifies that Unicore shall pay
Phoenix a prepayment on future royalties and a percentage royalty rate based on
net revenues generated by sales of the CardWare product. In addition, the
Addendum specifies that the royalty rate paid by Unicore as defined in the
License Agreement will be lowered in exchange for cash consideration paid to
Phoenix.
On March 31, 1999, the Company signed a Software Purchase Agreement with
Phoenix under the terms of which the Company acquired all title, rights and
obligations relating to the CardWare product for cash consideration and the
termination of the Addendum as to CardWare.
On June 10, 1999 the NASDAQ Listing Qualification Panel (the "Panel") held
a hearing on the Company's request for continued inclusion on the NASDAQ
National Market. The Panel, in a decision
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dated July 19, 1999, determined to delist the Company's shares from the NASDAQ
National Market and noted the Company did not comply with the requirements for
continued listing on the NASDAQ Small Cap Market. The Panel based its decision
primarily on its lack of confidence in the Company's ability to achieve and
maintain compliance with the minimum bid price requirement of Rule 4450(a)(5).
The Panel also cited its concern that the Company would not maintain the level
of net tangible assets required by Marketplace Rule 4450(a)(3). The Company's
shares now trade on the OTC Bulletin Board.
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Products
The following table sets forth the Company's products:
<TABLE>
<CAPTION>
Product Title Description Date
- ------------- ----------- ----
<S> <C> <C>
CheckIt/R/ CheckIt 98 collects detailed system information, test system components, August 1998
pinpoints problems, locates hidden conflicts and restores critical system
files for fast and easy PC troubleshooting. CheckIt automatically detects
problems, identifies exactly what is not working and guides the user
directly to the information and tests needed to fix it. CheckIt also
tests and corrects Y2K hardware problems.
CheckIt The CheckIt 98 Diagnostic Suite features the portable, self-booting August 1998
Diagnostic diagnostics of CheckIt for DOS, new CheckIt 98, FastMove! file transfer
Suite/R/ utility, NetOptimizer Internet performance enhancement software and
Bigelow's PC Technician's Troubleshooting Pocket Reference. Professional
technicians use this product to troubleshoot PC problems, test hardware
components, diagnose setup conflicts, optimize modem configuration,
calibrate video components, and benchmark PC performance and conduct
burn-in and certification tests. The CheckIt Diagnostic Suite also
includes a Y2K hardware tests and fixes feature.
CheckIt CheckIt NetOptimizer gives Internet users an easy and safe way to May 1998
NetOptimizer/R/ fine-tune their Internet connection through an automatic or manual tune-up
selection. In addition, NetOptimizer performs a complete set of modem
diagnostic tests and corrects some common port and modem problems. In
addition to the tests, a complete list of details and specifications about
the consumer's modem and the current driver in use is available at the
touch of a button. NetOptmimizer's benchmark utility provides the means
for an Internet user to evaluate the current and past performance of their
ISP connections.
FastMove!/R/ FastMove! is a file synchronization and transfer program that keeps files March 1995
and directories on desktop PCs, laptops, networks and Zip drives (last update
synchronized and up-to-date with the click of a button. FastMove! also October 1996)
includes an Ultra Flex Parallel Transfer Cable.
BIOS Upgrade Unicore BIOS Upgrade Solutions for PCs provide a cost-effective way of
Solutions allowing end-users to extend the useful life of their PC systems without
replacing them entirely.
PC Unicore's POSTcard(R) offers hardware diagnostic solutions allowing MIS
Diagnostics personnel and PC end-users alike to quickly determine the causes of their
Software system failures.
Year 2000 Unicore's Millenium/Pro is a cost-effective solution enabling PCs without
Solutions Year 2000 BIOS compliance to provide accurate and uninterrupted operation
during the transition into the Year 2000.
PC Card Unicore's CardWare(R) enables PCs and portable computers to install,
Software configure and operate peripheral devices that comply with PCMCIA
standards. CardWare(R) provides a number of benefits over traditional
PC Card software, including support for Windows NT, the efficient use
of system memory, greater portability, ease of maintenance and a more
modular design.
