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, 1998
[ ] 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)
(978) 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 September 30, 1998, there were outstanding 17,187,820 shares of Common
Stock, $.01 par value per share.
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FOCUS ENHANCEMENTS, INC.
FORM 10-QSB
QUARTERLY REPORT
September 30, 1998
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, 1998
and December 31, 1997 3
Consolidated Statements of Operations
for the Three Months Ended September 30, 1998 and 1997 4
Consolidated Statements of Operations
for the Nine Months Ended September 30, 1998 and 1997 5
Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 1998 and 1997 6-7
Statement of Changes in Equity for the Nine
Months Ended September 30, 1998 8
Statement of Changes in Equity for the Nine
Months Ended September 30, 1997 9
Notes to Consolidated Financial Statements 10-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-21
PART II. OTHER INFORMATION
1. Legal Proceedings 22
Item 2. Changes in Securities 22
Item 3. Default upon Senior Securities 22
Item 4. Submissions of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
2
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<TABLE>
<CAPTION>
FOCUS ENHANCEMENTS, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
September 30, December 31,
1998 1997
------------ ------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 3,009,532 $ 719,851
Securities available for sale 438,684 595,000
Accounts receivable, net of allowances of $430,251 and $820,998
at September 30, 1998 and December 31, 1997, respectively 9,742,460 5,538,132
Inventories 3,264,443 3,989,604
Prepaid expenses and other current assets 525,802 470,907
------------ ------------
Total current assets 16,980,921 11,313,494
Property and equipment, net 1,322,501 1,068,918
Other assets, net 280,689 288,482
Goodwill, net 4,099,514 1,249,750
------------ ------------
Total assets $ 22,683,625 $ 13,920,644
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 909,475 $ 2,220,000
Obligations under capital leases 26,837 102,320
Accounts payable 3,569,290 5,515,913
Accrued liabilities 272,696 855,961
------------ ------------
Total current liabilities 4,778,298 8,694,194
Notes payable
Deferred Income 84,212 84,212
Obligations under capital leases 44,260 73,855
Notes Payable 914,668 --
------------ ------------
Total liabilities 5,821,438 8,852,261
------------ ------------
Stockholders' equity
Preferred stock, $.01 par value; 3,000,000 shares authorized; none issued -- --
Common stock, $.01 par value; 25,000,000 shares authorized,
17,637,820 and 14,010,186 shares issued and outstanding at
September 30, 1998 and December 31, 1997, respectively 176,378 140,102
Additional paid-in capital 38,505,745 27,339,892
Accumulated deficit (20,963,490) (22,411,611)
------------ ------------
17,718,633 5,068,383
Accumulated other comprehensive income (loss) (156,316) --
Treasury Stock (700,130) --
------------ ------------
Total stockholders' equity 16,862,187 5,068,383
Total liabilities and stockholders' equity $ 22,683,625 $ 13,920,644
============ ============
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
3
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FOCUS ENHANCEMENTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
September 30, September 30,
1998 1997
------------- ------------
Net sales $ 7,266,180 $ 6,913,013
Cost of goods sold 4,207,259 4,764,299
------------ ------------
Gross profit 3,058,921 2,148,714
------------ ------------
Operating expenses:
Sales, marketing and support 1,473,426 1,147,392
General and administrative 571,280 415,775
Research and development 323,073 331,318
Depreciation & amortization expense 218,091 109,586
------------ ------------
Total operating expenses 2,585,870 2,004,071
------------ ------------
Income from operations 473,051 144,643
Interest expense, net (16,819) (72,466)
Other income, net 11,493 351,279
------------ ------------
Income before income taxes 467,725 423,456
Income tax expense -- 9,550
------------ ------------
Net income $ 467,725 $ 413,906
============ ============
Net income per common share
Basic $ 0.03 $ 0.03
============ ============
Diluted $ 0.03 $ 0.03
============ ============
Weighted average common shares outstanding
Basic 17,427,999 14,582,324
============ ============
Diluted 18,118,926 15,172,554
============ ============
The accompanying notes are an integral part of the
consolidated financial statements.
