10QSB 1 doc1.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-QSB [X] Quarterly Report Pursuant to Section 13 or 15(d) of the securities Exchange Act of 1934 For the quarter ended MARCH 31, 2003 [ ] 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 0-15949 INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. (Exact name of registrant as specified in its charter) CALIFORNIA 94-2862863 ---------- ---------- (State or other jurisdiction of (I.R.S. Employer identification No.) incorporation or organization) 75 ROWLAND WAY, NOVATO, CA 94945 (Address of principal executive offices) (Zip code) (415) 878-4000 -------------- (Registrant's telephone number including area code) Indicate by check mark whether 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, and (2) has been subject to such filing requirements for the past 90 days. YES X NO - As of April 30, 2003, 22,810,732 shares of Registrant's common stock, no par value, were outstanding. Transitional Small Business Disclosure Format: YES NO X - 1 INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. AND SUBSIDIARIES TABLE OF CONTENTS
TABLE OF CONTENTS 2 PART I - FINANCIAL INFORMATION 3 ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 3 CONDENSED CONSOLIDATED BALANCE SHEETS 3 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (L0SS) 4 CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY 5 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 12 ITEM 3. CONTROLS AND PROCEDURES 19 PART II - OTHER INFORMATION 20 ITEM 1. LEGAL PROCEEDINGS 20 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 20 ITEM 3. DEFAULTS UPON SENIOR SECURITIES 20 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 21 ITEM 5. OTHER INFORMATION 21 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 21 SIGNATURES 22 EXHIBIT 10.1 26 EXHIBIT 99.1 30 EXHIBIT 99.2 31
2 PART I - FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts)
(UNAUDITED) --------------------- ----------------- MARCH 31, 2003 JUNE 30, 2002 --------------------- ----------------- ASSETS Current assets: Cash and cash equivalents $1,054 $2,455 Restricted cash 65 600 Receivables, less allowances for doubtful accounts, discounts and returns of 1,312 798 $158 and $217 Inventories 322 387 Other current assets 709 324 --------------------- ----------------- TOTAL CURRENT ASSETS 3,462 4,564 Fixed assets, net 388 390 Other Assets Software development costs and license fees, net 443 931 Domain names, net 604 756 Distribution rights, net 384 491 Goodwill, net 271 271 --------------------- ----------------- TOTAL ASSETS $5,552 $7,403 ===================== ================= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Short term debt and current portion of long-term debt $626 $1,930 Trade accounts payable 1,337 1,425 Accrued and other liabilities 838 1,329 Accrued arbitration award 179 330 Deferred revenue 1,849 1,309 --------------------- ----------------- TOTAL CURRENT LIABILITIES 4,829 6,323 Accrued arbitration award 445 463 Long term debt and other obligations 255 374 --------------------- ----------------- TOTAL LIABILITIES 5,529 $7,160 Shareholders' equity: Common stock, no par value; 300,000,000 authorized; Issued and outstanding 35,241 35,159 22,810,732 and 22,778,899 shares Accumulated deficit (35,181) (34,891) Accumulated other comprehensive loss (37) (25) --------------------- ----------------- TOTAL SHAREHOLDERS' EQUITY 23 $243 --------------------- ----------------- ===================== ================= TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $5,552 $7,403 ===================== =================
See Notes to Condensed Consolidated Financial Statements 3 INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (L0SS) (In thousands, except per share amounts) (Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, 2003 2002 2003 2002 ---- ---- ---- ---- Net revenues $3,946 $3,661 $10,555 $9,385 Product costs 1,184 712 2,954 2,229 ------------- ------------ -------------- ----------- GROSS MARGIN 2,762 2,949 7,601 7,156 Costs and expenses: Sales and marketing 929 846 2,635 2,040 General and administrative 1,307 1,114 3,635 3,433 Research and development 604 535 1,875 1,680 ------------- ------------ -------------- ----------- TOTAL OPERATING EXPENSES 2,840 2,495 8,145 7,153 ------------- ------------ -------------- ----------- OPERATING INCOME (LOSS) (78) 454 (544) 3 ------------- ------------ -------------- ----------- Other income and (expense): Interest and other, net (91) (579) (247) (945) Gain on disposition of fixed assets -- 9 -- 10 Gain on product line sale -- -- -- 20 Settlement costs (113) 184 (113) 166 Gain on extinguishment of debt 134 -- 569 7,970 ------------- ------------ -------------- ----------- INCOME (LOSS) BEFORE INCOME TAX (148) 69 (335) 7,224 Income tax provision (benefit) (45) 1 (45) 3 ------------- ------------ -------------- ----------- NET INCOME (LOSS) (103) 68 (290) 7,221 ------------- ------------ -------------- ----------- Other comprehensive loss, net of tax: Foreign currency translation, net of tax (10) 6 (12) (5) ------------- ------------ -------------- ----------- OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX ($113) $74 ($302) $7,216 ============= ============ ============== =========== Basic earnings (loss) per share ($0.00) $0.01 ($0.01) $0.65 Diluted earnings (loss) per share ($0.00) $0.01 ($0.01) $0.59 Shares used in computing basic earnings (loss) per share information 22,807 14,082 22,800 11,180 Shares used in computing diluted earnings (loss) per share information 22,807 15,056 22,800 12,154
See Notes to Condensed Consolidated Financial Statements 4 INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Nine Months ended March 31, 2003 (In thousands) (Unaudited)
Accumulated Other Common Stock Accumulated Comprehensive Shares Amount Deficit Loss Total ------------------------------------------------------------------------------- BALANCE AT JUNE 30, 2002 22,779 $35,159 ($34,891) ($25) $243 =============================================================================== Issuance of common stock related to: Settlement of debt 10 8 8 Stock options exercise 22 5 5 Issuance of warrants related to: Employee compensation 259 259 Baystar debt refinancing 184 184 Consulting services rendered 78 78 Reversal of employee warrant amortization (461) (461) Issuance of stock options related to: Consulting services rendered 15 15 Variable accounting adjustment (6) (6) Net loss (290) (290) Foreign currency translation adjustment (12) (12) ------------------------------------------------------------------------------- BALANCE AT MARCH 31, 2003 22,811 $35,241 ($35,181) ($37) $23 ===============================================================================
See Notes to Condensed Consolidated Financial Statements 5 INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
