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 December 31, 1998 or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Commission File Number: 000-22172
MIDISOFT CORPORATION
(Exact name of small business issuer as specified in its charter)
Washington 91-1345532
(State or other jurisdiction of (I.R.S.employer incorporation
or organization) Identification No.)
1605 NW Sammamish Road, Suite 205,
Issaquah, Washington 98027
(Address of principal executive offices)
(425) 391-3610
(Issuer's telephone number)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
None N/A
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)
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 period 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
Issuer's revenues for its most recent fiscal year were $1,759,954.
Aggregate market value of voting stock held by non-affiliates of the registrant
as of April 14, 1999 was $13,718,920 (based upon the closing sale price of $2.00
per share on such date). Number of shares of Common Stock outstanding as of
April 14, 1999: 7,020,621 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's Proxy Statement relating to its 1999 annual meeting of
shareholders is incorporated by reference into Part III of this Annual Report on
Form 10-KSB.
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TABLE OF CONTENTS
Part I
Page
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Item 1. Description of Business........................................... 3
Item 2. Description of Property........................................... 8
Item 3. Legal Proceedings................................................. 8
Item 4. Submission of Matters to a Vote of Security Holders............... 9
Part II
Item 5. Market for Common Equity and Related Shareholder Matters.......... 10
Item 6. Management's Discussion and Analysis or Plan of Operation......... 10
Item 7. Financial Statements.............................................. 19
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.......................................... 39
Part III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act................. 39
Item 10. Executive Compensation............................................ 39
Item 11. Security Ownership of Certain Beneficial Owners and Management.... 39
Item 12. Certain Relationships and Related Transactions.................... 39
Item 13. Exhibits List and Reports on Form 8-K............................. 39
SIGNATURES................................................................... 43
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PART I
Item 1. DESCRIPTION OF BUSINESS
General
Midisoft Corporation was founded in 1986 as an innovator of music technology.
Over the past 13 years, the Company has established itself as a provider of
award-winning music software and sound utilities for the control of audio and
the management of media files. Midisoft's product lines include music creation
and distribution with integration of sound and media on the PC and over the
Internet. The Company's music products enable users to enjoy, explore, learn,
create and share music. Midisoft pioneered the development of music technology,
including the ability to view (visually interact with) musical notation of
sounds while played with a musical instrument linked to a PC. Midisoft's
Internet products promote the convergence of sound with other technologies that
enhance the experience of combining and controlling music, sound and video with
other Internet capabilities.
The Company markets its products on a worldwide basis in two ways. Music
products are sold on the Internet and at retail stores and the Internet products
are downloadable and sold to hardware manufacturers and content aggregators and
providers. In 1998, the Company deployed a strategy of selling music software to
musical instrument stores that have a focused clientele of musicians. This
channel has proven cost-efficient. Costs of reaching this niche are more
economical than that of general consumer-related audiences. The Company
continues to sell its music software directly to customers through its inside
sales staff and increased visibility of the website.
The second distribution method is selling audio utilities to original equipment
manufacturers and Internet products to content aggregators and providers.
Although this distribution channel is currently in a state of change, there are
revenue opportunities for those companies willing and agile enough to adjust
their strategies. The Company's contracts with companies such as Diamond
Multimedia enable end users to gain exposure to Midisoft's audio utilities on a
mass market scale. The Company also has formed alliances with Internet content
aggregators and providers to download its Internet Media Player, opening
exposure to Internet users.
During the last two years, the Company redesigned and developed its music
products and refocused its strategic products to meet the increasing demand for
access to new technologies. In 1998, the Company released Midisoft Studio 6.0,
the first notation-based sequencer that combines digital editing and recording
capabilities in one application, and Desktop Sheet Music 2.0. These latest
editions of the music software provide increased flexibility and ease-of-use
demanded by customers. The Company also released MediaWorks '98, the media
player for the desktop personal computer, and Internet Media Player, the add-on
to Microsoft's Windows Media Player that allows access and management of content
sourced from the Internet.
Emergence of the Internet as a medium for distributing sound, voice messages and
music globally has amplified expansion of audio technology. As new technologies
evolve, the Company believes it can continue to be a premiere provider of audio
control expertise.
Products
Midisoft Music Product Line consists of Midisoft Studio 6.0, Midisoft Desktop
Sheet Music 2.0, Midisoft Play Piano, Midisoft MidiKit, and Midisoft Family
Music Center. The Company creates and markets these products to bring music
education, composition and professional quality music creation to the PC
desktop.
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Midisoft Studio(TM) 6.0 Midisoft Studio 6.0 is a music sequencer utilizing and
extending technology that was first introduced by Midisoft in 1986. The product
creates and edits music digitally, and publishes high-quality music notation
(sheet music). Midisoft Studio 6.0 is differentiated from other music sequencers
because it uses the same notation engine incorporated in Midisoft Desktop Sheet
Music. This capability currently is not found in competing products .
Midisoft Desktop Sheet Music(TM). Desktop Sheet Music 2.0, released at the end
of the third quarter of 1998, includes significant functionality improvements
based on extensive beta use evaluations. Targeted at the estimated $433.5
million per year category of printed music (National Association of Music
Merchants, 1998 Statistical Survey), Desktop Sheet Music creates and publishes
professional sheet music. The product, imports standard MIDI files for
conversion to high-quality music notation (sheet music).
Midisoft MIDIKit(R). Midisoft MIDIKit's universal MIDI connector and MIDI editor
transforms a PC into a music recording studio. Cables connect the PC's sound
card to a MIDI musical instrument. The product's Recording Session Plus software
provides MIDI recording, composing and editing capability, as well as digital
audio recording.
Midisoft Play Piano(TM) 2.0. Midisoft Play Piano 2.0 combines core Midisoft
technologies and new proprietary technologies for creating interactive music
learning experiences based on individual student needs. The product imports MIDI
files and with artificial intelligence creates custom music lessons.
Midisoft Family Music Center(TM). Family Music Center incorporates Midisoft Play
Piano and Midisoft Studio with a keyboard, MIDI connector and a Connect and Play
video, targeting family entertainment.
Midisoft's Internet Product Line consists of Midisoft Internet Media Player,
Midisoft MediaWorks '98, Internet Audio Postcard, Midisoft Internet SoundBar,
and Midisoft AudioPro. Derivatives of these products are planned for development
for new and existing contracts, including audio and content aggregators, as well
as downloads from Internet destination and portal sites.
Internet Media Player(TM) In July 1998, the Company released Internet Media
Player(TM) v3.0, a streaming media player, with full support for Microsoft
Corporation's NetShow v3.0. The player provides Internet users with capabilities
to locate, organize and directly access links to streaming content, such as live
radio and TV broadcasts, concert "webcasts," on-line news and entertainment.
This product also plays MP3 files, the current file format of choice of the
Internet music enthusiast.
Internet Media Player was a featured NetShow (now Windows Media) Partner
third-party product on Microsoft's web site and was included on two Microsoft
Tools CDs, distributed to more than 50,000 commercial and corporate software
developers. Internet Media Player is sold and distributed to end-users via the
Company's Web site and targeted ad banner advertising on streaming-specific web
sites. Of particular interest to third-party customers is the ability to "brand"
Internet Media Player with corporate logos, advertising and streaming content
links, as well as the ability to automatically refresh advertising and content
via the Internet.
MediaWorks(TM) `98 In late June 1998, the Company released MediaWorks `98 v1.0,
a multimedia playback application for Windows 95/98 and NT. MediaWorks `98
provides an extensible audio/video player supporting most popular file formats.
The product features an intuitive user interface, as well as an integrated
database engine, the MediaFinder , which simplifies locating and managing media
files.
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The Company is marketing MediaWorks `98 to its traditional third-party
customers, on its web site (http://www.midisoft.com/html/catalog/
mw98/default.htm) and on download sites, such as BuyDirect.com and ZDNet. New
versions of MediaWorks `98 will feature plug-in architecture for rapid
deployment of enhancements and modules supporting enhanced file formats.
Midisoft AudioPro(TM). AudioPro supports MIDI, wave audio and CD audio for
third-party programs, providing software sound tools and flexibility to manage
and edit interactive multimedia audio data.
Midisoft Internet Audio Postcard(TM). Midisoft Internet Audio Postcard adds
voice to digital snapshots or video files. It includes a player for Internet
distribution. .
Midisoft Internet Sound Bar(R) Internet Sound Bar controls sound from the PC
desktop. With this product users send Audio Mail, create Audio Notes, annotate
digital pictures or video with sound, then distribute their creations on the
Internet The software plays CD's and locates and collects all sound and music
files on the PC. This functionality is controlled from a Windows-style task bar,
positioned on the screen edge.
Market Overview
With proliferation of the Internet as an engaging medium for communication,
entertainment and recreation, Midisoft believes the PC will continue to be a
platform for creating and experiencing music, sound and video. In the broadest
sense, the potential market for the Company's audio and media control software
is every PC that ships into a home or business. IDC forecasts unit shipments of
PC's to grow 14.1% in 1999 to more than 96 million, with the number of
households owning a personal computer, expected to reach 43% in the U. S. This
obviously presents substantial segments for music and related applications. The
National Association of Music Merchants estimates 62 million amateur musicians
reside in the U.S. The Company expects that music tutorials, creation,
appreciation and enjoyment with PC's will continue.
The Company also believes that office computer users will become increasingly
aware and experienced in using sound effects, such as background music
integrated with visual effects in their business presentations
Strategy
Midisoft is deploying a strategy designed to meet the demands of users of music
as well as makers of music. For example, the Company recently customized its
Desktop Sheet Music product for sale into the Christian music market. The
customized version features functionality tailored to the requirements of music
pastors and directors. These users of music require sheet music each week for
use by soloist performers or choirs. In addition, the product contains a
selection of hymns that can be transposed and varied to fit the particular
voices or members of a choir. The Company is identifying other music users for
similar customization and product sales.
Midisoft believes that the Internet will continue to provide a platform for
promoting, marketing and selling music and related products and services MP3,
the file format for compression of audio files, is the second most frequently
searched for term on the leading Internet search engines, according to
Searchterms.com. Jupiter Communications estimates music downloads and other
music sales will reach $1.4 billion by 2002. The Company is positioning its
Internet Products to exploit these trends. Internet Media Player is a candidate
for private labeling on destination and portal websites. The Company has
initiated arrangements with content aggregators and providers for the download
of the Internet Media Player.
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Marketing, Sales and Distribution
The Company markets its products to end users through retail distribution,
third-party manufacturers and Internet destinations and portals. Products
offered directly to end users include the Company's flagship music products.
Music products also have found a home as a product differentiator for sound card
and personal computer manufacturers. The uniqueness of the products allows the
Company to leverage its audio expertise onto the Internet with Internet Media
Player. The Company markets its products principally by attending trade shows,
advertising in periodicals oriented toward retailers and end-users, Web
advertising and direct mailings.
Distribution
Retail distribution is direct through the Company's Retail Channel Sales group.
