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U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-KSB
[ ] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended
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[X] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from April 1, 2000 to June 30, 2000
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Commission file number 033-23138-D
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HEARTSOFT, INC.
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(Name of small business issuer in its charter)
Delaware 87-0456766
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
or organization)
3101 North Hemlock Circle, Broken Arrow, Oklahoma 74012
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(Address of principal executive offices)
(918) 362-3600
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(Issuer's Telephone Number)
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange
on which registered
None None
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Securities registered under Section 12(g) of the Exchange Act:
None
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(Title of class)
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Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. [X] Yes [ ] No
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
The issuer's revenue for the year ended March 31, 2000 was $315,557 and for the
three months ended June 30, 2000 was $164,307.
The aggregate market value of the voting stock held by non-affiliates at
September 15, 2000 was $15,313,492. This amount was computed using the average
bid and ask price as of September 15, 2000. For purposes of this computation,
all officers, directors and 5% beneficial owners of the issuer are deemed to be
affiliates.
As of September 15, 2000, the issuer had outstanding a total of 11,101,837
shares of its $.0005 par value Common Stock.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
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HEARTSOFT, INC.
FORM 10-KSB
TABLE OF CONTENTS
Item number and caption Page number
PART I
Introduction 4
Cautionary Statement Regarding Forward-Looking Information 4
Item 1. Description of Business 4
Item 2. Description of Property 10
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11
PART II
Item 5. Market for Common Equity and Related Stockholder Matters 12
Item 6. Management's Discussion and Analysis or Plan of Operation 13
Item 7. Financial Statements 18
Item 8. Changes In and Disagreements with Accountants on Accounting
and Financial Disclosure 19
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act 19
Item 10. Executive Compensation 21
Item 11. Security Ownership of Certain Beneficial Owners and Management 22
Item 12. Certain Relationships and Related Transactions 23
Item 13. Exhibits and Reports on Form 8-K 23
Summary of Risk Factors 27
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PART I
INTRODUCTION
By Unanimous Written Consent dated August 4, 2000, the Company changed
the fiscal year of the Company from the period beginning April 1 and ending
March 31 to the period beginning July 1 and ending June 30, effective for the
fiscal year beginning July 1, 2000. Unless otherwise specified, the "Fiscal Year
2000" or the "2000 Fiscal Year" will refer to the period from April 1, 1999 to
March 31, 2000 and the "Transition Period" will refer to the period from April
1, 2000 to June 30, 2000. The "Fiscal Year 2001" will refer to the period from
July 1, 2000 to June 30, 2001.
THIS FORM 10-KSB CONTAINS FORWARD-LOOKING STATEMENTS THAT COULD DIFFER FROM
ACTUAL FUTURE RESULTS.
This Form 10-KSB contains "forward-looking" statements regarding potential
future events and developments affecting the business of Heartsoft, Inc., a
Delaware corporation ("Heartsoft," or the "Company," including its subsidiary).
Forward-looking statements may be indicated by the words "expects," "estimates,"
"anticipates," "intends," "predicts," "believes" or other similar expressions.
Forward-looking statements appear in a number of places in this Form 10-KSB and
may address the intent, belief or current expectations of Heartsoft and its
Board of Directors and management with respect to Heartsoft and its business.
Heartsoft's ability to predict results or the effect of any future events on
Heartsoft's operating results is subject to various risks and uncertainties.
ITEM 1. DESCRIPTION OF BUSINESS.
GENERAL DEVELOPMENT OF BUSINESS
Heartsoft was incorporated in the State of Delaware in June 1988.
Historically, Heartsoft has been engaged in the design and publishing of its own
proprietary educational software products for distribution to the education
market and consumer market. In early 1999, Heartsoft began to evaluate potential
business opportunities regarding the development and distribution of a new
software product which would restrict the viewing of inappropriate material over
the Internet by young children. During the first calendar quarter of 1999, the
Company committed to the design and development of a secure children's Internet
browser.
Subsequently, the Company concluded that in addition to the market for
children's on-line Internet safety, sufficient demand may also exist for certain
proprietary technologies which it owns to be used in other markets. These
markets include, but are not limited to, certain government agencies,
corporations, professional, and educational organizations. On July 17, 2000, the
Company formed a wholly owned subsidiary, Plug-Invention Technologies, Inc. to
market the company's proprietary pornographic image recognition and detection
technology and other Internet security solutions to corporations, organizations
and governmental agencies throughout North America. The new division will
initially operate within the corporate infrastructure at the Company and will
establish its own team of management and sales
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personnel as its first products are prepared for sale.
INDUSTRY BACKGROUND AND GROWTH OF THE INTERNET
The Internet has emerged as a global medium enabling millions of people
worldwide to share information, communicate and conduct business electronically.
Estimates by the International Data Corporation ("IDC") indicate that the number
of Web users could grow from approximately 150 million worldwide in 1998 to
approximately 500 million worldwide by the end of 2003. A study released in 2000
estimates that nearly 24 million teens and children currently have access to the
Internet. Recent reports place the number of Internet users in excess of 340
million.
As demand for Internet access is increased by the growth in the number
of businesses conducting commerce over the Internet, the need for businesses to
ensure that their employees operate in a safe and secure environment also
increases. In addition to the increasing use of the Internet at schools, homes
and libraries, this growing business acceptance of the Web represents an
enormous opportunity for the demand of safe and secure access to the Internet.
IDC estimates that commerce over the Internet will increase from approximately
$40 billion worldwide in 1998 to approximately $900 billion worldwide in 2003.
THE HEARTSOFT SOLUTION
Heartsoft believes it understands the many challenges that the
increased demand by schools and businesses for Internet derived information will
have on the marketplace. As the use of the Internet increases, the probability
of individuals encountering offensive material is also likely to increase.
The Company also believes the social, political and legal reactions to
objectionable material on the Internet will be a major impetus for both schools
and businesses to protect their Internet users from encountering unwanted
objectionable material. Heartsoft is now engaged in the concept of bringing a
completely integrated Internet security solution into both the classroom and the
corporate workplace through the incorporation of advanced artificial
intelligence technologies.
PRODUCTS
During the fiscal year ended March 31, 2000 and the three months ended
June 30, 2000, the Company continued development of INTERNET SAFARI(TM), a
secure Internet browser for children. This proprietary product has been under
in-house development and, after several delays, is expected to be available
during the Fiscal Year 2001. A beta version of INTERNET SAFARI(TM) on the Apple
Macintosh platform was released on September 23, 2000 and the Company
anticipates that it will release a beta version of INTERNET SAFARI(TM) on the
Windows platform on or before September 30, 2000.
INTERNET SAFARI(TM) is designed for children ages 4 through 12 years to
help simplify their use of the Internet. INTERNET SAFARI(TM) is a full-featured
secure Internet browser for
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children that utilizes the sights and sounds of a jungle safari user interface
with cartoons, sounds and a host of proprietary features. INTERNET SAFARI(TM)
provides a high level of Internet security by combining artificial intelligence
with advanced image detection and recognition software that has the capability
to detect digitized pornographic images. Security is achieved through the
interaction of two proprietary programs:
o an artificial intelligence based Internet security software application;
and
o an image detection and recognition program to detect and block pornographic
imagery.
INTERNET SAFARI(TM) also features:
o adjustable tolerance levels within security features to help allow the
browser to be accommodated to the maturity of its user;
o one-click access to top on-line content providers;
o a database of hand-selected children's web sites broken into content
channels designed as a starting place for Internet viewing; and
o full Internet URL support enabling children to have access to the entire
Internet.
INTERNET SAFARI(TM) will be distributed to both the consumer and educational
markets.
One of the Company's proprietary software products currently being
marketed is its award winning THINKOLOGY(TM), a three titled software series
that facilitates learning by helping young children increase their critical
thinking and higher order reasoning skills. Released in late 1998,
THINKOLOGY(TM) has garnered the prestigious 1999 Media & Methods Portfolio
Award. THINKOLOGY(TM) has also received several favorable reviews in top
educational and consumer magazines, including FamilyPC and Multimedia Schools.
Other Heartsoft programs include: the HEARTSOFT BESTSELLER SITE
LICENSE, which contains 12 of the Company's top selling titles under a license
allowing the teacher to copy the software for every computer in the school, and
the HEARTSOFT K-8 LIBRARY (consisting of 35 software titles in the current
product line).
MARKETS
The Company believes that there are two basic markets for its current
proprietary software technology: the education market and the consumer or retail
market. Because the Company believes greater competition, higher barriers to
entry and shorter product life exists in the consumer market, it has
historically chosen to concentrate on the introduction of its products into the
educational market with the intent of expanding into the consumer market at some
later date. Therefore, during initial product development, the Company creates
routines designed for the educational market by placing emphasis on content and
instructional methodology.
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EDUCATION MARKET
The education market consists of school systems, home schools and
individual educators requiring core curriculum materials and supplemental
materials for use in the classroom. The Company derives most of its sales
revenues from this market.
In the education market, as opposed to the consumer market, products
enjoy a longer life span and obsolescence is less of a concern. This difference
can be attributed, in part, to the fact that users in the education market tend
to upgrade hardware less frequently than users in the consumer market.
Additionally, products in the education market often have life-spans as long as
seven years because such products are based on core curriculum concepts that do
not change significantly from year to year.
The Company is not aware of a dominant company or companies that offer
curriculum materials of the type the Company offers in the education market. The
majority of the companies offering products to the education market focus on
large network solutions or integrated learning systems, which result in a
comprehensive curriculum-based solutions. While such building-wide curriculum
solutions are comprehensive in nature, they are very expensive, often costing
between $50,000 to $100,000 per building. In contrast, the Company's typical
site licensing fees are less than $2,000.
CONSUMER MARKET
While the Company currently receives most of its income from sales to
the education market, the Company anticipates that it will begin to move into
the consumer market with the introduction of INTERNET SAFARI(TM) during the
Fiscal Year 2001. The consumer market consists of individuals who purchase
educational software for use in the home. The overall growth in this market is a
result of several major trends, including the increasing number of computer
systems in the home, the improved multimedia capabilities of these systems and
the increasing demand for a greater number of high quality, affordably priced
software applications. The opportunities for consumers to purchase a vast number
of software products and technologies from a wide variety of sources has
increased consumers' expectations for high quality multimedia software. To
increase its ability to reach this market, the Company needs to evaluate the
revenue potential for various consumer software distribution channels.