NINE MONTHS ENDED MARCH 31, -------------------------------------------- 2003 2002 -------------------- -------------------- Cash flows from operating activities: NET CASH (USED) PROVIDED BY OPERATING ACTIVITIES ($395) $1,809 -------------------- -------------------- Cash flows from investing activities: Purchase of equipment and furniture (181) (71) Software development costs (44) (17) Proceeds from product line and domain name sales -- 20 Acquisition of subsidiary from related party -- (266) Additions to other assets (8) (155) -------------------- -------------------- NET CASH USED BY INVESTING ACTIVITIES (233) (489) -------------------- -------------------- Cash flows from financing activities: Accounts Receivable Financing 684 -- Increase in notes payable -- 479 Debt repayments (1,313) (1,209) Repayment of capital lease obligations (137) (218) Proceeds from issuance of common stock 5 755 -------------------- -------------------- NET CASH USED BY FINANCING ACTIVITIES (761) (193) -------------------- -------------------- Effect of exchange rate change on cash and cash equivalents (12) (5) Net increase (decrease) in cash and cash equivalents (1,401) 1,122 Cash and cash equivalents at beginning of period 2,455 1,230 -------------------- -------------------- CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $1,054 $2,352 ==================== ====================
See Notes to Condensed Consolidated Financial Statements 6 INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The interim condensed consolidated financial statements have been prepared from the records of International Microcomputer Software, Inc. and Subsidiaries ("IMSI") without audit. All significant inter-company balances and transactions have been eliminated in consolidation. In the opinion of management, all adjustments, which consist of only normal recurring adjustments, to present fairly the financial position at March 31, 2003 and the results of operations and cash flows for the three and nine months ended March 31, 2003 and 2002 have been made. The interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in our Annual Report on Form 10-KSB for the fiscal year ended June 30, 2002. The results of operations for the three and nine months ended March 31, 2003 are not necessarily indicative of the results to be expected for any other interim period or for the full year. 2. SEGMENT INFORMATION We have four reportable operating segments based on the sales market. The North America and Other Foreign segments are geographic locations and generate revenues and incur expenses related to the sale of our PC productivity software. The ArtToday.com segment comprises the revenues and expenses related to subscriptions sold through ClipArt.com, Photos.com and RebelArtist.com. The Keynomics segment represents our productivity software subsidiary. The following table details segment information as follows (in thousands):
QUARTER ENDED MARCH 31, 2003 ARTTODAY.COM KEYNOMICS NORTH AMERICA OTHER FOREIGN ELIMINATIONS TOTAL ---------------------------------------------------------------------------------------------------------------------------- Net Revenues $1,413 $442 $1,811 $280 $-- $3,946 Operating income (loss) 152 65 (272) (23) -- (78) Identifiable assets 3,085 232 2,374 350 (489) 5,552 ---------------------------------------------------------------------------------------------------------------------------- QUARTER ENDED MARCH 31, 2002 ---------------------------------------------------------------------------------------------------------------------------- Net Revenues 1,082 239 2,219 121 -- 3,661 Operating income (loss) 402 (84) 137 (1) -- 454 ---------------------------------------------------------------------------------------------------------------------------- NINE MONTHS ENDED MARCH 31, 2003 ---------------------------------------------------------------------------------------------------------------------------- Net Revenues 3,634 1,066 5,298 557 -- 10,555 Operating income (loss) 315 57 (864) (52) -- (544) ---------------------------------------------------------------------------------------------------------------------------- NINE MONTHS ENDED MARCH 31, 2002 ---------------------------------------------------------------------------------------------------------------------------- Net Revenues 3,013 320 5,650 402 -- 9,385 Operating income (loss) 1,008 (103) (932) 31 -- 3
7 3. EARNINGS (LOSS) PER SHARE Basic earnings per share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed using the weighted average number of common and potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of the incremental common shares issuable upon on exercise of stock options and warrants (using the treasury stock method). Potentially dilutive securities are excluded from the computation if their effect is anti-dilutive. The following table sets forth the computation of basic and diluted earnings (loss) per share:
THREE MONTHS ENDED NINE MONTHS ENDED ------------------------- ------------------------- MARCH 31, MARCH 31, MARCH 31, MARCH 31, 2003 2002 2003 2002 ------------ ------------ ------------- ----------- NUMERATOR: Net income (loss) ($103) $68 ($290) $7,221 Numerator for basic earnings per share - Income (Loss) available to common ($103) $68 ($290) $7,221 stockholders Numerator for diluted earnings per share - Income (Loss) available to ($103) $68 ($290) $7,221 common stockholders after assumed conversions DENOMINATOR: Denominator for basic earnings per share - weighted average shares 22,806,882 14,081,521 22,799,624 11,179,696 outstanding Effect of dilutive securities using the treasury stock method as at March 31, 2003: 5,254,077 Warrants Outstanding -- -- -- -- 2,223,321 Stock Options Outstanding -- -- -- -- Effect of dilutive securities using the treasury stock method as at March 31, 2002: 1,539,291 Warrants Outstanding -- 488,856 -- 488,856 2,050,237 Stock Options Outstanding -- 485,171 -- 485,171 Dilutive potential common shares -- 974,027 -- 974,027 Denominator for diluted earnings per share - adjusted weighted 22,806,882 15,055,548 22,799,624 12,153,723 average shares and assumed conversion BASIC EARNINGS (LOSS) PER SHARE ($0.00) $0.01 ($0.01) $0.65 DILUTED EARNINGS (LOSS) PER SHARE ($0.00) $0.01 ($0.01) $0.59
8 4. SETTLEMENT COSTS During the quarter ended March 31, 2003, we incurred a charge of $60,000 relating to the full and final settlement of the "Sorrentino Vs. Digital Creative Corporation, et al." matter as disclosed under "Legal Proceedings". We also incurred a $50,000 charge relating to the settlement of infringement claims. With these settlements all legal proceeding related to these matters have ended. 5. GAIN ON EXTINGUISHMENT OF DEBT Consistent with our efforts over the past two years, we continue to resolve, on a case by base basis, trade and bank debt. Our efforts resulted in the extinguishment and write-off of $154,000 of debt in the quarter ending March 31, 2003 resulting in a gain of $134,000. We are continuing our efforts to resolve our past due liabilities which will likely result in additional write-offs and extinguishment gains although the number and amount of such future settlements is not determinable. As of March 31, 2003, we had $297,000 of such past due liabilities recorded. The following table details the major write-offs and settlements we entered into during the three and nine-month periods ended March 31, 2003 and 2002 and their effects on our financial statements (in thousands):
