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U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended MARCH 31, 2000
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[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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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) 251-1066
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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. [ ]
The issuer's revenue for the year ended March 31, 2000 was $315,557.
The aggregate market value of the voting stock held by non-affiliates at March
31, 2000 was $20,227,637. This amount was computed using the average bid and ask
price as of March 31, 2000. For purposes of this computation, all officers,
directors and 5% beneficial owners of Registrant are deemed to be affiliates.
As of March 31, 2000, the issuer had outstanding a total of 11,055,337 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
Cautionary Statement Regarding Forward-Looking Information 4
Risk Factors 4
Item 1. Description of Business 10
Item 2. Description of Property 16
Item 3. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security Holders 17
PART II
Item 5. Market for Common Equity and Related Stockholder Matters 17
Item 6. Management's Discussion and Analysis or Plan of Operation 18
Item 7. Financial Statements 23
Item 8. Changes In and Disagreements with Accountants on Accounting
and Financial Disclosure 23
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act 23
Item 10. Executive Compensation 25
Item 11. Security Ownership of Certain Beneficial Owners and Management 26
Item 12. Certain Relationships and Related Transactions 26
Item 13. Exhibits and Reports on Form 8-K 27
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PART I
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). Such statements relate to, among other things:
o future operations of Heartsoft;
o the development of new products and distribution channels and product
sales;
o competition for customers for Heartsoft's products;
o the uncertainty of developing or obtaining rights to new products that
will be accepted by the market;
o the timing of the introduction of new products into the market;
o the limited market life of Heartsoft's products; and
o other statements about Heartsoft or the educational software market.
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. Some of these risks and uncertainties include competition for
products and customers, the Company's expectations regarding its new Internet
Web browser for children, INTERNET SAFARI(TM), the Company's ability to develop
or obtain rights to new products and the limited market life of Heartsoft's
current products.
RISK FACTORS
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 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, 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 for
the foreseeable future. There is no assurance that additional financing will be
available, or, if available, that such financing will be on terms favorable to
the Company. Failure to obtain such additional financing would have a material
adverse effect on the Company's business, financial condition and results of
operations.
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LIMITED RESOURCES COULD RESTRAIN THE COMPANY'S GROWTH.
The Company currently needs additional funds to sustain its operations
and continue its policy of growth. Additional financing may not be available on
favorable terms or at all. If the Company raises additional funds by selling
stock, the percentage ownership of the Company's current shareholders will be
reduced. If the Company cannot raise adequate funds to satisfy its capital
requirements, the Company may have to limit its operations significantly. The
Company's future capital requirements depend upon many factors, including:
o the rate at which the Company expands its sales and marketing
operations;
o the extent to which the Company develops its products;
o the rate at which the Company updates its technology;
o the Company's ability to complete its planned private placement;
o the rate at which the Company expands; and
o the response of competitors to the Company's product and service
offerings.
THE COMPANY MAY EXPERIENCE POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS.
The Company's quarterly revenues and operating results have varied
significantly in the past and are likely to vary substantially in the future.
Quarterly revenues and operating results may fluctuate as a result of a variety
of factors, including:
o changes in the level of operating expenses;
o demand for the Company's products;
o the introduction of new products and product enhancements by the
Company or its competitors;
o changes in customer budgets;
o competitive conditions in the industry; and
o general economic conditions.
Further, the Company's customers often experience delays associated with
internal authorization procedures when purchasing the Company's products. For
these and other reasons, the sales cycles for the Company's products are
typically lengthy and subject to a number of significant risks outside the
Company's control including customers' budgetary constraints and internal
authorization reviews. The Company historically has operated with little backlog
because its software products are generally shipped as orders are received. The
Company cannot ensure that it will be profitable in future quarters.
THE COMPANY'S REVENUES HAVE DEPENDED ON SALES OF ITS PRINCIPAL PRODUCTS.
To date, the Company has derived substantially all of its revenue from
the sale of its 40 educational products. 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.
