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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 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 0-25646
EXPERT SOFTWARE, INC.
STATE OF DELAWARE - I.R.S. EMPLOYER IDENTIFICATION NO.: 65-0359860
800 Douglas Road
Executive Tower, Suite #750
Coral Gables, FL 33134
(305) 567-9990
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
As of July 31, 1996 there were 7,481,138 shares of the Registrant's Common
Stock, $ .01 par value, outstanding.
The exhibit index is on page 13.
Page 1 of 13.
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EXPERT SOFTWARE, INC.
INDEX TO FORM 10-Q
SIX MONTHS ENDED JUNE 30, 1996
Page
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Part I - Financial Information
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Item 1. Financial Statements.
Condensed Consolidated Balance Sheets as of
June 30, 1996 and December 31, 1995......................................................... 3
Condensed Consolidated Statements of Operations for the
Three Months and Six Months Ended June 30, 1996 and 1995.................................... 4
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1996 and 1995..................................................... 5
Notes to Condensed Consolidated Financial Statements......................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7
Part II - Other Information
- ---------------------------
Item 1. Legal Proceedings.................................................................... 12
Item 4. Submission of Matters to a Vote of Security Holders.................................. 13
Item 6. Exhibits and Reports on Form 8-K..................................................... 13
Signatures.................................................................................... 13
This Form 10-Q contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The Company's actual results could differ materially from
those set forth in the forward-looking statements. Factors that might cause
such a difference are discussed in the section entitled "Factors Affecting
Future Operating Results" on page 11 of this Form 10-Q.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
EXPERT SOFTWARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
June 30, December 31,
1996 1995
------------- -------------
ASSETS (unaudited)
CURRENT ASSETS:
Cash and equivalents.......................... $ 3,897 $ 912
Marketable securities......................... -- 6,222
Accounts receivable, net...................... 2,300 6,570
Inventories, net.............................. 2,201 3,962
Income taxes receivable....................... 1,401 --
Prepaid expenses.............................. 757 504
Deferred income taxes......................... 3,103 807
-------
Total current assets...................... 13,659 18,977
------- -------
PROPERTY AND EQUIPMENT, net...................... 2,362 2,575
ACQUIRED SOFTWARE TECHNOLOGY, net................ 180 3,575
ACQUIRED INTANGIBLES, net........................ 51 608
DEFERRED INCOME TAXES............................ 4,471 3,295
OTHER ASSETS..................................... 8 39
------- -------
Total assets.............................. $20,731 $29,069
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable............................. $ 3,222 $ 2,581
Accrued expenses............................. 3,898 5,745
Current portion of capital lease obligations. 131 95
-------
Total current liabilities................. 7,251 8,421
CAPITAL LEASE OBLIGATIONS, net of current portion -- 14
------- -------
STOCKHOLDERS' EQUITY:
Preferred stock............................... -- --
Common stock.................................. 75 75
Additional paid-in capital.................... 23,169 23,126
Accumulated deficit........................... (9,764) (2,567)
Total stockholders' equity................ 13,480 20,634
Total liabilities and stockholders' equity $20,731 $29,069
======= =======
The accompanying notes to condensed financial statements
are an integral part of these balance sheets.
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EXPERT SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1996 1995 1996 1995
--------- --------- --------- --------
NET SALES.................................... $ 6,354 $5,772 $ 16,737 $11,728
-------- ------ -------- -------
OPERATING COSTS AND EXPENSES:
Cost of sales............................... 6,851 2,140 10,744 4,340
Marketing and sales......................... 2,632 1,194 5,294 2,525
General and administrative.................. 3,029 894 4,783 1,670
Development................................. 890 509 1,750 1,004
Loss on impairment of intangible assets..... 5,700 -- 5,700 --
Amortization of non- compete agreement...... -- -- -- 338
-------- ------ -------- -------
Total operating costs and expenses........ 19,102 4,737 28,271 9,877
-------- ------ -------- -------
Operating income (loss)................... (12,748) 1,035 (11,534) 1,851
Other income, net............................ 29 122 69 51
-------- ------ -------- -------
Income (loss) before provision (benefit) for
income taxes.............................. (12,719) 1,157 (11,465) 1,902
Provision (benefit) for income taxes......... (4,727) 404 (4,268) 683
-------- ------ -------- -------
Net income (loss)........................... $ (7,992) $ 753 $ (7,197) $ 1,219
======== ====== ======== =======
Net income (loss) per share of common stock. $ (1.07) $ .10 $ (.96) $ .17
======== ====== ======== =======
Weighted average number of common stock and
stock equivalents outstanding................ 7,481 7,562 7,481 6,779
======== ====== ======== =======
The accompanying notes to condensed financial statements
are an integral part of these statements.