The Company has a stock balancing program for its retail products that, under
certain circumstances, allows for the exchange of products by resellers. The
Company monitors and manages the volume of its sales to retailers and
distributors and their inventories as substantial overstocking in the
distribution can result in high returns or the requirement of substantial price
protection in subsequent periods. A price protection program allows resellers a
price reduction from the Company for unsold product. The Company believes it
provides adequate reserves for returns and price protection which are based on
estimated future returns of products, taking into account promotional
activities, the timing of new product introductions, distributor and reseller
inventories and other factors and that its current reserves will be sufficient
to meet return and price protection requirements for the foreseeable future.
Internationally, retail products are generally sold through republishers.
The Company expanded its presence into Musical Instrument ("MI") stores in 1998.
The Company currently has shelf space in the two largest MI chains, Sam Ash and
Guitar Center, as well as prominent regional MI resellers. The Company believes
that MI retailers generate higher sales per store for these types of products
than computer software retailers do.
Direct Sales. The Company has an inside sales group that sells product directly
to end users through a toll-free number listed in advertising by the Company.
This group is responsible for targeted direct mail marketing and sells product
upgrades and accessories to registered customers.
Web Sales. Web sales are an increasingly important channel for the Company. The
Company has developed its Internet web site to promote the complete product line
and conduct secured online transactions. In addition, the Company has
sublicensed certain of its downloadable software products to other Internet
stores such as Digital River and c|net.
As part of its sales efforts, the Company generates a marketing database of
registered users for direct mail opportunities. Further, the surveying of
current users, collation of user feedback from technical support calls, input by
customers and the Company's sales force is evaluated in determining the features
and function of the next set of product releases in the context of the Company's
own strategic planning.
The Company distributes product direct to third-party manufacturers through its
internal sales force. The Company supplies one master disk, which the
manufacturer duplicates.
Customer Support: The Company provides a high level of support across the
distribution spectrum. Support includes on-site training for third party
manufacturers, as well as on-going telephone support. In turn, these groups
provide support for their customers directly. The Company also offers free
support to end-users of its retail products.
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Competition
The software market for audio and music on the PC is highly competitive and
rapidly changing. The Company's competitors, many of which have greater
financial, marketing and technical resources than the Company, offer similar
products and target the same customers. The Company believes its ability to
compete depends upon many factors within and outside its control, including the
ability to offer product enhancements, functionality, performance, price,
reliability, customer support, sales and marketing efforts and distribution.
There can be no assurance that competition will not adversely affect future
operating results or financial condition.
Manufacturing
The Company utilizes a third-party contractor for assembly and outbound
distribution. The Company uses in-house capability for customer order
processing, component inventory procurement, material requirements planning and
production scheduling. The manufacturing process for software involves
duplication of software code onto floppy diskettes or CD's, printing of
packaging and documentation and assembly of final packaged products.
Manufacturing output can generally be increased rapidly to respond to increases
in demand. The Company has experienced occasional delays in manufacturing its
products resulting from not consistently remaining within credit terms with some
of its vendors The Company has not encountered unusual levels of returns
resulting from product defects.
The Company generates and responds to customer demand through Web-based
distribution whereby customers order products and download the Company's
software directly to their PCs, This eliminates most of the traditional order
processing and manufacturing steps. Third-party sales require duplication of the
Company's software code onto a CD, generally referred to as a "golden master."
The manufacturer then transfers the software code from golden masters onto their
hardware.
Proprietary Rights
The Company relies primarily on trade secret, trademark and copyright laws,
treaties and contractual agreements, to protect its proprietary rights. The
Company attempts to keep results of its research and development programs
proprietary to protect its marketed software products against misappropriation
and infringement by third parties. However, there can be no assurance that the
Company will in all instances be able to prevent others from misappropriating or
infringing upon the Company's proprietary information and software products.
The Company intends to maintain the integrity of its trade name, trademarks,
copyrights and other proprietary rights against unauthorized use and to protect
against infringement and unfair competition where circumstances warrant.
Although the Company believes that its products do not infringe on any copyright
or other proprietary rights of third parties, there are currently significant
legal uncertainties relating to the application of copyright and patent law in
the field of software. The Company has no assurance that third parties will not
obtain, or do not have, patents covering features of the Company's products, in
which event the Company or its customers might be required to obtain licenses to
use such features. If a patent holder refuses to grant a license on reasonable
terms or at all, the Company may be required to alter certain products or stop
marketing them.
Employees
The Company, as of March 17, 1999, employed 18 employees. Of these, 8 are
employed in administration, 4 in product development and 6 in sales and
marketing. Employees are covered
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by confidentiality agreements, and no employee has an employment contract. None
of the Company's employees are represented by a union or other bargaining group.
The Company believes it maintains good employee relations.
Dividends
The Company has declared no dividends on its Common Stock since its inception.
It is the present policy of the Company to retain earnings and capital for use
in its business. Any payment of dividends on the Common Stock in the future will
be dependent upon the Company's financial restrictions, if any, under debt
obligations, as well as other factors that the Board of Directors may deem
relevant.
Forward-Looking Statements
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, and such statements are subject to the safe harbors
created thereby. These forward-looking statements include the plans and
objectives of management for future operations, including plans and objectives
relating to (a) the development of new music, strategic and Internet products,
(b) the expansion of domestic and international marketing, sales and
distribution programs, (c) the continued protection of proprietary technologies
and (d) the ability to fund continued operations out of existing working
capital, additional capital infusion and cash flow from future operations. The
forward-looking statements included herein are based on current expectations
that involve a number of risks and uncertainties. These forward-looking
statements are based on assumptions that the Company will continue to develop
and introduce new music, strategic and Internet products on a timely basis, that
rapid changes in technology will not make the Company's products obsolete or
otherwise reduce their ability to compete in the marketplace, that competitive
conditions within the industry will not change materially or adversely, that the
use of multimedia PC's in homes and small offices will continue to grow, that
management's decision to focus the Company's resources on music and sound
products will reduce certain expenses from the levels which were experienced in
1997 and 1998, and that there will be no material adverse change in the
Company's operations or business. Assumptions relating to the foregoing involve
judgments with respect to, among other things, future economic, competitive and
market conditions, and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions underlying the
forward-looking statements are reasonable, any of the assumptions could prove
inaccurate and, there can be no assurance that the forward-looking information
will prove to be accurate. In light of the significant uncertainties inherent in
the forward-looking information included herein, the inclusion of such
information should not be regarded as a representation by the Company or any
other person that the objectives or plans of the Company will be achieved.
Item 2. DESCRIPTION OF PROPERTY
The Company's principal offices are located in approximately 17,000 square feet
of office space in Issaquah, Washington, which the Company leases pursuant to a
lease expiring in April 2000 with an option to extend through April 2002. The
Company currently pays $25,725 per month under its lease agreement. The Company
considers its leased properties to be in good condition, well maintained, and
generally suitable and adequate for its present and foreseeable future needs.
Item 3. LEGAL PROCEEDINGS
In 1997, an entity which sold substantially all of its assets to the Company in
1995 demanded that the Company arbitrate certain claims arising from the sale.
The claims aggregated in excess of $1
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million. The parties reached an agreement in July 1998 outside of arbitration.
In exchange for the mutual release of all claims and counterclaims, the Company
agreed to provide consideration of $420,000, $25,000 in cash and the remainder
comprised of forgiveness of $112,000 in debt and issuance of approximately
630,000 Midisoft common shares. The Company agreed to file a registration
statement for these shares within 30 days after final authorization by the
shareholders in 1998, but has not filed the registration statement as of this
date. Midisoft intends to file a registration statement at the earliest possible
date. $20,000 of the $25,000 has been paid. The debt of $112,000 has been fully
reserved and $283,000 for the additional common shares has been booked as of
December 31, 1998. Midisoft agreed to remove restrictive legends on 166,667 of
previously issued shares. It is anticipated that the releases and consideration
will be exchanged in 1999.
In March 1997, a former sales representative ("Plaintiff") filed suite in
Michigan against Midisoft under a certain manufacturer's representative
agreement ("Agreement") entered into between the parties in November 1994.
Plaintiff claims that the Company breached the Agreement by failing to pay
commissions and is seeking damages in excess of $75,000. Midisoft denies that it
failed to pay commissions under the Agreement and is asserting counterclaims for
over payments and return credits. Damages asserted by the Company equal the
damages claimed by the Plaintiff. The parties are awaiting a trial date, which
is reportedly to occur sometime in April 1999. The ultimate outcome cannot be
determined at this time, but the Company believes that it has meritorious
defenses and is vigorously defending against the claim.
On April 3, 1997 the Company began arbitration proceedings against a former
customer. On September 24, 1997, the Company was awarded a judgement in the
amount of $194,983.37 against the former customer. The amount of the award
represents the sum of 1) $160,000.00, the unpaid portion of the base annual
license royalty under the Company's OEM License Agreement and 2) $34,983.37,
representing interest on the unpaid installments from their respective due dates
through the date of the award computed at 12% per annum. In November 1998, the
former customer had exhausted its appeals when the Washington State Court of
Appeals denied the former customer's appeal motion, thereby terminating the
appellate process. In March 1999, the Company amended the judgement to add
attorneys' fees and interest accrued since the original judgement was entered.
The total amount of the amended judgement is $247,925.34. The Company has
engaged a California law firm to enforce judgement in the state of California,
the headquarters location of the former customer.
As of December 31, 1998, the Company had $345,000 of accounts payable that were
current, $37,000 extended to between 31 and 60 days and $799,000 extended over
60 days. The level of extended accounts payable results from the Company's
negative operating cash. The Company has entered into plans to extend payments
beyond due dates in the original purchase orders. There is no certainty that the
Company will be able to continue to meet extended payment terms. The Company has
received demand letters from certain vendors requesting immediate payment of
amounts owing them totaling approximately $401,000. Twelve of these vendors have
initiated litigation for claims totaling $131,000 and 8 of these have received
judgments totaling approximately $95,000. The Company has reached settlement
agreements with some vendors and is negotiating with the remainder. Some vendors
have stopped making sales to the Company and others have required cash on
delivery terms.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of shareholders was held on October 30, 1998 near the
Company's headquarters in Issaquah, Washington. Matters submitted to the
shareholders for a vote were as follows:
Election of Directors - Mr. Larry Foster and Ms. Marsha Murry were reelected as
directors of the Company. Their three year terms expire at the 2001 annual
meeting of shareholders. Mr.
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Foster's nomination received 5,345,267 votes FOR, 295,824 votes were withheld
and there were 186,751 broker non-votes. Ms. Murry's nomination received
5,337,598 votes FOR, 303,493 votes were withheld and there were 186,751 broker
non-votes.
Selection of Independent Accountants - The selection of PricewaterhouseCoopers
LLP as the Company's independent accountants was ratified. The results of the
vote were 5,593,913 FOR and 33,898 AGAINST with 13,280 abstentions and 186,751
broker non-votes.
Proposal to Amend the Articles of Incorporation to Increase the Authorized
Common Shares to 25 Million - This increase of 15 million shares in the
authorized common shares was approved by the shareholders. The results of the
vote were 5,196,653 FOR and 410,788 AGAINST with 33,650 abstentions and 186,751
broker non-votes.