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THE COMPANY FACES CERTAIN RISKS ASSOCIATED WITH THE MANAGEMENT OF 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,
will further place a strain on the Company's resources and personnel when added
to the day-to-day activities of the Company. In particular, the Company is
currently developing a new secure Internet browser for children, INTERNET
SAFARI(TM). INTERNET SAFARI(TM) was originally scheduled to be released during
the first calendar quarter of 2000. The Company has experienced delays in
connection with the release of INTERNET SAFARI(TM) due to limited resources.
INTERNET SAFARI(TM) is now in the final stages of beta testing and is scheduled
to be released prior to the school year beginning fall of 2000.
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 in the process of developing a secure Internet browser for children.
The development of any new products utilizing the Internet involves significant
technical risks. The Company may not be successful in developing and marketing
product enhancements or new products. The Company could experience difficulties
that delay or prevent the successful development and marketing of product
enhancements or new products. The Company cannot guarantee that any new products
and product enhancements it may introduce will achieve market acceptance.
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. The Company believes its ability
to compete depends upon many factors including:
o the timely development and introduction of new products and product
enhancements;
o product functionality;
o product performance;
o price;
o product reliability;
o customer service and support;
o sales and marketing efforts; and
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o product distribution.
Some of the Company's primary and potential competitors are
substantially larger than the Company 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 also expects that competition
will increase as a result of software industry consolidation. In addition,
current and potential competitors have established or may establish cooperative
relationships among themselves or prospective customers. Accordingly, new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. Increased competition may result in price reductions,
reduced gross margins and loss of market share, any of which would have a
material adverse effect on the Company's business, operating results and
financial condition. The Company cannot ensure it will be able to compete
successfully against current or future competitors.
THE COMPANY DEPENDS UPON MANAGEMENT AND CERTAIN KEY EMPLOYEES.
The Company has experienced significant changes in its business,
including an expansion in the Company's staff and customer base, and the
expansion of its product lines. Such changes have placed and may continue to
place a significant strain on the Company's management and operations. In order
to manage such change in the future, the Company must continue to enhance its
operational, financial and management information systems and to hire, train and
manage employees. If the Company is unable to implement these systems and manage
such changes effectively, the Company's business, operating results and
financial condition could be materially and adversely affected. The Company
believes that its future success will also depend in large part upon its ability
to attract and retain highly skilled technical, managerial and marketing
personnel. Competition for such personnel is intense. The Company cannot ensure
that it will be successful in attracting and retaining the personnel it requires
to continue growing. Because of the Broken Arrow, Oklahoma (Tulsa metropolitan
area) location of the Company's headquarters, the Company may have difficulty in
attracting and retaining qualified management and technical employees who may be
required to move to become employed by the Company.
The Company's success depends to a significant extent on the
performance and continued services of its senior management and certain other
key employees. The loss of one or more of senior management and key employees
could have a material adverse effect upon the Company. In October 1999, the
Company entered into an employment agreement with its Vice President of Sales
and Marketing, Nita Seng, in order to reduce the risk of losing a key employee.
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 secrets laws, confidentiality procedures and
contractual provisions to protect its proprietary rights. The Company has also
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. Despite the Company's efforts to protect its
proprietary
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rights, unauthorized parties may attempt to copy aspects of the Company's
products or to obtain and use information that the Company regards as
proprietary. In addition, the laws of some foreign countries do not protect the
Company's proprietary rights as well as the laws of the United States. The
Company cannot guarantee that its means of protecting its proprietary rights
will be adequate or that the Company's competitors will not independently
develop similar technology.
The Company does not believe that any of its products infringe upon the
proprietary rights of third parties. However, third parties could claim
infringement by the Company with respect to current or future products. The
Company expects that software product developers such as itself will
increasingly be subject to infringement claims as the number of products in the
educational software market increase and the functionality of such products
overlap. Defense of any such claims, with or without merit, could be
time-consuming, result in costly litigation, cause product shipment delays or
require the Company to enter into royalty or licensing agreements. Such royalty
or licensing agreements, if required, may not be available on terms acceptable
to the Company or at all. Any dispute regarding the proprietary rights of third
parties could have a material adverse effect upon the Company's business,
operating results and financial condition.