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EXPERT SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
----------------------------
1996 1995
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................................... $(7,197) $ 1,219
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation of property and equipment............. 488 193
Amortization of acquired software technology....... 390 22
Amortization of acquired intangibles............... 83 --
Provision for doubtful accounts.................... 1,030 --
Provision for sales returns........................ 3,021 2,202
Provision for inventory reserves................... 2,638 170
Loss on impairment of intangibles.................. 5,700 --
Amortization of non-compete agreement.............. -- 338
Deferred income tax benefit........................ (3,472) 124
Changes in current assets and liabilities:
(Increase) decrease in accounts receivable......... (676) (1,232)
(Increase) decrease in income tax receivable....... (1,401) --
(Increase) decrease in inventories................. (1,026) (13)
(Increase) decrease in prepaid expenses............ (362) (263)
(Increase) decrease in other assets................ 7 2
Increase (decrease) in accounts payable............ 401 (356)
Increase (decrease) in accrued expenses............ (188) 713
Increase (decrease) in income taxes payable........ (2,144) --
------- -------
Net cash (used in) provided by operating activities (2,708) 3,119
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Maturities of marketable securities................ 6,222 --
Purchases of property and equipment................ (594) (687)
Net cash provided by (used in)
investing activities........................... 5,628 (687)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock......... -- 18,000
Stock options exercised............................ 43 --
Payment of subordinated debt to unrelated parties.. -- (500)
Payment of subordinated debt to related parties.... -- (3,900)
Payment of redeemable preferred stock.............. -- (2,200)
Dividends paid on redeemable preferred stock....... -- (41)
Borrowings under capital lease obligations......... 89 --
Payments on capital lease obligations.............. (67) --
------- -------
Net cash used in financing activities............ 65 11,359
------- -------
Net increase in cash and equivalents............. 2,985 13,791
CASH AND EQUIVALENTS, beginning of period............ 912 3,553
------- -------
CASH AND EQUIVALENTS, end of period.................. $ 3,897 $17,344
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest........... $ 19 $ 119
======= =======
Cash paid during the period for income taxes....... $ 2,748 $ 70
======= =======
The accompanying notes to condensed consolidated financial
statements are an integral part of these statements.
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EXPERT SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1996
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated balance sheet as of December 31, 1995, which
has been derived from audited financial statements, and the unaudited interim
condensed consolidated financial statements included herein, have been prepared
pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and note disclosures normally included in
annual financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to those rules and
regulations, although the Company believes that the disclosures made are
adequate to make the information presented not misleading. These financial
statements should be read in conjunction with the financial statements and the
notes thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1995.
In the opinion of the Company, the accompanying condensed consolidated
financial statements contain all adjustments necessary to present fairly the
financial position of the Company as of June 30, 1996, and the results of
operations and cash flows for the three months and six months ended June 30,
1996 and 1995. In addition to the normal recurring accruals, management also
recorded certain other material adjustments to the current financial
statements. As more fully discussed in Part I, Item 2, these adjustments
include recognizing a loss from the impairment of intangible assets, recording
inventory losses, and providing additional allowances against accounts
receivable for possible future returns from customers and for doubtful
accounts. Results of operations and cash flows for the period ending June 30,
1996 are not necessarily indicative of the results of operations of the entire
fiscal year.
The accounting policies followed for quarterly financial reporting
purposes are the same as those disclosed in the Company's audited financial
statements for the year ended December 31, 1995, included in the Form 10-K.
2. THE ORGANIZATION
Expert Software, Inc. (the "Company") publishes and distributes computer
software under the "Expert" trade name. The Company's products address a broad
range of consumer interest and everyday tasks for the productivity, lifestyle,
small office/home office, entertainment and education market categories. The
Company sells its products directly to large retailers, as well as to
distributors.
