<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarter ended SEPTEMBER 30, 1998
------------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission File Number 0-15949
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-2862863
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification No.)
75 ROWLAND WAY, NOVATO, CA 94949
(Address of principal executive offices) (Zip code)
(415) 257-3000
(Registrant's telephone number including area code)
Indicate by check mark whether 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, and (2) has been subject to such filing requirements
for the past 90 days.
YES [X] NO [ ]
As of November 10, 1998, 5,676,229 shares of Registrant's common stock, no par
value, were outstanding.
<PAGE> 2
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Interim Consolidated Financial Statements
Consolidated Balance Sheets at September 30, 1998 and June 30, 1998 3
Consolidated Statements of Operations for the three months ended
September 30, 1998 and 1997 4
Consolidated Statements of Cash Flows for the three months
ended September 30, 1998 and 1997 5
Notes to Consolidated Financial Statements 6-10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-18
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Changes in Securities and Use of Proceeds 19
Item 3. Defaults upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holder 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
</TABLE>
2
<PAGE> 3
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
(Unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 JUNE 30, 1998
------------------ -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 3,878 $ 2,093
Receivables, less allowances for doubtful
accounts and returns of $4,298 and $4,231 13,441 13,149
Inventories, net 6,188 6,549
Prepaid royalties and licenses, net 2,886 2,517
Deferred tax assets, net 2,666 1,762
Other current assets 779 759
-------- --------
Total current assets 29,838 26,829
Furniture and equipment, net 3,430 3,430
Deferred tax assets, net 2,218 2,676
Capitalized software development costs, net 1,742 2,101
Other assets, net 62 314
-------- --------
Total assets $ 37,290 $ 35,350
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Credit line payable 9,623 7,948
Short-term debt and other obligations 904 842
Trade accounts payable 9,140 6,915
Current portion of notes payable 1,359 1,434
Wages, benefits and sales tax payable 890 932
Contracts payable 1,470 1,621
Deferred revenue 126
Income taxes payable 5 313
-------- --------
Total current liabilities 23,517 20,005
Long-term debt and other obligations 1,443 1,682
-------- --------
Total liabilities 24,960 21,687
Shareholders' equity:
Common stock, no par value; 300,000,000 authorized;
issued and outstanding 5,668,729 and 5,684,170 shares,
respectively 12,445 12,718
Retained earnings 41 1,255
Cumulative translation adjustment 129 (25)
Notes receivable from shareholders (285) (285)
-------- --------
Total shareholders' equity 12,330 13,663
-------- --------
Total liabilities and shareholders' equity $ 37,290 $ 35,350
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
3
<PAGE> 4
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------
1998 1997
----------------------------- ------------------------------
<S> <C> <C> <C> <C>
Net revenues $ 13,360 100.0% 12,511 $ 100.0%
Product costs 5,370 40.2% 4,531 36.2%
----------- ----------- ----------- ------------
Gross margin 7,990 59.8% 7,980 63.8%
Costs and expenses:
Sales and marketing 5,684 42.5% 3,655 29.2%
General and administrative 1,744 13.1% 991 7.9%
Research and development 2,281 17.1% 1,635 13.1%
Write-off of purchased research and development 6,367 50.9%
----------- ----------- ----------- ------------
Total operating expenses 9,709 72.7% 12,648 101.1%
----------- ----------- ----------- ------------
Operating loss (1,719) (12.9)% (4,668) (37.3)%
Other expense, net (177) (1.3)% (198) (1.6)%
----------- ----------- ----------- ------------
Loss before income taxes (1,896) (14.2)% (4,866) (38.9)%
Benefit for income taxes (683) (5.1)% (1,752) (14.0)%
----------- ----------- ----------- ------------
Net loss $ (1,214) (9.1)% (3,114) $ (24.9)%
=========== =========== =========== ============
Net loss per share - Basic and diluted $ (0.21) $ (0.60)
=========== ===========
Weighted average common and equivalent
shares used to compute net loss per share
- Basic and diluted 5,666,790 5,169,289
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements
4
<PAGE> 5
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(IN THOUSANDS)
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(1,214) $(3,114)
Adjustments to reconcile net loss to net cash provided
(used) by operating activities
Depreciation and amortization 1,094 802
Deferred taxes 2 (2,290)
Write-off of purchased in-process research and development 6,367
Write-off of deferred offering costs 215
Changes in:
Receivables, net (612) (1,681)
Inventories, net 361 (292)
Prepaid royalties and licenses, net (658) (490)
Other current assets (17) (69)
Trade accounts payable 2,225 294
Wages, benefits and sales tax payable (151) 7
Contracts payable (42) 8
Deferred revenue 126
Income taxes payable (756) (355)
Foreign currency translation 153 145
------- -------
Net cash provided (used) by operating activities 726 (668)
------- -------
Cash flows from investing activities:
Purchase of equipment (269) (484)
Additions to capitalized software development costs (139)
Cash paid for acquisition of software development
costs and in-process technologies (1,233)
Other (16)
------- -------
Net cash used by investing activities (408) (1,733)
------- -------
Cash flows from financing activities:
Credit line borrowings 2,025 2,605
Credit line repayments (350) (515)
Repayments under term loan, net (188) (306)
Capital lease and other obligations repayments (67) (119)
Proceeds from issuance of common stock 47 112
------- -------
Net cash provided by financing activities 1,467 1,777
------- -------
Net increase in cash and cash equivalents 1,785 (624)
Cash and cash equivalents at beginning of period 2,093 1,126
------- -------
Cash and cash equivalents at end of the period $ 3,878 $ 502
======= =======
SUPPLEMENTAL DISCLOSURES OF NON-CASH
FINANCING AND INVESTING ACTIVITIES
Equipment acquired through capital lease obligations $ 239 $ 305
Acquisition of products and in-process technologies
in exchange for:
Trade payables $ 383
Notes payable $ 1,034
Common stock $ 5,240
IMSI common stock received in satisfaction of receivable $ 320
</TABLE>
See Notes to Consolidated Financial Statements
5
<PAGE> 6
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying interim consolidated financial statements have been prepared
from the records of International Microcomputer Software, Inc. and Subsidiaries
(the "Company") without audit. In the opinion of management, all adjustments,
which consist only of normal recurring adjustments (other than those described
below), necessary to present fairly the financial position, results of
operations and cash flows as of and for the periods ended September 30, 1998,
and for all periods presented, have been made. The interim consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto contained in the Company's Annual Report
on Form 10-K for the fiscal year ended June 30, 1998.