The distribution of consumer software has expanded beyond traditional
software retailers and computer stores to include:
o warehouse clubs;
o general merchandise outlets;
o Internet service providers (ISPs);
o original equipment manufacturers (OEMs) such as Dell, Compaq, Gateway,
Apple, etc.; and
o on-line Internet stores, also known as e-commerce solutions.
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The consumer software market is extremely competitive and highly volatile
as multimedia software publishers vie for a limited amount of available retail
shelf space. These characteristics necessitate that companies achieve a greater
sell-through of unit volumes by building brand name recognition, establish
strong relationships with retailers and consistently upgrading products to offer
state-of-the-art capabilities and rich content. Rapid changes in technology and
customer requirements also need to be considered.
Advances in computer technology spur the introduction of newer and
faster computers. As a result, publishers need to constantly introduce new
software to take advantage of these improved technologies. Consumer software
products become obsolete much sooner than education software, sometimes in as
little as two to three years. Educational software publishers who cater to the
consumer market incur substantially increased development costs because of the
need for more frequent product introductions or upgrades.
MAJOR CUSTOMERS
Heartsoft markets its products nationwide to many diverse groups that
are governed by unrelated buying decisions. No single customer represents a
significant portion of the Company's revenues. Heartsoft most effectively
strengthens relationships with existing customers by additional and upgrade
sales in situations where customers can add to their Heartsoft library.
SOURCES AND AVAILABILITY OF RAW MATERIALS
The most important raw materials purchased by the Company are computer
diskettes and pre-duplicated CD-ROMs, both of which are obtained from domestic
suppliers. The Company also purchases certain components from domestic
manufacturers and printers for its packaging materials. The Company endeavors to
obtain the lowest possible cost when purchasing raw materials and components
while meeting specified quality standards. The Company is not dependent upon any
one source for its raw material or the major components of its manufactured
products. The Company anticipates that it will have adequate sources of supplies
to meet its manufacturing requirements for the foreseeable future.
MARKETING AND DISTRIBUTION
As of June 30, 2000, the Company utilized a sales and marketing staff
of 11 employees to market its products in the United States and abroad. The
Company anticipates hiring five additional employees in the sales area during
the Fiscal Year 2001. During the last quarter in the Fiscal Year 2000, the
Company conducted a directed mail marketing campaign from sales leads generated
from its participation in two recent regional education technology conferences.
The Company has also implemented a direct target marketing campaign that
promotes existing product lines to education customers. Educational sales are
made directly to individual teachers and to regional school systems and
districts, with shipments being made from the Company's Broken Arrow office to
the purchaser. The Company also advertised its products in reseller catalogs
with aggregate circulations of approximately 5,000,000 in preparation of the
spring buying season.
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The Company's products and sales strategy focus on a "niche" market
within the consumer and educational markets. Three of the Company's best selling
products, HEARTSOFT BESTSELLER SITE LICENSE, HEARTSOFT K-8 LIBRARY, and
THINKOLOGY(TM), sell from prices ranging from approximately $400 to $1,400,
depending on the configuration. Further, each product license allows multiple
use of the software throughout the school. Within the consumer, or home market,
the Company's products sell in the price range from approximately $10 to over
$100 depending on configuration and educational support materials. To support
and service its customers, the Company supplies technical support through its
in-house technical support team. The Company's warranty on its products is
lifetime for content, and one year for disc errors.
The Company relies on a professional sales staff with many years of
experience and extensive contacts in the education software market to sell the
Company's proprietary titles. In addition, the Company also has access to
certain distribution channels through the use of Value-Added-Resellers (VARs).
With respect to its publishing activities, the Company's development staff
oversees the development of the software. Additionally, the Company assembles
its raw materials creating a final package at its Broken Arrow, Oklahoma
facilities. All of the proprietary software titles developed by the Company have
been copyrighted. All of the Company's products currently in development will be
copyrighted prior to release.
RESEARCH AND DEVELOPMENT
All research and development activities of the Company are
company-sponsored, rather than customer-sponsored. Product development costs are
capitalized as incurred once technological feasibility has been established.
Ongoing work includes completion of its new secure Internet browser for
children, INTERNET SAFARI(TM). The Company anticipates the addition of two new
titles in its critical thinking skill series, THINKOLOGY(TM) and is evaluating
the possibility of marketing its proprietary filtering technology as a software
plug-in for other computer software applications.
BACKLOG
The Company has no current order backlog and has experienced minimal
occurrences in the past. Each order is filled on demand with sophisticated,
high-speed diskette duplicators that can duplicate a disk in as little as 25
seconds. The Company utilizes companies that provide CD-ROM duplication services
in five to fifteen business days. Any production delays are most frequently
caused by delays in raw material receipt. These delays rarely exceed 24-48
hours.
WORKING CAPITAL
To support the Company's policy of growth and to meet working capital
needs during the development of INTERNET SAFARI(TM), the Company secured
approximately $247,500 and $1,910,000 in funding during the three months ended
June 30, 2000 and fiscal year ended March 31, 2000, respectively, through
private placements of convertible debt and Common Stock.
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During the three months ended June 30, 2000, the Company sold 325,000
shares of restricted common stock. Proceeds of the sale aggregated $275,000 less
offering expenses of $27,500.
During fiscal year ended March 31, 2000, the Company:
o Borrowed $1,010,000 under a convertible note agreement. These borrowings
were satisfied by conversions into 1,100,000 shares of restricted common
stock.
o Sold 775,000 shares of $.01 par value preferred stock, Series A, in a
private placement. Proceeds of the sale aggregated $775,000, less offering
expenses of $77,500.
o Sold 150,000 shares of restricted common stock. Proceeds of the sale
aggregated $225,000 less offering expenses of $22,500.
The proceeds of the convertible debt and private placements of equity
met the Company's working capital needs through September of 2000. The Company
is currently in the process of negotiating another private placement of equity
securities that the Company anticipates will allow it to meet working capital
requirements until the release of INTERNET SAFARI(TM), although there is no
assurance that the private placement will be consummated.
EMPLOYEES
At June 30, 2000, the Company had 30 full-time employees, 2 part-time
employees and 2 contract employees, none of whom are represented by unions.
Management considers its relations with its employees to be good.
COPYRIGHTS, PATENTS, TRADEMARKS, LICENSES AND CONCESSIONS
The Company routinely copyrights its proprietary software titles.
Further, the Company is in the process of securing registered trademarks on its
corporate name, and its leading proprietary products. The Company has also filed
a preliminary patent application in connection with its new Internet browser for
children, INTERNET SAFARI(TM).
ENVIRONMENTAL MATTERS
The Company's operations are of a nature that laws concerning the
environment do not substantially affect the Company's domestic operations. The
Company believes that it presently complies with these laws and that future
compliance will not materially adversely affect the Company's earnings or
competitive position.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company leases its principal office location in Broken Arrow,
Oklahoma, a suburb of Tulsa. The Broken Arrow office, which includes both
executive offices and production space, contains 7,628 square feet (1,200 sq.
ft. of production/warehouse space and 6,428 sq. ft. of office
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space), located in a business office park at 3101 N. Hemlock Circle, Broken
Arrow, Oklahoma. The lease expires December 1, 2004. The Company anticipates
acquiring approximately 1,700 square feet of additional office space in the same
office building by October of 2000.
ITEM 3. LEGAL PROCEEDINGS.
INVESTIGATION BY THE FORT WORTH DISTRICT OFFICE OF THE SECURITIES AND EXCHANGE
COMMISSION.
By letters dated February 23, 2000 and March 8, 2000, the Fort Worth
District Office of the Securities and Exchange Commission (the "SEC") notified
the Company, and two of its officers, Benjamin P. Shell ("Shell") and Jimmy L.
Butler ("Butler"), of the Fort Worth District Office's intent to recommend to
the SEC that a lawsuit be brought against the Company, Shell and Butler based on
alleged violations of Sections 5(a), 5(c) and 17(a) of the Securities Act of
1933, Sections 10(b), 13(a) and 16(a) of the Securities Exchange Act of 1934,
and Rules 10b-5, 13a-1, 13a-13 and 16a-3 thereunder.
The investigation by the SEC involved, among other things, allegations
regarding the wording of certain press releases issued by the Company from
January 1999 to March 1999. On September 5, 2000, the Company settled the action
brought by the SEC. As a part of the terms of the settlement, the SEC filed a
complaint against the Company in the United States District Court for the
Northern District of Oklahoma on September 5, 2000. The complaint was filed with
stipulations and consents and agreed final judgments that were approved by the
SEC and Heartsoft. On September 15, 2000, the Court accepted these stipulations
and consents and entered the agreed final judgments resolving the lawsuit and
implementing the settlement.
Under the terms of the stipulations and consents and the agreed final
judgments, the Company, Mr. Shell and Mr. Butler are permanently enjoined from
committing violations of certain securities laws and Mr. Shell and Mr. Butler
are required to individually pay disgorgement of certain trading profits,
interest and civil penalties totaling $146,402.99 and $129,850.94, respectively.
The Company and Messrs. Shell and Butler neither admitted nor denied any of the
allegations in the complaint filed by the SEC.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted to a vote of security holders, through
solicitation of proxies or otherwise, during the period from March 31, 1999
through June 30, 2000.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION:
Shares of the Company's Common Stock are traded in the over-the-counter
system, through the NQB Bulletin Board under the symbol "HTSF." The range of
high and low bid information for the Company's Common Stock during the last two
years and the Transition Period, as reported by the NASDAQ Stock Market, Inc.,
was as follows:
Quarter Ended High Bid Low Bid
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June 30, 1998 $0.5313 $0.4063
September 30, 1998 $0.4375 $0.1500
December 31, 1998 $0.2500 $0.1250
March 31, 1999 $5.9375 $0.1700
June 30, 1999 $2.0000 $1.2188
September 30, 1999 $1.7813 $1.2188
December 31, 1999 $4.8438 $1.2500
March 31, 2000 $5.0000 $1.7500
June 30, 2000 $2.0000 $1.3750
The above quotes reflect inter-dealer prices without retail mark-up or
markdown or commissions, and may not represent actual transactions.
HOLDERS:
As of September 15, 2000, there were 448 holders of record, and
according to the Company's estimate approximately 3,000 beneficial owners, of
the Company's Common Stock.
DIVIDENDS:
Since its inception, no cash dividends have been paid on the Company's
Common Stock and the Company does not anticipate paying cash dividends in the
foreseeable future.