4
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FOCUS ENHANCEMENTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Nine Months Ended
September 30, September 30,
1998 1997
------------ -------------
Net sales $ 19,390,215 $ 17,839,430
Cost of goods sold 11,054,551 12,089,949
------------ ------------
Gross profit 8,335,664 5,749,481
------------ ------------
Operating expenses:
Sales, marketing and support 3,920,763 3,112,609
General and administrative 1,346,764 1,083,661
Research and development 878,797 763,156
Depreciation & amortization expense 574,590 301,267
------------ ------------
Total operating expenses 6,720,914 5,260,693
------------ ------------
Income from operations 1,614,750 488,788
Interest expense, net (154,229) (209,109)
Other income, net 17,261 395,110
------------ ------------
Income before income taxes 1,477,782 674,789
Income tax expense 29,661 12,700
------------ ------------
Net income $ 1,448,121 $ 662,089
============ ============
Net income per common share
Basic $ 0.09 $ 0.05
============ ============
Diluted $ 0.09 $ 0.05
============ ============
Weighted average common shares outstanding
Basic 16,054,513 12,787,591
============ ============
Diluted 16,702,305 13,031,965
============ ============
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,
1998 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,448,121 $ 662,089
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization 574,590 301,267
Amortization of discount on note payable 4,583 0
Gain on the forgiveness of accounts payable -- (125,427)
Deferred Income -- 84,212
Changes in operating assets and liabilities, net of the
effects of acquisition;
(Increase) decrease in accounts receivable (3,864,571) (4,514,833)
(Increase) decrease in marketable securities 0 (595,000)
Decrease (increase) in inventories 1,096,996 (607,373)
Decrease (increase) in prepaid expenses and other assets (54,895) (217,546)
Decrease (increase) in other assets 7,793 --
(Decrease) increase in accounts payable (2,043,512) 1,766,971
(Decrease) increase in accrued liabilities (621,285) 413,788
----------- -----------
Net cash used in operating activities (3,452,180) (2,831,852)
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (618,394) (534,932)
Net proceeds from sale of fixed assets 800
Cash paid in acquisitions, net of cash received (930,563) --
----------- -----------
Net cash used in investing activities (1,548,957) (534,132)
----------- -----------
Cash flows from financing activities:
Payments on notes payable (1,740,478) (268,336)
Payments under capital lease obligations (105,078) (70,043)
Payments for purchase of treasury stock (700,130)
Net proceeds from private offerings of common stock 2,827,355 5,650,099
Net proceeds from exercise of common stock options and warrants 7,009,149 133,075
----------- -----------
Net cash provided by financing activities 7,290,818 5,444,795
----------- -----------
Net increase in cash and cash equivalents 2,289,681 2,078,811
Cash and cash equivalents at beginning of period 719,851 413,894
----------- -----------
Cash and cash equivalents at end of period $ 3,009,532 $ 2,492,705
=========== ===========
Supplemental Cash Flow Information:
Interest paid $ 154,229 $ 134,943
Income taxes paid $ 29,661 $ 3,150
Issuance of Common Stock Warrants $ -- $ 42,000
The accompanying notes are an integral part of the consolidated financial statements.
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<CAPTION>
<S> <C>
Supplemental schedule of noncash investing and financing activities:
On March 31, 1998, the Company purchased certain assets and assumed certain
liabilities of Digital Vision, Inc. as follows:
Fair value of tangible assets acquired 224,957
Fair value of liabilities assumed (384,495)
-----------
Fair value of net assets acquired (159,538)
Common stock issued (1,115,625)
Cash paid (46,980)
===========
Excess of cost over fair value of net assets acquired $(1,322,143)
===========
Supplemental schedule of noncash investing and financing activities:
On July 29, 1998, the Company purchased certain assets and assumed certain
liabilities of PC Video Conversion as follows:
Fair value of tangible assets acquired 613,336
Fair value of liabilities assumed (80,367)
-----------
Fair value of net assets acquired 532,969
Common stock issued (350,000)
Cash paid (700,000)
Note Payable (910,085)
Acquisition Costs (229,781)
===========
Excess of cost over fair value of net assets acquired $(1,656,897)
===========
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
7
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<TABLE>
<CAPTION>
FOCUS ENHANCEMENTS, INC.
STATEMENT OF CHANGES IN EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
Accumulated
Additional Other
Comprehensive Common Paid-in Accumulated Comprehensive Treasury
Income (loss) Stock Capital Deficit (loss) Stock Total
------------- --------- ----------- ------------- ------------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $ -- $ 140,102 $27,339,892 $(22,411,611) $ -- $ -- $ 5,068,383
Comprehensive Income
Net income 1,448,121 1,448,121 1,448,121
Other comprehensive income, net of tax
Unrealized (loss) on securities (156,316) (156,316) (156,316)
-----------
Comprehensive income $ 1,291,805
===========
Common stock issued 36,276 11,265,853 11,302,129
Treasury stock purchased (700,130) (700,130)
--------- ----------- ------------ --------- --------- -----------
Balance, September 30, 1998 $ 176,378 $38,605,745 $(20,963,490) $(156,316) $(700,130) $16,962,187
========= =========== ============ ========= ========= ===========
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
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<TABLE>
<CAPTION>
FOCUS ENHANCEMENTS, INC.
STATEMENT OF CHANGES IN EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
Additional
Comprehensive Common Paid-in Accumulated
Income (loss) Stock Capital Deficit Total
------------- -------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ -- $113,018 $21,285,037 $(20,425,532) $ 972,523
Comprehensive Income
Net income 662,089 662,089 662,089
Other comprehensive income, net of tax
Unrealized (loss) on securities --
--------
Comprehensive income $662,089
========
Common stock issued 25,147 5,758,027 5,783,174
-------- ----------- ------------ ----------
Balance, September 30, 1997 $138,165 $27,043,064 $(19,763,443) $7,417,786
======== =========== ============ ==========
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
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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, 1998 and for the three- and nine-month periods
ended September 30, 1998 and 1997 are unaudited and should be read in
conjunction with the consolidated financial statements and notes thereto for the
year ended December 31, 1997 included in the Company's Annual Report on Form
10-KSB for the year ended December 31, 1997. The consolidated financial
statements include the accounts of the Company and its wholly-owned subsidiaries
PC Video Conversion Inc., Lapis Technologies, Inc., TView, Inc. and FOCUS
Enhancements B.V. On March 31, 1998, the Company acquired certain assets and
assumed certain liabilities of Digital Vision, Inc. in a transaction accounted
for under the purchase method of accounting. On July 29, 1998, the Company
acquired certain assets and assumed certain liabilities of PC Video Conversion
Inc. in a transaction accounted for under the purchase method of accounting.