The results of operations for the three months ended September 30, 1998 and 1997
are not necessarily indicative of the results to be expected for the full year.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Certain reclassifications have been made to prior periods to conform to the
presentation as of and for the periods ended September 30, 1998.
2. INVENTORIES
Inventories consist primarily of CD ROMs, diskettes, manuals, hardware,
freight-in, production costs and packing supplies for the Company's software
products. Inventories are valued at the lower of cost or market, on a first-in,
first-out basis, and consist of:
<TABLE>
<CAPTION>
September 30, June 30,
1998 1998
------------- --------
<S> <C> <C>
Raw materials $ 2,860 $ 2,882
Finished goods 4,008 4,282
------- -------
6,868 7,164
Reserves for obsolescence (680) (615)
------- -------
$ 6,188 $ 6,549
======= =======
</TABLE>
The Company evaluates the estimated net realizable value of inventories at each
balance sheet date and records write downs to net realizable value and reserves
for obsolescence for any finished goods or raw materials for which the carrying
value is in excess of the estimated net realizable value.
3. CAPITALIZED SOFTWARE DEVELOPMENT COSTS
Costs incurred in the initial design phase of software development are expensed
as incurred as research and development. Once the point of technological
feasibility is reached, direct production costs are capitalized. The Company
ceases capitalizing computer software costs when the product is available for
general release to customers. Costs associated with acquired completed software
are capitalized. Total capitalized software development costs were $5,400,000
and $5,261,000 at September 30, 1998 and June 30, 1998, respectively, less
accumulated amortization of $3,658,000 and $3,160,000, respectively.
6
<PAGE> 7
The Company amortizes capitalized software development costs on a
product-by-product basis. The amortization for each product is the greater of
the amount computed using (a) the ratio of current gross revenues to the total
of current and anticipated future gross revenues for the product or (b) 18 or 60
months. In addition, the Company evaluates the net realizable value of each
software product at each balance sheet date and records write-downs to net
realizable value for any products for which the carrying value is in excess of
the estimated net realizable value.
During the quarter ended September 30, 1998, the Company reevaluated the
economic lives of products for which it capitalized software acquisition or
development costs. As a result, effective July 1, 1998, the Company increased
the amortization period from 36 to 60 months for acquired software development
costs related to visual content products. The effect of this change in
accounting estimate was $99,000 in the first quarter of fiscal 1999. Effective
April 1, 1998, the Company had increased the amortization period from 18 to 36
months. Total visual content amortization expense, charged to product costs, was
$158,000 and $222,000 in the three month periods ended September 30, 1998 and
September 30, 1997 respectively.
4. AMENDED BANK LINE OF CREDIT
On May 4, 1998, as amended September 24, 1998, the Company entered into a new
line of credit agreement with a bank under which it can borrow the lesser of
$13,500,000 or 80% of eligible accounts receivable, at the bank's reference rate
plus 1/2% or LIBOR plus 2%, at the Company's option. The line of credit
agreement requires the Company to comply with certain financial covenants
including maintenance of net worth and working capital requirements. Under the
terms of the agreement, all assets not subject to liens of other financial
institutions have been pledged as collateral against the line of credit. The
credit line expires October 31, 1999.
5. BASIC AND DILUTED EARNINGS PER SHARE
Basic EPS is computed by dividing net income (loss) by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur from common shares issuable as a result of
the exercise or conversion of stock options, restricted stock warrants or other
convertible securities.