</TABLE>
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Results of Operations
The following is a preliminary discussion of the financial condition and
results of operations of the Company as of June 30, 1999 and for the three
months ended June 30, 1999 and 1998, respectively, and should be read in
conjunction with the accompanying Quarterly Condensed Consolidated Financial
Information and Notes thereto and the Company's audited consolidated financial
statements and notes thereto for the year ended December 31, 1998, included in
the Company's Annual Report on Form 10-KSB and is qualified in its entirety by
reference thereto.
The following table sets forth, for the periods indicated certain consolidated
statement of income information as a percentage of the Company's total revenues
represented by each item. The Company's historical results are not necessarily
indicative of results in any future period.
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1999 1998 1999 1998
------ ------- ------- ------
<S> <C> <C> <C> <C>
Net revenues 100% 100% 100% 100%
Cost of revenues 12 30 15 24
------ ------- ------- -----
Gross profit 88 70 85 76
Operating expenses:
Research and development 13 88 15 40
Sales and marketing 25 140 18 68
General and administrative 37 45 45 22
Restructure - 119 47 29
Amortization of other intangibles 64 - 37 -
------ ------- ------- -----
Total operating expenses 139 392 162 159
------ ------- ------- -----
Income (loss) from operations (51) (322) (77) (83)
Interest and other income, net 2 24 3 12
------ ------- ------- -----
Income before income taxes (49) (298) (74) (71)
Provision for income taxes 0 - 0 -
------ ------- ------- -----
Net income (loss) (49) (298) (74) (71)
</TABLE>
COMPARISON OF THREE MONTH PERIODS ENDED JUNE 30, 1999 AND 1998
REVENUES. The Company's revenues consist of product sales, software
license fees and engineering services revenues. Product revenues are recorded at
the time products are shipped, but the Company records a reserve for product
returns at each period-end which covers 100% of inventory in the sales channel.
The reserves for such inventory are classified as deferred revenue on the
Company's balance sheet. The Company's operations are subject to substantial
and unpredictable 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. Software license fees are recognized upon
delivery of the product, fulfillment of acceptance terms, if any,
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and satisfaction of significant supports obligations, if any. Engineering
service revenues generally consist of amounts charged for customization of the
software prior to delivery and are generally recognized as the services are
performed. Revenues increased by approximately $1,192,624, or 65%, for the three
month period ended June 30, 1999, from the same period of the prior year
primarily due to higher sales of the Company's BIOS upgrade and Year 2000
solutions partially offset by lower sales of its utility software packages as a
result of increasing competition in the utility software industry and a change
from royalty-based sales to direct product sales.
COST OF REVENUES. Cost of revenues consists of the cost of materials,
freight expenses, inventory obsolescence reserves, fees paid to an outsource-
production fulfillment house, royalties paid to other software development
companies and direct costs associated with engineering services revenues. Cost
of revenues as a percentage of revenue decreased to 12% of revenues for the
three-month period ended June 30, 1999, as compared to 30% of revenues for the
same period of the prior year. This decrease was primarily due to the Company's
decision to terminate the production of its software at an existing fulfillment
house, and relocate production to another fulfillment house. The Company
anticipates that production at the new fulfillment house will commence during
the third quarter of its fiscal year.
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of engineering personnel and related expenses and equipment costs.
Research and development expenses decreased by approximately $335,243, or 58%,
for the three month period ended June 30, 1999, from the same period of the
prior year primarily due to lower engineering personnel and related expenses in
the U.S., partially offset by higher engineering personnel and related expenses
in Europe.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
personnel and related expenses, sales commissions, travel costs, retail product
merchandising and promotions. Sales and marketing expenses decreased by
approximately $470,622, or 51%, for the three month period ended June 30, 1999,
from the same period of the prior year primarily due to lower sales and
marketing personnel and related expenses, lower travel costs and lower retail
product merchandising and promotions.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of personnel and related expenses, professional services and
facilities costs. General and administrative expenses increased by
approximately $388,805, or 131%, for the three month period ended June 30, 1999,
from the same period of the prior year due to higher general and administrative
personnel and related expenses and higher professional services fees.