The results of operations of Digital Vision, Inc. have been included in the
accompanying consolidated financial statements since April 1, 1998. The results
of operations of PC Video Conversion Corp. have been included in the
accompanying consolidated financial statements since July 29, 1998. The
following unaudited pro forma information presents a summary of the consolidated
results of operations of the Company as if the acquisitions had occurred at the
beginning of the nine-month period presented.
Pro forma Results
Nine Months Ended
September 30,
1998 1997
-----------------------------
Net sales 21,391,000 20,839,000
Income from operations 1,718,000 654,000
Net income 1,526,333 777,000
Net income per common share
Basic $ .09 $ .05
Diluted .09 .05
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-month periods ended September 30, 1998 are
not necessarily indicative of the results that may be expected for any future
period.
2. NET INCOME PER SHARE
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128 - "Earnings
Per Share" which requires earnings per share to be calculated on a basic and
dilutive basis. Basic earnings per share represents income available to common
stock divided by the weighted-average number of common shares outstanding during
the period. Diluted earnings per share reflects additional common shares that
would have been outstanding if dilutive potential common shares had been issued,
as well as any adjustment to income that would result from the assumed
conversion. Potential common shares that may be issued by the Company relate
solely to outstanding stock options and warrants, and are determined using the
treasury stock method. The assumed conversion of outstanding dilutive stock
options and warrants would increase the shares outstanding but would not require
an adjustment to income as a result of the conversion. For the nine-
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months ended September 30, 1998 and 1997, options and warrants applicable to
1,940,040 shares and 4,665,937 shares, respectively, were anti-dilutive and
excluded from the diluted earnings per share computation. The statement is
effective for interim and annual periods ending after December 15, 1997, and
requires the restatement of all prior period earnings per share data presented.
Accordingly, the Company has restated all earnings per share data for prior
periods presented herein.
3. COMPREHENSIVE INCOME
In June 1997, FASB issued SFAS No. 130, "Reporting Comprehensive
Income", effective for fiscal years beginning after December 15, 1997.
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Certain FASB statements, however, require
entities to report specific changes in assets and liabilities, such as
unrealized gains and losses on available-for-sale securities, as a separate
component of the equity section of the balance sheet. Such items, along with net
income, are components of comprehensive income. SFAS No. 130 requires that all
items of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. Additionally,
SFAS No. 130 requires that the accumulated balance of other comprehensive income
be displayed separately from retained earnings and additional paid-in-capital in
the equity section of the balance sheet. The Company adopted these disclosure
requirements in the first quarter of 1998 and has presented comparative
disclosure for the nine months ended September 30, 1998 and September 30, 1997,
respectively. In 1997, the Company had no other components of comprehensive
income other than net income.
4. INCOME TAXES
The Company has utilized its net operating loss carryforwards in
estimating its provision for income taxes in the three- and nine-month periods
ended September 30,1998.
5. INVENTORIES
Inventories consist of the following:
September 30, December 31,
1998 1997
------------- ------------
Finished goods $2,876,155 $3,304,444
Raw materials 388,288 685,160
---------- ----------
$3,264,443 $3,989,604
========== ==========
6. NOTES PAYABLE
Lines of Credit, Banks. The Company maintains a revolving line of
credit with a bank, which is fully drawn as of September 30, 1998. Borrowings
under the line are payable upon demand and are collateralized by all of the
assets of the Company, except as noted below. Borrowings, aggregating $660,000
at September 30, 1998, bear interest at the bank's prime rate plus 1% (9% at
September 30, 1998). In November of 1998, the line of credit was extended to
December 15, 1998.
Term Line of Credit. The Company owed $1,500,000 to an unrelated party
under a term line of credit. The Company repaid this obligation, in full, on
July 10, 1998.
Term Loan, Bank. On March 31, 1998, the Company assumed a $329,953 bank
loan resulting from the purchase of certain assets and the assumption of certain
liabilities of Digital Vision, Inc. The borrowings bear interest at the Wall
Street Journal prime rate plus 2% (10% at September 30, 1998). The terms of the
note require payment of interest only through September 30, 1998. The
outstanding balance at September 30, 1998 is payable thereafter in monthly
installments, with interest, until the loan expiration date of June 30, 1999. At
September 30, 1998, the outstanding amount owed on this loan was $249,475.
Notes payable, Related Party. On July 29, 1998, the Company issued a
$1,000,000 note payable to a related party in conjunction with the acquisition
of PC Video. The Company paid PC Video $700,000 in cash and delivered this
promissory note in the principal amount of $1,000,000 providing payment of
principal and interest at 3.5% over a period of 36 months. The Company computed
a discount of $89,915 on this note based on its incremental borrowing rate. In
addition, the Company issued 122,796 shares of common stock as a result of the
acquisition, which were valued at $350,000 and the Company has agreed to
register under the Securities Act of 1933, as amended, by no later than November
30, 1998. The Company also assumed approximately $79,650 of liabilities in
connection with this acquisition. The acquisition is being accounted for as a
purchase and resulted in goodwill of approximately $1,657,000.
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7. COMMON STOCK TRANSACTIONS
On March 3, 1998, the Company completed a financing of approximately
$3,000,000 in gross proceeds from the sale of 1,092,150 shares of common stock
and warrants to purchase 327,645 shares of common stock in a private placement
to an unaffiliated accredited investor. The warrants are exercisable until March
3, 2005. The shares issued in connection with this transaction and issuable upon
exercise of the warrants were registered under the Securities Act of 1933 on
April 22, 1998. Fees and expenses associated with this offering amounted to
approximately $172,600 yielding net proceeds of $2,827,400. In connection with
this transaction, the Board of Directors authorized the grant of warrants to the
placement agent to purchase 21,429 shares of the Company's common stock at a
price of $4.2118 per share exercisable for a period of five years.