Net loss and the weighted average numbers of shares outstanding (denominator)
used to calculate basic earnings per share are reconciled to the numbers of
shares used in calculating diluted earnings per share as follows:
<TABLE>
<CAPTION>
Three Months Ended September 30,
------------------------------------
1998 1997
----------- -----------
<S> <C> <C>
Net Loss $(1,214,000) $(3,114,000)
----------- -----------
Shares used to compute basic EPS 5,667,000 5,169,000
Add effect of dilutive securities:
Stock options 589,000 917,000
----------- -----------
Shares used to compute diluted EPS 6,256,000(1) 6,086,000(1)
=========== ===========
</TABLE>
(1) Not presented as results were anti-dilutive
7
<PAGE> 8
6. WRITE-OFF OF PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
There were no acquisitions affecting in-process research and development for the
quarter ended September 30, 1998.
During the quarter ended September 30, 1997, the Company completed the following
four acquisitions of products, in-process technologies or companies. Each was
accounted for using purchase accounting. The aggregate purchase prices for the
acquisitions were comprised as follows:
COMPONENTS OF PURCHASE PRICES FOR ACQUISITIONS
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF VALUE OF ASSUMPTION AGGREGATE
COMMON COMMON NOTES OF NET PURCHASE
SELLER STOCK STOCK PAYABLE CASH LIABILITIES PRICE
------ ---------- ---------- ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Quarterdeck....... -- $ -- $ -- $1,000,000 $ -- $1,000,000
MapLinx........... -- -- 233,500 233,500 383,000 850,000
Mediapaq.......... 20,000 240,000 -- -- 160,000 400,000
Corel............. 346,020 5,000,000 640,000 -- -- 5,640,000
---------- ---------- ---------- ---------- ---------- ----------
366,020 $5,240,000 $ 873,500 $1,233,500 $ 543,000 $7,890,000
========== ========== ========== ========== ========== ==========
</TABLE>
The Company allocated the purchase prices for the acquisitions as follows:
ALLOCATION OF AGGREGATE PURCHASE PRICES OF ACQUISITIONS
<TABLE>
<CAPTION>
PURCHASED IN-PROCESS
RESEARCH AND
SELLER DEVELOPMENT CAPITALIZED SOFTWARE GOODWILL
------ -------------------- -------------------- --------
<S> <C> <C>
Quarterdeck........... $ 517,000 $ 483,000 --
MapLinx............... 506,000 331,000 $13,000
Mediapaq.............. 300,000 100,000 --
Corel................. 5,044,000 517,000 79,000
---------- ---------- -------
$6,367,000 $1,431,000 $92,000
========== ========== =======
</TABLE>
See notes 2, 4, 5 and 6 to the consolidated financial statements included in the
Company's Annual Report on Form 10-K for the Fiscal Year Ended June 30, 1998 for
a further description of these acquisitions and the write-off of purchased
in-process research and development.
7. NOVEMBER 1998 SUBORDINATED LOAN FACILITY WITH WARRANTS
On November 3, 1998, the Company borrowed $2,500,000 under a new three-year
subordinated loan facility entered into with Silicon Valley Bank. The interest
rate is 12%. As part of the loan facility, the Company issued detachable
warrants, which have a five-year term, to purchase shares of the Company's
common stock. At closing, the Company issued 30,000 warrants to purchase common
stock at $7.00 per share. The warrants issued will increase, as amounts
advanced under this facility remain outstanding as follows:
<TABLE>
Additional warrants
If not paid in full prior to: to be issued Exercise price per share
----------------------------- --------------------- ------------------------
<S> <C> <C>
October 31, 1999 5,000 $7.00
January 31, 2000 25,000 7.00
April 30, 2001 65,000 6.00
October 31, 2001 125,000 5.00
</TABLE>
8
<PAGE> 9
The Company will record additional interest expense over the life of the loan
facility related to the warrants.
8. OCTOBER 1998 ACQUISITION OF ORG PLUS
On September 29, 1998, The Learning Company ("TLC") paid the Company
approximately $1,690,000, representing amounts due to the Company, after
discount, from the Family Heritage sale ($1,260,000 - see note 3 to the
consolidated financial statements included in the Company's Annual Report on
Form 10-K for the Fiscal Year Ended June 30, 1998) and other existing
contractual agreements ($430,000). The Company had not recorded revenues or
receivables for such amounts due from TLC.
The $1,690,000 cash receipt from TLC did not result in revenue recognition by
the Company for the quarter ended September 30, 1998. Accordingly, such amount
was included in cash and cash equivalents and as a current liability at
September 30, 1998.
On October 2, 1998, TLC and the Company entered into a software license
agreement whereby TLC sold Org Plus to the Company in exchange for $3,500,000 as
follows: $1,700,000 paid by the Company on October 2, 1998, and $450,000 due on
each of January 1, 1999, April 1, 1999, July 1, 1999 and October 1, 1999.
In the quarter ending December 31, 1998, the Company will record the value of
the Org Plus acquisition. The Company has not yet completed its allocation of
the purchase price; however, it expects that the purchase price will be
allocated to acquired software development costs, brand and goodwill, to be
amortized over periods not to exceed five years.
