FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OF 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended 6/30/2004 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from to ------------------------ ---------------------------- 1MAGE SOFTWARE, INC. -------------------- (Exact name of Registrant as specified in its charter) 0-12535 (Commission File Number) COLORADO 84-0866294 -------- ---------- (State of Incorporation) (IRS Employer Identification Number) 6025 S. QUEBEC ST. SUITE 300 ENGLEWOOD CO 80111 (303) 694-9180 ----------------------------------------------- -------------- (Address of principal executive offices) (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and, (2) has been subject to such filing requirements for the past 90 days. Yes X No ------ ----- Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes No X ---- ---- As of August 16, 2004, there were 3,302,597 shares of the Registrant's Common Stock outstanding. Page 1 TABLE OF CONTENTS PART I. FINANCIAL INFORMATION ITEM 1 FINANCIAL STATEMENTS Balance Sheets -June 30, 2004, and December 31, 2003...................3 Statements of Operations -for three months ended June 30, 2004 and June 30, 2003......................................................4 Statements of Operations -for six months ended June 30, 2004 and June 30, 2003......................................................5 Statements of Cash Flows -for six months ended June 30, 2004 and June 30, 2003 .....................................................6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations..............................................8 Item 3 Quantitative and Qualitative Disclosures About Market Risk......9 Item 4 Controls and Procedures.........................................9 PART II. OTHER INFORMATION Items 1-5..............................................................10 Item 6 Exhibits and Reports on Form 8-K................................10 2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS 1MAGE SOFTWARE, INC. BALANCE SHEETS Unaudited June 30, December 31, ASSETS 2004 2003 -------------------------------- CURRENT ASSETS: Cash and cash equivalents $ 35,093 $ 143,505 Receivables: Trade (less allowance: 2004, $25,000; 2003, $20,000) 511,741 609,216 Deferred tax asset 20,000 20,000 Prepaid expenses and other current assets 13,843 55,457 Inventory 16,335 11,517 Employee advances 5,592 19,631 ------------- ------------- Total current assets 602,604 859,326 PROPERTY AND EQUIPMENT, at cost, net 41,093 43,465 OTHER ASSETS: Software development costs, net 671,946 694,262 Loan costs, net 17,289 25,929 Deferred tax asset 40,000 40,000 Rent/security deposit 7,841 7,841 Inventory 2,508 2,958 ------------- ------------- TOTAL ASSETS $ 1,383,281 $ 1,673,781 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Line of credit-Bank $ 190,000 $ -- Line of credit-Related Party 213,600 -- Current portion of capital lease obligations 4,161 3,663 Deferred revenue 272,000 287,000 Accounts payable 112,062 162,255 Accrued liabilities 209,810 230,958 ------------- ------------- Total current liabilities 1,001,633 683,876 ------------- ------------- LONG-TERM OBLIGATIONS: Capital lease obligations 7,096 7,105 Line of credit-Bank -- 139,314 Line of credit-Related Party -- 54,600 ------------- ------------- 7,096 201,019 ------------- ------------- SHAREHOLDERS' EQUITY: Common stock, $.004 par value - 10,000,000 shares authorized; shares outstanding: 2004: 3,302,597 and 2003: 3,287,597 13,210 13,150 Additional paid-in capital 7,294,838 7,288,455 Accumulated deficit (6,933,496) (6,512,719) ------------- ------------- Total shareholders' equity 374,552 788,886 ------------- ------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,383,281 $ 1,673,781 ============= ============= See Notes to Condensed Financial Statements 3 1MAGE SOFTWARE, INC. STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended June 30, 2004 2003 -------------- ------------ REVENUE System sales and software licenses $ 93,434 $ 246,294 Services and annual fees 240,488 261,066 -------------- ------------ Total revenue 333,922 507,360 -------------- ------------ COST OF REVENUE System sales and software licenses 94,951 133,819 Services and annual fees 116,665 93,494 -------------- ------------ Total cost of revenue 211,616 227,313 -------------- ------------ GROSS PROFIT 122,306 280,047 % of Revenue 37% 55% OPERATING EXPENSES: Selling, general & administrative 378,552 313,195 -------------- ------------ LOSS FROM OPERATIONS (256,246) (33,148) -------------- ------------ OTHER INCOME/(EXPENSE): Interest expense (9,800) (4,041) Interest income 31 1,143 Other income 101 -- -------------- ------------ Total other income (expense) (9,668) (2,898) -------------- ------------ LOSS BEFORE INCOME TAXES (265,914) (36,046) PROVISION FOR INCOME TAXES -- -- -------------- ------------ NET LOSS $ (265,914) $ (36,046) ============== ============ BASIC AND DILUTED LOSS PER COMMON SHARE: $ (.08) $ (.01) ============== ============ WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: 3,300,125 3,244,927 ============== ============ See Notes to Condensed Financial Statements 4 1MAGE SOFTWARE, INC. STATEMENTS OF OPERATIONS (UNAUDITED) Six Months Ended June 30, 2004 2003 ------------- ------------ REVENUE System sales and software licenses $ 249,441 $ 398,284 Services and annual fees 528,225 537,744 ------------- ------------ Total revenue 777,666 936,028 ------------- ------------ COST OF REVENUE: System sales and software licenses 197,216 251,636 Services and annual fees 254,716 185,705 ------------- ------------ Total cost of revenue 451,932 437,341 ------------- ------------ GROSS PROFIT 325,734 498,687 % Of Revenue 42% 53% OPERATING EXPENSES: Selling, general & administrative 727,821 622,617 ------------- ------------ LOSS FROM OPERATIONS (402,087) (123,930) ------------- ------------ OTHER INCOME/(EXPENSE): Interest income 113 1,593 Interest expense (18,904) (8,092) Other income 101 138,519 ------------- ------------ Total other income (expense) (18,690) 132,020 ------------- ------------ INCOME/(LOSS) BEFORE INCOME TAXES (420,777) 8,090 PROVISION FOR INCOME TAXES -- -- ------------- ------------ NET INCOME/(LOSS) $ (420,777) $ 8,090 ============= ============ BASIC AND DILUTED INCOME/(LOSS) PER COMMON SHARE: $ (0.13) $ 0.00 ============= ============ WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: Basic 3,293,860 3,197,062 ============= ============ Diluted 3,293,860 3,203,950 ============= ============ See Notes to Condensed Financial Statements 5 1MAGE SOFTWARE, INC. STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months Ended June 30, 2004 2003 ------------- ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net Earnings/(Loss) $ (420,777) $ 8,090 Adjustments to reconcile earnings to net cash provided by operating activities: Depreciation and amortization 168,168 164,052 Deferred revenue (15,000) (11,000) Settlement of payable -- (138,375) Issuance of stock for services -- 7,000 Changes in assets and liabilities: Receivables 97,475 32,370 Inventory (4,368) 1,745 Prepaid expenses and other assets 55,653 (11,460) Accounts payable (50,193) 27,174 Accrued liabilities (21,148) (27,658) ------------- ------------ Net cash provided by (used for) operating activities (190,190) 51,938 ------------- ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (4,563) (2,245) Additions to capitalized software (128,284) (130,863) ------------- ------------ Net cash used for investing activities (132,847) (133,108) ------------- ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net additions (repayments) to the line of credit-Bank 50,686 (10,000) Additions to the line of credit- Related Party 159,000 40,000 Principal payments under capital lease obligations (1,504) (460) Proceeds from exercise of stock options 6,443 -- ------------- ------------ Net cash provided by financing activities 214,625 29,540 ------------- ------------ DECREASE IN CASH AND CASH EQUIVALENTS (108,412) (51,630) CASH AND CASH EQUIVALENTS, beginning of period 143,505 149,738 ------------- ------------ CASH AND CASH EQUIVALENTS, end of period $ 35,093 $ 98,108 ============= ============ See Notes to Condensed Financial Statements 6 Supplemental Cash Flows Information Issuance of stock and stock purchase warrants for deferred loan origination fees related to the DEMALE, LLC line of credit $ -- $ 38,889 Capital lease obligation incurred for equipment 1,993 -- 7 1MAGE SOFTWARE, INC. NOTES TO INTERIM FINANCIAL STATEMENTS GENERAL: Management has elected to omit substantially all notes to the unaudited interim financial statements. Reference should be made to the Company's annual report on Form 10-K for the year ended December 31, 2003 as this report incorporates the Notes to the Company's year-end financial statements. The condensed balance sheet of the Company as of December 31, 2003 has been derived from the audited balance sheet of the Company as of that date. UNAUDITED INTERIM INFORMATION: The unaudited interim financial statements contain all necessary adjustments (consisting of only normal recurring adjustments), which, in the opinion of Management, are necessary for a fair statement of the results for the interim periods presented. The results of operations for the interim periods presented are not necessarily indicative of those expected for the year. REVENUE RECOGNITION - Revenue from the sale of software licenses, computer equipment, and existing application software packages is recognized when the software and computer equipment are shipped to the customer, remaining vendor obligations are insignificant, there are no significant uncertainties about customer acceptance and collectibility is probable. Revenue from related services, including