On March 31, 1998, the Company issued approximately 350,000 shares of
common stock valued at approximately $1,115,600 in conjunction with the
acquisition of certain assets of Digital Vision, Inc. Shares issued as part of
this transaction have been registered under the Securities Act of 1933. In
addition, the Company agreed to pay approximately $47,000 in cash for the net
assets with a preliminary estimated fair value of approximately ($160,000),
consisting of accounts receivable ($164,400), inventory ($60,600) offset by the
assumption of notes payable ($330,000) and accounts payable ($55,000). The
resulting goodwill of approximately $1,322,000 will be amortized over its
estimated benefit period of ten years.
The Company received gross proceeds of $6,146,887 as a result of the
conversion of 910,650 of the Company's Redeemable Common Stock Purchase Warrants
(the "Warrants") issued in connection with the Company's initial public offering
in May 1993. The Company issued 1,649,202 shares of common stock as a result of
the exercise of the warrants. In accordance with the anti-dilution provisions of
the Warrants, the holder was entitled to receive 1.811 shares of common stock
for each Warrant exercised. The Warrants were exercisable at a price of $6.75
per Warrant until May 26, 1998.
On July 29, 1998, the Company acquired certain assets and assumed
certain liabilities of PC Video Conversion, Inc. ("PC Video"). At the closing,
the Company paid PC Video $700,000 in cash and delivered a promissory note in
the principal amount of $1,000,000 providing payment of principal and interest
at 3.5% over a period of 36 months. The Company computed a discount of $89,915
on the note based on its incremental borrowing rate. In addition, the Company
issued 122,796 shares of common stock as a result of the acquisition, which were
valued at $350,000 and the Company has agreed to register under the Securities
Act of 1933, as amended, by no later than November 30, 1998. The Company also
assumed approximately $79,650 of liabilities in connection with this
acquisition. The acquisition is being accounted for as a purchase and resulted
in goodwill of approximately $1,657,000.
8. TREASURY STOCK TRANSACTIONS
Through September 30, 1998, the Company has repurchased 450,000 shares
of its common stock at an average price of $1.56 per share for an aggregate
amount of $700,130.
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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, 1997.
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, 1997, including, but not limited to, the section therein entitled
"Certain Factors That May Affect Future Results."
RESULTS OF OPERATIONS
Three-Month Period Ended September 30, 1998 As Compared
With The Three-Month Period Ended September 30, 1997
Net Sales
Net sales for the three-month period ended September 30, 1998 ("Q3 98")
were approximately $7,266,000 as compared with $6,913,000 for the three-month
period ended September 30, 1997 ("Q3 97"), an increase of $353,000 or 5%. The
increase in sales was due primarily to the acceptance of the Company's PC to TV
product line in the consumer retail, VAR, and mail order channels in North
America and in Europe. Specifically, net sales in Q3 98 to the Company's US
resellers increased 128% to approximately $6,161,000 from $2,702,000 in Q3 97.
Net sales to international resellers declined 63% in Q3 98 to approximately
$275,000 from $752,000 in Q3 97. This decrease was due to poor economic
conditions in the Asian market combined with the sale of the Company's
networking product line that contributed approximately $300,000 in Q3 97. Net
sales to OEM/Licensing customers decreased 76% to $830,000 in Q3 98 from
$3,459,000 in Q3 97. This decrease reflects the Company not shipping its
PC-to-TV products to a large television manufacturer that is experiencing
financial difficulty (in Q3 97 sales to this customer amounted to approximately
$1,700,000). In addition, a significant OEM customer utilizing the FS300 Digital
Video Co-processor for the Asian marketplace pushed its Q3 98 and Q4 98
requirements out until the first half of 1999. During Q3 98, the company shipped
$0 in networking products compared to approximately $426,000 in Q3 97. This
decline was due to the Company selling its Network product line in the third
quarter of 1997.
As of September 30, 1998, the Company had a sales order backlog of
approximately $ 825,000.
Cost of Goods Sold
Cost of goods sold were approximately $4,207,000 or 58% of net sales,
for Q3 98, as compared with $4,764,000 or 69% of net sales, for Q3 97, a
decrease of approximately $557,000 or 12%. The Company's gross profit margins
for Q3 98 and Q3 97 were 42% and 31%, respectively. As a percentage
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of sales, cost of goods sold was lower in Q3 98 principally due to the cost of
goods reduction in the Company's PC-to-TV products utilizing the FS300 digital
Video Co-Processor.
Sales, Marketing and Support Expenses
Sales, marketing and support expenses were approximately $1,473,000 or
20% of net sales, for the Q3 98, as compared with $1,147,000 or 17% of net
sales, for Q3 97, an increase of approximately $326,000 or 28%. The increase is
due primarily to additional staffing, advertising and marketing expenses
resulting from domestic channel expansion efforts.
General and Administrative Expenses
General and administrative expenses for Q3 98 were approximately
$571,000 or 8% of net sales, as compared with $416,000, or 6% of net sales for
Q3 97, an increase of approximately $155,000 or 37%. The increase is due
primarily to increases in staffing and professional services.