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. However, despite testing,
new products or enhancements 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. Such
errors can cause delays in shipments that materially and adversely affect the
Company's competitive position and operating results. Although the Company has
not experienced material adverse effects resulting from any such errors to date,
the Company cannot ensure that its new products or releases will be error free
even after commencement of commercial shipments. Discovery of errors in the
Company's products after the commencement of commercial shipping could result in
the following:
o loss of revenues;
o delays in market acceptance;
o diversion of development resources;
o damage to the Company's reputation; and
o increased service and warranty costs.
Any of these occurrences could have a material adverse effect upon the Company's
business, financial condition and results of operations.
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
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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.
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 (except for shares
purchased by "affiliates" of the Company as such term is defined in Rule 144)
would be eligible for sale as the applicable holding periods expire. In the
future, these shares may be sold only pursuant to a registration statement under
the Securities Act or an applicable exemption, including pursuant to Rule 144.
Under Rule 144, a person who has owned Common Stock for at least one year may,
under certain circumstances, sell within any three-month period a number of
shares of Common Stock that does not exceed the greater of 1% of the then
outstanding shares of Common Stock or the average weekly trading volume during
the four calendar weeks prior to such sale. In addition, a person who is not
deemed to have been an affiliate of the Company at any time during the three
months preceding a sale, and who has beneficially owned the restricted
securities for the last two years is entitled to sell all such shares without
regard to the volume limitations, current public information requirements,
manner of sale provisions and notice requirements. 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 Stock, possibly having a depressive effect on any trading market for the
Common Stock, and may impair the Company's ability to raise capital at that time
through additional sale of its equity securities.
THE COMPANY DOES NOT EXPECT TO DECLARE OR PAY ANY DIVIDENDS IN THE FORESEEABLE
FUTURE.
The Company has not declared or paid any dividends on its Common Stock.
The Company currently intends to retain future earnings to fund the development
and growth of its business, to repay indebtedness and for general corporate
purposes, and, therefore, does not anticipate paying any cash dividends in the
foreseeable future.
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. For transactions
covered by this penny stock rule, broker-dealers must make certain disclosures
to purchasers prior to the purchase or sale. Consequently, 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.
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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 its own
proprietary educational software products for distribution to the education
market and consumer market. In 1999, Heartsoft decided to evaluate several
potential business opportunities involving limiting the amount of objectionable
material viewed by children who have access to the Internet through the use of a
Web browser or an e-mail service. After much review, the Company has formulated
the opinion that in addition to the area of children's safety sufficient demand
may also exist for its screening technology in some typical non-children
environments. Some of these other environments include, but are not limited to,
certain government agencies, corporations and professional organizations.
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 this
year estimates that nearly 24 million teens and children currently have access
to the Internet.
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 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 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 end 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, the Company continued
development of INTERNET SAFARI(TM), a secure Internet browser for children. This
proprietary product has
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been under in-house development and, after several delays, is expected to be
available prior to the school year beginning fall of 2000. INTERNET SAFARI(TM)
is currently in the final stages of beta testing. INTERNET SAFARI(TM) is
designed for children ages 4 through 12 years to help simplify their use of the
Internet. INTERNETSAFARI(TM) is a full-featured secure Internet browser for
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 a text-filtering program that contains a database of restricted words
and phrases; and
o a image detection and recognition program which utilizes heuristics 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 data base 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 programs 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 products 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 38 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
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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.
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 much 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 nearly all of its income from
sales to the education market, the introduction of INTERNET SAFARI(TM) during
the fiscal year 2001 will mark the beginning of the Company's move into the
consumer market. 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);
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o original equipment manufacturers (OEMs) such as Dell, Compaq, Gateway,
Apple, etc.; and
o on-line Internet stores, also known as e-commerce solutions.
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 need to 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 March 31, 2000, the Company utilized a sales and marketing staff
of ten inside people to market its products in the United States and abroad. The
Company anticipates hiring five additional people in the sales area during the
2001 fiscal year. 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. An
additional direct marketing campaign promoting the HEARTSOFT BESTSELLER SITE
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LICENSE and THINKOLOGY(TM) is anticipated in the next quarter to coincide with
the education market buying cycle. 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 a circulation of
approximately 5,000,000 in preparation of the spring buying season.
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.
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WORKING CAPITAL
Working capital practices in the software industry center on
inventories and accounts receivable. The Company regularly reviews its working
capital components in order to maintain the lowest level necessary in light of
anticipated needs.