Proposal to Reserve an Additional 500,000 Shares under the 1989 Stock Option
Plan - This proposal was defeated. The shareholder votes were 1,470,063 FOR and
529,468 AGAINST with 83,509 abstentions and 3,744,802 broker non-votes. Although
the measure received a majority of the votes cast, a majority of the total
outstanding shares was required for passage.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Market Information. The Company's Common Stock is traded under the symbol
"MIDI". The Company's Common Stock was quoted on the Nasdaq National Market
through September 9, 1997. Since that time, the Common Stock has traded on the
OTC Bulletin Board. The following table sets forth the range of high and low
closing bid prices, as reported, from January 1, 1997 through December 31, 1998.
The prices set forth reflect inter-dealer quotations, without retail markups,
markdowns or commissions, and do not necessarily represent actual transactions.
As of March 17, 1999, the number of holders of record of the Company's Common
Stock was approximately 1,567. Since certain of the shares of Common Stock are
held in street name, there may be additional beneficial holders of the Company's
Common Stock.
High Low
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1997
First quarter $ 2.5000 $ 1.1250
Second quarter 2.0000 1.0625
Third quarter 4.6250 3.0313
Fourth quarter 1.6250 0.4375
1998
First quarter $ 1.2500 $ 0.6250
Second quarter 0.8125 0.3125
Third quarter 1.0000 0.3750
Fourth quarter 0.7500 0.2300
Dividends. The Company has declared no dividends on its Common Stock since its
inception. It is the present policy of the Company to retain earnings and
capital for use in its business. Any payment of dividends on the Common Stock in
the future will be dependent upon the Company's financial condition, results of
operations, current and anticipated cash requirements, plans for expansion,
restrictions, if any, under debt obligations, as well as other factors that the
Board of Directors may deem relevant.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion should be read in conjunction with the Financial
Statements and notes thereto.
General
The Company's revenues include sales of software and software licenses net of
sales returns. Cost of revenues includes the costs of manuals, software
duplication, packaging materials, assembly, paper goods, shipping, amortization
of software development costs and royalty fees paid to licensors of third-party
software bundled with the Company's products.
Research and development expenses consist primarily of personnel and equipment
costs required to conduct the Company's development effort. Software development
costs are expensed as incurred.
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Revenue from products licensed to OEMs consisting of one-time license fees and
contracts for minimum advances against future unit licenses are recognized when
the criteria for fixed fee revenue recognition under American Institute of
Certified Public Accountants' Statement of Position No. 97-2, Software Revenue
Recognition (SOP 97-2) is satisfied. These criteria include, but are not limited
to, delivery of the software master, the Company's lack of other significant
obligations to the customer and a determination that the collectability of the
amount due is probable. Contracts that do not meet the fixed fee revenue
recognition criteria in SOP 97-2 included in deferred revenue are recognized as
revenue on the installment basis as payments from customers are received, or
until the Company has no significant obligations. Additional royalty use or unit
copy royalty fees are recognized when they are earned pursuant to the license
agreements and upon notification of shipment from the OEMs. Revenue from sales
to distributors, other resellers and end-users net of a provision for
anticipated returns, is recognized when the products are shipped. The allowance
for returns is evaluated each quarter taking into consideration, among other
things, known return requests from distributors, anticipated return requests
based on the distributor's rate of product sale, returns due to product upgrades
and historical distributor return patterns.
During 1997 and 1998, the Company's research and development, marketing and
sales efforts were focused upon the Company's core technologies in sound and
music. The Company has continued to reduce its reliance on technology licensed
from others through internal development of superior technologies or through
direct acquisition of desirable technologies.
At December 31, 1998, the Company had Federal net operating loss carryovers of
approximately $26.1 million, which expire beginning 2008. In certain
circumstances, as specified in Section 382 of the Internal Revenue Code, a 50%
or more ownership change by certain combinations of the Company's stockholders
during any three-year period would result in limitations on the Company's
ability to utilize its net operating loss carryforwards. An investor owns
$3,000,000 in principal amount of convertible debentures and associated warrants
and has the right to purchase an additional $1,000,000 in convertible debentures
by June 1999. If the debenture holder were to exercise all its warrants and
convert all the debt it holds, a change in control of the Company would result.
Seasonality
Sales to distributors tend to be greater in the third and fourth quarter as
consumers buy software to supplement their holiday computer hardware purchases.
OEM sales are concentrated in a small number of large customer contracts and
tend to occur sporadically. Direct sales generally increase when software
upgrades become available.
Comparison of Years Ended December 31, 1998 and 1997
Sales for 1998 were $1.8 million compared to $3.0 million in 1997. Sales to
software distributors and resellers, together with direct sales, represented 79%
and 70% of sales for the years ended December 31, 1998 and 1997, respectively.
OEM sales represented 21% and 30% during the same periods. Sales to distributors
and resellers were lower in part from higher returns and lower units sales in
1998 compared to 1997. The Company believes that the decline in OEM sales is
substantially related to significant industry-wide reductions in PC prices,
which began in the fourth quarter of 1997. These pricing pressures persisted
during 1998. In this light, actions by the Company's OEM customers to reduce
their costs and number of suppliers has adversely affected the Company's OEM
sales in 1998 compared to 1997. The Company has responded by repositioning its
OEM products to take advantage of enhanced internet-based functionality and by
pursuing partnerships with internet content aggregators. International sales
accounted for 8% of the Company's revenues in 1998 compared to 13% of revenues
in 1997 resulting from the Company's continued emphasis on US sales in 1998.
12
<PAGE>
Gross profit for 1998 was $1.1 million, a decrease of $0.2 million, compared to
$1.3 million for the prior year. As a percentage of net revenues, gross profit
increased to 62% in 1998 from 45% in 1997. Gross profits, in general, are
affected by the mix of OEM licensing sales versus music product sales as well as
the mix within music products. The retail channel and inside sales channel for
music products consist of boxed product. OEM costs of sales generally consist of
one master CD from which OEMs duplicate the Company's software. Accordingly,
gross profit is higher on OEM sales compared to sales into other channels. Costs
were lower in 1998 compared with the same period in the prior year due primarily
to the absence of software amortization expense in 1998. Software amortization
costs for the year ended December 31, 1997 were $455,000. These assets were
fully amortized in 1997. Without amortization expense, cost of sales for the
year ended December 31, 1997 would have been 40% as compared to 38% in 1998.
Contributing to gross margin increase was the elimination of software
amortization expenses offset by a higher level of returns and a change in sales
mix, reflecting lower OEM sales, in 1998 compared to 1997. Also, increased cost
of goods sold in 1998 resulted in part from higher unit production and component
costs resulting from lower volumes and smaller order quantities. The Company has
kept royalty costs low as it has concentrated on internal development of sound
and music software.
Research and development expenses for 1998 were $626,000, a decrease of $362,000
compared to $988,000 for 1997. As a percentage of net revenues, research and
development expenses increased to 36% in 1998 from 33% in 1997. This reflects
the Company's commitment to sustain internal development of its industry leading
software for the production and management of sound and music. The Company's
continued investment in product development reflects commitments to continually
introduce new or improved products.
Sales and marketing expenses for 1998 were $1.2 million, a decrease of $0.6
million, compared to $1.8 million for 1997. As a percent of net revenues, sales
and marketing expenses increased to 68% in 1998 from 61% in 1997. Principal cost
reductions were in sales and marketing employees, advertising, and trade shows.
The increase in sales and marketing expense as a percentage of sales resulted
from lower sales. The reduction in expense levels reflects the Company's
continuing emphasis on cost controls and targeting marketing and sales efforts
into direct sales channels.
General and administrative expenses for 1998 were $1.9 million, a decrease of
$200,000, compared to $2.2 million for 1997. As a percentage of net revenues,
these expenses for 1998 increased to 106% from 72% in 1997. The increase in
general and administrative expense as a percentage of sales is due to lower
sales in 1998. G&A expense is comprised mainly of fixed obligations and the
Company is endeavoring to reduce these costs by restructuring certain lease
agreements, reducing insurance, legal and other professional services fees.
Interest expense for 1998 was $1.6 million, an increase of $0.6 million compared
to $1 million in 1997. The increase in interest expense results from non-cash
charges relating to the intrinsic value of in-the-money conversion options
related to the convertible debentures and detachable warrants issued by the
Company in 1998.
Liquidity and Capital Resources
As of December 31, 1998, the Company's principal sources of liquidity included
cash and cash equivalents of $270,000 and net accounts receivable of $183,000.
As of December 31, 1998, working capital was negative $1.2 million.
The Company's operating activities used cash of $1.5 million for the year ended
December 31, 1998 due primarily to operating losses of $2.6 million.
13
<PAGE>
Current assets decreased $358,000 to $610,000 at December 31, 1998 from $968,000
at the end of 1997. The decrease was due to reductions of accounts receivable,
inventories and prepaid expenses totaling $538,000, offset by an increase in
cash of $180,000. Long term assets decreased $117,000 to $367,000 at December
31, 1998 from $484,000 at the end of 1997. This decrease resulted largely from
depreciation of fixed assets. There were no significant additions to fixed
assets in 1998. The total of current liabilities and deferred revenue were $1.8
million at December 31, 1998, an increase of $0.1 million from the balance at
December 31, 1997 of $1.7 million. An increase in accounts payable of $200,000
in 1998 was partially offset by a decrease of $100,000 in other accrued
expenses. Shareholders' equity decreased $2.1 million to negative $3.2 million
at December 31, 1998 from a negative $1.1 million at the end of 1997. The change
in equity resulted from a net loss recorded in 1998 of $4.2 million, partially
offset by additions to equity for the issuance of stock in settlement of claims
and outstanding accounts payable of $300,000 and $1.7 million, reflecting the
fair value of warrants and the intrinsic value of convertible debentures, both
associated with the securities purchase agreement executed October 28, 1997, as
described below.
On October 28, 1997, the Company entered into a Securities Purchase Agreement,
which was amended on January 7, 1998, (the "Agreement") with an unrelated third
party (the "Lender"). The Agreement provides for the sale of $2 million of
convertible debentures with the option for an additional $2 million through June
1999. The Company sold $500,000 of debentures on each of October 28, 1997,
November 28, 1997, January 9, 1998 and January 28, 1998. The first $1 million in
debentures sold are convertible into a total of 1,666,667 shares of Common Stock
and were issued with warrants to purchase an additional 833,333 shares of Common
Stock at a price of $1.50 per share. The second $1 million in debentures sold
are convertible into a total of 1,923,077 shares of Common Stock and were issued
with warrants to purchase an additional 961,538 shares of Common Stock at a
price of $1.25 per share. The debentures bear interest at the rate of 1% per
annum payable in cash or, at the Company's option, in shares of Common Stock.
The Company is obligated to pay a finder's fee of 3% of the money raised as that
money is received by the Company. The Company has the right to redeem these
debentures at any time prior to conversion for an amount equal to the sum of the
outstanding principal amount plus accrued interest plus a redemption premium
which increases from 7% of the principal amount if redeemed within 45 days from
issuance to 25% of the outstanding principal amount if the redemption date is
more than 90 days from the issuance date. For so long as the debentures are
outstanding or the Lender owns at least 25% of the Company's outstanding Common
Stock, the Lender shall have the right to (i) approve certain merger or
acquisition transactions, (ii) appoint two of the Company's five directors with
the Company's concurrence and (iii) purchase any equity securities the Company
may propose to sell. The first of the Lender's board positions was filled by Mr.
