FORM 10-QSB
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File Number 1-11860
FOCUS Enhancements, Inc.
(Exact name of small business issuer as specified in its charter)
Delaware 04-3186320
(State or other jurisdiction of (IRS Employer
incorporation or organization) identification No.)
142 North Road
Sudbury, MA 01776
(Address of principal executive offices)
(508) 371 - 2000
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15 (d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes _X No_____
As of October 22, 1996, there were outstanding 10,797,051 shares of Common
Stock, $.01 par value per share.
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FOCUS ENHANCEMENTS, INC.
FORM 10-QSB
QUARTERLY REPORT
September 30, 1996
TABLE OF CONTENTS
Page
Facing Page 1
Table of Contents 2
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets at September 30, 1996
and December 31, 1995 3
Consolidated Statements of Operations
for the Three Months Ended September 30, 1996 and 1995 4
Consolidated Statements of Operations
for the Nine Months Ended September 30, 1996 and 1995 5
Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 1996 and 1995 6
Notes to Consolidated Financial Statements 7-9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10-17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 2. Changes in Securities 18
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
Exhibit 11- Computation of Primary and Fully Diluted Earnings Per Share
2
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<TABLE>
<CAPTION>
FOCUS ENHANCEMENTS, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
September 30, December 31,
1996 1995
-------------- -----------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 672,216 $2,140,043
Accounts receivable, net of allowance of $499,110 and $296,887
at September 30, 1996 and December 31, 1995, respectively 4,900,176 1,860,592
Inventories 1,925,496 1,862,335
Prepaid expenses and other current assets 266,350 346,458
-------------- -----------
Total current assets 7,764,238 6,209,428
Property and equipment, net 397,512 417,849
Other assets, net - 105,379
Goodwill, net 1,369,728 2,227,723
-------------- -----------
Total assets $ 9,531,478 $8,960,379
============== ===========
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current liabilities:
Notes payable $ 2,547,458 $3,637,458
Obligations under capital leases 41,821 133,497
Accounts payable 3,417,557 1,228,860
Accrued liabilities 1,641,770 346,928
-------------- -----------
Total current liabilities 7,648,606 5,346,743
Obligations under capital leases 178,488 26,310
-------------- -----------
Total liabilities 7,827,094 5,373,053
-------------- -----------
Stockholders' equity
Preferred stock, $.01 par value; 3,000,000 shares authorized; - -
none issued
Common stock, $.01 par value: 16,000,000 shares authorized,
10,797,051 and 7,171,862 shares issued and outstanding at
September 30, 1996 and December 31, 1995, respectively. 107,971 71,719
Additional paid-in capital 20,470,273 13,168,730
Accumulated deficit (18,873,860) (9,653,123)
-------------- -----------
Total stockholders' equity 1,704,384 3,587,326
-------------- -----------
Total liabilities and stockholders' equity $ 9,531,478 $8,960,379
============== ===========
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
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FOCUS ENHANCEMENTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
September 30, September 30,
1996 1995
---------------- ---------------
Net sales $ 3,327,228 $4,126,078
Cost of goods sold 3,479,135 1,567,275
---------------- ---------------
Gross profit (loss) (151,907) 2,558,803
---------------- ---------------
Operating expenses:
Sales, marketing and support 940,860 803,559
General and administrative 1,960,508 789,524
Research and development 532,319 243,855
Purchased research and development 2,000,000 -
---------------- ---------------
Total operating expenses 5,433,687 1,836,938
---------------- ---------------
Income (loss) from operations (5,585,594) 721,865
Interest expense, net (65,504) (132,403)
Other income (expense) - -
---------------- ---------------
Income (loss) before income taxes (5,651,098) 589,462
Income tax expense 6,541 -
---------------- ---------------
Net income (loss) $(5,657,639) $ 589,462
================ ===============
Net income (loss) per common share
Primary $ (0.60) $ 0.08
================ ===============
Fully Diluted $ (0.60) $ 0.07
================ ===============
Weighted average common and common
equivalent shares outstanding
Primary 9,476,462 7,771,617
================ ===============
Fully Diluted 9,476,462 8,306,036
================ ===============
The accompanying notes are an integral part
of the consolidated financial statements.
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FOCUS ENHANCEMENTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Nine Months Ended
September 30, September 30,
1996 1995
----------------- ----------------
Net sales $11,498,362 $12,834,953
Cost of goods sold 11,193,421 7,321,988
----------------- ----------------
Gross profit 304,941 5,512,965
----------------- ----------------
Operating expenses:
Sales, marketing and support 2,917,645 2,229,170
General and administrative 3,192,833 1,728,622
Research and development 1,150,260 726,292
Purchased research and development 2,000,000 -
----------------- ----------------
Total operating expenses 9,260,738 4,684,084
----------------- ----------------
Income (loss) from operations (8,955,797) 828,881
Interest expense, net (235,607) (408,227)
Other income(expense) (12,792) 276,081
----------------- ----------------
Income before income taxes (9,204,196) 696,735
Income tax expense 16,541 -
----------------- ----------------
Net income (loss) $ (9,220,737) $ 696,735
================= ================
Net income (loss) per common share
Primary $ (1.09) $ 0.11
================= ================
Fully Diluted $ (1.09) $ 0.10
================= ================
Weighted average common and common
equivalent shares outstanding
Primary 8,477,011 6,393,333
================= ================
Fully Diluted 8,477,011 7,190,035
================= ================
The accompanying notes are an integral part
of the consolidated financial statements.