3. INVENTORIES
Inventories consisted of the following as of June 30, 1996 and December
31, 1995 (in thousands):
1996 1995
------ ----
Finished goods ............................... $1,696 $2,699
Raw materials................................. 505 1,263
------ ------
$2,201 $3,962
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4. INITIAL PUBLIC OFFERING
In April 1995, the Company completed an initial public offering of
3,105,000 shares of its common stock of which 1,700,000 were sold by the
Company and 1,405,000 shares were offered by certain of the Company's
stockholders. The offering price was $12.00 per share and the proceeds to the
Company, net of the underwriters discount of $1,428,000, was $18,972,000.
Costs associated with the offering include legal, accounting and other direct
costs of $1,017,000. The Company used $2,241,000 of net proceeds to redeem
preferred stock, including interest and dividends, and $4,019,000 to repay
subordinated debt, including interest.
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5. ACQUISITION AND LEGAL PROCEEDINGS
In November 1995, the Company acquired all of the outstanding common stock
of Swfte International, Ltd ("Swfte"), a developer and publisher of consumer
software for the educational and entertainment markets. The acquisition of
Swfte was accounted for using the purchase method of accounting and,
accordingly, the results of Swfte since November 2, 1995 are included in the
Company's consolidated statements of operations. Swfte assets and liabilities
were recorded in the accompanying consolidated balance sheet at values
representing an allocation of the purchase price. Approximately $4.5 million
of the initial purchase price for Swfte was recorded as intangible assets to
be amortized over two to two and one-half years. During the three months ended
June 30, 1996, a loss on the impairment of these intangible assets was
recorded. See "Loss on Impairment of Intangibles" under Item 2 below.
The acquisition agreement provides for additional contingent cash
consideration of up to $8.0 million. The contingent purchase price is payable
in two installments in April 1997 and April 1998 and is based upon a percentage
of the amount by which revenues derived from future sales of Swfte products and
technologies exceed certain minimum revenue targets. The first contingent
installment is payable if such revenues exceed certain specified levels for
both the fourth quarter of 1995 and the fiscal year 1996, while the second
installment is payable if such revenues exceed certain levels for the fiscal
year 1997. Because the fourth quarter Swfte revenue requirement was not
achieved, the terms of the acquisition agreement do not provide for any payment
of the contingent purchase price to be made in April 1997. Currently the
acquisition and subsequent payments are in dispute with the former owners of
Swfte. (See "Legal Proceedings", Part 2, Item 1).
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data as a
percentage of net sales, for comparative purposes, for the periods indicated.
Three Months Ended Six Months Ended
June 30, June 30,
1996 1995 1996 1995
--------- --------- -------- --------
Net sales......................................... 100% 100% 100% 100%
------- -------- ------- -------
Operating costs and expenses:
Cost of sales................................... 108 37 64 37
Marketing and sales............................. 41 21 32 22
General & administrative........................ 48 15 29 14
Development..................................... 14 9 10 9
Loss on impairment of intangibles............... 90 -- 34 --
Amortization of non- compete agreement.......... -- -- -- 3
---- --- --- --
301 82 169 84
---- --- --- --
Operating income.................................. (201) 18 (69) 16
Other income (expense)............................ -- 2 -- --
--- --- -- --
Income before provision (benefit) for income taxes (201) 20 (69) 16
Provision (benefit) for income taxes.............. (75) 7 (26) 6
---- --- --- --
Net income........................................ (126)% 13% (43) 10%
==== === === ==
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GENERAL
Results of operations for the periods ended June 30, 1996 were impacted
significantly by a slowdown of sales at the retail level during the three
months then ended; provisions for potential excess inventories of $2.6 million
and a reduction in the estimated inventory value for product returned of $1.4
million; an increase in estimated product returns that exceeded expectations by
$0.5 million; an increase in the provision for doubtful accounts of $1.0
million; and losses recorded in connection with the Swfte acquisition totaling
$5.7 million. The slowdown in retail sales resulted in the Company not meeting
sales objectives, which contributed to excess inventories. In addition, the
Company experienced difficulties in the implementation of new management
information systems which contributed to purchasing higher levels of inventory
than were necessary in the normal course of business. Additionally, higher
levels of returns resulted in increased inventory. Based on the foregoing,
management determined that the value assigned to the returned goods should be
lower than that assigned in prior periods, and reserves for potential excess
inventories should be increased, causing an increase in the cost of sales.