Research and Development Expenses
Research and development expenses for Q3 98 were approximately
$323,000, or 4% of net sales, as compared to $331,000, or 5% of net sales, for
Q3 97, a decrease of approximately $8,000 or 2%. The decrease is due principally
to a decrease in consulting fees of approximately $56,000 offset by an increase
in staffing of approximately $49,000.
Depreciation & Amortization Expense
Depreciation & amortization expense for Q3 98 was approximately
$218,000 or 3% of net sales, as compared to $110,000, or 2% of net sales, for Q3
97, an increase of $108,000, or 98%. The increase is primarily attributable to
increased depreciation associated with purchases of property and equipment and
amortization associated with the acquisitions of Digital Vision, Inc. and PC
Video Conversion.
Interest Expense, Net
Net interest expense for Q3 98 was approximately $17,000 or .2% of net
sales, as compared to $72,000, or 1.0% of net sales, for Q3 97, a decrease of
$55,000, or 76%. The decrease is primarily attributable to a reduction in
outstanding debt balances and the reduction of certain fees incurred with the
extension of the Company's revolving line of credit.
Other Income (Expense)
Other Income (Expense) for Q3 98 was approximately $12,000 as compared
to $ 351,000, for Q3 97. Other income in Q3 97 was $348,727 resulting from the
sale of the Company's networking product line.
Net Income
For the quarter ended September 30, 1998, the Company reported net
income of approximately $468,000, or $0.03 per share, on both a basic and
diluted basis, as compared to $414,000 or $0.03 per share, on both a basic and
diluted basis, for the quarter ended September 30, 1997.
14
<PAGE>
Nine-Month Period Ended September 30, 1998 As Compared
With The Nine-Month Period Ended September 30, 1997
Net Sales
Net sales for the nine-month period ended September 30, 1998 (the "98
Period") were approximately $19,390,000 as compared with $17,839,000 for the
nine-month period ended September 30, 1997 (the "97 Period"), an increase of
$1,551,000 or 9%. The growth in net sales is due to the acceptance of the
Company's PC-to-TV product line in the consumer retail, VAR and mail order
channels. Specifically, net sales in the 98 Period, to the Company's US
resellers increased 68% to approximately $15,427,000 from $9,138,000 in the 97
Period. Net sales to international resellers declined 66% to approximately
$744,000 from $2,170,000 for the same nine-month period in 1997. This decrease
was due to poor economic conditions in the Asian market combined with the sale
of the Company's networking product line that contributed sales of approximately
$1,021,000. Net sales to OEM/Licensing customers decreased 57% to approximately
$2,813,000 in the 98 Period from $6,531,000 for the nine-month period in 1997.
This decrease was primarily due to the Company not shipping its PC-to-TV
products to a large television manufacturer who is experiencing financial
difficulties (sales to this customer amounted to approximately $300,000 in the
97 period).
Cost of Goods Sold
Cost of goods sold were approximately $11,055,000 or 57% of net sales,
for the 98 Period, as compared with $12,090,000 or 68% of net sales, for the 97
Period, a decrease in absolute dollars of $1,035,000 or 9%. The Company's gross
profit margins for the 98 Period and the 97 Period were 43% and 32%,
respectively. As a percentage of sales, cost of goods sold was lower in the 98
Period principally due to reduced manufacturing costs achieved as a result of
the use of the Company's FS300 integrated circuit in manufacturing of the
Company's products, combined with a decrease in OEM sales on which margins are
typically lower.
Sales, Marketing and Support Expenses
Sales, marketing and support expenses were approximately $3,921,000 or
20% of net sales, for the 98 Period, as compared with $3,113,000 or 17% of net
sales, for the 97 Period, an increase of $808,000 or 26%. The increase in
absolute dollars is due primarily to additional staffing, advertising and
marketing expenses resulting from domestic channel expansion efforts.
General and Administrative Expenses
General and administrative expenses for the 98 Period were
approximately $1,3478,000 or 8% of net sales, as compared with $1,084,000 or 6%
of net sales for the 97 Period, an increase of $263,000 or 24%. The increase in
absolute dollars is due primarily to increases in staffing of $50,000,
professional services of $40,000 and acquisition related expenses of $118,000
Research and Development Expenses
Research and development expenses for the 98 Period were approximately
$879,000 or 5% of net sales, as compared with $763,000 or 4% of net sales, for
the 97 Period, an increase of $116,000 or 15%. The increase is due principally
to increases in staffing of $75,000 and recruiting expenses of $15,000.
Depreciation & Amortization Expense
Depreciation & amortization expense for the 98 Period was approximately
$575,000 or 3% of net sales, as compared to $301,000 or 2% of net sales, for the
97 Period, an increase of $274,000, or 91%. The
15
<PAGE>
increase is primarily attributable to increased depreciation associated with
purchases of property and equipment and amortization associated with the
acquisitions of Digital Vision, Inc. and PC Video Conversion.
Interest Expense, Net
Net interest expense for the 98 Period was approximately $154,000 or
.8% of net sales, as compared to $209,000 or 1.2% of net sales, for the 97
Period, a decrease of $55,000, or 26%. The decrease is primarily attributable to
a reduction in outstanding debt balances and the reduction of certain fees
incurred with the extension of the Company's revolving line of credit.
Other Income
Other Income for the 98 Period was approximately $17,000 as compared to
$395,000, for the 97 Period, primarily due to the recognition of a $348,727 gain
on the sale of the Company's networking product line in the 97 Period.