INTEREST INCOME, NET. Interest income, net consists primarily of interest
expense associated with a note outstanding and interest income on cash and cash
equivalents, net of expenses. Interest income, net decreased by approximately
$123,455 for the three month period ended June 30, 1999, from the same period of
the prior year due primarily to decreased holdings of short-term investments.
AMORTIZATION OF GOODWILL AND ACQUIRED INTANGIBLES. During the three months
ended June 30, 1999 the company began amortizing the goodwill and the acquired
intangibles associated with the acquisition of Unicore. The majority of the
goodwill and acquired intangibles will be amortized through the third quarter of
2000.
LIQUIDITY AND CAPITAL RESOURCES
During the three months ended June 30, 1999, the Company used cash
resources of approximately $940,000 for operating activities.
The Company's cash and cash equivalents, restricted cash, and investments
totaled $5.7 million at June 30, 1999. Working capital decreased from
approximately $5.6 million at December 31, 1998 to approximately $3.4 million at
June 30, 1999. Cash and cash equivalents increased from $940,308 at March 31,
1999 to $1,029,794 at June 30, 1999. The decrease in working capital, partly
offset by an increase in cash and cash equivalents, was due primarily to
decreased holdings of short-term investments; pre-paid royalty payments to
Phoenix and the final payment to Phoenix for the purchase of the CardWare
product.
The Company has a bank line of credit, which provides for borrowings up to
$500,000, bears interest at the bank's prime rate of 7.75% at June 30, 1999 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 June 30, 1999.
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<PAGE>
This line of credit prohibits acquisitions of other entities without the prior
approval of the bank and restricts the payment of cash dividends.
Management believes that the Company's existing cash and periodic
borrowings under the line of credit will be sufficient to fund the Company's
operations at currently anticipated levels through December 31, 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.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 ("SFAS No. 131"), "Disclosures About
Segments of an Enterprise and Related Information." SFAS No. 131 supersedes SFAS
No. 14 and requires segment information to be reported on the basis that is used
entirely for evaluating segment performance and deciding how to allocate
resources to segments in quarterly and annual reports. SFAS No. 131 is
effective for annual reports for fiscal years beginning after December 15, 1997,
and is applicable to interim financial statements beginning with the second year
of application. The Company believes that the effect of adopting the new
standards will not be material to its consolidated financial statements.
RISK FACTORS
Acquisition Risk; Difficulties of Integrating Two Companies
The acquisition of Unicore by the Company will require substantial
attention from management. The benefits of this acquisition will not be achieved
unless the operations of both companies are successfully combined in a timely
manner with operating efficiencies. The difficulties of assimilation may be
increased by the need to integrate personnel and to combine different corporate
cultures. The diversion of the attention of management and any difficulties
encountered in the transition process could have an adverse effect on the
revenues and operating results of the combined company. The successful
integration of the two companies will also require integration of the companies'
product offerings and the coordination of their research and development and
sales and marketing efforts. In addition, the process of assimilating the two
organizations could cause the interruption of, or a loss of momentum in, the
activities of either or both of the companies' businesses, which could have a
material adverse effect on the Company's operations.
COMPETITION
The Company competes against many other software vendors both directly, in
the form of competing products, and indirectly, in the form of limited shelf
space, for software products 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 new products or new versions of existing products, along with market
acceptance of the Company's products currently being sold at retail. As other
software developers provide greater functionality, features, user value and
performance in their products that eliminate or reduce the need for the
Company's BIOS Upgrades, the market for the Company's products could be
materially diminished. There can be no assurance that other participants in the
software and PC industries will not develop products and solutions that reduce
the demand or obviate the need for the Company's products.