Additionally, the products obtained in the Swfte acquisition are selling at
levels substantially below projected levels. Together with other developments
which are described below under "Loss on Impairment of Intangibles", this led
management to record a material loss on the impairment of the intangible assets
arising from the Swfte acquisition. This loss includes additional reserves for
returns and marketing allowances against the acquired accounts receivable,
additional reserves against the acquired inventories, adjustments to fixed
assets, and accruals for guaranteed royalty agreements entered into prior to
the acquisition that are not expected to be recouped in the ordinary course of
business. See the discussion at "Loss on Impairment of Intangibles" below for
further information on these adjustments.
COMPARISON OF THREE MONTHS ENDED JUNE 30 1996 AND 1995
NET SALES. Net sales for the three months ended June 30 increased from $5.8
million in 1995 to $6.4 million in 1996, an increase of $0.6 million, or
10%. The increase was due primarily to increased units sold. International
sales increased from 11% of net sales to 24% in 1996 as the Company
increased unit sales to existing international distributors and continued to
broaden its international efforts by establishing relationships with foreign
publishers and distributors. The Company experienced a drop off of sales in
the second quarter of 1996 as a result of a more pronounced seasonality and
retailers keeping tighter inventory levels on their shelves.
COST OF SALES. Cost of sales increased from $2.1 million in 1995 to $6.8
million in 1996, an increase of $4.7 million, or 220%. In the second quarter
of 1996, the Company's evaluation of the estimated inventory value for
products returned from customers was changed and resulted in a $1.4 million
charge to cost of sales. The Company's valuation reflects principally the
impact of new product versions rendering older product versions obsolete or
unsalable, the return of slow-moving products, and existing excess
quantities of inventory. Such slow-moving products and products for which
new versions have been released are difficult to sell through alternative
channels. When the sales objectives for the June quarter were not achieved,
an evaluation of inventories was performed and a valuation adjustment of
$2.6 million was recorded, of which $1.2 million related to Swfte
inventories acquired subsequent to the acquisition and $1.4 million of
Expert brand inventories for which on hand quantities exceed expected future
demand. Cost of sales consists primarily of product costs (printed
material, boxes, disk and CD costs, assembly and shipping), freight charges,
reserves for excess and obsolete inventories and royalties to outside
programmers and content providers. The Company expects cost of sales in
future periods will increase over historical levels due to the impact on
ongoing results of operations of the change in the estimated value of products
returned from customers discussed above.
MARKETING AND SALES. Marketing and sales expense increased from $1.2 million in
1995 to $2.6 million in 1996, an increase of $1.4 million, or 117%, and
increased as a percentage of net sales from 21% of net sales in 1995 to 41% in
1996. This increase was primarily the result of higher advertising costs ($0.6
million), increased promotional costs ($0.4 million), and increased personnel
costs ($0.2 million). As a result of not meeting sales expectations, marketing
costs represented a higher percentage of revenues in 1996 than in 1995.
Additional costs were also incurred to open new sales channels, particularly
grocery stores. The Company's marketing spending consists principally of
activities to promote the Company's products and brand name, including costs to
promote and support the Company's growing international sales, increased
personnel and increased "in-store" promotions. The Company intends to continue
to launch new marketing promotions and to hire additional personnel as needed.
As a result the Company expects marketing and sales expenses to increase in
dollar amount, but to be lower as a percentage of sales in the future.
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GENERAL AND ADMINISTRATIVE. General and administrative ("G&A") expense
increased from $0.9 million in 1995 to $3.0 million in 1996 an increase of $2.1
million, or 233%, and increased as a percentage of net sales from 15% to 48%,
respectively. This increase was primarily due to increased provisions for
doubtful accounts ($1.0 million), legal costs related to a lawsuit with the
former owners of Swfte, increased staff and other expenses necessary to support
the Company's growth ($0.5 million), and increased facilities costs. The
Company anticipates that it may continue to incur risks for uncollectible
accounts. The Company also anticipates that G&A expenses for at least the
remainder of 1996 will reflect higher expenditures for legal expenses related
to the Swfte litigation and additional personnel costs and professional fees
related to continued implementation of the Company's management systems and
related activities.