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<TABLE>
<CAPTION>
FOCUS ENHANCEMENTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30, September 30,
1996 1995
---------------- ----------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (9,220,737) $ 696,735
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 3,747,824 697,328
Amortization of deferred compensation - 63,998
Gain on forgiveness of accounts payable - (272,647)
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (3,001,627) 897,894
Increase in notes receivable (37,957) -
Decrease (increase) in inventories (63,161) 124,873
Decrease(increase) in prepaid expenses and other assets 80,108 (96,144)
Increase (decrease) in accounts payable 2,188,697 (1,266,900)
Increase in accrued liabilities 1,294,843 143,380
---------------- ----------------
Net cash used in operating activities (5,012,010) 988,517
---------------- ----------------
Cash flows from investing activities:
Purchase of property and equipment (214,895) (57,071)
Investment in TView, Inc. (569,728) -
Purchase of intangible assets - (85,547)
---------------- ----------------
Net cash used in investing activities (784,623) (142,618)
---------------- ----------------
Cash flows from financing activities:
Payments on notes payable (1,090,000) (642,891)
Payments under capital lease obligations 60,502 (128,572)
Net proceeds from private offering of common stock 4,363,538 1,119,641
Net proceeds from exercise of warrants 894,015 -
Proceeds from exercise of common stock options and warrants 100,751 22,871
---------------- ----------------
Net cash provided by financing activities 4,328,806 371,049
---------------- ----------------
Net increase (decrease) in cash and cash equivalents (1,467,827) 1,216,948
Cash and cash equivalents at beginning of period 2,140,043 81,181
---------------- ----------------
Cash and cash equivalents at end of period $ 672,216 $ 1,298,129
================ ================
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
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FOCUS ENHANCEMENTS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated financial statements of FOCUS Enhancements, Inc. ("the
Company") as of September 30, 1996 and for the three and nine month periods
ended September 30, 1996 and 1995 are unaudited and should be read in
conjunction with the consolidated financial statements and notes thereto for the
year ended December 31, 1995 included in the Company's Annual Report on Form
10-KSB for the year ended December 31, 1995. The consolidated financial
statements include the accounts of the Company and its wholly-owned
subsidiaries, Lapis Technologies, Inc. and FOCUS Enhancements bv. Effective
September 30, 1996, the Company completed the acquisition of TView, Inc., which
will operate as a third wholly-owned subsidiary. In the opinion of management,
the consolidated financial statements include all adjustments (consisting only
of normal recurring adjustments) necessary for a fair presentation of the
results of the interim periods. The results of operations for the three and nine
months ended September 30, 1996 are not necessarily indicative of the results
that may be expected for any future period.
2. NET INCOME (LOSS) PER SHARE
Per share amounts are calculated using the weighted average number of
common shares and common share equivalents outstanding during periods of net
income. Common share equivalents are attributable to unexercised stock options
and warrants and are computed using the treasury stock method. Per share amounts
are calculated using only the weighted average number of common shares
outstanding during periods of net loss.
3. NOTE RECEIVABLE
On January 5, 1996, an officer of the Company borrowed $40,000 under a
promissory note, bearing interest at 8.5% per annum and due not later than
January 5, 1997. At September 30, 1996, the balance is included in accounts
receivable.
4. INVENTORIES
Inventories consist of the following:
September 30, December 31,
1996 1995
Finished goods $ 1,343,534 $ 1,669,003
Raw materials 581,962 193,332
--------------------- --------------------
$ 1,925,496 $ 1,862,335
===================== ====================
5. NOTES PAYABLE
The Company maintains a line of credit with a bank which permits
borrowings up to $900,000. Borrowings under the line of credit are payable on
demand and are collateralized by all of the assets of the Company except as
noted below. Borrowings aggregating $850,000 at September 30, 1996 bear interest
at the bank's prime rate plus 1% and are personally guaranteed by an investor.
On June 25, 1996, the line of credit was extended by the lender until March 7,
1997. As of September 30, 1996, the Company is in violation of certain covenants
under its
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agreement for the line of credit with the bank. The Company is in the process of
negotiating with the bank for a waiver with respect to the violations.
In October 1994, the Company borrowed $2,500,000 from an unrelated
individual under a term line of credit note (the "term note") due February 1,
1996. The term note accrues interest at the prime rate plus 2%, payable
quarterly in arrears, and was originally collateralized by the inventory,
accounts receivable and contract rights related to the Company's business with
Apple Computer, Inc. In January 1996, the Company repaid $1,000,000 of the
amount owed under the term note. On June 28, 1996, the Company negotiated an
amendment to the term note with the lender to extend the due date of the term
note to March 31, 1997. In consideration of the extension, the Company granted a
second security interest on all of the assets of the Company and issued 50,000
warrants to the lender exercisable for a period of three years at a price of
$2.07 per share. At September 30, 1996, the Company owed $1,500,000 to the
lender under the term note.