ABILITY TO RESPOND TO RAPID TECHNOLOGICAL CHANGE; NEW PRODUCT DEVELOPMENT
The market for utility and system management software is characterized by
rapidly changing technology, evolving industry standards and frequent new
product introductions. The general trend in the software and PC industries is
toward shorter product life cycles, resulting in rapid product and technology
obsolescence. The ability of the Company to grow 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
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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, some of the products currently
under consideration involve complicated diagnostic technologies, which are more
complex than those previously encountered in the development of the Company's
products. There can be no assurance that the Company will be successful in
developing such enhancements or new software, or, even if successful, that it
will not experience delays in achieving such developments. Any failure or delay
by the Company to develop such enhancements or new software or the failure of
its software to achieve market acceptance would adversely affect the Company's
business, financial condition and results of operations. In addition, there can
be no assurance that products or technologies developed by others will not
render the Company's software or technologies non-competitive or obsolete.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company has experienced and expects to continue to experience
fluctuations in its quarterly results of operations. The Company's revenues are
affected by a number of factors, including the demand for the Company's
products, the demand for PCs, timing of new product introductions, product mix,
volume and timing of customer orders, activities of competitors and the ability
of the Company to penetrate new markets. Quarterly revenues and results of
operations therefore depend on the volume and timing of orders received during
the quarter, which are difficult to forecast. Because the Company's staffing
and other operating expenses are based on anticipated revenues, delays in the
receipt of orders can cause significant variations in results of operations from
quarter to quarter. The Company also may choose to reduce prices, increase
spending in response to competition or pursue new market opportunities, each of
which decisions may adversely affect the Company's business, financial condition
and results of operations.
Due to all of the foregoing factors, it is likely that in some future
quarters the Company's operating results will be below the expectations of
public market analysts and investors. Regardless of the general outlook for the
Company's business, the announcement of quarterly results of operations below
analyst and investor expectations is likely to result in a decline in the
trading price of the Company's Common Stock.
ABILITY TO ATTRACT AND RETAIN KEY EMPLOYEES
The Company believes that its future success will depend in large part upon
its ability to attract and retain highly skilled technical, management and sales
and marketing personnel. The loss of services of one or more of these key
employees, particularly Pierre A. Narath, the Company's Chairman, President and
Chief Executive Officer and a member of the Company's Board of Directors, and
Jason K. Raza, a Vice President of the Company, could have a material adverse
effect on the Company's business, financial condition and results of operations.
Moreover, because the development of the Company's software requires knowledge
of computer hardware, diagnostic software, operating system software, system
management software and application software, key technical personnel must be
proficient in a number of disciplines. Competition for such technical personnel
is intense, and the failure of the Company to hire and retain talented technical
personnel or the loss of one or more key employees could have an adverse effect
on the Company's business, financial condition and results of operations.
Future growth, if any, of the Company will require additional engineering,
sales and marketing, and financial and administrative personnel to expand
customer services and support and to expand operational and financial systems.
There can be no assurance that the Company will be able to attract and retain
the necessary personnel to accomplish its growth strategies or that it will not
experience constraints that will adversely affect its ability to satisfy
customer demand in a timely fashion. If the Company's management is unable to
manage growth effectively, the Company's business, financial condition and
results of operations could be adversely affected.
MANAGEMENT
The Company's ability to compete effectively and manage future growth, if
any, will require the Company to continue to improve its financial and
management controls, reporting systems and procedures on a timely basis, and to
expand, train and manage its work force. There can be no assurance that the
Company will be able to do so successfully, and the failure to do so would have
a material adverse effect
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<PAGE>
upon the Company's business, financial condition and results of operations. The
Company's success will depend to a significant degree on the ability of its
executive officers and other members of its senior management, none of whom has
any prior experience managing public companies in their current roles, to manage
future growth, if any.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
The Company's success depends in significant part on the development,
maintenance and protection of its intellectual property. The Company regards
all of its software as proprietary and attempts to protect it with a combination
of patents, copyrights, trademarks and trade secrets, employee and third-party
nondisclosure agreements and other methods of protection. Despite these
precautions and the protection of copyright laws, it may be possible for
unauthorized third parties to copy the Company's software or to reverse engineer
or obtain and use information that the Company regards as proprietary. The
Company licenses its object and source code under written license agreements.
Certain provisions of such licenses, including provisions protecting against
unauthorized use, copying, transfer and disclosure of the licensed programs, may
be unenforceable under the laws of certain jurisdictions. In addition, the laws
of some foreign jurisdictions do not protect the Company's proprietary rights to
the same extent as do the laws of the United States. There can be no assurance
that the protections put in place by the Company will be adequate.