RECENT SALES OF UNREGISTERED SECURITIES:
During the three months ended June 30, 2000, the Company has issued the
following securities without registering the securities under the Act of 1933:
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<TABLE><CAPTION>
----------------------------- --------------- -------------------- ---------------- -------------------------
NAME CLASS NO. OF SHARES DATE CONSIDERATION
----------------------------- --------------- -------------------- ---------------- -------------------------
<S> <C> <C> <C> <C>
Kathleen M. Hurley Common 25,000 05/24/00 Board Member services
valued at $30,468.
----------------------------- --------------- -------------------- ---------------- -------------------------
Dale Hill (*) Common 325,000 6/28/00 Cash consideration of
$275,000.
----------------------------- --------------- -------------------- ---------------- -------------------------
------------------------
(*) The Company agreed to issue these shares on June 28, 2000; however, as of September 28, 2000, these shares
have not yet been issued. In connection with this placement, the Company paid offering expenses of $27,500.
</TABLE>
The Company relied on the exemption set forth in Section 4(2) of the
Securities Act of 1933, as amended, in connection with the issuances of stock
set forth above. All parties listed above are sophisticated persons or entities,
performed services for the Company or personally knew members of Company's
management staff at the time of the transactions listed above.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The following discussion should be read in conjunction with the audited
financial statements as well as the associated Notes to the audited financial
statements.
GENERAL
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The Company is a provider of proprietary educational computer software
products distributed to the education and consumer markets. Its products are
sold through an internal sales organization, national and international
resellers, United States based catalogers with an annual aggregate circulation
of approximately 5,000,000 catalogs and online through four corporate websites,
www.heartsoft.com, www.internet-safari.com, www.thinkology.com, and
www.isafari.com.
Through the fiscal year ending March 31, 2000 and the three months
ended June 30, 2000, the Company's product line was comprised of approximately
50 educational software programs that assist young children in pre-kindergarten
through the 6th grade to practice and learn basic curriculum subjects. However,
during Fiscal Year 2001, the Company anticipates the release of its new secure
Internet browser for children, INTERNET SAFARI(TM). The release of INTERNET
SAFARI(TM) will broaden the Company's product line to include an Internet-based
software solution. A beta version of INTERNET SAFARI(TM) on the Apple Macintosh
platform was released on September 23, 2000 and the Company anticipates that it
will release a beta version of INTERNET SAFARI(TM) on the Windows platform on or
before September 30, 2000.
The Company intends to continue to expand its traditional educational
software business through internal growth as well as by focusing a substantial
portion of its resources on the introduction and sale of INTERNET SAFARI(TM).
Beginning in Fiscal Year 2001, the Company intends to use the Internet to expand
its geographic reach deeper into the consumer market both in the United States
and internationally.
For the year ended March 31, 2000, the Company experienced a loss of
$1,524,133 and accumulated a total deficit of $4,754,841. For the three months
ended June 30, 2000, the
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Company experienced a loss of $470,676 and accumulated a total deficit of
$5,225,517. These losses and accumulated deficit have been primarily caused by
the Company's efforts in positioning itself for the release of INTERNET
SAFARI(TM) and are related, for the most part, to marketing and general and
administrative expenses. The Company does not anticipate reaching profitability
for at least 15 months.
To reach profitability, the Company plans, among other things, to do
the following:
o introduce its secure Internet browser, INTERNET SAFARI(TM) during Fiscal
Year 2001;
o expand the marketing of all of the Company's products for the consumer and
school markets by utilizing additional marketing resources such as direct
mail, on-line purchasing, demonstration versions of key products, magazine
advertising and more;
o establish strategic joint venture partners both in the United States and
internationally.
The Company plans to strengthen its brand name awareness and position
and to utilize its technological infrastructure and software development
capabilities to continue refining and upgrading its current and future products.
Accordingly, the Company intends to invest heavily in marketing and advertising,
new partnerships and strategic alliances, and its technology infrastructure. The
Company also anticipates that it will continue to experience losses similar to
or greater than those described above during the next 15 months. Significant
increases in the Company's advertising and marketing campaigns will contribute
to such loss. The Company believes that this program of expansion is necessary
to continue building its brand recognition and ability to generate revenues.
Further, if the investments mentioned above are successful, the Company
anticipates that it will see an increase in revenues and a narrowing of losses
as percentage of revenues. The Company expects that the combination of increased
revenues and decreased expenses as percentage of revenues will lead to
profitability.
The Company believes that its investment in the development of INTERNET
SAFARI(TM) and the secure browser's release represents a key element of its
future and that the Company can become a leading player in the children's
Internet market.
RESULTS OF OPERATIONS
---------------------
THREE MONTHS ENDED JUNE 30, 2000 vs. THREE MONTHS ENDED JUNE 30, 1999
Net Revenue
Revenue for the three months ended June 30, 2000 increased to $164,307
from $117,800 for the three months ended June 30, 1999, an increase of $46,507
or 39%. The increase is primarily the result of hiring a Vice President of Sales
and Marketing in late 1999, reorganizing
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and expanding the education sales division from five to eleven employees, and
continuing the implementation of a broad-based marketing strategy. The marketing
strategy focused on adding quality sales personnel and directing their efforts
in promoting educational programs to schools while maintaining existing reseller
business. It also included higher attendance at trade shows and increased direct
mailings, both of which contributed to the increase in revenues.
Cost of Production
Cost of production includes all costs associated with the acquisition
of raw materials, assembly of finished products, warehousing, shipping, and
payroll associated with production and shipping of finished products. This
expense category also includes labor costs associated with maintaining and
implementing enhancements to existing educational programs as well as
miscellaneous costs related to the needs of the Production Department. Cost of
production for the three months ended June 30, 2000 was $62,322 compared to
$20,783 for the three months ended June 30, 1999, an increase of $41,539 or
200%. Cost for the acquisition of raw materials increased approximately $11,887
as a result of increased sales as noted in the Net Revenue discussion above.
Miscellaneous expenses for production supplies, cabling, wiring, etc., increased
approximately $15,228. Labor costs associated with maintaining and enhancing
existing educational programs increased approximately $7,124.
General and Administrative
Total general and administrative (G&A) expense for the three months
ended June 30, 2000 was $328,568 compared to $128,444 for the same period in
1999, an increase of $200,124 or 156%. The increase in G&A expense is directly
attributable to building the infrastructure, assuming full reporting status to
become compliant with SEC regulations, and strengthening strategic customer and
investor relationships all of which are critical to minimizing risks to the
Company and execution of its business plan. Additionally, on a historical basis,
executive management focused primarily on the development of educational
programs resulting in capitalization of appropriate executive salaries.
Beginning in late 1999, this focus shifted from development to more of an
administrative role resulting in an expensing of appropriate executive salaries
and an increase in related G&A payroll costs. An approximate breakdown by
component of the major increases in G&A expense follows: payroll and benefits
$75,722, professional fees $62,196, and travel $34,368.
Sales and Marketing
Sales and marketing expenses for the three months ended June 30,
2000 was $196,814 versus $54,992 for the three months ended June 30, 1999, an
increase of $141,822 or 258%. As noted previously, in the Net Revenue
discussion, a Vice President of Sales and Marketing was hired in late 1999, the
education sales division was reorganized and expanded, and the Company's
broad-base marketing strategy is continuing to be implemented. All of the above
factors, coupled with direct mail campaigns targeted at schools, new advertising
materials and higher attendance at industry trade-shows lead to increased
expenses in sales and marketing. An approximate breakdown by component of the
major increases in sales and marketing expense follows: payroll and benefits
$67,160, advertising $54,737 and conferences $7,956.
15
<PAGE>
YEAR ENDED MARCH 31, 2000 vs. YEAR ENDED MARCH 31, 1999
Net Revenue
Revenue for the year ended March 31, 2000 decreased to $315,557 from
$527,915 for the year ended March 31, 1999, a decrease of 40%. The decrease is
primarily attributable to the implementation of a new long-term business plan
that included plans for internal reorganization of the Company's sales and
marketing division as well as the development of significant new software
products. In October, 1999, the Company hired Ms. Nita Seng, a veteran of the
educational software market as Vice President of Sales and Marketing.
Immediately upon joining the Company, Ms. Seng began an extensive analysis of
product sales, which included configuration, price and positioning. Ms. Seng
substantially reorganized the Company's education sales division and began
hiring and training additional sales personnel.
Cost of Production
The Company includes in cost of production all costs associated with
the acquisition of components, assembly of the finished products, warehousing,
shipping and payroll for personnel associated with the production and shipping
of the finished product. Cost of production for the year ended March 31, 2000
was $158,988 compared to $102,600 for the year ended March 31, 1999. This
represents a 55% increase in cost of production.
During the reorganization of the Sales and Marketing Division, which
began in October, 1999, the Company reduced the pricing of certain
configurations of its educational software. During ensuing months, the Company
saw an increase in the sale of the number of units shipped, but the revenue
received from each unit was lower causing an increase of cost of materials as a
percentage of total revenues.
The Company anticipates that costs of production will decrease as a
percentage of sales as the internal reorganization positively impacts efficiency
of operations and revenues increase over the next 1-2 years. The Company also
anticipates that an increased focus on district-wide school purchases of the
Company's products and the ability to increase the purchase of raw materials in
bulk will further reduce cost of production as a percentage of sales.
General and Administrative
Total general and administrative expenses for the year ended March 31,
2000 increased to $925,162 as compared to $551,715 for the same period in 1999,
an increase of 68%. This increase in G&A expenses is again directly attributable
to the initial execution of a new business plan as described elsewhere in this
Form 10-KSB.
In addition, G&A costs related to hiring additional staff Company-wide
combined with increased infrastructure costs related to the general expansion
impacted expenses, such as office space, office furnishings and computer and
telecommunication equipment. Costs related to legal
16
<PAGE>
and accounting fees rose by 369% as the Company resumed its fully reporting
status and compliance to expanding SEC guidelines.
Sales and Marketing
Sales and Marketing expenses for the fiscal year ending March 31, 2000
were $462,643 compared to $239,756 for the year ending March 31, 1999, an
increase of 93%. Again, implementation of the Company's expanded business plan,
as discussed above in General and Administrative, contributed to this increase.
The Company significantly expanded its Sales and Marketing group during the last
five months of fiscal year ended March 31, 2000 by hiring nine new personnel,
including Ms. Nita Seng, Vice President of Sales and Marketing.
Other expenses associated with numerous direct mail campaigns targeted
to schools, new advertising print materials and a substantial increase in
expenses related to the attendance of industry trade-shows also contributed to
the increase in sales and marketing expenses. The Company utilizes a direct mail
approach to notify educators of the Company's planned presence at key
conferences throughout the year and for promotional purposes during school
funding cycles. Costs associated with direct mail campaigns are reflected in
advertising.