Additionally, in June 1996, the Company entered into a security
agreement with its largest inventory supplier regarding certain amounts owed by
the Company to the supplier. At September 30, 1996, the outstanding amount owed
the supplier was approximately $2,100,000. The amounts owed the supplier are
secured by a third security interest in the Company's assets.
6. COMMON STOCK TRANSACTIONS
In the third quarter ended September 30, 1996, the Company sold
approximately 790,000 shares of common stock for gross proceeds of approximately
$1,500,000 in connection with a private offering to foreign investors. The
common stock is unregistered and subject to restrictions on trading in the
United States for a period of forty-one days. In connection with the offering,
the Company incurred fees and expenses of approximately $162,000. Net proceeds
of the offering were approximately $1,338,000.
For the nine month period ended September 30, 1996, the Company sold
approximately 2,019,000 shares of common stock for gross proceeds of
approximately $4,825,000 in connection with private offerings to foreign
investors. The common stock is unregistered and subject to restrictions on
trading in the United States for a period of forty-one days. In connection with
the offerings, the Company incurred fees and expenses of approximately $357,000.
Net proceeds of the offerings were approximately $4,468,000.
For the nine month period ended September 30, 1996, the Company issued
approximately 793,000 shares of common stock upon the exercise of approximately
786,000 public and private warrants, receiving gross proceeds of approximately
$1,021,000.
7. ACQUISITION OF TVIEW, INC.
On October 18, 1996, FOCUS Enhancements, Inc, a Delaware corporation
("FOCUS" or the "Company") consummated the acquisition of all the capital stock
of TView, Inc ("TView")., a Delaware corporation, pursuant to the terms and
conditions set forth in the Agreement and Plan of Merger, dated as of September
30, 1996 (the "Agreement and Plan of Merger"), by and among FOCUS, TView and
FOCUS Acquisition Corp., a Delaware corporation and wholly owned subsidiary of
FOCUS.
In consideration for the capital stock of TView, the Company paid to
TView stockholders an aggregate of $2,000,000 in FOCUS Enhancements common
stock, $.01 par value per share, which aggregated 732,869 shares of such stock.
In addition, Thomas Hamilton and Steve Morton, former officers and principal
stockholders of TView, became Vice President - Research and Development and Vice
President -
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Hardware Engineering, respectively, of the Company. Each of Messrs. Hamilton and
Morton entered into one year employment agreements and two year non competition
agreements. Messrs. Hamilton and Morton will be paid annual salaries of $110,000
and received options to purchase 80,000 shares of common stock under the
Company's Stock Option Plan.
The merger is being accounted for as a tax free reorganization under
the provisions of Section 368(a)(2)(D) if the Internal Revenue Code of 1986, as
amended. Due to the amount of assets purchased as compared to the total assets
of the Company, the transaction qualifies as the acquisition of a significant
business under Regulation S-X of the Securities Act of 1933, as amended.
In accordance with Regulation S-X, Rules 3.05 and 11.01, financial
statements for the business being acquired along with the pro forma financial
information showing the combined financial statements of the Company and TView,
Inc. are required to be filed. However, it is currently impracticable to provide
such financial information due to the unavailability of financial statements of
TView, Inc.
As a result of the forgoing, the Company undertakes to file the
required financial statements along with the pro forma financial information
within 60 days from the date of the closing of the acquisition.
In connection with the acquisition of TView, the Company reviewed its
existing technology and concluded that it was appropriate to write down a
portion of the remaining goodwill related to the Lapis acquisition. Accordingly,
the Company took a charge of approximately $1,273,000 in the quarter ended
September 30, 1996.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Introduction
The following information should be read in conjunction with the
consolidated financial statements and notes thereto in Part I, Item 1 of this
Quarterly Report and with Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the Company's Annual Report on
Form 10-KSB for the year ended December 31, 1995.
The Company does not provide forecasts of the future financial
performance of the Company. However, from time to time, information provided by
the Company or statements made by its employees may contain "forward looking"
information that involves risks and uncertainties. In particular, statements
contained in this Form 10-QSB which are not historical facts constitute forward
looking statements and are made under the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. Each forward looking statement should
be read in conjunction with the consolidated financial statements and notes
thereto in Part I, Item 1, of this Quarterly Report and with the information
contained in Item 2, including, but not limited to, "Certain Factors That May
Affect Future Results" contained herein, together with the Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in the Company's Annual Report on Form 10-KSB for the year ended
December 31, 1995, including, but not limited to, the section therein entitled
"Certain Factors That May Affect Future Results."
RESULTS OF OPERATIONS
Three-Month Period Ended September, 1996 As Compared
With The Three-Month Period Ended September 30, 1995
Net Sales
Net sales for the three-month period ended September 30, 1996 were
$3,327,228 as compared with $4,126,078 for the three-month period ended
September 30, 1995, a decrease of $798,850 or 19%. The decline in revenues
resulted primarily from the continued reduction in orders from Apple for the
Company's L-TV product and orders for the Company's graphics/connectivity
products for Apple's PowerBook 190 and 5300 laptop computers. This was offset by
increased OEM revenues related to sales of the Company's PC to TV products under
the agreement with Zenith Electronics which accounted for approximately
$1,850,000 or 55% of the Company's third quarter revenues.