DEVELOPMENT. Development expense increased from $0.5 million in 1995 to $0.9
million in 1996, an increase of $0.4 million, or 80%, and increased as a
percentage of net sales from 9% of net sales in 1995 to 14% in 1996.
Development expense includes increased expenses related to product upgrades,
new product activities, quality control and expanded customer service support,
including increased staffing and other expenses associated with the Swfte
development activities.
LOSS ON IMPAIRMENT OF INTANGIBLES. During the three months ended June 30,
1996, management reevaluated the carrying value of the intangible assets
recorded in connection with the November 1995 acquisition of Swfte. These
intangible assets consisted of acquired software technology, a license
agreement to use the Bicycle brand name in certain card game software, the
assembled workforce acquired, and Swfte's customer list. This reevaluation of
the intangible assets was necessitated by management's determination based on
recent results of operations that the expected sales and cash flows from the
acquired assets will be substantially lower than had been previously expected
by management.
The acquired Swfte products originally projected to generate the most
significant sales and cash flows are selling at substantially lower than
expected rates. Certain of those titles now face new competition from other
publishers, which has taken market share away from those titles. In
particular, the card games category has become more competitive as a result of
recent marketing efforts by Sierra On Line, and others. Additionally, certain
other acquired titles were released shortly before the acquisition of Swfte.
Based on low sales rates, some retailers are discontinuing certain of these new
titles and management has determined their expected future sales are minimal.
A significantly higher level of returns has been experienced with the products
acquired in the acquisition over the rate of returns experienced with the
Company's other products. Management believes that certain titles were sold
into the distribution and retail channel prior to the acquisition at higher
rates than could be supported by sales through to the end users. This has
prompted distributors and retailers to return these products. This overstock
of product and returns experience has, in management's judgment, damaged the
brand and reduced their expected future sales levels.
Lower than expected acceptance of the acquired products, together with the
terminations expected in closing the Swfte facilities in Delaware to
consolidate all operations at the Company's headquarters in Florida, caused
management to write-off the value originally ascribed to the workforce in
place.
Value was originally ascribed to Swfte's customer list based upon management's
assessment of the value of Swfte's experience in dealing with certain
educational channels and bookstores. Due to the lower than expected sales
rates and higher than expected returns rates for the acquired products,
management no longer believes this to be true, and accordingly has written-off
the costs assigned to the customer list.
These factors are not expected to be short-term or temporary in nature, causing
management to reduce the carrying value of the intangible assets by $3.5
million. Management also determined that the lower demand for the acquired
products and recent customer claims for pre-acquisition cooperative marketing
and price protection credits required an additional provision for reserves for
returns of $1.1 million higher than originally provided on the acquired
accounts receivable; and a provision for reserves $0.2 higher than originally
provided on the acquired inventory. Such provisions were recorded during the
three months ended June 30, 1996, and are included in the stated loss on
impairment of intangibles. Additionally, the lower than expected sales and
higher than expected returns levels on the acquired products indicate that the
minimum royalties required under certain contracts and prepaid royalties will
not be recouped in the ordinary course of business. Approximately $0.3 million
of such royalties have therefore been accrued as part of the loss on impairment
of intangibles as of June 30, 1996. Similarly, losses on fixed assets and
certain other assets determined to have lower values than originally assigned
have been accrued as part of the loss on impairment of intangibles as of June
30, 1996.
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OTHER INCOME. Other income, which includes interest income and interest
expense, decreased from $122,000 in 1995 to $29,000 in 1996, primarily due
to the reduced balance of interest bearing deposits and investments.
PROVISION (BENEFIT) FOR INCOME TAXES. The provision (benefit) for income taxes
changed from a provision of $0.4 million in 1995 to a benefit of $4.8 million
in 1996. The effective rate for the combined federal and state income tax
provision was approximately 37% for both 1995 and 1996.