9. OCTOBER 1998 ACQUISITION OF ZEDCOR, INC.
In October 1998, the Company acquired 100% of the common stock of Zedcor, Inc.,
a major internet provider of art and animations, for a total purchase price of
$3,500,000 as follows: $970,500 in IMSI stock (176,455 shares at $5.50 per
share) and $2,529,500 in cash payments, payable as follows: $300,000 due
November 1, 1998, and approximately $185,800 due in twelve quarterly payments,
commencing on November 1, 1998. The Company has not yet completed its allocation
of the purchase price, however it expects that the $3,500,000 purchase price
will be allocated to software development costs related to visual content
products and goodwill, to be amortized over periods not to exceed five years.
10. QUARTER ENDED SEPTEMBER 30, 1998 CHARGES
In the quarter ended September 30, 1998 the Company increased reserves for
cooperative advertising commitments by approximately $500,000, incurred
approximately $350,000 of expenses related to the move its corporate
headquarters from San Rafael to Novato, California, and wrote off approximately
$250,000 of deferred offering costs related to the preparation of an S-1
filing earlier in fiscal 1998.
9
<PAGE> 10
11. COMPREHENSIVE INCOME
Comprehensive income includes changes in the balance of items that are reported
directly in a separate component of stockholders' equity on the condensed
consolidated balance sheets. The reconciliation of net loss to comprehensive
loss is as follows.
<TABLE>
<CAPTION>
Three Months Ended September 30,
--------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Net Loss $(1,214,000) $(3,114,000)
Other comprehensive gain
Foreign currency translation
adjustments 153,000 145,000
Total comprehensive loss $(1,061,000) $(2,969,000)
=========== ===========
</TABLE>
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the consolidated
financial statements and the notes thereto and in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations in the
Company's Form 10-K for the year ended June 30, 1998 (the "Form 10-K"). This
quarterly report on Form 10-Q, and in particular Management's Discussion and
Analysis of Financial Condition and Results of Operations, may contain
forward-looking statements regarding future events or the future performance of
the Company that involve certain risks and uncertainties including those
discussed in the "Other Factors that May Affect Future Operating Results"
section of this Form 10-Q, as well as in the Company's Form 10-K, as filed with
the Securities and Exchange Commission ("SEC"). Actual events or the actual
future results of the Company may differ materially from any forward-looking
statements due to such risks and uncertainties. The Company assumes no
obligation to update these forward-looking statements to reflect actual results
or changes in factors or assumptions affecting such forward-looking statements.
This analysis is not intended to serve as a basis for projection of future
events.
OVERVIEW AND SUMMARY OF RESULTS
The Company reported net revenues for the three months ended September 30, 1998
of $13,360,000 compared to $12,511,000 for the comparable quarter in fiscal
1998, representing an increase of 7%. The Company reported a net loss of
$1,214,000 or ($0.21) per share for the quarter ended September 30, 1998,
compared to a net loss of $3,114,000 or ($0.60) per share for the comparable
quarter of fiscal 1998, representing an increase in earnings of $1,900,000. In
the quarter ended September 30, 1998 the Company increased reserves for
cooperative advertising commitments by approximately $500,000, incurred
approximately $350,000 of expenses related to the move its corporate
headquarters from San Rafael to Novato, California, and wrote off approximately
$250,000 of deferred offering costs related to the preparation of an S-1 filing
earlier in fiscal 1998. During the comparable quarter of fiscal 1998, the
Company incurred a charge of $6,400,000 relating to the write-off of in-process
research and development costs.
RESULTS OF OPERATIONS
NET REVENUES
Net revenues for the three month period ended September 30, 1998 were
$13,360,000 compared to $12,511,000 in the comparable quarter of the previous
fiscal year, representing an increase of 7%.
During the quarter ended September 30, 1998, the Company's significant new
product releases and upgrades included VoiceDirect(TM) Continuous and
VoiceDirect Continuous Gold, a speech recognition software for use in
Windows(R); DreamHouse(R) 3D and Talk & Draw Architect, both of which are
building design software programs; MasterClips(R) 500,000+, MasterClips
1,000,001 and MasterClips Web Art, premium clip art software available on CD-Rom
and online; Micro Cookbook Deluxe Suite, which included over 12,000 recipes; and
Hijaak(R) Express v4.5, a graphic tool used for converting, capturing and
organizing graphic images.
11
<PAGE> 12
Net revenues in absolute dollars and as a percentage of total net revenues for
each of the Company's principal product categories were as follows for the
periods indicated:
Three Months Ended September 30,
<TABLE>
<CAPTION>
1998 1997
------------------- -------------------
<S> <C> <C> <C> <C>
Business applications $ 6,096,000 46% $ 6,206,000 50%
Utilities 1,577,000 12% 2,312,000 18%
Visual content 3,909,000 29% 2,805,000 22%
Other products 1,778,000 13% 1,188,000 10%
----------- --- ----------- ---
Total $13,360,000 100% $12,511,000 100%
=========== === =========== ===
</TABLE>
Net revenues in the business applications category for the three month period
ended September 30, 1998 decreased by $110,000 or 2% from the comparable period
of fiscal 1998. The introduction of five new products during the period
subsequent to September 30, 1997 (E-mail animator, Flow, Lumiere, MasterPhoto
Studio, MultiMedia Fusion) compensated in part for a relative decline in
TurboProject and TurboCAD revenue during the quarter ended September 30, 1998.