Advertising costs for the fiscal year ended March 31, 2000 were
$171,701 compared to $125,686 for the fiscal year ended March 31, 1999, a 37%
increase.
The costs associated with conferences include booth rental fees,
equipment and travel expenses. Expenses associated with conferences for fiscal
year ended March 31, 2000 were $83,352 compared to $29,710 in fiscal year ended
March 31, 1999, a 180% increase.
YEAR ENDED MARCH 31, 1999 vs. YEAR ENDED MARCH 31, 1998
Net Revenue
Net Revenue for the year ended March 31, 1999 was $527,915 compared to
$560,128 for the year ended March 31, 1998, a decrease of 6%. Fluctuations in
advertising campaigns and turnover in internal sales staff contributed to the
small decrease in revenue.
Operating Expense
Total general and administrative expenses decreased 20% for the year
ended March 31, 1999 when compared to the year ended March 31, 1998. Total
payroll expenses increased 2% when compared to payroll expenses for the year
ended March 31, 1998. With the completion of the Company's new critical thinking
skills product, THINKOLOGY(TM), the Company began to focus a substantial portion
of its resources to building an inside sales team. This enhanced focus on sales
is reflected in an increase in sales payroll expense, which rose 35% in the year
ended March 31, 1999 as compared to the year ended March 31, 1998. During the
year ending March 31, 1999, the Company decreased administrative payroll
expenses by 16% when compared to the earlier year's figures. This decrease was
attributable to increased efficiencies within the
17
<PAGE>
organization's administrative office and the implementation of job
cross-training, which allowed redundant administrative positions to be
eliminated.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
The Company's principal sources of liquidity include cash and accounts
receivable of $365,449. Total assets for the Company increased 53% to $1,221,635
for fiscal year ended March 31, 2000 compared to $798,310 for the fiscal year
ended March 31, 1999.
The Company reduced total liabilities by 54% to $356,732 for the fiscal
year ended March 31, 2000 compared to $781,162 for the fiscal year ended March
31, 1999. During the year ended March 31, 2000, the Company received an
aggregate total of $2,083,521 from financing activities. This represents
proceeds received from private placements of convertible debt and Common Stock
as discussed under Working Capital in Item 1 of this Form 10-KSB.
In order to maintain current level of operations, the Company will need
to secure additional funding sources to meet its operating expenses. Such
funding sources may include, but are not limited to, additional private
placements of common or convertible equities, placement of debt with banks,
private or public investors, or other lending institutions and/or licensing
agreements with strategic partners.
The Company believes that through a combination of outside sources of
capital and revenues generated from product sales it will have sufficient
sources of capital to meet its operating needs. However, any substantial delays
in receipt of or failure to obtain such capital may prevent the Company from
operating as a going concern, given its limited revenues and capital reserves.
ITEM 7. FINANCIAL STATEMENTS.
The Financial Statements of the Company are set forth on pages F-1
through F-15 inclusive, found at the end of this report.
INDEX TO FINANCIALS STATEMENTS
Independent Auditors' Report................................................F-1
Balance Sheets at March 31, 2000 and June 30, 2000..........................F-2
Statements of Operations for the years ended March 31, 1999 and 2000
And for the three months ended June 30, 1999 and 2000.......................F-4
Statements of Changes in Stockholders' Equity for the years ended March
31, 1999 and 2000 and for the three months ended June 30, 1999 and 2000.....F-5
18
<PAGE>
Statements of Cash Flows for the years ended March 31, 1999 and 2000
and for the three months ended June 30, 1999 and 2000.......................F-6
Notes to Financial Statements...............................................F-7
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.
The following sets forth information as of June 30, 2000 concerning the
Company's executive officers and directors:
NAME AGE POSITION
--------------------------------------------------------------------------------
Benjamin P. Shell, Jr. 37 Chairman of the Board, President and
Chief Executive Officer
--------------------------------------------------------------------------------
Jimmy L. Butler, Jr. 36 Director, Vice-President of
Development, and Secretary
--------------------------------------------------------------------------------
Kathleen Hurley 54 Director
--------------------------------------------------------------------------------
Rodger Graham* 47 Chief Financial Officer
--------------------------------------------------------------------------------
Juanita L. Seng 47 Vice President, Sales and Marketing
--------------------------------------------------------------------------------
* Joined the Company on August 28, 2000.
BENJAMIN P. SHELL, CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER
As a co-founder of Heartsoft, Benjamin Shell has played a key role in
the development and growth of the Company since its inception. Since 1989, Mr.
Shell has served as the Company's President, Chief Executive Officer and
Chairman of the Board of Directors. Not only has he overseen the development of
over 60 of the Company's former and current software titles, but he is also
personally responsible for programming more than 50 of those titles himself. Mr.
Shell believes in the principle that a strong management team augmented with a
talented and highly creative staff is required to profitably compete in today's
rapidly changing education technology markets.
19
<PAGE>
JIMMY L. BUTLER, DIRECTOR, VICE-PRESIDENT OF DEVELOPMENT, AND SECRETARY
As a co-founder of Heartsoft, Jimmy Butler has more than ten years of
educational software development experience with the Company. Mr. Butler served
as Vice-President of Marketing from 1987 to 1993. His diverse exposure to the
educational and software industry includes:
o designing and implementing direct mail campaigns;
o market analysis;
o telemarketing;
o direct sales to school administrators;
o new product design;
o content writing; and
o hosting dozens of national trade shows.
Mr. Butler also works in the areas of corporate imaging, marketing
position, new product development, crossover markets, public relations and
advertising campaigns.
Mr. Butler has held the position of Vice-President of Development since
1993. In this position, he was recently responsible for the conversion of 40
products to the Macintosh platform, from conceptualization to final release.
KATHLEEN HURLEY, DIRECTOR
Ms. Hurley is Vice-President of Marketing and Strategic Relationships
for NetSchools Corporation. Prior to joining NetSchools, she was Senior
Vice-President of Education Marketing for The Learning Company. Ms. Hurley
serves on several industry and education advisory boards, including: the
Software and Information Industry Association (SIIA), the International Society
for Technology in Education (ISTE), the Council of the Great City Schools
Technology Steering Committee, and the National Catholic Education Exhibitors
Association. Ms. Hurley also heads up the Education Advisory Board for Target
Stores. Prior to working for The Learning Company, she was the Senior Vice
President of SkillsBank Corporation. Ms. Hurley has held various positions with
IBM, Mindscape, Grolier, and DLM. Ms. Hurley began her career working with
learning disabled students after receiving her Masters degree at the Jersey City
State College. She also continues to support her undergraduate institution, the
University of Dayton, by serving on the school of education's advisory board.
RODGER GRAHAM, CHIEF FINANCIAL OFFICER
Mr. Graham joined the Company as its Chief Financial Officer on August
28, 2000. Mr. Graham brings over 20 years of broad-based experience in the areas
of accounting, strategic planning, and risk management to the Company. Prior to
joining Heartsoft, Inc., Mr. Graham was Vice President, Treasurer, and
Controller for BuyItNow.com, an on-line webplaza of specialty Internet retail
stores. At BuyItNow.com, his responsibilities included:
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<PAGE>
o the evaluation and direction of financial and human resource
activities;
o overseeing the budgeting process;
o implementation of cost controls; and
o reporting of financial results.
He is an internationally recognized expert in risk management and
previously served as the National Director of Enterprise Risk Services for
Deloitte & Touche LLP where he oversaw the design and delivery of comprehensive
risk management programs for the Firm's most prestigious Fortune 500 clients and
educational organizations. Prior to Deloitte & Touche, Mr. Graham served as the
Director of Accounting and Finance for MAPCO, Inc. Mr. Graham is a Certified
Public Account and a Certified Internal Auditor.
JUANITA L. SENG, VICE PRESIDENT, SALES AND MARKETING
As Vice President of Sales and Marketing for Heartsoft, Inc, Juanita
Seng brings fifteen years experience in the education technology market to
Heartsoft. Ms Seng joined Heartsoft, in October, 1999 from The Learning Company
School ("TLC") where she held the position of Director, Product Sales for North
America. At TLC, Ms. Seng managed a staff comprised of inside and outside sales,
which was responsible for sales in schools in the United States and Canada of
all software brands ranging under The Learning Company umbrella, including The
Learning Company, Broderbund, Mindscape, Creative Wonders, Grolier and others.
Prior to employment by The Learning Company, Ms Seng had extensive
management experience in the hardware and software reseller market, including
managing Apple Education Sales Agent resellers in the Florida and the
southeastern United States. Added to Ms. Seng's list of accomplishments is her
prior involvement in the entrepreneurial end of the business that included the
ownership of a hardware reseller in the Atlanta, GA metropolitan area. Ms. Seng
is a former educator with eleven years classroom experience.
ITEM 10. EXECUTIVE COMPENSATION.
The following table sets forth information with respect to compensation
received by the Chief Executive Officer and Vice-President of Sales and
Marketing of Heartsoft. During the past three fiscal years and the three months
ended June 30, 2000, no other executive officers of Heartsoft received a total
annual salary and bonus that exceeded $100,000.
21
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE><CAPTION>
Name and Other Annual
Principal Positions Period Salary Bonus Compensation
----------------------- ------ ------ ----- ------------
<S> <C> <C> <C> <C>
Benjamin P. Shell, Transition Period $ 29,400 N/A $ 2,361 (2)
President and Chief 2000 Fiscal Year $ 70,125 (1) N/A $ 9,400 (2)
Executive Officer 1999 Fiscal Year $ 46,800 N/A $ 9,444 (2)
1998 Fiscal Year $ 46,800 N/A $ 9,561 (2)
Juanita L. Seng, Transition Period $ 26,923 $ 1,206 $ 2,563 (5)
Vice-President, 2000 Fiscal Year (3) $ 50,000 $ 76,875 (4) $ 6,752 (5)
Sales and Marketing
------------------------
(1) From April 1, 1999 to November 15, 1999, Mr. Shell received a base salary of $46,800 per year. On
November 15, 1999, Mr. Shell's base salary increased to $109,000 per year.
(2) Unless otherwise specified, All Other Annual Compensation consists of car allowance provided by the
Company.
(3) Ms. Seng was hired in October of 1999. The figures under Ms. Seng's Salary, Bonus and Other Annual
Compensation reflect payments made from October of 1999 to March 31, 2000.