installation and software modifications, is recognized upon performance of services. Maintenance revenue is recognized ratably over the maintenance period. INCOME TAXES - The Company follows the liability method of accounting for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109. Under this method, deferred income taxes are recorded based upon differences between the financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when the underlying assets or liabilities are received or settled. The Company has recorded a valuation allowance against the deferred tax assets due to the uncertainty of ultimate realizability. EARNINGS (LOSS) PER SHARE - Earnings/ (Loss) per share is computed by dividing net income (loss) by the weighted average number of common and equivalent shares outstanding during the period. Outstanding stock options are treated as common stock equivalents for purposes of computing diluted earnings per share. As the Company incurred a net loss for the three and six months ended June 30, 2004 and for the three months ended June 30, 2003, the outstanding stock options and stock purchase warrants were antidilutive and have been excluded from the computation of diluted earnings per share. For the six months ended June 30, 2003, approximately 7,000 outstanding stock options are considered dilutive and are included in the denominator for the computation of diluted earnings per share. STOCK-BASED COMPENSATION - The Company has three stock-based employee compensation plans. The Company accounts for these plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation. 8 -------------------------------------------------------------------------------------------- For the Three Months Ended For the Six Months Ended June 30, June 30, -------------------------------------------------------------------------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- -------------------------------------------------------------------------------------------- Net income (loss), as reported $ (265,914) $ (36,046) $ (420,777) $ 8,090 -------------------------------------------------------------------------------------------- Less: Total stock-based employee compensation cost determined under the fair value based method, net of income taxes (5,806) (28,281) (11,613) (43,354) -------------------------------------------------------------------------------------------- Pro forma net income (loss) $ (271,720) $ (64,327) $ (432,390) $ (35,264) -------------------------------------------------------------------------------------------- Earnings per share: -------------------------------------------------------------------------------------------- Basic and Diluted - as reported $ (.08) $ (.01) $ (.13) $ .00 -------------------------------------------------------------------------------------------- Basic and Diluted - pro forma $ (.08) $ (.02) $ (.13) $ (.01) -------------------------------------------------------------------------------------------- LINE OF CREDIT - RELATED PARTY - On April 1, 2003, the Company entered into a $300,000 revolving line-of-credit agreement (the "Agreement") with DEMALE, LLC, an entity owned by certain stockholders of the Company. The line expires on June 30, 2005 and requires the Company, among other things, to maintain certain financial conditions. At June 30, 2004, there was $213,600 borrowed against this line. The line is secured by substantially all of the Company's assets but is subordinated to the bank line of credit, which holds a senior lien on the same assets. Interest is accrued and payable quarterly at prime plus 1 1/2% (6.5% at June 30, 2004) but may not be less than 7%; therefore, at June 30, 2004, interest was being accrued at 7%. 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations OVERVIEW In the quarter ended June 30, 2004, 1mage Software, Inc. (the "Company") generated only $334,000 in revenue, a 34% drop from year ago levels. The quarterly results were another setback for the Company as it seeks to consistently generate revenues comparable to those generated prior to the termination by Reynolds & Reynolds, Inc., its largest customer, of its 1996 Subscription and Maintenance Agreement with the Company. Since Reynolds' termination in April 2002, the Company's revenues have been dramatically reduced. Revenues from the Company's new customers since that time, which would have otherwise represented business growth, have been used instead to sustain operations. Similarly, the Company's $266,000 net loss for the recent quarter represents a setback for the Company's efforts to achieve a consistent record of profitability in the post-Reynolds era. In addition, while the Company brought various legal actions against Reynolds on various grounds, the recent dismissal of the Company's claims by an arbitrator means that a successful resolution of those legal actions is now