In the quarter ended September 30, 1997, TurboCAD sales had increased due
to an upgrade and introduction of TurboCAD Pro in the preceding quarter.
Net revenues in the utilities category for the three month period ended
September 30, 1998 decreased by $735,000, or 32%, from the comparable period of
fiscal 1998. Increased sales during the quarter ended September 30, 1998 of the
VoiceDirect product line were offset by a decline in sales from Net Accelerator
and WinDelete, which are at the end of their version cycle.
Net revenues in the visual content category for the three month period ended
September 30, 1998 increased by $1,104,000, or 39%, respectively from the
comparable period of fiscal 1998. The increase in revenue during the quarter
ended September 30, 1998 is due primarily to the successful introduction of
MasterClips 500,000+ and MasterClips 1,000,001.
Net revenues in the other products category for the three month period ended
September 30, 1998 increased by $590,000, or 50%, from the comparable period of
fiscal 1998. The increase is due primarily to sales of Micro Cookbook and
proceeds from the sale of Family Heritage.
Net revenues from domestic sales increased by 10% to $9,108,00, or 68% of net
revenues, for the three month period ended September 30, 1998 from $8,284,000,
or 66% of net revenues, for the comparable period in the previous fiscal year.
Net revenues from international sales were $4,252,000 or 32% of net revenues for
the three month period ended September 30, 1998, compared to $4,227,000 or 34%
net revenues for the three months ended September 30, 1997.
The Company's international net revenues in the three month period ended
September 30, 1998 were generated primarily from Germany, the United Kingdom and
Australia. Although the Company believes that the risks associated with
transactions in foreign currencies are mitigated by diversified exposure to
multiple currencies, the Company's operating results may be affected by the
risks customarily associated with international operations, including a
devaluation of the U.S. dollar, increases in duty rates, exchange or price
controls, longer collection cycles, government regulations, political
instability and changes in international tax laws.
12
<PAGE> 13
The Company recognizes revenue, net of estimated returns and allowances, upon
shipment of a product and only when no significant obligations remain and
collectability is probable. The Company's return policy allows its distributors,
subject to certain limitations, to return purchased products in exchange for new
products or for credit towards future purchases as part of stock balancing
programs. In addition, the Company provides price protection to its distributors
when it reduces the prices of its products. End users may return products
through dealers and distributors within a reasonable period from the date of
purchase for a full refund, and retailers may return older versions of products
for a full refund. Various distributors and resellers may have different return
practices that adversely affect the number of products that are returned to the
Company. Product returns often occur when the Company introduces upgrades and
new versions of products or when distributors or resellers overestimate demand.
The Company's allowances for doubtful accounts and returns is based upon its
best judgment and estimates at the time and is comprised of both reserves for
expected bad debts and reserves for expected sales returns. Reserves for
doubtful accounts and expected sales returns is based primarily on historical
averages and were 24.2% and 24.3% of gross receivables at September 30, 1998 and
June 30, 1998, respectively.
PRODUCT COSTS
Product costs increased from $4,531,000 to $5,370,000 representing an increase
as a percentage of net revenues were 36% to 40% three month periods ended
September 30, 1997 and September 30, 1998, respectively. Major factors
contributing to the increase were higher material and labor costs due to
increased product shipments, the effect of deferred revenue, and increased
amortization costs of capitalized software due to acquisitions made in the
fiscal year ended June 30, 1998.
The Company amortizes capitalized software development costs on a
product-by-product basis. The amortization for each product is the greater of
the amount computed using (a) the ratio of current gross revenues to the total
of current and anticipated future gross revenues for the product or (b) 18 or 60
months.
During the quarter ended September 30, 1998, the Company reevaluated the
economic lives of products for which it capitalized software acquisition or
development costs. As a result, effective July 1, 1998, the Company increased
the amortization period from 36 to 60 months for acquired software development
costs related to visual content products. The effect of this change in
accounting estimate was $99,000 in the first quarter of fiscal 1999. Total
visual content amortization expense, charged to product costs, was $158,000 and
$222,000 in the three month periods ended September 30, 1998 and September 30,
1997 respectively.
SALES AND MARKETING
Sales and marketing expenses increased from $3,655,000 to $5,683,000 for the
three month periods ended September 30, 1997 and September 30, 1998,
respectively. Sales and marketing expenses as a percentage of net revenues
increased from 29% to 43% of net revenues for the three month periods ended
September 30, 1997 and September 30, 1998, respectively. The increases are
primarily due to the booking of additional reserves for cooperative
advertising, and increased marketing staff, merchandisers and corporate sales
representatives.