BALANCE BEFORE BALANCE AFTER GAIN ON EXTINGUISHMENT OF SETTLEMENT SETTLEMENT DEBT ---------------------- -------------------- --------------------------- QUARTER ENDED MARCH 31, 2003 DCDC $-- $-- $-- Baystar Capital, LLC -- -- -- Other Unsecured 154 20 134 ---------------------- -------------------- --------------------------- TOTAL 154 20 134 ====================== ==================== =========================== ---------------------- -------------------- --------------------------- QUARTER ENDED MARCH 31, 2002 -- -- -- ====================== ==================== =========================== NINE MONTHS ENDED MARCH 31, 2003 DCDC 107 80 27 Baystar Capital, LLC 681 597 84 Other Unsecured 645 187 458 ---------------------- -------------------- --------------------------- TOTAL 1,433 864 569 ====================== ==================== =========================== NINE MONTHS ENDED MARCH 31, 2002 Silicon Valley Bank 3,262 1,200 2,062 Baystar Capital, LLC 6,256 625 5,631 Other Unsecured 317 40 277 ---------------------- -------------------- --------------------------- TOTAL $9,835 $1,865 $7,970 ---------------------- -------------------- ---------------------------
6. SFAS NO. 142, ACCOUNTING FOR GOODWILL Effective July 1, 2002, we adopted SFAS NO. 142 GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS No. 142 addresses the methods used to amortize intangible assets and to assess impairment of those assets, including goodwill resulting from business combinations accounted for under the purchase method. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, except for the non-amortization provisions of the statement, which were effective for business combinations completed after June 30, 2001. Included in our assets at March 31, 2003 and June 30, 2002, is goodwill with a net carrying value of $271,000. Our policy is to review the recoverability of goodwill at a minimum of once per year and record an impairment loss when the fair value of the assets does not exceed the carrying amount of the asset. With the adoption of SFAS No. 142 on July 1, 2002, we no longer amortize goodwill. Had we continued to amortize goodwill, we would have incurred amortization expense of approximately $29,000 and $88,000 in the three and nine-month periods ended March 31, 2003 as compared to $20,000 and $136,000 which were recognized during the same periods in the prior fiscal year. 9 7. SFAS NO. 148, ACCOUNTING FOR STOCK-BASE COMPENSATION In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Base Compensation - Transition and Disclosure" which amends SFAS No. 123, "Accounting for Stock-Based Compensation," and provides alternative methods of transition to SFAS No. 123's fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 and Accounting Principles Board ("APB") Opinion No. 28, "Interim Financial Reporting," to require disclosure of the effects of an entity's accounting policy with respect to stock-based compensation on reported net income and earnings per share in annual and interim financial statements. The disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of whether the compensation is accounted for using the fair value method of SFAS No. 123 or the intrinsic value method of APB Opinion No. 25. As allowed by SFAS No. 123, we utilize the accounting method prescribed by APB Opinion No. 25 and have adopted the disclosure requirements of SFAS No. 148. The following table illustrates the effect on net income (loss) and net income (loss) per common share if we had applied fair value recognition provisions of SFAS No. 123 to stock based employee compensation.
THREE MONTHS ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, (IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2003 2002 NET INCOME (LOSS) ($103) $74 ($302) $7,216 Add Back: Reversal in the current year of prior year stock-based employee compensation expense determined under intrinsic value methodology, net of related tax effects 173 Deduct: Total stock-based employee compensation expense determined under fair value methodology, net of related tax effects (17) (99) (246) (549) ============ ============ ============ ============ PRO FORMA NET INCOME (LOSS) ($120) ($25) ($375) $6,667 ------------ ------------ ------------ ------------ Net income (loss) per common share: Basic - as reported ($0.00) $0.01 ($0.01) $0.65 Basic - pro forma ($0.01) ($0.01) ($0.02) $0.60 Diluted - as reported ($0.00) $0.01 ($0.01) $0.59 Diluted - pro forma ($0.01) ($0.01) ($0.02) $0.55
8. SUBSEQUENT EVENTS IMAGELINE SETTLEMENT On April 18, 2003, we entered into a global settlement with Imageline by execution of a written Settlement Agreement and Mutual General Release ("Settlement"). The settlement restructured our previous settlement with Imageline and fully and finally resolved all disputes with Imageline and its president and principal shareholder, George Riddick. Under the terms of the restructured Settlement, the approximately $2.7 million judgment entered in favor of Imageline on February 29, 2000 has been vacated and set aside in its entirety and the litigation matters listed above have been dismissed with prejudice, in exchange for; o An immediate payment of $621,750 o A promissory note for $178,250 plus simple interest of 10% per annum due on or before April 18, 2004 o Licensing and republishing rights to certain intellectual property o The issuance of 600,000 fully vested three year warrants with a strike price of $0.46 per share to purchase the Company's common stock 10 In return, the restructured settlement ends all litigation among the parties, eliminates an existing judgment against IMSI, and removes a lien on certain of IMSI's assets. The licenses granted in this settlement agreement will not negatively affect IMSI's ongoing operations and will allow the Company to end an expensive and time consuming legal dispute. The restructured Settlement also included a general mutual release of all claims, both known and unknown, as between IMSI and ArtToday, on the one hand, and Imageline and George Riddick, on the other hand, through the April 18, 2003 effective date of the Settlement. As a result of this restructured settlement, IMSI will recognize an additional non-operating charge of approximately $380,000 in its financial statements for the quarter ended June 30, 2003. FIVE-YEAR, 15% SECURED PROMISSORY NOTES, WITH WARRANTS ATTACHED In March 2003, we initiated a private placement of five-year, 15% secured promissory notes to accredited investors. We are seeking to raise a minimum of $650,000 and up to a maximum of $1,500,000 in the offering. Purchasers of the notes are also to receive warrants to purchase IMSI's common stock at the rate of one warrant for each $2.00 of principal of the notes. These warrants will have a strike price of $0.45 and will expire on the earlier of April 30, 2008 or three years after full payment of the notes. The notes are being secured by the pledge of the common stock of ArtToday.com, our wholly owned subsidiary. The offering is being conducted directly by IMSI. Proceeds of the offering are intended to retire existing debt, purchase of and/or license of digital content and software assets and fund general working capital needs. The first closing was held on April 28, 2003, and the final closing will occur on or before May 15, 2003. As at May 1, 2003, we had accepted subscriptions from investors to purchase $650,000 notes and all such funds have been received and deposited. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read in conjunction with the consolidated financial statements and the notes thereto and in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations in our Fiscal 2002 Form 10-KSB. This quarterly report on Form 10-QSB, and in particular this "Management's Discussion and Analysis of Financial Condition and Results of Operations," may contain forward-looking statements regarding future events or our future performance. These future events and future performance involve certain risks and uncertainties including those discussed in the "Other Factors That May Affect Future Operating Results" section of this Form 10-QSB, as well as in our Fiscal 2002 Form 10-KSB, as filed with the Securities and Exchange Commission ("SEC"). Actual events or our actual future results may differ materially from any forward-looking statements due to such risks and uncertainties. We assume no obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements. This analysis is not intended to serve as a basis for projection of future events. CRITICAL ACCOUNTING POLICIES In accordance with recent Securities and Exchange Commission guidance, those material accounting policies that we believe are the most critical to an investor's understanding of our financial results and condition have been expanded and are discussed below. Certain of these policies are particularly important to the portrayal of our financial position and results of operations and require the application of significant judgment by our management to determine the appropriate assumptions to be used in the determination of certain estimates. REVENUE RECOGNITION Revenue is recognized in accordance with American Institute of Certified Public Accountants Statement of Position ("SOP") 97-2, Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2, With Respect to Certain Transactions. Revenue is recognized when persuasive evidence of an arrangement exists (generally a purchase order), product has been delivered, the fee is fixed and determinable and collection of the resulting account is probable. o Revenue from packaged product sales to resellers and end users is recorded at the time of the sale net of estimated returns. o Revenue from sales to distributors is recognized when the product sells through to retailers and end users. Sales to distributors permit limited rights of return according to the terms of the contract. o For software delivered via the Internet, revenue is recorded when the customer downloads the software. o Subscription revenue is recognized ratably over the contract period. o Revenue from hybrid products is allocated to the underlying components based on the ratio of the value of each component to the total price and each portion is recognized accordingly. o Non-refundable advanced payments received under license agreements with no defined terms are recognized as revenue when the customer accepts the delivered software. o Revenue from software licensed to developers, including amounts in excess of non-refundable advanced payments, is recorded as the developers ship products containing the licensed software. o Revenue from minimum guaranteed royalties in republishing agreements is recognized ratably over the term of the agreement. Royalties in excess of the guaranteed minimums are recognized when collected. o Revenue from Original Equipment Manufacturer (OEM) contracts is recognized upon completion of our contractual obligations. The purpose of OEM contracts is to increase our customer base by seeding the marketplace with older versions of our software, bundled with other manufacturers' products. RESERVE FOR RETURNS, PRICE DISCOUNTS AND REBATES Reserves for returns, price discounts and rebates are estimated using historical averages, open return requests, channel inventories, recent product sell-through 12 activity and market conditions. Our allowances for returns, price discounts and rebates are based upon management's best judgment and estimates at the time of preparing the financial statements. Reserves are subjective estimates of future activity that are subject to risks and uncertainties, which could cause actual results to differ materially from estimates. Our return policy generally allows our distributors to return purchased products primarily in exchange for new products or for credit towards future purchases as part of stock balancing programs. These returns are subject to certain limitations that may exist in the contract with an individual distributor, governing, for example, aggregate return amounts, and the age, condition and packaging of returned product. Under certain circumstances, such as terminations or when a product is defective, distributors could receive a cash refund if returns exceed amounts owed. INVENTORIES Inventories are valued at the lower of cost or market and are accounted for on the first-in, first-out basis. Management performs periodic assessments to determine the existence of obsolete, slow moving and non-salable inventories, and records necessary provisions to reduce such inventories to net realizable value. GOODWILL, INTANGIBLE AND OTHER LONG LIVED ASSETS Property, equipment, intangible and certain other long-lived assets are amortized over their useful lives. Useful lives are based on management's estimates of the period that the assets will generate revenues. Long-lived assets and goodwill are written down to fair value whenever events or changes indicate that the carrying amount of an asset may not be recoverable. Our policy is to review the recoverability of all long-lived assets including goodwill at a minimum of once per year and record an impairment loss when the fair value of the assets does not exceed the carrying amount of the asset. RESULTS OF OPERATIONS The following table sets forth our results of operations for the three and nine months ended March 31, 2003 and 2002 in absolute dollars and as a percentage of net revenues. It also details the changes from the prior fiscal year in absolute dollars and in percentages: 13
FISCAL QUARTER ENDED MARCH 31, ------------------------------------------------------------ 2003 2002 ----------------- ----------------- ------------------- $ % AS % AS % CHANGE CHANGE $ OF SALES $ OF SALES FROM FROM PREVIOUS PREVIOUS YEAR YEAR ----------------- ----------------- ------------------- Net Revenues $ 3,946 100.0% $ 3,661 100.0% $ 285 7.8% Product Cost 1,184 30.0% 712 19.4% 472 66.4% -------- -------- --------- ------- --------- --------- GROSS MARGIN 2,762 70.0% 2,949 80.6% 187 -6.4% Operating Expenses Sales & Marketing 929 23.6% 846 23.1% 83 9.8% General & Administrative 1,307 33.1% 1,114 30.4% 193 17.4% Research & Development 604 15.3% 535 14.6% 69 12.8% -------- -------- --------- ------- --------- --------- TOTAL OPERATING EXPENSES 2,840 72.0% 2,495 68.2% 345 13.8% ----------------------------------------- -------- -------- --------- ------- --------- --------- OPERATING INCOME (LOSS) (78) -2.0% 454 12.4% (532) -117.3% ----------------------------------------- -------- -------- --------- ------- --------- --------- Other Income (Expenses) Interest (Expense) (137) -3.5% (75) -2.1% (62) 82.2% Interest Income 1 0.0% 3 0.1% (2) -54.9% Foreign Exchange Gains 37 0.9% 14 0.4% 23 167.9% Gain On Liquidation Of Foreign Subs - 0.0% - 0.0% - 0.0% Other (Expense) Income 8 0.1% (25) -0.7% 33 -132.0% Loss On Stock Issuance - 0.0% (495) -13.5% 495 -100.0% Gain On Disposal Of Fixed Assets - 0.0% 9 0.3% (9) -100.0% Gain On Sales Of Product Line - 0.0% - 0.0% - Settlement Costs (113) -2.9% 184 5.0% (297) -161.4% Gain From Extinguishment Of Debt 134 3.4% - 0.0% 134 ----------------------------------------- -------- -------- --------- ------- --------- --------- TOTAL OTHER INCOME (EXPENSES) (70) -1.8% (385) -10.5% 315 -81.8% ----------------------------------------- -------- -------- --------- ------- --------- --------- INCOME (LOSS) BEFORE TAX (148) -3.8% 69 1.9% (217) -316.2% ----------------------------------------- -------- -------- --------- ------- --------- --------- Income Tax Expense (Benefit) (45) -1.1% 1 0.0% (46) -9003.1% ----------------------------------------- -------- -------- --------- ------- --------- --------- NET INCOME (LOSS) $(103) -2.6% $ 68 1.9% $ (171) -251.8% ----------------------------------------- -------- -------- --------- ------- --------- ---------