To support the Company's policy of growth and meet working capital
needs during the development of INTERNET SAFARI(TM), the Company secured
approximately $2,000,000 in funding during the fiscal year ended March 31, 2000
through private placements of convertible debt and Common Stock.
On August 30, 1999, Hi-Tel Group, Inc. ("Hi-Tel") loaned the Company
$1,010,000 pursuant to a Convertible Promissory Note between the Company and
Hi-Tel. According to the terms of the promissory note, Hi-Tel had the option to
convert the debt into shares of the Company's Common Stock. From July 30, 1999
through October 30, 1999, Hi-Tel converted the entire principal amount of the
promissory note into Heartsoft Common Stock.
On February 15, 2000, the Company privately placed approximately
170,000 shares of restricted Common Stock with Dale L. Hill. After expenses, the
Company received a total of approximately $202,500 from the sale of these
shares.
On March 1, 2000, the Company privately placed 775,000 convertible
Preferred Shares with Hi-Tel. Under the terms of the Stock Purchase Agreement
between the Company and Hi-Tel Group, Hi-Tel received 775,000 shares of Series A
Convertible Preferred Stock ("Preferred Stock") and a warrant to purchase
200,000 shares of Common Stock of the Company ("Warrant") in exchange for
approximately $697,500 after expenses. The Preferred Stock may be converted into
Common Stock, at any time, using the following formula: [$775,000/(0.6 x Closing
Bid Price)] x [Number of Shares of Preferred Stock Converted/775,000]. Upon the
exercise of any portion of the Warrant, the Company will receive the lesser of
60% of the Company's closing bid price on the day of such exercise or $3.00
times the number shares purchased by using the Warrant. The "Closing Bid Price"
will be calculated as an average of the closing bid price, as reported by the
Nasdaq Stock Market, Inc., for the 20 consecutive trading days preceding the
conversion of the Preferred Stock or the exercise of the Warrant, whichever is
applicable.
The proceeds of the convertible debt and private placements of equity
met the Company's working capital needs through June 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 March 31, 2000, the Company had 30 full-time employees and 3
part-time employees, none of whom are represented by unions. Management
considers its relations with its employees to be good.
15
<PAGE>
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-edge 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 space), located in
a business office park at 3101 N. Hemlock Circle, Broken Arrow, Oklahoma. The
lease expires December 1, 2004. This lease provides the Company first
right-of-refusal as additional space becomes available. 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 it's 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 Company, Shell and Butler have discussed the allegations with
representatives of the Fort Worth District Office and have proposed a resolution
of the dispute which, if accepted, would result in the filing of a lawsuit by
the SEC against the Company, Shell and Butler. Upon the filing of the lawsuit,
certain stipulations and consents would be submitted by the Company, Shell and
Butler, and final judgments would be entered by the Court whereby the Company,
Shell and Butler would be permanently enjoined from committing violations of the
aforementioned securities laws and whereby Shell and Butler would pay to the SEC
disgorgement, interest and civil penalties totaling $146,402.99 and $129,850.94,
respectively. The proposed settlement must undergo a review and approval process
at several levels of the
16
<PAGE>
SEC and consequently, it is not currently known whether the proposed settlement
will be accepted 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 March 31, 2000.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
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, as reported by the NASDAQ Stock Market, Inc., was as follows:
Quarter Ended High Bid Low Bid
------------- -------- -------
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
The above quotes reflect inter-dealer prices without retail mark-up or
markdown or commissions, and may not represent actual transactions.
As of March 31, 2000, there were 454 holders of record, and according
to the Company's estimate approximately 3,000 beneficial owners, of the
Company's Common Stock.
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.
17
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
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
-------
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 three corporate websites,
www.heartsoft.com, www.internet-safari.com, www.thinkology.com.
Through the fiscal year ended March 31, 2000, the Company's product
line was comprised of approximately 40 educational software products that assist
young children in pre-kindergarten through the 6th grade to practice and learn
basic curriculum subjects. However, during fiscal 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.
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 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 ending March 31, 2000, the Company experienced a loss of
$1,524,133 and accumulated a total deficit of $4,754,841. These net 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 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;
18
<PAGE>
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.