J. Larry Smart, President and Chief Executive Officer of Visioneer, Inc., a
public company. The second position has been filled by Mr. Robert Orbach,
President and founder of B. Orbach, Inc.
The Company and the debenture holder amended the Securities Purchase Agreement,
with respect to the proposed June 15, 1998 sale of $1,000,000 of convertible
debentures, to provide for the sale of up to $1,000,000 of Senior Convertible
Secured Notes in 1998. The first $500,000 of these notes are for five years and
bear interest at the rate of one percent (1%) per annum, payable in cash
annually on the anniversary date of the notes. These notes are convertible into
2,500,000 shares of Common Stock. The note holder also received five year
warrants to purchase 500,000 shares of Common Stock at an exercise price of
$0.75 per share. The notes will be secured by first, prior and perfected
interests in all intellectual property rights, fixed assets and contracts for
product delivery. The note holder had the option to purchase an additional
$500,000 of notes with terms and conditions similar to those referenced above,
with a conversion price equal to forty-seven percent (47%) of the value of each
share of common stock for the ten trading days prior to exercise of the
conversion option. This option was exercised in two installments. The Company
sold $250,000 of these notes in December 1998 and a like amount in March 1999.
Each of these notes are convertible into 1,000,000 shares of Common Stock. The
note holder also received five year
14
<PAGE>
warrants to purchase 500,000 shares of Common Stock at an exercise price of
$0.75 per share with each note.
The debenture holder has the right to purchase an additional $1,000,000 of
convertible debentures in 1999. If the debenture holder were to exercise all its
warrants and convert all the debt it holds and has a right to acquire, a change
in control of the Company would result.
Simultaneous with the execution of the original Agreement, the Company entered
into a Registration Rights Agreement with the Lender, whereby the Company agreed
to use its reasonable best efforts to file a registration statement to register
the Common Stock which is issuable upon the conversion and exercise of the
debentures and warrants. The Company has agreed that it will bear all costs
associated with such registration, excluding underwriting commissions or
discounts.
In September 1997, the Company received $250,000 for which it was to issue a 5%
convertible note due September 1998 (the Note). The Note and accrued interest
were to be convertible into common stock at a conversion price of $0.65 per
share, at the option of the holder, at any time after October 30, 1997 through
maturity. A debt discount of $135,000 was recorded related to the intrinsic
value of the in-the-money conversion option at the close of the debt
transaction. The discount was expensed on October 30, 1997. The note agreement
has not been executed and the lender has requested changes to certain terms of
the agreement. The Company expects that the final agreement will provide for a
convertible note bearing interest from 5% to 8% with a conversion price of $0.65
per share, maturing in two to three years.
To date, the Company has financed its operations principally through net
proceeds from two public offerings and private placements of debt and equity.
Cash on hand, along with cash generated from the sale of products and
collections of accounts receivable, is not expected to be sufficient to meet the
Company's requirements for the next 3 months. The Company's ability to fund
continued operations depends on raising additional capital. Should the Company
be unable to raise additional capital, the Company will be required to
significantly reduce operations, reduce expenses, and may find it necessary to
file for protection under the bankruptcy code. Such steps would likely have a
material adverse effect on the Company's ability to establish profitable
operations in the future. The Company will continue to pursue other financing
arrangements to increase its cash reserves. There can be no assurance the
Company will be capable of raising additional capital or that the terms upon
which such capital will be available to the Company will be acceptable.
Trade Debt and Other Matters
As of December 31, 1998, the Company had $345,000 of accounts payable that were
current, $37,000 extended to between 31 and 60 days and $799,000 extended over
60 days. The level of extended accounts payable results from the Company's
negative operating cash. The Company has entered into plans to extend payments
beyond due dates in the original purchase orders. There is no certainty that the
Company will be able to continue to meet extended payment terms. The Company has
received demand letters from certain vendors requesting immediate payment of
amounts owing them totaling approximately $401,000. Twelve of these vendors have
initiated litigation for claims totaling $131,000 and 8 of these have received
judgments totaling approximately $95,000. The Company has reached settlement
agreements with some vendors and is negotiating with the remainder. Some vendors
have stopped making sales to the Company and others have required cash on
delivery terms.
Nasdaq
Effective with the close of business September 9, 1997 the Nasdaq delisted the
Company's Common Stock from the Nasdaq National Market. The Company was unable
to evidence a minimum of $2,000,000 in net tangible assets and compliance with
all the requirements for continued listing on the Nasdaq National Market.
Although the Common Stock trades on the OTC Bulletin Board, the Company believes
that the delisting of its stock has adversely affected its ability to raise
capital.
15
<PAGE>
YEAR 2000
The Year 2000 or Y2K problem is somewhat predictable in its timing, but
unpredictable in its effects. In order to conserve limited computer memory, many
computer systems, software programs, and other microprocessor dependent devices
were created using only two digit dates, such that 1998 was represented as 98.
These systems may not recognize certain 1999 dates, and the year 2000 and
beyond, with the result that processors and programs may fail to complete the
processing of information or revert back to the year 1900. As we approach the
year 2000, we expect computer systems and software used by many companies in a
wide variety of applications to experience operating difficulties unless they
are modified or upgraded to process information involving, related to, or
dependent upon the century change. Failures could incapacitate systems essential
to the functioning of commerce, building systems, consumer products, utilities,
and government services locally as well as worldwide. Significant uncertainty
exists concerning the scope and magnitude of problems associated with Y2K.
State Of Readiness
The Company has established a Y2K Task Force to address these risks. The Y2K
Task Force, comprised of the CEO, CFO and Director of Information Technology, is
leading the Year 2000 risk management efforts. The Y2K Task Force is
coordinating the identification and testing of computer hardware and software
applications, with a goal to ensure availability and integrity of the
information systems and the reliability of the operational systems utilized by
the Company.
Year 2000 Project Methodology and Approach
The Year 2000 Project at Midisoft Corporation uses the following five-phase
methodology and approach:
The first two phases are "work in progress" and are being updated in an ongoing
basis.
Phase I - Inventory. Collect a comprehensive list of components that may be
affected by the Year 2000 issues. Components are categorized into facilities,
hardware, software, and services.
Phase II - Assessment. Evaluate the inventory to determine which components will
function properly with the turn of the century and rank components based on
their potential impact to the company. Each component is assigned priority as
follows:
Critical ("1"): Will potentially impair the company's ability
to do business should the component fail.
Important ("2"): Will adversely affect some productivity should the
component fail.
Inconvenient ("3"): Will cause minor inconvenience should the component fail.
Non-Essential ("4"): Will have no impact should the component fail.
Based on assigned priorities from Phase I and II, the following phases will be
carried out to the critical (priority 1) components first, followed by important
(priority 2) components, then inconvenient (priority 3) components and finally
non-essential (priority 4) components if resources and time are available. The
Company is committed to complete testing of all critical and important
components before August 31, 1999.
16
<PAGE>
Phase III - Remediation. Analyze all components affected by Year 2000,
identifying problem areas and repairing / replacing non-compliant components.
Phase IV - Testing. Thorough testing of all affected systems, including present
and future date testing to simulate Year 2000 dates.
Phase V - Implementation. Place all components that have been successfully
tested into production.
Year 2000 Testing Criteria and Tools Utilized
Information systems are being tested with a licensed software program; a
diagnostic tools designed for personal computers and servers that will identify
Y2K issues related to computer hardware, software and data. To date, this
testing appears to have been successful and has yielded no significant problems.
With the constant introduction of new computer equipment and software,
information systems testing will continue throughout the year.
The company uses different test criteria and test dates for different
computing platforms.
Hardware: On PC and LAN server hardware platforms, Midisoft has
adopted the NSTL's Ymark2000 test program during the assessment phase
to identify non compliant hardware. NSTL, a division of McGraw-Hill
Companies, is a leading independent testing facility for the computer
industry.
Software: During the remediation and testing phases, Midisoft has
adopted GMT's Check2000 PC Deluxe for testing and corrective actions.
Microsoft products are also being tested using the Microsoft Product Analyzer
available from their web site at www.microsoft.com/y2k. This program checks all
Microsoft products installed against their online database that contains the
latest results from their internal testing.
Data: Check2000 PC Deluxe will be used to identify and examine individual data
in a variety of storage formats. Data files with potential date issues will be
identified and presented to the user for ranking to determine the importance of
each file detected. Based on this ranking, all critical and important files will
be analyzed for non-compliant dates and corrected accordingly.
Year 2000 Supplier and Partner Status
The company does not currently utilize Electronic Data Interchange (EDI) with
any of its partners or vendors but will thoroughly test any EDI situation that
may arise between now and March 1, 2000.
Suppliers and Partners have been identified and ranked based on the same
criteria as phase II.
Critical ("1"): Will potentially impair the company's ability
to do business should the supplier / partner fail.
Important ("2"): Will adversely affect some productivity should
the supplier / partner fail.
Inconvenient ("3"): Will cause minor inconvenience should the
supplier / partner fail.
Non-Essential ("4"): Will have no impact should the supplier / partner fail.
17
<PAGE>
If critical suppliers do not satisfy the companies Year 2000 compliance
requirements, alternative suppliers will be identified. As a contingency plan,
inventory levels may be raised prior to December 1999 to assure continued
delivery of products to customers through March 2000.
Risks
In the event such third parties cannot provide the with products, services, or
systems that meet the Year 2000 requirements on a timely basis, or in the event
Year 2000 issues prevent such third parties from timely delivery of products or
services required by the Company, the Company's results of operations could be
materially adversely affected. To the extent Year 2000 issues cause significant
delays in, or cancellation of, decisions to purchase, the Company's products or
services, the Company's business, results of operations, and financial position
would be materially adversely affected. The Company is assessing these risks and
in some cases has initiated formal communications with significant suppliers and
customers to determine the extent to which the Company is vulnerable to these
third parties' failure to remediate their own Year 2000 issues. There can be no
assurance the Company will identify and remediate all significant Year 2000
risks, or that such risks will not have a material adverse effect on the
Company's business, results of operations, or financial position. Accordingly,
the Company will continue to develop contingency plans in anticipation of
unexpected Year 2000 events. Based on its assessment of year 2000 risks to date,
the Company does not believe any material exposure to significant business
interruption exists as a result of Year 2000 compliance issues.
Contingency Plans
Since the Year 2000 problem is pervasive, few, if any, companies can make
absolute assurances that they will identify and remediate all Y2K risks.
Accordingly, the Company expects the risk assessment and contingency planning to
remain an ongoing process leading up to and beyond the year 2000. In addition,
the potential Year 2000 problem is being addressed as part of the Company's
overall emergency preparedness program that includes contingency planning for
other potential major catastrophes like earthquakes, fires and floods.
The Companies approach to Financial Risk Transfer has two main areas of focus.
Secure the broadest insurance coverage available at a reasonable cost and avoid
exclusions or restrictions of coverage, if possible. Explore other Financial
Risk Transfer products and/or Y2K specific insurance coverage to the extent that
it becomes available at economically feasible levels.
Estimated Costs
The Company is continuing to assess the potential impact of the century change
on its business, results of operations, and financial position. The total cost
of these Year 2000 compliance activities is not anticipated to be material to
the Company's financial position or its results of operations. The cost of
internal resources dedicated to the Year 2000 has not been estimated at this
time.
