<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996.
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 0-19155
STATE OF THE ART, INC.
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-3664592
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
56 TECHNOLOGY
IRVINE, CALIFORNIA 92718
(Address of principal executive offices) (Zip Code)
(714) 753-1222
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number or shares outstanding of the issuer's classes of common
stock, as of the latest practicable date.
As of November 1, 1996 the issuer had 11,141,689 shares of common stock, no par
value, outstanding.
<PAGE>
STATE OF THE ART, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<S> <C>
Condensed Consolidated Balance Sheets
September 30, 1996 and December 31, 1995 2
Condensed Consolidated Statements of Income
Three and nine months ended September 30, 1996
and September 30, 1995 3
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 1996
and September 30, 1995 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 6 - 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 10
Item 6(a). Exhibits 10
Item 6(b). Reports on Form 8-K 10
SIGNATURES 11
</TABLE>
1
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
STATE OF THE ART, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................... $ 18,502 $ 16,681
Short-term investments...................................................... 17,653 17,102
Accounts receivable, net.................................................... 4,566 5,175
Inventories................................................................. 1,300 1,086
Prepaid expenses............................................................ 1,429 768
Income taxes receivable..................................................... 638 --
Deferred income taxes....................................................... 288 237
------------- ------------
Total current assets...................................................... 44,376 41,049
------------- ------------
Property and equipment, net................................................. 5,613 4,357
Capitalized software development costs, net................................. 1,271 1,398
Other assets................................................................ 139 828
------------- ------------
$ 51,399 $ 47,632
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................ $ 2,911 $ 1,965
Accrued expenses............................................................ 1,687 1,270
Deferred revenue............................................................ 1,252 1,165
Income taxes payable........................................................ -- 769
Notes payable............................................................... 7 11
------------- ------------
Total current liabilities.................................................. 5,857 5,180
------------- ------------
Accrued rent................................................................. 232 195
Other noncurrent liabilities................................................. -- 7
------------- ------------
Total liabilities.......................................................... 6,089 5,382
------------- ------------
Shareholders' equity:
Preferred stock, 1,000,000 shares authorized, none issued and outstanding... -- --
Common stock, no par value; 25,000,000 shares authorized,11,134,939
and 10,923,436 shares issued and outstanding at September 30, 1996 and
December 31, 1995, respectively............................................ 18,225 16,460
Retained earnings........................................................... 27,085 25,790
------------- ------------
Total shareholders' equity.............................................. 45,310 42,250
------------- ------------
$ 51,399 $ 47,632
============= ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
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STATE OF THE ART, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------ ------------------------------
September 30, September 30, September 30, September 30,
1996 1995 1996 1995
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net revenues.................................. $ 11,054 $ 12,194 $ 36,439 $ 32,390
Cost of revenues.............................. 2,636 2,829 7,646 7,495
------------- ------------- ------------- -------------
Gross profit.................................. 8,418 9,365 28,793 24,895
Operating expenses:
Sales and marketing......................... 5,676 4,388 15,126 11,588
Research and development.................... 3,191 2,250 9,114 5,451
General and administrative.................. 1,220 1,072 3,606 3,105
------------- ------------- ------------- -------------
Total operating expenses...................... 10,087 7,710 27,846 20,144
------------- ------------ ------------- -------------
Operating income (loss)....................... (1,669) 1,655 947 4,751
Interest income............................... 354 323 1,045 911
------------- ------------ ------------- -------------
Income (loss) before income taxes............. (1,315) 1,978 1,992 5,662
Provision for (benefit from) income taxes..... (460) 693 697 1,982
------------- ------------ ------------- -------------
Net income (loss)............................. $ (855) $ 1,285 $ 1,295 $ 3,680
============= ============ ============= =============
Net income (loss) per share (Note 2).......... $ (0.07) $ 0.12 $ 0.11 $ 0.33
============= ============ ============= =============
Weighted average common shares
and equivalents (Note 2)..................... 11,834 11,123 11,692 11,179
============= ============ ============= =============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
STATE OF THE ART, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
<TABLE>
<CAPTION>
Nine months ended
September 30,
-------------------------
1996 1995
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income........................................................ $ 1,295 $ 3,680
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization................................... 1,908 1,719