Finally, while the Company's revenue has fluctuated significantly in
recent quarters as the Company shifted available resources between product
development and sales and marketing, there is no guarantee that such
fluctuations will cease nor that the Company will reach profitability.
RESULTS OF OPERATIONS
---------------------
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.
19
<PAGE>
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 54% 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 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. Expenses
for sales and marketing rose 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.
20
<PAGE>
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 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.
21
<PAGE>
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 in other sections of this Form 10-KSB.
The Company believes that although it is incurring an on-going
operating loss it has sufficient operating capital to meet its obligations
through the end of the first fiscal quarter 2001. However, in order to maintain
current level of operations, the Company will need to draw upon 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.
22
<PAGE>
ITEM 7. FINANCIAL STATEMENTS.
The Financial Statements of the Company are set forth on pages F-1
through F-14 inclusive, found at the end of this report.
INDEX TO FINANCIALS STATEMENTS
Independent Auditors' Report............................................... F-1
Balance Sheet.............................................................. F-2
Statements of Operations................................................... F-4
Statements of Changes in Stockholders' Equity.............................. F-5
Statements of Cash Flows................................................... 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 March 31, 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
-------------------------------------------------------------------------------
Juanita L. Seng 47 Vice President, Sales and Marketing
-------------------------------------------------------------------------------
23
<PAGE>
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.
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.
24
<PAGE>
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, no other executive
officers of Heartsoft received a total annual salary and bonus that exceeded
$100,000.
SUMMARY COMPENSATION TABLE
<TABLE><CAPTION>
Name and Other Annual
Principal Positions Year Salary Bonus Compensation
----------------------- ---- ------ ----- ------------
<S> <C> <C> <C> <C>
Benjamin P. Shell, 2000 $ 70,125(1) N/A $ 9,400(2)
President and Chief 1999 $ 46,800 N/A $ 9,444(2)
Executive Officer 1998 $ 46,800 N/A $ 9,561(2)
Juanita L. Seng, 2000(3) $ 50,000 $ 76,875(4) $ 8,850(5)
Vice-President,
Sales and Marketing
</TABLE>
------------------------
(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) All Other Annual Compensation for Mr. Shell 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, 2000 when the price of the Company's Common Stock
closed at $1.4375.
(5) This figure includes $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 Compensation for 2000 for Ms. Seng consists of car allowance
provided by the Company.
25
<PAGE>
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 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.
BENEFICIAL OWNERSHIP
--------------------
NAME AND ADDRESS NUMBER PERCENTAGE
OF BENEFICIAL OWNER OF SHARES OF TOTAL
------------------- --------- --------
Benjamin P. Shell, Chairman of the Board
President, and Chief Executive Officer
3101 North Hemlock Circle
Broken Arrow, OK 74102 928,792 8.40%
Jimmy L. Butler, Director, Vice-President,
Development, and Secretary
3101 North Hemlock Circle
Broken Arrow, OK 74102 823,625 7.45%
Kathleen Hurley, Director
3521 N. Military Road
Arlington, VA 22207 6,000 0.05%
Juanita L. Seng, Vice-President, Sales
and Marketing
3101 North Hemlock Circle
Broken Arrow, OK 74102 50,000 0.45%
All executive officers and directors
as a group (4 persons) 1,808,417 16.35%
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None.
26
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
EXHIBIT NO. DESCRIPTION
--------------------------------------------------------------------------------
*3.1 Articles of Incorporation of the Company.
*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.
27
<PAGE>
*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.
*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. and Hi-Tel
Group, Inc. attached as Exhibit B.
10.26 Web Service Agreement by and between Heartsoft, Inc. and
Gaggle, Inc. dated June 9, 2000.
*21.1 Subsidiaries of Heartsoft.
23.1 Consent of Tullius Taylor Sartain & Sartain LLP.
27.1 Financial Data Schedule.
28
<PAGE>
-------------
* Incorporated by reference to the Company's Form 10-KSB/A filed on January
22, 2000
(b) Reports on Form 8-K:
A. 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.
B. 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, 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.
29
<PAGE>
C. 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.
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: 07/14/00 /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: 07/14/00 /s/ Benjamin P. Shell
-------------------------------------
Benjamin P. Shell, Chairman of the
Board, President, and Chief Executive
Officer Executive Officer and
Principal Financial Officer)
Date: 07/14/00 /s/ Jimmy L. Butler, Jr.
