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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Fiscal Year ended June 30, 1999
or
[ ] Transition report pursuant to Section 13 or 15(d) of the Exchange Act of
1934 for the Transition Period from _____ to _____
Commission File No. 0-15949
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-2862863
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
75 ROWLAND WAY, NOVATO, CALIFORNIA 94945
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (415) 878-4000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: common
stock, no par value
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
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in the definitive
proxy or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. [X]
The aggregate market value of the voting stock of the registrant by
non-affiliates of the registrant as of October 20, 1999 was
approximately $15,949,750.
As of October 20, 1999, 7,024,409 Shares of Registrant's common stock,
no par value, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED JUNE 30, 1999
TABLE OF CONTENTS
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PART I
Item 1. Business 3
Item 2. Properties and Facilities 11
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 12
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters 13
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 15
Item 7a. Quantitative and Qualitative Disclosures about Market Risk 33
Item 8. Financial Statements and Supplementary Data 33
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 33
PART III
Item 10. Directors and Executive Officers of the Registrant 35
Item 11. Executive Compensation 37
Item 12. Security Ownership of Certain Beneficial Owners and Management 40
Item 13. Certain Relationships and Related Transactions 40
PART IV
Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K 41
Signatures 70
Exhibit Index 71
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PART I
FORWARD-LOOKING INFORMATION
This Annual Report of International Microcomputer Software, Inc ("IMSI") on Form
10-K contains certain forward-looking statements, particularly those identified
with the words, "anticipates," "believes," "expects," "plans," and similar
expressions. These statements reflect management's best judgement based on
factors known to them at the time of such statements. Discussions containing
such forward-looking statements may be found in the material set forth under
"Legal Proceedings" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations", generally, and specifically therein under
the captions "Liquidity and Capital Resources" and "Future Performance and
Additional Risk Factors" as well as elsewhere in this Annual Report on Form
10-K. Actual events or results may differ materially from those discussed
herein. The risk factors discussed under "Future Performance and Additional Risk
Factors", among others, should be considered carefully by the reader in
evaluating our prospects and future financial performance.
ITEM 1. BUSINESS
GENERAL
International Microcomputer Software, Inc. ("IMSI" ) was incorporated in
California in November 1982. Our corporate headquarters are in Novato,
California, with subsidiary and branch offices maintained in the United Kingdom,
Germany, Australia, South Africa, France, Sweden, and Canada. We are a developer
and publisher of PC productivity software in the precision design, graphic
design, business applications and utilities categories targeted primarily to
small to medium-sized businesses, professionals and consumers. The precision
design category includes IMSI's computer assisted drawing ("CAD") products; the
graphic design category includes IMSI's visual content products. IMSI sells its
software in 10 languages in more than 40 countries. IMSI's best-known product
families include TurboCAD and FloorPlan in the precision design category,
MasterClips in the graphic design category and Org Plus and FormTool in the
business applications category.
We develop and market productivity software in categories that extend the basic
functionality of PCs beyond the word processing, spreadsheet, electronic mail
and database applications provided by standard office productivity software
suites. Our products enhance PC functionality by providing and/or expanding
capabilities in areas such as precision drawing, graphics, forms automation,
project management and scheduling. IMSI has sought to create product franchises
by developing, licensing or acquiring products in categories where it believes
it can capture market share with better technology, lower prices or a more
extensive distribution network. Our PC applications have appealed to a broad
variety of users, particularly professionals and small to medium-sized
businesses, in categories under-served by major software vendors. IMSI is
refocusing on providing community and destination web sites addressing the
precision design and graphic design markets.
IMSI distributes its products worldwide, primarily through the retail channel.
In addition, we sell directly to the corporate, education and government markets
as well as to other consumers through strategic partners, direct mail and
e-mail. Since 1998, IMSI has focused on building relationships with online
resellers and distributors. We are also building an Internet based revenue
stream from our visual content web sites, especially ArtToday.com, and our new
precision design web sites, SolutionCity.com, Floorplan.com and Turbocad.com.
Although selling our product through our traditional network of domestic and
international retail distribution relationships achieved poor results in fiscal
year 1999 when compared to prior years, as of June 30, 1999 these traditional
distribution channels remained IMSI's primary source of revenue.
As announced on June 24, 1999, IMSI initiated a company-wide restructuring of
its operations in response to its large year to date losses in fiscal year 1999.
The major components of the restructuring plan were as follows:
- Manufacturing and warehouse outsourcing
- Facilities consolidation
- Personnel reductions
- Divestiture of non-core products and focus on high margin product lines
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IMSI's goal is to complete its restructuring by December 31, 1999.
BACKGROUND
IMSI completed its initial public offering in July 1987, raising net proceeds of
approximately $2,600,000. In August 1988, we acquired Milan Systems America,
Inc. and the rights to TurboCAD. In September 1995, we acquired the rights to
the FloorPlan product line from Forte/ComputerEasy International, Inc. On
September 30, 1997, we acquired the rights to established products, Corel Flow,
Corel Family Tree, and Lumiere, and four in-process technologies, CorelCAD,
Click and Create, VisualCADD and Corel Personal Architect in the CAD,
diagramming and consumer categories from Corel. In October 1998, we acquired all
the outstanding stock of Zedcor, Inc., an Internet provider of art and visual
content and owner of the web site, ArtToday.com.
STRATEGY
Our objective is to effectively transition from a productivity software company
to a company that provides community and destination web sites addressing the
precision design and graphic design markets. To achieve its objective, IMSI's
strategy includes the following key elements:
Precision Design - Our precision design strategy is based on web-enabling the
functionality of our FloorPlan and TurboCAD software, and enhancing these
products with the scheduling capabilities of our TurboProject software. We
believe these products are well positioned for the online home design and
remodeling markets since they improve the user experience by making it more
interactive. IMSI is evaluating strategic partnering opportunities to assist in
enhancing the experience of home design and remodeling over the Internet.
Graphic Design - IMSI plans to build on its ArtToday web site to offer relevant
content, community, and an affinity network for graphic design professionals.
ArtToday.com, which has over 75,000 paid subscribers and one million visits per
month, offers users unlimited access to more than 750,000 graphic images, web
art, photos, fonts, and animations. IMSI is building a network of affinity
partners and affiliates to drive traffic and build content.
Transition Out of Non-Core Products: Historically, we have followed a strategy
of growth by expansion of product franchises. While that strategy has had
previous success, it was not successful during fiscal 1999. IMSI is planning to
sell or license its non-core products. In this way, IMSI hopes to obtain the
cash resources necessary to fund its transition to the Internet as well as meet
interim operating costs. Toward this end, IMSI sold its Easy Language product
line for $1.7 million in August 1999. IMSI hopes to sell the rights to some or
all of its non-core software product line during fiscal year 2000.
PRODUCTS
PRECISION DESIGN
Our precision design products accounted for 35%, 25% and 27% of our net revenues
in fiscal 1999, 1998 and 1997, respectively. IMSI's precision design products
include the following:
- TURBOCAD is a CAD software product that allows a user to create precision
drawings. TurboCAD offers comprehensive functionality for the technical
professional combined with ease-of-use for the novice user. TurboCAD is used
by architects, engineers and contractors in small- and medium-sized
businesses, as well as by workgroups within many large corporations such as
Pennzoil, Dow Chemical, Bechtel, Babcock & Wilcox, Houston Lighting & Power,
and Motorola. TurboCAD includes integrated 3D construction capabilities,
file compatibility with other CAD software (including AutoCAD by Autodesk),
and integrated raster-to-vector conversion. TurboCAD v6 Professional
includes a software development kit that permits end-user and third-party
developer customization of the software.
- TURBOCAD SOLID MODELER is a 3D CAD program that allows users to
conceptualize, construct and revise product models and prototypes. Designed
for engineering professionals, TurboCAD Solid Modeler uses the
industry-standard ACIS drawing engine and includes many advanced features
such as a recordable tree history, 2D and 3D constraint systems, rendering,
programmable scripting language, a customizable user interface and
dimensioning.
- FLOORPLAN 3D is a software tool for residential and commercial space layout
that allows a user to view and walk through
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plans in three dimensions.
- STANLEY HOME DESIGN is a software tool that allows residential home
remodelers to draw and preview a prospective home. The product is a
combination of the software capabilities found in IMSI's FloorPlan and
TurboProject products. Stanley Home Design is marketed through an alliance
with The Stanley Works. Stanley Home Design was released by IMSI in the
first quarter of fiscal year 2000.
GRAPHIC DESIGN.
Our visual content products include art images, photographs, video clips,
animations and fonts stored in electronic form that can be used to enhance
communication by making online, onscreen and printed output more visually
appealing. Graphic design products accounted for 34%, 31% and 47% of our net
revenues in fiscal 1999, 1998 and 1997, respectively. Our visual content
products include the following:
- MASTERCLIPS PREMIUM IMAGE COLLECTION includes collections of up to
1,250,000 unique art and photographic images. MasterClips Premium Image
Collection products include a browser, clip art editor and design guide.
- ARTTODAY ONLINE offers a collection of approximately 750,000
downloadable images on line at www.arttoday.com for an annual
subscription fee.
- MASTERPHOTOS is a collection that includes medium to high-resolution
photo images. The MasterPhotos 50,000 and MasterPhotos 25,000
collections cover categories such as animals, transportation, sports and
foods and include unique historical images of many subjects, such as
famous people and major events.
- MASTERPHOTOS STUDIO is a software suite that enables users to edit,
enhance, manage and catalog photographs. MasterPhotos Studio supports
scanners, digital cameras, Internet file formats and Adobe PhotoShop
plug-in filters.
- GRAPHICS CONVERTER converts most visual content, sound, font and video
files to one of over 65 file formats and allows users to organize,
browse, manipulate, compress and retrieve an array of file types and
formats. Users can also compress and catalog files to create custom
content libraries.
BUSINESS APPLICATIONS
Our business applications products include business graphics and general office
products. These products accounted for 21%, 14% and 6% of IMSI's net revenues in
fiscal 1999, 1998 and 1997, respectively. IMSI's business applications products
include the following:
- FLOW! enables general business users to create a wide variety of
diagrams, including flowcharts, organization charts, timelines, block
diagrams, geographic maps and marketing charts. Flow also includes
features that allow the user to enhance the information content of
diagrams. Flow users can link diagrams to databases and associate
non-graphical data with shapes within a diagram.
- MASTERPUBLISHER is a desktop publishing suite that allows users to
create custom, high-quality publications for both business and personal
use. MasterPublisher's design and layout tools include fonts,
professionally drawn images and hundreds of useful templates. Completed
documents can be published on the World Wide Web.
- LUMIERE VIDEO STUDIO is a digital video editing software program that
enables users to assemble excerpts from a variety of media sources,
including video, audio and still images. Lumiere's easy to use
drag-and-drop features enable users to create professional looking audio
and video tracks for multimedia presentations, training demonstrations,
advertising campaigns, movies and home viewing.
- MULTIMEDIA FUSION is an easy-to-use software application that allows
users to create multimedia presentations, applications, games and screen
savers. This product includes a number of powerful tools and
comprehensive libraries to combine text, graphics, video, animation and
audio into professional multimedia projects, without additional
programming or scripting.
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- HIJAAK is a professional 32-bit graphics toolkit that allows users to
convert, manage and view over 85 graphics file formats including 3D and
full Postscript files.
- TURBOPROJECT is a sophisticated project management tool that allows
users to create and manage a project schedule, allocate resources and
establish and track project budgets. TurboProject Professional allows
users to divide large projects into sub-projects and distribute the
sub-projects to individual managers over company networks. The
sub-projects can then be reintegrated to update a master project
schedule.
- FORMTOOL is a forms automation product that allows users to design and
print personal forms quickly, or choose from over 400 pre-built
templates. The user can then complete and electronically sign and route
the form over a company Intranet to other users in the organization.
Data is automatically stored in an integrated relational database.
FormTool Scan & OCR includes optical character recognition and scanning
features for easier form design.
- PEOPLESCHEDULER is an application designed for an organization of any
size to manage and schedule hourly employees and resources.
PeopleScheduler includes the ability to manage budgeting, shifts,
breaks, lunches, vacations and attendance.
- MAPLINX allows users to map data and visualize geographical information
from a database, including data related to customers, branch locations
and personnel. MapLinx works with most contact management programs,
spreadsheets and databases.
- ORG PLUS is an application designed for creating professional
organization charts. Org Plus completely automates chart creation so
that no drawing or manual positioning of boxes is required. Org Plus
features automated sorting and drag and drop capabilities.
UTILITIES PRODUCTS. Our utilities products enable the more efficient and secure
use of PCs. These products accounted for 11%, 19% and 12% of IMSI's net revenues
in fiscal 1999, 1998 and 1997, respectively. Our utilities products include the
following:
- NETACCELERATOR is a caching product that speeds up web surfing by
pre-fetching links on a web page and then simultaneously downloading
both the links' text and graphic content. This process maximizes the
efficiency of the PC modem, browser and Internet connection. When a link
is selected, if it has been pre-fetched, the downloaded page will appear
almost immediately.
- WINDELETE uninstalls, archives, moves and transports Windows
applications and manages their Internet cache to free up wasted hard
drive space, prevents accidental deletions and maximizes hard drive
performance. WinDelete also includes virus protection and compression
features.
- UPDATENOW! is designed to enable PC users to keep their systems current,
thereby enhancing overall system performance and avoiding the problems
frequently encountered as a result of outdated software and device
drivers. UpdateNow allows PC users to easily locate many of the most
recent software updates and patches applicable to their systems and
download and install them automatically via the Internet. A bundled
version of UpdateNow, Year2000 Now, adds increased Y2K capabilities to
the UpdateNow product.
OTHER PRODUCTS. IMSI also markets other products, including but not limited to
EASY Language (which was sold by IMSI in August 1999 for $1.7 million to
Learnout and Hauspie), MICROCOOKBOOK for recipe and menu planning and the IMSI
MOUSE line of input devices.
SALES AND DISTRIBUTION
We sell our products worldwide primarily to small to medium-sized businesses,
professionals and consumers through the retail channel. IMSI also utilizes
direct mail and e-mail in the consumer, corporate, education and government
markets. In addition, IMSI sells product via the Internet.
RETAIL. In North America, IMSI sells its products primarily through a network of
distributors, including Ingram Micro, Merisel, GT Interactive and Navarre, which
in turn distribute IMSI's products to over 12,000 retail stores in North
America, such as Staples, Office Depot, OfficeMax, PriceCostco, Sam's Club,
CompUSA, Micro Center, WalMart and Best Buy. In addition,
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IMSI has direct purchase agreements with major retailers such as Electronics
Boutique, Hastings, MusicLand and Babbages. IMSI and its distributors also sell
its products through catalog resellers and online stores. Ingram Micro
represented 18.3%, 20.4% and 11.9% and Tech Data represented 9.0%, 12.7% and
10.9% of IMSI's net revenues for fiscal 1999, 1998 and 1997 respectively. No
single direct-to-retail customer accounted for more than 10% of IMSI's net
revenues in fiscal 1999, 1998 or 1997.
Internationally, IMSI sells its products in more than 40 countries through a
network of subsidiary offices and distributors. IMSI maintains sales offices in
the United Kingdom, France, Germany, Sweden, Australia, and South Africa and has
distributors and republishers in several other countries. As part of its
restructuring plan, IMSI is consolidating European operations in Germany. While
the United Kingdom and France will still have sales offices, Sweden will be
completely serviced from Germany. Internationally, IMSI sells its products
through the retail, online and OEM channels. IMSI generally localizes its
products for international markets by translating the documentation, software
and marketing programs into up to 10 different languages, including French,
Spanish, German, Italian, Japanese and Portuguese. Our international business is
subject to certain risks common to international operations, such as government
regulations, import restrictions, currency fluctuations and restrictions and
reduced protection for IMSI's copyrights and trademarks.
IMSI's agreements with its distributors are generally nonexclusive and may be
terminated by either party without cause. Our distributors may decide not to
continue carrying our products due to our declining sales revenue. Our
distributors are not within our control, are not obligated to purchase our
products and represent other vendors' product lines, including competing
products. On September 27, 1999, one of our primary distributors, Tech Data,
terminated its agreement with us. Our largest retailer, CompUSA, which was
served by Tech Data, continues to carry our products and is now served by an
alternative distributor. We expect other retailers that were served by Tech Data
to switch to alternative distributors.
Our return policy allows our distributors, subject to certain limitations, to
return purchased products primarily in exchange for new products or for credit
towards future purchases as part of stock balancing programs. In addition, IMSI
provides price protection to its distributors when it reduces the price of its
products. End users may return products through dealers and distributors within
a reasonable period of time from the date of purchase for a full refund.
Retailers may return older versions of products. Product returns often occur
when IMSI introduces upgrades and new versions of products or competitive
products are introduced into the market. Our channel sales force works with
major customers to help manage appropriate inventory levels.
DIRECT MAIL. We conduct direct mail campaigns to existing customers for new
products and upgrades of existing products. These mailings generally offer a
specially priced specific product, as well as complementary or enhanced products
for a further charge. Our database of registered users includes 700,000
customers worldwide. Direct mail sales represented approximately 11%, 11% and
13% of IMSI's net revenues in fiscal 1999, 1998 and 1997, respectively.
CORPORATE. IMSI believes that certain of its products, particularly its
TurboCAD, TurboProject, Org Plus and Hijaak are well-suited for use within
larger corporations. Over the past year, IMSI has sold site licenses to some
large companies, including Fortune 100 companies. IMSI markets to these
corporations through a combination of telemarketing, mailings and e-mailing.
ONLINE. IMSI markets its products via the Internet from its own web sites, as
well as through strategic partnerships with online resellers such as America
Online, Buy.com, Outpost.com, Beyond.com, Digital River, Bitsource,
Releasenow.com, Netsales.com, and Egghead.com. Net revenues from this
distribution channel have not been significant to date. IMSI has recently
established a web site, SolutionCity.com, which offers light versions of its
products free to consumers. Several thousand of its products have been
downloaded from this site. Many of these customers have been converted to paying
customers through e-mail campaigns.
OTHER. IMSI also sells its products worldwide through hardware and software
OEMs, who republish or bundle its products for either a fixed royalty or a per
copy royalty. IMSI also sells its products to educational institutions through
campus resellers, bookstores and educational mail order companies. Finally, IMSI
sells certain non-competitive products of other companies in its international
markets. Net revenues from these distribution channels have not been significant
to date.
MARKETING
Our marketing efforts include retail marketing and merchandising. These efforts
are directed at strengthening IMSI's product and corporate brands, building
customer loyalty, maximizing upgrade and repeat purchases and developing
incremental revenue opportunities. Our retail marketing strategy typically
focuses on high impact product packaging and retail promotions such as end-cap
displays, special pricing and rebate coupons. In addition, IMSI actively
participates in cooperative advertising
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programs with its reseller customers, including advertising, brochures and
catalogs. IMSI also seeks to increase market share and brand recognition through
public relations activities and participation in popular trade and computer
shows.
CUSTOMER SUPPORT
IMSI provides professional customer support to its end-users by telephone,
facsimile, and e-mail at no-charge for 90-days for all products. IMSI also
offers extensive quality customer support on its web site by offering answers to
frequently asked questions, providing product discussion forums and making
intelligent help and search engines available. In addition, several newer
products released by IMSI contain an online link to web-based support that
automatically updates or patches the user's software via the web. Support
representatives are extensively trained in IMSI's products; customer feedback is
shared among support representatives. This feedback is also made available to
quality assurance and product management in order to track product operability
and enhance the development of product improvements and upgrades. Our worldwide
customer support center is located in Albuquerque, New Mexico, and is
supplemented with additional customer support provided internationally through
IMSI's various subsidiary offices. Additional support staffs are employed
directly by IMSI's various distributors.
PRODUCT DEVELOPMENT
We develop products primarily for the Microsoft Windows platform and, in some
cases, for the Macintosh operating system. IMSI targets PC applications that
have been under-served by major software vendors but that have immediate
benefits and appeal to a broad variety of users, particularly professionals and
small- and medium-sized businesses. IMSI generally creates product
specifications and manages the product development and quality assurance process
from its offices in Novato, California. Engineering management and certain
programming is carried out from IMSI's development center in Ottawa, Canada.
Most program coding and quality testing is performed using contract programmers
in development centers in various locations in Russia. Contract programmers
located outside the United States are generally dedicated on a full-time basis
to IMSI's products. The cost of programmers in foreign countries is generally
lower than programmers available in the United States. In addition, programming
talent is generally more available outside the United States than in the United
States, where the market for programmers is highly competitive. IMSI makes
extensive use of the Internet and Internet-based development tools to facilitate
programming in remote locations.
Our general policy is to own, either through internal development or
acquisition, the core technology of our principal products. Where appropriate,
IMSI will augment its core technology with licensed technology. IMSI possesses
and is continually enhancing its core technology in vector graphics, precision
design, project management technology, and project and time management
processes.
As of June 30, 1999, we had 76 employees in our product and development
organization, and we contracted with approximately 77 independent contractors,
substantially all of which were located overseas. Our research and development
expenses totaled $8.1 million, $8.6 million (excluding purchased in-process
research and development expenses), and $4.6 million for fiscal 1999, 1998 and
1997, respectively.
ACQUISITION AND LICENSING
Historically, IMSI has created new product franchises in part by licensing and
acquiring products in growing segments of its existing product categories where
it believed it could capture market share with better technology, lower prices
and its extensive distribution. We sought to acquire or license early stage
products, where we could add value through our global distribution network and
development resources. We target product or company acquisitions or product or
technology licenses when time-to-market or cost considerations outweigh the
value of developing the product in-house or where we do not have the necessary
development expertise. Due to the skills, infrastructure and expense required to
market software products effectively, IMSI has been frequently approached by
software developers who desire that IMSI license or acquire their products. In
addition, from time to time larger companies have approached us with products
that they wish to divest. We may continue acquiring companies and products and
licensing products and technologies to the extent that such companies, products
or technologies become available and we believe that they would further enhance
our product portfolio.
However, as part of our restructuring plan announced on June 24, 1999, we are in
the process of reducing our gross product SKU's by approximately 75% in order to
concentrate more fully on our strongest core products. IMSI plans to divest
non-core products when opportunities to do so are presented. In August 1999,
IMSI sold the rights to its Easy Language product for $1.7 million. IMSI hopes
to sell the rights to some or all of its non-core software product line during
fiscal year 2000.
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Currently, IMSI licenses MasterClips E-Mail Animator, RamShield, MasterPhotos
Studio, Update Now! and Web Business Builder. We have acquired the technology
for TurboCAD Solid Modeler and 3D Modeler, Visual CADD, MapLinx,
PeopleScheduler, Flow, FloorPlan Design Suite, Lumiere, Multimedia Fusion and
HiJaak. We also license and acquire visual content from third parties, including
artists, photographic agencies and visual content aggregators. Where feasible,
IMSI endeavors to acquire images on a perpetual, worldwide basis and with
electronic download rights. The licenses have terms ranging from one year to
perpetual and are generally not exclusive. Licensing fees associated with
licensed technology are generally paid by way of sales-based royalties, which
are included in our product costs.
OPERATIONS
IMSI controls the purchasing, inventory and marketing associated with its
products primarily from its headquarters in Novato, California. Our product
development organization produces master diskettes or CD-ROMs and the
documentation for each product. The duplication of such diskettes or CD-ROMs,
the printing of the documentation and the packaging for the products are
performed by third parties in accordance with our specifications. IMSI
warehouses and ships the final products from its Vacaville, California facility,
as well as from various international locations. IMSI also contracts with third
parties in Europe to handle the duplication, printing, packaging and fulfillment
of a number of its products intended for international distribution.
As part of its restructuring effort, in July 1999, IMSI and DisCopyLabs (DCL)
finalized an agreement whereby DCL will gradually assume all of IMSI's U.S.
fulfillment, warehousing, and product shipping duties. Accordingly, IMSI will be
closing its warehouse facility in Vacaville. IMSI anticipates completing this
transition by December 31, 1999. DCL will charge IMSI per unit fees for its
services. Under this new variable cost production fulfillment model, IMSI
believes it will be better able to manage and predict its product costs,
especially during periods of fluctuating sales volumes.
IMSI has multiple sources of supply for substantially all product components. To
date, IMSI has not experienced any material difficulties or delays in the
printing, packaging or assembly of its products. During fiscal year 2000 and
beyond, IMSI will become dependent on a single vendor, DCL, for the fulfillment,
warehousing, and shipping of its products. To the extent that this vendor is
unable to perform these functions in a cost-efficient and timely manner, and if
a transition to a substitute vendor cannot be completed in a timely fashion,
IMSI's business, operating results and financial condition could be adversely
affected.
COMPETITION
The PC productivity software industry is highly competitive and is characterized
by rapid changes in technology and customer requirements. Important factors in
the market include product features and functionality, quality and performance,
reliability, brand recognition, ease of understanding and operation, advertising
and dealer merchandising, access to distribution channels and retail shelf
space, marketing, pricing, availability and quality of support services. There
has been a consolidation among competitors in the market for IMSI's products.
Many of IMSI's current and potential competitors have larger technical staffs,
more established and larger marketing and sales organizations, significantly
greater financial resources, greater name recognition and better access to
consumers than does IMSI. Our relatively small size could adversely affect our
ability to compete with larger companies for sales to dealers, distributors and
retail outlets, to obtain shelf space for our products in retail outlets and to
acquire products from third parties, who may desire to have their products sold
or published by larger entities. The rapid pace of technological change
constantly creates new opportunities for existing and new competitors and can
quickly render existing technologies less valuable. It also requires IMSI to
enhance its existing products and to offer new products on a timely basis. IMSI
has limited resources and therefore must restrict its product development
efforts to a relatively small number of projects.
IMSI competes with other software companies in its efforts to acquire products
or companies and to publish software developed by third parties. The competition
to publish software developed by third parties is primarily on the basis of
brand-name reputation, the terms offered to software developers and the ability
to market new products.
Each of our major products competes with one or more products from one or more
major independent software vendors. For example, TurboCAD competes with AutoCAD
from Autodesk Inc. and IntelliCAD from Visio Corporation. On September 15, 1999
Microsoft, announced it would acquire Visio Corporation. FloorPlan competes with
3D Architect from Broderbund Software Inc., a subsidiary of Mattel, Home
Architect from Cendant Corporation, Home Design Suite from Autodesk, Dream Home
Designer from Alpha Software Corporation, Home Design 3D from Expert Software,
Inc. and Punch Software's Home Design Suite. TurboProject competes with
MicrosoftProject. MasterClips competes with ClickArt from Broderbund Software
Inc., MegaGallery from Corel Corporation, Holy Cow! from Macmillan Digital
Publishing USA and Art Explosion from Nova
9
<PAGE> 10
Development. WinDelete competes with Uninstaller from CyberMedia Inc.,
CleanSweep and Norton Uninstaller from Symantec Corporation. Net Accelerator
competes with SurfExpress from Connectix, Speed Surfer from Kissco and Net.jet
from Peak Technologies.
Our strategy has been to develop productivity and utility applications that do
not compete directly with applications or features included in operating systems
and applications suites offered by major software vendors such as Microsoft,
Lotus Development Corp. and Corel. However, such software vendors may in the
future choose to expand the scope and functionality of their products to support
some or all of the features currently offered by certain of IMSI's products,
which could adversely affect demand for our products. In particular, Microsoft
has periodically added utility features, e.g. disk compression utilities and
desk-top facing features, to its Windows operating systems that were previously
only supported by third-party vendors and that materially reduced demand for
third-party utility products. In addition, Microsoft's Windows 98 contains
features for the automatic updating of Windows 98, including third party device
drivers, and many Microsoft applications via the Internet, which could adversely
impact sales of IMSI's Update Now! product. Windows 98 also contains the latest
version of Microsoft's Internet Explorer, which handles the caching of Web pages
more efficiently. This feature may adversely impact sales of IMSI's Net
Accelerator product family.