Subsequent Events
As discussed above, in March 1999 the Company issued 1% convertible debentures
in exchange for $250,000. The debentures are convertible into a total of
1,000,000 shares of Common Stock and carry detachable warrants to purchase an
additional 500,000 shares of Common Stock at $0.75 per share. The debentures
mature in March 2004.
18
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
Report of Independent Accountants
To the Board of Directors
and Shareholders of
Midisoft Corporation
In our opinion, the accompanying balance sheet and the related statements of
operations, of changes in shareholders' equity (deficit) and of cash flows
present fairly, in all material respects, the financial position of Midisoft
Corporation at December 31, 1998 and 1997, and the results of its operations and
its cash flows for the years then ended in conformity with generally accepted
accounting principles. 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 of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As described in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
and has a net capital deficiency that raise substantial doubt about its ability
to continue as a going concern. Management's plans in regard to these matters
are also described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
PricewaterhouseCoopers LLP
Seattle, Washington
April 14, 1999
<PAGE>
Midisoft Corporation
Balance Sheet
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
1998 1997
<S> <C> <C>
Assets
Current assets
Cash and cash equivalents $ 270,000 $ 90,000
Accounts receivable, net 183,000 574,000
Inventories 115,000 222,000
Prepaids and other 42,000 82,000
------------ ------------
Total current assets 610,000 968,000
Long-term receivable 195,000 195,000
Property and equipment, net 116,000 239,000
Debt issuance costs, net of accumulated amortization
of $23,000 in 1998 and $0 in 1997 56,000 50,000
------------ ------------
$ 977,000 $ 1,452,000
------------ ------------
Liabilities and Shareholders' Deficit
Current liabilities
Trade accounts payable $ 1,181,000 $ 969,000
Current portion of long-term debt 250,000 250,000
Accrued wages and payroll taxes 93,000 100,000
Other accrued expenses 273,000 391,000
Deferred revenue 6,000 30,000
------------ ------------
Total current liabilities 1,803,000 1,740,000
------------ ------------
Long-term debt, net of discount 2,258,000 740,000
------------ ------------
Warrant obligations 81,000 81,000
------------ ------------
Commitments and contingencies (Notes 11, 12 and 13)
Shareholders' deficit
Preferred stock, Series A convertible, no par value; 2,500,000 shares
authorized, zero issued and outstanding in 1998 and 1997
Common stock, no par value; 25,000,000 shares authorized, 7,251,000 issued
and outstanding in 1998 and 6,359,000 issued
and outstanding in 1997 20,488,000 20,165,000
Additional paid-in capital 3,026,000 1,245,000
Notes receivable from shareholders (191,000) (191,000)
Accumulated deficit (26,488,000) (22,328,000)
------------ ------------
Total shareholders' deficit (3,165,000) (1,109,000)
------------ ------------
$ 977,000 $ 1,452,000
------------ ------------
</TABLE>
See accompanying notes to financial statements.
<PAGE>
Midisoft Corporation
Statement of Operations
- --------------------------------------------------------------------------------
December 31,
1998 1997
Revenues $ 1,760,000 $ 3,004,000
Cost of revenues 672,000 1,659,000
----------- -----------
Gross profit 1,088,000 1,345,000
----------- -----------
Operating expenses
Sales and marketing 1,190,000 1,842,000
General and administrative 1,864,000 2,151,000
Research and development 626,000 988,000
----------- -----------
Total operating expenses 3,680,000 4,981,000
----------- -----------
Operating loss (2,592,000) (3,636,000)
Interest expense (1,565,000) (1,035,000)
Interest income 17,000 6,000
Other expense (20,000) (64,000)
----------- -----------
Net loss $(4,160,000) $(4,729,000)
----------- -----------
Basic and diluted net loss per share $ (0.64) $ (0.79)
----------- -----------
Weighted-average shares outstanding 6,457,000 6,014,000
----------- -----------
See accompanying notes to financial statements.
<PAGE>
Midisoft Corporation
Statement of Changes in Shareholders' Equity (Deficit)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Preferred stock Common stock Additional Notes
-------------------- ----------------------- paid-in receivable from
Shares Amount Shares Amount capital shareholders
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 1,100 $ 1,100,000 5,345,000 $18,733,000 $ -- $ --
Stock options exercised in
exchange for a note receivable 175,000 191,000 (191,000)
Preferred stock converted (1,100) (1,100,000) 776,000 1,141,000
Common stock issued 63,000 100,000
Warrants issued with
convertible debt 273,000
In the money conversion option
on convertible debt 862,000
Warrants issued for debt
and services 110,000
Net loss
----- ----------- --------- ----------- ---------- ----------
Balance at December 31, 1997 -- -- 6,359,000 20,165,000 1,245,000 (191,000)
Common stock issued 91,000
Common stock issued in
settlement of claims 650,000 283,000
Common stock issued in
settlement of accounts payable 128,000 38,000
Exercise of stock options 23,000 2,000
Warrants issued with
convertible debt 416,000
In the money conversion option
on convertible debt 1,334,000
In the money options granted 31,000
Net loss
----- ----------- --------- ----------- ---------- ----------
Balance at December 31, 1998 -- $ -- 7,251,000 $20,488,000 $3,026,000 $ (191,000)
----- ----------- --------- ----------- ---------- ----------
<CAPTION>
Total
shareholders'
Retained equity
deficit (deficit)
<S> <C> <C>
Balance at December 31, 1996 $(17,558,000) $ 2,275,000
Stock options exercised in
exchange for a note receivable --
Preferred stock converted (41,000) --
Common stock issued 100,000
Warrants issued with
convertible debt 273,000
In the money conversion option
on convertible debt 862,000
Warrants issued for debt
and services 110,000
Net loss (4,729,000) (4,729,000)
------------ -----------
Balance at December 31, 1997 (22,328,000) (1,109,000)
Common stock issued --
Common stock issued in
settlement of claims 283,000
Common stock issued in
settlement of accounts payable 38,000
Exercise of stock options 2,000
Warrants issued with
convertible debt 416,000
In the money conversion option
on convertible debt 1,334,000
In the money options granted 31,000
Net loss (4,160,000) (4,160,000)
------------ -----------
Balance at December 31, 1998 $(26,488,000) $(3,165,000)
------------ -----------
</TABLE>
See accompanying notes to financial statements.
<PAGE>
Midisoft Corporation
Statement of Cash Flows
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997
<S> <C> <C>
Cash flows from operating activities
Net loss $(4,160,000) $(4,729,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 127,000 657,000
Amortization of debt discount & debt issuance costs 1,541,000 875,000
Warrants issued for debt and services 110,000
Common stock issued in settlement of claims 283,000
In the money options granted 31,000
Changes in operating assets and liabilities:
Decrease in accounts receivable, net 391,000 708,000
Decrease in inventories 107,000 720,000
Decrease in prepaids and other 40,000 200,000
Increase in long-term receivable (195,000)
Increase in trade accounts payable 250,000 278,000
Decrease in accrued wages and payroll taxes (7,000) (86,000)
(Decrease) increase in other accrued expenses (118,000) 273,000
Decrease in deferred revenue (24,000) (791,000)
Increase in warrant obligations 81,000
----------- -----------
Net cash used in operating activities (1,539,000) (1,899,000)
----------- -----------
Cash flows from investing activities
Additions to property and equipment (4,000) (20,000)
----------- -----------
Net cash used in investing activities (4,000) (20,000)
----------- -----------
Cash flows from financing activities
Stock options exercised 2,000
Issuance of common stock 100,000
Proceeds from issuance of long-term debt and warrants,
net of debt issue costs 1,721,000 1,200,000
----------- -----------
Net cash provided by financing activities 1,723,000 1,300,000
----------- -----------
Net increase (decrease) in cash and cash equivalents 180,000 (619,000)
Cash and cash equivalents, beginning of year 90,000 709,000
----------- -----------
Cash and cash equivalents, end of year $ 270,000 $ 90,000
=========== ===========
Supplemental cash flow information
Cash paid during year for interest $ -- $ 58,000
=========== ===========
See Note 15 for supplemental information of noncash financing activities.
</TABLE>
See accompanying notes to financial statements.
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
1. Organization and business
Midisoft Corporation (the Company) is a provider of innovative applications
for the use of sound on the personal computer (PC). The Company was
incorporated in Washington in 1986 and introduced its first product,
Midisoft Studio, in that year. The Company has focused its product lines to
include music learning and creativity and the integration of sound and
media in today's PC environment. The Company divides these product lines
into two development categories, music products and strategic products. The
Company's music products enable users to enjoy, explore, learn, create and
share music. The Company pioneered the development of MIDI technology,
including the ability of users to instantly view musical notation of sounds
played through a piano keyboard, or other MIDI-equipped instrument, linked
to a PC. Midisoft's strategic products promote the convergence of sound
with other technologies into the personal computer desktop, allow users to
enhance their computing experience, and communicate more effectively with
and through computers. The Company markets its products on a worldwide
basis to (i) original equipment manufacturers (OEMs), which "bundle" one or
more of Midisoft's products with their own products, (ii) distributors and
resellers, which directly supply the retail distribution channel, and (iii)
end users, catalog companies, and businesses.
Going concern and liquidity
The Company has incurred substantial operating losses during the past
several years. The financial statements have been prepared assuming the
Company will continue as a going concern and do not include any adjustments
to reflect the possible future effects on the recoverability and
classification of assets and liabilities that may result from this
uncertainty.
The Company has required substantial working capital to fund its
operations. To date, the Company has financed its operations principally
through the net proceeds from its initial public offering and other debt
and equity transactions. The Company's ability to continue as a going
concern is dependent upon numerous factors, including its ability to obtain
additional financing, the level of future revenues and its ability to
reduce operating expenses. The Company is actively pursuing possible
sources of additional working capital. There can be no assurance that the
Company will be able to obtain additional financing.
If the Company is unable to obtain sufficient funds to satisfy its cash
requirements, it may be forced to curtail operations, dispose of assets or
seek extended payment terms from its vendors. Such events would materially
and adversely affect the value of the Company's equity securities. There
can be no assurance that the Company will be able to reduce expenses or
successfully complete other steps necessary to continue as a going concern.
2. Significant accounting policies
Revenue recognition
Revenue from products licensed to OEMs consisting of one-time license fees
and contracts for minimum advances against future unit licenses are
recognized when the criteria for fixed fee revenue recognition under
Statement of Position No. 97-2, Software Revenue Recognition, (SOP 97-2)
are satisfied. These criteria include, but are not limited to, delivery of
the software master, the Company's lack of other significant obligations to
the customer and a determination that collectibility of the amount due is
probable. Revenues on contracts which do not meet the fixed fee revenue
recognition criteria in
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
SOP 97-2 are included in deferred revenue in the accompanying balance sheet
and are recognized as revenue on the instalment basis as payments are
received or until the Company has no significant obligations. Additional
royalty use or unit copy royalty fees are recognized when they are earned
pursuant to the license agreements and upon notification of shipment and
payment from the OEMs. Revenue from sales to distributors, other resellers
and end users, net of a provision for anticipated returns, is recognized
when the products are shipped. The allowance for returns is evaluated each
quarter taking into consideration, among other things, known return
requests from distributors, anticipated return requests based on the
distributor's rate of product sale, returns due to product upgrades and
historical distributor return patterns.