NINE MONTHS ENDED MARCH 31, ------------------------------------------------------------ 2003 2002 ------------------------------------- ---------------------- $ % $ AS % $ AS % CHANGE CHANGE OF SALES OF SALES FROM FROM PREVIOUS PREVIOUS YEAR YEAR --------------------- -------------- ---------------------- Net Revenues $ 10,555 100.0% $ 9,385 100.0% $ 1,170 12.5% Product Cost 2,954 28.0% 2,229 23.8% 725 32.5% --------------------- -------------- ---------------------- GROSS MARGIN 7,601 72.0% 7,156 76.2% 445 6.2% Operating Expenses Sales & Marketing 2,635 25.0% 2,040 21.7% 595 29.2% General & Administrative 3,635 34.4% 3,433 36.6% 202 5.9% Research & Development 1,875 17.8% 1,680 17.9% 195 11.6% --------------------- -------------- ---------------------- TOTAL OPERATING EXPENSES 8,145 77.2% 7,152 76.2% 992 13.9% ----------------------------------------- --------------------- -------------- ---------------------- OPERATING INCOME (LOSS) (544) -5.2% 3 0.0% (547) -15679.2% ----------------------------------------- --------------------- -------------- ---------------------- Other Income (Expenses) Interest (Expense) (332) -3.1% (547) -5.8% 215 -39.4% Interest Income 12 0.1% 9 0.1% 3 28.1% Foreign Exchange Gains 23 0.2% 15 0.2% 8 52.2% Gain On Liquidation Of Foreign Subs 46 0.4% - 0.0% 46 100.0% Other (Expense) Income 4 0.0% 73 0.8% (69) -94.7% Loss On Stock Issuance - 0.0% (495) -5.3% 495 -100.0% Gain On Disposal Of Fixed Assets - 0.0% 10 0.1% (10) -100.0% Gain On Sales Of Product Line - 0.0% 20 0.2% (20) -100.0% Settlement Costs (113) -1.1% 166 1.8% (279) -168.2% Gain From Extinguishment Of Debt 569 5.4% 7,970 84.9% (7,401) -92.9% ----------------------------------------- --------------------- -------------- ---------------------- TOTAL OTHER INCOME (EXPENSES) 209 2.0% 7,221 76.9% (7,012) -97.1% ----------------------------------------- --------------------- -------------- ---------------------- INCOME (LOSS) BEFORE TAX (335) -3.2% 7,224 77.0% (7,559) -104.6% ----------------------------------------- --------------------- -------------- ---------------------- Income Tax Expense (Benefit) (45) -0.4% 3 0.0% (48) -1572.3% ----------------------------------------- --------------------- -------------- ---------------------- ----------------------------------------- --------------------- -------------- ---------------------- NET INCOME (LOSS) $ (290) -2.7% $ 7,221 76.9% $ (7,511) -104.0% ----------------------------------------- --------------------- -------------- ----------------------
14 NET REVENUES Net revenues of each of our principal product categories in dollars and as a percentage of total net revenues for the three and nine months ended March 31, 2003 and 2002 are summarized in the following table (in thousands except for percentage amounts):
---------------------------------------------------- ------------------------------------------------- Quarter Ended March 31, Nine months Ended March 31, ---------------------------------------------------- ------------------------------------------------- 2003 2002 Changes 2003 2002 Changes ----- ----- ------- ----- ----- ------- $ % $ % $ % $ % $ % $ % ---------------- --------------- ---------------- --------------- -------------- ------------------ Visual Design $ 1,141 29% $ 1,410 39% $ (269) -19% $ 2,798 27% $ 3,350 36% $ (552) -16% Graphic Design 1,536 39% 1,324 36% 212 16% 4,295 41% 3,751 40% 544 14% Business Application & Other 1,268 32% 926 25% 342 37% 3,462 33% 2,284 24% 1,176 51% -------------------------------------------------------------------------------- -------------------------------------------------- Net Revenues $ 3,946 100% $ 3,661 100% $ 285 8% $ 10,555 100% $ 9,385 100% $ 1,168 12% -------------------------------------------------------------------------------- --------------------------------------------------
Sales of FloorPlan(R) and IMSI's flagship product, TurboCAD(R), decreased in the three and nine months ended March 31, 2003 as compared to the same reporting periods in the previous fiscal year, resulting in an overall decrease in revenues in the visual design category. The primary reason for this decrease is the timing of the launch of the new version of TurboCAD(R) 9.0 which was introduced in March 2003. With the launch of version 8 in December 2001, the comparable periods from the previous fiscal year included the full effect of the newly released product as compared to only one month's effect for TurboCAD(R) 9.0. Sales also were affected by a slightly longer release lifecycle for version 8 (fifteen months versus our plan of 12 months for version 9) than we had experienced in the past. The introduction of TurboCADCAM during fiscal 2003 slightly offset the overall decrease in sales in the visual design category. Overall revenues in the graphic design category increased during the three and nine months ended March 31, 2003 as compared to the same periods of the previous fiscal year. The introduction of several new graphics products during fiscal 2003, including ClipArt & More(R) and Animations & More(R), along with increased subscriptions for graphic content from our wholly owned subsidiary ArtToday.com positively impacted revenues in the graphic design category. For the nine months ended March 31, 2003, revenues from ArtToday.com were $3.6 Million and represented approximately 84% of total sales in the graphic design category. Sales from ArtToday.com increased 19% from the $3.0 Million recognized during the nine-month period ended March 31, 2002. This increase is attributable to a higher number of paid subscribers as a result of a wider range of subscription choices and the introduction of our new subscription service, Photos.com. As ArtToday.com's revenues are based on subscriptions, these amounts are initially deferred and then recognized over the subscription periods, which extend up to twelve months. As of March 31, 2003, approximately $1,358,000 of subscription revenue related to ArtToday.com was deferred and will be recognized over the next twelve months. This balance represents an increase of $135,000 as compared to the quarter ended December 31, 2002. The increase in revenues in the business application and other category during the three and nine months ended March 31, 2003, as compared to the same periods in the previous fiscal year, was primarily due to our acquisition of Keynomics, a productivity software provider, in November 2001 and to the introduction during fiscal 2003 of several new software titles (TurboTyping, The Lord of the Rings activity studio series, Legacy Family Tree and QuickVerse essential) to this category. Revenues from Keynomics were $441,000 and $1,066,000 for the three months and nine months ended March 31, 2003, respectively. This compares to $239,000 and $320,000 of revenues from Keynomics recognized during the three and nine months ended March 31, 2002, respectively. Internationally, we distribute our products through our wholly owned Australian subsidiary and republishing partners in Europe and Asia. During the quarter ended March 31, 2003, we stopped the liquidation of our German subsidiary with a petition to the German Court which allowed us to utilize the wholly owned subsidiary to sell directly into the European Union. The following table details the revenue breakdown between the domestic and international markets for the periods indicated.