The Company believes that its software does not presently infringe the
copyrights of any third parties. However, there can be no assurance that other
parties will not make allegations of infringement in the future. Such
assertions could require the Company to discontinue the use of certain software
codes or processes, to cease the manufacture, use and sale of infringing
products, to incur significant litigation costs and expenses and to develop non-
infringing technology or to obtain licenses to the alleged infringing
technology. Although the Company has been able to acquire licenses from third
parties in the past, there can be no assurance that the Company would be able to
develop alternative technologies or to obtain such licenses or, if a license
were obtainable, that the terms would be commercially acceptable to the Company
in the event such assertions are made in the future.
VOLATILE MARKET FOR STOCK
The market for the Company's stock is highly volatile. The trading price
of the Company's Common Stock has been and will continue to be subject to
fluctuations in response to financial condition and results of operations,
announcements of technological innovations or new products by the Company and
its competitors, changes in the Company's or its competitors' product mix or
product direction, changes in the Company's revenue mix and revenue growth
rates, changes in expectations of growth for the PC industry, as well as other
events or factors which the Company may not be able to influence or control.
Statements or changes in opinions, ratings or earnings estimates made by
brokerage firms and industry analysts relating to the market in which the
Company does business, companies with which the Company competes or relating to
the Company specifically could have an immediate and adverse effect on the
market price of the Company's stock. In addition, the stock market has from
time to time experienced extreme price and volume fluctuations that have
particularly affected the market price for many high-technology companies and
that often have been unrelated to the operating performance of these companies.
These broad market fluctuations may adversely affect the market price of the
Company's Common Stock.
YEAR 2000 RISKS
Overview. The Company is in the process of analyzing and addressing what is
known as the Year 2000 Issue. The Year 2000 Issue has arisen because many
existing computer programs use only two digits to identify a year in the data
field. These programs were designed and developed without considering the impact
of the upcoming change in the century and, accordingly, could misconstrue dates
such as "00" as the year 1900 rather than 2000. The failure of computer programs
and systems to properly recognize dates beginning in the year 2000 could
adversely affect the Company's business activities.
The Company's Year 2000 Compliance Program. The Company has initiated its
Year 2000 Compliance Program. The purpose of the program is to: identify
important systems that are not yet Year 2000 compliant; initiate replacement or
remedial action to assure that key systems will continue to operate in the Year
2000; and test the replaced or remedied systems. The Company expects to
substantially complete its Year 2000 Compliance Program activities before the
end of 1999.
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Information Technology Systems. The Company's critical internal information
technology ("IT") systems consist of its electronic mail system, internal
financial systems, corporate communications system, desktop and file management
systems, software development tools and I/S management tools. The Company is
contacting the vendors of these systems and obtaining assurances that these IT
systems are currently in material Year 2000 compliance. To the extent that some
employees may be using older versions of these systems that may not be
compliant, the Company intends to upgrade such systems to achieve material Year
2000 compliance. The Company is still in the process of evaluating other areas
of its existing internal IT systems at this time and will seek further
assurances from its vendors as necessary. The Company plans to test its critical
IT systems during 1999. The Company intends to evaluate the need for contingency
plans for these internal IT systems given the assurances of compliance the
Company has received for these systems. While the Company will work diligently
with all of its IT system providers, there is no guarantee that these IT systems
providers will meet Year 2000 compliance. The failure of any such IT system to
be Year 2000 compliant could have a negative effect on the business activities
of the Company.
Non-Information Technology Systems. The Company is conducting an assessment
of its non-information technology systems (such as voice mail, telephone and
other systems containing embedded microprocessors) and is in the process of
determining the nature and extent of any work that may be required to make any
non-IT systems Year 2000 compliant.