(4) This figure includes a $5,000 signing bonus and a initial grant of stock of 50,000 shares, both of which
became due upon Ms. Seng's execution of her Engagement Agreement with the Company. The stock was issued to
Ms. Seng on approximately October 18, 1999 when the price of the Company's Common Stock closed at $1.4375.
(5) These figures include $5,625 paid to provide housing for Ms. Seng in Tulsa through June of 2000. As of
June of 2000, Ms. Seng has relocated to Tulsa and will no longer receive a monthly stipend for housing. The
remaining portion under All Other Annual Compensation for 2000 for Ms. Seng consists of car allowance
provided by the Company.
</TABLE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding the
beneficial ownership of the Company's Common Stock as of March 31, 2000 and June
30, 2000 by (i) each director, (ii) each of the named executive officers, (iii)
all executive officers and directors of the Company as a group, and (iv) all
those known by the Company to be beneficial owners of more than five percent of
the Company's Common Stock. This table is based upon information supplied by
officers, directors and principal shareholders. Subject to community property
laws where applicable, each of the shareholders named in this table has sole
voting and investment power with respect to the shares indicated as beneficially
owned.
22
<PAGE>
<TABLE><CAPTION>
BENEFICIAL OWNERSHIP AS OF BENEFICIAL OWNERSHIP AS OF
MARCH 31, 2000 JUNE 30, 2000
-------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NUMBER PERCENTAGE NUMBER OF PERCENTAGE
NAME AND ADDRESS OF SHARES OF TOTAL SHARES OF TOTAL
OF BENEFICIAL OWNERS
Benjamin P. Shell, Chairman of the
Board, President, and Chief Executive
Officer
3101 North Hemlock Circle Broken
Arrow, OK 74102 928,792 8.40% 928,792 8.38%
Jimmy L. Butler, Director, Vice-
President, Development, and Secretary
3101 North Hemlock Circle
Broken Arrow, OK 74102 781,749 7.07% 758,249 6.84%
Kathleen Hurley, Director
3521 N. Military Road
Arlington, VA 22207 6,000 0.05% 31,000 0.28%
Juanita L. Seng, Vice-President, Sales
and Marketing
3101 North Hemlock Circle
Broken Arrow, OK 74102 50,000 0.45% 50,000 0.45%
All executive officers and directors as
a group (4 persons) 1,766,541 15.97% 1,768,041 15.95%
</TABLE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
EXHIBIT NO. DESCRIPTION
--------------------------------------------------------------------------------
*3.1 Articles of Incorporation of the Company.
23
<PAGE>
*3.2 By-Laws of the Company.
*4.1 Specimen of Certificate for Heartsoft, Inc. Common
Stock.
*10.1 Corporate Note to Dale Hill dated October 21, 1998.
*10.2 Corporate Note to Dale Hill dated February 10, 1998.
*10.4 Promissory Note dated October 16, 1999 to Tulsa
National Bank.
*10.5 Promissory Note dated December 16, 1999 to Bank of
Oklahoma.
*10.6 Equipment Lease with Auto & Equipment Leasing by
Flex, Inc. dated February 12, 1998.
*10.7 Software Agreement dated May 16, 1997 between
Heartsoft, Inc. and Heartsoft 1997 Limited
Partnership.
*10.8 Acquisition Note dated May 16, 1997 from Heartsoft
1997 Limited Partnership.
*10.9 Assumption Agreement dated April 30, 1997 by and
among Heartsoft 1997 Limited Partnership, Heartsoft,
Inc. and Limited Partners.
*10.10 Joint Venture Agreement dated May 16, 1997 between
Heartsoft, Inc. and Heartsoft 1997 Limited
Partnership.
*10.11 Software Agreement dated July 30, 1997 between
Heartsoft, Inc. and Heartsoft II 1997 Limited
Partnership.
*10.12 Acquisition Note dated July 30, 1997 from Heartsoft
II 1997 Limited Partnership.
*10.13 Assumption Agreement dated July 30, 1997 by and among
Heartsoft II Limited Partnership, Heartsoft, Inc. and
Limited Partners.
*10.14 Joint Venture Agreement dated July 30, 1997 between
Heartsoft, Inc. and Heartsoft II 1997 Limited
Partnership.
*10.15 Software Agreement dated October 28, 1997 between
Heartsoft, Inc. and Heartsoft III 1997 Limited
Partnership.
*10.16 Acquisition Note dated October 28, 1997 from
Heartsoft III 1997 Limited Partnership.
24
<PAGE>
*10.17 Assumption Agreement dated July 30, 1997 by and among
Heartsoft III 1997 Limited Partnership, Heartsoft,
Inc. and Limited Partners.
*10.18 Joint Venture Agreement dated October 28, 1997
between Heartsoft, Inc. and Heartsoft III 1997
Limited Partnership.
**10.19 Convertible Promissory Note dated August 30, 1999
between Heartsoft, Inc. and Hi-Tel Group, Inc.
**10.20 Letter Agreement by and between Heartsoft, Inc. and
the Weather Channel Enterprises, Inc. dated September
1, 1999.
**10.21 Cobranding Program Agreement by and between
Heartsoft, Inc. and Ask Jeeves, Inc. dated September
16, 1999.
**10.22 Engagement Agreement by and between Heartsoft, Inc.
and Juanita Seng dated October 1, 1999.
**10.23 Lease dated November, 1999 for commercial office
space in Broken Arrow, Oklahoma.
**10.24 Lease dated January, 2000 for commercial office space
in Broken Arrow, Oklahoma.
**10.25 Stock Purchase Agreement by and between Heartsoft,
Inc. and Hi-Tel Group, Inc. dated March 1, 2000 with
Certificate of Designation of the Series A
Convertible Preferred Stock attached as Exhibit A and
Common Share Purchase Warrant between Heartsoft, Inc.
attached as Exhibit B.
**10.26 Web Service Agreement by and between Heartsoft, Inc.
and Gaggle, Inc. dated June 9, 2000.
10.27 Amendment to Stock Purchase Agreement by and between
Heartsoft, Inc. and Hi-Tel Group, Inc. dated
September 27, 2000.
10.28 Amendment to Heartsoft, Inc. Common Share Purchase
Warrant by and between Heartsoft, inc. and Hi-Tel
Group, Inc. dated September 27, 2000.
*21.1 Subsidiaries of Heartsoft.
23.1 Consent of Tullius Taylor Sartain & Sartain LLP.
25
<PAGE>
27.1 Financial Data Schedule.
-------------
* Incorporated by reference to the Company's Form 10-KSB/A for the period ended
March 1, 1999, which was filed on January 22, 2000
** Incorporated by reference to the Company's Form 10-KSB fore the period ended
March 31, 2000, which was filed on July 14, 2000.
(b) Reports on Form 8-K:
FORM 8-K FILED ON FEBRUARY 9, 2000:
During the beginning of the calendar year 2000, the Company discovered that
some reports that the Company believed had been previously filed with the
Securities and Exchange Commission were in fact not filed. One of these reports
was a Form 8-K for the period ended March 31, 1997. On February 9, 2000, the
Company filed this Form 8-K along with several other SEC reports. The Form 8-K
filed on February 9, 2000, included Unaudited Financial Statements of the
Company for the quarter ending March 31, 1997 and reported the following events
that occurred during the period ended March 31, 1997:
1. Due to changes in personnel employed by the Company's Certifying
Accountants, Cross & Robinson, Tulsa, Oklahoma, the Company's Board of
Directors is currently considering a change in the Company's certifying
accountants. The Board's consideration of this decision has delayed
release of fiscal 1996's audited financial statement and related 10-K
filing. The Company hopes to remedy this situation and to file its
fiscal 1996 10-K within 90 days from March 31, 1997.
2. During the fourth quarter of fiscal 1996, the Company's board of
directors, by unanimous consent, agreed to discontinue the company's
Advanced Technologies Division in Dallas, Texas. Although the division
had been in existence for only 18 months, it was unable to reach
profitability, and the Company's board of directors unanimously agree
that continued investment in the division would not cause a turn around
in the immediate future. The closing of the Advanced Technologies
division will have a material affect on the Company's ongoing
operations by reducing related expenses and reducing gross revenues.
Subsequently, the Board also decided to re-focus all of the Company's
resources into the promulgation of its core products division related
to the development and sales of its proprietary educational software
products for schools.
3. During the fourth quarter of fiscal 1996, Charles R. Carlson agreed
to and did resign from the Company's Board of Directors. Mr. Carlson's
decision was related to the Board's unanimous consent to discontinue
the operations of the Company's Advanced Technologies Division in
Dallas, Texas.
FORM 8-K FILED ON APRIL 10, 2000:
On April 10, 2000, the Company filed a Form 8-K reporting that on March 31,
2000, the Company issued a press release stating that the release of its secure
Internet browser for children,
26
<PAGE>
INTERNET SAFARI(TM), would be moved from the first calendar quarter to the
second calendar quarter of 2000. This Form 8-K did not include any financial
statements.
FORM 8-K FILED ON JUNE 29, 2000:
On June 29, 2000, the Company filed a Form 8-K reporting that on June
21, 2000, the Company issued a press release stating that INTERNET SAFARI(TM),
Heartsoft's new secure Internet browser for children, is in final beta testing
prior to its release. The Form 8-K also reported that on June 27, 2000, the
Company issued a press release stating that Heartsoft is planning to have
INTERNET SAFARI(TM) available to meet its district-wide shipping schedule to
schools for the upcoming school year.
Heartsoft had previously stated in reports filed with the Securities
and Exchange Commission and press releases that it expected to release INTERNET
SAFARI(TM) during second calendar quarter of 2000. Heartsoft now expects to
release INTERNET SAFARI(TM) during the third calendar quarter of 2000. This Form
8-K did not include any financial statements.
SUMMARY OF RISK FACTORS
THE COMPANY'S FUTURE SUCCESS DEPENDS UPON KEY EMPLOYEES.
The Company has experienced significant changes in its business over
the last 18 months, including but not limited to, an expansion in the Company's
customer base as well as its product lines. Such changes have placed and may
continue to place a significant strain on the Company's employees. The Company
believes that its future success may depend in part upon its ability to retain
existing, as well as, attract highly skilled technical, managerial and marketing
personnel. Competition for such personnel can be intense.
Additionally, the loss of one or more of senior management could have a
material adverse effect upon the Company. In order to reduce the risk of losing
a key employee, the Company entered into an employment agreement with its Vice
President of Sales and Marketing, Nita Seng, in October 1999.