COMPARISON OF SIX MONTHS ENDED JUNE 30 1996 AND 1995
NET SALES. Net sales for the six months ended June 30 increased from $11.8
million in 1995 to $16.7 million in 1996, an increase of $4.9 million, or
42%. The increase was due primarily to increased units sold International
sales increased from 10% of net sales to 25% in 1996 as the Company
increased unit sales to existing international distributors and continued to
broaden its international efforts by establishing relationships with foreign
publishers and distributors. The Company experienced a drop off of sales in
the second quarter of 1996 as a result of seasonality and retailers keeping
tighter inventory levels on their shelves. As the software industry becomes
more consumer oriented, it could be subject to more seasonality. As a result
the Company anticipates a more pronounced seasonal trend to develop in
future periods.
COST OF SALES. Cost of sales increased from $4.3 million in 1995 to $10.7
million in 1996, an increase of $6.4 million, or 148%. In the second
quarter of 1996, the Company's evaluation of the estimated inventory value
for products returned from customers was changed in resulted in a $1.4
million charge to cost of sales. The Company's valuation reflects
principally product development efforts resulting in new product versions,
the return of slow-moving products, and existing excess quantities of
inventory. Such slow-moving products and products for which new versions
have been released are difficult to sell through alternative channels. When
the sales objectives were not achieved, an evaluation of the inventories was
performed and a valuation adjustment of $2.6 million was recorded, of which
$1.2 million related to Swfte inventories acquired subsequent to the
acquisition which do not have future sales benefit for the company. The
remaining $1.4 million consisted of inventories for which on hand quantities
exceed expected future demand. Cost of sales consists primarily of product
costs (printed material, boxes, disk and CD costs, assembly and shipping),
freight charges, reserves for excess and obsolete inventories and royalties
to outside programmers and content providers.
MARKETING AND SALES. Marketing and sales expense increased from $2.5 million in
1995 to $5.3 million in 1996, an increase of $2.8 million, or 112%, and
increased as a percentage of net sales from 22% of net sales in 1995 to 32% in
1996. This increase was primarily the result of higher advertising costs ($1.7
million), increased promotional costs ($0.2 million), and increased personnel
costs ($0.4 million). As a result of seasonality and not meeting sales
expectations, marketing costs represented a higher percentage of revenues in
1996 than in 1995. Additional costs were also incurred to open new sales
channels, particularly grocery stores. The Company's marketing spending
consists principally of activities to promote the Company's products and brand
name, including costs to promote and support the Company's growing
international sales, increased personnel and increased "in-store" promotions.
The Company intends to continue to launch new marketing promotions and to hire
additional personnel as needed. As a result the Company expects marketing and
sales expenses to increase in dollar amount but to be lower as a percentage of
sales in the future.
GENERAL AND ADMINISTRATIVE. General and administrative ("G&A") expense
increased from $1.7 million in 1995 to $4.8 million in 1996 an increase of $3.1
million, or 182%, and increased as a percentage of net sales from 14% to 42%,
respectively. This increase was attributable primarily due to increased
provisions for doubtful accounts ($1.0 million), legal costs related to a
lawsuit with the former owners of Swfte, increased staff other expenses
necessary to support the Company's growth ($0.9 million), and increased
facilities costs. The Company also anticipates that G&A expenses for at least
the remainder of 1996 will reflect higher expenditures for legal expenses
related to the Swfte litigation and additional personnel costs and
professional fees related to continued implementation of the Company's
management systems and related activities.
DEVELOPMENT. Development expense increased from $1.0 million in 1995 to $1.8
million in 1996, an increase of $0.8 million, or 80%, and increased as a
percentage of net sales from 9% of net sales in 1995 to 10% in 1996.
Development expense includes increased expenses related to product upgrades,
new product activities, quality control and expanded customer service support,
including increased staffing and other expenses associated with the Swfte
development activities.
LOSS ON IMPAIRMENT OF INTANGIBLES. See discussion under this topic at
"Comparison of Three Months Ended June 30, 1996 and 1995" above.