Quarter ended March 31, Nine months ended March 31, ----------------------------------------------------------- --------------------------------------------------- 2003 2002 2003 2002 ------------------- ----------------- ------------------ ---------------- $ % of total $ % of total $ Change % change $ % of total $ % of total $ Change %change ------------------- ----------------- ------------------ ------------------ ---------------- ---------------- Domestic sales $3,446 87% $3,377 92% $69 2% $9,462 90% $8,434 90% $1,028 12% International sales 500 13% 284 8% 216 76% 1,093 10% $951 10% 142 15% -------------------------------------- ----------------- ------------------ ------------------ ---------------- ---------------- Total Net Sales $3,946 100% $3,661 100% $285 8% $10,555 100% $9,385 100% $1,170 12% -------------------------------------- ----------------- ------------------ ------------------ ---------------- ----------------
We are currently serving the domestic and international retail markets using direct sales methods and republishing agreements. Low barriers to entry, intense price competition, and business consolidations continue to characterize the 15 consumer software industry. Any one of these factors along with the intermittent unfavorable retail conditions, including erosion of margins from competitive marketing and high rates of product returns, may adversely affect our revenues in the future. Our international revenues may be affected by the risks customarily associated with international operations, including a devaluation of the U.S. dollar, increases in duty rates, exchange or price controls, longer collection cycles, government regulations, political instability and changes in international tax laws. PRODUCT COSTS Our product costs include the costs of CD-ROM duplication, printing of manuals, packaging and fulfillment, freight-in, freight out, license fees, royalties that we pay to third parties based on sales of published software and amortization of capitalized software acquisition and development costs. Costs associated with the return of products, such as refurbishment and the write down in value of returned goods are also included in product costs. The increase in product costs in absolute dollars and as a percentage of net revenues for the three and nine months ended March 31, 2003 as compared to the same periods from the previous fiscal year was primarily attributable to increased royalty expenses and to a change in product mix. GROSS MARGIN During the quarter ended March 31, 2003, gross margin declined to 70% from 81% in the comparable quarter from the previous fiscal year. Gross margin also declined from 76% to 72% in the nine months ended March 31, 2003 as compared to the same period in the previous fiscal year. This decrease in gross margin is mainly attributable to additional royalty expenses, sales returns and provisions and a shift in our product mix towards the "business application and other" segment from the "visual design" segment. The Keynomics margin contribution and the slightly improved gross margin from ArtToday.com partially offset the decrease in our aggregate gross margin in the three and nine months ended March 31, 2003. Given the uncertain product lifecycle for some of our historically high margin products and depending on the success of newer versions launches, we may see our gross margin decline further in future reporting periods. SALES AND MARKETING Our sales and marketing expenses consist primarily of salaries and benefits of sales and marketing personnel, commissions, advertising, printing and direct mail expenses. The increase in sales and marketing expenses during the three months ended March 31, 2003 as compared to the same period in the previous fiscal year is primarily due to increased personnel charges and promotional and marketing expenses related to ArtToday.com. The increase in sales and marketing expenses for the nine months ended March 31, 2003 is mainly the result of the addition of sales and marketing expenses related to Keynomics' business which was acquired November 29, 2001. The additional sales and marketing expenses relating to Keynomics were $6,000 and $260,000 for the three months and nine months ended March 31, 2003, respectively. GENERAL AND ADMINISTRATIVE Our general and administrative expenses consist primarily of the salaries and benefits for employees in the legal, finance, accounting, human resources, information systems and operations departments and fees to our professional advisors. The increase in general and administrative expenses during the nine months ended March 31, 2003 as compared to the same period from the previous fiscal year was mainly the result of increased general and administrative expenses relating to ArtToday.com's business in part offset by the reversal of $432,000 of amortization of the intrinsic value of warrants issued, but unvested, to our Chief Executive Officer, Mr. Martin Wade III. On November 12, 2002, we amended Mr. Wade's Employment Agreement whereby IMSI and Mr. Wade agree to the full and complete cancellation of all outstanding warrants granted to Mr. Wade. Increased general and administrative expenses of ArtToday.com in the three and nine month ended March 31, 2003 included higher bank and internet service charges, higher lease expenses and payroll charges, all necessary to sustain the aggressive growth in ArtToday.com's business. 16 RESEARCH AND DEVELOPMENT Our research and development expenses consist primarily of salaries and benefits for research and development employees and payments to independent contractors. The increase in research and development expenses in the three months ended March 31, 2003 as compared to the same period from the previous fiscal year resulted mainly from increased personnel costs relative to ArtToday.com. The increase in research and development expenses in the nine months ended March 31, 2003 as compared to the same periods in the previous fiscal year is mainly the result of additional research and development expenses related to the Keynomics business as we only consolidated their expenses beginning December 1, 2001. INTEREST AND OTHER, NET Interest and other expenses, net, include interest and penalties on debt instruments, foreign currency transaction gains and losses, and other non-recurring items. The following table summarizes the components of interest and other, net for the three and nine-month periods ended March 31, 2003 and 2002: FISCAL QUARTER ENDED MARCH 31, ------------------------------------------------------ 2003 2002 -------- --------- INTEREST AND OTHER, NET Interest expense $ (45) (75) Interest related to warrants issued (92) - Interest income 1 3 Foreign exchange gain 37 14 Other (expense) income 8 (521) -------------------------------- -------- --------- TOTAL $ (91) $ (579) -------------------------------- -------- --------- NINE MONTHS ENDED MARCH 31, ------------------------------------------------------ 2003 2002 -------- --------- INTEREST AND OTHER, NET Interest expense $ (148) (392) Interest related to warrants issued (184) (65) Interest income 12 9 Foreign exchange gain 23 15 Gain on liquidation of foreign subs 46 - Penalties - (90) Other (expense) income 4 (422) -------------------------------- -------- --------- TOTAL $ (247) $ (945) -------------------------------- -------- --------- The decrease in interest expense is mainly the result of the restructuring of our bank debt that we began in fiscal 2002. On July 30, 2001 we entered into an agreement with Baystar, wherein Baystar agreed to accept $626,000 as settlement of all obligations due. Payments were to be made in four quarterly payments beginning September 30, 2002. Interest was to accrue at 8% per annum from August 31, 2001 until the September 2002 payment, and at 12% per annum thereafter until the claim is paid in full on or before June 30, 2003. On September 30, 2002, we amended the July 2001 agreement with Baystar whereby Baystar accepted $600,000 payable over six months beginning October 1, 2002. The amendment also called for us to issue 250,000, ten-year warrants to purchase IMSI common stock at $0.50 per share. Interest expense included $92,000 and $184,000 relating to the amortization of these warrants during the quarter and nine months ended March 31, 2003, respectively. As previously disclosed in our restated Form 10-QSB/A for the quarter ended March 31, 2002, Other income included a $495,000 charge resulting from the issuance of 9,000,000 common shares and $250,000 in cash to DCDC in exchange for the retirement of the Union Bank Note which they had previously acquired from Union Bank of California. 17 SETTLEMENT COSTS During the quarter ended March 31, 2003, we incurred a charge of $60,000 relating to the settlement of the "Sorrentino Vs. Digital Creative Corporation, et al." matter as disclosed under "legal Proceedings". We also incurred a $50,000 relating to a settlement of infringement claims. PROVISION FOR INCOME TAXES In the three months ended March 31, 2003, we recorded a tax benefit of $47,000 related to the reduction of our estimate of our California income tax expense recognized in our financial statements at June 30, 2002. We have not recorded a tax benefits for domestic tax losses because of the uncertainty of realization. We adhere to Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes," which requires an asset and liability approach to financial accounting and reporting for income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2003, we had $1,054,000 in cash and cash equivalents. This represents a $1,401,000 decline from the $2,455,000 balance at June 30, 2002 and $119,000 decline from the $1,173,000 balance at December 31, 2002. Working capital at March 31, 2003 was a negative $1,367,000. This represents an improvement over the negative working capital at December 31, 2002 of $1,488,000, at June 30, 2002 of $1,759,000 and at March 31, 2002 of $4,628,000. The improvement in working capital over the previous periods occurred as we further reduced our current liabilities through payments to creditors and restructuring of debt. Our operating activities used cash of $395,000 during the nine months ended March 31, 2003. This compares to a positive cash flow generated from operations of $1,809,000 in the nine months ended March 31, 2002. Our net loss, combined with the increase in accounts receivable, as we extended longer terms to our customers, contributed to the usage of cash in the nine months ended March 31, 2003. The increase in Keynomics' accounts receivable, due to its longer collection cycle, was offset by factoring transactions that are captured in our financing activities. The decline in our profitability for the nine months ended March 31, 2003 as compared to the same period from the previous fiscal year and additional working capital needs to invest in inventory and accounts receivable explains the transition from a positive to a negative operating cash flow. Our investing activities consumed cash of $233,000 during the nine months ended March 31, 2003, principally used to maintain our computer infrastructure. These investments, mainly ArtToday.com related, are consistent with our strategy to grow that division and position it among the leading content providers over the Internet. Investment activities, which used $489,000 in cash during the comparable period of the previous fiscal year, related primarily to the acquisition of Keynomics and the purchase of domain names, a necessary driver to ArtToday.com's growth. Our financing activities consumed net cash of $761,000 for the nine-month period ended March 31, 2003, mainly used to make scheduled payments to BayStar on our renegotiated note and to further reduce our total debt. While we were able to significantly reduce our bank debt during the comparable period of the previous fiscal year, our financing activities used only $193,000 during the nine months ended March 31, 2002 as a result of the $700,000 raised through a private placement and the exercise of warrants by certain executives and senior advisers to the company. During March 2003, we initiated, through a private placement to accredited investors, an offering of five-year 15% secured promissory notes with warrants attached. We are seeking to raise a minimum of $650,000 and up to a maximum of $1,500,000 in the offering. Purchasers of the notes are also to receive warrants to purchase IMSI's common stock at the rate of one warrant for each $2.00 of principal of the notes. These warrants will have a strike price of $0.45 and will expire on the earlier of April 30, 2008 or three years after full payment of the note. Proceeds of the offering are intended to retire existing debt, purchase of and/or license of digital content and software assets and fund 18 general working capital needs. As at May 1, 2003, we had accepted subscriptions from investors to purchase $650,000 notes and all committed funds have been received and deposited. In October 2002, we acquired software in order to support the growth in ArtToday.com's business. This software purchase was partially financed by the vendor and secured by a $65,000 standby letter of credit from Wells Fargo Bank which in turn required cash collateral in the form of certificate of deposit to be deposited with them. These certificates of deposits were classified on our balance sheet as restricted cash as of March 31, 2003. Historically, we have financed our working capital and capital expenditure requirements primarily from retained earnings, short-term and long-term bank borrowings, capitalized leases and sales of common stock. To support future growth, we may seek additional equity and/or debt financing. However, we believe that we have sufficient funds to support our operations at least for the upcoming twelve months, based on our current cash position and other potential credit and equity sources. If we continue to improve our financial performance, we believe that we will be able to obtain any additional financing required. In addition, we will continue to engage in discussions with third parties concerning the sale or license of our remaining non-core product lines and/or the sale or license of part of our assets. The forecast period of time through which our financial resources will be adequate to support working capital and capital expenditure requirements is a