During the quarter ended September 30, 1996, sales to Apple represented
1% of the Company's revenues as compared to 67% of revenues during the
comparable quarter in 1995.
As of September 30, 1996, the Company had a sales order backlog of
approximately $718,000.
Cost of Goods Sold
Cost of goods sold were $3,479,135 or 105% of net sales, for the
three-month period ended September 30, 1996, as compared with $1,567,275 or 38%
of net sales, for the three months ended September 30, 1995, an increase of
$1,911,860 or 122%. The increase in cost of goods sold in both absolute dollars
and on a percentage basis is due principally to lower margin OEM sales volume
for the Company's Micro Presenter and PC to TV products to Zenith,
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inventory refurbishment costs of approximately $300,000 associated with the
Company's graphics/connectivity products for Apple's PowerBook 190 and 5300
laptop computers and increased inventory reserves for inventory obsolescence of
approximately $400,000. By comparison, cost of goods for the three month period
ended September 30, 1995 were favorably impacted by the high volume of Apple
royalty revenue.
Sales, Marketing and Support Expenses
Sales, marketing and support expenses were $940,860 or 28% of net
sales, for the three-month period ended September 30, 1996, as compared with
$803,559, or 19% of net sales, for the three-month period ended September 30,
1995, an increase of $137,301 or 17%. The increase in sales, marketing and
support expenses in absolute dollars and on a percentage basis is primarily the
result of increased promotion expenditures related to domestic and international
channel expansion efforts.
General and Administrative Expenses
General and administrative expenses for the three-month period ended
September 30, 1996 were $1,960,508 or 58% of net sales, as compared with
$789,524, or 19% of net sales for the three-month period ended September 30,
1995, an increase of $1,170,984 or 148%. The increase is due to the write down
of intangibles of approximately $1,273,000 associated with the Company's prior
acquisitions of Lapis and Inline partially offset by cost reductions initiated
by management during the third quarter.
Research and Development Expenses
Research and development expenses for the three-month period ended
September 30, 1996 were $532,319, or 16% of net sales, as compared to $243,855,
or 6% of net sales, for three-month period ended September 30, 1995 an increase
of $288,464 or 118%. The increase in research and development expenses in both
absolute dollars and as a percentage of revenue is due to higher staffing levels
and related expenses associated with new product development and enhancement of
the Company's current and future product offerings.
Purchased Research and Development
Effective as of September 30, 1996, the Company acquired TView, Inc, in
a purchase transaction for approximately $2,570,000. The Company issued
$2,000,000 of its Common Stock and assumed net liabilities of approximately
$570,000. As a result of the acquisition, the Company charged $2,000,000 to
operations, representing the portion of the purchase price allocated to in
process research and development.
Interest Expense, Net
Net interest expense for the three-month period ended September 30,
1996 was $65,504, or 2% of net sales, as compared to $132,403, or 3% of net
sales, for the three-month period ended September 30, 1995 a decrease of
$66,899, or 51%. Interest expense for the three-month period ended September 30,
1996 arose primarily from the $2,500,000 term note, which the Company issued in
October 1994 to an unrelated party, and a $900,000 line of credit with its
commercial bank.
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RESULTS OF OPERATIONS
Nine-Month Period Ended September 30, 1996 As Compared
With The Nine-Month Period Ended September 30, 1995
Net Sales
Net sales for the nine-month period ended September 30, 1996 were
$11,498,362 as compared with $12,834,953 for the nine-month period ended
September 30, 1995, a decrease of $1,336,591 or 10%. In May 1995, the Company
restructured its agreement with Apple Computer, Inc. ("Apple") regarding the
Company's L-TV product so that it could recognize royalty revenue rather than
product sales with related cost of goods sold, as it had in its transactions
with Apple during the first quarter of 1995. The restructuring of the agreement
resulted from the severe liquidity and cash flow problems experienced by the
Company at the end of 1994 and during the first six months of 1995. In the nine
months ended September 30, 1996, the Company recognized royalty revenues from
Apple of approximately $340,000 or 3% of net sales, with 100% gross margin as
compared to approximately $3,623,000 for the comparable period in 1995. The
Company expects that royalty revenues from the Apple agreement will not be
material for the remainder of 1996.
In addition, net sales in the nine-month period ended September 30,
1996, were lower due to a significant reduction in orders from Apple for the
Company's L-TV product and orders for the Company's graphics/connectivity
products for Apple's PowerBook 190 and 5300 laptop computers. During the period,
sales to Apple represented 9% of the Company's revenues as compared to 53% of
revenues in the first nine months of 1995. It is anticipated that revenues from
Apple will continue to decline, on a percentage basis, as the Company continues
to diversify its distribution channels.
The Company recognized revenues under its agreement with Zenith
Electronics for its PC to TV products during the nine-month period ended
September 30, 1996 of approximately $3,270,000 or 28% of total revenues. There
were no sales to Zenith Electronics in the first nine months of 1995.