Provision for deferred income taxes............................. (38) (6)
Gain on sale of property and equipment.......................... 1 2
Changes in assets and liabilities:
Accounts receivable............................................ 609 (370)
Inventories.................................................... (214) (242)
Prepaid expenses............................................... (661) (311)
Other assets................................................... 676 (651)
Accounts payable............................................... 946 140
Accrued expenses............................................... 417 (1,097)
Deferred revenue............................................... 87 (441)
Income taxes payable........................................... (874) (28)
Notes payable.................................................. (4) --
Accrued rent................................................... 37 (21)
Other noncurrent liabilities................................... (7) (9)
---------- ----------
Net cash provided by operating activities................... 4,178 2,365
Cash flows from investing activities:
Purchase of short-term investments................................ (551) (562)
Proceeds from sale of property and equipment...................... 17 1
Capital expenditures -- property and equipment.................... (2,605) (1,861)
Capital expenditures -- software development costs................ (450) (547)
---------- ----------
Net cash used in investing activities....................... (3,589) (2,969)
Cash flows from financing activities:
Proceeds from sale of common stock under stock option plan........ 1,232 1,134
---------- ----------
Net cash provided by financing activities................... 1,232 1,134
---------- ----------
Net increase in cash and cash equivalents........................... 1,821 530
Cash and cash equivalents at beginning of period.................... 16,681 13,506
---------- ----------
Cash and cash equivalents at end of period.......................... $ 18,502 $ 14,036
========== ==========
Supplemental disclosures of cash flow information:
Interest paid..................................................... $ 11 $ 2
========== ==========
Income taxes paid................................................. $ 1,609 $ 1,954
========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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STATE OF THE ART, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)
1. Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles and
with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim
financial information. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
consolidated financial statements. In the opinion of management, all
adjustments (consisting only of normal recurring accruals) considered necessary
for a fair presentation have been included. The operating results for the three
month and nine month periods ended September 30, 1996 are not necessarily
indicative of the results that may be expected for the year ending December 31,
1996. For further information, refer to the consolidated financial statements
and related notes included in the Company's Annual Report on Form 10-K for the
year ended December 31, 1995.
2. Net Income Per Share:
Net income (loss) per share was computed based on the weighted average
number of common shares and equivalents outstanding during the three and nine
month periods ended September 30, 1996, as well as the similar periods ended
September 30, 1995. Primary and fully diluted net income per share are
approximately the same. The number of shares used in the calculations for these
periods was 11,834,000, 11,692,000, 11,123,000 and 11,179,000 respectively,
which include incremental shares related to stock options granted of 722,000,
669,000, 413,000 and 640,000, respectively. The Company has granted certain
stock options which have been treated as common share equivalents in computing
net income per share.
5
<PAGE>
PART I. ITEM 2.
STATE OF THE ART, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
OVERVIEW:
Revenue for the third quarter ended September 30, 1996 decreased 9% resulting in
a net loss of $855,000 or $0.07 per share as compared to net income of
$1,285,000 or $0.12 per share for the corresponding quarter of the prior year.
For the nine month period ended September 30, 1996 the Company's net income
decreased 65% to $1,295,000 or $0.11 per share on net revenues of $36,439,000 as
compared to $3,680,000 or $0.33 per share on net revenues of $32,390,000 for the
nine month period ended September 30, 1995.
FORWARD LOOKING INFORMATION:
This Quarterly Report on Form 10-Q contains certain forward looking statements,
including statements concerning expected fourth quarter revenues and projected
future costs. Such statements involve risks and uncertainties, which could
cause actual results to differ from those projected.
RESULTS OF OPERATIONS:
Net revenues for the third quarter and nine month period ended September 30,
1996 were $11,054,000 and $36,439,000, respectively. This constituted a
$1,140,000 or 9% decrease for the third quarter over third quarter 1995, and a
$4,049,000 or 13% increase for the nine month period over the same nine month
period of the prior year. The revenue for the third quarter decreased as a
result of decreased sales of software licenses. The revenue for the nine month
period increased as a result of increased sales of software licenses, support
services and business forms. Software license revenues from the Company's
Acuity Financials, MAS 90 for Windows, MAS 90 EVOLUTION/2 and Business Works
product lines decreased $904,000 or 9% for the third quarter as compared to the
same quarter of the previous year and increased $3,805,000 or 15% for the nine
month period over the same nine month period of 1995. The decrease in the third
quarter was primarily attributed to transition issues associated with the
Company's release of new products in the Windows and Client Server environments.