THE COMPANY'S FUTURE SUCCESS DEPENDS UPON DEVELOPMENT OF NEW PRODUCTS AND
ENHANCEMENT OF EXISTING PRODUCTS.
In order to remain competitive in the educational software market, the
Company must develop and introduce new products and product enhancements on a
timely basis. If the Company fails to develop and introduce new products and
enhancements on a timely basis, it could have a material adverse effect on the
Company's financial condition and results of operations.
THE COMPANY FACES CERTAIN RISKS ASSOCIATED WITH PRODUCT DEFECTS.
Prior to release of new products or upgrades to existing products, the
Company conducts exhaustive testing of those products. Despite intensive
testing, new products or enhancements
27
<PAGE>
may contain undetected errors or "bugs" that are discovered only after a product
has been installed and used by customers. There can be no assurance that such
errors will not be discovered in the future.
THE COMPANY FACES CERTAIN RISKS ASSOCIATED WITH MANAGING GROWTH.
The Company is experiencing a period of transition and product
introductions that has and may continue to place a significant strain on its
resources. Expansion of the Company's product lines, additional product
development and product introductions, or acquisitions of other technologies,
may further place a strain on the Company's resources and personnel, when added
to the existing management of the Company's day-to-day activities.
THE COMPANY'S SUCCESS DEPENDS IN PART ON ITS ABILITY TO ADAPT TO RAPID
TECHNOLOGICAL CHANGE.
The educational software market is subject to rapid technological
change, new product introductions, evolving industry standards and changes in
customer demands. The introduction of new technologies and the emergence of new
industry standards can render existing products obsolete and unmarketable. The
Company's future success will depend in part on its ability to enhance existing
products and to develop new products that meet changing client requirements.
THE COMPANY IS SUBJECT TO INTENSE COMPETITION.
The educational software market is highly competitive and rapidly
changing. A number of companies offer products similar to the Company's products
and target the same customers as the Company. Some of the Company's primary and
potential competitors are substantially larger and have significantly greater
financial, technical and marketing resources as well as established channels of
distribution. As a result, these competitors may be able to respond more quickly
to emerging technologies and changes in customer requirements and can devote
greater resources to their businesses.
THE COMPANY MAY NOT BE ABLE TO EFFECTIVELY PROTECT ITS INTELLECTUAL PROPERTY.
The Company's success is heavily dependent upon its confidential and
proprietary intellectual property. The Company relies primarily on a combination
of copyright, trademark and trade secret laws. The Company has filed a
preliminary patent application in connection with its new Internet browser for
children, INTERNET SAFARI(TM). Trade secret and copyright laws afford only
limited protection.
THE COMPANY MAY NOT BE ABLE TO SECURE ADDITIONAL FINANCING NECESSARY TO SUSTAIN
AND GROW ITS OPERATIONS.
The Company's audited financial statements for the fiscal year ended
March 31, 2000 and for the three months ended June 30, 2000 have been qualified
on a going concern basis principally due to lack of long term financing to
achieve its goal of completing the development of and releasing its new secure
Internet browser for children, INTERNET SAFARI(TM). To date,
28
<PAGE>
the Company has funded its transition period to the introduction of INTERNET
SAFARI(TM) primarily through revenues generated by other products and equity
financings. The Company will need additional capital before INTERNET SAFARI(TM)
begins generating a sufficient cash flow to sustain operations and anticipated
growth.
THE COMPANY'S REVENUES DEPEND ON CONTINUED MARKET ACCEPTANCE OF PRODUCTS.
To date, the Company has derived substantially all of its revenue from
the sale of approximately 50 educational programs. Accordingly, the Company's
results will depend on continued market acceptance of these existing products
and acceptance of its new products, including INTERNET SAFARI(TM). Failure to
achieve such acceptance could have a material adverse effect on the Company's
business, financial condition and results of operations.
CERTAIN RESTRICTED SHARES OF THE COMPANY WILL BE ELIGIBLE FOR SALE IN THE FUTURE
AND COULD AFFECT THE PREVAILING MARKET PRICE OF THE COMPANY'S COMMON STOCK.
Certain of the outstanding shares of Common Stock are "restricted
securities" under Rule 144 of the Securities Act, and would be eligible for sale
as the applicable holding periods expire. Sales or the expectation of sales of a
substantial number of shares of Common Stock in the public market by selling
stockholders could adversely affect the prevailing market price of the Common.
THE COMPANY'S COMMON STOCK MAY BE SUBJECT TO SECONDARY TRADING RESTRICTIONS
RELATED TO PENNY STOCKS.
Certain transactions involving the purchase or sale of Common Stock of
the Company may be affected by a Securities and Exchange Commission rule for
"penny stocks" that imposes additional sales practice burdens and requirements
upon broker-dealers that purchase or sell such securities. The penny stock rule
may impede the ability of broker-dealers to purchase or sell the Company's
securities for their customers and the ability of persons now owning or
subsequently acquiring the Company's securities to resell such securities.
29
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
HEARTSOFT, INC.
(Registrant)
Date: 09/28/00
/s/ Benjamin P. Shell
----------------------------------------------------
Benjamin P. Shell, Chairman of the Board, President,
and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Date: 09/28/00
/s/ Benjamin P. Shell
----------------------------------------------------
Benjamin P. Shell, Chairman of the Board, President,
and Chief Executive Officer
(Principal Executive Officer)
Date: 09/28/00
/s/ Jimmy L. Butler
---------------------------------------------------
Jimmy L. Butler, Jr., Director and Vice-President
Date: 09/28/00
/s/ Rodger Graham
---------------------------------------------------
Rodger Graham, Chief Financial Officer
(Principal Financial Officer)
Date: 09/28/00
/s/ Kathy Howell
---------------------------------------------------
Kathy Howell, Chief Financial Controller
(Principal Accounting Officer)
30
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Heartsoft, Inc.
We have audited the accompanying balance sheets of Heartsoft, Inc., as of June
30, and March 31, 2000, and the related statements of operations, changes in
stockholders' equity, and cash flows for the three month period ended June 30,
2000, and the years ended March 31, 2000, and 1999. 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 audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 financial statements referred to above present fairly, in
all material respects, the financial position of Heartsoft, Inc. as of June 30,
and March 31, 2000, and the results of its operations and its cash flows for the
three month period ended June 30, 2000, and the years ended March 31, 2000, and
1999, in conformity with accounting principles generally accepted in the United
States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 9 to the
financial statements, the Company has experienced recurring operating losses and
negative cash flows from operating activities, which increased to $470,676 and
$375,801, respectively, for the three months ended June 30, 2000, and $1,524,133
and $1,244,884, respectively, for the year ended March 31, 2000. These
conditions raise substantial doubt about its ability to continue as a going
concern. Management's plans regarding those matters are also described in Note
9. The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
TULLIUS TAYLOR SARTAIN & SARTAIN LLP
Tulsa, Oklahoma
August 15, 2000, except as to Note 10,
as to which the date is September 26, 2000
F-1
<PAGE>
HEARTSOFT, INC.
BALANCE SHEETS
June 30, March 31,
2000 2000
---------- ----------
Assets
Current assets:
Cash $ 93,820 $ 334,794
Accounts receivable, trade, net of allowance
of $18,672 and $8,000 at June 30, 2000
and March 31, 2000, respectively 64,412 30,655
Inventories, at cost 47,020 45,694
Other 7,059 9,219
---------- ----------
Total current assets 212,311 420,362
Property and equipment, at cost:
Property and equipment 227,744 218,962
Less accumulated depreciation 121,615 115,716
---------- ----------
Property and equipment, net 106,129 103,246
Other assets:
Developed software, net 745,378 693,419
Other 4,668 4,608
---------- ----------
Total other assets 750,046 698,027
---------- ----------
Total assets $1,068,486 $1,221,635
========== ==========
See notes to financial statements.
F-2
<PAGE>
HEARTSOFT, INC.
BALANCE SHEETS
<TABLE><CAPTION>
June 30, March 31,
2000 2000
----------- -----------
<S> <C> <C>
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 283,639 $ 218,753
Notes payable 66,551 83,927
Accrued expenses 76,569 54,052
----------- -----------
Total current liabilities 426,759 356,732
Commitments and contingencies -- --
Stockholders' equity:
Preferred stock, $0.01 par value, 5,000,000 shares
authorized, 827,000 shares issued 8,270 8,270
Common stock, $0.0005 par value, 30,000,000 shares
authorized, 11,080,337 shares and 11,055,337
shares issued, at June 30 and March 31,
Respectively 5,653 5,528
Additional paid-in capital 5,853,321 5,605,946
Accumulated deficit (5,225,517) (4,754,841)
----------- -----------
Total stockholders' equity 641,727 864,903
----------- -----------
Total liabilities and stockholders' equity $ 1,068,486 $ 1,221,635
=========== ===========
</TABLE>
See notes to financial statements.
F-3
<PAGE>
HEARTSOFT, INC.
STATEMENTS OF OPERATIONS
<TABLE><CAPTION>
Three month
periods ended Years ended
June 30, March 31,
------------------------------- -------------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
(unaudited)
<S> <C> <C> <C> <C>
Net sales $ 164,307 $ 117,800 $ 315,557 $ 527,915
Costs and expenses:
Costs of production 62,322 20,783 158,988 102,600
Sales and marketing 196,814 54,992 462,643 239,756
General and administrative 328,568 128,444 925,162 551,715
Depreciation and
amortization 40,337 29,286 148,837 181,697
----------- ----------- ----------- -----------
Total operating expenses 628,041 233,505 1,695,630 1,075,768
----------- ----------- ----------- -----------
Operating loss (463,734) (115,705) (1,380,073) (547,853)
Other income and expense:
Gain on sale of interest in
software library -- -- -- 153,277
Interest expense (3,101) (12,118) (143,089) (121,897)
Other, net (3,841) (704) (971) (10,608)
----------- ----------- ----------- -----------
(6,942) (12,822) (144,060) 20,772
----------- ----------- ----------- -----------
Loss before income taxes (470,676) (128,527) (1,524,133) (527,081)
Income taxes -- -- -- --
----------- ----------- ----------- -----------
Net loss $ (470,676) $ (128,527) $(1,524,133) $ (527,081)
=========== =========== =========== ===========
Net loss per common
share -
basic and diluted $ (0.04) $ (0.01) $ (0.14) $ (0.07)
=========== =========== =========== ===========
</TABLE>
See notes to financial statements.