Cost of Goods Sold
Cost of goods sold were $11,193,421 or 97% of net sales, for the
nine-month period ended September 30, 1996, as compared with $7,321,988 or 57%
of net sales, for the nine months ended September 30, 1995, an increase of
$3,871,433 or 53%. The increase in cost of goods sold in absolute dollars and as
a percentage of sales is due principally to the write down and refurbishment of
inventory related to the Company's graphics/connectivity products for the
Powerbook 190 and 5300 laptop computer, as well as, additional provisions made
for inventory obsolescence.
As previously disclosed in the Company's Annual Report on Form 10-KSB
for the year ended December 31, 1995, the Company experienced a significant
reduction in orders for the Company's L-TV product and graphics/connectivity
products for the Powerbook 190 and 5300 laptop computers during the period ended
September 30, 1996. During the first five months of 1996, management became
aware of various product quality and sell-through issues relating to Apple's
Powerbook 190 and 5300 products, including a recall by Apple of the products in
May 1996. Because of the uncertainty with respect to these Apple products and
the likelihood that demand for the Company's graphic/connectivity products would
be significantly below the Company's then existing inventory levels, management
decided to minimize the Company's
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inventory exposure and recorded a charge of $2.2 million in the first quarter of
1996. In the second quarter of 1996, this inventory was liquidated through the
Company's distribution channels which had the result of reducing cost of goods
sold as a percentage of total revenues.
Sales, Marketing and Support Expenses
Sales, marketing and support expenses were $2,917,645 or 25% of net
sales, for the nine-month period ended September 30, 1996, as compared with
$2,229,170, or 17% of net sales, for the nine-month period ended September 30,
1995, an increase of $688,475 or 31%. The increase in sales, marketing and
support expenses in both absolute dollars and as a percentage of net sales is
primarily the result of increased staffing, marketing and advertising
expenditures related to the Company's distribution channel expansion efforts
both domestically and internationally.
General and Administrative Expenses
General and administrative expenses for the nine-month period ended
September 30, 1996 were $3,192,833 or 28% of net sales, as compared with
$1,728,622 or 13% of net sales for the nine-month period ended September 30,
1995, an increase of $1,474,211 or 84%. The increase is due primarily to the
write down of intangibles of approximately $1,273,000 associated with the
Company's prior acquisitions of Lapis and Inline and higher than expected audit,
legal and outside consulting fees associated with the Company's 1995 audit and
related filings.
Research and Development Expenses
Research and development expenses for the nine-month period ended
September 30, 1996 were $1,150,260, or 10% of net sales, as compared to
$726,292, or 6% of net sales, for nine-month period ended September 30, 1995, an
increase of $423,968 or 58%. The increase in research and development expenses
in both absolute dollars and as a percentage of revenue is due to increased
staffing levels and related expenses associated with new product development and
enhancement of the Company's current and future product offerings, as well as
the transition of activities to Beaverton, Oregon as a result of the acquisition
of TView, Inc.
Purchased Research and Development
Effective as of September 30, 1996, the Company acquired TView, Inc, in
a purchase transaction for approximately $2,570,000. The Company issued
$2,000,000 of its Common Stock and assumed net liabilities of approximately
$570,000. As a result of the acquisition, the Company charged $2,000,000 to
operations, representing the portion of the purchase price allocated to in
process research and development.
Interest Expense, Net
Net interest expense for the nine-month period ended September 30, 1996
was $235,607, or 2% of net sales, as compared to $408,227, or 3% of net sales,
for the nine-month period ended September 30, 1995, a decrease of $101,941, or
38%. Interest expense for the nine-month period ended September 30, 1996 arose
primarily from the $2,500,000 term note, which the Company issued in October
1994 to an unrelated party, and a $900,000 line of credit with its commercial
bank. In addition, expenses related to the issuance of warrants to lenders in
1995 and 1996 are included in interest expense for the period ended September
30, 1996.
LIQUIDITY AND CAPITAL RESOURCES
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For the nine months ended September 30, 1996, net cash used in
operating activities was $5,567,186 consisting primarily of a net loss of
$9,220,737 and an increase in accounts receivable of $3,035,541. These were
partially offset by increased accounts payable and accrued liabilities totaling
$2,722,957 as well as depreciation of property, plant and equipment and
amortization of goodwill relating to the Lapis acquisition and the write off of
purchased research and development totaling $3,747,824. Net cash provided by
financing activities was $4,150,318 due primarily to proceeds of approximately
$5,358,000 from the exercise of warrants, stock options and issuance of shares
of common stock in private placements described below. The proceeds were
partially offset by the payment of notes payable totaling $1,090,000 which
included the repayment of $1,000,000 of the amount owed under the Company's
$2,500,000 term note.
As of September 30, 1996, the Company had a working capital of
$115,632, as compared to working capital of $862,686 at December 31, 1995, a
decrease of $747,054. The decrease is primarily attributable to the increase in
accounts receivable of approximately $2,998,000 offset by increases in accounts
payable of approximately $1,697,000 and accrued liabilities of approximately
$1,026,000 from December 31, 1995.
For the nine month period ended September 30, 1996, the Company sold
approximately 2,019,000 shares of common stock for gross proceeds of
approximately $4,825,000 in connection with a private offering to private
investors. This stock is unregistered and subject to restrictions on private
trading in the United States for a period of forty-one days. In connection with
the offering, the Company incurred fees of approximately $357,000. Net proceeds
of the offering were approximately $4,468,000.