Warranties and returns
The Company warrants products against defects and has policies permitting
the return of products under certain circumstances. The Company's
distributor agreements provide for sales returns, stock rotation,
cooperative advertising and price protection. Customers are granted price
protection for a period of up to 60 days after the Company reduces the
price of a product. The Company provides for warranties and returns at the
time of product sale.
Advertising costs
The Company generally provides for cooperative advertising at agreed-upon
rates. Advertising costs, included in sales and marketing expenses, are
expensed as incurred and were $330,000 and $449,000 for the years ended
December 31, 1998 and 1997, respectively.
Research and development
Research and development expenses consist principally of payroll and
related expenses for design and development of the Company's products.
Research and development costs related to these activities are expensed
as incurred.
Income taxes
The Company follows the asset and liability method of accounting for income
taxes. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to difference between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases. If it is more likely than not that some portion of a deferred
tax asset will not be realized, a valuation allowance is recorded.
Net loss per share
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 (FAS 128), Earnings per Share.
FAS 128 replaced the previously reported primary and fully diluted earnings
per share with basic and diluted earnings per share. Basic earnings per
share excludes any dilutive effects of options, warrants and convertible
securities. The adoption of FAS 128 did not have a material impact on the
Company's earnings per share. Net loss per share assuming dilution for the
years ended December 31, 1998 and 1997 is equal to basic net loss per share
due to the fact that the effect of common stock equivalents outstanding
during the periods is anti-dilutive.
The following table sets forth the computation of basic and diluted net
loss per share:
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
Year ended December 31,
1998 1997
Numerator:
Net loss $(4,160,000) $(4,729,000)
Less: Preferred stock dividends (41,000)
----------- -----------
$(4,160,000) $(4,770,000)
----------- -----------
Denominator:
Weighted-average shares 6,457,000 6,014,000
----------- -----------
Basic and diluted net loss per share $ (0.64) $ (0.79)
----------- -----------
Common stock equivalents, consisting of warrants, stock options and
convertible securities, are anti-dilutive, and are detailed in Note 10.
Cash and cash equivalents
The Company considers all highly liquid investments with a maturity of
three months or less at the date of purchase to be cash equivalents.
Short-term investments classified as cash equivalents are stated at the
lower of cost or market, which approximates fair value.
Inventories
Inventories are valued at the lower of cost or market using the first-in,
first-out method. The Company continuously reviews its inventories for
obsolete, slow-moving and nonsalable items and establishes a reserve for
such items.
Property and equipment
Property and equipment are recorded at cost less accumulated depreciation
and amortization, and are depreciated using the straight-line method over
the estimated useful lives of the related assets, which range from three to
seven years. Leasehold improvements are amortized over shorter of the
economic useful lives or the term of the lease.
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
Concentration of credit risk/financial instruments
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of accounts receivable, for
which collateral is generally not required. The Company's trade receivables
include amounts due from U.S. and foreign customers in the computer
software and hardware industry and are derived from sales of products, OEM
licensing fees and unit royalties (Note 3). The Company performs ongoing
credit evaluations of its customers' financial condition and limits its
exposure to losses by limiting the amount of credit extended whenever
deemed necessary.
The carrying values of cash and cash equivalents and other assets and
liabilities (such as accounts receivable and payable) approximate fair
value at December 31, 1998 and 1997.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the 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 revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Stock compensation
The Company accounts for stock-based employee compensation under the
provisions of FAS 123, Accounting for Stock-Based Compensation (FAS 123).
FAS 123 establishes financial accounting and reporting standards for
stock-based employee compensation plans and for the issuance of equity
instruments to acquire goods and services from nonemployees.
The Company has elected to apply the disclosure-only provisions of FAS 123.
Accordingly, the Company accounts for stock-based compensation to employees
using the intrinsic-value method prescribed in Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. Compensation cost for stock options is measured as the
excess, if any, of the fair market value of the Company's common stock at
the date of grant over the exercise price. The Company records the fair
value of equity securities issued to nonemployees in accordance with the
provisions of FAS 123.
3. Accounts receivable and major customer information
The Company operates a single business segment. During 1998 and 1997, the
Company had revenue from foreign customers of $147,000 and $391,000,
respectively. Foreign sales as a percentage of the Company's total revenue
in 1998 and 1997 were 8% and 13%, respectively. In 1998 and 1997, separate
domestic reseller customers accounted for revenues of $1,079,000 and
$1,835,000, respectively, equal to 61% of the Company's total revenue in
the periods. During 1998, one customer accounted for 46% of total revenue.
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
Accounts receivable are summarized as follows:
December 31,
1998 1997
OEM's $ 17,000 $ 137,000
Resellers and other 411,000 930,000
----------- -----------
428,000 1,067,000
Less: Allowance for doubtful accounts (72,000) (260,000)
Less: Allowance for warranty and returns (173,000) (233,000)
----------- -----------
$ 183,000 $ 574,000
=========== ===========
Accounts receivable consist principally of amounts due from OEMs and
reseller customers for licensing fees, royalties and direct sales of
products. OEM customer payment terms typically are one year in duration and
require payments to be made in quarterly instalments. At December 31, 1998
and 1997, OEM accounts receivable amounts not yet due were $1,000 and
$16,000, equal to 6% and 12%, respectively, of total OEM receivables. At
December 31, 1998 and 1997, reseller accounts receivable amounts not yet
due were $257,000 and $425,000 equal to 60% and 46%, respectively, of total
reseller receivables.
The Company's primary credit concentrations involve domestic and foreign
OEM and reseller customers. Foreign customers are primarily located in
Western Europe, Taiwan, Singapore, Korea and Japan. Domestic customers
comprised $415,000 and $1,054,000 of accounts receivable at December 31,
1998 and 1997, respectively. Foreign customers comprised $13,000 of
accounts receivable at December 31, 1998 and 1997. At December 31, 1998 and
1997, four customers accounted for an aggregate balance of $359,000 and
$807,000 of accounts receivable, respectively.
4. Inventories
Inventories are summarized as follows:
December 31,
1998 1997
Raw materials and work-in-process $ 106,000 $ 212,000
Finished goods 29,000 75,000
Less: Allowance for obsolescence (20,000) (65,000)
--------- ---------
$ 115,000 $ 222,000
--------- ---------
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
5. Property and equipment
Property and equipment are summarized as follows:
December 31,
1998 1997
Equipment $ 925,000 $ 925,000
Furniture 91,000 93,000
Leasehold improvements 30,000 30,000
----------- -----------
Property and equipment, at cost 1,046,000 1,048,000
Less: Accumulated depreciation (930,000) (809,000)
----------- -----------
$ 116,000 $ 239,000
----------- -----------
6. Bank credit line facility
The Company's bank line-of-credit matured May 18, 1998 and was not renewed.
7. Other accrued expenses
The following table summarizes the components of the other current
liabilities:
December 31,
1998 1997
Accrued tax liabilities $133,000 $135,000
Other accrued expenses 140,000 256,000
-------- --------
$273,000 $391,000
-------- --------
8. Convertible debt
In September 1997, the Company received $250,000 for which it was to issue
a 5% convertible note due September 1998 (the Note). The Note and accrued
interest were to be convertible into common stock at a conversion price of
$0.65 per share, at the option of the holder, at any time after October 30,
1997 through maturity. A debt discount of $135,000 was recorded related to
the intrinsic value of the in-the-money conversion option at the close of
the debt transaction. The discount was expensed on October 30, 1997. The
note agreement has not been executed and the lender has requested changes
to certain terms of the agreement. The Company expects that the final
agreement will
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
provide for a convertible note bearing interest from 5% to 8% with a
conversion price of $0.65 per share, maturing in two to three years.
In October and November 1997, the Company issued $500,000 of 1% convertible
debentures (the Debentures) due October and November 2000, respectively,
for a total of $1,000,000. The Debentures are collateralized by a perfected
security interest in all assets of the Company and are convertible into
common stock at a conversion price of $0.60 per share at any time through
maturity, unless previously redeemed or repurchased. At any time, the
entire amount of the outstanding notes is redeemable at the Company's
option at prices ranging from 107% to 125% of the principal amount thereof,
depending on the date of redemption, together with accrued interest through
the date the redemption price is paid to the holder. The Debentures were
issued with detachable warrants that entitle the holders to purchase
833,333 shares of the Company's common stock at a price of $1.50 per share,
and expire in October and November 2002. A debt discount of $273,000 has
been recorded related to the fair value of the warrants. The discount is
amortized using the effective interest method over the term of the debt. In
addition, a debt discount of $727,000 was recorded related to the intrinsic
value of the in-the-money conversion option. This discount was expensed
immediately as the Debentures may be converted at any time. Debt issue
costs of $50,000 related to the Debenture sale have been capitalized and
will be amortized over the life of the debt.
In January 1998, an additional 1% debenture was issued in exchange for
proceeds totaling $1,000,000. The Debenture is convertible into 1,923,077
shares of common stock and carries detachable warrants to purchase an
additional 961,538 shares of common stock at a price of $1.25 per share.
The debenture matures in January 2001. A debt discount of $278,000 has been
recorded related to the fair value of the warrant, which will be amortized
to interest expense over the term of the debt. An additional discount of
$722,000 was recorded related to the intrinsic value of the in-the-money
conversion option. The discount related to the conversion option was
expensed on the issue date.
In June and December 1998, the Company issued another $500,000 and
$250,000, respectively, of 1% convertible debentures due June 2003 and
December 2003. The Debentures are convertible into common stock at a
conversion price of $0.20 per share and $0.25 per share, respectively, at
any time through maturity, unless previously redeemed or repurchased. The
Debentures were issued with detachable warrants that entitle the holders to
purchase 1,000,000 shares of the Company's common stock at a price of $0.75
per share, and expire between June and December 2003. A debt discount of
$138,000 has been recorded related to the fair value of the warrants. The
discount is amortized using the effective interest method over the term of
the debt. In addition, a debt discount of $612,000 was recorded related to
the intrinsic value of the in-the-money conversion option. This discount
was expensed immediately as the Debentures may be converted at any time. At
any time, the entire amount of the outstanding notes is redeemable at the
Company's option at prices ranging from 107% to 125% of the principal
amount thereof, depending on the date of redemption, together with accrued
interest through the date the redemption is paid to the holder.
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
Among other restrictions, the Debentures restrict the Company's other third
party borrowings to $400,000. The Company is in compliance with all
operating and financial covenants of the debentures at December 31, 1998.
The scheduled maturities of long-term debt outstanding at December 31,
1998, are summarized as follows: $0 in 1999, $500,000 in 2000,
$1,000,000 in 2001, $0 in 2002 and $750,000 in 2003, and $0 thereafter.
9. Income taxes
There is no provision for income taxes for the years ended December 31,
1998 and 1997 due to the net losses incurred. A valuation allowance has
been recorded for deferred tax assets because realization is primarily
dependent on generating sufficient taxable income prior to the expiration
of net operating loss carry-forwards.