F-4
<PAGE>
HEARTSOFT, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years ended March 31, 2000 and 1999 and
Three month period ended June 30, 2000
<TABLE><CAPTION>
Preferred Stock Common Stock Additional
-------------------------- -------------------------- Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit Total
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, March 31, 1998 1,218,500 $ 12,185 6,329,157 $ 3,165 $ 2,898,537 $(2,703,627) $ 210,260
Convert preferred stock
to common (838,625) (8,386) 670,900 336 8,050 -- --
Warrant exercise -- -- 444,600 222 -- -- 222
Sale of common stock -- -- 1,373,730 687 263,555 -- 264,242
Stock issued for
services -- -- 338,827 169 69,336 -- 69,505
Net loss -- -- -- -- -- (527,081) (527,081)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, March 31, 1999 379,875 3,799 9,157,214 4,579 3,239,478 (3,230,708) 17,148
Convert preferred stock
to common (327,875) (3,279) 165,200 81 3,198 -- --
Sale of preferred stock 775,000 7,750 -- -- 689,750 -- 697,500
Sale of common stock -- -- 1,500,000 750 1,385,271 -- 1,386,021
Stock issued for
services -- -- 203,835 99 148,268 -- 148,367
Stock issued for
debt repayment -- -- 140,000 75 139,925 -- 140,000
Common stock issued in
lieu of preferred
dividends -- -- 39,088 19 (19) -- --
Adjustments of
previous issuances -- -- (150,000) (75) 75 -- --
Net loss -- -- -- -- -- (1,524,133) (1,524,133)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, March 31, 2000 827,000 8,270 11,055,337 5,528 5,605,946 (4,754,841) 864,903
Stock issued
for service -- -- 25,000 125 (125) -- --
Cash received for stock
unissued -- -- -- -- 247,500 -- 247,500
Net loss -- -- -- -- -- (470,676) (470,676)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, June 30, 2000 827,000 $ 8,270 11,080,337 $ 5,653 $ 5,853,321 $(5,225,517) $ 641,727
=========== =========== =========== =========== =========== =========== ===========
</TABLE>
See notes to financial statements.
F-5
<PAGE>
HEARTSOFT, INC.
STATEMENTS OF CASH FLOWS
<TABLE><CAPTION>
Three month
periods ended Years ended
June 30, March 31,
-------------------------- --------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
(unaudited)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (470,676) $ (128,527) $(1,524,133) $ (527,081)
Adjustments to reconcile net loss to
Cash used in operating activities:
Depreciation and amortization 40,337 29,286 148,836 181,697
Stock issued for services -- -- 148,268 69,505
Gain on sale of software library -- -- -- (153,277)
Changes in:
Accounts receivable (33,757) (19,158) 15,943 221,498
Inventories (1,328) (12,836) (25,343) (10,744)
Other assets 2,220 1,809 5,380 (3,234)
Accounts payable 64,886 (32,629) 25,013 14,559
Accrued expenses 22,517 (17,706) (38,848) 69,878
----------- ----------- ----------- -----------
Net cash used in operating activities (375,801) (179,761) (1,244,884) (137,199)
CASH FLOWS FROM INVESTING ACTIVITIES
------------------------------------
Capitalized software development costs (86,397) (32,376) (199,283) (136,128)
Capitalized intangible costs -- -- -- --
Payments for the purchase of property (8,775) (3,204) (75,554) --
----------- ----------- ----------- -----------
Net cash used in investing activities (95,172) (35,580) (274,837) (136,128)
CASH FLOWS FROM FINANCING ACTIVITIES
------------------------------------
Proceeds from sale of software library -- -- -- 165,512
Proceeds from issuance of long-term -- 12,173 -- 345,000
debt
Proceeds from issuance of common
and preferred stock 247,375 175,500 2,083,521 264,465
Repayments under line of credit -- -- -- (152,500)
Principal payments on notes payable (17,376) (9,744) (270,595) (311,972)
----------- ----------- ----------- -----------
Net cash provided by financing
activities 229,999 177,929 1,812,926 310,505
----------- ----------- ----------- -----------
Net increase (decrease) in cash (240,974) (37,412) 293,205 37,178
Cash at beginning of period 334,794 41,589 41,589 4,411
----------- ----------- ----------- -----------
Cash at end of period $ 93,820 $ 4,177 $ 334,794 $ 41,589
=========== =========== =========== ===========
Supplemental disclosures:
Cash paid during the period for
interest $ 3,101 $ 8,112 $ 203,089 $ 46,676
=========== =========== =========== ===========
Common stock issued for debt
repayment $ -- $ -- $ 140,000 $ --
=========== =========== =========== ===========
</TABLE>
See notes to financial statements.
F-6
<PAGE>
HEARTSOFT, INC.
NOTES TO FINANCIAL STATEMENTS
Three month periods ended June 30, 2000 (audited) and 1999 (unaudited)
Years ended March 31, 2000 and 1999
NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Heartsoft, Inc., including its subsidiary described below ("Heartsoft" or the
"Company"), a publicly held Delaware corporation, was formed on January 15,
1988. On August 16, 1991, Heartsoft Software, Inc., an Oklahoma corporation, was
organized as a wholly owned subsidiary of Heartsoft, in which the actual
day-to-day operations of the Company are conducted.
CHANGE IN YEAR END
The Company changed its fiscal year end from March 31 to June 30 effective June
30, 2000.
NATURE OF OPERATIONS
The Company is engaged in publishing its own proprietary educational software
and licensing technological products for distribution to the education market.
The Company sells its products to schools and to end-users through telephone
sales and direct response reseller catalogs. The Company's principal market is
in the United States and Canada. Heartsoft's operations include only one
business segment.
REVENUE RECOGNITION
Revenues from the sale of software products are recognized upon shipment,
provided that no significant obligations remain outstanding and collection of
the receivable is probable. Shipments of software previews to customers include
the right of return for 30 days. Sales on these shipments are not recognized
until expiration of the preview period. Allowances for estimated returns are
provided at the time of sale. The Company evaluates the adequacy of allowances
for returns and doubtful accounts primarily based upon its evaluation of
historical and expected sales experience. The allowances for returns and
doubtful accounts are based upon information available at the reporting date. To
the extent the future market, customer mix, channels of distribution, product
pricing and general economic and competitive conditions change, the estimated
allowances required for returns and doubtful accounts may also change.
F-7
<PAGE>
INVENTORIES
Inventories consist primarily of raw materials such as CD-ROM and floppy discs
and manuals. They are stated at the lower of cost, determined by using the
first-in, first-out method, or market.
ADVERTISING AND MARKETING COSTS
The Company expenses advertising costs, excluding co-operative advertising, as
incurred. Co-operative advertising programs are initially capitalized and then
expensed over the period of the specific contract for services. Capitalized
advertising costs are not material at June 30 and March 31, 2000. Advertising
costs totaled $74,596 and $9,040 for the periods ended June 30, 2000 and 1999,
respectively, and $171,701 and $125,686 for the years ended March 31, 2000 and
1999, respectively.
DEPRECIATION
The Company's property and equipment is carried at cost and depreciated over the
estimated useful lives of the related assets. Depreciation is computed using the
straight-line method over a seven-year period for both financial reporting and
federal income tax purposes.
DEVELOPED SOFTWARE
Costs for new software products and enhancements to existing software products
are expensed as incurred until technological feasibility has been established.
Once the project reaches technological feasibility, all software development
costs are capitalized until the project is ready for release. Software
development costs are amortized on the straight-line method over a maximum of
seven years or the expected life of the product, whichever is less. Amortization
expense of software development costs was $34,438 for the period ended June 30,
2000.
INCOME TAXES
Deferred tax liabilities and assets are determined based on the differences
between the financial statement basis and tax basis of assets and liabilities,
using enacted tax rates in effect for the year in which the differences are
expected to reverse. Statement of Financial Accounting Standards ("SFAS") 109,
"Accounting for Income Taxes," also requires a valuation allowance against net
deferred tax assets if, based upon the available evidence, it is more likely
than not that some or all of the deferred tax assets will not be realized.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash, accounts receivable, accounts payable and accrued expense amounts reported
in the accompanying balance sheet approximate fair value. Accounts receivable
are unsecured. Based on the borrowing rates currently available to the Company,
the carrying amounts reported in the accompanying balance sheet for notes
payable approximate fair value.
F-8
<PAGE>
CONCENTRATIONS OF CREDIT RISK
Heartsoft markets to educators nationwide, which is a large, diverse group
governed by unrelated buying decisions. Thus, no single customer represents a
significant portion of the Company's revenues or accounts receivable. The
education market consists of both school systems and individual educators
requiring core curriculum materials as well as supplemental materials.
EMPLOYEE STOCK OPTIONS
When the exercise price of employee stock options equals or exceeds the market
value of the stock at date of grant, the Company recognizes no compensation
expense.
EARNINGS PER SHARE
Basic net loss per share is computed using the weighted average number of common
shares outstanding during the period. Diluted net loss per share is computed
using the weighted average number of common shares outstanding during the
period, plus the dilutive effect of common stock equivalents.
COMPREHENSIVE INCOME
The Company has no comprehensive income items for the three months ended June
30, 2000. Therefore, net loss equals comprehensive income.
NEW ACCOUNTING STANDARDS
The Company will adopt SFAS No. 133, "Accounting for Derivative Investments and
Hedging Activities" during 2001. Currently, the Company does not engage in
hedging activities or transactions involving derivatives.
MANAGEMENT ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
regarding items such as allowances for sales returns and uncollectible accounts,
and valuation allowances for deferred tax assets that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenue and expenses during the reporting period. Actual results could differ
from those estimates.
NOTE 2 - CANADIAN LIMITED PARTNERSHIPS
During 1997, the Board of Directors of the Company authorized the sale of an
aggregate undivided 45% interest of the Company's "K-8 Library" (the "Software
Library") pursuant to the terms of a Software Agreement ("Software Agreement")
entered into between the Company and Heartsoft
F-9
<PAGE>
1997 Limited Partnership, Heartsoft II 1997 Limited Partnership, and Heartsoft
III 1997 Limited Partnership, all Ontario, Canada limited partnerships (the
"Partnerships").
The Partnerships were formed by their general partner to acquire the investment
in the Software Library and to take advantage of certain Canadian tax laws. The
general partner of the Partnerships, which is unrelated to Heartsoft, is
responsible for their operation. The Company has no involvement or association
with the Partnerships other than through the Joint Venture Agreement.