unlikely. Accordingly, the Company will be rededicating itself to the development of new customers and new markets in the future. The more pressing challenge faced by the Company today, however, is that of liquidity. Because the Company has limited capital resources, namely a bank line of credit and a private line of credit from its shareholders, it cannot sustain such losses indefinitely without an adverse effect on its liquidity and operations. As a result, the Company implemented across the board pay cuts of 10% effective June 30 and has reduced headcount to 15 employees. Moreover, preliminary indications are that, with the distraction of the Reynolds arbitration hearing and decision no longer before it, the Company's sales should be stronger in the third quarter. RESULTS OF OPERATIONS FOR THREE MONTHS ENDED JUNE 30, 2004 VERSUS JUNE 30, 2003 The Company reported revenue of $334,000 for the second quarter of 2004, a $173,000 decrease (34%) from $507,000 posted for the second quarter in 2003. This decrease was due to a $125,000 (61%) decrease in revenue from software licenses and a $38,000 (17%) decrease in annual license fee revenue. In addition, legal expenses of $76,000 for the quarter represented a 176% increase over the second quarter of 2003, contributing to a $65,000 increase in Selling, General and Administrative expenses. Consequently, the Company posted a net loss of $266,000 or $(.08) per share, as compared to a net loss of $36,000, or $(.01) per share, for the same quarter a year ago. Annual license fee revenue of $185,000 for the second quarter was 17% lower than the $223,000 reported in the preceding year due to the timing of revenue recognition for certain customers. Revenue from hardware sales of $13,000 decreased $28,000 (69%) over the same quarter in 2003. SG&A expenses of $379,000 were $65,000 (21%) greater than the same quarter in 2003, primarily due to increases in legal and compensation expenses. 10 RESULTS OF OPERATIONS FOR SIX MONTHS ENDED JUNE 30, 2004 VERSUS JUNE 30, 2003 The Company reported revenue of $778,000 for the six months ended June 30, 2004, a decrease of $158,000, or 17%, from the $936,000 reported for the first six months in 2003. Gross profit decreased $173,000 for the comparable year to date periods. Software sales decreased $89,000, or 29%. Hardware sales decreased $60,000, or 70%, as a result of customers' varying needs for equipment. Annual license fees decreased $63,000, or 15%. For the six months ended June 30, 2004, gross profit as a percent of revenue was 42%, as compared to 53% for the year earlier period. SG&A expenses of $728,000 for the second quarter 2004 were $105,000 or 17% higher than $623,000 for the six months ended June 30, 2003, primarily due to increased salaries, legal expenses, and travel costs. The Company reported a net loss of $421,000, or $(.13) per share, for the six months ended June 30, 2004, as compared to net income of $8,090, or $.00 per share, for the same period one year ago. In first quarter 2003, the Company settled a liability of $139,000, which is included in other income, that related to a volume sale from a prior year that was tied to the purchase of future software licenses. LIQUIDITY AND CAPITAL RESOURCES The Company's cash and cash equivalents of $35,000 decreased approximately $108,000 during the six months ended June 30, 2004 as compared to December 31, 2003. During 2004, the Company used cash of $128,000 for deferred development expenses. The Company had a working capital deficit of $399,000 as of June 30, 2004, versus working capital of $175,000 as of December 31, 2003 and a working capital deficit of $94,000 as of June 30, 2003. The decline in working capital during the six months is attributable to the reclassification of the Company's private line of credit as short term debt since it matures in June, 2005. Included in current liabilities is $272,000 for Deferred Revenue, which represents payments on annual maintenance contracts that will be earned over the next twelve months. The Company had drawn $190,000 on its bank line of credit on June 30, 2004. The $200,000 bank line matures in February, 2005 and is collateralized by all accounts receivable and general intangibles of the Company. In addition, as of June 30, 2004, the Company had drawn $213,600 on its line of credit with DEMALE, a related party. This private line of credit has a cap of $300,000 and expires in June, 2005 and is secured by a second lien on the same assets as the bank line of credit. As noted above, the termination by Reynolds of its 1996 Subscription and Maintenance Agreement and the resulting loss of Reynolds as a customer has had a material adverse impact on the Company's revenue. There has been a corresponding adverse impact on cash flow and liquidity. The Company has failed to replace all of the revenue lost as a result of the termination of the 1996 contract and Reynolds' subsequent actions. At this point in time, in light of the arbitrator's decision to dismiss the Company's claims against Reynolds, it is unlikely that a significant amount of that lost revenue will be awarded to the Company in the ongoing litigation between the Company and Reynolds. Based on the arbitrator's decision, it is possible that the Company will never obtain a meaningful recovery from Reynolds. The Company's financial resources include cash on hand, revenues from operations, and management of funds available on its revolving lines of credit. In the Company's judgment, sufficient financial resources are available to meet current working capital needs. 