Net Income
For the nine-months period ended September 30, 1998, the Company
reported net income of approximately $1,448,000, or $0.09 per share, on both a
basic and diluted basis as compared to $662,000, or $0.05 per share, on both a
basic and diluted basis for the nine-months period ended September 30, 1997.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities for the nine-month periods ended
September 30, 1998 and 1997 was approximately ($3,452,180) and ($2,831,852),
respectively. In the 98 Period, net cash used in operating activities consisted
primarily of an increase in accounts receivable of $3,864,571 and decreases in
inventory of $1,096,996, accounts payable of $2,403,512 and accrued liabilities
of $621,285. This was offset by non-cash charges for depreciation and
amortization of $574,590, and net income of $1,448,121. As of September 30,
1998, accounts receivable from a major distributor and from a major national
retailer represented approximately 53% and 10%, respectively, of total accounts
receivable. In the 98 Period, the Company wrote-off approximately $400,000 of
uncollectable accounts receivable against a reserve established at December 31,
1997. In the 98 Period, the Company continued to record provisions for potential
future uncollectable accounts. The Company continually monitors inventory levels
at its resellers, and during the 98 Period experienced improved sell-through and
lower inventory levels of its products in its distribution channels. In the 97
period, net cash used in operations activities consisted primarily of an
increase in accounts receivable and inventory of $4,514,833 and $607,373,
respectively. This was offset by an increase in accounts payable of $1,766,971,
depreciation and amortization (non-cash charge) of $301,267, and net income of
$662,089.
Net cash used in investing activities for the nine-month periods ended
September 30, 1998 and 1997 was ($1,548,957) and ($534,132), respectively. In
the 98 Period, the Company acquired the assets and liabilities of PC Video
Conversion Corp. for approximately $929,000 which included the actual cost and
related expenses incurred in connection with the completion of the acquisition.
In addition to that activity in the 98 Period the Company also paid acquisition
costs of approximately $47,000 for the purchase of Digital Vision, Inc. The only
other activities in the 98 Period and the 97 Period where cash was used in
investing activities was principally for the purchase of property and equipment
in amounts of $618,394 and $534,932, respectively.
Net cash provided from financing activities for the nine-month periods
ended September 30, 1998 and 1997 was $7,290,818 and $5,444,795, respectively.
In the 98 Period, the Company received $2,827,355 in net proceeds from private
offerings of common stock and $7,009,149 from the exercise of
16
<PAGE>
common stock options and warrants. The Company's financing proceeds were offset
by payments on notes payable, treasury stock and capital lease obligations. In
the same nine-month period in 1997, the Company received $5,650,099 in net
proceeds from private offerings of Common Stock and $133,075 from the exercise
of common stock options and warrants. The 97 Period financing proceeds were
offset by payments on notes payable and capital lease obligations.
As of September 30, 1998, the Company had working capital of
$12,202,623, as compared to $2,619,300 at December 31, 1997, an increase of
$9,583,323. The Company's cash position increased to $3,009,532 at September 30,
1998, an increase of $2,289,681, or 318%, over amounts at December 31, 1997.
On March 3, 1998, the Company sold 1,092,150 shares of common stock and
warrants to purchase 327,645 shares of common stock for gross proceeds of
approximately $3,000,000 in a private placement to an unaffiliated accredited
investor. The warrants are exercisable until March 3, 2005 if during the period
ending August 25, 1999, the average of the closing bid prices of the Company's
common stock during any consecutive 20 trading days is equal to or less than
$2.7469. The shares issued in connection with this transaction and issuable upon
exercise of the warrants were registered under the Securities Act of 1933 on
April 22, 1998. Fees and expenses associated with this offering amounted to
approximately $172,600 yielding net proceeds of $2,827,400. In connection with
this transaction, the Board of Directors authorized the grant of warrants to the
placement agent to purchase 21,429 shares of the Company's common stock at a
price of $4.2118 per share exercisable for a period of five years.
The Company received gross proceeds of $6,146,887.50 as a result of the
conversion of 910,650 of the Company's Redeemable Common Stock Purchase Warrants
(the "Warrants") issued in connection with the Company's initial public offering
in May 1993. The Company issued 1,649,202 shares of common stock as a result of
the conversion. In accordance with the anti-dilution provisions of the Warrants,
the holder was entitled to receive 1.811 shares of common stock for each Warrant
exercised. The Warrants were exercisable at a price of $6.75 per Warrant until
May 26, 1998.
Although the Company has been successful in the past in raising
sufficient capital to fund its operations, there can be no assurance that the
Company will achieve sustained profitability or obtain sufficient financing in
the future to provide the liquidity necessary for the Company to continue
operations.
In November 1998, the Company received a waiver of the covenants
contained in its revolving line of credit, together with a revision of the loan
covenants and an agreement to extend the line until December 15, 1998.
Effects of Inflation and Seasonality
The Company believes that inflation has not had a significant impact on
the Company's sales or operating results. The Company's business does not
experience substantial variations in revenues or operating income during the
year due to seasonality.
Environmental Liability
The Company has no known environmental violations or assessments.
Year 2000
General
The Company's Year 2000 compliance project (the "Project") is
proceeding on schedule. The Project is addressing the issue of computer programs
and embedded computer chips being unable to distinguish
17
<PAGE>
between the year 1900 and the year 2000. In early 1998, in order to improve
access to business information and to strengthen its infrastructure through
common, integrated computing systems across the Company, the Company began a
business systems replacement project with systems that use programs primarily
from Macola, Inc. The installation of the new systems, which are expected to
make approximately 90 percent of the Company's business computer systems Year
2000 compliant, is scheduled for completion by mid-1999. The Macola system will
replace a non-compliant accounting and manufacturing system. Implementation of
the Macola programs is on schedule and approximately 20 percent complete. To
facilitate the Project, The Company has retained outside consultants with
expertise in wide area networking ("WAN"), systems integration and
business/contact data management.