forward-looking statement that involves risks and uncertainties, and actual results could vary. Furthermore, any additional equity financing may be dilutive to shareholders, and debt financing may involve restrictive covenants. If we fail to raise capital when needed, the lack of capital will have a material adverse effect on our business, operating results and financial condition. OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS Other factors that may cause fluctuations of, or a decline in, operating results in the future include the market factors and competitive factors described in our Fiscal 2002 Form 10-KSB, under "Risk Factors." Factors that may affect operating results in the future include, but are not limited to: o Market acceptance of our products or those of our competitors o Timing of introductions of new products and new versions of existing products o Expenses relating to the development and promotion of such new products and new version introductions o Intense price competition and numerous end-user rebates o Projected and actual changes in platforms and technologies o Accuracy of forecasts of, and fluctuations in, consumer demand o Extent of third party royalty payments o Rate of growth of the consumer software and Internet markets o Timing of orders or order cancellation from major customers o Changes or disruptions in the consumer software distribution channels o Economic conditions, both generally and within the software or Internet industries ITEM 3. CONTROLS AND PROCEDURES (a) Under the supervision and with the participation of IMSI's management, including IMSI's principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), within 90 days of the filing date of this report. Based on their evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective. (b) We have evaluated our accounting procedures and control processes related to material transactions to ensure they are recorded timely and accurately in the financial statements. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in paragraph (a) above. 19 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS IMAGELINE, INC. VS. INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. Pease refer to Form 10-QSB for the quarter ended December 31, 2002 for previous disclosure regarding this litigation. The following is an update of that disclosure. On April 18, 2003, we entered into a global settlement with Imageline by execution of a written Settlement Agreement and Mutual General Release ("Settlement"). The settlement restructured our previous settlement with Imageline and fully and finally resolved all disputes with Imageline and its president and principal shareholder, George Riddick. ,Under the terms of the restructured Settlement, the approximately $2.7 million judgment entered in favor of Imageline on February 29, 2000 has been vacated and set aside in its entirety and the litigation matters listed above have been dismissed with prejudice, in exchange for; o An immediate payment of $621,750 o A promissory note for $178,250 plus simple interest of 10% per annum due on or before April 18, 2004 o Licensing and republishing rights to certain intellectual property o The issuance of 600,000 fully vested three year warrants with a strike price of $0.46 per share to purchase the Company's common stock In return, the restructured Settlement ends all litigation among the parties, eliminates an existing judgment against IMSI, and removes a lien on certain of IMSI's assets. The licenses granted in this settlement agreement will not negatively affect IMSI's ongoing operations and will allow the Company to end an expensive and time consuming legal dispute. The restructured Settlement also included a general mutual release of all claims, both known and unknown, as between IMSI and ArtToday, on the one hand, and Imageline and George Riddick, on the other hand, through the April 18, 2003 effective date of the Settlement. As a result of this restructured settlement, IMSI will recognize an additional non-operating charge of approximately $380,000 in its financial statements for the quarter ended June 30, 2003. SORRENTINO VS. DIGITAL CREATIVE DEVELOPMENT CORPORATION, ET AL. Please refer to Form 10-QSB for the quarter ended December 31, 2002 for previous disclosure regarding this litigation. The following is an update of that disclosure. We entered into a settlement of this litigation with Mr. Sorrentino as of February 13, 2003, pursuant to which we agreed to pay $60,000 to Mr. Sorrentino, in equal installments over twelve months, and the parties agreed to a stipulation of discontinuance of the action with prejudice. Separately, Mr. Sorrentino also entered into a settlement agreement with the other named parties in the action, including certain of IMSI's Directors. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not Applicable ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable 20 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable ITEM 5. OTHER INFORMATION Not Applicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K EXHIBITS: The following documents are filed as a part of this Report: EXHIBIT 10.1 Employment Agreement (William J. Bush, CFO) EXHIBIT 99.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 EXHIBIT 99.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 REPORTS ON FORM 8-K None 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DATE: MAY 8, 2003 INTERNATIONAL MICROCOMPUTER SOFTWARE, INC. ----------------- ------------------------------------------ By: /s/ Martin Wade, III Martin Wade, III Director & Chief Executive Officer By: /s/ William J. Bush William J. Bush Chief Financial Officer (Principal Accounting Officer) 22 CERTIFICATION OF CHIEF EXECUTIVE OFFICER UNDER SECTION 302 OF THE SARBANES-OXLEY ACT I, Martin Wade, III, certify that: 1. I have reviewed this quarterly report on Form 10-QSB of International Microcomputer Software, Inc; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periods covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the periods in which this quarterly report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c. Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls. 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant efficiencies and material weaknesses. Dated: May 8, 2003 By: /s/ Martin Wade, III Martin Wade, III Director & Chief Executive Officer 23 CERTIFICATION OF CHIEF FINANCIAL OFFICER UNDER SECTION 302 OF THE SARBANES-OXLEY ACT I, William J. Bush, certify that: 1. I have reviewed this quarterly report on Form 10-QSB of International Microcomputer Software, Inc; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periods covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the periods in which this quarterly report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c. Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls. 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant efficiencies and material weaknesses. Dated: May 8, 2003 By: /s/ William J. Bush William J. Bush Chief Financial Officer (Principal Accounting Officer) 24 INDEX TO EXHIBITS: The following documents are filed as a part of this Report:
EXHIBIT EXHIBIT TITLE PAGE NUMBER 10.1 Employment Agreement (William J. Bush, CFO) 26 99.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 30 99.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 31
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