From January 1 through September 30, 1996, the Company issued
approximately 793,000 shares of common stock upon the exercise of approximately
786,000 private and public warrants, receiving gross proceeds of approximately
$1,021,000.
From its inception through September 30, 1996, the Company has incurred
approximately $18.9 million of accumulated losses. The report of independent
accountants on the Company's financial statements as of and for the years ended
December 31, 1995 and 1994 includes an explanatory paragraph to the effect that
the Company's ability to continue as a going concern is dependent upon the
Company's ability to achieve its fiscal 1996 operating plan, including the
achievement of sustained profitability, and obtaining additional sources of
financing. In 1995, the Company redefined its operating model to achieve
profitability by discontinuing sales of lower- margin, non-proprietary products,
by focusing its marketing efforts on its higher-margin proprietary products,
emphasizing sales to OEMs and the reseller channel, limiting inventory levels
and reducing operating costs. In 1996, the Company expects to continue to use
this business model. The Company's ability to achieve profitability in 1996 is
dependent upon its securing additional contracts from OEM partners such as Apple
and Zenith Electronics, Inc., as well as, increasing revenues through its
domestic and international distributors. The Company does not have any material
commitments for capital expenditures. Management anticipates that current
working capital, funds generated through the revised business model, and
additional funds that may be received from debt or equity financing will be
sufficient to fund operations for at least 12 months. The Company has extended
the term of its $900,000 line of credit and its $2,500,000 term note with its
commercial bank and its unaffiliated lenders to extend until March 1997. There
can be no assurance that the Company will achieve sustained profitability or
obtain sufficient financing to provide the liquidity necessary for the Company
to continue operations.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
The following discussion of the Company's risk factors should be read
in conjunction with the financial statements and related notes thereto. The
following factors among others, could
14
<PAGE>
cause actual results to differ materially from those contained in forward
looking statements contained or incorporated by reference in this report and
presented by management from time to time. Such factors, among others, may have
a material adverse effect upon the Company's business, results of operations and
financial condition.
Reliance on Major Customers. Approximately 50% of the Company's net
sales during the year ended December 31, 1995 and approximately 9% of the
Company's net sales during the nine months ended September 30, 1996 were derived
from sales of the Company's L-TV product to Apple Computer, Inc. ("Apple"). In
August 1994, the Company entered into a two year Master Purchase Agreement with
Apple under which Apple agreed to bundle and distribute the Company's L-TV
product with Apple's "Presentation System" product offering. Although orders
under this agreement represented over 50% of the Company's revenues in 1995,
management believes that orders under this agreement in 1996 will not be
material to the Company's revenues for the year as a whole. The Company believes
it may secure additional contracts from Apple in the future, however, no
assurances can be given that the Company will be successful in securing one or
more additional contracts.
In the first quarter of 1996, the Company began shipments under its
agreement with Zenith Electronics for its PC to TV convergence products.
Revenues through the nine month period ended September 30, 1996 were
approximately $3,270,000 or 28% of revenues. Management believes that orders
under this agreement will continue throughout 1996, however, no assurances can
be given as to the estimated annual revenue to be generated from this agreement
in 1996. On October 17, 1996, the Company announced a exclusive agreement with
Zenith Electronics for its PC to TV technology products. The agreement includes
a guarantee of $12,000,000 in revenues through the end of 1997 and includes a
nonbinding option to extend its exclusive agreement through the end of 1998 with
potential purchases up to $30,000,000.
Future Capital Needs. At September 30, 1996, the Company had a working
capital of $115,632 cash and cash equivalents of $644,967 and was fully drawn on
its $900,000 line of credit with its bank and its $2.5 million term note with an
unaffiliated lender. Historically, the Company has been required to meet its
short- and long-term cash needs through debt and the sale of Common Stock in
private placements in that cash flow from operations has been insufficient. In
December 1995, the Company received gross proceeds of $1 million from the sale
of Common Stock to four investors in a private placement. In the first nine
months of 1996, the Company received approximately $5,338,000 in proceeds from
the exercise of warrants, stock options and sale of common stock.
The Company's future capital requirements will depend on many factors,
including cash flow from operations, continued progress in its research and
development programs, competing technological and market developments, and the
Company's ability to market its products successfully. During 1996, the Company
may be required to raise additional funds through equity or debt financing, of
which there can be no assurance. Any equity financing could result in dilution
to the Company's then-existing stockholders that the Company will be able to
obtain. Sources of debt financing may result in higher interest expense. Any
financing, if available, may be on terms unfavorable to the Company. If adequate
funds are not available, the Company may be required to curtail its activities
significantly.
Limited Availability of Capital under Credit Arrangements with Lenders.
The Company maintains a $900,000 line of credit with Silicon Valley Bank. As of
September 30, 1996, approximately $850,000 is owed to the Bank under the line of
credit. Pursuant to its agreement with the Bank, the line of credit terminated
in April 1996, and has been extended until March 7, 1997.