The Internet is having a pronounced effect on the traditional retail channels
through which many of our products are sold. Increasing numbers of software
users are buying their software over the Internet rather than from a retail
outlet. We may not be able to transition our business to the Internet quickly or
effectively enough to take advantage of this change in buyer preference. In
addition, our traditional distribution channel, the retail market, will likely
be diminished by this change.
The software industry has limited barriers to entry, and the availability of
personal computers with continuously expanding capabilities, at progressively
lower prices, contributes to the ease of market entry. IMSI believes that
competition in the industry will continue to intensify as a number of software
companies extend their product lines into additional product categories and as
additional competitors enter the market. In addition, widespread use of the
Internet has reduced barriers to entry in the software market by allowing
software developers to distribute their products online without relying on
access to traditional distribution networks. As a result of the proliferation of
competing software developers, more products are competing for limited shelf
space. We cannot assure investors that our products will achieve and/or sustain
market acceptance and generate significant levels of revenues in future periods
or that we will have the resources required to compete successfully in the
future.
The markets for IMSI's products are characterized by significant price
competition, and IMSI expects it will continue to face increasing pricing
pressures. In response to such competitive pressures, IMSI has reduced the price
of some of its products. Product prices may continue to decline and we may not
be able to respond to such declines with additional product price reductions. If
we significantly reduced the prices of one or more of our products, there can be
no assurance that such price reductions would result in an increase in unit
sales volume. Prolonged price competition would have a material adverse effect
on our operating results, including reduced profit margins and loss of market
share.
Approximately 67% of IMSI's revenues were derived from sales of the TurboCAD,
Floorplan and MasterClips product lines in fiscal year 1999 as compared to 53%
in fiscal year 1998. Sales of TurboCAD and MasterClips significantly declined in
fiscal year 1999, from $29 million to $20 million, primarily due to lower unit
sales. A continued decline in TurboCAD and MasterClips sales, a decline in
Floorplan sales, or a decline in the gross margin on one or more of these
products could worsen IMSI's results of operations. Thus, IMSI may be more
vulnerable to market declines and competition in the markets for such products
than companies with more diversified sources of revenues.
PROPRIETARY RIGHTS AND LICENSES
Our ability to compete effectively depends in part on our ability to develop and
maintain proprietary aspects of our technology. To protect our technology, we
rely on a combination of copyrights, trademarks, trade secret laws, restrictions
on disclosure and transferring title and other methods. We hold no patents, and
existing copyright and trade secret laws afford only limited protection. We also
generally enter into confidentiality or license agreements with our employees
and consultants, and control access to and distribution of our documentation and
other proprietary information.
Despite the foregoing precautions, it may be possible for a third-party to copy
or otherwise obtain and use IMSI's products or technologies without
authorization, or to develop similar technologies independently. IMSI does not
include in its products any mechanism to prevent or inhibit unauthorized
copying. Policing unauthorized use of IMSI's technology is difficult, and while
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<PAGE> 11
IMSI is unable to determine the extent to which software piracy of its products
exists, software piracy can be expected to be a persistent problem. If a
significant amount of unauthorized copying of IMSI's products were to occur,
IMSI's business, operating results and financial condition could be adversely
affected. In addition, effective copyright, trademark and trade secret
protection may be unavailable or limited in certain foreign countries, and the
global nature of the Internet makes it virtually impossible to control the
ultimate destination of IMSI's products. There can be no assurance that the
steps taken by IMSI will prevent misappropriation or infringement of its
technology. In addition, litigation may be necessary to protect IMSI's trade
secrets or to determine the validity and scope of the proprietary rights of
others. Such litigation could result in substantial costs and diversion of
resources that could have a material adverse effect on IMSI's business,
operating results and financial condition.
As the number of software products in the industry increases and the
functionality of these products further overlaps, software developers and
publishers may increasingly become subject to infringement claims. From time to
time, IMSI has received, and may receive in the future, notice of claims of
infringement of other parties' proprietary rights. Although IMSI investigates
claims and responds as it deems appropriate, there can be no assurance that
infringement or invalidity claims (or claims for indemnification resulting from
infringement claims) will not be asserted or prosecuted against IMSI.
Irrespective of the validity or the successful assertion of such claims, IMSI
would incur significant costs and diversion of resources with respect to the
defense thereof, which could have a material adverse effect on IMSI's business,
operating results and financial condition. If any valid claims or actions were
asserted against IMSI, we might seek to obtain a license under a third party's
intellectual property rights. There can be no assurance, however, that under
such circumstances a license would be available on commercially reasonable
terms, or at all.
IMSI provides its products to end users under non-exclusive licenses, which
generally are non-transferable and have a perpetual term. IMSI makes source code
available for certain products. The provision of source code may increase the
likelihood of misappropriation or other misuse of IMSI's intellectual property.
IMSI licenses all of its products pursuant to shrink-wrap licenses, or Internet
click-wrap licenses, that are not signed by licensees and therefore may be
unenforceable under the laws of certain jurisdictions.
EMPLOYEES
As of June 30, 1999, IMSI had approximately 221 employees, including 69
in sales and marketing, 76 in product development, 41 in operations and 35 in
administration and finance. In addition, IMSI has about 77 Russian software
developers working as contractors under a software development contract. None of
IMSI's employees are represented by a labor union, and IMSI has experienced no
work stoppages. As part of IMSI's restructuring plan, currently 90 employees
have been, or are scheduled for termination in the following departments: sales
and marketing, 22; general and administrative, 8; manufacturing, 23; and R&D,
37. Our success depends to a significant extent upon the performance of our
executive officers and key technical and marketing personnel. IMSI's large year
to date losses and headcount reductions may have hurt employee morale and caused
employees concern about our viability. IMSI has lost, and may continue to lose,
key personnel due to these events.
ITEM 2. PROPERTIES AND FACILITIES
Our principal administrative, sales and marketing, as well as certain research
and development facilities are located in Novato, California, occupying
approximately 36,000 square feet of office space. As part of its restructuring
efforts, IMSI has subleased approximately 50% of its Novato headquarters office.
IMSI also leases 58,000 square feet of warehouse space in Vacaville, California.
In July 1999, IMSI and DisCopyLabs (DCL) finalized an agreement whereby DCL will
gradually assume all of IMSI's fulfillment, warehousing, and product shipping
duties. Accordingly, IMSI will be shutting down its warehouse facility in
Vacaville. IMSI anticipates closing its warehouse facility by December 31, 1999.
In addition, IMSI leases additional facilities in Albuquerque, New Mexico;
Sydney, Australia; Paris, France; Munich, Germany; Johannesburg, South Africa;
Stockholm, Sweden; London, the United Kingdom; and Ottawa, Canada. As part of
IMSI's plan of restructuring, warehousing and back office functions for the
United Kingdom, France, Sweden and Germany will be consolidated in Germany.
Facilities in the United Kingdom and France will be reduced to sales offices and
all functions for Sweden will provided by the German office.
ITEM 3. LEGAL PROCEEDINGS
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On April 23, 1998 IMSI began arbitration proceedings against Imageline, Inc.
before the American Arbitration Association in San Francisco, California. IMSI
requested that all matters within the scope of the agreements between Imageline
and IMSI be resolved by arbitration, including a dispute in which Imageline sued
Mindscape, Inc. for alleged copyright infringement, for which IMSI may be
required to indemnify Mindscape, in whole or in part. IMSI further requested
that the arbitration decide the rights and liabilities of the parties, and the
validity of the copyrights under which Imageline asserted its claims against
IMSI. IMSI also requested compensatory damages and attorney's fees.
On August 12, 1999 Imageline filed a counterclaim in the arbitration, alleging
breach by IMSI of an agreement between the parties, including unauthorized
sublicensing, and instituting arbitration proceedings without notice and
opportunity to cure. Imageline requested liquidated damages, alleged to be more
than $200,000, compensatory damages of at least $500,000, punitive damages,
legal fees, interest and costs. On January 14, 2000, Imageline received a $2.6
million arbitration award against IMSI for intellectual property violations.
IMSI is appealing the award in the federal district court in Richmond, VA.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fiscal
year ended June 30, 1999 other than the election of nominees to IMSI's Board of
Directors and approval of the amendment to IMSI's Employee Incentive Plan.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Presently, our common stock is traded on the NASDAQ National Market under the
symbol "IMSI." Historically, trading volume of our common stock has been very
small. The market for the common stock has been materially less liquid than that
of most other publicly traded companies. Significant sales of common stock by
officers and directors or other shareholders could have an adverse effect on the
market price of our common stock.
The following table sets forth the quarterly high bid and low asked prices of
the common stock for fiscal 1998 and fiscal 1999, as quoted on the NASDAQ. Such
prices represent prices between dealers and do not include retail mark-ups,
markdowns or commissions and may not represent actual transactions.
<TABLE>
<CAPTION>
CLOSING SALES PRICES
Fiscal Year 1998 High Bid Low Asked
-------- ---------
<S> <C> <C>
First Quarter $13.63 $ 9.63
Second Quarter 18.38 13.00
Third Quarter 17.13 12.44
Fourth Quarter 18.00 14.00
Fiscal Year 1999
First Quarter 15.13 5.63
Second Quarter 10.25 3.63
Third Quarter 14.00 8.75
Fourth Quarter 11.88 4.79
</TABLE>
There were approximately 1,097 holders of record of the common stock as of
October 20, 1999. IMSI believes that additional beneficial owners of its common
stock hold their shares in street names.
IMSI has not paid any cash dividends on its common stock and does not plan to
pay any such dividends in the foreseeable future. Its Board of Directors will
determine IMSI's future dividend policy on the basis of many factors, including
results of operations, capital requirements and general business conditions.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the
Consolidated Financial Statements, including the related notes, and Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS DATA: (Amounts in thousands except per share amounts)
Year ended June 30, 1999 1998 1997 1996 1995
------------------- ---- ---- ---- ---- ----
RESTATED(2)
<S> <C> <C> <C> <C> <C>
Net Revenues $ 37,679 $ 62,065 $41,839 $25,679 $ 20,300
Operating income (loss) (23,890) 86 4,367 1,801 (370)
Income (loss) before income
taxes and extraordinary item (25,770) (673) 4,237 1,539 (424)
Extraordinary item(1) (959) -- -- -- --
Net income (loss) (26,966) (370) 2,597 954 (435)
Net income (loss) Per share:
Basic $ (4.30) $ (0.07) $ 0.53 $ 0.20 $ (0.09)
Diluted $ (4.30) $ (0.07) $ 0.46 $ 0.18 $ (0.09)
Weighted average common
Shares
Basic 6,275 5,513 4,946 4,795 4,705
Diluted 6,275 5,513 5,682 5,288 4,705
</TABLE>
<TABLE>
<CAPTION>
BALANCE SHEET DATA:
As of June 30, 1999 1998 1997 1996 1995
-------------- ---- ---- ---- ---- ----
RESTATED(2)
<S> <C> <C> <C> <C> <C>
Working capital $ (1,227) $ 6,572 $ 7,334 $ 3,092 $1,967
Total assets 27,144 35,655 17,573 11,058 7,470
Long term debt and other
Obligations 6,599 1,682 2,042 565 103
Stockholders' equity $ 1,442 $13,411 $ 7,495 $ 4,522 $3,397
</TABLE>
(1) Extraordinary item related to debt extinguishment.
(2) See Note 16 to the consolidated financial statements.
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<PAGE> 15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESTATEMENT, AS OF AND FOR THE YEAR ENDED JUNE 30, 1998
Subsequent to the issuance of IMSI's 1998 financial statements, IMSI's
management, after consultation with our current auditors, determined that we
should have deferred the recognition of revenue related to three advanced
royalty payments recorded in fiscal 1998 for certain technology licensing
agreements. Previously, IMSI recognized revenue in the amount of these advanced
payments upon execution of the licensing agreement. Upon reviewing certain
licensing agreements, IMSI determined that it should have deferred the amounts
of these advanced payments. The revenue related to these advance payments should
have been recognized as it was earned as royalties under the terms of the
agreements. As a result, the financial statements as of and for the year ended
June 30, 1998 have been restated from amounts previously reported to defer
recognition of $407,000 of revenue until earned as royalties in subsequent
periods. See Note 16 to the consolidated financial statements.
RESULTS OF OPERATIONS
NET REVENUES
Net revenues were $37.7 million, $62.1 million, and $41.8 million, in fiscal
1999, 1998, and 1997 respectively. The drop in fiscal year 1999 net revenues
represented a 39.3% decrease from fiscal year 1998 net revenues, which had risen
$20.2 million or 48.3 % from fiscal year 1997. Decreases in net revenues for the
fiscal year 1999 were experienced in all product families. Net revenues for each
of IMSI's principal product categories in absolute dollars and as a percentage
of net revenues were as follows for the periods indicated (in thousands except
for percentage amounts):
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------------------------------------------------------------
1999 1998 1997
----------------------------------- ---------------- -------------
CHANGE FROM As restated
PREVIOUS YEAR
---------------
$ % $ % $ % $ %
------- --- ------- ---- ------- --- ------- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Precision design $13,168 35% $ (2,490) -16% $15,658 25% $11,302 27%
Graphic design 12,928 34% (5,983) -32% 18,911 31% 19,461 47%
Business applications 8,013 21% (968) -11% 8,981 14% 2,558 6%
Utilities 3,921 11% (7,838) -67% 11,759 19% 4,816 12%
Other products 2,511 7% (5,649) -69% 8,160 13% 4,656 10%
Increase in sales reserves (2,862) -8% (1,458) -104% (1,404) -2% (954) -2%
------- --- -------- ---- ------- --- ------- ---
Total net revenues $37,679 100% $(24,386) -39% $62,065 100% $41,839 100%
======= === ======== ==== ======= === ======= ===
</TABLE>
Net revenues from sales of products in the precision design category fell by
$2.5 million or 16%, after increasing in fiscal year 1998 by $4.4 million or 39%
from fiscal year 1997. Sales revenue from IMSI's flagship product, TurboCAD,
declined by 34% in fiscal year 1999. The percentage decline of TurboCAD sales
was greater in the international market than the North American market. Sales of
FloorPlan increased by approximately 44% during fiscal year 1999 compared to
fiscal 1998.
Net revenues from sales of products in the graphic design category fell by $6
million or 32% from fiscal year 1998 net revenues. Sales revenue from the most
significant revenue producing product line within this category, MasterClips,
decreased by approximately 30% in fiscal year 1999. The decline in MasterClips
sales was primarily due to a significant increase in competitive product
offerings and discount pricing in the visual content market. Revenues from
IMSI's wholly owned subsidiary, Zedcor, Inc., owner of the ArtToday.com and
other visual content web sites, are included in this category. Because Zedcor's
revenues are based on subscriptions, these amounts are initially deferred and
then amortized over the subscription, generally over 12 to 15 months. As of June
30, 1999, approximately $1,758,000 of revenue related to ArtToday.com and IMSI's
other visual content web sites remained deferred.
During fiscal year 1999, we offered hybrid products which included both a
MasterClips product and a subscription to ArtToday.com. These hybrid products
were not well received by consumers and contributed to the decline in
MasterClips sales.
Net revenues from sales of products in the business application category fell by
$1.0 million or 11% from fiscal year 1998 after
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increasing $6.4 million or 251% from fiscal year 1997. Sales of TurboProject,
FormTool, HiJaak, MapLinx, People Scheduler and Web Business Builder, all
declined in fiscal year 1999. Sales of Flow, Lumiere, and MultiMedia Fusion,
which were introduced in the second half of fiscal year 1998, increased in
fiscal year 1999. Sales of Org Plus and Sales Forecaster, which were introduced
in fiscal year 1999, added to fiscal year 1999 revenues. Declines in business
application revenues reflect the general decline in our overall product sales.
Net revenues from sales of products in the utilities category fell by $7.8
million or 67% from fiscal year 1998 after increasing $6.9 million or 144% from
fiscal year 1997. The decrease in net revenues during fiscal 1999 was primarily
due to lower unit sales of WinDelete, NetAccelerator, and Voice Direct. The
decline in revenue was primarily due to the utility market undergoing increased
competition, heavy price discounting and rebating. Certain of IMSI's single
product utility offerings were unable to compete against popular utility suite
products offered by larger and better-known companies such as Network Associates
(McAfee) and Symantec. Due to the sales revenue from UpdateNow and Year2000 Now
being based on subscriptions, these revenue amounts are initially deferred and
then amortized over the subscription, generally over 15 months. As of June 30,
1999, $1,053,000 of UpdateNow and Year2000 Now revenue remained deferred.
In the first half of fiscal 1999, market conditions deteriorated for IMSI's
products in the visual content and utilities categories. In June 1998, The
Learning Company purchased Broderbund, the publisher of Click Art, a product
competitive to IMSI's MasterClips product. In subsequent months, Broderbund and
Corel aggressively reduced prices and offered rebates to increase their sales
and market share. IMSI responded in some instances with matching discounts and
rebates, but nevertheless experienced a significant decline in sales due to
these competitive pressures.
In September 1998, Network Associates purchased Cybermedia, developer of
uninstaller, a competitor to IMSI's WinDelete product. In October 1998, Symantec
purchased Quarterdeck, the developer of Cleansweep, a product that is also a
competitor to IMSI's Windelete product. Symantec and Network Associates are two
of the largest and most formidable competitors in the PC productivity software
market. In both instances Symantec and Network Associates relaunched these
products with aggressive marketing campaigns, and in product bundles with their
other products. The affect of these actions was increased competition and a
reduction in sales of Windelete, an IMSI utilities product.
In the first half of fiscal 1999, IMSI also experienced significant competition
in the voice recognition category. Dragon Systems, IBM, Learnout & Haspie and
Philips all introduced new products and reduced prices during this period,
resulting in significant declines in sales of VoiceDirect, IMSI's voice
recognition product.
The foregoing events, unprecedented intense pricing pressure, aggressive
competitive market campaigns by larger and more well-known competitors, and
IMSI's inability to support proactive marketing programs due to cash flow
concerns caused a general decline in sales and significant product returns to
IMSI from our distributors.
On September 27, 1999, TechData notified us that it would terminate its
distribution agreement with us within 60 days as a result of a disagreement over
payment terms. Although TechData was one of our largest distributors, we
anticipate only a minimal impact on future sales because other distributors
assumed substantially all of the accounts previously serviced by TechData.
Based on reports received from TechData, we estimated, as of September 27, 1999,
that Tech Data held $566,000 of IMSI product in its inventory. Because our
distributorship agreement with TechData allowed for product returns upon
termination, our return reserve included an allowance of $566,000 for TechData's
entire reported inventory as of September 30, 1999. After September 30, 1999,
Tech Data requested to return $575,000 of IMSI inventory. We received inventory
of approximately $265,000 on December 19, 1999 and approximately $257,000 on
January 27, 2000, for a total of approximately $522,000. We do not anticipate
receiving any further returns from TechData.
IMSI's agreement with TechData required us to accept returns of the products in
TechData's inventory at the price paid by TechData less any subsequent returns
or credits, provided that the products were unopened and in their original
factory sealed packages. To date, we have credited TechData for only $25,000 of
the $522,000 in returns because we believe the remainder of the product
inventory returned by TechData did not meet these conditions. TechData has
contested our right to refuse the balance of the returns.
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<PAGE> 17
IMSI's receivable balance from TechData as of September 30, 1999 was
approximately $752,000. After applying the reserve for expected returns, the net
receivable due from TechData at September 30, 1999, was $186,000. We do not
anticipate paying a cash refund to TechData for returned product. The financial
statements as of December 31, 1999 will reflect the entire receivable due from
TechData as uncollectable based on our subsequent discussions with and
correspondence from TechData.
On December 31, 1999, IMSI wrote down the entire inventory returned to IMSI by
TechData, which had been valued at $25,010, to zero.
Approximately 54%, 49% and 68% of IMSI's net revenues in fiscal 1999, 1998 and
fiscal 1997, respectively, were comprised of net revenues derived from IMSI's
two most popular product families, TurboCAD and MasterClips. Significant
decreases in sales revenues occurred in IMSI's two most popular products,
TurboCAD and MasterClips, which are the leading products in IMSI's precision
design and graphic categories, respectively. Extended engineering delays in
localizing TurboCAD for foreign markets hurt overseas sales.
Product upgrades, and their introduction dates, in fiscal year 1999 were:
- WinDelete v5 - October 31, 1998
- TurboProject v3 - December 30, 1998
- TurboCAD v6 - February 28, 1999
- MasterClips 375,000 - March 30, 1999
- MasterClips 1,250,000 - March 30, 1999
FormTool Scan and OCR was released on June 30, 1998, before the first quarter of
fiscal year 1999.
Product returns often increase when IMSI introduces upgrades and new versions of
products. New version releases may result in an increase in return reserves.
Therefore, new product introductions by competitors also increase returns. As of
June 30, 1999, management considered likely product upgrades and factored in an
appropriate increase in the return reserve for such products accordingly.
Net revenues from international sales decreased 32.7% to $12.4 million in fiscal
1999 from $18.5 million in fiscal 1998, while net revenues from domestic sales
decreased 42.1% to $25.2 million in fiscal 1999 from $43.6 million in fiscal
1998. As a result, net revenues from international sales increased as a
percentage of IMSI's net revenues to 33% in fiscal 1999 from 30% in fiscal 1998.
These absolute dollar decreases in net revenues from international sales were
primarily the result of decreased sales through existing distribution channels.
Our revenues from international sales in each of the periods were generated
primarily from Germany, the United Kingdom and Australia. Although IMSI believes
that the risks associated with transactions in foreign currencies are mitigated
by diversified exposure to multiple currencies, IMSI'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.
RESERVE FOR RETURNS, PRICE DISCOUNTS AND REBATES
IMSI recognizes revenue net of estimated returns and allowances for returns,
price discounts and rebates, upon shipment of a product and only when no
significant obligations remain and collectability is probable. Our return policy
generally allows our distributors to return purchased products primarily in
exchange for new products or for credit towards future purchases as part of
stock balancing programs, subject to certain limitations that may exist in the
contract with an individual distributor, governing, for example, aggregate
return amounts, and the age, condition and packaging of returned product. Under
certain circumstances, such as terminations or when a product is defective,
distributors could receive a cash refund if returns exceed amounts owed. In
addition, foreign distributors can return product for payment if return amounts
exceed amounts owed.
In December 1998, IMSI's primary distributor in Germany exited the software
distribution business. On May 27, 1999, as a result of the termination, the
German distributor returned $248,000 of previously paid resaleable product and
IMSI refunded the full $248,000. . In March 1999, IMSI
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<PAGE> 18
decided to terminate its relationship with its primary distributor in Australia
and sell directly to retail outlets. The previously paid resaleable product
returned upon termination by the Australian distributor was valued at $304,000.
We paid $189,000 in June 1999 to the Australian distributor and relieved
$115,000 in receivables as a result of that termination. IMSI anticipates that
the German distributor will make additional claims in fiscal year 2000. As of
June 30, 1999, IMSI had no current liability to any other foreign or domestic
distributor for resaleable product returned on termination. In addition, IMSI
provides price protection to its distributors when it reduces the prices of its
products. End users may return products through dealers and distributors within
60 days from the date of purchase for a full refund, and retailers may return
older versions of products for a full refund. Generally, distributors and
retailers have no time limit to return merchandise, except that distributors
have 60-90 days to return merchandise upon termination of the distributorship
agreement.
Our allowances for returns, price protection and rebates are based upon our best
judgment and estimates at the time of preparing the financial statements.
Reserves for returns, price discounts and rebates are estimated using, among
other things, historical averages and a consideration of open return requests.
Due to return activity that did not appear fully consistent with historical
estimates, beginning with the quarter ended December 31, 1998, we supplemented
the process by which we establish our reserve estimates with a consideration of
channel inventories in the U.S., recent product sell-through activity and market
conditions.
Information available in regards to channel inventory and sell through activity
is limited. This information, generated by third parties from whom IMSI
purchases the data, does not cover all of our customers and is unaudited.
Management is required to exercise judgement in estimating future returns, price
discounts and rebates. Total reserves for returns, price discounts and rebates,
not including reserves for bad debt, were 50%, 20%, and 19% of gross receivables
at June 30, 1999, 1998 and 1997, respectively.
In establishing return reserves at June 30, 1999, we obtained information about
inventory levels at our primary U.S. distributors and retailers. We compared
these inventory levels to our estimates of future sell-through based on
information obtained about the U.S. market from PC Data. Based on this
information and our historical experience, we established the amount of return
reserves. We also considered the actual results subsequent to the end of the
fiscal year up to the filing of the Form 10-K in establishing our return
reserve.
Current and planned product upgrades are now among the factors used to establish
reserves for product inventory. Other factors include product sales trends,
competition from other products, and product inventory on hand. Prior to
December 31, 1998, the Company did not consider separately the effect of product
upgrades in determining the reserve for returns because it believed that the
impact of product upgrades on returns was already appropriately reflected in the
historical estimates.
Reserves are subjective estimates of future activity, that are subject to
certain risks and uncertainties, which could cause actual results to differ
materially from estimates.
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The following table details our allowances for rebates, sales returns and price
discounts for the periods presented (in thousands):
<TABLE>
<CAPTION>
Rebates Returns Discount Total
------- -------- -------- --------
<S> <C> <C> <C> <C>
Reserve balance 6/30/96 $ -- $ 1,049 $ 101 $ 1,150
Additions to reserve -- 4,681 1,899 6,580
Charges -- (4,141) (1,454) (5,595)
------- -------- ------- --------
Reserve balance 6/30/97 -- 1,589 546 2,135
Additions to reserve -- 9,355 2,050 11,405
Charges -- (7,946) (2,313) (10,259)
------- -------- ------- --------
Reserve balance 6/30/98 -- 2,998 283 3,281
Additions to reserve 2,474 17,714 6,146 26,334
Charges (2,376) (15,463) (5,610) (23,449)
------- -------- ------- --------
Reserve balance 6/30/99 $ 98 $ 5,249 $ 819 $ 6,166
======= ======== ======= ========
</TABLE>
During fiscal year 1999, we received about $4.3 million of product returns from
fiscal year 1998 sales. As of June 30, 1998, we reserved approximately $3.0
million for returns. Accordingly, of the $17.7 million of additions to the
return reserves recorded in fiscal year 1999, $16.4 million of the additions
related to fiscal year 1999 sales. Although the dollar value of the reserve
balance at June 30,1999 is much lower than sales reserved in fiscal 1999, this
lower amount is justified by the continuing decline in our gross revenues
throughout fiscal year 1999. The return reserve balance at June 30, 1999 is also
consistent with the reduced level of inventory in the channel associated with
the declining shipments of our products. The following table illustrates the
percentage impact of returns, rebates, and price discounts on gross revenue of
$64,013,000, $73,470,000, and $48,419,000 in fiscal year 1999, 1998, and 1997,
respectively, and the resulting net revenues, as reflected in the consolidated
statement of operations.
<TABLE>
<CAPTION>
(in thousands) 1999 1998 (as restated) 1997
---------------- ------------------ ----------------
Amount % Amount % Amount %
------- ----- -------- ------ ------- -----
<S> <C> <C> <C> <C> <C> <C>
Gross Revenues $64,013 100.0% $73,470 100.0% $48,419 100.0%
Additions to
Reserves for:
Returns 17,714 27.7% 9,355 12.7% 4,681 9.7%
Price discounts 6,146 9.6% 2,050 2.8% 1,899 3.9%
Rebates 2,474 3.9% -- -- -- --
------- ----- ------- ----- ------- -----
$26,334 41.2% $11,405 15.5% $ 6,580 13.6%
------- ----- ------- ----- ------- -----
Net Revenues $37,679 58.8% $62,065 84.5% $41,839 86.4%
======= ===== ======= ===== ======= =====
</TABLE>
PRODUCT COSTS
Our product costs include the costs of diskette and CD-ROM duplication, printing
of manuals, packaging and fulfillment, freight-in, license fees, royalties that
IMSI pays to third parties based on sales of published software and amortization
of capitalized software acquisition and development costs. Costs associated with
the return of products, such as refurbishment and the write down in value of
returned goods are also included in Product Costs. A change in retail market
conditions caused a significant increase in fiscal year 1999 returns. Product
costs represented 67%, 38%, and 40% of net revenues in fiscal 1999, 1998 and
fiscal 1997, respectively.