13
<PAGE> 14
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased from $991,000 to $1,744,000 for
the three month periods ended September 30, 1997 and September 30, 1998,
respectively. These increases are primarily due to the Company's write-off of
deferred offering costs relating to preparation for an S-1 filing, the
Company's move to its corporate headquarters, and continued infrastructure
improvements and headcount additions, primarily in the areas of information
systems, human resources, accounting and operations. General and administrative
expenses as a percentage of net revenues increased from 8% to 13% of net
revenues for the three month period ended September 30, 1997 and September 30,
1998, respectively.
RESEARCH AND DEVELOPMENT
Research and development expenses increased from $1,635,000 to $2,282,000 for
the three month periods ended September 30, 1997 and September 30, 1998. This
increase can be attributed to an increase in domestic headcount, the utilization
of additional independent contractors and other third party development costs
relating to the development and expansion of the Company's product offerings.
Research and development costs as a percentage of net revenues increased from
13% to 17% of net revenues for the three month periods ended September 30, 1997
and September 30, 1998, respectively. The percentage increases reflect the
Company's continued commitment to invest in research and development.
WRITE-OFF OF PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
There were no acquisitions affecting in-process research and development for the
quarter ended September 30, 1998.
In the period ended September 30, 1997, the Company expensed $6,367,000 of
in-process research and development resulting from the acquisitions from Corel,
Quarterdeck, MapLinx and MediaPaq. These transactions have been described in
detail in the Company's 10-K for the year ended June 30, 1998.
OTHER EXPENSE, NET
Other expense, net, which consists of interest expense on short- and long-term
borrowings as well as net gains or losses on foreign currency transactions,
decreased from $198,000 to $177,000 for the three month periods ended September
30, 1997 and September 30, 1998, respectively. For the three month period ended
September 30, 1998, other expense, net consisted of $105,000 in foreign exchange
gain and $282,000 of interest expense, compared to $107,000 in foreign exchange
loss and $91,000 of interest expense for the comparable period in the previous
fiscal year.
PROVISION FOR INCOME TAXES
The Company's effective tax rate is 36% for the three month period ended
September 30, 1998 and for the three month period ended September 30, 1997.
14
<PAGE> 15
OCTOBER 1998 ACQUISITION OF ORG PLUS
On September 29, 1998, The Learning Company ("TLC") paid the Company
approximately $1,690,000, representing amounts due to the Company, after
discount, from the Family Heritage sale ($1,260,000 - see note 3 to the
consolidated financial statements included in the Company's Annual Report on
Form 10-K for the Fiscal Year Ended June 30, 1998) and other existing
contractual agreements ($430,000). The Company had not recorded revenues or
receivables for such amounts due from TLC.
The $1,690,000 cash receipt from TLC did not result in revenue recognition by
the Company for the quarter ended September 30, 1998. Accordingly, such amount
was included in cash and cash equivalents and as a current liability at
September 30, 1998.
On October 2, 1998, TLC and the Company entered into a software license
agreement whereby TLC sold Org Plus to the Company in exchange for $3,500,000 as
follows: $1,700,000 paid by the Company on October 2, 1998, and $450,000 due on
each of January 1, 1999, April 1, 1999, July 1, 1999 and October 1, 1999.
In the quarter ending December 31, 1998, the Company will record the value of
the Org Plus acquisition. The Company has not yet completed its allocation of
the purchase price; however, it expects that the purchase price will be
allocated to acquired software development costs, brands and goodwill, to be
amortized over periods not to exceed five years.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its working capital and capital expenditure
requirements primarily from net income before depreciation and amortization,
short-term and long-term bank borrowings, capitalized leases and sales of common
stock pursuant to the exercise of options. Working capital decreased to
$6,321,000 at September 30, 1998 from $7,728,000 at June 30, 1998 resulting
primarily from an increase in credit line borrowings.
The Company's operating activities provided (used) net cash of $726,000 and
($668,000) for the three months ended September 30, 1998 and September 30, 1997
respectively. For the three months ended September 30, 1998, net cash provided
by operating activities resulted from primarily an increase in current
liabilities of $1.4 million, a major component of which was the increased
liability of $1.7 million due to the Org Plus transaction described above and a
reduction in income taxes payable of $756,000. The increase in current
liabilities was offset in part by an increase in prepaid royalties and licenses
of $658,000. For the three months ended September 30, 1997, net cash used by
operating activities resulted primarily from a decrease in deferred taxes and
income taxes payable of $2.6 million, net income before depreciation of $2.3
million, and an increase in accounts receivable of $1.7 million that was offset
primarily by the one-time write-off of capitalization costs of $6.4 million.
The Company's investing activities (used) net cash of ($408,000) and
($1,733,000) during the three months ended September 30, 1998 and September 30,
1997 respectively. For the three months ended September 30, 1998, net cash used
by investing activities resulted from equipment purchases of $269,000 and
additions to software development costs of $139,000. For the three months ended
September 30, 1997, net cash used by investing activities was due
15
<PAGE> 16
primarily to the acquisition of software development costs and in-process
technlogies of $1.2 million and equipment purchases of $484,000.
The Company's financing activities provided net cash of $1.5 and $1.8 million
during the three months ended September 30, 1998 and September 30, 1997
respectively. For the three month period ended September 30, 1998, net cash
provided by financing activities resulted primarily in net credit line
borrowings of $1.7 million. For the three month period ended September 30, 1997,
net cash provided by financing activities resulted primarily in net credit line
borrowings of $2.1 million.