Third-Party Suppliers, Vendors and Customers. The Company's Year 2000
Compliance Program also includes an investigation of the Year 2000 compliance of
its major suppliers, vendors, customers and business partners. For example,
where the Company's products and services incorporate third-party software the
Company will be verifying these third-party suppliers' Year 2000 compliance. If
cases occur where the non-compliance of third-party components does affect
features or functions used by the Company in its products, the Company intends
to install upgrades (most of which are currently available) to achieve material
compliance. In addition, the Company is in the process of testing its
application software. To date, the Company has found its application software to
be Year 2000 compliant. Given the number of components and the complexity of the
software incorporated in the Company's products and services, the Company
believes that in the course of conducting its Year 2000 Compliance Program, it
could reasonably discover that the Year 2000 problem may affect its software or
components. However, the Company regularly develops software updates to its
product offerings as a natural course of business and the Company does not
expect that these Year 2000 updates will be excessively complex or expensive to
implement.
Year 2000 Costs and Expenses. To date, the costs associated with the Year
2000 Issue and the Company's Year 2000 Compliance Program have not been
material. The Company will incur costs that include internal resources, software
and equipment upgrades and replacement. Based on currently available
information, the Company believes that the expense associated with its ongoing
efforts will not be material and will be funded through operations.
Contingency Plans. At the present time, the Company has not yet formulated
contingency plans for addressing problems due to the Year 2000 Issue. The
Company has been assured that its critical internal IT systems are compliant by
the vendors of those systems and the Company will evaluate the need for
contingency plans for internal IT systems given those assurances. The Company is
currently in the process of evaluating the Year 2000 Issue with respect to its
non-IT systems and with respect to its major suppliers, vendors, customers and
business partners. As this evaluation process proceeds, the Company will
formulate appropriate contingency plans. The Company expects that any required
contingency planning will be completed no later than the end of 1999.
Various statements in this discussion of Year 2000 are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. These statements include statements of the Company's expectations,
statements with regard to schedules and expected completion dates and statements
regarding expected Year 2000 compliance. These forward-looking statements are
subject to various risk factors, which may materially affect the Company's
efforts to achieve Year 2000 compliance. These risk factors include the
inability of the Company to complete the plans and modifications that it has
identified, the failure of software vendors to deliver the upgrades and repairs
to which they have committed, the wide variety of information technology systems
and components, both hardware and software, that must be evaluated and the large
number of vendors and customers with which the Company interacts. The Company's
assessments of the effects of Year 2000 on the Company are based, in part, upon
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<PAGE>
information received from third parties and the Company's reasonable reliance on
that information. Therefore, the risk that inaccurate information is supplied by
third parties upon which the Company reasonably relied must be considered as a
risk factor that might affect the Company's Year 2000 efforts. The Company is
attempting to reduce the risks by utilizing an organized approach, extensive
testing and allowance of ample contingency time to address issues identified by
tests.
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<PAGE>
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"). The
Court sustained the Company's demurrer to the complaint without leave to amend
on January 23, 1998 and Intervention appealed the decision. On April 5, 1999,
the California Court of Appeals affirmed the Court's decision and dismissed the
case with prejudice.
On March 23, 1999, the Company was in receipt of a Complaint and Summons
("Complaint") filed against the Company by Otto Legerer and GSV Immobilien
Ges.m.b.H. Mr. Legerer formerly served as the Company's Managing Director of
European Operations. The Complaint alleges, among other items, breach of
contract in regards to his termination. The Complaint indicates that Mr.
Legerer is seeking compensatory and certain other damages. The Company believes
that the Complaint is without merit and will defend itself vigorously.
The Company is also subject to other legal proceedings and claims, which
arise, in the ordinary course of its business. Although occasional adverse
decisions (or settlements) may occur, the Company believes that the final
disposition of such matters will not have a material adverse effect on the
financial position or results of operations of the Company.
Item 6. Exhibits and Reports On Form 8-K.
(a) Exhibits
The following exhibits are filed herewith:
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
Current Report on Form 8-K/A filed on May 24, 1999
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<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOUCHSTONE SOFTWARE CORPORATION
August 16, 1999 By: /s/ Pierre A. Narath
---------------------------
Pierre A. Narath
Chairman, President and
Chief Executive Officer
August 16, 1999 By: /s/ Christopher J. Gaudette
---------------------------
Christopher J. Gaudette
Controller/Principal Accounting Officer
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<PAGE>
EXHIBIT INDEX
Exhibit No. Description
27 Financial Data Schedule
-21-
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