The Company has traditionally sold applications based upon DOS operating systems
and with the release of Windows and Client Server products, the need for new
training programs and installation help and guidelines adversely affected sales
of the new products during the third quarter of 1996. In addition, the Company
believes that some customers delayed sales in anticipation of the expansion of
breadth of application modules. In order to address these issues, the Company
has aggresively implemented training and installation programs to its reseller
channel. The increase in revenues for the nine month period was primarily due to
increased MAS 90 product sales.
6
<PAGE>
The Company sold the Apple product lines of FlexWare and MacP&L in the second
quarter of 1996. As a result, revenues from these products were reduced to
immaterial amounts in the third quarter of 1996. The revenue from the Apple
product lines was $279,000 and $752,000 for the third quarter and nine month
period of 1995, respectively.
Software license revenues from the Company's MAS 90 product line decreased
approximately $418,000 or 5% in the third quarter over third quarter 1995 and
accounted for 70% of the Company's total revenues for the quarter as compared to
67% of the Company's total revenues in the same quarter of the previous year.
For the nine month period, MAS 90 license revenues increased $4,102,000 or 20%
over the same nine month period of the prior year and accounted for 68% of the
total Company's revenues for the nine month period, as compared to 64% of the
total Company's revenues for the same nine month period in the prior year. As
stated above, the third quarter 1996 revenue was negatively impacted by the
transition issues associated with the introduction of new Windows and Client
Server products. Business Works software license revenues decreased 29% or
$486,000 for the quarter as compared to the third quarter of 1995, and decreased
9% or $457,000 for the nine month period over the comparable nine month period
in the prior year. The Company attributes the decline in the Business Works
revenue in the third quarter of 1996 to reduced upgrade sales. The Company had
a major enhancement to the product in the second quarter of 1995 and there was
no similar enhancement in the current year.
The Company's support services experienced a revenue decrease of 4% or $49,000
in the third quarter and an increase of 12% or $393,000 for the nine month
period as compared to similar periods of the prior year. Business forms revenue
grew 11% or $94,000 in the third quarter and 9% or $243,000 for the nine month
period as compared to the same periods of the prior year and can be attributed
to increased volume and pricing.
Quarterly revenues can fluctuate significantly when compared to similar periods
of the prior year due to the timing of product introductions, enhancements,
upgrades, commencement of sales and marketing promotions and general economic
conditions. As a result, one quarter's performance as compared to a comparable
period in the prior year is not necessarily indicative of the Company's expected
performance in subsequent quarters or the year. Because the Company is in the
transition phase of releasing new products and technology to market, future
revenues are dependent on a number of factors including, but not limited to,
customer acceptance, competition and reseller productivity.
Furthermore, the Company operates with minimal backlog because orders are
generally shipped on an immediate basis. As a result, the Company's quarterly
revenues and operating results are difficult to forecast since they are
dependent upon the volume and timing of orders received during any period.
Historically, the revenue volume for the first, second and third quarters of the
year have been lower than the fourth quarter. The historically higher revenue
volume in the fourth quarter has been largely due to two factors: higher end-
user demand for the Company's software products and the release of the Company's
annual payroll tax update program. Management believes this pattern will
continue into the fourth quarter of 1996.
7
<PAGE>
Cost of revenues in the third quarter of 1996 was 24% as a percentage of
revenue, in comparison to 23% in the third quarter of the prior year. For the
nine month period ended September 30, 1996, cost of revenues was 21% as a
percentage of revenue, as compared to 23% for the same period of the prior year.
For the third quarter 1996, increased material costs were primarily responsible
for the increase in cost of revenues. The decrease in cost of revenues for the
nine month period 1996, as a percentage of revenue, is primarily due to the
higher prices for the MAS 90 for Windows products. The Company continues to
pursue cost reduction opportunities whenever practicable, however, there can be
no assurance that it will be able to maintain its current level of cost of
revenues when expressed as a percentage of revenues for the remainder of 1996.
Operating expenses, when expressed as a percentage of net revenues, for the
third quarter were 91% as compared to 63% for the third quarter of the prior
year, and were 76% for the nine month period ended September 30, 1996 in
comparison to 62% for the same period of the prior year. Total operating
expenses for the third quarter and nine month period ended September 30, 1996
increased 31% or $2,377,000 and 38% or $7,702,000, respectively, over comparable
periods of the prior year. The increase in operating expenses as compared with
the comparable periods of the prior year consisted of sales and marketing
expense increases of 29% or $1,288,000 for the quarter and 31% or $3,538,000 for
the nine month period; research and development expense increases of 42% or
$941,000 for the quarter and 67% or $3,663,000 for the nine month period; and
general and administrative expense increases of 14% or $148,000 for the quarter
and 16% or $501,000 for the nine month period.