IMSI reviews its product inventories for obsolescence at the end of each
reporting period. IMSI reserves a portion of its recorded inventory book
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<PAGE> 20
value to account for its anticipated inability to sell certain products or the
anticipated inability to sell certain products at a net realizable value that is
greater than their recorded cost. Products that are in IMSI's inventory but are
not currently being sold are fully reserved. As part of its restructuring plan,
IMSI identified a limited number of core products that it plans to continue to
sell on a long-term basis. Reserves for non-core products that IMSI will
continue to sell in the normal course of business but will no longer manufacture
or actively market have been increased as part of the Company's restructuring.
As of June 30, 1999, IMSI reserved $2,184,000 for non-core products in its
inventory. IMSI also completely reserved $1,017,000 of other products in its
inventory that it no longer sells, and reserved $144,000 of core products
inventory that it estimated to be in excess of consumer demand.
At the end of each quarter, IMSI performs a physical inventory, evaluates this
inventory for impairment, and records the value of inventory, including any
returned products from both foreign and domestic distributors, at the lower of
cost or market. While IMSI believes there is a market for both core and non-core
products, it has reduced the carrying value of non-core products as a result of
its decision to focus solely on core products and discontinue supporting
non-core products.
IMSI amortizes capitalized software development costs on a product-by-product
basis. The amortization recorded 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) the economic life
of such product. Aggregate amortization of such costs was $2,429,000,
$1,196,000, and $224,000 in fiscal 1999, 1998 and fiscal 1997, respectively. The
increase in product costs as a percentage of net revenues in fiscal year 1999
was primarily attributable to a lower sales volume over which to spread fixed
manufacturing burden and overhead costs, costs associated with high product
returns, increased purchase discounts offered to customers and increased
end-user rebates.
SALES AND MARKETING EXPENSES
Our sales and marketing expenses consist primarily of salaries and benefits for
sales and marketing personnel, commissions, advertising, printing and direct
mail expenses. Sales and marketing expenses decreased 1% to $18.4 million in
fiscal 1999 from $18.6 million in fiscal 1998, which represented an increase of
55% from $12.0 million in fiscal 1997. Cost reduction efforts associated with
IMSI's restructuring plan did not significantly reduce sales and marketing
expenses in fiscal year 1999 due to these measures being initiated late in the
year. The slight decrease in sales and marketing expenses during fiscal year
1999 was due to lower headcount that was offset by additional cooperative
advertising. The increase in 1998 was primarily due to increased headcount,
additional cooperative advertising and increased commissions to support a higher
level of sales. IMSI had 69, 141 and 76 sales and marketing personnel at June
30, 1999, 1998 and 1997, respectively. Sales and marketing expenses represented
49%, 30%, and 29% of net revenues in fiscal 1999, 1998 and fiscal 1997,
respectively.
GENERAL AND ADMINISTRATIVE EXPENSES
Our general and administrative expenses consist primarily of salaries and
benefits for employees in the legal, finance, accounting, human resources,
information systems and operations departments and fees to IMSI's professional
advisors. General and administrative expenses increased 63% to $8.2 million in
fiscal 1999 from $5.0 million in fiscal 1998, which represented a 25% increase
from $4.0 million in fiscal 1997. At the beginning of fiscal 1999 IMSI was in a
growth pattern, increasing general and administrative expenses, when market
conditions deteriorated for its products. IMSI had 35, 56 and 45 administrative
personnel at June 30, 1999, 1998 and 1997, respectively. The decrease in fiscal
year 1999 headcount is related to IMSI's downsizing. During fiscal year 1999,
IMSI had significant increases in accounting, legal and consulting fees paid to
outside third parties, particularly in connection with litigation, which caused
a significant increase in administrative expenses. The increases during fiscal
1998 from 1997 were primarily due to continued infrastructure improvements and
headcount additions, primarily in the areas of information systems, human
resources, accounting and operations. General and administrative expenses
represented 22%, 8% and 10% of net revenues in fiscal 1999, 1998 and fiscal
1997, respectively. Although the sharp increase in these percentages from fiscal
1998 to fiscal 1999 was partly due to the increase in general and administrative
expenses in absolute dollars, it is primarily attributable to the steep decline
in fiscal 1999 revenues.
RESEARCH AND DEVELOPMENT EXPENSES
Our research and development expenses consist primarily of salaries and benefits
for research and development employees and payments to independent contractors.
Research and development expenses decreased 6% to $8.1 million in fiscal 1999
from $8.6 million in fiscal 1998, which represented an 89% increase from $4.6
million in fiscal 1997. The fiscal year 1998 increases
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<PAGE> 21
were due to domestic headcount increases, utilization of additional software
development contractors outside of the United States and growth in other
third-party development costs relating to development and expansion of IMSI's
product offerings. IMSI had 76, 115 and 80 research and development employees at
June 30, 1999, 1998 and 1997, respectively. In addition, IMSI used significant
numbers of independent research and development contractors outside of the
United States. The additional contractors hired were engaged primarily in
enhancing and modifying products and in-process technologies that IMSI had
acquired from third parties and, to a lesser extent, in developing new products.
For fiscal 1999, 1998 and fiscal 1997, IMSI capitalized software acquisition and
development costs of $3.2 million, $3.2 million, and $44,000, respectively.
Research and development expenses represented 21%, 14% and 11% of net revenues
in fiscal 1999, 1998 and 1997, respectively. The increase in this percentage
during fiscal year 1999 was attributable to the relative steep decline in fiscal
1999 revenues.
RESTRUCTURING CHARGE
In response to its large losses in fiscal year 1999, after approval by IMSI's
Board of Directors, a plan of restructuring was announced on June 24, 1999, and
IMSI initiated a company-wide restructuring of its operations. The four major
components of the restructuring plan were manufacturing and warehouse
outsourcing, facilities consolidation, personnel reductions, and divestiture of
non-core products to focus on high margin product lines.
All appropriate costs associated with implementing the restructuring plan,
whether paid in fiscal year 1999 or beyond, are recognized as a cost or expense
on IMSI's fiscal year end June 30, 1999 income statement. Some of the
restructuring costs or expenses represent a write-off of existing assets. Costs
or expenses related to the restructuring that are not from write-offs of
existing assets or were not paid by June 30, 1999, $1,440,000 in total, are
accrued and recognized as a liability, within accrued and other liabilities, on
IMSI's June 30, 1999 balance sheet.
IMSI began its restructuring in June 1999 and anticipates completing its
restructuring by end of fiscal year 2000. Restructuring costs of $3,271,000 that
would have been recognized through cost of sales in the normal course of
business (inventory, royalties, license fees, capitalized software, warehouse
costs, warehouse outsourcing costs) are included in the income statement as a
component of costs of goods sold. Restructuring costs of $1,508,000 that would
have been reported as operating expenses in the normal course of business are
reported in the income statement under the "restructuring charge" line item.
The fair value of furniture, fixtures, equipment and leasehold improvements not
associated with specific product lines was based on current market prices for
used equipment and furniture, less disposal costs. The fair value of the
intangible assets associated with the non-core product lines held for sale,
including EZ Language and business utility product lines, was determined from
pending discussions with potential purchasers of these product lines.
21
<PAGE> 22
The following table summarizes these restructuring costs by segment:
<TABLE>
<CAPTION>
(in thousands) COST OF GOODS SOLD OPERATING EXPENSE
North North
America UK America UK Total
------ --- ------ ---- ------
<S> <C> <C> <C> <C> <C>
Write down of inventory of non-core products $2,096 $88 $2,184
Write down of intangibles associated with
Non-core products, total:
License Fees 217 217
Goodwill 5 5
Prepaid Royalties 143 143
Capitalized Software 159 159
Write down of furniture, fixtures,
equipment and leasehold improvements:
Novato -
Computers and peripherals 150 150
Tenant improvements 139 139
Furniture and fixtures 109 109
Vacaville & Albuquerque -
Furniture and fixtures 25 25
U.K. -
Furniture and fixtures 41 41
Abandoned leases and associated costs:
Novato -
Rent 180 180
Broker's fee 65 65
Excess furniture lease 14 14
Additional walls and doors 29 29
Miscellaneous charges 3 3
Vacaville warehouse -
Rent 249 249
Broker's fee 103 103
Albuquerque tech support facility 110 110
U.K. -
Rent 6 6
Labor cost for shutdown of office 19 19
Warehouse transition costs 284 284
Personnel reduction and severance costs:
U.S. 35 470 505
U.K. 41 41
------ --- ------ ---- ------
$3,183 $88 $1,402 $107 $4,780
====== === ====== ==== ======
</TABLE>
Write down of inventory of non-core products. In the restructuring, we
identified products in our precision design and graphic design categories, or
those in our business application category sold in combination with our design
products, such as TurboProject, as "core products" that we will continue to sell
and support. "Non-core products" consist of those products in our inventory
that, due to the restructuring plan, we will continue to sell, but no longer
support with upgrades, improvements, or marketing programs. "Other products"
refers to products that we no longer sell.
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<PAGE> 23
Non-core products include current and previous versions of:
<TABLE>
<S> <C> <C> <C>
3D Artist Graphics Converter People Scheduler VoiceDirect
CD Copier Hijaak Solid Modeler
Conversational Skills Lumiere TurboSketch
Cookbook MapLinx UpdateNow
E-mail animator MasterPublisher MasterPhotos
EZ Language Mouse WebArt
Family Home CollectioN MultiMedia Fusion Web Business Builder
Flow Net Accelerator WinDelete
FormTool Org Plus Year 2000
</TABLE>
Non-core products also include older versions of FloorPlan, MasterClips, and
TurboCAD. We estimate that sales of all non-core products will be discontinued
by June 30, 2000.
Our restructuring charge included $2,184,000 in inventory write-downs related to
non-core products, $2,096,000 of which we included in our U.S. segment. We based
this impairment of the value of our inventory on our subjective estimate,
product by product, of how much our inventory exceeds customer demand, looking
at factors such as inventory levels at IMSI facilities and as reported by
distributors, sales data from internal sources and PC Data, and marketing and
sales department estimates based on historical and current market trends. Market
conditions continue to change, which may necessitate reserving product
inventories in the future at higher levels than that recorded as of June 30,
1999.
At June 30, 1999, the adjusted cost basis of non-core products, after
considering the $2,184,000 write down in value of these products, was
$1,079,000. We believe this value of the non-core product inventory will be
recovered, consistent with our restructuring plan, through a combination of
sales in our existing distribution channels, sales through alternative channels,
such as software liquidators, or by the sale or license of the rights to the
non-core product lines.
Write down of intangible assets associated with non-core products. We reviewed
our intangible assets associated with non-core product lines for impairment in
accordance with SFAS 121 and adjusted the carrying value of these assets as
necessary. These intangible assets included license fees, capitalized goodwill
and brand names, prepaid royalties, and capitalized software. We believed these
assets were impaired because we no longer manufacture or actively market the
non-core products with which they are associated. The intangible assets
associated with Easy Language and our business utility product lines were not
written off in the restructuring. We determined that the net realizable value of
these intangible assets associated with the remainder of our non-core product
lines was $0, and accordingly wrote down $525,000 in our U.S. segment.
The following table provides a summary of the carrying value of all assets
associated with our non-core products as of June 30, 1999.
<TABLE>
<CAPTION>
Write down in
connection Adjusted cost
Cost basis with basis at
at June 30, 1999 restructuring June 30, 1999
---------------- ------------- -------------
<S> <C> <C> <C>
Inventory $3,263 $2,184 $1,079
License fees 217 217 0
Goodwill 5 5 0
Prepaid royalties 224 143 81
Capitalized software 336 159 177
------ ------ ------
$4,045 $2,708 $1,160
------ ------ ------
</TABLE>
Write down of furniture, fixtures, equipment and leasehold improvements. Because
our restructuring plan called for the reduction of employees and the
consolidation of facilities, we determined to write down $464,000 of furniture,
fixtures, equipment and leasehold improvements at our Novato headquarters,
Vacaville, California and Albuquerque, New Mexico facilities, and our U.K.
office. The write down of $398,000 of fixed assets in Novato consisted of
$150,000 of computers
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<PAGE> 24
and peripherals, $139,000 of tenant improvements, and $109,000 of furniture and
fixtures. The write down of $25,000 and $41,000 of fixed assets in Vacaville and
Albuquerque and the U.K., respectively, consisted of furniture and fixtures.
These assets were abandoned and are no longer being used in the operation of the
business.
Abandoned leases and associated costs. We wrote off a total of $778,000 for
abandoned leases and associated costs in both U.S. and U.K. segments. As part of
the restructuring, we vacated half of the office space leased at our Novato
headquarters in June 1999, which we plan to sublease. The write down of $291,000
in Novato consisted of four months rent for the space to be subleased of
$180,000, the broker's fee to sublease the space of $65,000, an excess furniture
lease of $14,000, the cost of additional walls and doors to partition the space
of $29,000, and miscellaneous charges of $3,000.
As part of the restructuring, we plan to vacate the Vacaville warehouse entirely
by February 2000. We determined that about 50% of the costs of the warehouse
should be written off ($249,000), along with a broker's fee to sublet unoccupied
space ($103,000), in the restructuring. Because of the reduction in product
lines and corresponding reduction in the need for technical support, we wrote
off 50% ($110,000) of the future rent for the Albuquerque technical support
facility. Because the restructuring plan calls for the consolidation of our
foreign offices, we wrote down $25,000 in expenses associated with vacating our
U.K. office.
Warehouse transition costs. As we make the transition to outsourcing of our
warehouse, fulfillment, and shipping functions, we included warehouse transition
costs of $284,000 in the restructuring charge. We estimated that our warehouse
would remain open for four months during the transition and that 50% of the
operating expenses were associated with shutting down the facility. We accrued
50% of the cost of operating the warehouse for this four-month period as an
operating expense and will recognize the remaining costs (those that benefit the
future period) as cost of sales.
Personnel reduction and severance costs. As part of the restructuring plan, IMSI
planned to terminate 90 employees by the end of fiscal year 2000 in the
following departments: sales and marketing (22); general and administrative (8);
manufacturing (23); and research and development (37). Our total restructuring
charge relating to personnel reduction and severance costs was $546,000, of
which $505,000 applied to the U.S. segment and $41,000 to the U.K. segment.
These costs were recorded as operating expenses. We also forgave a $35,000 note
receivable from a shareholder and company executive who was terminated as part
of the restructuring. We recorded this amount as a cost of goods sold.
As a result of the restructuring, IMSI expects reduced future costs and reduced
future revenues. IMSI expects to reduce payroll costs by approximately $266,000
per month and expects to reduce rent costs by approximately $71,000 per month as
a result of the its warehouse closing, the closing of its U.K. office, and the
subleasing of half of its headquarters office space, and corresponding reduction
in employees. Due to the write off of approximately $464,000 in furniture and
equipment assets, depreciable over 3 to 5 years, future periods will be relieved
of this depreciation charge. IMSI expects revenues to decline substantially
because it is marketing and selling fewer products and the demand for current
products is declining. The following table details the classification of cash
and non-cash amounts.
<TABLE>
<CAPTION>
Cash Non-Cash Total
---------- ---------- ----------
<S> <C> <C> <C>
Restructuring Charge $ 956,000 $ 552,000 $1,508,000
Product Costs 657,000 2,615,000 3,272,000
---------- ---------- ----------
$1,613,000 $3,167,000 $4,780,000
========== ========== ==========
</TABLE>
Non-cash restructuring charges relate to the write off or write down of
fixed assets, inventory, license fees, goodwill, prepaid royalties and
capitalized software. See Note 2 of the June 30, 1999 consolidated financial
statements.
WRITE OFF OF PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
24
<PAGE> 25
In the fiscal year ended June 30, 1998, IMSI expensed $6.4 million of
purchased in-process research and development resulting from the acquisitions
from Quarterdeck, Computer Concepts, MediaPaq and Corel. No such charges were
incurred in connection with the acquisitions made in 1999. See Note 3 to the
June 30, 1999 consolidated financial statements.
INTEREST AND OTHER EXPENSE, NET
Our interest and other expenses, net are comprised of interest accrued on debt
instruments, amortization of the fair value of warrants issued in connection
with debt, foreign currency transaction gains and losses, and other
non-recurring items. Interest and other expense, net was $1,880,000, $759,000
and $130,000 in fiscal 1999, fiscal 1998 and fiscal 1997, respectively.
Interest and other expense net, excluding foreign currency transactions and
other de minimus items, was $1,650,000, $603,000, and $164,000 in fiscal 1999,
1998 and fiscal 1997, respectively. Interest expense on debt instruments
increased to $1,082,000 in fiscal year 1999, consistent with IMSI's increased
long term borrowings and higher interest rates in fiscal year 1999.
Approximately $246,000 and $65,000 of other expense in 1999 relates to the
issuance of 40,476 shares and 10,000 shares respectively to Zedcor shareholders
as discussed in Note 7 to the consolidated financial statements. Approximately
$237,000 of other expense relates to the amortization of the warrants issued to
Silicon Valley Bank and BayStar Capital, L.P. as discussed in Notes 5 and 6 to
the consolidated financial statements.
Foreign currency transaction loss was $235,000 in fiscal 1999 and $153,000 in
fiscal 1998. There was a foreign currency gain of $34,000 in fiscal 1997. IMSI
does not attempt to hedge its foreign currency positions.
PROVISION (BENEFIT) FOR INCOME TAXES
Our effective tax rate was 0.1 %, (45.0 %), and 38.7% in fiscal 1999, fiscal
1998 and fiscal 1997, respectively. We recorded a valuation allowance of
$11,126,000 in fiscal year 1999 due to the uncertainty of realizing deferred tax
assets, which reduced the effective rate in 1999. See Note 11 to the
consolidated financial statements.
LIQUIDITY AND CAPITAL RESOURCES
Our operating activities used net cash of $2.7 million, $1.6 million and
$400,000, respectively in fiscal 1999, 1998, and 1997. Excluding the changes in
operating assets and liabilities, operating activities in fiscal year 1999 used
$16.2 million in cash, due to IMSI's large operating losses. Large reductions in
accounts receivable and inventories and an increase in accrued and other
liabilities minimized the use of cash caused by IMSI's large net loss. Accrued
liabilities increased as IMSI slowed its payments as a result of declining cash
receipts. In particular, accrued rebates payable increased significantly because
of the intense price competition and increase in rebates offered during fiscal
year 1999. In fiscal year 1998, net cash used by operating activities resulted
primarily from a $5.4 million increase in receivables, a $3.1 million increase
in inventories and a $3.3 million increase in prepaid royalties and licenses,
which were not entirely offset by IMSI's net income before depreciation and
amortization of $4.1 million. In fiscal 1997, net cash used by operating
activities resulted primarily from increases in receivables of $3.4 million,
inventories of $934,000 and prepaid royalties and licenses of $1.8 million,
offset in part by IMSI's income before depreciation and amortization of $2.1
million and increases in trade accounts payable of $1.4 million and smaller
increases in other payables.
Our investing activities used net cash of $5.7 million, $3.9 million and
$367,000 in fiscal 1999, 1998 and fiscal 1997, respectively. In fiscal 1999, net
cash used by investing activities resulted primarily from the purchase of $1.2
million of equipment, the acquisition of $2.2 million of software development
costs and $2.4 million of goodwill, trademark and brand. These amounts are
primarily associated with the Zedcor, Inc. acquisition and the Org Plus
acquisition (See Note 3 to the June 30, 1999 consolidated financial statements).
In fiscal year 1998, net cash used by investing activities resulted primarily
from the addition of $2.7 million to capitalized software acquisition and
development costs and $1.0 million of equipment purchases. In fiscal 1997, net
cash used by investing activities resulted primarily from $323,000 of equipment
purchases.
Net cash provided by financing activities was $10.1 million, $6.6 million and
$1.6 million in fiscal 1999, 1998 and fiscal 1997, respectively. In fiscal 1999,
net cash provided by financing activities resulted primarily from term loan
borrowings of $7.5 million and the issuance of $6.2 million of common stock (See
Note 7 to the June 30, 1999 consolidated financial statements). This inflow of
cash was partially offset by a net repayment of $2.5 million on IMSI's credit
line from Union Bank of California
25
<PAGE> 26
(See Note 4 to the June 30, 1999 consolidated financial statements). On November
3, 1998, IMSI borrowed $2.5 million under a three-year subordinated loan
facility with Silicon Valley Bank (See Note 5 to the June 30, 1999 financial
statements). On May 26, 1999, IMSI issued to BayStar Capital, LP a three-year $5
million principal amount 9% subordinated convertible note (see Note 6 to the
June 30, 1999 consolidated financial statements).
In fiscal 1998, net cash provided by financing activities resulted primarily
from $16.4 million of borrowings under IMSI's credit line, offset in part by
$10.3 million of repayments under capital leases, term loans and other
obligations, and $526,000 from the issuance of common stock. In fiscal 1997, net
cash provided by financing activities resulted primarily from $1.5 million of
net borrowings under a term loan and $481,000 from sales of common stock, offset
in part by $373,000 of capital lease and other obligations repayments.
On March 3, 1999, IMSI entered into a stock purchase agreement and related
agreements with Capital Ventures International ("CVI"). Under the terms of the
agreement, CVI paid IMSI $5 million and IMSI issued 437,637 shares of its common
stock. IMSI may be required to issue additional shares depending on the market
price of the common stock at certain future dates. Additionally, pursuant to the
CVI agreement, CVI can purchase up to $3 million worth of additional shares of
common stock, up to a maximum number of 375,117 shares. CVI also acquired a
warrant to purchase 131,291 shares of common stock, at an initial exercise price
of $14.8525 per share. See Note 7 to the consolidated financial statements,
"Issuance of Common Stock".
On May 4, 1998 IMSI entered into a line of credit agreement with Union Bank
under which it could borrow the lesser of $13,500,000 or 80% of eligible
accounts receivable, at Union Bank's reference rate plus 1/2 % or LIBOR plus 2
%, at IMSI's option. We borrowed up to approximately $10.0 million under the
line of credit agreement . Union Bank also provided a $1.5 million term loan at
the same interest rate. The line of credit was to expire on October 31, 1999 and
the repayment of the term loan was due by the same date.
Due to our defaults under the agreements, the line of credit was changed to a
non-revolving, reducing loan with no further borrowings available. The interest
rate is now at Union Bank's reference rate plus 3%. Under the terms of the
agreements, all assets not subject to liens of other financial institutions were
pledged as collateral against the loans. The amended loan agreements still
require us to comply with certain financial covenants including maintenance of
net worth and working capital requirements. We are in default of many of these
covenants.
We made payments to Union Bank that decreased the amount owed to $6,150,000 as
of June 30, 1999. Union Bank can declare all loans, and the obligations under
the agreements, to be immediately due and payable and can commence immediate
enforcement and collection actions.
The loans provided that they were due on September 30, 1999. As of September 30,
1999, we had reduced the debt owed to Union Bank to about $4.8 million. We
anticipate that we will be able to repay the remaining amount owed with proceeds
we expect to generate from the sale of non-core product lines. Given our intent
to repay Union Bank with such proceeds, IMSI is in the process of negotiating a
60-day forbearance from September 30, 1999 to cure its defaults. Enforcement and
collection actions by Union Bank could have a material adverse effect on IMSI's
business, operating results and financial condition.
On May 26, 1999 we announced a private placement transaction with BayStar
Capital, L.P. We issued a three year $5 million principal amount 9% Senior
Subordinated Convertible Note, and a warrant to acquire 250,000 shares of our
common stock, to BayStar. The note is convertible into shares of common stock at
an initial conversion price of $7.5946 per share.
The conversion price is subject to adjustment, including adjustment to a reset
conversion price on May 24, 2000, which may be as low as $4.6228 per share, or
lower if defined events occur, such as the issuance of common stock, or grant
rights to purchase stock, at a price lower than the then existing conversion
price. These conditions are designed to prevent dilution of the conversion
feature of the convertible note and dilution of the exercise price of the
warrant. The trading value of IMSI's common stock on the date of issuance of the
subordinated convertible debt was $6.50. The value of the contingent beneficial
conversion feature at the date of commitment, and the potential charge to
earnings, is $2,030,000. See Note 6 to the consolidated financial statements,
"Convertible Subordinated Debt."
Although our cash and cash equivalents increased $1.6 million to $3.7 million at
June 30, 1999 from $2.1 million at June 30, 1998, working capital declined from
$6.6 million at June 30, 1998 to a negative $1.2 million at June 30, 1999. The
sharp decline in working capital is partially due to the accumulation of $3.2
million in deferred revenue as of June 30, 1999. Excluding deferred revenue,
working capital declined $5.0 million to $2.0 million. IMSI believes that its
existing cash and cash
26
<PAGE> 27
equivalents will be insufficient to satisfy IMSI's working capital and capital
expenditure requirements over the next 12 months.
Deferred revenue increased from $407,000 in fiscal 1998 to $3,178,000 in fiscal
1999. Most of the increase was attributable to deferred revenue from
ArtToday.com subscriptions. Standard 12-month subscriptions, accounting for
$1,316,000 of deferred revenues, are recognized over 12 months from the date of
purchase. IMSI also sells ArtToday.com subscriptions in combination with
subscriptions to utility programs, which are recognized over 15 months. The
deferred revenue from these combined subscriptions was $2,728,000. Deferred
revenue also included a $200,000 receivable from TLC whose collection was not
assured. The remaining $136,000 of deferred revenue related to other license or
pre-paid contracts. Previously deferred revenue of $1,609,000 was recognized in
1999.
The financial statements have been prepared on a basis that contemplates IMSI's
continuation as a going concern and the realization of our assets and
liquidation of our liabilities in the ordinary course of business. We have an
accumulated deficit of $25,963,000 at June 30, 1999, and negative cash flows
from operations of $2,741,000 in fiscal 1999. IMSI is also in default of various
loan covenants. These matters, among others, raise substantial doubt about our
ability to remain a going concern for a reasonable period of time. The financial
statements do not include any adjustments relating to the recoverability or
classification of assets or the amounts and classification of liabilities that
might result from the outcome of this uncertainty. IMSI's continued existence is
dependent on its ability to obtain additional financing sufficient to allow it
to meet its obligations as they become due and to achieve profitable operations.
See Note 1 to the consolidated financial statements, "Basis of Presentation and
Realization of Assets."
IMSI will require additional working capital to meet its ongoing operating
expenses, to execute its planned transition to the Internet, to develop new
products, and to conduct other activities. Historically, IMSI has financed its
working capital and capital expenditure requirements primarily from retained
earnings, short-term and long-term bank borrowings, capitalized leases and sales
of common stock. During fiscal year 1999, IMSI relied primarily on the issuance
of long-term debt and the issuance of common stock. In fiscal year 1999, short
term net credit line borrowings decreased $2.5 million while borrowings under
term loans, primarily long term, increased $7.5 million. Common stock increased
by $14.8 million, of which $6.2 million was issued for cash. A portion of the
stock issued in fiscal year 1999 was used to retire debt and other liabilities.
The large accumulated losses of IMSI and the relative small amount of
shareholder's equity remaining as of June 30, 1999 will make it difficult for
IMSI to obtain new debt financing or to obtain equity financing at attractive
prices.