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AMORTIZATION OF NONCOMPETE AGREEMENT. Amortization expense decreased from $0.3
million in 1995 to zero in 1996. In February 1995, the Company released Bloc
from the remaining nine month term under the non-compete agreement as a part of
a general settlement of the parties' obligations relating to the 1992
Acquisition and, as a result, the remaining net book value of the non-compete
agreement was expensed in the first quarter of 1995.
OTHER INCOME. Other income, which includes interest income and interest
expense, increased from $51,000 in 1995 to income of $69,000 in 1996. In
February 1995, the Company repaid $500,000 in subordinated debt thereby
eliminating interest on this portion of its subordinated indebtedness. In
connection with the Company's initial public offering in April 1995, the
remainder of the subordinated indebtedness of $3.9 million was repaid,
eliminating that interest expense going forward. The 1996 interest income
was principally derived from the investment of the excess proceeds from the
Company's initial public offering.
PROVISION FOR INCOME TAXES. The provision (benefit) for income taxes changed
from a provision of $0.7 million in 1995 to a benefit of $4.3 million in 1996.
The effective rate for the combined federal and state income tax provision was
approximately 37% for both 1995 and 1996.
LIQUIDITY AND CAPITAL RESOURCES
Prior to its initial public offering of common stock, the Company financed
its operations through cash generated by operations, subordinated debt and
private sales of common and redeemable preferred stock. In April 1995, the
Company completed its initial public offering of 3,105,000 shares of common
stock at $12.00 per share, 1,700,000 shares of which were offered by the
Company, and 1,405,000 shares of which were offered by the current
shareholders. The Company received net proceeds of approximately $17.9 million
from the sale of these 1,700,000 shares of common stock. Of this amount,
approximately $6.3 million was used to repay subordinated debt and redeemable
preferred stock.
As of June 30, 1996, the Company had $6.4 million in working capital and
$3.9 million in cash. To date, the Company has not invested in any financial
instruments that involve a high level of complexity or risk. Net cash used by
operating activities was $2.7 million for the six months ended June 30, 1996,
primarily due to the payment of approximately $2.7 million for income taxes
related to 1995 and 1996, as well as increased investments in accounts
receivable and inventories. Increases in gross accounts receivable
were offset by the increases in provisions for returns and doubtful accounts
discussed above. Inventories increased primarily due to difficulties in the
implementation of new management information systems which contributed to
purchasing higher levels of inventory than were necessary in the normal course
of business. Such increases in inventory were offset by the provisions for
excess inventories discussed above. Net cash provided by investing activities
was $5.6 million, primarily due to the maturity and sales of certain marketable
securities, offset by purchases of property and equipment.
The Company believes that cash generated by operations may be affected by an
increase in working capital requirements as it continues to expand operations.
In response to such growth in working capital requirements, the Company entered
into a two-year, $5 million revolving line of credit in May 1996. The Company
is required to maintain certain financial ratios and comply with other terms
and conditions in order to borrow under the line. There have been no borrowings
to date under the line of credit. As a result of the Company's performance in
the second quarter, the Company is no longer in compliance with its revolving
line of credit, however, it is in the process of seeking an amendment to the
line of credit modifying the financial ratios to reflect its year to date
results of operations. Additionally, the Company believes there are
alternative sources of capital available which will be sufficient to meet
working capital and capital expenditures requirements through at least 1996.
From time to time, the Company evaluates potential acquisitions of products,
businesses and technologies that would complement or expand the Company's
business. The Company currently does not have any commitments or agreements
with respect to any such acquisitions. There can be no assurance that any such
acquisitions will be made.