The components of deferred income taxes are summarized as follows:
December 31,
1998 1997
Deferred income tax assets
Net operating losses $ 8,887,000 $ 7,710,000
Accrued liabilities and allowances 76,000 197,000
Capitalized software 121,000
Equity instruments 72,000 65,000
Other 227,000 236,000
----------- -----------
9,262,000 8,329,000
Deferred income tax liabilities
Other (9,000) (12,000)
Valuation allowance (9,253,000) (8,317,000)
----------- -----------
$ -- $ --
=========== ===========
At December 31, 1998, the Company had federal net operating losses of
approximately $26,137,000 that expire beginning in 2008. In certain
circumstances, as specified in the Internal Revenue Code, a 50% or more
ownership change by certain combination of the Company's stockholders
during any three-year period would result in limitations on the Company's
ability to utilize its net operating loss carry-forward. The value of the
Company's stock at the time of the ownership change is the primary factor
in determining the limit on the Company's ability to utilize its net
operating loss carry-forward.
Certain net operating losses arise from the deductibility for tax purposes
of compensation under nonqualified stock options equal to the difference
between the fair value of the stock on the date of exercise and the
exercise price of the options. For financial reporting
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
purposes, the tax effect of this deduction when recognized will be
accounted for as a credit to shareholders' deficit.
10. Shareholders' deficit
Preferred Stock
In 1996, the Company's Board of Directors designated 1,100 shares of
preferred stock as Series A convertible preferred stock (the Series A
Preferred Stock). All 1,100 shares were issued at a price of $1,000 per
share in an off-shore private placement completed in October 1996. The
Series A Preferred Stock was convertible at the holder's option into shares
of common stock at a price equal to the lesser of 85% of the closing bid as
of the date of conversion or 100% of the closing bid price of the common
stock as of the date of issuance of the Series A Preferred Stock. Holders
of the Series A Preferred Stock were entitled to an 8% cumulative dividend
payable in cash or common stock, at the holder's option, at the time of
conversion. All 1,100 shares, plus accrued dividends, were converted to
common stock over the six-month period from January 16 through July 17,
1997. The principal value of $1,100,000 and the accrued dividends of
$41,000 were converted to 747,797 and 28,408 shares of common stock,
respectively, at an average price of $1.56 per share.
Common Stock
During the year ended December 31, 1998, the Company finalized the terms of
the sale of common stock which was recorded in fiscal 1997. Under the new
terms, the Company issued 91,000 additional shares of common stock to the
investors.
As further described in Note 13, the Company issued 650,000 shares of
common stock in settlement of claims. The Company recorded expense totaling
$283,000 based on the fair market value of the common stock on the
settlement date.
Additionally, during the year ended December 31, 1998, the Company issued
128,000 shares of common stock in settlement of outstanding accounts
payable totaling $38,000.
At December 31, 1998, the Company has reserved the following shares of
common stock:
Warrants 3,073,042
Stock options 1,068,881
Convertible debentures 7,474,359
Warrants
In connection with the July 26, 1994 and the July 19, 1993 public stock
offerings, the Company has agreed to issue the Underwriter Representatives,
for nominal consideration, warrants to purchase an aggregate of 38,000 and
100,000 shares of common stock at a price of $12.90 and $4.20,
respectively. The warrants to purchase 100,000 shares of common stock
expired in 1998 without exercise.
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
In connection with the conversion of the Series A Preferred Stock, the
Company issued warrants to purchase an aggregate of 747,797 shares of
common stock at a price equal to $8.50 per share. The warrants expired in
1998 without exercise. Additionally, the Company agreed to issue the
Placement Agent warrants to purchase 25,000 shares of common stock at a
price of $6.00 per share.
Additionally, a warrant to purchase 40,171 shares of the Company's common
stock at an exercise price of $1.17 was issued to a bank in connection with
the short-term bank borrowings described in Note 6. The warrant expires in
September 2002 and carries a right to require the Company to purchase the
warrant for $63,000 or the fair value of the warrant, at the holder's
option, at any time after December 31, 1997. The warrant is subject to
certain anti-dilution provisions. The fair value of the warrant of $81,000
was expensed during 1997.
In connection with an attempt to arrange a private placement of equity
financing, the Company agreed to sell to the agent for nominal
consideration, a warrant to purchase 10,000 shares of common stock at a
price of $1.25 per share. The warrant expired in 1998 without exercise. The
fair value of the warrant of $10,000 was expensed during 1997.
In connection with the sale of common stock, the Company issued warrants in
August 1997 to purchase 100,000 shares of common stock at a price of $1.25
per share. These are two-year warrants expiring in 1999.
In connection with an unsecured loan of $40,000 from an officer, the
Company issued a warrant to purchase 75,000 shares of common stock at a
price of $.75 per share. The warrant will expire in 2002. Interest expense
of $100,000 was recognized based on the fair value of the warrant. The loan
was repaid during 1997.
As described in Note 8, during 1998 and 1997 the Company issued warrants to
purchase 1,961,538 and 833,333 shares, respectively of common stock to the
holder of convertible debentures.
Stock option plan
The Company has adopted the 1989 Stock Option Plan (the 1989 Plan), as
amended September 28, 1994, to provide for the granting of both Incentive
Stock Options (ISOs) and Nonqualified Stock Options for employees,
directors and consultants of the Company to acquire ownership in the
Company and provide them with incentives for their service.
Under the terms of the 1989 Plan, 1,350,000 shares of common stock may be
issued. The 1989 Plan is currently administered by the Compensation and
Option Committee of the Board of Directors which determines the terms and
conditions of the options granted under the 1989 Plan, including exercise
price, number of option shares granted and the vesting period of such
options. Upon termination of a participant's employment or consulting
relationship with the Company, unvested options terminate and vested
options remain exercisable for a period not to exceed three months. The
exercise price of all ISOs granted under the 1989 Plan must be at least
equal to the fair market value of the common stock of the Company on the
date of grant. The exercise price of all ISOs
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
granted under the 1989 Plan are determined by the Compensation and Option
Committee and the term may not exceed ten years.
On February 10, 1998 the Company adopted the 1998 Stock Option Plan (the
1998 Plan) to provide for the granting of options to independent directors
and outside consultants. Under the terms of the 1998 Plan, 500,000 shares
of common stock may be issued. The 1998 Plan is currently administered by
the Board of Directors which determines the terms and conditions of the
options granted and the vesting of such options.
On April 9, 1998, the Company's board of directors authorized the repricing
of all options outstanding at September 17, 1997 to $0.75 per share.
At December 31, 1998 and 1997, options for 361,436 and 215,000 shares,
respectively, of common stock were exercisable and options for 507,375 and
160,000 shares, respectively, of common stock were available for future
grants under the two plans. Activity with respect to both plans is as
follows:
Weighted-
average
exercise
Shares price
Options outstanding, December 31, 1996 701,936 $ 2.64
Granted 468,000 1.33
Exercised (175,000) 1.09
Canceled (433,014) 2.65
-------- --------
Options outstanding, December 31, 1997 561,922 2.02
Granted 941,922 0.81
Exercised (22,875) 0.10
Canceled (789,297) 1.72
-------- --------
Options outstanding, December 31, 1998 691,672 $ 0.78
-------- --------
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
The following table summarizes information about fixed-price options
outstanding and exercisable at December 31, 1998:
Options outstanding Options excercisable
--------------------------------------------------- ----------------------
Weighted-
average Weighted- Weighted-
Range of remaining average average
exercise Options contractual exercise Options exercise
prices outstanding life price exercisable price
0.10-0.94 649,672 8.14 $ 0.76 351,436 $ 0.76
1.13-1.19 42,000 8.89 $ 1.19 10,000 $ 1.19
The Company follows the intrinisic-value method in accounting for its stock
options. Under this method, the Company recognized no compensation expense
on stock options issued to employees if the exercise price of the option
equals or exceeds the fair market value of the Company's common stock on
the date of grant. For options granted with an exercise price less than
fair market value the Company recognized $31,000 and $0 of compensation
expense for the years ended December 31, 1998 and 1997, respectively. Had
compensation cost been recognized based on the fair value at the grant date
for options awarded under the Plan, the pro forma amounts of the Company's
net loss and net loss per share for the years ended December 31, 1998 and
1997 would have been as follows:
Year ended December 31,
1998 1997
Net loss as reported $ (4,160,000) $ (4,729,000)
------------- -------------
Net loss pro forma $ (4,465,000) $ (5,030,000)
------------- -------------
Loss per share as reported $ (0.64) $ (0.79)
------------- -------------
Loss per share pro forma $ (0.69) $ (0.84)
------------- -------------
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions
for the years ended December 31, 1998 and 1997, respectively: risk-free
interest rates of 5.512% to 5.673% and 4.934% to 6.748%; expected option
life of five to ten years; expected volatilities of 124% and 84% to 125%;
and no expected dividends. The weighted-average fair value of options
granted during 1998 and 1997 was $0.79 and $0.83, respectively, for options
with an exercise price equal to market. The weighted-average fair value of
options granted during 1998 and 1997 at a price above market was $0.59 and
$0.87, respectively. The
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
weighted-average fair value of options granted in 1998 at a price below
market was $0.88.
11. License agreements
The Company has license agreements with various developers and producers of
computer software which require the Company to pay royalties. During the
years ended December 31, 1998 and 1997, total royalty expense was $13,000
and $5,000, respectively.
12. Lease commitments
The Company leases office facilities for its operations. The lease contains
renewal and expansion provisions, exercisable at the discretion of the
Company. The Company's lease includes scheduled increases over the term of
the lease. The total payment amount is being recognized as expense on a
straight-line basis over the term of the lease. Future minimum lease
commitments for all noncancelable operating leases are summarized as
follows:
Year ending December 31,
1999 $ 273,000
2000 68,000
---------
$ 341,000
=========
Rent expense for 1998 and 1997 was $256,000 and $281,000, respectively. The
Company received $86,000 and $98,000 from sublease income for the years
ended December 31, 1998 and 1997, respectively.
13. Contingencies
In 1997, an entity which sold substantially all of its assets to the
Company in 1995 demanded that the Company arbitrate certain claims arising
from the sale. The claims aggregate in excess of $1 million. The parties
reached an agreement in July 1998 outside of arbitration. In exchange for
the mutual release of all claims and counterclaims, the Company agreed to
provide consideration of $420,000, $25,000 of which is cash and the
remainder comprised of forgiveness of $112,000 in debt and issuance of
approximately 630,000 shares of the Company's common stock. At December 31,
1998, Midisoft has paid $20,000 of the $25,000, the debt has been fully
reserved and $283,000 of expense has been recognized related to the
issuance of common stock.
The Company is subject to various claims and lawsuits in the ordinary
course of business. In the opinion of management, the ultimate resolution
of these matters will not have a material adverse effect on the Company's
financial condition, results of operations or cash flows.
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
14. Notes receivable from stockholders
The Company has made advances and loans to employees in connection with the
purchase of common stock under the Employee Stock Option Plan. Promissory
notes totaling $191,000 are held by the Company from the Company's Chief
Executive Officer and former Chief Financial Officer. Interest on these
loans is set at 8% per annum. The officers have pledged the 175,000 shares
of common stock as collateral for these loans. The full unpaid principal
and accrued interest amounts are due and payable on August 1, 2000, but can
be prepaid at any time. The terms of these notes receivable cause the
underlying shares to be considered variable stock options. For variable
stock options, compensation cost is measured as the amount by which the
quoted market value of the shares exceeds the option price. At December 31,
1998, the quoted market price of the Company's common stock was less than
the option price. Accordingly, no compensation expense was recorded.