To a large extent, IMSI plans to meet its working capital needs in the coming
fiscal year through sales or license of the rights to its non-core products. As
part of its restructuring strategy, IMSI plans to reduce the number of its
product categories by approximately 75% through sales of its non-core product
lines. To this end, IMSI sold the rights to the EZ Language product for $1.7
million in August 1999. Moreover, IMSI has engaged in, and expects to engage in,
discussions with third parties concerning sale or license of a material part of
its remaining non-core product lines. The sale of the rights to these products
is consistent with our strategy of focusing on our core products while
transitioning to the Internet. This strategy also includes reducing our costs
through manufacturing and warehouse outsourcing, facilities consolidation, and
personnel reductions.
As of June 30, 1999, we had $3.7 million of cash and cash equivalents. To date,
IMSI has received $1.3 million in tax refunds in the first quarter of fiscal
year 2000 and $2.1 million in the second quarter of fiscal year 2000. We
anticipate that we will receive an additional $300,000 in income tax refunds in
fiscal year 2000. IMSI believes that the cash derived from the sale or license
of non-core product lines and its tax refunds will improve its working capital
position significantly. If our restructuring efforts succeed in improving our
financial performance, management believes it will be able to obtain the
additional financing our working capital needs require. There can be no
assurance that we will be successful in our efforts.
Our forecast period of time through which our financial resources will be
adequate to support our working capital and capital expenditure requirements is
a forward-looking statement that involves risks and uncertainties, and actual
results could vary. The factors described in "Risk Factors" will affect our
future capital requirements and the adequacy of our available funds. No
assurance can be given that needed financing will be available on terms
attractive to us, or at all. Furthermore, any additional equity financing, if
available, may be dilutive to shareholders, and debt financing, if available,
may involve restrictive covenants. If IMSI fails to raise capital when needed,
then lack of capital will have a material adverse effect on IMSI's business,
operating results, financial condition and ability to continue as a going
concern.
Although IMSI had no material commitments for capital expenditures, as of June
30, 1999 it has long term debt obligations of $6.6 million, as well as
obligations totaling $1.8 million and $6.0 million due over the next five years
under capital and
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operating leases, respectively.
IMSI's international revenues are generally denominated in foreign currencies of
IMSI's subsidiaries. Consequently, a decrease in the value of a relevant foreign
currency in relation to the U.S. dollar can adversely affect IMSI's net
revenues. Further, a decrease in the value of a relevant foreign currency in
relation to the U.S. dollar occurring after sale and before receipt of payment
by IMSI would have an adverse effect on IMSI's results of operations. IMSI had a
$235,000 loss, a $153,000 loss, and a $34,000 gain related to foreign currency
transactions in fiscal 1999, 1998 and 1997, respectively.
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FUTURE PERFORMANCE AND ADDITIONAL RISK FACTORS
PERFORMANCE AND OPERATING RESULTS CONTINUE TO DECLINE DURING FISCAL 1998 AND
1999. IMSI has experienced, and may continue to experience, deteriorating
operating results due to a variety of factors. The following table shows IMSI's
operating income (loss) and net income (loss) for the periods presented (in
thousands), as restated.
<TABLE>
<CAPTION>
FISCAL 1999 FISCAL 1998 (RESTATED)
-------------------------- --------------------------
QUARTER ENDING OPERATING NET INCOME OPERATING NET INCOME
INCOME (LOSS) (LOSS) INCOME (LOSS) (LOSS)
------------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
September 30 $ (1,719) $ (1,106) $(4,668) $(3,114)
December 31 (6,033) (4,274) 2,140 1,220
March 31 (6,231) (10,739) 1,894 1,000
June 30 (9,907) (10,847) 720 524
-------- -------- -------- --------
$(23,890) $(26,966) $ 86 $ (370)
======== ======== ======== ========
</TABLE>
We experienced growth during fiscal 1997. However, starting in fiscal year 1998,
our operating results began to steadily worsen. For the quarter ended September
30, 1997, IMSI reported a net loss of approximately $3.1 million, reflecting in
part, charges related to the write-off of in-process research and development,
amounting to approximately $6.4 million from several product acquisition and
licensing transactions. Although we were profitable for the remaining quarters
of fiscal year 1998, the amount of profits declined after the quarter ending
December 31, 1997. IMSI reported steadily worsening losses during fiscal year
1999.
Beginning in the quarter ended March 31, 1999, we recorded valuation allowances
against our deferred tax assets to reduce our accumulated tax benefit to the
amount anticipated to be realized. This valuation allowance caused the net loss
for this period to be greater than its operating losses. During fiscal 1999, we
recorded an extraordinary expense of $959,000 related to the issuance of our
common stock at a discount for the repayment of debt and for settlement of other
contractual obligations.
Factors that may cause fluctuations of, or a continuing decline in, operating
results in the future include, but are not limited to,
- market acceptance of our products or those of our competitors;
- the timing of introductions of new products and new versions of
existing products;
- expenses relating to the development and promotion of such new
products and new version introductions;
- product returns and reserves;
- intense price competition and numerous end-user rebates;
- projected and actual changes in platforms and technologies;
- the accuracy of forecasts of, and fluctuations in, consumer demand;
- the extent of third party royalty payments;
- the rate of growth of the consumer software market;
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- fluctuations in foreign exchange rates;
- the timing of orders or order cancellation from major customers;
- changes or disruptions in the consumer software distribution
channels;
- the acquisition and successful 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 our industry.
We may pay fees in advance or guarantee royalties, which may be
substantial, to obtain software licenses from third parties. Because of these
and other factors, our operating results in any given period are difficult to
predict. As occurred in fiscal year 1999, any significant shortfall in revenues
and earnings from the levels expected by securities analysts and stockholders
could result in a substantial decline in the market price of our common stock.
Although we suffered a general decline in revenues during fiscal year 1999,
historically our business has been affected somewhat by seasonal trends,
including higher net revenues in the fiscal quarter ended December 31 as a
result of strong calendar year-end holiday purchases by end users of our
products. As a result, we may experience lower net revenues in the fiscal
quarters ended March 31, June 30 and September 30. Seasonality of the European,
Asia/Pacific and other international markets could also impact our operating
results and financial condition in a particular quarter because international
sales are a significant portion of net revenues.
Products are generally shipped as orders are received. Therefore, we have
historically operated with little order backlog. 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. A
significant portion of our operating expenses are relatively fixed. Planned
expenditures are based on sales forecasts. If revenue levels are below
expectations, operating results are likely to be materially adversely affected.
Without growth in revenues in any particular quarter, our 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 our common stock might be materially adversely affected. Due to
all of the foregoing factors, IMSI 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.
OUR RELATIVELY SMALL SIZE IN AN INTENSELY COMPETITIVE, RAPIDLY CHANGING
MARKETPLACE, OUR LESS RECOGNIZED BRAND COMPARED TO LARGER AND BETTER RECOGNIZED
COMPETITORS, CREATES THE RISK THAT WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY IN
THE FUTURE. We face competition from a large number of sources, and from larger
competitors. Many of our current and potential competitors have larger technical
staffs, more established and larger marketing and sales organizations,
significantly greater financial resources, greater name recognition, and better
access to consumers than we do.
Our relatively small size could adversely affect our ability to compete
with larger companies, for sales to dealers, distributors, and retail outlets,
and to acquire products from third parties, who may desire to have their
products sold or published by larger entities. Larger companies may be more
successful in obtaining shelf space in retail outlets, and in competing for
sales to dealers and distributors.
Technological change constantly creates new opportunities, and can quickly
render existing technologies less valuable. Change requires us to enhance our
existing products and to offer new products on a timely basis. We have limited
resources and therefore must restrict our product development efforts to a
relatively small number of projects.
We compete with other software companies to acquire products or companies, and
to publish software developed by third parties. Competition to publish software
developed by third parties is primarily on the basis of brand-name reputation,
the terms offered to software developers, and the ability to market new
products.
The PC productivity software market is highly competitive. Important factors in
the market include product features and functionality, quality and performance,
reliability, brand recognition, ease of understanding and operation, rapid
changes in
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technology, advertising and dealer merchandising, access to distribution
channels and retail shelf space, marketing, pricing and availability and quality
of support services.
Each of our major products competes with products from major independent
software vendors:
- TurboCAD competes with AutoCAD from Autodesk Inc. and IntelliCAD
from Visio Corporation. Microsoft, the world's largest software
company, announced on September 15, 1999 that it would acquire
Visio.
- FloorPlan competes with 3D Architect from Broderbund Software, Inc.,
Home Architect from Cendant Corporation, Home Design Suite from
Autodesk, Dream Home Designer from Alpha Software Corporation and
Home Design 3D from Expert Software, Inc.
- MasterClips competes with ClickArt from Broderbund Software Inc.,
MegaGallery from Corel Corporation, Holy Cow! from Macmillan Digital
Publishing USA and Art Explosion from Nova Development.
- TurboProject competes with Microsoft Project.
- WinDelete competes with Uninstaller from CyberMedia, Inc. and
CleanSweep and Norton Uninstaller from Symantec Corporation.
- Net Accelerator competes with SurfExpress from Connectix, Speed
Surfer from Kissco and Net.jet from Peak Technologies.
Our strategy has been to develop productivity and utility applications that do
not compete directly with applications, or features included in operating
systems and applications suites, offered by major software vendors such as
Microsoft, Lotus Development Corp. and Corel. However, such software vendors may
in the future choose to expand the scope and functionality of their products to
support some or all of the features currently offered by certain of our
products, which could adversely affect demand for our products.
The software industry has limited barriers to entry. The availability of
personal computers with continuously expanding capabilities, at progressively
lower prices, contributes to the ease of market entry. We believe that
competition in the industry will continue to intensify as a number of software
companies extend their product lines into additional product categories and as
additional competitors enter the market.
Use of the Internet reduces barriers to entry in the software market. Software
developers distribute their products online without relying on access to
traditional distribution networks. Because of the proliferation of competing
software developers, an increasingly large number of products compete for
limited shelf space.
There can be no assurance that our products will achieve or sustain market
acceptance, and generate significant levels of revenues in subsequent quarters,
or that we will have the resources required to compete successfully in the
future.
UNPRECEDENTED PRICING PRESSURE, AND NUMEROUS END-USER REBATE PROGRAMS, CONTINUE
TO IMPACT OUR FINANCIAL RESULTS. The markets for our products are characterized
by significant price competition. We expect to continue to face increasing
pricing pressures. In fiscal year 1999, IMSI faced unprecedented price
pressures. In response to such competitive pressures, IMSI significantly reduced
the price of several of its products and offered numerous end-user rebate
programs. There can be no assurance that product prices will not continue to
decline or that IMSI will not respond to such declines with additional product
price reductions and rebates. Despite a significant reduction in the prices of
one or more of our products, there can be no assurance that such price
reductions will result in an increase in unit sales volume. Prolonged price
competition has had a material adverse effect on our operating results,
including reduced profit margins and loss of market share, and is likely to
continue to do so in the future.
WE HAVE REDUCED AVAILABILITY OF BANK FINANCING, CREATING A RISK OF LACK OF
LIQUIDITY. As discussed under "Liquidity and Capital Resources", we are in
default under our line of credit agreement with Union Bank of California. IMSI
currently has no borrowing availability under this or any other credit facility.
No assurance can be given that we will be successful in obtaining
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new sources of credit in the future. Our reduced availability of bank financing
could have a material adverse effect on management's ability to execute its
operating plans.
WE NEED TO RAISE ADDITIONAL FUNDS. ADDITIONAL DILUTION, OR SENIOR RIGHTS,
PREFERENCES OR PRIVILEGES, MAY RESULT FROM ADDITIONAL EQUITY OR CONVERTIBLE DEBT
ISSUES. We anticipate that available funds and cash flows generated from
operations will not be sufficient to meet our needs for working capital and
capital expenditures for the next 12 months. Therefore, we will need to raise
significant new working capital in the near future, to support operations and to
fund our plans. Our plans include Internet expansion, developing new or enhanced
products, and responding to competitors.
If we raise funds, we may issue equity or convertible debt, and we intend to
sell or license product lines as part of our restructuring. If we issue equity
or convertible debt, the percentage of ownership of current stockholders will be
reduced. Stockholders will experience additional dilution, and such securities
may have rights, preferences or privileges senior to those of the holders of our
common stock. We may also raise funds by selling assets.
We don't know whether additional financing will be available on terms favorable
to us, or at all. If adequate funds are not available, or are not available on
acceptable terms, or if we are not able to sell assets, we may not be able to
meet existing obligations, fund our Internet plans, develop or enhance services
or products, or respond to competitive pressures. Lack of funds could have a
material adverse effect on our business, operating results and financial
condition. See "Liquidity and Capital Resources."
POTENTIAL PENALTIES FOR AGREEMENTS RELATING TO REGISTRATION OF SHARES. We agreed
to file one or more registration statements covering the resale of the shares
described in Notes 6 and 7 to the consolidated financial statements, including
shares issued or issuable under agreements with The Learning Company (now
Mattel, Inc.), Capital Ventures International, BayStar Capital, Americ Disc and
Homestyles. We have filed registration statements pursuant to these agreements.
The SEC Division of Corporate Finance has had, and continues to have, comments
related to the registration statements. We plan to continue to work with the SEC
to resolve those comments. However, as a result of delays in the effectiveness
of the registration statements, we may be liable for financial penalties or
other payments under the terms of the agreements. The aggregate amount of one or
more of these penalties or other payments could be a material amount. IMSI is
negotiating with some of these entities, including negotiations for the issuance
of additional shares of common stock, but there is no guarantee that such
negotiations will be successful. See Notes 6 and 7 to the consolidated financial
statements.
OUR ABILITY TO CONTINUE AS A GOING CONCERN DEPENDS ON GENERATING CASH FLOW TO
MEET OBLIGATIONS, REPAYING OR REFINANCING BANK DEBT, RAISING FUNDS, AND
IMPLEMENTING THE RESTRUCTURING PLAN SUCCESSFULLY. Because of our need for funds,
and our substantial losses during fiscal 1999, we instituted measures intended
to reduce costs, improve operations and cash flows. The actions included
substantial personnel reductions and cost cutting programs. IMSI may take
further measures, including further personnel reductions, during fiscal 2000 and
thereafter.
Our continuation as a going concern is dependent upon our ability to obtain
additional financing or refinancing, to generate sufficient cash flow to meet
our obligations on a timely basis, to implement our restructuring plans, and
ultimately to achieve successful operations. The restructuring plan calls for a
divestiture of non-core products and a concentration on the core graphics and
precision design product lines.
We plan to raise funds through product spin-offs and product rights sales, as
part of the restructuring. In August 1999, IMSI sold the Easy Language product
to Lernout & Hauspie for $1.7 million. Additionally, we received an income tax
refund of approximately $3.4 million after June 30, 1999. We expect to receive
additional tax refunds of approximately $300,000 during fiscal year 2000.
OUR SMALL SIZE AND LIMITED RESOURCES, IN A MARKET WITH RAPIDLY CHANGING
TECHNOLOGY, CREATES THE RISK OF LACK OF CUSTOMER ACCEPTANCE OF OUR PRODUCTS,
BECAUSE OF POTENTIAL FAILURE TO UPGRADE EXISTING PRODUCTS, OR POTENTIAL FAILURE
TO DEVELOP NEW PRODUCTS. The markets for our products have rapidly changing
technology. New products are introduced frequently. New and emerging
technologies create uncertainty. Customer requirements and preferences change
frequently. Product obsolescence and advances in computer software and hardware
require us to develop new products and to enhance our products to remain
competitive.
The pace of change is accelerating in both hardware and software. PC
hardware steadily advances in power and
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function. Software is increasingly complex and flexible. Software development
costs increase, and development takes longer.
Despite testing, errors or "bugs" may still be found in new software releases.
Delays in shipping new products or upgrades, as well as the discovery of errors
or "bugs" after release, may result in adverse publicity, customer
dissatisfaction and delay or loss of product revenues. Errors or "bugs" could
require significant design modification or corrective releases, and could result
in an increase in product returns. We cannot provide assurance that future
products and upgrades will be released in a timely manner or that they will
receive market acceptance, if and when released.
New products, capabilities or technologies may replace or shorten the life
cycles of our existing products. The announcement of new products by us or by
our competitors may cause customers to defer purchasing our existing products,
or cause distributors to return products to us. Rapid changes in the market, and
more new products available to consumers, increase the degree of consumer
acceptance risk for our products.
There is a risk of failure in our product development efforts. We may not have
the resources required to respond to technological changes or to compete
successfully in the future. Delays or difficulties associated with new product
introductions or upgrades could have a material adverse effect on our business,
operating results and financial condition.
Because software development costs increase, and software market introduction
costs increase, the financial risks for new product development will increase.
The risks of delays in the introduction of such new products will also increase.
If we fail to develop or acquire new products in a timely manner, as revenues
decrease from products reaching the end of their natural life cycles, our
operating results will be adversely affected.
Because of our small size and capital resources relative to some of our
competitors, our ability to avoid technological obsolescence through acquisition
or development of new products or upgrades of existing products may be more
limited than companies with more funds.
COMPETITION WITHIN DISTRIBUTION CHANNELS, PRODUCT RETURNS OR PRICE PROTECTION,
OR VARIANCE FROM RETURN ESTIMATES, MAY ADVERSELY AFFECT OUR BUSINESS.
Competition for distribution channels, and for retail shelf space, is intense.
We have no long-term distribution agreements with any reseller. We cannot
provide any assurance that our distributors and retailers will continue to
purchase our products, or provide shelf space and promotional support. We cannot
provide any assurance that the Internet will be an effective new distribution
channel.
Our distributors and retailers carry competing product lines. There is
substantial pressure from distributors and retailers to obtain marketing and
promotional funds, for price discounts and favorable return policies in
connection with access to shelf space, and for in-store promotions and sales of
products, which has an adverse impact on our net revenues and profitability.
Consolidation among the companies within our distribution channels has reduced
the number of available distributors, which has increased the competition for
shelf-space. We cannot provide any assurance that these pressures will not
continue or increase.
Intense competition and continuing uncertainties characterize the distribution
channels through which consumer software products are sold. New resellers have
emerged, such as general mass merchandisers and superstores. New channels have
developed, such as the Internet. Large customers, such as retail chains and
corporate users, seek to purchase directly from software developers, instead of
purchasing from distributors or resellers. Although IMSI is attempting to take
advantage of these new distribution channels, no assurance can be given that
these efforts will be successful. Consolidations, and financial difficulties of
some distributors and resellers, are additional uncertainties.
We allow distributors to return products in exchange for new products, or for
credit towards future purchases, as part of stock balancing programs. We provide
price protection to our distributors when we reduce the price of our products.
End users may return products through dealers and distributors within a
reasonable period from the date of purchase for a full refund. Retailers may
return older versions of products. These practices are standard in the software
industry. IMSI makes these allowances to remain competitive with other software
manufacturers. There are shipping, handling and refurbishment costs associated
with receiving returns and processing them for resale.
IMSI's high rate of returns during fiscal 1999 contributed to our negative
financial results. We may experience significant product returns in future
periods due to product update cycles, new product releases, software quality,
and introduction of new competitive products by other companies.
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The announcement of a new product or product version (an upgrade) requires IMSI
to clear the channel of distribution of the older version of the product being
replaced by the upgrade. Price protection and product returns may occur to clear
the channel. Price protection primarily takes place when inventory at a
particular reseller is not sufficient to offset the cost of returning product to
IMSI.
Large distributors may attempt to exert their influence on us in order to alter
terms of trade. Large retailers may exert similar influences. Such tactics, if
resisted by us, could trigger termination. In the event of termination, the
distributor or retailer will generally be entitled to full credit for all
products returned to us in resaleable condition. Returns may cause shipping,
handling and processing costs, and may cause unplanned surges in inventory
levels, which we may be unable to liquidate at normal selling prices.
We attempt to monitor channel inventories and provide appropriate reserves.
Actual product returns may differ from our reserve estimates. Such differences
could be material to our operating results and financial condition.
We manufacture our products based upon estimated future sales, and accordingly,
if the level of actual orders of products falls short of management's estimates,
inventory levels could be excessive, which could add to inventory write-offs and
have an adverse impact on our business, operating results and financial
condition.
BECAUSE A SUBSTANTIAL AMOUNT OF OUR REVENUE DEPENDS ON A FEW DISTRIBUTORS AND
RETAILERS, AN ADVERSE CHANGE IN OUR RELATIONSHIP WITH ANY OF THESE FEW
DISTRIBUTORS AND RETAILERS COULD MATERIALLY AFFECT US. Sales to a limited number
of distributors and retailers are, and are expected to continue to be, a
substantial amount of our revenues. Sales to our two largest distributors
accounted for approximately 27% of net revenues during fiscal year 1999, and 33%
in fiscal 1998.
Arrangements with our distributors and retailers may generally be terminated at
any time by the distributor or retailer. On September 27, 1999, one of our
primary distributors, Tech Data, terminated its agreement with us. Our largest
retailer, CompUSA, which was served by Tech Data, continues to carry our
products and is now served by an alternative distributor. We expect other
retailers that were served by Tech Data to switch to alternative distributors.
If we are unable to collect receivables from any of our largest customers, then
our operating results and financial condition could be materially adversely
affected. The loss of, or reduction in sales to, or any other adverse change in
our relationship with any of our principal distributors or retailers, or
principal accounts sold through such distributors, could materially adversely
affect our operating results and financial condition.
Sales of our products are typically made on credit, with terms that vary
depending upon the customer and the nature of the product. Our distributors and
retailers compete in a volatile industry. They are subject to the risk of
bankruptcy or other business failure. Some distributors and retailers have
experienced difficulties. IMSI does carry receivables insurance on approximately
15 of its largest customers. Although we maintain a reserve for uncollectible
receivables, we cannot provide any assurance that our reserve will prove to be
sufficient or that the difficulties for these or additional distributors and
retailers will not continue, which could have an adverse effect on our business,
operating results and financial condition.
OUR INTELLECTUAL PROPERTY MAY BE VULNERABLE TO UNAUTHORIZED USE, AND THE RISKS
OF INFRINGEMENT OR LAWSUITS. Our ability to compete effectively depends in part
on our ability to develop and maintain proprietary aspects of our technology. To
protect our technology, we rely on a combination of copyrights, trademarks,
trade secret laws, restrictions on disclosure and transferring title, and other
methods. We hold no patents. Copyright and trade secret laws afford limited
protection. IMSI also generally enters into confidentiality or license
agreements with employees and consultants. We generally control access to and
distribution of documentation and other proprietary information.
Despite precautions, it may be possible for a third party to copy or otherwise
obtain and use our products or technologies without authorization, or to develop
similar technologies independently. We do not include in our products any
mechanism to prevent or inhibit unauthorized copying. Policing unauthorized use
of our technology is difficult. We are unable to determine the extent to which
software piracy of our products exists. Software piracy is a persistent problem.
If a significant amount of unauthorized copying of our products were to occur,
our business, operating results and financial condition could be adversely
affected.
In addition, effective copyright, trademark and trade secret protection may be
unavailable or limited in certain foreign countries.
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The global nature of the Internet makes it virtually impossible to control the
ultimate destination of IMSI's products. There can be no assurance that the
steps we take will prevent misappropriation or infringement of IMSI's
technology. Litigation may be necessary to protect our trade secrets or to
determine the validity and scope of the proprietary rights of others. Such
litigation could result in substantial costs and diversion of resources that
could have a material adverse effect on our business, operating results and
financial condition.
Software developers and publishers are increasingly subject to infringement
claims. From time to time, we have received, and may receive in the future,
notice of claims of infringement of other parties' proprietary rights. We
investigate claims and respond, as we deem appropriate. We cannot provide any
assurance that infringement or invalidity claims, or claims for indemnification
resulting from infringement claims, will not be asserted or prosecuted against
us.
Defending such claims is expensive and diverts resources. If any valid claims or
actions were asserted against us, we might seek to obtain a license under a
third party's intellectual property rights. We cannot provide any assurance,
however, that under such circumstances a license would be available on
commercially reasonable terms, or at all.
We provide our products to end users under non-exclusive licenses, which
generally are non-transferable and have a perpetual term. We make source code
available for certain of our products. Providing source code increases the
likelihood of misappropriation or other misuse of our intellectual property. We
license all of our products pursuant to shrink-wrap licenses, or click-wrap
licenses on the Internet, that are not signed by licensees and therefore may be
unenforceable under the laws of certain jurisdictions.
OUR DEPENDENCE ON THIRD PARTY DEVELOPERS COULD HAVE A MATERIAL ADVERSE EFFECT ON
OUR BUSINESS, BECAUSE OF THE RISK OF LOSS OF LICENSES TO SOFTWARE DEVELOPED BY
THIRD PARTIES, OR LOSS OF SUPPORT FOR THOSE LICENSES. Our business strategy has
historically depended in part on our relationships with third-party developers,
who provide products that expand the functionality of our software. Many of
these licenses require payment of royalties based on the number of products
sold. In other cases, we may be required to pay substantial up-front royalties
and development fees to software developers before the commercial viability of
their products has been tested.
If such products fail to achieve success, then we could have substantial charges
against our earnings. Licenses from third parties for several of our products
have limited terms and are non-exclusive. We cannot provide any assurance that
these third-party software licenses for current products or for new products
will continue to be available on commercially reasonable terms, or that the
software will be appropriately supported, maintained or enhanced by the
licensors.
If we were to lose licenses for software developed by third parties, then we
would have increased costs and lost sales. Product shipments would be delayed or
reduced until equivalent software could be developed, which would have a
material adverse effect on our business, operating results and financial
condition.
Talented development personnel are in high demand. We cannot provide any
assurance that independent developers will be able to provide development
support to us in the future. If sales of software utilizing third-party
technology increase disproportionately, operating income as a percent of revenue
may be below historical levels due to third-party royalty obligations.
OUR USE OF DEVELOPMENT TEAMS OUTSIDE THE UNITED STATES INVOLVES RISK, INCLUDING
CONTROL AND COORDINATION RISKS. We program code and quality test most of our
products outside the United States. We use contract programmers in development
centers in Russia, Ukraine, India, and other countries. The cost of programmers
outside of the United States is lower than the cost of programmers in the United
States.
Relying on foreign contractors presents a number of risks. Managing, overseeing
and controlling the programming process is more difficult because of the
distance between our management and the contractors. Our contractors have
different cultures and languages from our managers, making coordination more
difficult.
Our agreements provide that we own the source code developed by the programmers.
But the location of the source code outside the United States makes it more
difficult for us to ensure that access to our source code is protected. If we
lose the services of these programmers, then our business, operating results and
financial condition would be materially adversely affected. We probably could
find other programmers in the United States or in other countries, but the costs
could significantly increase our expenses.
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<PAGE> 36
ACQUIRING PRODUCTS AND TECHNOLOGIES CREATES THE RISK OF FAILURE TO INTEGRATE AND
MANAGE THE ACQUIRED BUSINESS. IMSI has in the past acquired, and expects to
continue from time to time in the future to acquire, businesses, technologies,
services, product lines and/or content databases that are complementary to
IMSI's business in order to broaden its product lines and geographic sales
channels. For example, in October 1998, IMSI acquired all the outstanding common
stock of Zedcor, Inc., an Internet provider of art and visual content, which
maintains the ArtToday.com web site, at www.arttoday.com..
We may face in the future increased competition for acquisition opportunities,
which may inhibit our ability to complete acquisitions, and increase the costs
of completing acquisitions. Further, there can be no assurance that IMSI will be
successful in identifying suitable acquisition opportunities in the future, or
that IMSI will be able to successfully integrate acquired technologies,
services, product lines or businesses.
Acquisitions entail a number of risks, including managing a larger and
more geographically disparate business; diversion of management attention;
successfully completing development of and marketing acquired products to
markets with which we may not be familiar; integrating the acquired products
into our product lines; coordinating diverse operating structures, policies and
practices; and integrating the employees of the acquired companies into our
organization and culture.
If we fail to integrate and manage acquired businesses successfully, to
retain our employees, and to successfully address new markets associated with
such acquired businesses, then our business, operating results and financial
condition would be materially adversely effected. Some of our acquisitions
involved issuances of equity securities, and resulted in various charges and
expenses that have adversely affected, and will continue to adversely affect,
our operating results and financial condition.