15
<PAGE>
In October 1994, the Company borrowed $2,500,000 from an unaffiliated
lender to help finance its inventory and accounts receivable under its Master
Purchase Agreement with Apple. The Company issued to this unaffiliated lender
its term note in the aggregate principal amount of $2,500,000. The term note
accrues interest at the revolving rate of prime plus 2%, is payable quarterly in
arrears at the end of December, March, June, and September, and was due February
1, 1996. The term note was originally secured by those specific assets financed
under the agreement with Apple, including accounts receivable, finished goods,
inventory, raw materials, work-in-process and contract rights arising under the
Apple agreement. The Company has fully utilized the proceeds of this term note
to finance purchase orders received from Apple. In January 1996, the Company
repaid approximately $1 million of the amount owed under the term note. On June
28, 1996, the Company negotiated an amendment to the term note with the lender
to extend the due of the term note to March 31, 1997. Pursuant to the amendment,
the Company granted the lender a second security interest in all the assets of
the Company.
Component Supply Problems. The Company purchases all of its parts from
outside suppliers and from time to time experiences difficulty in obtaining some
components or peripheral devices. The Company attempts to reduce the risk of
supply interruption by evaluating and obtaining alternative sources for various
components or peripheral devices. However, there can be no assurance that supply
shortages will not occur in the future which could significantly increase the
cost, or delay of shipment of, the Company's products, which in turn could
adversely affect its results of operations.
Dependence on Apple Macintosh Platform: Adverse Effects of Reduced
Apple Macintosh Sales. Historically, a substantial portion of the Company's
sales have been derived from products designed for use on the Apple Macintosh
family of personal computers. The Company expects that sales of products for use
with Macintosh computers will represent a smaller portion of its net sales for
the foreseeable future. Although sales of Macintosh computers have increased
from year to year, there can be no assurance that such sales will continue to be
widely accepted as a platform for high performance applications. Also, there can
be no assurance that other computer platforms will not gain increased acceptance
in the Company's markets as these platforms evolve to support applications
similar to those offered for the Macintosh. In addition, there can be no
assurance that the Company will be able to make timely and successful
introductions of products for other platforms.
Reliance on Single Vendor. Approximately 60% of the components for the
Company's products are manufactured on a turnkey basis by a single vendor, Pagg
Corporation. In the event that the vendor were to cease supplying the Company,
management believes there are alternative vendors for the components for the
Company's products. However, the Company would experience short-term delays in
the shipment of its products.
Market Acceptance. The Company's sales and marketing strategy
contemplates sales of its products to the personal computer and Macintosh
enhancements markets. There can be no assurance that the Company's marketing
strategy will be effective and that consumers of personal computer or Macintosh
enhancements will buy the Company's products. The failure of the Company to
penetrate these enhancements markets would have a material adverse effect upon
its operations and prospects. Market acceptance of the Company's current and
proposed products will depend upon the ability of the Company to demonstrate the
advantages of its products over other computer enhancement products.
Competition. The personal computer and Macintosh enhancements market is
extremely competitive. The Company competes with computer retail stores,
including superstores, certain hardware and software vendors which sell directly
to end-users, and other direct marketers of personal computer and/or Macintosh
enhancements and peripheral products. Many of the Company's competitors,
including Apple, Radius and Asante, have greater market recognition
16
<PAGE>
and greater financial, technical, marketing and human resources than the
Company. Although the Company is not currently aware of any announcements by its
competitors that would have a material impact on the Company or its operations,
there can be no assurance that the Company will be able to compete successfully
against existing companies or new entrants to the marketplace.
Technological Obsolescence. The personal computer and Macintosh and
enhancements market is characterized by extensive research and development and
rapid technological change resulting in product life cycles of nine to eighteen
months. Development by others of new or improved products, processes or
technologies may take the Company's products or proposed products obsolete or
less competitive. The Company will be required to devote substantial efforts and
financial resources to enhance its existing products and to develop new
products. There can be no assurance that the Company will succeed with these
efforts.
Protection of Proprietary Information. The Company does not have any
patents. The Company treats its technical data as confidential and relies on
internal nondisclosure safeguards, including confidentiality agreements with
employees, and on laws protecting trade secrets to protect its proprietary
information. There can be no assurance that these measures will adequately
protect the confidentiality of the Company's proprietary information or that
others will not independently develop products or technology that are equivalent
or superior to those of the Company. While it may be necessary or desirable in
the future to obtain licenses relating to one or more of its products or
relating to current or future technologies, there can be no assurance that the
Company will be able to do so on commercially reasonable terms.
Dependence on Key Personnel. The Company's success depends to a
significant extent, upon a number of key employees. The loss of services of one
or more of these employees, especially the Company's Chief Executive Officer and
President, Thomas L. Massie, could have a material adverse effect on the
business of the Company. The Company believes that its future success will also
depend in part upon its ability to attract, retain and motivate qualified
personnel. Competition for such personnel in the computer industry is intense.
Although the Company has not in the past experienced difficulty in attracting
and retaining qualified personnel, there can be no assurance that the Company
will be successful in attracting and retaining such personnel in the future.
Volatility of Stock Price. The price of the Company's Common Stock and
Redeemable Common Stock Purchase Warrants has fluctuated widely in the past.