-------------------------------------
Jimmy L. Butler, Jr., Vice-President
Date: 07/14/00 /s/ Kathy Howell
-------------------------------------
Kathy Howell, Chief Financial
Controller
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Heartsoft, Inc.
We have audited the accompanying balance sheet of Heartsoft, Inc., as of March
31, 2000, and the related statements of operations, changes in stockholders'
equity, and cash flows for 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 March 31,
2000, and the results of its operations and its cash flows for the two years
then ended, 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 $1,524,133 and
$1,244,884, respectively, in fiscal 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
June 16, 2000
F-1
<PAGE>
HEARTSOFT, INC.
BALANCE SHEET
March 31, 2000
ASSETS
Current assets:
Cash $ 334,794
Accounts receivable, trade, net of allowance of $8,000 30,655
Inventories, at cost 45,694
Other 9,219
----------
Total current assets 420,362
Property and equipment, at cost:
Property and equipment 218,962
Less accumulated depreciation 115,716
----------
Property and equipment, net 103,246
Other assets:
Developed software, net 693,419
Other 4,608
----------
Total other assets 698,027
----------
Total assets $1,221,635
==========
See notes to financial statements.
F-2
<PAGE>
HEARTSOFT, INC.
BALANCE SHEET
March 31, 2000
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 218,753
Notes payable 83,927
Accrued expenses 54,052
-----------
Total current liabilities 356,732
Commitments and contingencies --
Stockholders' equity:
Preferred stock, $0.01 par value, 5,000,000 shares
authorized, 827,000 shares issued 8,270
Common stock, $0.0005 par value, 30,000,000 shares
authorized, 11,055,337 shares issued 5,528
Additional paid-in capital 5,605,946
Accumulated deficit (4,754,841)
-----------
Total stockholders' equity 864,903
-----------
Total liabilities and stockholders' equity $ 1,221,635
===========
See notes to financial statements.
F-3
<PAGE>
HEARTSOFT, INC.
STATEMENTS OF OPERATIONS
Years ended March 31, 2000 and 1999
2000 1999
----------- -----------
Net sales $ 315,557 $ 527,915
Costs and expenses:
Costs of production 158,988 102,600
Sales and marketing 462,643 239,756
General and administrative 925,162 551,715
Depreciation and amortization 148,837 181,697
----------- -----------
Total operating expenses 1,695,630 1,075,768
----------- -----------
Operating loss (1,380,073) (547,853)
Other income and expense:
Gain on sale of interest in software library -- 153,277
Interest expense (143,089) (121,897)
Other, net (971) (10,608)
----------- -----------
(144,060) 20,772
----------- -----------
Loss before income taxes (1,524,133) (527,081)
Income taxes -- --
----------- -----------
Net loss $(1,524,133) $ (527,081)
=========== ===========
Net loss per common share - basic and diluted $ (0.14) $ (0.07)
=========== ===========
See notes to financial statements.
F-4
<PAGE>
HEARTSOFT, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years ended March 31, 2000 and 1999
<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
=========== =========== =========== =========== =========== =========== ===========
</TABLE>
See notes to financial statements.
F-5
<PAGE>
HEARTSOFT, INC.
STATEMENTS OF CASH FLOWS
Years ended March 31, 2000 and 1999
2000 1999
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,524,133) $ (527,081)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 148,836 181,697
Stock issued for services 148,268 69,505
Gain on sale of software library -- (153,277)
Changes in:
Accounts receivable 15,943 221,498
Inventories (25,343) (10,744)
Other assets 5,380 (3,234)
Accounts payable 25,013 14,559
Accrued expenses (38,848) 69,878
----------- -----------
Net cash used in operating activities (1,244,884) (137,199)
CASH FLOWS FROM INVESTING ACTIVITIES
Capitalized software development costs (199,283) (136,128)
Payments for the purchase of property (75,554) --
----------- -----------
Net cash used in investing activities (274,837) (136,128)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of software library -- 165,512
Proceeds from issuance of long-term debt -- 345,000
Proceeds from issuance of common and preferred stock 2,083,521 264,465
Repayments under line of credit -- (152,500)
Principal payments on notes payable (270,595) (311,972)
----------- -----------
Net cash provided by financing activities 1,812,926 310,505
----------- -----------
Net increase (decrease) in cash 293,205 37,178
Cash at beginning of year 41,589 4,411
----------- -----------
Cash at end of year $ 334,794 $ 41,589
=========== ===========
Supplemental disclosures:
Cash paid during the year for interest $ 203,089 $ 46,676
=========== ===========
Common stock issued for debt repayment $ 140,000 $ --
=========== ===========
See notes to financial statements.