Future acquisitions may also result in potential charges that may
adversely affect our earnings and may involve the issuance of shares of our
stock to owners of acquired businesses, resulting in dilution in the percentage
of our stock owned by other stockholders.
We believe that our future growth will depend, in part, upon the success
of our past and possible future acquisitions. We cannot provide assurances that
the anticipated benefits of business combinations and product acquisitions will
be realized. We cannot provide assurances that we will be able successfully to
integrate acquired technologies, services, product lines or businesses.
OUR INTERNET STRATEGY CREATES ADDITIONAL COSTS AND INTRODUCES NEW UNCERTAINTIES
WITH NO ASSURANCE OF RESULTS. Our marketplace now has a higher emphasis on the
Internet, on Internet-related services, and on content tailored for the
Internet. We plan to take advantage of opportunities created by the Internet and
online networks. During fiscal year 1999, we incurred, and expect in the future
to incur, significant costs for our Internet infrastructure. The costs include
additions to hardware, increases in Internet personnel, acquisitions and cross
licenses to drive traffic to our web sites, and a transition to an Internet
sales and marketing strategy.
We cannot provide any assurance that our Internet strategy will be successful,
or that the costs and investments in this area will provide adequate, or any,
results. Delivery of software using the Internet will necessitate some changes
in our business. These changes include addressing operational challenges such as
improving download time for pictures, images and programs, ensuring proper
regulation of content quality and developing sophisticated security for
transmitting payments. If we fail to adapt to and utilize such technologies and
media successfully and in a timely manner, then our competitive position and our
financial results could be materially and adversely affected.
WE FACE RISKS, INCLUDING CURRENCY RISKS, ASSOCIATED WITH OUR INTERNATIONAL
OPERATIONS. International sales represented 33% of IMSI's revenues during fiscal
1999 and 30% in fiscal 1998. Our international sales are denominated in foreign
currencies. We expect that international sales will continue to account for a
significant portion of our revenues in the future. If a relevant foreign
currency decreases in relation to the U.S. dollar, monetary assets held in
foreign currency can decrease in dollar value as a result. We do not hedge
foreign currency risk.
Difficulties managing foreign accounts receivable, longer collection
cycles from foreign customers, repatriation restrictions or other restrictions
on foreign currencies, and tariffs, may affect our international results. Other
risks occur in international operations, including difficulties managing foreign
operations, the timely and successful launch of foreign products, government
regulations, import and export restrictions, changes in international tax laws,
political instability and, in certain jurisdictions, reduced protection for our
intellectual property rights.
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<PAGE> 37
We commit significant time, and development resources, to localizing or
customizing certain of our products for selected international markets. We
develop and support international sales channels. Our efforts to develop
products for targeted international markets, or to develop additional
international sales and support channels, can entail considerable expense, and
may not be successful. If our effort to target a specific market fails, the
failure could have a material adverse effect on our business, operating results
and financial condition.
WE MAY NOT BE ABLE TO ATTRACT AND RETAIN KEY PERSONNEL. Our success depends to a
significant extent on the performance and continued service of our senior
management and key employees. We maintain no key person insurance. We do not
have employment agreements or non-competition agreements with all of our key
employees. Competition for highly skilled employees with technical, Internet,
management, marketing, sales, product development and other specialized training
is intense, and the supply is limited.
The strong demand for these skills in the United States continued during fiscal
2000. We cannot provide any assurance that we will be successful in attracting,
motivating and retaining such personnel. Our significant losses in fiscal 1999
and the decline in our stock price are additional risks that have contributed to
high staff turnover in areas such as accounting and research and development.
This turnover has contributed to disruption in continuity in our knowledge base
and may continue to do so in the future.
Our board of directors and management experienced changes in fiscal 1999. As
previously reported in a press release and in our quarterly Report on Form 10-Q
for the period ended March 31, 1999, IMSI announced the appointment of Costa
John, our Chief Financial Officer, as our Chief Executive Officer. Mr. John
remains the Chief Financial Officer, and became a member of the Board of
Directors. Martin Sacks, formerly Chief Executive Officer and President of IMSI,
resigned as CEO and President but remains a director and was elected Chairman of
the Board. As part of the restructuring of the management team and the Board,
Geoffrey Koblick, formerly Chief Operating Officer and Chairman, retired from
both positions, and as a director, but continues to be available as an advisor
to IMSI. Robert Mayer, who continues as executive Vice President of Worldwide
Sales and Marketing, has resigned as a director.
We have historically experienced difficulty in attracting highly qualified
programmers and software engineers in the U.S. We cannot provide any assurance
that we will be successful in attracting, motivating and retaining such
personnel. We cannot provide any assurance that one or more key employees will
not leave us or compete against us. If we fail to attract qualified employees or
to retain the services of key personnel, then our business, operating results
and financial condition could be materially adversely affected.
DIRECTORS AND OFFICERS HAVE A SIGNIFICANT INFLUENCE OVER OUR COMPANY, BECAUSE
THEY BENEFICIALLY OWN A SIGNIFICANT PERCENTAGE OF OUR SHARES. As of June 30,
1999, the present directors and executive officers of IMSI and their respective
affiliates, in the aggregate, beneficially own approximately 15% of the
outstanding common stock. As a result, these shareholders may possess influence
over IMSI. Such influence may have the effect of delaying or preventing a change
in control of IMSI, impeding a merger, consolidation, takeover or other business
combination involving IMSI or discouraging a potential acquirer from making a
tender offer or otherwise attempting to obtain control of IMSI.
OUR RELIANCE ON OUTSOURCING COULD MATERIALLY ADVERSELY AFFECT OUR OPERATING
RESULTS BECAUSE OF LACK OF SUPPLY. We outsource most of the production of our
products. Production primarily involves duplication of media and printing user
manuals and packaging materials. In July 1999, IMSI and DisCopyLabs ("DCL")
finalized an agreement under which DCL will gradually assume all of IMSI's
fulfillment, warehousing, and shipping functions. Due to this change, IMSI will
be closing its primary warehouse in Vacaville, California. We intend to continue
outsourcing in the future, as long as it is economical to do so. We believe that
we have adequate alternative suppliers of outsourcing services. But the loss of
a supplier, especially DCL, or our inability to obtain contract services, could
materially adversely affect our operating results.
While DCL holds some inventory for shipment, IMSI has not transferred title to
any assets to DCL. The transition of product inventory and information systems
to DCL was still in the implementation phase at September 30, 1999. Systems
integration risks and inventory and fulfillment risks may affect our ability to
ship products effectively and cause costly delays or cancellation of customer
orders. Our divestiture of non-core products may reduce unit sales to the point
that outsourced costs of production may increase.
OUR COMMON STOCK PRICE IS HIGHLY VOLATILE AND IS SUBJECT TO WIDE
FLUCTUATIONS AND MARKET RISK. The market price of our common stock is highly
volatile. Our stock is subject to wide fluctuations in response to factors such
as:
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<PAGE> 38
- actual or anticipated variations in our operating results,
- announcements of technological innovations,
- new products or services introduced by us or our competitors,
- changes in financial estimates by securities analysts,
- conditions and trends in the software market,
- general market conditions, and
- other factors, such as recessions, interest rates or international
currency fluctuations.
Historically, the trading volume of our common stock has been very small. The
market for our common stock has been materially less liquid than that of most
other publicly traded companies. Small trading volume and a less liquid market
may amplify price changes in our stock. If a significant amount of our common
stock is sold, then our stock price could decline significantly.
The NASDAQ Stock Market, where our stock is traded, experiences extreme price
and volume fluctuations that have particularly affected the market prices for
stock in technology companies. Price fluctuations in technology stock prices are
often unrelated or disproportionate to the operating performance of technology
companies. The trading prices of many technology companies' stocks are at or
near historical highs and reflect price to earnings ratios substantially above
historical levels.
We cannot provide any assurance that these trading prices and price to earnings
ratios will be sustained. The market price of our common stock may be adversely
affected by these broad market factors.
OUR REGISTRATION OF A SIGNIFICANT NUMBER OF SHARES FOR POSSIBLE PUBLIC RESALE
COULD ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK. On June 8, 1999, we
filed a registration statement covering the possible resale from time to time of
approximately 1,100,857 outstanding shares of common stock held by, and
approximately 1,223,966 shares that may be issued in the future to, the selling
stockholders named in that registration statement. On June 25, 1999, we filed
another registration statement covering possible resale of approximately 85,677
outstanding shares held by the selling stockholders, 263,000 shares that may be
issued if warrants are exercised by the selling stockholders, 658,362 shares
issuable on conversion of a note held by the selling stockholders, and 490,151
shares issuable because of price adjustments in agreements with the selling
stockholders named in that registration statement. On October 20, 1999 we had
7,024,409 shares outstanding. The total shares covered by those two registration
statements, 3,822,013 shares, represent about 54% of the currently outstanding
shares. Sales of the shares covered by those registration statements could
adversely affect the market price of our common stock.
YEAR 2000 ISSUES COULD AFFECT OUR BUSINESS IF OUR PRODUCTS, OR THE SYSTEMS WE
USE, OR THE SYSTEMS OUR SUPPLIERS USE FAIL BECAUSE THEY ARE NOT YEAR 2000
COMPLIANT. Software, embedded processors, or computer systems may fail if they
do not accurately recognize the Year 2000. We recognize the need to ensure that
our 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. We established procedures for
evaluating and managing the risks and costs associated with this problem. As
part of the general upgrade of our information systems, we are putting in place
systems that will be Year 2000 compliant.
We have initiated a Year 2000 Compliance Plan that addresses three types of
systems that must be Year 2000 compliant.
Products: Our software products have been undergoing Year 2000 Compliance
testing since January 1998. All current versions of our products are Year 2000
compliant. Our products that are no longer current and products developed years
ago may not be Year 2000 compliant. We advise our customers to upgrade to
current versions of our products.
INFORMATION TECHNOLOGY SYSTEMS: We identified all internal data processing and
networking systems that we believe are at risk from the Year 2000 problem, and
reviewed the manufacturer's Year 2000 Compliance statement for each system. Any
systems that are determined to be non-compliant will be upgraded or replaced.
Internal testing was done for any mission critical system for which the
manufacturer's Year 2000 Compliance statement was not adequate to ensure the
reliability
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<PAGE> 39
of the system. All information technology systems will be verified as Year 2000
Compliant by November 1999. In addition, no new information technology systems
will be implemented without first ensuring that they are Year 2000 Compliant.
NON-INFORMATION TECHNOLOGY SYSTEMS: We have identified a wide range of general
computing and facilities systems that must be verified as Year 2000 Compliant.
The majority of these systems will be upgraded or replaced as necessary during
normal maintenance if they are not compliant. The manufacturer's Year 2000
Compliance statements are currently under review for the remaining systems and
will be upgraded or replaced if necessary. Because new systems are continually
being integrated, the effort to ensure Year 2000 Compliance for these systems is
an ongoing effort.
We have communicated with our customers and suppliers to determine their Year
2000 compliance readiness, and the extent to which we are vulnerable to any
third party Year 2000 issues. However, there can be no guarantee that the
systems of other companies on which our systems rely will be timely converted.
Failure to convert by another company, or a conversion that is incompatible with
our systems, would have a material adverse effect on us, our results of
operations and our financial condition.
OUR BOARD OF DIRECTORS MAY ISSUE PREFERRED STOCK TO PREVENT A TAKEOVER. The
Board of Directors is authorized to issue up to 20,000,000 shares of Preferred
Stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares without any further vote
or action by the shareholders. The rights of the holders of common stock will be
subject to, and may be adversely affected by, the rights of the holders of any
Preferred Stock that may be issued in the future. The issuance of Preferred
Stock, while providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could have the effect of delaying,
deferring or preventing a change in control of IMSI. IMSI has no current plans
to issue shares of Preferred Stock.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
IMSI is exposed to the impact of interest rate and foreign currency
fluctuations. IMSI'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.
IMSI's major market risk exposure is changing interest rates in the United
States, which would change interest expense on IMSI's line of credit and term
loan.
Most of IMSI'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 IMSI's net revenues. IMSI's foreign
currency transactional exposures exist primarily with the U.K. pound and German
mark.
IMSI does not hedge interest rate or foreign currency exposure.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements and the financial statement schedule are attached as an
exhibit at Item 14(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On April 19, 1999, IMSI was informed by Deloitte & Touche LLP ("D&T"), that it
had resigned as IMSI's independent accounting firm. D&T's audit reports on our
financial statements for the fiscal years ended June 30, 1998 and 1997 did not
contain an adverse opinion or a disclaimer of opinion and were not qualified or
modified as to uncertainty, audit scope or accounting principles.
In connection with the audits of IMSI's consolidated financial statements for
each of the two fiscal years ended June 30, 1998 and 1997, and in the interim
periods subsequent to June 30, 1998, preceding the date of D&T's resignation,
there were no "reportable events," as that term is defined in the instructions
to Form 8-K and the applicable regulations. In connection with the audits of our
consolidated financial statements for each of the two fiscal years ended June
30, 1998 and 1997, and in the interim periods subsequent to June 30, 1998,
preceding the date of D&T's resignation, there were no "disagreements" with D&T
on any matter of accounting principles or practices, financial statement
disclosure or auditing scope or procedure which, if not resolved to the
satisfaction of D&T would have caused D&T to make reference to the matter in
their report, except as follows:
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<PAGE> 40
On September 29, 1998, The Learning Company ("TLC") paid IMSI approximately
$1.69 million, representing amounts due to IMSI from the sale of the Family
Heritage line of software products by IMSI to TLC ($1.26 million) and other
existing contractual agreements ($430,000). IMSI had not recorded revenues or
receivables for such amounts due from TLC in its financial statements for prior
periods. On October 2, 1998, TLC and IMSI entered into a software license
agreement whereby TLC sold Org Plus, a software program, to IMSI in exchange for
$3.5 million as follows: $1.7 million paid by IMSI on October 2, 1998, and
$450,000 due on each of January 1, 1999,April 1, 1999, July 1, 1999 and October
1, 1999. IMSI initially believed that revenue should be recognized on a cash
basis in the quarter ended September 30, 1998 for the $1.69 TLC payment, and
that the full acquisition price of $3.5 million, for IMSI's acquisition of Org
Plus should be accounted for separately in the quarter ended December 31,1998.
D&T's position was that the two transactions should be treated as one
transaction in the quarter ended December 31, 1998 due to several factors. The
audit committee of our Board of Directors discussed the subject matter of the
accounting disagreement with Deloitte & Touche. IMSI discussed the subject
matter of the accounting disagreement with other independent accounting firms.
After these discussions with D&T, the Company agreed and accounted for the above
transactions in accordance with D&T's position. Accordingly, IMSI did not
recognize revenue for the quarter ended September 30, 1998 for the cash receipt
from TLC. In the quarter ending December 31, 1998, IMSI recorded the acquisition
of OrgPlus at a net amount of $1,810,000.
On May 5, 1999, the Board of Directors of IMSI, pursuant to the recommendation
of the audit committee, approved a resolution authorizing management to engage
Grant Thornton LLP ("Grant Thornton") as IMSI's independent auditor, upon such
terms as may be negotiated by management. On May 5, 1999, the Company appointed
Grant Thornton as IMSI's independent auditor. IMSI previously reported on a Form
8-K filed April 26, 1999, that on April 19, 1999, IMSI received a letter from
Deloitte & Touche LLP ("D&T"), resigning as IMSI's independent accounting firm.
During IMSI's two most recent fiscal years and the subsequent interim period
before engaging Grant Thornton, neither IMSI nor anyone acting on its behalf
consulted Grant Thornton regarding (i) either: the application of accounting
principles to a specified transaction, either completed or proposed; or the type
of audit opinion that might be rendered on IMSI's financial statements; or (ii)
any matter that was either the subject of a disagreement or a reportable event
(as defined in Item 304 of Regulation S-K).
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<PAGE> 41
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The names of all members of the Board of Directors of IMSI, and information
about them as of October 1, 1999 are set forth below:
<TABLE>
<CAPTION>
NAME AGE OCCUPATION SINCE
<S> <C> <C> <C>
William H. Lane III(1)(2) 61 Former Vice President, 1999
Chief Financial Officer,
Secretary and Treasurer of
Intuit, Inc.
Abe Ostrovsky(1)(2) 56 Chairman of JetForm 1998
Corporation
Martin Sacks 39 Chairman of the Board of 1988
the Company
Costa John 43 President, Chief Executive 1999
Officer, and Chief
Financial Officer of the
Company
</TABLE>
(1) Member of the Compensation Committee. (2) Member of the Audit Committee.
Mr. Lane became a director in February 1999. Mr. Lane is President and CEO of
Canyon Vista, Inc., a management consulting company. Mr. Lane retired from
Intuit, Inc. in 1996, having served as its Vice President, Chief Financial
Officer, Secretary and Treasurer. Mr. Lane also served in a similar capacity at
ChipSoft, Inc., before Intuit acquired the company in December 1993. Mr. Lane
also serves on the boards of Cyberian Outpost, Inc., MetaCreations Corporation,
and Aspect Technology. Mr. Lane received a Bachelor of Arts degree in Economics
from Columbia University and a certificate from the Advanced Management Program
at the Harvard Graduate School of Business Administration.
Mr. Ostrovsky became a director in August 1998. Mr. Ostrovsky joined JetForm
Corporation in 1991 as Chief Operations Officer and became Chief Executive
Officer and Chairman in 1992. In December 1995, Mr. Ostrovsky resigned as an
officer of JetForm and continues as Chairman of the Board of that company. Mr.
Ostrovsky also serves on the boards of NetManage, Inc., Seec, Inc., Genicom,
Inc. and Ixla Corp. (Australia). Mr. Ostrovsky studied mechanical engineering at
the University of Miami.
Mr. Sacks became Chairman of the Board in May 1999. Mr. Sacks joined IMSI in
1988 when the company he founded, Milan Systems America, Inc., merged with IMSI.
Mr. Sacks served as President and Chief Executive Officer of IMSI from 1990
until May 1999. Mr. Sacks received his Bachelor of Commerce and Bachelor of
Accounting degrees from the University of Witwatersrand, South Africa.
Mr. John joined IMSI in February 1999. He was appointed Chief Financial Officer
in April 1999 and Chief Executive Officer in May 1999. He was elected to the
Board of Directors in August 1999. Mr. John was a Management Consulting Partner
until February 1995 at Grant Thornton, International. From March 1995 to March
1999, Mr. John was Chief Executive Officer of Didactix, Inc., a strategic
financial advisory company. Mr. John was appointed in June 1998 to serve as
Chief Executive Officer of San Francisco Blues, Inc., until March 1999. Mr. John
received Bachelors degrees in Accounting and in Business Economics, and a
Masters degree in Financial Management, from the University of Witwatersrand,
South Africa.
Charles Federman served as a member of the Board of Directors from May 1996
until September 30, 1999, when he resigned from the Board. Mr. Federman is 43
years old and is Chairman of the Executive Committee and a Managing Director of
the BRM Group, an information and technology mergers and acquisitions firm. Mr.
Federman was with Broadview Associates from October 1983 to January 1998, where
he was Chairman of the Executive Committee from 1994 to 1996 and Chairman of the
Board from 1996 to 1997. He serves on the boards of Brio Technology, Inc. and
BackWeb Technologies, Ltd., and was formerly on the boards of Phoenix
Technologies Ltd. and Mathsoft, Inc. Mr. Federman received a Bachelor of Science
degree from the University of Pennsylvania, Wharton School of Business.
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All directors hold office until the next annual meeting of shareholders and
until their successors are elected and qualified, or until their earlier
resignation, removal or death. Executive officers are chosen by, and serve at
the discretion of, the Board.
EXECUTIVE OFFICERS
The names of the Executive Officers of IMSI during fiscal 1999 and information
about them are set forth below:
Robert Mayer has served as IMSI's Vice President of Sales since 1990, as a
director from 1985 to May 1999, and is currently Executive Vice President of
Worldwide Sales. Mr. Mayer is 45 years old. He received a Bachelor of Arts
degree from the University of California, and Bachelor and Masters of Science
degrees from the University of Washington.
Geoffrey Koblick was Chairman of the Board of Directors and Secretary of IMSI
from its inception in 1982 until May 1999. Mr. Koblick served as President of
IMSI from 1982 through September 1987, and from July 1988 to June 1990, as
General Counsel from 1982 to May 1999, and as Chief Operating Officer from 1988
to May 1999. Mr. Koblick is 45 years old. He is currently a consultant to IMSI
under a severance agreement until May 2000.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's directors and executive
officers, and persons who own more than ten percent of a registered class of the
Company's equity securities, to file with the Commission initial reports of
ownership and reports of changes in ownership of the Company's Common Stock and
other equity securities of the Company. Officers, directors and greater than ten
percent shareholders are required by the Commission's regulations to furnish the
Company with copies of all Section 16(a) forms they filed. To the Company's
knowledge, based on review of the copies of such reports furnished to the
Company, during the last fiscal year all Section 16(a) filing requirements
applicable to the Company's officers, directors, and greater than ten percent
beneficial owners were complied with.
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ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth all compensation awarded, earned or paid for
services rendered in all capacities to the Company and its subsidiaries during
each of the fiscal years ended June 30, 1999, 1998 and 1997 to (i) the Company's
chief executive officer during fiscal 1999, and (ii) the Company's other
executive officers other than the Chief Executive Officer, who were serving as
executive officers at the end of fiscal 1999 whose compensation exceeded
$100,000 for fiscal 1999 (collectively, "Named Persons"). Messrs. Sacks and
Koblick were executive officers during part of fiscal 1999 but were not
executive officers at the end of fiscal 1999.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION ------------------
NAME AND ----------------------- OTHER ANNUAL SECURITIES
PRINCIPAL POSITIONS FISCAL YEAR SALARY($)(1) BONUS($) COMPENSATION($)(2) UNDERLYING OPTIONS
------------------- ----------- ------------ -------- ------------------ ------------------
<S> <C> <C> <C> <C> <C>
Costa John(3) 1999 66,667 0 0 --
President, Chief
Executive Officer, and
Chief Financial Officer
Martin Sacks 1999 220,000 9,706 5,141 --
Chairman of the Board(4) 1998 200,000 48,137 7,346 50,000
1997 200,000 22,500 5,249 --
Geoffrey B. Koblick 1999 200,000 9,706 7,252 --
Consultant(5) 1998 176,667 38,937 6,256 45,000
1997 160,000 16,000 5,249
Robert Mayer 1999 180,000 4,171 7,367
Executive Vice President 1998 143,387 59,864 7,603 30,000
of Worldwide Sales 1997 138,000 8,511 5,249 --
</TABLE>
(1) Amounts stated above are the actual amounts received, and were based upon
an annual salary of $220,000, $220,000, $200,000, $180,000, for Messrs.
John, Sacks, Koblick, Mayer, respectively.
(2) Includes payments of medical and dental insurance premiums by the Company.
(3) Mr. John joined the company in February 1999, became Chief Financial
Officer in April 1999, and became President and Chief Executive Officer in
May 1999, when his salary was increased from $160,000 to $220,000.
(4) Acted as President and Chief Executive Officer until May 1999.
(5) Acted as Chairman of the Board, Chief Operating Officer and General Counsel
until May 1999. Mr. Koblick is currently a Consultant to the company under
a severance agreement until May 5, 2000.
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OPTION GRANTS
The following table sets forth information regarding individual grants of
options to acquire the Company's Common Stock during fiscal 1999 to each Named
Person.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-----------------
RATES OF
STOCK PRICE
APPRECIATION
% OF TOTAL EXERCISE FOR OPTION TERM(4)
OPTIONS GRANTED OR ------------------
OPTIONS TO EMPLOYEES BASE PRICE EXPIRATION
NAME GRANTED(1) IN FISCAL YEAR(2) ($/SHR)(3) DATE 5%($) 10%($)
---- ---------- ----------------- ---------- ---------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Costa John 60,000 8% 12.13 2/1/09 457,800 1,074,000
Martin Sacks 100,000 14% 6.50 10/6/08 408,000 1,036,000
Geoffrey B. Koblick 90,000 13% 6.50 10/6/08 368,100 932,400
Robert Mayer 80,000 11% 6.50 10/6/08 327,200 828,800
</TABLE>
(1) The options granted during fiscal year 1999 vest over a five-year period of
time, with 20% of the options vesting upon completion of each year of
service. On July 1, 1999 vesting was changed to 4 year vesting for options
granted on or after July 1, 1999.
(2) The Company granted options to purchase 719,825 shares of Common Stock to
employees during fiscal 1999.
(3) The exercise price may be paid in cash, or the Administrator of the Plan
may in its discretion authorize the acceptance of full recourse notes,
securities, surrender of shares issuable upon exercise with a fair market
value equal to the exercise price, or any other property.
(4) The 5% and 10% assumed compound rates of stock appreciation are mandated by
the rules of the Securities and Exchange Commission and do not represent
the Company's estimate or projection of future Common Stock prices.
44
<PAGE> 45
OPTIONS EXERCISED
The following table sets forth information with respect to the options exercised
during fiscal 1999 by the Named Persons during fiscal 1999, including the
aggregate value of gains on the date of exercise. In addition, this table
includes the number of shares covered by both exercisable and non-exercisable
stock options as of June 30, 1999. Also reported are the values for
"in-the-money" options, which represent the positive spread between the exercise
price of any such existing stock options and the fiscal year-end price of the
Common Stock.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
FY-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS/SARs IN-THE-MONEY OPTIONS
AT JUNE 30, 1999 AT JUNE 30, 1999($)
VALUE
NAME EXERCISE # REALIZED($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ---------- ----------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
Costa John 0 0 0/60,000(1) 0/0(2)
Martin Sacks 0 0 250,771/137,500(1) 537,677/0(2)
Geoffrey B. Koblick 0 0 142,500/123,750(1) 237,405/0(2)
Robert Mayer 0 0 66,108/102,500(1) 136,411/0(2)
</TABLE>
(1) These options, which have a five-year vesting period, become exercisable
over time based on continuous employment with the Company and in certain
cases are subject to various performance criteria or vest in full upon
acquisition of the Company.
(2) Based on the difference between the market price of the Common Stock at
June 30, 1999 ($4.875 per share), and the aggregate exercise prices of
options shown in the table.
45
<PAGE> 46
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of September 30, 1999, the beneficial
ownership of the Company's Common Stock by (i) each person who is known by the
Company to own of record or beneficially more than five percent (5%) of the
Company's Common Stock, (ii) each director or nominee, (iii) each other
executive officer (of which there are none) named in the Summary Compensation
Table, above in Item 11, and (iv) all directors and executive officers as a
group. Except as otherwise indicated, the shareholders listed in the table have
sole voting and dispositive power with respect to the shares indicated, subject
to community property laws where applicable. The business address of Messrs.
Mayer, Sacks, and Ostrovsky is 75 Rowland Way, Novato, California 94945. The
business address of Mr. Lane is 10695 Magdalena, Los Altos Hills, California
94024. The business address of Mr. Koblick is 5 Hill Road, Ross, California
94957. The business address of BayStar Capital. L.P. is 505 Montgomery Street,
20th Floor, San Francisco, California 94111. The business address of Capital
Ventures International is in care of Heights Capital Management, 425 California
Street, Suite 1100, San Francisco, California 94104.
<TABLE>
<CAPTION>
NAME AND ADDRESS
OF BENEFICIAL OWNER SHARES BENEFICIALLY OWNED(1) PERCENTAGE OF CLASS(1)
------------------- ---------------------------- ----------------------
<S> <C> <C>
BayStar Capital, L.P.(2) 908,362 11.45%
Martin Sacks(3) 554,133 7.6%
Geoffrey Koblick(4) 526,350 7.3%
Robert Mayer(5) 475,694 6.7%
Capital Ventures International 437,637 5.9%
Charles Federman(6) 53,750 *
All directors and executive officers
as a group (8 persons)(7) 1,086,822 14.7%
</TABLE>
------------------------
* Less than one percent of the Company's outstanding common stock.