On May 4, 1998, as amended September 24, 1998, the Company entered into a new
line of credit agreement with a bank under which it can borrow the lesser of
$13,500,000 or 80% of eligible accounts receivable, at the bank's reference rate
plus 1/2 % or LIBOR plus 2%, at the Company's option. The line of credit
agreement requires the Company to comply with certain financial covenants
including maintenance of net worth and working capital requirements. Under the
terms of the agreement, all assets not subject to liens of other financial
institutions have been pledged as collateral against the line of credit. The
credit line expires October 31, 1999.
On November 3, 1998, the Company borrowed $2,500,000 under a new three-year
subordinated loan facility entered into with Silicon Valley Bank. The interest
rate is 12%. As part of the loan facility, the Company issued detachable
warrants, which have a five-year term, to purchase shares of the Company's
common stock. At closing, the Company issued 30,000 warrants to purchase common
stock at $7.00 per share. The warrants issued will increase, as amounts advanced
under this facility remain outstanding as follows:
<TABLE>
<CAPTION>
Additional warrants
If not paid in full prior to: to be issued Exercise price per share
----------------------------- --------------------- ------------------------
<S> <C> <C>
October 31, 1999 5,000 $7.00
January 31, 2000 25,000 7.00
April 30, 2001 65,000 6.00
October 31, 2001 125,000 5.00
</TABLE>
The Company will record additional interest expense over the life of the loan
facility related to the warrants.
The Company believes that its existing cash and cash equivalents, cash flow from
operations, any remaining availability under its line of credit, and proceeds
from the subordinated loan facility will be sufficient to satisfy the Company's
working capital and capital expenditure requirements for at least the next 12
months. However, in order to support expansion of the Company's operations,
future acquisitions of products or companies, increases in expenses or other
factors, the Company expects to seek additional debt or equity financing in the
near term. The Company's forecast period of time through which its financial
resources will be adequate to support its working capital and capital
expenditure requirements is a forward-looking statement that involves risks and
uncertainties, and actual results could vary. There can be no assurance that
such funding, if needed, will be available on terms attractive to the Company,
or at all. Furthermore, any additional equity financing may be dilutive to
shareholders, and debt financing, if available, may involve restrictive
covenants. The failure of the Company to raise capital when
16
<PAGE> 17
needed could have a material adverse effect on the Company's business, operating
results and financial condition.
OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
The Company has experienced, and expects to continue to experience, significant
fluctuations in operating results due to a variety of factors. The Company has
experienced growth during fiscal 1998, 1997 and 1996. However, the Company
reported a net loss in the current quarter of $1.2 million due in part to an
increase in reserves for cooperative advertising commitments, the Company's move
of its corporate headquarters, and the write-off of deferred offering costs
relating to the preparation of an S-1 filing earlier in the year. In addition,
for the quarter ended September 30, 1997, the Company reported a net loss of
approximately $3.1 million, reflecting in part charges, accounted for primarily
as a write-off of in-process research and development, amounting to
approximately $6.4 million relating to several product acquisition and licensing
transactions.
Factors that may cause fluctuations in operating results in the future include,
but are not limited to, market acceptance of the Company's products or those of
its competitors; the timing of introductions of new products and new versions of
existing products; expenses relating to the development and promotion of such
new product and new version introductions; product returns and reserves;
difficulty in securing retail shelf space for the Company's products; changes in
pricing policies by the Company or its competitors; changes in product mix;
projected and actual changes in platforms and technologies; timely and
successful adaptation to such platforms or technologies; the accuracy of
forecasts of, and fluctuations in, consumer demand; the extent of third party
royalty payments; market seasonality; the rate of growth of the consumer
software market; fluctuations in foreign exchange rates; the timing of orders or
order cancellation from major customers; order cancellations; changes or
disruptions in the consumer software distribution channels; the successful
acquisition and integration of new businesses, products and technologies; the
timing of any write-offs in connection with such acquisitions; and economic
conditions, both generally and within the Company's industry. In addition, the
Company's strategy is to increase the focus of its sales efforts on volume
licensing to corporate accounts, and the timing of such licenses could
significantly affect quarterly results of operations. The Company may also be
required to pay fees in advance or to guarantee royalties, which may be
substantial, or to obtain software licenses from third parties before the
commercial viability of such software has been determined, which could cause
operating results to fluctuate. As a result of these and other factors, the
Company's operating results in any given period are inherently difficult to
predict. Any significant shortfall in revenues and earnings from the levels
expected by securities analysts and shareholders could result in a substantial
decline in the trading price of the Company's common stock.