11 FORWARD LOOKING STATEMENTS Some of the statements made herein that are not historical facts may be considered "forward looking statements," including but not limited to the statements made in the Overview section of this Management's Discussion and Analysis. All forward-looking statements are, of course, subject to varying levels of uncertainty. In particular, statements which suggest or predict future events or state the Company's expectations or assumptions as to future events may prove to be partially or entirely inaccurate, depending on any of a variety of factors, such as adverse economic conditions, new technological developments, competitive developments, competitive pressures, changes in the management, personnel, financial condition or business objectives of one or more of the Company's customers, increased governmental regulation or other actions affecting the Company or its customers as well as other factors. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INAPPLICABLE ITEM 4. CONTROLS AND PROCEDURES Internal Controls As of the end of the period reported on in this report, the company has undertaken an evaluation under the supervision and with the participation of management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective, in all material respects, with respect to the recording, processing, summarizing and reporting, within the time periods specified in the SEC's rules and forms, of information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act. There have been no significant changes in the Company's internal controls during the quarter ended June 30, 2004, or in other factors that could significantly affect internal controls subsequent to the date of the evaluation described above. PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On June 17, 2004, the company received notification from the American Arbitration Association that all of the Company's claims against the Reynolds and Reynolds Company ("Reynolds") submitted for arbitration had been dismissed and a second hearing would be held, as previously scheduled, on October 11, 2004 for consideration of Reynolds' counterclaims against the Company. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS INAPPLICABLE ITEM 3. DEFAULTS UPON SENIOR SECURITIES INAPPLICABLE ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Registrant's annual meeting of shareholders was held on June 7, 2004. At the meeting, David R. DeYoung, Mary Anne DeYoung, Robert Wiegand II, John G. Mazza and Spencer D. Lehman were elected as directors. The shareholders approved and ratified the appointment of BKD, LLP as the Company's independent accountants for the year ending 12 December 31, 2004, and approved an amendment to the Company's Equity Incentive Plan to increase the number of shares available under the Plan. The number of votes cast for or withheld for each director was as follows: NOMINEE FOR WITHHELD David R. DeYoung 3,187,281 10,458 Mary Anne DeYoung 3,187,281 10,458 Robert Wiegand II 3,187,309 10,430 John G. Mazza 3,187,366 10,373 Spencer D. Lehman 3,187,366 10,373 The number of votes cast for, against and abstentions for ratification of the auditors was as follows: FOR AGAINST ABSTAIN 3,169,719 27,745 275 The number of votes cast for, against and abstentions for approval of the amendment to the Company's Equity Incentive Plan was as follows: FOR AGAINST ABSTAIN 1,900,963 24,110 525 ITEM 5. OTHER INFORMATION INAPPLICABLE ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBIT TABLE 31.1 CERTIFICATE OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 31.2 CERTIFICATE OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 32 CERTIFICATE OF CEO AND CFO PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (B) REPORTS ON FORM 8-K A report on Form 8-K dated June 17, 2004 under Item 5 was filed with the Commission on June 24, 2004. 13 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. 1MAGE SOFTWARE, INC. (Registrant) Date: 8/16/2004 /S/ DAVID R. DEYOUNG -------------------- David R. DeYoung President, Principal and Chief Executive Officer Date: 8/16/2004 /S/ MARY ANNE DEYOUNG --------------------- Mary Anne DeYoung Vice President, Finance and Principal Financial Officer