The Company has developed a contingency plan to make the programs that
are scheduled to be replaced by the Macola programs Year 2000 compliant. The
contingency plan includes contracted on-site support, work flow modification,
and integration of Year 2000 compliant systems. A decision to implement the
contingency plan is expected to be made by the end of first quarter 1999.
Remaining business software programs are expected to be made Year 2000 compliant
through the Project, including those supplied by vendors, or they will be
retired. None of the Company's other information technology (IT) projects have
been delayed due to the implementation of the Project.
Project
The Project is being implemented in two phases: Phase I, installation
of the hardware and business applications, will precede the WAN installation and
the integration of various communications systems. Phase I is expected to be
completed by December 21, 1998 and Phase II is expected to be completed by April
30, 1999.
The Project is divided into two major sections - infrastructure and
applications software (sometimes collectively referred to as "IT Systems") and
third-party suppliers and customers ("External Agents"). The general phases
common to all sections are: (1) inventorying Year 2000 items; (2) assigning
priorities to identified items; (3) assessing the Year 2000 compliance of items
determined to be material to the Company; (4) repairing or replacing material
items that are determined not to be Year 2000 compliant; (5) testing material
items; and (6) designing and implementing contingency and business continuation
plans for each organization and company location.
At September 30, 1998, the inventory and priority assessment phases of
each section of the Project had been completed and the Company is in the process
of assessing Year 2000 compliance of its material items and repairing or
replacing such items. Material items are those believed by the Company to have a
risk involving the safety of individuals, or that may cause damage to property
or the environment, or that have a material effect on the Company's revenues.
The testing phases of the Project will be performed by the Company and will be
ongoing as hardware or system software is remedied, upgraded or replaced.
The infrastructure portion of the IT section consists of hardware and
systems software other than applications software. The Company estimates that
approximately 50 percent of the activities required to achieve infrastructure
Year 2000 compliance had been completed at September 30, 1998. Contingency
planning for infrastructure is scheduled to commence in fourth quarter 1998. All
infrastructure activities are expected to be completed by March 31, 1999.
The application software portion of the IT section includes both the
conversion of applications software that is not Year 2000 compliant and, where
available from the supplier, the replacement of such software. The Company
estimates that the software conversion phase was more than 10 percent complete
at September 30, 1998, and the remaining conversions are expected to be
completed by mid-1999.
18
<PAGE>
The testing phase for application software is ongoing and is expected
to be completed by mid-1999. The vendor software replacements and upgrades are
presently behind schedule, although, the Company currently believes that
replacements and upgrades will be completed on schedule by mid-1999. Contingency
planning for application software is scheduled to begin in fourth quarter 1998
and be completed by mid-1999.
The External Agents section includes the process of identifying and
prioritizing critical suppliers and customers at the direct interface level, and
communicating with them about their plans and progress in addressing their own
Year 2000 issues. Detailed evaluations of the most critical third parties have
been initiated. These evaluations will be followed by the development of
contingency plans, which are scheduled in the fourth quarter of 1998, with
completion by mid-1999. The Company estimates that this section was on schedule
at September 30, 1998. Follow-up reviews of External Agents are expected to be
undertaken through the remainder of 1999.
Costs
The total cost associated with required modifications to become Year
2000 compliant is not expected to be material to the Company's financial
position. The estimated total cost of the Project is approximately $300,000. The
total amount expended on the Project through September 30, 1998, was $150,000,
of which approximately $140,000 related to the cost to repair or replace
software and related hardware problems, and approximately $10,000 related to the
cost of identifying and communicating with External Agents. The estimated future
cost of completing the Project is estimated to be approximately $150,000 --
$130,000 to repair or replace software and related hardware, and $20,000 to
identify and communicate with External Agents. Funds for the Project are
provided from a separate budget of $300,000 for all items other than External
Agent costs, which are included in existing operating budgets. Ancillary costs
of implementing the Macola business replacement systems are not included in
these cost estimates.
Risks
The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition. The Project is expected to
significantly reduce the Company's level of uncertainty about the Year 2000
problem and, in particular, about the Year 2000 compliance and readiness of its
material External Agents. The Company believes that, with the implementation of
new business systems and completion of the Project as scheduled, the possibility
of significant interruptions of normal operations should be reduced.
Readers are cautioned that forward-looking statements contained in the
year 2000 Update should be read in conjunction with the Company's disclosures
under the heading: "CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS" beginning on
page 21.
The Company is including the following cautionary statement to take
advantage of the "safe harbor" provisions of the PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995 for any forward-looking statement made by, or on behalf of,
the Company. The factors identified in this cautionary statement are important
factors (but not necessarily all important factors) that could cause actual
results to differ materially from those expressed in any forward-looking
statement made by, or on behalf of, the Company.
19
<PAGE>
Where any such forward-looking statement includes a statement of the
assumptions or bases underlying such forward-looking statement, the Company
cautions that, while it believes such assumptions or bases to be reasonable and
makes them in good faith, assumed facts or bases almost always vary from actual
results, and the differences between assumed facts or bases and actual results
can be material, depending on the circumstances. Where, in any forward-looking
statement, the Company, or its management, expresses an expectation or belief as
to future results, such expectation or belief is expressed in good faith and
believed to have a reasonable basis, but there can be no assurance that the
statement of expectation or belief will result, or be achieved or accomplished.