(1) Assumes that the person has exercised, to the extent exercisable on or
before 60 days from the date of the table, all options, convertible
securities, and warrants to purchase Common Stock held by such person and
that no other person has exercised any outstanding options, convertible
securities or warrants.
(2) Includes 658,362 shares issuable to BayStar on conversion of a note and
250,000 shares issuable to BayStar on exercise of a warrant.
(3) Includes 263,271 shares issuable upon the exercise of stock options held by
Mr. Sacks within 60 days from the date of the table.
(4) Includes 153,750 shares issuable upon the exercise of stock options held by
Mr. Koblick within 60 days from the date of the table.
(5) Includes 73,608 shares issuable upon the exercise of stock options held by
Mr. Mayer within 60 days from the date of the table.
(6) Includes 30,125 shares issuable upon the exercise of options held by Mr.
Federman within 60 days from the date of the table.
(7) Includes 369,804 shares subject to options so exercisable held by all
officers and directors as a group.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There is a severance agreement between IMSI and Geoffrey Koblick, a founder of
the Company. Mr. Koblick is receiving as separation payments twelve months of
his base salary of $200,000 from May 5, 1999 to May 5, 2000, and Mr. Koblick is
a consultant to the Company during this time. IMSI forgave a promissory note in
the amount of $35,000. Mr. Koblick is entitled to exercise his stock options as
incentive options, and vesting continues, until May 5, 2000.
46
<PAGE> 47
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS PART OF THIS ANNUAL REPORT ON FORM 10-K:
<TABLE>
<S> <C> <C>
1. Financial Statements
Independent Auditors' Report for the years ended
June 30, 1998 and 1997 42
Independent Auditors' Report for the year ended
June 30, 1999 43
Consolidated Balance Sheets at June 30, 1999 and
1998 (restated) 44
Consolidated Statements of Operations for the
years ended June 30, 1999, 1998 (restated) and
1997 45
Consolidated Statements of Shareholders' Equity
for the years ended June 30, 1999, 1998 (restated)
and 1997 46
Consolidated Statements of Cash Flows for the
years ended June 30, 1999, 1998 (restated) and
1997 47
Notes to Consolidated Financial Statements 48
2. Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts
for the years ended June 30, 1999, 1998 and 1997 68
(b) REPORTS ON FORM 8-K: 69
(c) EXHIBITS: SEE EXHIBIT INDEX 71
</TABLE>
47
<PAGE> 48
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
International Microcomputer Software, Inc.
We have audited the accompanying consolidated balance sheet of International
Microcomputer Software, Inc. and subsidiaries (the "Company") as of June 30,
1998 and the related consolidated statements of operations, shareholders'
equity, and cash flows for the fiscal years ended June 30, 1998 and 1997. Our
audits also included the financial statement schedule for the years ended June
30, 1998 and 1997, listed in the Index at Item 14(a) 2. These financial
statements and financial statement schedule are the responsibility of IMSI's
management. Our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with audit standards generally accepted in
the United States of America. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above, present
fairly, in all material respects, the financial position of International
Microcomputer Software, Inc. and subsidiaries as of June 30, 1998 and the
results of their operations and their cash flows for the fiscal years ended June
30, 1998 and 1997 in conformity with accounting principles generally accepted in
the United States of America. Also, in our opinion, such financial statement
schedule for the years ended June 30, 1998 and 1997, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.
As discussed in Note 16, the accompanying consolidated financial statements as
of and for the fiscal year ended June 30, 1998 have been restated.
/s/ DELOITTE & TOUCHE LLP
-------------------------
San Francisco, California
August 5, 1998 (October 22, 1999 as to Note 16)
48
<PAGE> 49
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
International Microcomputer Software, Inc.
We have audited the accompanying consolidated balance sheet of International
Microcomputer Software, Inc. and subsidiaries (the "Company") as of June 30,
1999, and the related consolidated statements of operations, shareholders'
equity, and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
International Microcomputer Software, Inc. and subsidiaries as of June 30, 1999,
and the consolidated results of their operations and their consolidated cash
flows for the year then ended in conformity with accounting principles generally
accepted in the United States of America.
We have also audited Schedule II as listed in the Index at Item 14(a) 2 for the
year ended June 30, 1999. In our opinion, this schedule presents fairly, in all
material respects, the information required to be set forth therein.
As discussed in the last paragraph of Note 7, the Company has restated its 1999
financial statements.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As shown in the financial statements,
the Company incurred a net loss of $26,966,000 during the year ended June 30,
1999, and, as of that date, the Company's current liabilities exceeded its
current assets by $1,227,000 and it was in default of various loan covenants.
These factors, among others, as discussed in Note 1 to the financial statements,
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 1. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/GRANT THORNTON LLP
---------------------
San Francisco, California
October 22, 1999 (except for the last paragraph of
Note 7 as to which the date is September 8, 2000)
49
<PAGE> 50
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1999 AND 1998
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
1999 1998
---- ----
Restated Restated
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 3,681 $ 2,093
Receivables, less allowances for doubtful
accounts, discounts and returns of $7,445 and $4,081 4,933 13,299
Inventories 2,895 6,549
Prepaid royalties and licenses 1,858 2,517
Income tax receivable 3,751 --
Deferred taxes -- 1,917
Other current assets 758 759
-------- --------
Total current assets 17,876 27,134
Furniture and equipment 3,632 3,430
Deferred tax assets 465 2,676
Capitalized software development costs 2,856 2,101
Other assets 2,315 314
-------- --------
Total assets $ 27,144 $ 35,655
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long term debt $ 7,110 $ 10,224
Trade accounts payable 2,256 5,916
Accrued and other liabilities 5,119 4,015
Accrued restructuring charges 1,440 --
Deferred revenue 3,178 407
-------- --------
Total current liabilities $ 19,103 $ 20,562
Long term debt and other obligations 6,599 1,682
-------- --------
Total liabilities $ 25,702 $ 22,244
Commitments and contingencies -- --
Shareholders' equity:
Common stock, no par value; 300,000,000 authorized;
Issued and outstanding 7,014,078 and 5,684,179 shares 27,526 12,718
Retained earnings (Accumulated deficit) (25,963) 1,003
Accumulated other comprehensive income (loss) 129 (25)
Notes receivable from shareholders (250) (285)
-------- --------
Total shareholders' equity 1,442 13,411
-------- --------
Total liabilities and shareholders' equity $ 27,144 $ 35,655
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
50
<PAGE> 51
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS YEARS
ENDED JUNE 30, 1999, 1998 AND 1997 (IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- -------
Restated Restated
<S> <C> <C> <C>
Net revenues $ 37,679 $ 62,065 $41,839
Product costs 25,424 23,382 16,893
-------- -------- -------
Gross margin 12,255 38,683 24,946
-------- -------- -------
Costs and expenses:
Sales and marketing 18,387 18,611 12,026
General and administrative 8,181 5,005 3,988
Research and development 8,069 8,614 4,565
Restructuring charge 1,508 -- --
Write off purchased in process
research and development -- 6,367 --
-------- -------- -------
Total operating expenses 36,145 38,597 20,579
-------- -------- -------
Operating income (loss) (23,890) 86 4,367
Interest and other expense, net 1,880 759 130
-------- -------- -------
Income (loss) before income taxes and
extraordinary item (25,770) (673) 4,237
Income tax provision (benefit) 237 (303) 1,640
-------- -------- -------
Income (loss) before extraordinary item (26,007) $ (370) $ 2,597
Extraordinary loss on extinguishment
of debt (959) -- --
-------- -------- -------
Net income (loss) $(26,966) $ (370) $ 2,597
======== ======== =======
Basic income (loss) per share $ (4.30) $ (0.07) $ 0.53
Diluted income (loss) per share $ (4.30) $ (0.07) $ 0.46
Shares used in calculating:
Basic income (loss) per share 6,275 5,513 4,946
Diluted income (loss) per share 6,275 5,513 5,682
</TABLE>
See Notes to Consolidated Financial Statements
51
<PAGE> 52
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED JUNE 30, 1999 AS RESTATED, 1998 AS RESTATED AND
1997 (IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS)
<TABLE>
<CAPTION>
Comprehensive
Retained Accumulated Notes
Common Stock Earnings Other Receivable
------------ Accumulated Comprehensive Income from
Shares Amount Deficit) Income (Loss) (Loss) Shareholders Total
--------- -------- -------- ------------- -------- ------------ --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at July 1, 1996 4,834,689 $ 5,973 $ (1,224) $ 66 $(293) $ 4,522
Issuance of common stock under 294,070 480 480
stock bonus and option plans
Net income 2,597 $ 2,597 2,597
Foreign currency translation (112) (112) (112)
--------
Comprehensive income $ 2,485
========
Payment of note receivable 8 8
--------- -------- -------- ----- ----- --------
Balance at June 30, 1997 5,128,759 6,453 1,373 (46) (285) 7,495
Issuance of common stock under
stock bonus and option plans
and for exercise of warrant 189,400 623 623
Issuance of common stock
- Corel 346,020 5,000 5,000
- MediaPaq 20,000 240 240
Deferred compensation 30 30
amortization
Tax benefit from exercise of
stock options 372 372
Net loss, as restated (370) $ (370) (370)
Foreign currency translation
adjustment 21 21 21
--------- -------- -------- ----- -------- ----- --------
Comprehensive loss $ (349)
========
Balance at June 30, 1998, as restated 5,684,179 12,718 1,003 (25) (285) 13,411
Issuance of common stock under
stock bonus and option plans 163,365 960 960
Issuance of common stock related to:
- Acquisitions 194,508 1,107 1,107
- Settlement of debt 503,913 5,696 5,696
- Zedcor agreement 50,476 311 311
- Capital Ventures agreement 437,637 5,000 5,000
Value attributed to warrants: 776 776
- Silicon Valley Bank
- Baystar Capital, L.P. 1,162 1,162
Common stock received in satisfaction
of receivable (20,000) (320) (320)
Forgiveness of notes receivable from
shareholder 35 35
Deferred compensation amortization 116 116
Net loss (26,966) $(26,966) (26,966)
Foreign currency translation adjustment 154 154 154
--------
Comprehensive Loss $(26,812)
========
Balance at June 30, 1999 7,014,078 $ 27,526 $(25,963) $ 129 $(250) $ 1,442
========= ======== ======== ===== ===== ========
</TABLE>
See Notes to Consolidated Financial Statements
52
<PAGE> 53
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1999, 1998 AND 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- -------
Restated RESTATED
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $(26,966) $ (370) $ 2,597
Adjustments to reconcile net income (loss) to net
cash used by operating activities
Depreciation and amortization 4,308 4,147 2,098
Amortization of deferred compensation 116 402 --
Amortization of warrants 237 -- --
Bad debt reserve 479 (8) 656
Returns reserve 2,251 1,409 540
Rebates reserve 98 0 0
Price discounts reserve 536 (263) 445
Provision for inventory obsolescence 238 472 (37)
Deferred taxes 4,128 (2,855) (602)
Forgiveness of notes receivable from shareholders 35 -- 8
Loss on disposal of fixed assets 232 -- --
Write-off of purchased in-process research and development -- 6,367 --
Restructuring charges 3,167 -- --
Foreign currency translation 235 153 (34)
Charge related to stock issued at discount 918 -- --
Changes in assets and liabilities:
Receivables 4,568 (6,581) (5.055)
Inventories 1,232 (3,533) (897)
Prepaid royalties and licenses 196 (3,277) (1,779)
Income taxes receivable (3,751) -- --
Other current assets 51 (281) (8)
Trade accounts payable (422) 943 1,424
Accrued and other liabilities 1,162 1,289 244
Accrued restructuring charges 1,440
Deferred revenue 2,771 407 --
-------- -------- -------
Net cash used by operating activities (2,741) (1,579) (400)
-------- -------- -------
Cash flows from investing activities:
Purchase of equipment (1,190) (1,026) (323)
Acquisitions of software development (2,171) (2,708) (44)
costs and in-process technologies
Purchase of goodwill, trademark and brand (2,404) -- --
Other 36 (170) --
-------- -------- -------
Net cash used by investing activities (5,729) (3,904) (367)
-------- -------- -------
Cash flows from financing activities:
Credit line borrowings 2,025 16,358 4,869
Credit line repayments (4,573) (8,410) (4,869)
Borrowings (repayments) under term loans - net 7,496 (1,282) 1,476
Capital lease and other obligations repayment - net (992) (611) (373)
Proceeds from issuance of common stock 6,183 526 481
-------- -------- -------
Net cash provided by financing activities 10,139 6,581 1,584
Effect of exchange rate change on cash and cash equivalents (81) (131) (78)
-------- -------- -------
Net increase in cash and cash equivalents 1,588 967 739
Cash and cash equivalents at beginning of year 2,093 1,126 387
-------- -------- -------
Cash and cash equivalents at end of the year $ 3,681 $ 2,093 $ 1,126
======== ======== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid $ 1,584 $ 552 $ 178
Income taxes paid $ 308 $ 2,592 $ 1,910
SUPPLEMENTAL DISCLOSURES OF NON-CASH FINANCING AND INVESTING ACTIVITIES
Equipment acquired through capital lease obligations $ 984 $ 1,462 $ 768
Common stock received in satisfaction of receivable 320 -- --
Repayment of payables and accrued and other liabilities
with IMSI common stock 3,090 -- --
Repayment of term loans with IMSI common stock 2,606 -- --
Acquisition of technology and assets in exchange for:
Long term debt -- 300 --
Trade payables -- 383 --
Notes payable 4,030 1,034 --
Common stock 1,107 5,240 --
</TABLE>
See Notes to Consolidated Financial Statements
53
<PAGE> 54
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
International Microcomputer Software, Inc. ("IMSI" or the "Company") was
incorporated in California in November 1982. IMSI has wholly-owned subsidiaries
located in Tucson, Arizona; Munich, Germany; Sydney, Australia; London, England;
Johannesburg, South Africa; Paris, France; and Stockholm, Sweden. IMSI develops
and publishes PC productivity software in the precision design (computer
assisted drawing), graphic design (visual content), business applications, and
utilities categories targeted to small to medium-size businesses, professionals,
and consumers.
BASIS OF PRESENTATION AND REALIZATION OF ASSETS
The financial statements have been prepared on a basis that contemplates IMSI's
continuation as a going concern and the realization of our assets and
liquidation of our liabilities in the ordinary course of business. We have an
accumulated deficit of $25,963,000 at June 30, 1999, and negative cash flows
from operations of $2,741,000 in fiscal 1999. IMSI is also in default of various
loan covenants. These matters, among others, raise substantial doubt about our
ability to remain a going concern for a reasonable period of time. The financial
statements do not include any adjustments relating to the recoverability or
classification of assets or the amounts and classification of liabilities that
might result from the outcome of this uncertainty. IMSI's continued existence is
dependent on its ability to obtain additional financing sufficient to allow it
to meet its obligations as they become due and to achieve profitable operations.
IMSI plans to meet its working capital needs in the coming fiscal year through
sales or license of the rights to its non-core products. As part of its
restructuring strategy, IMSI plans to reduce the number of its product
categories by approximately 75% through sales of its non-core product lines. To
this end, IMSI sold the rights to the Easy Language product for $1.7 million in
August 1999. Moreover, IMSI has engaged in, and expects to engage in,
discussions with third parties concerning sale of a material part of its
remaining non-core product lines. The sale of the rights to these products is
consistent with our strategy of focusing on our core products while
transitioning to the Internet. This strategy also includes reducing our costs
through manufacturing and warehouse outsourcing, facilities consolidation, and
personnel reductions.
IMSI has received $1.3 million in tax refunds in the first quarter of fiscal
year 2000 and $2.1 million in the second quarter of fiscal year 2000. We
anticipate that we will receive an additional $300,000 in income tax refunds in
fiscal year 2000. IMSI believes that the cash derived from the sale of non-core
product lines and its tax refunds will improve its working capital position
significantly. If our restructuring efforts succeed in improving our financial
performance, management believes it will be able to obtain the additional
financing our working capital needs require. There can be no assurance that we
will be successful in our efforts.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of IMSI and its
wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and the accompanying
notes. Significant estimates used in the consolidated financial statements
include the estimates of (i) doubtful accounts, sales returns, price protection
and rebates (ii) anticipated future gross revenues from products for which
software development costs have been capitalized, (iii) provision for income
taxes and realizability of the deferred tax assets, (iv) the life and
realization of identifiable intangible assets, (v) restructuring costs and (vi)
provisions for obsolete inventory. The amounts IMSI will
54
<PAGE> 55
ultimately incur or recover could differ materially from IMSI's current
estimates. The underlying assumptions and facts supporting these estimates could
change in fiscal 2000 or thereafter.
REVENUE RECOGNITION
Revenue is recognized when earned. For fiscal 1999 the Company has adopted
American Institute of Certified Public Accountants Statement of Position ("SOP")
97-2, Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2, With
Respect to Certain Transactions. Prior to fiscal 1999 the Company followed SOP
91-1. Revenue from packaged product sales to distributors, resellers and end
users is recorded when related products are shipped. For software delivered via
the Internet, revenue is recorded when the customer downloads the software.
Subscription revenue is recognized ratably over the contract period, generally
12 to 15 months. Revenue from hybrid products is allocated to the underlying
components based on the ratio of the value of each component to the total price
and that portion is recognized accordingly. Non-refundable advanced payments
received under license agreements are recognized as revenue when the customer
accepts the delivered software. Revenue from software licensed to developers,
including royalties earned in excess of non-refundable advanced payments, is
recorded as the developers ship products containing the licensed software. Costs
related to post-contract customer support, which are minimal and include limited
telephone support and on-line maintenance for certain products, are accrued.
Sales to distributors permit limited rights of return upon termination or when a
product is defective. Reserves for returns, price discounts and rebates are
estimated using historical averages and a consideration of open return requests.
Beginning with the quarter ended December 31, 1998, we also considered channel
inventories, recent product sell-through activity and market conditions in
establishing our reserves.
CONCENTRATIONS
Financial instruments that potentially subject IMSI to concentrations of credit
risk consist of cash and cash equivalents and accounts receivable. IMSI sells a
majority of its products to a limited number of distributors. At times, cash
balances held at financial institutions were in excess of federally insured
limits. We place our cash and cash equivalents at well-known, quality financial
institutions. Cash held at foreign locations totaled $959,000 as of June 30,
1999. Although IMSI maintains receivable insurance on its largest customers and
also performs ongoing credit evaluations in the normal course of business, it
generally requires no collateral on its product sales.
Two distributors accounted for more than 10% of IMSI's net revenue in fiscal
1999, 1998, and 1997. Ingram Micro represented 18.3%, 20.4% and 11.9% and Tech
Data represented 9.0%, 12.7% and 10.9% of IMSI's net revenues for fiscal 1999,
1998, and 1997 respectively.
ROYALTY AGREEMENTS
IMSI has entered into certain agreements whereby it is obligated to pay
royalties on software published. Royalties are generally paid based on a
percentage of sales on respective products or on a fee per unit sold basis.
Software royalties are expensed as product costs during the period in which the
related revenues are recorded.
CASH AND CASH EQUIVALENTS
IMSI considers all highly liquid investments purchased with an original maturity
of 90 days or less to be cash equivalents.
CAPITALIZED SOFTWARE DEVELOPMENT COSTS AND LICENSE FEES
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 in compliance
with Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting
for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed."
IMSI 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 at June
30, 1999 and 1998 were $8,289,000 and $5,261,000 respectively, less accumulated
amortization of $5,433,000 and $3,160,000, respectively.
IMSI amortizes capitalized software development costs on a product-by-product
basis. The amortization for each product is the
55
<PAGE> 56
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 36 months, depending on the product. IMSI 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.
Effective April 1, 1998, IMSI increased the amortization period from 18 to 36
months for costs related to visual content license fees. IMSI now adheres to a
36 month amortization period for all visual content license fees, excluding
those visual content assets obtained in the Zedcor, Inc. acquisition (see Note
3). These Zedcor, Inc. acquisition costs are being amortized over 60 months.
Total amortization expense of capitalized software and license fees, all of
which was charged to product costs, was $3,000,000, $1,196,000, and $224,000 in
fiscal years 1999, 1998, and 1997, respectively.
INVENTORIES
Inventories, consisting primarily of diskettes, manuals, hardware, freight in,
production costs and packing supplies, are valued at the lower of cost or market
and are accounted for on the first-in, first-out basis. Management performs
periodic assessments to determine the existence of obsolete, slow moving and
non-salable inventories, and records necessary provisions to reduce such
inventories to net realizable value.
IMSI reserves a portion of its inventory book value to account for anticipated
inability to sell some products at a net realizable value greater than their
recorded cost. Reserves for non-core products, products that IMSI will continue
to sell in the normal course of business but will no longer manufacture or
actively market, have been increased $2,184,000 as part of IMSI's restructuring.
Other products in IMSI's inventory that are no longer being sold are fully
reserved. All inventory reserves are recognized as a component of cost of goods
sold.
FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost. Depreciation of furniture and
equipment is computed using the straight-line method over the estimated useful
lives of the respective assets of 3 to 5 years. Depreciation of software and
computer equipment is computed using the straight-line method over an estimated
useful life of 3 years.
INCOME TAXES
Income taxes are accounted for using the asset and liability approach for
financial reporting. IMSI recognizes deferred tax liabilities and assets for the
expected future tax consequences of temporary differences between the financial
statement carrying amount and the tax basis of assets and liabilities and net
operating loss and tax credit carry forwards. Valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected
to be realized.
FOREIGN CURRENCY TRANSLATION
The asset and liability accounts of foreign subsidiaries are translated from
their respective functional currencies at the rates in effect at the balance
sheet date, and revenue and expense accounts are translated at weighted average
rates during the periods. Foreign currency translation adjustments are included
in other comprehensive income. Foreign currency transaction gains and losses are
included in the Statement of Operations.
LONG LIVED ASSETS
IMSI follows SFAS No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets To Be Deposed Of which requires that long-lived
assets, certain identifiable intangibles, and goodwill related to those assets
be written down to fair value whenever events or changes indicate that the
carrying amount of an asset may not be recoverable. IMSI's policy is to review
the recoverability of all intangible assets at a minimum of once per year and
record an impairment loss when the undiscounted cash flows do not exceed the
carrying amount of the asset.
FAIR VALUE OF FINANCIAL INSTRUMENTS
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<PAGE> 57
The fair value of cash and cash equivalents, accounts receivable and accounts
payable approximates carrying value due to the short-term nature of such
instruments. The fair value of long-term obligations are not determinable due to
covenant defaults.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the AcSEC issued SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. This statement requires
companies to capitalize qualifying computer software costs incurred during the
application development stage and amortize them over the software's estimated
useful life. IMSI currently capitalizes the costs associated with developing or
purchasing internal use software and amortizes these costs over the software's
estimated useful life.
In June 1998, The Financial Accounting Standards Board ("FASB") issued SFAS No
133, Accounting for Derivative Instruments and Hedging Activities, which defines
derivatives, requires that all derivatives be carried at fair value and provides
for hedge accounting when certain conditions are met. SFAS No. 133, as amended
by SFAS No. 137, is effective for IMSI in fiscal 2002. Although IMSI has not
fully assessed the implications of SFAS No. 133 as amended, IMSI does not
believe that the adoption of this statement will have a material effect on
financial condition or results of operations.
RECLASSIFICATIONS
Certain fiscal 1998 and 1997 amounts have been reclassified to conform to the
fiscal 1999 presentation.
2. RESTRUCTURING CHARGE
In response to its large year to date losses in fiscal year 1999, IMSI initiated
a company-wide restructuring of its operations. After approval by IMSI's Board
of Directors, IMSI announced on June 24, 1999 that it had completed development
of its plan of restructuring. The major actions of the restructuring plan were
as follows:
- Manufacturing and warehouse outsourcing.
- Facilities consolidation.
- Personnel reductions.
- Divestiture of non-core products and focus on core product lines.
IMSI began its restructuring in June 1999 and anticipates completing its
restructuring by the end of the fiscal year 2000. Restructuring costs of
$3,271,000 that would have been recognized through cost of sales in the normal
course of business (inventory, royalties, license fees, capitalized software,
warehouse costs, warehouse outsourcing costs) are included in the income
statement as a component of costs of goods sold.Restructuring costs of
$1,508,000 that would have been reported as operating expenses in the normal
course of business are reported in the income statement under the "restructuring
charge" line item.
The fair value of furniture, fixtures, equipment and leasehold improvements not
associated with specific product lines was based on current market prices for
used equipment and furniture, less disposal costs. The fair value of the
intangible assets associated with the non-core product lines held for sale,
including EZ Language and business utility product lines, was determined from
pending discussions with potential purchasers of these product lines.
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<PAGE> 58
The following table details the restructuring charge by segment and the
components that comprise the operating expense and costs of goods sold. For a
complete description of the items in the table, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
(in thousands) COST OF GOODS SOLD OPERATING EXPENSE
North North
America UK America UK Total
-------------------------------------------------
<S> <C> <C> <C> <C> <C>
Write down of inventory of non-core $2,096 $88 $2,184
products
Write down of intangibles associated with
non-core products, total:
License Fees 217 217
Goodwill 5 5
Prepaid Royalties 143 143
Capitalized Software 159 159
Write down of furniture, fixtures,
equipment and leasehold improvements:
Novato -
Computers and peripherals 150 150
Tenant improvements 139 139
Furniture and fixtures 109 109
Vacaville & Albuquerque -
Furniture and fixtures 25 25
U.K. -
Furniture and fixtures 41 41
Abandoned leases and associated costs:
Novato -
Rent 180 180
Broker's fee 65 65
Excess furniture lease 14 14
Additional walls and doors 29 29
Miscellaneous charges 3 3
Vacaville warehouse -
Rent 249 249
Broker's fee 103 103
Albuquerque tech support facility 110 110
U.K. -
Rent 6 6
Labor cost for shutdown of office 19 19
Warehouse transition costs 284 284
Personnel reduction and severance costs:
U.S. 35 470 505
U.K. 41 41
-------------------------------------------------
$3,183 $88 $1,402 $107 $4,780
</TABLE>
58
<PAGE> 59
In accordance with EITF 94-3, the restructuring charges recognized as of June
30, 1999, are not associated with or do not benefit activities that will be
continued and are not associated with or are not incurred to generate revenues
after the restructuring plan's commitment date. These costs are either
incremental to other costs incurred by IMSI in the conduct of its activities
prior to the commitment date and will be incurred as a direct result of the
restructuring plan or represent amounts under a contractual obligation that
existed prior to the commitment date and will either continue after the
restructuring plan is completed, with no economic benefit to the enterprise, or
IMSI will incur a penalty to cancel the contractual obligation.
As part of the restructuring plan, IMSI planned to terminate 90
employees by the end of fiscal year 2000 in the following departments:
sales and marketing (22); general and administrative (8); manufacturing
(23); and research and development (37). Our total restructuring charge
relating to personnel reduction and severance costs was $546,000, of
which $505,000 applied to the U.S. segment and $41,000 to the U.K.
segment. These costs were recorded as operating expenses. We also
forgave a $35,000 note receivable from a shareholder and company
executive who was terminated as part of the restructuring. We recorded
this amount as a cost of goods sold.
The following chart summarizes the cash and non-cash portions of the
restructuring charge (in thousands):
<TABLE>
<CAPTION>
Cash Non-Cash Total
<S> <C> <C> <C>
Write down of inventory for non-core products $ -- $2,096 $2,096
Write down of furniture, fixtures, equipment -- 423 423
and leasehold improvements
Write down of intangibles associated with -- 525 525
non-core products
Abandoned leases and associated costs 753 -- 753
Warehouse transition costs 284 -- 284
Personnel reduction and severance costs 469 35 504
------ ------ ------
U.S. Segment Subtotal 1,506 3,079 4,585
------ ------ ------
Foreign 107 88 195
------ ------ ------
Total restructuring charge: $1,613 $3,167 $4,780
====== ====== ======
</TABLE>
3. ACQUISITIONS
Zedcor, Inc.