F-6
<PAGE>
HEARTSOFT, INC.
NOTES TO FINANCIAL STATEMENTS
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.
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 45 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.
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.
F-7
<PAGE>
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 March 31, 2000. Advertising costs totaled
$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 $125,401, and $162,533 for the years
ended March 31, 2000, and 1999, respectively.
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
The Company follows SFAS No. 128, "Earnings Per Share," ("SFAS 128"), which
requires the presentation of basic and diluted 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 two years in the period
ended March 31, 1999. 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
F-9
<PAGE>
Heartsoft 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, 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, 2000, is approximately $2,300,000.
F-10
<PAGE>
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following at March 31, 2000:
Office furniture, fixtures and equipment $ 137,267
Production and development equipment 72,464
Leasehold improvements 9,231
-----------
$ 218,962
===========
Depreciation expense was $19,164 for each of the years ended March 31, 2000 and
1999.
NOTE 4 - NOTES PAYABLE
Notes payable consist of the following at March 31, 2000:
Note payable to a bank, due $1,034 monthly including
interest at 9%, due October 2000 $ 7,019
Notepayable 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
Notepayable to a finance company, $4,575 monthly
including interest at 14.82%, due February 2001,
secured by property and equipment 73,781
-----------
Total 83,927
Current portion 83,927
-----------
Noncurrent portion $ --
===========
F-11
<PAGE>
NOTE 5 - COMMITMENTS AND CONTINGENCIES
The Company leases office facilities under an operating lease for $5,988 per
month plus adjustments over the life of the lease. Rental expense was $67,318
and $56,382 for the years ended March 31, 2000 and 1999, respectively. Future
annual payments under operating leases are $70,788 for fiscal 2001, $70,788 for
fiscal 2002, $70,788 for fiscal 2003, and $47,192 for fiscal 2004.
NOTE 6 - STOCKHOLDERS' EQUITY
PREFERRED STOCK
As of March 31, 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. In the event the registration statement is not effective by
August 1, 2000, the Company agreed to pay the purchaser $100,000 per month in
common stock, based on 60% of the closing bid price.
COMMON STOCK
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.
F-12
<PAGE>
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.
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. During the years ended March 31, 2000
and 1999, no stock options were issued under the Plan.
During the year ended March 31, 2000, 140,000 shares of common stock were issued
in repayment of $140,000 of debt.
The weighted-average grant date fair value of shares issued to vendors,
employees and for extinguishment of debt during the years ended March 31, 2000
and 1999, was $1.29 and $.21, respectively.
NOTE 7 - INCOME TAXES
At March 31, 2000, the Company had approximately $4,775,000 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 liabilities. Therefore, no provision for income taxes
has been reflected in the Company's statements of operations.
F-13
<PAGE>
NOTE 8 -- EARNINGS PER SHARE
Basic and diluted EPS for the years ended March 31, 2000 and 1999, were computed
as follows:
2000 1999
------------ ------------
Basic EPS computation:
Net loss $ (1,524,133) $ (527,081)
============ ============
Weighted average shares outstanding 10,739,719 7,746,136
------------ ------------
Basic and diluted net loss per share $ (0.14) $ (0.07)
============ ============
NOTE 9 - UNCERTAINTIES
The Company has experienced recurring operating losses and negative cash flows
from operating activities, which increased to $1,524,133 and $1,244,884,
respectively, in fiscal 2000. Revenues declined in fiscal 2000, while operating
expenses increased. 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 planned to
introduce significant new products in fiscal 2000. 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 in fiscal 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