While the Company's business has not generally been materially affected by
seasonal trends, the seasonality of the European, Asia/Pacific and other
international markets could impact the Company's operating results and financial
condition in a particular quarter given the significant portion of net revenues
contributed by international operations. These seasonal patterns may be
overshadowed in particular quarters by the timing of new product introductions,
expansion into international markets and other factors affecting the Company's
business. Furthermore, the markets for the Company's products are characterized
by significant price competition, which may cause the Company's operating
results to fluctuate. In addition to seasonal and product pricing factors, the
Company anticipates that its operating results for the remainder of Fiscal 1999
and Fiscal 2000
17
<PAGE> 18
will be affected by the timing and the number of new product releases or
upgraded versions of existing products, as well as marketing and promotional
expenditures in connection with the product releases and the timing of product
announcements or introductions by the Company's competitors.
Products are generally shipped as orders are received. The Company has
historically operated with little order backlog and sales and operating results
for any quarter have depended on the volume and timing of orders received during
that quarter, which cannot be predicted with any degree of certainty. However,
the Company reported a record backlog at the end of the quarter ended September
30, 1998 due to the release of MasterClips 1,000,001. A significant portion of
the Company's operating expenses is relatively fixed, and planned expenditures
are based on sales forecasts. Thus, if revenue levels are below expectations due
to either the timing of orders received or delays in product releases, operating
results are likely to be materially adversely affected. Without growth in
revenues in any particular quarter, the Company's increasing fixed operating
expenses could cause net income to decline when compared to the same period in
the previous year or the immediately preceding quarter. In such event, the
market price of the Company's common stock may be materially adversely affected.
Due to the foregoing factors, the Company believes that quarter to quarter
comparisons of its operating results are not necessarily meaningful and should
not be relied upon as indications of future performance.
YEAR 2000 RISKS. The Company recognizes the need to ensure its operations will
not be adversely impacted by Year 2000 software failures. Software failures due
to processing errors potentially arising from calculations using the Year 2000
date are a known risk. The Company has established procedures for evaluating and
managing the risks and costs associated with this problem, and, as part of the
general upgrade of the Company's information systems, the Company is putting in
place systems which will by Year 2000 compliant.
The Company has communicated with others with whom it does significant business
to determine their Year 2000 compliance readiness and the extent to which the
Company is vulnerable to any third party Year 2000 issues. However, there can
be no guarantee that the systems of other companies on which the Company's
systems relay will be timely converted, or that a failure to convert by another
company, or a conversion that is incompatible with the Company's systems, would
not have a material adverse effect on the Company. For further discussion
please refer to the subheading "Future Performance and Additional Risk Factors"
in the Company's Annual Report on Form 10-K for the Fiscal Year Ended June 30,
1998.
For further discussion please refer to the subheading "Future Performance and
Additional Risk Factors" in the Company's Annual Report on form 10-K for the
Fiscal Year Ended June 30, 1998.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to the impact of interest rate and foreign currency
fluctuations. The Company's objective in managing its exposure to interest rate
changes and foreign currency fluctuations is to limit the impact of interest
rate changes on earnings and cash flow and to lower its overall borrowing costs.
The Company's major market risk exposure is changing interest rates in the
United States, which would change interest expense on the Company's line of
credit and term loan.
Most of the Company's international revenues are denominated in foreign
currencies. Consequently a decrease in the value of a relevant foreign currency
in relation to the U.S. dollar could adversely affect the Company's net
revenues. The Company's foreign currency transactional exposures exist primarily
with the U.K. pound and German mark.
The Company does not utilize interest rate swaps or hedge exposures with foreign
currency forward contracts.
18
<PAGE> 19
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
Not Applicable
ITEM 2. Changes in Securities and Use of Proceeds
Not Applicable
ITEM 3. Defaults upon Senior Securities
Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
Not Applicable
ITEM 5. Other Information
Not Applicable
ITEM 6. Exhibits and Reports on Form 8-K
<TABLE>
<CAPTION>
Exhibits
--------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
No report on Form 8-K was filed during the quarter ended September 30, 1998.
19
<PAGE> 20
SIGNATURES
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.
DATE: November 16, 1998 INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
By: /s/ MARTIN SACKS
-----------------------------------------
Martin Sacks
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ KENNETH R. FINEMAN
-----------------------------------------
Kenneth R. Fineman
Vice President of Finance and Chief
Financial Officer
(Principal Financial Officer)
20
<PAGE> 21
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibits
--------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 3,878
<SECURITIES> 0
<RECEIVABLES> 17,739
<ALLOWANCES> 4,298
<INVENTORY> 6,188
<CURRENT-ASSETS> 29,838
<PP&E> 5,936
<DEPRECIATION> 2,506
<TOTAL-ASSETS> 37,290
<CURRENT-LIABILITIES> 23,517
<BONDS> 0
0
0
<COMMON> 12,445
<OTHER-SE> (115)
<TOTAL-LIABILITY-AND-EQUITY> 37,290
<SALES> 13,360
<TOTAL-REVENUES> 13,360
<CGS> 5,370
<TOTAL-COSTS> 5,370
<OTHER-EXPENSES> 9,709
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (177)
<INCOME-PRETAX> (1,896)
<INCOME-TAX> (683)
<INCOME-CONTINUING> (1,214)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,214)
<EPS-PRIMARY> (.21)
<EPS-DILUTED> (.21)
</TABLE>