In October 1998, IMSI acquired all the outstanding common stock of Zedcor, Inc.,
an Internet provider of art and animations. The total purchase price of $3.5
million consisted of $970,000 in IMSI stock (176,455 shares at $5.50 per share),
$300,000 in cash (paid by IMSI in November 1998), and $2,230,000 payable
pursuant to an 8% secured promissory note. The original repayment terms for the
promissory note called for quarterly payments of $188,000 of principal, plus
interest accrued as of the date of payment. The note also called for full
payment on the sooner of: (1) 36 months from the closing, (2) any increase in
the capital of IMSI by a new stock offering in excess of 20% of the then
outstanding shares of common stock, (3) the sale of substantially all of the
assets of IMSI or (4) the merger of IMSI with another entity. As of June 30,
1999, the note balance was satisfied by IMSI (see Note 7, "Zedcor Fee
Agreement"). The operating results of Zedcor are included in the statement of
operations from the date of acquisition. The purchase price for Zedcor, Inc. was
allocated as follows:
<TABLE>
<S> <C>
Net working capital $ 93,000
Capitalized software development costs (visual content products) 3,000,000
Goodwill 407,000
----------
$3,500,000
==========
</TABLE>
59
<PAGE> 60
Pro forma results of operations for fiscal 1998 (as restated), assuming that the
Zedcor acquisition occurred at the beginning of each year would be as follows
(in thousands except per share amounts). Pro forma results for fiscal 1999 would
not be materially different from those reported and are not presented:
<TABLE>
<CAPTION>
1998 (Unaudited)
----
<S> <C>
Revenues $62,988
Income (loss) before taxes (978)
Net income (loss) (538)
Diluted earnings (loss) per share $ (0.10)
</TABLE>
Org Plus
On March 13, 1998, IMSI sold the rights to Family Heritage, a product acquired
from Corel Corp. in September 1997, to Mindscape, Inc., which was subsequently
acquired by The Learning Company ("TLC"), for a purchase price of $2.5 million
(plus $115,000 for inventories and prepaid royalties). The purchase price was
split into four equal payments of $625,000, the first of which was paid upon
closing, and the second payment was paid July 15, 1998. The remaining
installments were due October 15, 1998, and January 15, 1999. However, no
separate notes payable for such amounts were issued by Mindscape. On September
29, 1998, TLC paid IMSI approximately $1.7 million representing amounts due to
IMSI, from the Family Heritage sale ($1,250,000) and other existing contractual
agreements ($430,000). On October 2, 1998, TLC and IMSI entered into a software
license agreement whereby TLC sold Org Plus to IMSI in exchange for $3.5 million
as follows: $1.7 million paid by IMSI on October 2, 1998, and $450,000 payments
due on each of January 1, 1999, April 1, 1999, July 1, 1999, and October 1,
1999. The September 29, 1998 $1.7 million cash receipt from TLC and the $3.5
million October 2, 1998 purchase of Org Plus from TLC were accounted for as one
transaction; accordingly, IMSI recorded the acquisition of Org Plus at a net
amount of $1.8 million, with $900,000 allocated to goodwill and $900,000
allocated to capitalized brand names. No revenue was recognized by IMSI as a
result of these transactions.
In January 1999, IMSI and TLC agreed to amend the terms of the Org Plus
agreement to allow IMSI to settle the $1.8 million cash obligation by the
issuance of 200,000 shares of IMSI common stock. The January Fee Agreement
required IMSI to file a registration statement by February 28, 1999, but it did
not specify a remedy if IMSI failed to do so.
In April 1999, IMSI agreed that if TLC sells any shares within 30 days following
the effectiveness of a registration statement covering the 200,000 shares, IMSI
will pay TLC the difference between the sales price and $8.50 per share, such
payment to be made either in cash, or by issuing additional shares based on the
average share price during the thirty day price protection period, at IMSI's
option. This April amendment required IMSI to file a registration statement by
May 15, 1999 and to use its "best efforts" to have the registration statement
declared effective by July 31, 1999. The April Amendment did not specify any
remedy if IMSI did not file the registration statement or have it declared
effective by the respective dates.
Based on the June 30, 1999 share price, IMSI was contingently liable to pay TLC
$725,000 under the April Amendment protection clause. IMSI filed a registration
statement on June 8, 1999 for the 200,000 shares, but that registration
statement is not yet effective.
.
On August 27, 1999, TLC (now owned by Mattel) served upon IMSI an arbitration
demand based on allegations that IMSI failed to timely file the registration
statement and asserting that the original obligation was revived. Management
believed that it had reached an agreement in principal with Mattel for the
issuance of 300,000 additional shares of common stock in satisfaction of its
claim. However, no written agreement has been executed between the parties.
In September 1999, IMSI and TLC orally agreed that, in consideration for 300,000
shares and the waiver of a $200,000 receivable due from TLC, TLC would not
terminate the April agreement and seek $1.8 million in cash and that it would
60
<PAGE> 61
deem any claim that TLC may have for additional shares to be satisfied. No
written agreement was executed and no shares have been delivered.
In view of the length of time that has passed since TLC and IMSI reached a
verbal agreement, during which time IMSI's stock price has fallen and TLC's
current shares remain unregistered, it is unlikely that TLC will continue to
accept 300,000 shares in satisfaction of all claims. The nature of the claims
that TLC might assert based on the agreements described above, and the
resolution of these potential claims, is highly speculative. Based on the terms
of the April agreement, no penalties have been incurred. The price protection
feature of the April agreement is contingent and a charge will be taken at the
time the contingency is resolved.
Fiscal Year 1998
During the first quarter of fiscal year 1998, IMSI completed the
following four acquisitions accounted for using purchase accounting. The
aggregate purchase prices for the acquisitions were comprised, and allocated, 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>
ALLOCATION OF AGGREGATE PURCHASE PRICES OF ACQUISITIONS
<TABLE>
<CAPTION>
PURCHASED IN-PROCESS
RESEARCH AND
SELLER DEVELOPMENT CAPITALIZED SOFTWARE GOODWILL
-------------------- -------------------- -------
<S> <C> <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>
ACQUISITION OF PRODUCTS AND IN-PROCESS TECHNOLOGIES FROM COREL CORPORATION
On September 30, 1997, the Company acquired the rights to three completed
products (Corel(R)Flow, Lumiere(TM) and Family Heritage(TM)(formerly, Corel
Family Tree(TM))) and four in-process technologies (CorelCAD(TM), Corel Click
and Create(TM), Visual CADD(TM) and Corel Personal Architect(TM)) in the CAD,
diagramming and consumer categories from Corel (the "Acquisition"), for $5
million in IMSI common stock (346,020 shares valued at approximately $14.45 per
share) and $640,000 in notes payable due in two installments, $140,000 due in
March 1998 (which was paid on June 3, 1998 with the proceeds from the Company's
borrowings under its new May 4, 1998 bank credit line), and $500,000 due in
September 1998. The Company allocated the $5,640,000 as described below, based
upon a discounted net cash flow analysis utilizing management's estimates and
costs to enable such technologies to reach technological feasibility and upon a
valuation.
The discounted net cash flow analysis as of September 30, 1997 was based upon
management's estimates of future net revenues from each of the three products
and four in-process technologies over the next four fiscal years, based upon
expected product costs and other operating expenses. The expected future net
cash flows were discounted using a 23% rate from in process technologies and 18%
for existing products.
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<PAGE> 62
As of September 30, 1997, the Company estimated that total future revenues from
all seven products/technologies acquired from Corel could exceed approximately
$20 million (approximately $17 million related to the in-process technologies
and approximately $3 million related to the developed technologies) over the
next four fiscal years. This is a forward-looking statement. There can be no
assurance that any revenues from such products/technologies will be generated by
the Company.
- $5,044,000 relating to the four in-process technologies was expensed as
purchased in-process research and development in the quarter ended September
30, 1997. At the time of the Acquisition, the Company determined that the
technological feasibility of the four in-process technologies had not yet
been established and that, as of September 30, 1997, such technologies had
no alternative future uses. These technologies required additional research
and developmental efforts to develop these products into commercially viable
products. From September 30, 1997 through June 30, 1998, the Company spent
approximately $300,000 on research and development to have the four
in-process technologies reach technological feasibility. CorelCAD products
(now called TurboCAD Solid Modeler and TurboCAD 3D Modeler) were released in
March 1998. Sales for the two products for fiscal year ended June 30, 1998
were approximately $700,000 and approximately $100,000 in fiscal year 1999.
Products called Click and Create and Personal Architect were released in
June 1998. Click and Create, now called Multimedia Fusion, had sales of
$244,000 in fiscal year 1998 and $340,000 in fiscal year 1999. The relevant
technology in Personal Architect was included in the new version of
Floorplan. Floorplan sales totaled $13,166,000 in fiscal year 1999. Visual
CADD (version 3) was released in the second quarter of fiscal year 1999 and
had fiscal year 1999 sales of $419,000.
- $517,000 relating to the three completed products was allocated to
capitalized software to be amortized over the shorter of the period of
expected revenues or 18 months, pursuant to the Company's amortization
policy for capitalized software development costs discussed in Note 1. The
Family Heritage product was released in two versions, Family Heritage and
Family Heritage Deluxe, which were released in November and December 1997,
respectively. The Company had net revenues of approximately $300,000 from
Family Heritage products during the fiscal year 1998. The Family Heritage
product was sold on March 13, 1998. The Company released products formerly
known as Lumiere and Flow in June 1998. Sales of Lumiere and Flow in fiscal
year 1999 were $385,000 and $634,000, respectively.
- $79,000 was allocated to goodwill to be amortized over 3 years.
ACQUISITION OF PRODUCTS AND IN-PROCESS TECHNOLOGIES FROM QUARTERDECK CORPORATION
On July 1, 1997, the Company acquired certain products and in-process
technologies from Quarterdeck, who was subsequently purchased by Symantec, for a
cash payment of $1 million. The Company utilized a discounted net cash flow
model with various estimates and assumptions to allocate the purchase price. The
discounted net cash flow analysis as of July 1, 1997 was based upon management's
estimates of future net revenue from the products/technologies over the next
three fiscal years, based upon expected unit sales and average selling prices of
comparable products, expected product costs and other operating expenses. The
expected future net cash flows were discounted using a 23% rate for in-process
technologies and 18% for existing products. Based upon the Company's estimates
of future cash flows and costs to have certain of these technologies reach
technological feasibility and based upon a valuation, the Company allocated the
purchase price as follows:
- $517,000 was allocated to purchased in-process research and development
related to Quarterdeck's "EZ Impact" technology. At the time of the
acquisition, management believed that technological feasibility of EZ Impact
had not yet been established and that, as of July 1, 1997, this technology
had no alternative future uses. The most significant estimate made by the
Company in determining the amount to be allocated to in-process research and
development was that the Company estimated future net revenues from EZ
Impact over the next three years, based upon expected unit sales and average
selling prices of comparable products. After the Company's in-depth review
of the competitive marketplace and the state of the EZ Impact technology
acquired in late calendar 1997, the Company determined that EZ Impact would
not ever become an economically viable product and abandoned further
development efforts.
- $483,000 was allocated to capitalized software to be amortized over the
shorter of the life of the products' expected revenues or 18 months,
pursuant to the Company's amortization policy for capitalized software
development costs discussed in Note 1. Such capitalized software related to
Quarterdeck's product Hijaak Pro. During the fiscal year ended June 30, 1998
and 1999, the Company had net revenues from Hijaak Pro of approximately $2.0
million and $1.2 million, respectively.
- ACQUISITION OF PRODUCTS AND IN-PROCESS TECHNOLOGIES FROM MAPLINX CORPORATION
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On July 1, 1997, the Company acquired certain products and in-process
technologies from MapLinx Corporation for a total purchase price of $850,000 as
follows: $233,500 in cash, a note payable for $233,500 and $383,000 in assumed
net liabilities. The Company utilized a discounted net cash flow model with
various estimates and assumptions to allocate the purchase price. The discounted
net cash flow analysis as of July 1, 1997 was based upon management's estimates
of future net revenues from the product/technologies over the next three fiscal
years, based upon expected unit sales and average selling prices of comparable
products, expected product costs and other operating expenses. The expected
future net cash flows were discounted using a 23% rate for in-process
technologies and 18% for existing products. Based upon the Company's estimates
of future cash flows and costs to have certain technologies reach technological
feasibility and based upon a valuation, the Company allocated the purchase price
between two products, MapLinx Mail Manager and MapLinx, and goodwill as follows:
- $506,000 was allocated to purchased in-process research and development
related to MapLinx Mail Manager. At the time of the acquisition, management
believed that technological feasibility of MapLinx Mail Manager had not yet
been established and that, as of July 1, 1997, these technologies had no
alternative future uses. This technology required additional research and
developmental efforts to develop these products into commercially viable
products. During the fiscal years ended June 30, 1998 and 1999, the Company
spent approximately $120,000 and $80,000, respectively, on research and
development. MapLinx Mail Manager was released in the second quarter of
fiscal 1999. Revenue from MapLinx Mail Manager totaled $394,000 in fiscal
year 1999.
- $331,000 was allocated to capitalized software related to the MapLinx
product, to be amortized over the shorter of the life of the period of
expected revenues or 18 months, pursuant to the Company's amortization
policy for capitalized software development costs discussed in Note 1.
During the fiscal year ended June 30, 1998, the Company had net revenues
from MapLinx of approximately $1.5 million. MapLinx had revenues of $439,000
in fiscal year 1999.
- $13,000 was allocated to goodwill to be amortized over three years.
ACQUISITION OF MEDIAPAQ, INC.
On August 22, 1997, the Company acquired 100% of the common stock of MediaPaq
for a total purchase price of $400,000 as follows: $240,000 in IMSI common stock
(20,000 shares at $12.00 per share) and $160,000 in assumed liabilities.
MediaPaq's products and in-process technologies consisted primarily of browser
software features that the Company believed it could incorporate into existing
products and future products under development in the Company's MasterClips
family of products. The expected future net cash flows as of August 22, 1997
were based upon management's estimates of future net revenues from the
product/technologies, based upon expected unit sales and average selling prices
of comparable products, expected product costs and other operating expenses. The
expected future net cash flows were discounted using a 23% rate for in-process
technologies and 18% for existing products. Based upon the Company's estimates
of future cash flows and costs to have certain of MediaPaq's products and
in-process technologies reach technological feasibility, the Company allocated
the purchase price as follows:
- $300,000 was allocated to purchased in-process research and development
related to browser software features that were expected to be incorporated
into the next version of MasterClips. At the time of the acquisition,
management believed that technological feasibility of certain of the
acquired technologies had not yet been established and that, as of August
22, 1997, these technologies had no alternative future uses. This technology
required additional research and developmental efforts to develop these
products into commercially viable products. From August 22, 1997 through
March 1998, the Company spent approximately $100,000 on research and
development to have the in-process technologies reach technological
feasibility. In March 1998, the Company released MasterClips 303,000
incorporating such browser software features.
- $100,000 was allocated to capitalized software related primarily to browser
software features that were incorporated into existing products MasterClips
202,000 and MasterClips 150,000 to be amortized over the shorter of the
products' expected revenues or 18 months, pursuant to the Company's
amortization policy for capitalized software development costs discussed in
Note 1.
- Sales of MasterClips family products totaled $17 million in fiscal 1998 and
$12 million in fiscal 1999.
4. AMENDED BANK LINE OF CREDIT AND TERM LOAN
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On May 4, 1998 IMSI entered into a line of credit agreement with Union Bank of
California ("Union") under which it could borrow the lesser of $13.5 million or
80% of eligible accounts receivable, at Union's reference rate plus 1/2 % or
LIBOR plus 2 %, at IMSI's option. We borrowed up to approximately $10.0 million
under the line of credit agreement. Union also provided IMSI a $1.5 million term
loan at the same interest rate. The line of credit was to expire on October 31,
1999 and the repayment of the term loan was due on the same date. Due to IMSI's
defaults under the agreements, the line of credit was revised as of September
24, 1998 to a non-revolving, reducing loan with no further borrowings available.
The interest rate was set at Union's reference rate plus 3%. The amended loan
agreements require IMSI to comply with certain financial covenants including
maintenance of net worth and working capital requirements. The revised loans
were due on September 30, 1999. Under the terms of the agreements, all assets
not subject to liens of other financial institutions have been pledged as
collateral against the loans.
As of September 30, 1999, IMSI is in default of many of these covenants. IMSI
reduced the debt owed to Union to approximately $4.8 million. IMSI anticipates
it will be able to repay the remaining amount owed to Union with proceeds to be
received from non-core product line sales or license. Given the intent of IMSI
to repay Union with such proceeds, IMSI is negotiating with Union to obtain a
60-day forbearance to provide time to allow IMSI to cure its defaults.
5. SUBORDINATED LOAN FACILITY WITH WARRANTS
On November 3, 1998, IMSI borrowed $2.5 million under a three-year subordinated
loan facility with Silicon Valley Bank. The interest rate is 12%. As part of the
loan facility, detachable warrants, which have a five-year term, are issuable to
purchase shares of IMSI's common stock as follows:
<TABLE>
<CAPTION>
If not paid in full prior to: Warrants to be issued Exercise price per share
----------------------------- --------------------- ------------------------
<S> <C> <C>
November 3, 1998 30,000 $7.00
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>
Management estimated that the fair value of the warrants, using the Black
Scholes option-pricing model, was $776,000. This value will be recorded as
additional interest expense over the life of the loan. IMSI has recorded
interest expense of $172,000 for the year ended June 30, 1999 for these
warrants. The valuation assumes the loan will not be repaid until November 3,
2001 and all warrants will be issued. The assumptions used in the valuation were
exercise of the warrants at expiration, 57% volatility and a risk-free interest
rate of 5.5%
6. SUBORDINATED CONVERTIBLE DEBT
On May 24, 1999, IMSI entered into a securities purchase agreement and related
agreements with BayStar Capital, L.P. ("BayStar"). We issued BayStar a three
year $5 million principal amount 9% Senior Subordinated Convertible Note, due
May 24, 2002 with interest paid quarterly. The note is convertible, at BayStar's
option, into shares of common stock at any time at an initial conversion price
of $ 7.5946 per share, which is 115% of the market price of the common stock on
the closing date of the transaction. We agreed to register the shares issuable
to BayStar.
The conversion price is subject to adjustment if we issue or sell stock in
defined transactions for less than the conversion price. Additionally, on the 12
month anniversary of the closing date, if the market price of the common stock
is lower than $6.604, then the conversion price will be adjusted to the greater
of (i) 115% of the average of the price of the common stock for the twenty (20)
trading days immediately preceding May 24, 2000 or (ii) $4.6228. The trading
value of its common stock on the date of issuance of the subordinated
convertible debt was $6.50. The value of the contingent beneficial conversion
feature at the date of commitment, and the potential charge to earnings, is
$2,030,000.
BayStar also received a warrant to purchase 250,000 shares of common stock at an
initial exercise price of $7.5946. Management estimated that the fair value of
the warrants, using the Black Scholes option-pricing model, was $1,162,000. This
value will be recorded as additional interest expense over the life of the loan.
IMSI has recorded interest expense of $65,000 for the year ended June 30, 1999
for this warrant. The assumptions used in the valuation were exercise of the
warrants at expiration, 105% volatility and a risk-free interest rate of 5.5%.
We may be required to issue additional shares depending on
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<PAGE> 65
the occurrence of specified events, including the failure to make timely
interest payments on the convertible note. In particular, in lieu of any late
interest payment, we may be required to issue shares of common stock to BayStar
equal to 200% of the amount of the late interest payment divided by the closing
price of the common stock on the date prior to payment. Furthermore, we may need
to adjust the stated interest rate, adjust the conversion price of the note,
adjust the exercise price of the warrant, or issue additional shares to prevent
dilution resulting from stock splits, stock dividends or other equity or debt
placements. A penalty of 1% of the principal amount per month accrues for each
month subsequent to September 21, 1999 until the shares to be issued to BayStar
are included in an effective registration statement. A registration statement on
Form S-3 was filed on June 25, 1999 which includes 1,375,000 shares of stock
issuable to BayStar, but that registration statement is not yet effective.
7. COMMON STOCK
On June 30, 1999, IMSI sold images to Corel Corporation in consideration for
20,000 of shares of IMSI common stock, out of a total of 346,020 shares Corel
acquired in September 1997 in connection with the purchase of several product
lines. The value attributed to the 20,000 shares ($320,000), and the images
sold, was the trading price of the shares on June 30, 1999. This royalty
transaction was among those transactions for which IMSI determined that revenue
should have been deferred to a subsequent period, as described in Note 16.
Shares of common stock were issued as a result of the following agreements that
IMSI entered into during fiscal year 1999:
Zedcor Fee Agreement. On February 25, 1999, IMSI entered into a fee agreement
with the former shareholders of Zedcor. Under the terms of the Zedcor Fee
Agreement, IMSI issued 150,321 shares of common stock, with a market value of
$11.44 per share, in satisfaction of $1,503,000 (less total cash payments of
$727,000) owed to the former shareholders of Zedcor under the terms of the
acquisition described in Note 3. In May 1999, IMSI agreed with the former Zedcor
shareholders to issue an additional 50,476 shares of common stock, valued at the
market price of $6.56 per share. Of the 50,476 shares issued, IMSI issued 40,476
shares under the Fee Agreement and 10,000 shares in consideration of the release
of a security interest held by the former Zedcor shareholders. We recognized a
charge of $311,000 upon the issuance fo the 50,476 shares.
The May 1999 amendments to the Zedcor Fee Agreement provide for the issuance of
additional shares if the average market price of IMSI stock is less that $8 per
share three days before the registration of the shares issued is declared
effective. This price protection applies only to the 190,797 shares issued for
the (i) conversion of the note balance into 150,321 shares, and (ii) the
issuance of the additional 40,476 shares under the May amendments to the Zedcor
Fee Agreement.
Asset Purchase Agreement. On December 24, 1998, IMSI purchased certain assets of
Clipartconnection.com, an Internet provider of art and animation, for a purchase
price of 18,053 shares of common stock valued at $150,000.
Garay Fee Agreement. On January 11, 1999, IMSI entered into a fee agreement with
the Law Offices of Mark Garay, Inc. ("Garay") Under the terms of the Garay Fee
Agreement, IMSI issued 11,112 shares of common stock, valued at $10.25 per
share, in satisfaction of a $100,000 debt owed for legal services performed.
TLC Fee Agreement. On October 2, 1998, The Learning Company ("TLC") and IMSI
entered into a software license agreement whereby TLC sold Org Plus to IMSI in
exchange for current and future cash payments. In January 1999, IMSI and TLC
agreed to amend the terms of the Org Plus agreement to allow IMSI to settle the
$1.8 million portion of the unpaid purchase price by the issuance of 200,000
shares of common stock, valued at $12.00 per share. See Note 3, above. See also
"Future Performance and Additional Risk Factors - Potential Penalties for
Agreements Relating to Registration of Shares."
Greentree Fee Agreement. On February 18, 1999, IMSI entered into a fee agreement
with Greentree to satisfy a $150,000 debt owed to Greentree under the terms of a
software license agreement between IMSI and Greentree. In settlement of this
debt, IMSI issued to Greentree 18,053 shares, valued at $11.00 per share.
65
<PAGE> 66
Capital Ventures International Agreement. On March 3, 1999, we entered into a
stock purchase agreement with Capital Ventures International ("CVI"). CVI paid
us $5 million and we issued 437,637 shares of our common stock, valued at $11.42
per share.
The agreement required us to issue additional shares to CVI if the market price
of our common stock on future dates before March 4, 2000 is less than $11.42.
Our obligation to issue additional shares to CVI is subject to a share limit,
initially defined as an additional 187,558 shares, which may be increased if we
conduct an equity or convertible rights transaction, within defined parameters,
on or before March 4, 2000.
Additionally, either 18 months after March 3, 1999, or if we announce within
that time period a capital transaction as defined in the agreement, then CVI can
purchase up to $3 million worth of additional shares of our common stock, at a
price initially defined as not less than $7.9975, which allows CVI to purchase a
maximum of 375,117 additional shares. The price for the optional purchase of
additional shares may be adjusted, with provisions that protect CVI against
dilution by a stock split, and ensure that CVI will realize the benefit of any
merger or distribution of shares.
CVI also received a warrant to purchase 131,291 shares of common stock with an
initial exercise price of the warrant of $14.8525 per share. The warrant expires
March 5, 2003. The warrant may be exercised at any time after March 3, 2000, or
earlier in the event we have a capital transaction as defined in the agreement.
The initial exercise price is $14.8525 per share. The exercise price and number
of shares issued is subject to adjustment with anti-dilution provisions similar
to the provisions for the optional additional share purchase.
We believed a total of 1,131,603 shares were potentially issuable to CVI. We
filed a registration statement on Form S-3 on June 8, 1999 for that number of
shares, but that registration statement is not effective. Under the agreement
with CVI, if the registration statement was not declared effective before July
3, 1999, then we are obligated to pay CVI one percent of the amount invested by
CVI for the first month after July 3, 1999, and two percent for each month
thereafter until the registration statement is declared effective.
Homestyles Agreement. On January 11, 1999, IMSI entered into a fee agreement
with Homestyles to satisfy a $90,000 debt IMSI owed under the terms of various
software license agreements. In settlement of this debt, IMSI issued 10,000
shares of common stock, valued at $10.25 per share.
Minnevich Agreement. On January 11, 1999, IMSI entered into a fee agreement with
Minnevich to satisfy a $45,000 debt owed under the terms of various software
license agreements. In settlement of this debt, IMSI issued 5,000 shares of
common stock, valued at $10.25 per share.
Gateway Agreement. On March 1, 1999, IMSI entered into a fee agreement with
Gateway to satisfy a $72,000 debt owed under the terms of various manufacturing
agreements. In settlement of this debt, IMSI issued 8,000 shares of common
stock, valued at $11.438 per share.
Spatial Agreement. On March 25, 1999, IMSI entered into a fee agreement with
Spatial to satisfy a $45,000 debt owed under the terms of various software
license agreements. In settlement of this debt, IMSI issued 5,000 shares of
common stock, valued at $11.25 per share.
StarBase Agreement. On March 26, 1999, IMSI entered into a fee agreement with
StarBase to satisfy a $121,000 debt owed under the terms of various software
license agreements. In settlement of this debt, IMSI issued 10,750 shares of
common stock, valued at $10.25 per share.
66
<PAGE> 67
Americ Disc Agreement On April 5, 1999, IMSI entered into a stock transfer
agreement with Americ Disc to satisfy a $700,000 debt owed for an outstanding
balance relating to duplication services. In settlement of this debt, IMSI
issued 63,987 shares of common stock, valued at $10.94 per share. Additionally,
Americ Disc received warrants to purchase 13,000 shares at $14.23 exercisable
for a period of four years.
Software Syndicate Fee Agreement. On June 7, 1999, IMSI entered in a fee
agreement with Software Syndicate to satisfy a $152,000 debt owed under terms of
various license agreements. In settlement, IMSI issued 21,690 shares of common
stock, valued at $7.00 per share.