Pursuant to the terms of the Software Agreement, the Company sold 45% interest
in the Software Library for $4,940,000 (Canadian), less related expenses, which
was payable 30% in cash and 70% by promissory notes (the "Acquisition Notes")
bearing interest at 5%, due in 2007. The Acquisition Notes are payable from
funds generated by the Partnerships through a joint venture with the Company
(evidenced by a Joint Venture Agreement).
Pursuant to the Joint Venture Agreement between the Company and the
Partnerships, Heartsoft retained the sole marketing rights, while Heartsoft and
the Partnerships jointly share in the revenues attributable to the future sales
of product utilizing the Software Library. The Partnerships are entitled to 100%
of all "gross sales" each year until all interest owed to the Company under the
Acquisition Notes is paid in full. After all interest has been paid, and until
all principal and interest has been paid, the Partnerships and the Company each
are entitled to 50% of the "gross margin" from sales attributable to the
interest in the Software Library. The "gross margin" is all gross revenues
generated from the interest in the Software Library, less returns, discounts and
cost of goods sold. After the Acquisition Notes have been paid in full
(including all accrued interest), the Company is entitled to 75% of the gross
margin, and the Partnerships the remaining 25%.
As of January 1, 1999, the Company has the option to terminate the Joint Venture
and reacquire the interest in the Software Library at a price to be negotiated
in good faith.
After deducting the allocable cost of the Software Library, the Company reported
gain on sale of $153,277 in fiscal 1999. The gain associated with the
Acquisition Notes has been deferred because its realization depends on the
Company's success in marketing the Software Library, resulting in no net
carrying value for the Acquisition Notes. Such gain will be recognized as the
Acquisition Notes are collected. In fiscal 1999, representing the Partnerships'
tax year ended December 31, 1998, interest on the Acquisition Notes amounted to
$112,313, and the principal balances were reduced by $26,800. During the year
ended March 31, 2000, representing the Partnership's tax year ended December 31,
1999, interest on the Acquisition Notes amounted to $119,647, and the principal
balances were reduced by $19,757. Since these amounts are realized through
software sales, they are reported in the statements of operations as such. The
principal balance of the Acquisition Notes at March 31 and June 30, 2000, is
approximately $2,300,000.
F-10
<PAGE>
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
June 30, March 31,
2000 2000
-------- --------
Office furniture, fixtures and equipment $146,049 $137,267
Production and development equipment 72,464 72,464
Leasehold improvements 9,231 9,231
-------- --------
$227,744 $218,962
======== ========
Depreciation expense was $5,899 and $4,791 for the three month periods ended
June 30, 2000 and 1999, and $19,164 for each of the years ended March 31, 2000
and 1999.
NOTE 4 - NOTES PAYABLE
Notes payable consist of the following:
June 30, March 31,
2000 2000
------- -------
Note payable to a finance company, $4,575
monthly including interest at 14.82%, due
February 2001, secured by property and
equipment $62,491 $73,781
Note payable to a bank, due $1,050 monthly
including interest at Wall Street Prime + 2%
(10.75% at March 31, 2000), due
June 2000 -- 3,127
Note payable to a bank, due $1,034 monthly
including interest at 9%, due October 2000 4,060 7,019
------- -------
Total 66,551 83,927
Current portion 66,551 83,927
------- -------
Noncurrent portion $ -- $ --
======= =======
F-11
<PAGE>
NOTE 5 - COMMITMENTS AND CONTINGENCIES
The Company leases office facilities under an operating lease for $6,578 per
month plus adjustments over the life of the lease. Rental expense was $19,071
and $14,420 for the three month periods ended June 30, 2000 and 1999,
respectively, and $67,318 and $56,382 for the year ended March 31, 2000 and
1999, respectively. Future annual payments under operating leases are $78,936
annually for fiscal 2001 through fiscal 2003 and $32,890 for fiscal 2004.
NOTE 6 - STOCKHOLDERS' EQUITY
PREFERRED STOCK
As of June 30, 2000, the Company had 52,000 shares of $.01 par value preferred
stock outstanding, convertible into common stock at the rate of .8 shares of
common stock per share of preferred stock.
During fiscal 2000, the Company sold 775,000 shares of $.01 par value preferred
stock, Series A, in a private placement. Proceeds of the sale aggregated
$775,000, less offering expenses of $77,500. The holders of Series A preferred
stock are not entitled to receive any dividends, and are entitled to $1.00 per
share preference in liquidation. Except in limited circumstances, the holders of
Series A preferred stock are not entitled to any voting rights. The Series A
preferred stock is convertible into common based on the average closing bid
price for 20 consecutive trading days preceding conversion, times 60%.
Conversion rights are at the option of the holder during the period that a
registration statement relating to the common stock underlying the Series A
preferred stock is effective. Conversion is automatic at the date such
registration is terminated.
Purchasers of the Series A preferred stock also received warrants to purchase
200,000 shares of common stock. The warrants expire on February 1, 2005, and are
exercisable at the lesser of (1) 60% of the closing bid price of the Company's
common stock or (2) $3.00.
Under the terms of the Series A Preferred Stock Purchase Agreement, the Company
agreed to file a registration statement with the Securities and Exchange
Commission relating to the common shares into which the Series A preferred stock
are convertible, and the common shares issuable upon exercise of the warrants.
The Company agreed to cause such registration statement to become effective by
August 1, 2000, which condition was not met. If it did not meet this condition,
the Company agreed to pay the purchaser $100,000 per month in common stock,
based on 60% of the closing bid price. (See Note 10).
COMMON STOCK
During the three months ended June 30, 2000, the Company sold 325,000 shares of
restricted common stock. Proceeds of the sale aggregated $275,000 less offering
expenses of $27,500. The shares were unissued at the period end. In connection
with the sale, Heartsoft agreed to file a registration statement relating to the
325,000 shares sold. If the registration statement is not
F-12
<PAGE>
effective by September 30, 2000, a penalty of 10,000 shares per month shall be
awarded until the 325,000 shares become free-trading. In addition, the Company
issued 25,000 shares as compensation for services.
During fiscal 2000, the Company borrowed $1,010,000 under a convertible note
agreement. These borrowings were satisfied by conversions into 1,100,000 shares
of restricted common stock. These transactions are included in the statements of
changes in stockholders' equity and cash flows with sales of common stock.
During the years ended March 31, 2000 and 1999, the Company entered into various
agreements with vendors under which the vendors received shares of Company
common stock in exchange for their services. The Company issued 203,835 and
338,827 shares of its common stock during the years ended March 31, 2000 and
1999, respectively, under these agreements and recognized general and
administrative expenses of $148,367 and $69,505, respectively. The transactions
were valued based on the underlying price of the Company's common stock on the
dates of issuance.
During the year ended March 31, 2000, 140,000 shares of common stock were issued
in repayment of $140,000 of debt.
EMPLOYEE BENEFIT AND STOCK OPTION PLAN
The Heartsoft, Inc. Employee Benefit and Stock Option Plan ("Plan") was
effective June 15, 1997, and terminates June 30, 2005. Awards under the Plan may
be granted by the Heartsoft Board of Directors in the form of stock issuance,
incentive stock options, or nonqualified stock options. The total number of
shares of common stock as to which stock issuances or options may be granted
under the Plan shall be 2,000,000. The option price of incentive stock options
shall not be less than 100% of the fair market value of the stock on the date of
grant. The option price of nonqualified stock options shall not be less than 25%
of the fair market value of the stock on the date of grant. The duration of each
option granted shall not exceed 10 years.
The weighted-average grant date fair value of shares issued to vendors and for
extinguishments of debt during the years ended March 31, 2000 and 1999, was
$1.29 and $0.21, respectively.
NOTE 7 - INCOME TAXES
At June 30, 2000, the Company had approximately $5,225,000 in net operating loss
carryforwards ("NOL's") expiring in 2009 through 2020. Management believes that
the Company does not meet the criteria for recognizing the tax benefit of net
operating loss carryforwards as a deferred tax asset and has established a
valuation allowance for the entire balance of the NOL's.
There are no material temporary differences between the bases of assets and
liabilities for income tax and financial reporting purposes that would give rise
to deferred tax assets and
F-13
<PAGE>
liabilities. Therefore, no provision for income taxes has been reflected in the
Company's statements of operations.
NOTE 8 -- EARNINGS PER SHARE
Basic and diluted EPS are computed as follows:
<TABLE><CAPTION>
Three month periods ended Years ended
June 30, March 31,
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Basic EPS
computation:
Net loss $ (470,676) $ (128,527) $ (1,524,133) $ (527,081)
Weighted average
shares
outstanding 11,065,502 9,944,326 10,739,719 7,746,136
------------ ------------ ------------ ------------
Basic and diluted
net loss per share $ (0.04) $ (0.01) $ (0.14) $ (0.07)
============ ============ ============ ============
</TABLE>
NOTE 9 - UNCERTAINTIES
The Company has experienced recurring operating losses and negative cash flows
from operating activities, which increased to $470,676 and $375,801,
respectively, for the three months ended June 30, 2000, and $1,524,133 and
$1,244,884, respectively, for the year ended March 31, 2000. Management
implemented a program to increase the marketing and sales staff, and these
additional expenses are not expected to have a substantial impact on revenues
until fiscal 2001. Management also plans to introduce significant new products
in fiscal 2001.
While product development expenditures have been substantial, the product
introductions have been delayed until fiscal 2001. In order to finance these
negative cash flows, the Company placed issues of preferred stock with warrants,
and common stock during the fifteen months ended June 30, 2000, realizing in
excess of $2,000,000 after offering expenses.
Management plans to introduce new products, including Heartsoft's children's
internet browser, "Internet Safari," in fiscal 2001. With new products and a
strengthened sales staff, management believes revenues from product sales will
increase dramatically. In order to finance the continuing costs of product
development and operating losses, management intends to raise additional capital
through equity offerings. However, the Company has no formal commitments for
equity placements. The ability of the Company to implement its operating plan
and to continue as a going concern depends on its ability to raise equity
capital and, ultimately, to achieve profitable operations.
F-14
<PAGE>
NOTE 10 - SUBSEQUENT EVENT
On September 26, 2000, the Company and the holder of the Series A preferred
stock entered into an amendment to the Stock Purchase Agreement (the
"Amendment"). Under the Amendment, the Company agreed to file a registration
statement relating to the common shares into which the Series A preferred stock
are convertible, and the common shares issuable upon exercise of the warrants,
and to cause such registration statement to become effective within a reasonable
time after October 1, 2000. The penalty for not having an effective registration
statement by August 1, 2000, was removed. In return, the Company agreed to issue
300,000 shares of common stock to the Series A preferred stockholder.
F-15