Management believes that such fluctuations may have been caused by quarterly
fluctuations in the Company's results of operations and other factors, including
changes in the personal computer market generally and in the market for products
related to the Apple operating system in particular. Due to the rapid
technological changes and highly competitive nature of the computer industry as
a whole, prices for the securities of technology companies have experienced
extreme volatility over the past several months and can be expected to
experience extreme volatility in the future. Such price volatility could have a
material adverse effect on the Company's ability to raise capital at favorable
valuations, as well as reduce the ability of a holder of the Company's
securities to sell them at favorable prices.
17
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not party to any pending legal proceedings, other than
routine litigation that is incidental to the business, which would have a
material adverse effect on the Company's financial position or results of
operation for the three and nine month periods ended September 30, 1996.
ITEM 2. CHANGES IN SECURITIES
No instruments defining the rights of the holders of any class of
registered securities have been materially modified nor have the rights
evidenced by any class of registered securities been materially limited or
qualified by the issuance or modification of any other class of securities.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE
None
ITEM 5. OTHER INFORMATION
On October 3, 1996, the Company announced that it had reached an
agreement in principle to acquire all the issued and outstanding stock of
Digital Vision, Inc., a developer of PC to TV multimedia products, for up to
700,000 shares of the Company's common stock. On November 14, 1996, the Company
and Digital Vision, Inc. mutually agreed to terminate the acquisition.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. The following exhibits are filed herewith:
11 - Statement Re: Computation of Per Share Earnings
27 - Financial Data Schedule
b. Reports on Form 8-K
During the quarter covered by this report, the following reports on
Form 8-K were filed:
Date of Form 8-K Summary of Item
---------------- -------------------
November 4, 1996 Registrant reported the acquisition of TView, Inc.
18
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
FOCUS Enhancements, Inc.
November 14, 1996 By: /s/ Thomas L. Massie
------------------------
Thomas L. Massie
President,
Chief Executive Officer and
Chairman of the Board
(Principal Executive Officer)
November 14, 1996 By: /s/ Jeremiah J. Cole, Jr.
---------------------------
Jeremiah J. Cole, Jr.
Vice President of Finance
(Principal Accounting Officer)
19
EXHIBIT 11
<TABLE>
<CAPTION>
FOCUS ENHANCEMENTS, INC.
STATEMENT COMPUTATION OF PER SHARE EARNINGS
(Unaudited)
Three months ended
September 30, September 30,
1996 1995
-------------- --------------
<S> <C> <C>
Net income (loss) $ (5,657,639) $ 589,462
============== ==============
Primary:
Weighted average number of common shares outstanding 9,476,462 6,618,109
Weighted average common equivalent shares 1,153,508
-------------- --------------
Weighted average number of common and common equivalent
shares outstanding used to calculate per share data 9,476,462 7,771,617
============== ==============
Fully diluted:
Weighted average number of common shares outstanding 9,476,462 6,618,109
Weighted average common equivalent shares 1,687,927
-------------- --------------
Weighted average number of common and common equivalent
shares outstanding used to calculate per share data 9,476,462 8,306,036
============== ==============
Net income (loss) per share
Primary $ (0.60) $ 0.08
============== ==============
Fully diluted $ (0.60) $ 0.07
============== =============
<CAPTION>
Nine months ended
September 30, September 30,
1996 1995
-------------- --------------
<S> <C> <C>
Net income (loss) $ (9,220,737) $ 696,735
============== ==============
Primary:
Weighted average number of common shares outstanding 8,477,011 5,831,957
Weighted average common equivalent shares - 561,376
-------------- --------------
Weighted average number of common and common equivalent
shares outstanding used to calculate per share data 8,477,011 6,393,333
============== ==============
Fully diluted:
Weighted average number of common shares outstanding 8,477,011 5,831,957
Weighted average common equivalent shares - 1,358,078
-------------- --------------
Weighted average number of common and common equivalent
shares outstanding used to calculate per share data 8,477,011 7,190,035
============== ==============
Net income (loss) per share
Primary $ (1.09) $ 0.11
============== ==============
Fully diluted $ (1.09) $ 0.10
============== ==============
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
unaudited financial statements of FOCUS Enhancements, Inc. for the period ended
September 30, 1996 and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<CASH> 672,216
<SECURITIES> 0
<RECEIVABLES> 5,399,286
<ALLOWANCES> 499,110
<INVENTORY> 1,925,496
<CURRENT-ASSETS> 7,764,238
<PP&E> 1,797,699
<DEPRECIATION> 1,400,187
<TOTAL-ASSETS> 9,531,478
<CURRENT-LIABILITIES> 7,648,606
<BONDS> 0
0
0
<COMMON> 107,971
<OTHER-SE> 1,596,413
<TOTAL-LIABILITY-AND-EQUITY> 9,746,514
<SALES> 11,498,362
<TOTAL-REVENUES> 11,498,362
<CGS> 11,193,421
<TOTAL-COSTS> 9,260,738
<OTHER-EXPENSES> 12,792
<LOSS-PROVISION> 499,110
<INTEREST-EXPENSE> 235,607
<INCOME-PRETAX> (9,204,196)
<INCOME-TAX> 16,541
<INCOME-CONTINUING> (9,220,737)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,220,737)
<EPS-PRIMARY> (1.09)
<EPS-DILUTED> 0
</TABLE>