Pursuant to the agreements described above, IMSI issued 503,913 shares, whose
cumulative value based on the closing price of the common stock on the date of
settlement was $5,696,000, to retire debt totalling $4,778,000. Because the
value of the shares issued was $918,000 greater than the face value of the
respective debt retired, IMSI recorded an extraordinary charge for the
extinguishment of debt of $959,000, or $0.15 per share, after including $41,000
for the costs incurred to issue and register the shares. This is summarized in
the following table:
<TABLE>
<CAPTION>
Face Difference
Number of Closing Closing Value of in
Shares Issued Price Value Debt Values
------------- ------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Zedcor Fee Agreement 150,321 $11.44 $1,720,000 $1,503,000 $217,000
Garay Fee Agreement 11,112 10.25 114,000 100,000 14,000
TLC Fee Agreement 200,000 12.00 2,400,000 1,800,000 600,000
Greentree Fee Agreement 18,053 11.00 199,000 150,000 49,000
Homestyles Agreement 10,000 10.25 103,000 90,000 13,000
Minnevich Agreement 5,000 10.25 51,000 45,000 6,000
Gateway Agreement 8,000 11.44 91,000 72,000 19,000
Spatial Agreement 5,000 11.25 56,000 45,000 11,000
StarBase Agreement 10,750 10.25 110,000 121,000 (11,000)
Americ Disc Agreement 63,987 10.94 700,000 700,000 0
Software Syndicate 21,690 7.00 152,000 152,000 0
------- ---------- ---------- --------
Total: 503,913 $5,696,000 $4,778,000 $918,000
======= ========== ========== ========
Cost of registration/issuance 41,000
---------
Total extraordinary charge $959,000
========
</TABLE>
IMSI had originally determined that the extraordinary charge related to the
extinguishment of debt amounted to $1,398,000. This amount was reduced to
$959,000 after IMSI reviewed the calculation of the loss associated with the
Zedcor Fee Agreement. The 1999 financial statements reflect the reduction of the
extraordinary loss to $959,000.
8. SEGMENT INFORMATION
IMSI has four reportable operating segments: North America, the United Kingdom,
Germany and Australia Each segment generates revenues and incurs expenses
related to the sale of our PC productivity software. Revenues and expenses
related to our expansion to the Internet are not material and are included in
the results of North America. IMSI has determined that the chief operating
decision maker is the Company's CEO who regularly reviews separate country
profit and loss reports. For purposes of reporting segment information under
SFAS No. 131, we have combined those countries that do not meet the quantitative
threshold in "Rest of World." General and administrative costs at the corporate
level, interest expense and the amortization of intangibles, capitalized
software development costs and license fees are not allocated to individual
countries and are included in the North America segment. Intangible assets are
included in the assets of the North America segment and are not allocated to the
other segments. Inter-segment revenues represent sales between segments and are
accounted for at cost plus a predetermined margin. The inter-segment
transactions are eliminated in the preparation of the consolidated financial
statements.
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<PAGE> 68
The following table details segment information as of and for the years ended
June 30 as follows (in thousands):
68
<PAGE> 69
<TABLE>
<CAPTION>
North Rest of Elimin-
America UK Germany Australia World ations Total
-------- ------- ------- --------- ------- -------- -------
Fiscal year 1999:
<S> <C> <C> <C> <C> <C> <C> <C>
Net Revenues - external customers $ 25,249 $ 3,188 $ 4,199 $ 2,471 $ 2,572 $37,679
- inter-segment 2,736 -- -- -- -- (2,736) --
Operating Income (loss) (23,259) 42 (1,152) 414 65 (23,890)
Interest and other expense, net (1,900) 0 1 6 13 (1,880)
Identifiable assets 22,446 827 1,757 1,038 1,076 27,144
Depreciation and amortization expense 4,133 62 72 23 18 4,308
Income tax expense (benefit) (22) 113 0 34 68 237
Extraordinary item (959) -- -- -- -- (959)
Net Income (loss) (26,027) (71) (1,151) 386 (103) (26,966)
Fiscal year 1998:
Net Revenues - external customers 43,593 5,193 7,195 3,585 2,499 62,065
- inter-segment 5,294 -- -- -- -- (5,294) --
Operating Income (loss) (5,444) 1,585 1,742 1,498 705 86
Interest income (expense) (766) (15) 12 3 7 (759)
Identifiable assets 29,435 1,224 2,787 1,453 756 35,655
Depreciation and amortization expense 3,979 77 46 27 18 4,147
Income tax expense (benefit) (334) 0 0 31 0 (303)
Net Income (loss) (5,812) 1,551 1,754 1,465 672 (370)
Fiscal year 1997:
Net Revenues - external customers 27,632 3,923 5,724 2,685 1,875 41,839
- inter-segment 6,991 (6,991)
Operating Income (loss) 3,570 (354) 1,474 (310) (13) 4,367
Interest income (loss) (130) (5) 0 3 2 (130)
Identifiable assets 12,799 1,280 1,334 1,147 1,013 17,573
Depreciation and amortization expense 1,974 61 21 26 16 2,098
Income tax expense (benefit) 1,609 0 0 31 0 1,640
Net Income (loss) $ 2,033 $ (411) $ 1,473 $ (420) $ (78) $ 2,597
</TABLE>
Each segment generates revenues from all of our product categories. Revenues by
categories are as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
-------------- ------------- -------------
$ % $ % $ %
------- --- ------- --- ------- ---
<S> <C> <C> <C> <C> <C> <C>
Precision design $13,168 35% $15,658 25% $11,302 27%
Graphic design 12,928 34% 18,911 31% 19,461 47%
Business applications 8,013 21% 8,981 14% 2,558 6%
Utilities 3,921 11% 11,759 19% 4,816 12%
Other products 2,511 7% 8,160 13% 4,656 10%
Increase in sales reserves (2,862) -8% (1,404) -2% (954) -2%
------- --- ------- --- ------- ---
Total net revenues $37,679 100% $62,065 100% $41,839 100%
======= === ======= === ======= ===
</TABLE>
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<PAGE> 70
9. INVENTORIES
At June 30, inventories consist of (in thousands):
<TABLE>
<CAPTION>
1998 1999
---- ----
<S> <C> <C>
Raw materials $ 2,343 $2,882
Finished goods 3,897 4,282
------- ------
6,240 7,164
Reserves for obsolescence (3,345) (615)
------- ------
$ 2,895 $6,549
======= ======
</TABLE>
As of June 30, 1999, IMSI's inventory reserves for obsolescence included charges
of $2,184,000 related to the Company's restructuring and its plan to divest
non-core product lines in order to focus on a limited number of core product
lines.
10. FURNITURE AND EQUIPMENT
At June 30, furniture and equipment consist of (in thousands):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Computer and office equipment $ 5,575 $ 4,965
Software 944 701
------- -------
6,519 5,666
Accumulated depreciation (2,887) (2,236)
------- -------
$ 3,632 $ 3,430
======= =======
</TABLE>
11. INCOME TAXES
The provision (benefit) for taxes on income for the years ended June 30, 1999,
1998, and 1997 was comprised of the following (in thousands):
<TABLE>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Current:
Federal $(3,990) $ 2,065 $1,778
State 0 397 324
Foreign 215 211 140
------- ------- ------
(3,775) 2,673 2,242
------- ------- ------
Deferred
Federal 3,565 (2,424) (285)
State 447 (431) (63)
Foreign 0 (121) (254)
------- ------- ------
4,012 (2,976) (602)
------- ------- ------
Total tax provision (benefit) $ 237 $ (303) $1,640
======= ======= ======
</TABLE>
70
<PAGE> 71
Deferred tax balances consisted of the following (in thousands):
<TABLE>
<CAPTION>
June 30,
1999 1998
-------- -------
<S> <C> <C>
Current assets
Allowance for doubtful accounts and returns $ 2,125 $ 1,362
Accrued vacation and other liabilities 97 293
Inventory reserve 386 192
Foreign reserves and other -- 157
Accrued restructuring costs 574 --
Research and development credit 95 --
-------- -------
3,277 2,004
Noncurrent assets
Package design costs 154 176
NOL carryforward 4,396 58
Purchased intangibles 3,790 2,596
Other 0 80
-------- -------
11,617 4,914
Valuation allowance (11,126) --
-------- -------
Total assets 491 4,914
-------- -------
Current liabilities -- (87)
Noncurrent liabilities
Capitalized software development costs -- (5)
Deferred state taxes -- (229)
Other (26) --
-------- -------
Total liabilities (26) (321)
-------- -------
Net deferred tax assets $ 465 $ 4,593
======== =======
</TABLE>
At June 30, 1999, IMSI had an operating loss carryforward of approximately
$11,400,000 for federal tax purposes, which expires in various amounts from 2001
to 2019 and related carryforwards for state purposes.
71
<PAGE> 72
The effective tax rate differs from the federal statutory rate for the years
ended June 30 as follows (in thousands):
<TABLE>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C> <C>
Federal tax at 34% statutory rate $ (8,762) $(229) $ 1,441
State tax provision, net of
federal benefit (1,504) (56) 172
Change in valuation allowance 11,126 -- (138)
Cost (benefit) related to offshore
intellectual property -- (335) 335
In-process technology write off,
nondeductible for tax -- 102 --
Foreign sales corporation benefit -- -- (68)
Other (623) 215 (102)
-------- ----- -------
Total income tax provision (benefit) $ 237 $(303) $ 1,640
======== ===== =======
</TABLE>
12. EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income (loss) by the
weighted average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution that could occur from common
shares issuable as a result of the exercise or conversion of stock options,
warrants or other convertible securities. A total of 1,611,100 potentially
dilutive securities for the year ending June 30, 1999 and 627,517 for the year
ending June 30, 1998 have not been included because their inclusion would be
anti-dilutive.
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 (loss) per share as follows (in thousands):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JUNE 30,
----------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Shares used to compute basic EPS 6,275 5,513 4,946
Add effect of dilutive securities:
Stock options -- -- 736
----- ----- -----
Shares used to compute diluted EPS 6,275 5,513 5,682
===== ===== =====
</TABLE>
13. STOCK OPTIONS AND EMPLOYEE STOCK INCENTIVE PLANS
IMSI's 1992 Stock Option Plan authorizes the issuance of up to 900,000 shares of
common stock. The 1993 Employee
72
<PAGE> 73
Incentive Plan, as amended, permits IMSI to grant options to purchase up to
2,925,000 shares of common stock to employees, directors and consultants at
prices not less than the fair market value at date of grant for incentive stock
options and not less than 85% of fair market value for nonstatutory stock
options. These options generally expire 10 years from the date of grant and
become exercisable ratably over a 4 to 5-year period. At June 30, 1999, 743,943
shares were available for future grants under the 1993 Plan.
73
<PAGE> 74
Option activity under the plans is as follows:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF AVERAGE
SHARES EXERCISE PRICE
<S> <C> <C>
Outstanding, July 1, 1997 1,323,662 $ 3.19
Granted (weighted average fair value of $5.65) 316,914 7.69
Exercised (133,456) 1.80
Canceled (239,500) 4.21
--------- ------
Outstanding, June 30, 1997 1,267,620 4.27
Granted (weighted average fair value of $7.58) 925,525 13.13
Exercised (171,952) 2.77
Canceled (173,055) 11.39
--------- ------
Outstanding, June 30, 1998 1,848,138 8.18
Granted (weighted average fair value of $5.39) 1,049,825 7.60
Exercised (164,150) 4.92
Canceled (800,556) 10.81
--------- ------
Outstanding, June 30, 1999 1,933,257 $ 7.00
========= ======
</TABLE>
Additional information regarding options outstanding as of June 30, 1999 is as
follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------------------------- -----------------------------
WEIGHTED AVG.
REMAINING
RANGE OF NUMBER CONTRACTUAL WEIGHTED AVG. NUMBER WEIGHTED AVG.
EXERCISE PRICES OUTSTANDING LIFE (YRS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
<S> <C> <C> <C> <C> <C>
$0.11 - 3.56 365,894 4.5 $ 1.92 355,880 $ 1.89
$3.67 - 5.92 271,506 6.9 4.34 199,209 4.21
$5.97 - 12.00 1,048,975 8.9 7.83 125,190 8.75
$12.13 - 18.38 246,882 8.9 14.01 9,859 13.64
--------- --- ------ ------- ------
1,933,257 7.8 $ 7.00 690,138 $ 3.98
========= === ====== ======= ======
</TABLE>
IMSI continues to account for stock-based awards issued to employees using the
intrinsic value method in accordance with Accounting Principles Board No. 25,
Accounting for Stock Issued to Employees and its related interpretations.
Accordingly, no compensation expense has been recognized in the financial
statements for employee stock arrangements as all grants have been made at fair
market value. SFAS No. 123, Accounting for Stock-Based Compensation, requires
the disclosure of pro forma net income and earnings per share had IMSI adopted
the fair value method in SFAS No. 123. Under this method, the fair value of
stock-based awards to employees is calculated through the use of option pricing
models, even though such models were developed to estimate the fair value of
freely tradable, fully transferable options without vesting restrictions, which
significantly differ from IMSI's stock option awards. These models also require
subjective assumptions, including future stock price volatility and expected
time to exercise, which greatly affect the calculated values. IMSI's
calculations were made using the Black-Scholes option pricing model with the
following weighted average assumptions: expected life of 5 years in 1999 and
1998 and 7 years in 1997; stock volatility, 105% in fiscal 1999, 57% in fiscal
1998 and 72% in fiscal 1997; risk free interest rates, 5.5% in 1999, 5.77% in
1998 and 6.70% in 1997; and no dividends during the expected term. IMSI's
calculations are based on a single option valuation approach and forfeitures are
recognized as they occur.
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<PAGE> 75
If the computed fair values of the 1999, 1998 and 1997 awards had been amortized
to expense over the vesting period of the awards, pro forma amounts would have
been:
<TABLE>
<CAPTION>
Restated
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Net income (loss)
As reported $(26,966,000) $ (370,000) $2,597,000
Pro forma (27,306,000) (1,839,000) 2,074,000
Diluted earnings (loss) per share
As reported $ (4.30) $ (0.07) $ 0.46
Pro forma (4.35) (0.33) 0.37
</TABLE>
14. COMMITMENTS
IMSI leases its facilities and certain equipment under various noncancelable
operating lease agreements expiring through 2004. IMSI also leases equipment
under capital leases, which expire at various dates through 2002. IMSI is
required to pay property taxes, insurance, and normal maintenance costs on most
property leases. Future minimum payments for capital leases and rental
commitments for noncancelable operating leases with remaining terms of over one
year at June 30, 1999 are as follows (in thousands):
<TABLE>
<CAPTION>
Capital Lease Operating
Obligations Leases
Fiscal:
<S> <C> <C> <C>
2000 $1,018 $1,480
2001 674 1,441
2002 118 1,374
2003 1,206
2004 462
Total minimum lease payments 1,810 $5,963
------ ======
Less amount representing interest 51
------
Capital lease obligations 1,759
Less current portion 960
------
Long term portion $ 799
======
</TABLE>
Capital lease obligations consist primarily of borrowings for computer
equipment, furniture and fixtures and leasehold improvements. The average term
is 3 years. Total rent expense for all operating leases was $1,294,000,
$965,000, and $727,000 for the fiscal years ended June 30, 1999, 1998, and 1997
respectively.
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<PAGE> 76
15. LONG-TERM DEBT.
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
June 30,
--------
1999 1998
---------------------
<S> <C> <C>
Bank line of credit and term note (Note 4) $ 6,154 $ 9,448
Subordinated loan facility, net of 1,896 -
unamortized warrant cost of $604 (Note 5)
Subordinated convertible debt, net of 3,900 -
unamortized warrant cost of $ 1,100 (Note 6)
Various promissory notes from product
acquisitions - 684
Capital leases 1,759 1,774
------- --------
Total 13,709 11,906
Less current portion 7,110 10,224
------- --------
Total long term debt $ 6,599 $ 1,682
======= ========
</TABLE>
16. RESTATEMENT.
AS OF AND FOR THE YEAR ENDED JUNE 30, 1998
Subsequent to the issuance of IMSI's 1998 financial statements, IMSI's
management determined that the Company should have deferred the recognition of
revenue related to three advanced royalty payments recorded in fiscal 1998 for
certain technology licensing agreements. Previously, IMSI recognized revenue in
the amount of these advanced payments upon execution of the licensing agreement.
Upon reviewing certain licensing agreements, IMSI determined that it should have
deferred the amounts of these advanced payments. The revenue related to these
advance payments should have been recognized as it was earned as royalties under
the terms of the agreements. As a result, the financial statements as of and for
the year ended June 30, 1998 have been restated from amounts previously reported
to defer recognition of $346,000 of revenue until earned as royalties in fiscal
year 1999, and $61,000 of revenue until earned in fiscal year 2000.
The significant effects of the restatement are as follows (in thousands, except
per share data):
<TABLE>
<CAPTION>
As
Previously As
Reported Restated
<S> <C> <C>
FOR THE YEAR ENDED JUNE 30, 1998
Revenues $62,472 $62,065
Income (loss) before taxes (266) (673)
Net income (loss) (118) (370)
Income (loss) per share - basic and diluted $ (0.02) $ (0.07)
AT JUNE 30, 1998
Deferred revenues 0 407
Retained earnings $ 1,255 $ 1,003
</TABLE>
FOR THE FISCAL 1999 AND 1998 QUARTERLY PERIODS (UNAUDITED)
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<PAGE> 77
As of July 1, 1998, IMSI changed the amortization period for visual content from
36 months to 60 months. In the fourth quarter of fiscal year 1999, reevaluating
the amortization periods, the Company's management revised the amortization
period for visual content to 36 months, effective for the entire fiscal year. As
a result, additional amortization charges of $99, $84 and $85 are attributable
to the quarterly periods ended September 30, 1998, December 31, 1998 and March
31, 1999, respectively.
<TABLE>
<CAPTION>
Increased
amortization
Amortization resulting from Total
recorded using revision to amortization
Quarter ending 60 months 36 months after revision
<S> <C> <C> <C>
September 30, 1998 $158 $ 99 $257
December 31, 1998 183 84 267
March 31, 1999 187 85 272
---- ---- ----
$528 $268 $796
==== ==== ====
</TABLE>
IMSI recorded amortization of $569,000 for visual content in the quarter ending
June 30, 1999, including the $268,000 of amortization from the revision to a 36
month amortization period.
Additionally, as discussed in Note 7, IMSI recorded an extraordinary charge
related to the retirement of debt through the issuance of common stock. This
charge, amounting to $959,000, resulted from transactions that occurred in the
quarter ended March 31, 1999. The unaudited quarterly financial statements
included in the Form 10-Q for the quarter ended March 31, 1999, did not include
this charge as the Company originally had determined that the common stock
issued in exchange for the debt had been issued at fair value. IMSI subsequently
recognized the difference between the value of the liability converted and the
value of the common stock issued based on the closing price of the Company's
common stock on the date of settlement as a charge to earnings.
IMSI's management also determined that one $500,000 advanced royalty payment
recognized in the first quarter of fiscal 1997 should have been recognized in
the second, third and fourth quarters of fiscal year 1997.
77
<PAGE> 78
The effect of restating previously issued quarterly financial information for
revenue recognition related to technology license agreements in fiscal 1997,
1998 and 1999, for the amortization of visual content assets and for recording
discounts associated with the retirement of debt with common stock, is as
follows (in thousands). Information relative to quarterly periods is unaudited.
<TABLE>
<CAPTION>
Revenues Net Income after Diluted income (loss)
extraordinary charge per share
Diluted income (loss)
Quarter Ended As Reported Restated As Reported Restated As Reported Restated
<S> <C> <C> <C> <C> <C> <C>
September 30, 1998 $13,360 $13,695 $ (1,214) $ (1,106) (0.21) (0.20)
December 31, 1998 10,261 10,275 (4,199) (4,274) (0.73) (0.74)
March 31, 1999 7,281 7,278 (9,692) (10,739) (1.52) (1.68)
June 30, 1999 6,431 6,431 (12,245) (10,847) (1.89) (1.67)
Fiscal Year 1999 $37,333 $37,679 $(27,350) $(26,966) (4.25) (4.30)
September 30, 1997 $12,511 $12,511 $ (3,114) $ (3,114) (0.60) (0.60)
December 31, 1997 16,380 16,380 1,220 1,220 0.19 0.19
March 31, 1998 16,671 16,436 1,145 1,000 0.18 0.15
June 30, 1998 16,910 16,738 631 524 0.21 0.20
Fiscal year 1998 $62,472 $62,065 $ (118) $ (370) (0.02) (0.07)
September 30, 1996 $8,112 $7,612 $410 $104 $ 0.07 $ 0.02
December 31, 1996 11,791 12,040 706 859 0.12 0.15
March 31, 1997 10,489 10,701 622 752 0.11 0.13
</TABLE>
78
<PAGE> 79
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
June 30, 1997 11,447 11,486 859 882 0.16 0.16
------- ------- -------- --------- ----- -----
Fiscal year 1997 $41,839 $41,839 $ 2,597 $ 2,597 $0.46 $0.46
==== ======= ======= ======== ========= ===== =====
</TABLE>
17. CONTINGENCIES
Various lawsuits, claims and proceedings of a nature considered normal to our
business are pending or have been asserted against us. Significantly, on April
23, 1998 IMSI began arbitration proceedings against Imageline, Inc. before the
American Arbitration Association in San Francisco, California. IMSI requested
that all matters within the scope of the agreements between Imageline and IMSI
be resolved by arbitration, including a dispute in which Imageline sued
Mindscape, Inc. for alleged copyright infringement, for which IMSI may be
required to indemnify Mindscape, in whole or in part. IMSI further requested
that the arbitration decide the rights and liabilities of the parties, and the
validity of the copyrights under which Imageline asserted its claims against
IMSI. IMSI also requested compensatory damages and attorney's fees.
On August 12, 1999 Imageline filed a counterclaim in the arbitration, alleging
breach by IMSI of an agreement between the parties, including unauthorized
sublicensing, and instituting arbitration proceedings without notice and
opportunity to cure. Imageline requested liquidated damages, alleged to be more
than $200,000, compensatory damages of at least $500,000, punitive damages,
legal fees, interest and costs. IMSI cannot provide any assurance as to the
outcome of the arbitration. An adverse outcome on this matter could require IMSI
to pay a large amount of damages to Imageline.
18. SUBSEQUENT EVENTS - UNAUDITED
Zedcor
In the third quarter of fiscal year 2000, IMSI agreed to immediately issue to
the former Zedcor shareholders an additional 185,005 shares, the maximum number
of additional shares to which they were entitled under the price protection, in
settlement of all claims. Written execution of this agreement is awaiting final
approval of the banks and creditors, who have already indicated that approval
will be granted. Because IMSI was not contractually obligated to offer the price
protection under the original Zedcor Fee Agreement, it will recognize a charge
equal to 185,005 shares times the market price of IMSI stock on the date of the
execution of the settlement agreement.
CVI
On March 1, 2000, IMSI agreed to settle its price protection adjustment
obligations to CVI with the issuance of 2,062,363 additional shares. Under this
agreement, IMSI has no further obligation to issue any additional adjustment
shares or other consideration to CVI and is relieved of making any payments to
CVI in connection with its failure to obtain effectiveness of the respective
registration statement. Since this resolution provides CVI with fewer shares
than it was entitle to under the original price protection agreement, no
additional charge was required to be booked.
79
<PAGE> 80
SCHEDULE II
80
<PAGE> 81
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
AND SUBSIDIARIES
Valuation and Qualifying Accounts
Years ended June 30, 1999, 1998 and 1997 (in thousands)
<TABLE>
<CAPTION>
Additions
Balance at charged to
beginning of costs and Balance at
Description period Expenses Deductions end of period
<S> <C> <C> <C> <C>
Year ended June 30, 1999
Allowance for doubtful
accounts 800 623 144 1,279
Return reserve 2,998 17,714 15,463 5,249
Price discounts reserve 283 6,146 5,610 819
Rebates reserve 2,474 2,376 98
Inventory reserve 615 3,555 825 3,345
----- ----- ------ -----
Year ended June 30, 1998
Allowance for doubtful
accounts 808 1,610 1618 800
Return reserve 1,589 9,355 7,946 2,998
Price discounts reserve 546 2,050 2,313 283
Rebates reserve 0
Inventory reserve 436 526 347 615
----- ----- ------ -----
Year ended June 30, 1997
Allowance for doubtful
accounts 152 1,069 413 808
Return reserve 1,049 4,681 4,141 1,589
Price discounts reserve 101 1,899 1,454 546
Rebates reserve
Inventory reserve 455 125 144 436
----- ----- ------ -----
</TABLE>
81
<PAGE> 82
(b) Reports on Form 8-K
Three reports on Form 8-K were filed during the last quarter of the fiscal year:
On April 26, 1999, IMSI filed a report on Form 8-K reporting that its
independent auditor, Deloitte & Touche LLP, resigned.
On May 12, 1999, IMSI filed a report on Form 8-K reporting that Grant
Thornton LLP was approved by a resolution of the Board of Directors as
the Company's independent auditor.
On May 24, 1999, IMSI filed a report on Form 8-K reporting that IMSI
raised $5 million through a private placement of a three-year, 9%
subordinated convertible note, with a fund managed by BayStar Capital,
L.P. See Note 6 to the consolidated financial statements, "Subordinated
Convertible Debt".
82
<PAGE> 83
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Novato, State of
California on October 27, 1999.
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
By: /s/ GEOFFREY KOBLICK
---------------------
Geoffrey Koblick
Chief Executive Officer
By: /s/ JEFFREY MORGAN
---------------------
Jeffrey Morgan
Chief Financial Officer (Principal Accounting Officer)
POWER OF ATTORNEY
KNOW ALL BY THESE PRESENTS that each individual whose signature appears below
constitutes and appoints Geoffrey Koblick and Jeffrey Morgan, and each of them,
his attorneys-in-fact, and agents, each with the power of substitution, for him
and in his name, place and stead, in any and all capacities, to sign any and all
amendments (including post-effective amendments) to this Report, and to file the
same, with all exhibits thereto and all documents in connection therewith, with
the Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents or any of them, or his or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
Pursuant to the Requirement of the Securities Exchange Act of 1934, the
following persons in the capacities and on August 10, 2000 have signed this
report below.
By: /s/ Geoffrey Koblick
---------------------
Geoffrey Koblick
Chairman of the Board of Directors
83
<PAGE> 84
By: /s/ Mark Boyer
------------------------
Mark Boyer
Director
By: /s/ Richard Hall
------------------------
Richard hall
Director
By: /s/ Robert Mayer
------------------------
Robert Mayer
Director
By: /s/ Michael Gariepy
------------------------
Michael Gariepy
Director
84
<PAGE> 85
INTERNATIONAL MICROCOMPUTER SOFTWARE, INC.
1999 FORM 10-K ANNUAL REPORT
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Number Exhibit Title Page
-------------- ------------- ----
<S> <C> <C>
3.01 Registrant's Amended and Restated Articles of Incorporation(1)
3.02 Registrant's Bylaws, as amended to date(1)
4.1 Securities Purchase Agreement dated March 3, 1999, between IMSI
and Capital Ventures International.(2)
4.1a Securities Purchase Agreement dated May 24, 1999, between IMSI
and BayStar Capital, L.P.(3)
4.2 9% Senior Subordinated Convertible Note dated May 24, 1999,
between IMSI and BayStar Capital, L.P.(4)
4.3 Common Stock Purchase Warrant Certificate dated May 24, 1999,
between IMSI and BayStar Capital, L.P.(4)
4.4 Registration Rights Agreement dated May 24, 1999, between IMSI
and BayStar Capital, L.P.(4)
21.1 Subsidiaries of the Registrant
23.1 Independent Auditors' Consent
23.2 Independent Auditors' Consent
27.1 Financial Data Schedule
</TABLE>
(1) Incorporated by reference to exhibits of the same number to Registrant's
Registration Statement on Form S-3 (File no. 33-69206) filed on September
22, 1993.
(2) Incorporated by reference to an exhibit of the same number to Registrant's
Report on Form 8-K filed on March 23, 1999.
(3) Incorporated by reference to an exhibit numbered 4.1 to Registrant's Report
on Form 8-K filed on May 24, 1999.
(4) Incorporated by reference to an exhibit of the same number to Registrant's
Report on Form 8-K filed on May 24, 1999.
85