FACTORS AFFECTING FUTURE OPERATING RESULTS
This Form 10-Q contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The Company's actual results could differ materially from
its
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historical operating results and from those set forth in the forward-looking
statements and may fluctuate between operating periods. Factors that might
cause such a differences and fluctuations include the following: the size and
rate of growth of the consumer software market, consolidation of the market,
market acceptance of the Company's products and those of its competitors,
development and promotional expenses relating to the introduction of new
products, new versions of existing products or new operating systems, evolving
distribution channels, the growth in popularity of the Internet and other new
technologies which could impact the distribution and purchase of software,
product returns, acquisitions of new businesses by the Company and related
charges and write-offs, changes in pricing policies by the Company and its
competitors, the accuracy of retailers' forecasts of consumer demand,
competition for retail space, consumer confidence, the timing of the receipt of
orders from major customers, account cancellations or delays in shipment,
future cash flow and working capital requirements, the outcome of the
litigation with the former owners of Swfte, implementation and expansion of the
Company's systems and operations to accommodate the Company's anticipated
future revenues, and other factors. In addition, the consumer software
business is seasonal due primarily to the increased demand for consumer
software during the year-end holiday buying season. Further, a significant
portion of sales within a quarter is typically not realized until late in that
quarter. As a result, it may be difficult for the Company to predict its net
sales for the quarter or to quickly adapt its spending levels within a quarter
to reflect changes in demand for its products. The market price of the
Company's Common Stock has been, and in the future will likely be, subject to
significant fluctuations in response to variations in quarterly operating
results and other factors, such as announcements of technological innovations
or new products by the Company or its competitors, or other events.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On December 11, 1995, David H. Goodman ("Goodman") and Irwin A. Bransky
("Bransky") brought suit against Expert in the Delaware Chancery Court in New
Castle County. Goodman is the former Chairman and Chief Executive Officer of
Swfte and Bransky is Swfte's former President. In their complaint (the
"Complaint"), Goodman and Bransky claim fraud, negligent misrepresentation,
breach of contract, breach of the implied covenant of good faith and fair
dealing, and violations of the Delaware Securities Act. The claims in the
Complaint are based generally on the acquisition of Swfte by Expert ("Merger"),
which took place pursuant to an Agreement and Plan of Merger ("Agreement")
dated October 16, 1995. Goodman and Bransky allege, among other things, that
Expert failed to make adequate efforts to sell Swfte products and to collect
Swfte's accounts receivable, all for the purpose of eliminating certain
additional consideration that would have been due to Goodman and Bransky under
the Agreement.
The plaintiffs are seeking the rescission of the Agreement or
alternatively, payment of the $8.0 million in contingent purchase price defined
in the Agreement, plus unspecified damages, interest, and plaintiffs costs and
expenses, including attorneys fees.
On January 5, 1996, the Company answered the Complaint, denying Goodman
and Bransky's allegations, and filed counterclaims seeking damages against them
for fraud, negligent misrepresentations, violations of the Delaware Securities
Act, breach of contract, breach of warranties, breach of the implied covenant
of good faith and fair dealing, indemnification, and breach of fiduciary duty.
In its counterclaim, Expert alleges that Goodman and Bransky provided Expert
with false and misleading information in connection with the Merger.
The Company also brought a lawsuit, which has been consolidated with the
Goodman and Bransky litigation, against Diane Bove, former Executive Vice
President of Swfte, concerning matters relating to the acquisition of Swfte.
The consolidated litigation concerning the Swfte acquisition is now in the
discovery phase.
Management believes the claims against the Company are without merit and
intends to vigorously defend the suit.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Annual Meeting of Stockholders of Expert Software, Inc. was held on
June 26, 1996, for the purpose of: (i) the election of Kenneth P. Currier and
A. Bruce Johnson as the two Class I Directors of the Company to serve until the
1999 Annual Meeting of Stockholders and until their successors are duly elected
and qualified; and (ii) the ratification of the selection of Arthur Andersen
LLP to serve as the Company's independent auditors for 1996. The following
table describes the results of the shareholder votes.
Votes
Votes --------
in Favor Withheld
--------- ---------
Election of Kenneth P. Currier
as a Class I Director 6,338,159 254,830
Election of A. Bruce Johnson
as a Class I Director 6,338,159 254,830
Votes Votes
in Favor Opposed Abstain
-------- ------- -------
Ratification of the selection of Arthur Andersen
LLP as independent auditors 6,352,021 238,230 2,738
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibit 11.
Statement regarding computation of earnings per share
Exhibit 27.
Financial Data Schedule (for SEC use only)
(b) Reports on Form 8 K
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereto duly authorized.
Expert Software, Inc.
/s/ Kenneth P. Currier
-------------------------
Kenneth P. Currier,
Chief Executive Officer
/s/ Charles H. Murphy
-------------------------
Charles H. Murphy,
Chief Financial Officer
(Principal Financial and Accounting Officer)
Dated: August 13, 1996
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