15. Supplemental cash flow information
The following items are supplemental information of noncash financing
activities:
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997
<S> <C> <C>
Common stock issued in settlement of claims $ 283,000 $ --
---------- ----------
Common stock issued in settlement of accounts payable $ 38,000 $ --
---------- ----------
Warrants issued with convertible debt $ 416,000 $ 273,000
---------- ----------
Preferred stock converted $ -- $1,100,000
---------- ----------
Stock options exercised in exchange for note receivable $ -- $ 191,000
---------- ----------
In the money options granted $ 31,000 $ --
---------- ----------
In the money conversion option on convertible debt $1,334,000 $ 862,000
---------- ----------
</TABLE>
16. Employee benefit plans
In June 1996, the Company adopted a qualified profit-sharing plan under the
provisions of Internal Revenue Code 401(k). The plan is available to all
employees meeting the eligibility requirements. Contributions by the
Company are based on a matching formula as defined in the plan. The Company
made no contributions to the plan in 1998 or 1997.
<PAGE>
Midisoft Corporation
Notes to Financial Statements
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
17. Subsequent events
In connection with the Debentures as described in Note 8, during the first
quarter of 1999 the Company issued additional 1% convertible debentures in
exchange for proceeds totaling $250,000. The debentures are convertible
into a total of 1,000,000 shares of common stock and carries detachable
warrants to purchase an additional 500,000 shares of common stock at a
price of $0.75 per share. The debentures mature in March 2004. A debt
discount of $76,000 has been recorded related to the fair value of the
warrant, which will be amortized to interest expense over the term of the
debt. An additional discount of $174,000 was recorded related to the
intrinsic value of the conversion option. The discount related to the
conversion option was expensed on the issue date.
<PAGE>
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
Item 9 is hereby incorporated by reference to the information in the
Company's Proxy Statement relating to its 1999 annual meeting of
Shareholders prepared in accordance with Section 14(a) of the
Securities and Exchange Act of 1934, as amended (the "Proxy
Statement").
ITEM 10. EXECUTIVE COMPENSATION
Item 10 is hereby incorporated by reference to the information in the
Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Item 11 is hereby incorporated by reference to the information in the
Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 12 is hereby incorporated by reference to the information in the
Proxy Statement.
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements: The following are filed as a part of this report
under ITEM 5.
<TABLE>
<CAPTION>
Page
<S> <C>
Report of PricewaterhouseCoopers LLP........................................................18
Balance Sheet - At December 31, 1998 and 1997...............................................19
Statement of Operations - For the Years Ended December 31, 1998 and 1997....................20
Statement of Shareholders' Equity (Deficit) - For the Years Ended December 31, 1998
and 1997....................................................................................21
Statement of Cash Flows - For the Years Ended December 31, 1998 and 1997....................22
Notes to Financial Statements - For the Years Ended December 31, 1998 and1997...............23
</TABLE>
(b) Reports on 8-K.
None
(c) Exhibits. The following exhibits are filed as part of this report:
Exhibit No. Description
----------- -----------
3.1.1(a) Articles of Incorporation of the Company as filed on
September 23, 1986 with the Secretary of State of the State
of Washington.
<PAGE>
Exhibit No. Description
----------- -----------
3.1.2(b) Articles of Amendment to Articles of Incorporation of the
Company as filed on February 22, 1989 with the Secretary of
State of the State of Washington.
3.1.3(b) Articles of Amendment to Articles of Incorporation of the
Company as filed on July 13, 1994 with the Secretary of
State of the State of Washington.
3.2.1(b) By-laws of the Company.
3.2.2(a) Amended and Restated By-laws of the Company.
4.1(b) Form of specimen certificate for Common Stock of the
Company.
4.2(f) Designation of Rights and Preferences of Series A
Convertible Preferred Stock.
4.3(h) Form of Securities Purchase Agreement dated October 28, 1997
4.4(h) Form of Registration Rights Agreement dated October 28, 1997
4.5(k) Form of Debenture dated October 28, 1997
4.6(l) Form of amendment to the Securities Purchase Agreement dated
June 15, 1998
10.1(b) Combined Incentive and Nonstatutory Stock Option Plan,
adopted February 22, 1989, and as amended April 30, 1994 and
September 28, 1994, authorizing 1,200,000 shares of Common
Stock for issuance pursuant to the combined Plan.
10.2.1(d) Industrial Lease, dated March 9, 1995, by and between I-90
Lake Place II Limited Partnership, as landlord, and the
Company, as tenant.
10.3.1(b) Software License Agreement, dated June 4, 1994, by and
between Music Technology Associates and the Company.
10.3.2(b) Software Rights Purchase Agreement, dated May 5, 1994, by
and between Music Technology Associates and the Company.
10.3.3(c) Software License Agreement, dated August 6, 1994 by and
between Dennis McMahon d/b/a Asystem, and the Company.
10.3.4(a) Software Purchase Agreement, dated April 15, 1994 by and
between Dennis McMahon d/b/a Asystem, and the Company.
10.3.5(d) Software Purchase Agreement, dated November 10, 1994 by and
between Dennis McMahon d/b/a Asystem, and the Company.
10.3.6(d) Software Purchase Agreement, dated December 22, 1994 by and
between Dennis McMahon d/b/a Asystem, and the Company.
10.4.1(b) Reseller Agreement, dated January 3, 1992, by and between
WestPoint Creative Ltd. and the Company.
10.4.2(b) Reseller Agreement, dated December 31, 1991, by and between
CPS Computer Distribution GmbH and the Company.
10.4.3(b) Reseller Agreement, dated February 13, 1992, by and between
Walop Electronics B.V. and the Company.
<PAGE>
Exhibit No. Description
----------- -----------
10.5.1(b) Distribution Agreement, dated August 26, 1992, by and
between Merisel, Inc. and the Company.
10.5.2(b) Distribution Agreement, dated July 14, 1992, by and between
Ingram Micro Inc. and the Company.
10.6.1(b) OEM License Agreement, dated August 26, 1992, by and between
MPC (Distribution) Ltd. and the Company.
10.6.2(b) OEM License Agreement, dated January 8, 1994, by and between
Ad Lib Multimedia Inc. and the Company.
10.6.3(b) OEM License Agreement, dated October 26, 1994 by and between
Media Vision Corporation 10.6.4 bForm of OEM License
Agreement between various OEM licensees and the Company.
10.6.5(a) OEM License Agreement, dated May 10, 1994, by and between
International Business Machines and the Company.
10.6.6(a) OEM License Agreement, dated May 17, 1994, by and between
Gateway 2000 and the Company.
10.6.7(a) OEM License Agreement, dated May 20, 1994, by and between
ASCII Corporation and the Company.
10.6.8(a) OEM License Agreement, dated May 20, 1994, by and between
I-O Data Devices and the Company.
10.6.9(e) OEM License Agreement, dated March 6, 1995, by and between
Genoa Systems Corporation and the Company.
10.6.10(e)OEM License Agreement, dated June 2, 1995, by and between
Acer America Corporation and the Company.
10.6.11(e)OEM License Agreement, dated June 5, 1995, by and between
NEC Technologies, Inc. and the Company.
10.7.1(e) Asset Purchase and Sale Agreement by and among Midisoft
Corporation, Ask Me Multimedia, Inc. and Michael O'Donnell
dated April 14, 1995.
----------
(a) Incorporated by reference from the Company's Registration
Statement on Form SB-2
(S.E.C. File No. 33-80064).
(b) Incorporated by reference from the Company's Registration
Statement on Form SB-2
(S.E.C. File No. 33-62468-5).
(c) Incorporated by reference from the Company's Form 10-KSB filed
March 30, 1994
(S.E.C. File No. 000-22172).
(d) Incorporated by reference from the Company's Form 10-KSB filed
April 13, 1995
(S.E.C. File No. 000-22172).
(e) Incorporated by reference from the Company's Form 10-KSB/A filed
August 4, 1995
(S.E.C. File No. 000-22172).
(f) Incorporated by reference from the Company's Form 10-KSB filed
April 15, 1997.
(S.E.C. File No. 000-22172).
(g) Incorporated by reference from the Company's Form 10-KSB/A filed
June 20, 1997
(S.E.C. File No. 000-22172).
(h) Incorporated by reference from the Company's Form 10-QSB filed
November 12, 1997
(S.E.C. File No. 000-22172).
<PAGE>
(i) Incorporated by reference from the Company's Form 8-K filed
January 9, 1997
(S.E.C. File No. 000-22172).
(j) Incorporated by reference from the Company's Form 8-K filed
November 3, 1997
(S.E.C. File No. 000-22172).
(k) Incorporated by reference from the Company's Form 10-KSB filed
April 15, 1998
(S.E.C. File No. 000-22172).
(l) Incorporated by reference from the Company's Form 10-QSB filed
August 14, 1998
(S.E.C. File No. 000-22172).
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
MIDISOFT CORPORATION
(Registrant)
Date: April 14, 1999 By: /S/Larry Foster
------------------------------------
Larry Foster, 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.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/Larry Foster Chairman of the Board, April 14, 1999
- ------------------------ President and Chief Executive Officer
Larry Foster
/s/Gary M. Cully Vice President, Finance and April 14, 1999
- ------------------------ and Chief Financial Officer
Gary M. Cully (Principal Accounting Officer)
/s/John Bauer Director April 14, 1999
- ------------------------
John Bauer
/s/Marsha Murry Director April 14, 1999
- ------------------------
Marsha Murry
/s/Robert Orbach Director April 14, 1999
- ------------------------
Robert Orbach
/s/J. Larry Smart Director April 14, 1999
- ------------------------
J. Larry Smart
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET DATED DEC. 30, 1998 AND THE STATEMENT OF OPERATIONS FOR THE TWELVE MONTH
PERIOD ENDING DEC. 30, 1998 FOUND ON PAGES 20 AND 21 OF THE COMPANY'S 10-KSB FOR
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000882692
<NAME> MIDISOFT CORPORATION
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 270
<SECURITIES> 0
<RECEIVABLES> 428
<ALLOWANCES> 245
<INVENTORY> 115
<CURRENT-ASSETS> 610
<PP&E> 1,047
<DEPRECIATION> 930
<TOTAL-ASSETS> 977
<CURRENT-LIABILITIES> 1,803
<BONDS> 0
0
0
<COMMON> 20,167
<OTHER-SE> (23,332)
<TOTAL-LIABILITY-AND-EQUITY> 977
<SALES> 1,760
<TOTAL-REVENUES> 1,760
<CGS> 672
<TOTAL-COSTS> 3,680
<OTHER-EXPENSES> 20
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,565
<INCOME-PRETAX> (4,160)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,160)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,160)
<EPS-PRIMARY> (0.64)
<EPS-DILUTED> (0.64) <F1>
<FN>
<F1> COMMON STOCK EQUIVALENTS NOT INCLUDED, AS IT WOULD BE ANTI-DILUTIVE.
</FN>
</TABLE>