Taking into account the foregoing, the following are identified as
important risk factors that could cause actual results with respect to the
Company's Year 2000 compliance to differ materially from those expressed in any
forward-looking statement made by, or on behalf of, the Company:
o The dates on which the Company believes the Project will be completed
and the Macola business computer system will be implemented are based
on management's best estimates, which were derived utilizing numerous
assumptions of future events, including the continued availability of
certain resources, third-party modification plans and other factors.
However, there can be no guarantee that these estimates will be
achieved, or that there will not be a delay in, or increased costs
associated with, the implementation of the Project.
o A delay in the implementation of the Macola systems could impact the
Company's readiness for the introduction of the Euro currency in
connection with the Company's European sales activities.
o Other specific factors that might cause differences between the
estimates and actual results include, but are not limited to, the
availability and cost of personnel trained in these areas, the ability
to locate and correct all relevant computer code, timely responses to
and corrections by third-parties and suppliers, the ability to
implement interfaces between the new systems and the systems not being
replaced, and similar uncertainties.
o Due to the general uncertainty inherent in the Year 2000 problem,
resulting in part from the uncertainty of the Year 2000 readiness of
third-parties and the interconnection of global businesses, the Company
cannot ensure its ability to timely and cost-effectively resolve
problems associated with the Year 2000 issue that may materially and
adversely affect its operations and business, or expose it to
third-party liability.
20
<PAGE>
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
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 involve risks and uncertainties. In particular, statements
contained in this Form 10-QSB which are not historical facts (including, but not
limited to, statements concerning international revenues, anticipated operating
expense levels and such expense levels relative to the Company's total revenues)
constitute forward looking statements and are made under the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. The
Company's actual results of operations and financial condition have varied and
may in the future vary significantly from those stated in any forward looking
statements. Factors that may cause such differences include, without limitation,
the availability of capital to fund the Company's future cash needs, reliance on
major customers, history of operating losses, limited availability of capital
under credit arrangements with lenders, market acceptance of the Company's
products, technological obsolescence, competition, component supply problems and
protection of proprietary information, as well as the accuracy of the Company's
internal estimates of revenue and operating expense levels and the Company's
ability to achieve Year 2000 compliance on a timely basis as more fully
described above.
21
<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 its business.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
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
The Company did not file any reports on Form 8-K during the quarter
ended September 30, 1998.
22
<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 16, 1998 By: \s\ Thomas L. Massie
Thomas L. Massie
Chief Executive Officer and
Chairman of the Board
(Principal Executive Officer)
November 16, 1998 By: \s\ Gary M. Cebula
Gary M. Cebula
Vice President of Finance
and Administration
(Principal Accounting Officer)
23
<TABLE>
<CAPTION>
EXHIBIT 11
FOCUS ENHANCEMENTS, INC.
STATEMENT OF COMPUTATION OF INCOME PER SHARE
Three months ended
September 30, September 30,
1998 1997
------------- -------------
<S> <C> <C>
Net income $ 467,725 $ 413,906
=========== ===========
Basic:
Weighted average number of common shares outstanding 17,427,999 14,582,324
=========== ===========
Diluted:
Weighted average number of common shares outstanding 17,427,999 14,582,324
----------- -----------
Weighted average common equivalent shares 690,927 590,230
Weighted average number of common and common equivalent
shares outstanding used to calculate per share data 18,118,926 15,172,554
=========== ===========
Net income per share
Basic $ 0.03 $ 0.03
----------- -----------
Diluted $ 0.03 $ 0.03
----------- -----------
<CAPTION>
Nine months ended
September 30, September 30,
1998 1997
------------- -------------
<S> <C> <C>
Net Income $ 1,448,121 $ 662,089
=========== ===========
Basic:
Weighted average number of common shares outstanding 16,054,513 12,787,591
=========== ===========
Diluted:
Weighted average number of common shares outstanding 16,054,513 12,787,591
Weighted average common equivalent shares 647,792 244,374
----------- -----------
Weighted average number of common and common equivalent
shares outstanding used to calculate per share data 16,702,305 13,031,965
=========== ===========
Net income per share
Basic $ 0.09 $ 0.05
----------- -----------
Diluted $ 0.09 $ 0.05
----------- -----------
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 3,009,532
<SECURITIES> 438,684
<RECEIVABLES> 10,172,711
<ALLOWANCES> 430,251
<INVENTORY> 3,264,443
<CURRENT-ASSETS> 16,980,921
<PP&E> 2,063,172
<DEPRECIATION> 740,671
<TOTAL-ASSETS> 22,683,625
<CURRENT-LIABILITIES> 4,678,298
<BONDS> 0
0
0
<COMMON> 176,378
<OTHER-SE> 38,605,745
<TOTAL-LIABILITY-AND-EQUITY> 22,683,625
<SALES> 19,390,215
<TOTAL-REVENUES> 19,390,215
<CGS> 11,054,551
<TOTAL-COSTS> 6,720,914
<OTHER-EXPENSES> (17,261)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 154,229
<INCOME-PRETAX> 1,477,782
<INCOME-TAX> 29,661
<INCOME-CONTINUING> 1,448,121
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,448,121
<EPS-PRIMARY> 0.09
<EPS-DILUTED> 0.09
</TABLE>