The increase in sales and marketing expenses can be attributed to higher
headcount and personnel related costs in addition to increased direct marketing
and advertising costs as a result of the Company's development and release of
two new major product lines, MAS 90 for Windows and Acuity Financials, both of
which began to ship in the second quarter of 1996. The increase in research and
development expenses can be attributed to higher headcount and personnel related
costs as a result of the Company's development and release of the two new major
product lines noted above. The increase in general and administrative expense
is primarily the result of increased costs related to amortization and
depreciation as a result of the Company's capital expenditures in the areas of
computer, telephone and management information systems.
The Company continues to project a trend toward higher personnel and related
costs in future quarters. The Company's introduction of MAS 90 for Windows and
Acuity Financials product lines will result in additional expenditures in future
quarters in the areas of product support, sales and marketing and research and
development. In addition, the Company plans to aggressively increase its
advertising and marketing plans in future periods to promote and launch its new
products to market. If the Company is not able to increase its revenue over the
third quarter 1996 level, the projected increase in expenditures could result in
a loss or lower profitability.
8
<PAGE>
Interest income for the third quarter of 1996 increased $31,000 or 10% to
$354,000 or 3% of net revenues as compared to $323,000 or 3% of net revenues in
the third quarter of 1995 primarily due to higher cash balances.
LIQUIDITY AND CAPITAL RESOURCES:
Working capital at September 30, 1996, totaled $38.5 million, an increase of
$2.6 million or 7% as compared to $35.9 million as of December 31, 1995.
On February 22, 1995, the Company entered into an agreement whereby it may
borrow, on a revolving credit line basis, up to $10,000,000. The revolving line
is unsecured. The Company has the option to pay interest on the revolving
credit line at the bank's prime interest rate, or LIBO rate plus 1.5 percent.
The agreement requires the Company to maintain certain compensating balances and
has certain restrictive covenants. The agreement expires March 15, 1997. As of
September 30, 1996, there are no outstanding balances on this revolving credit
line.
The Company has historically funded its operations primarily through positive
cash flows from operations. The Company believes that funds generated from
operations and existing cash balances and the available bank credit lines will
be sufficient to finance the Company's operations for at least the next twelve
months.
9
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PART II. OTHER INFORMATION.
ITEM 1. LEGAL PROCEEDINGS.
See the Company's Annual Report on Form 10-K for the year ended December 31,
1995, for a description of certain litigation.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits: Exhibit 27 filed this report.
(b) Reports on Form 8-K: The Company has not filed any reports on
Form 8-K during the quarter for which this report is filed.
10
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SIGNATURES:
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
STATE OF THE ART, INC.
Registrant
Date: November 14, 1996 By: /s/ DAVID W. HANNA
--------------------
David W. Hanna
Chairman of the Board
Date: November 14, 1996 By: /s/ JOE R. ARMSTRONG
--------------------
Joe R. Armstrong
Chief Financial Officer
(Principal Financial Officer)
11
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996
<PERIOD-START> JUL-01-1996 JAN-01-1996
<PERIOD-END> SEP-30-1996 SEP-30-1996
<CASH> 0 18,502
<SECURITIES> 0 17,653
<RECEIVABLES> 0 4,710
<ALLOWANCES> 0 144
<INVENTORY> 0 1,300
<CURRENT-ASSETS> 0 44,376
<PP&E> 0 11,620
<DEPRECIATION> 0 6,007
<TOTAL-ASSETS> 0 51,399
<CURRENT-LIABILITIES> 0 5,857
<BONDS> 0 0
0 0
0 0
<COMMON> 0 18,225
<OTHER-SE> 0 0
<TOTAL-LIABILITY-AND-EQUITY> 0 51,399
<SALES> 9,863 32,767
<TOTAL-REVENUES> 11,054 36,439
<CGS> 2,555 7,457
<TOTAL-COSTS> 2,636 7,646
<OTHER-EXPENSES> 10,087 27,846
<LOSS-PROVISION> 15 45
<INTEREST-EXPENSE> 3 11
<INCOME-PRETAX> (1,315) 1,992
<INCOME-TAX> (460) 697
<INCOME-CONTINUING> (855) 1,295
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (855) 1,295
<EPS-PRIMARY> (0.07) 0.11
<EPS-DILUTED> 0 0
</TABLE>
