The condensed consolidated balance sheet as of September 30, 2004, the condensed consolidated statement of operations for the nine-month and three-month periods ended September 30, 2004 and 2003, the condensed consolidated statement of stockholders’ equity for the nine-month period ended September 30, 2004 and the condensed consolidated statement of cash flows for the nine-month periods ended September 30, 2004 and 2003 have been prepared by the Company, without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position at September 30, 2004 and the results of operations for all of the periods reported have been made.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. The results of operations for the period ended September 30, 2004 are not necessarily indicative of the operating results for the full year.
2. INVENTORIES
Inventories consist of:
| |
|
|
September 30, 2004 |
|
December 31, 2003 |
|
| |
Raw materials |
|
$ |
282,221 |
|
$ |
283,917 |
|
| |
Finished goods |
|
|
71,838 |
|
|
93,465 |
|
| |
|
|
$ |
354,059 |
|
$ |
377,382 |
|
3. OTHER ASSETS
| |
|
|
September 30, 2004 |
|
December 31, 2003 |
|
| |
Software development costs, net of
accumulated amortization of $1,677,795
in 2004 and $1,224,428 in 2003 |
|
$ |
1,558,059 |
|
$ |
1,634,090 |
|
| |
Deposits |
|
|
13,461 |
|
|
3,685 |
|
| |
|
|
$ |
1,571,520 |
|
$ |
1,637,775 |
|
The Company capitalizes costs associated with the development of computer software for sale. Costs are capitalized at the point the Company determines that it is technologically feasible to produce the software title. Such costs are amortized at the greater of the amount computed using (a) the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for the product or (b) the straight-line method over the remaining estimated economic life of the product. Amortization begins when the product is available for general release to customers.
Covenants not to compete were amortized on a straight-line basis over two years, which was the life of the covenant agreements.
Amortization expense charged against earnings amounted to:
| |
|
|
Nine Months Ended September 30, |
|
| |
|
|
2004 |
|
2003 |
|
| |
Software development costs |
|
$ |
453,367 |
|
$ |
379,277 |
|
| |
|
|
|
|
|
|
|
|
| |
Covenants not to compete |
|
|
|
|
|
16,667 |
|
| |
|
|
$ |
453,367 |
|
$ |
395,944 |
|
4. STOCK BASED COMPENSATION
The Company applies APB Opinion No. 25 and related interpretations in accounting for all its stock option plans. Accordingly, no compensation cost has been recognized under these plans. The Company has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” which was released in December 2002 as an amendment to SFAS No. 123. The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all awards.
| |
|
|
Nine Months Ended September 30, |
|
| |
|
|
2004 |
|
2003 |
|
| |
Reported net income |
|
$ |
463,781 |
|
$ |
276,437 |
|
| |
|
|
|
|
|
|
|
|
| |
Stock-based employee compensation expense
determined under the fair value based method,
net of related tax effects |
|
|
(28,109 |
) |
|
(25,216 |
) |
| |
Pro forma net income |
|
$ |
435,672 |
|
$ |
251,221 |
|
| |
|
|
|
|
|
|
|
|
| |
Earnings per share (basic and diluted): |
|
|
|
|
|
|
|
| |
As reported |
|
$ |
0.02 |
|
$ |
0.02 |
|
| |
Pro forma |
|
$ |
0.02 |
|
$ |
0.01 |
|
5. CONTINGENCIES
On June 25, 2004, Merit Audio Visual, Inc. d/b/a Merit Software (“Merit”) filed a lawsuit in the Federal District Court for the Eastern District of Missouri against Siboney Corporation, Siboney Learning Group, Inc., and Ernest R. Marx (collectively “Siboney”), alleging copyright infringement and breach of contract and seeking damages of $3,450,000, injunctive relief, attorney’s fees, and costs. The lawsuit arose from a long-term relationship between the parties established in 1996 with a licensing agreement which grants Siboney the right to “create, market, sell, lease and distribute in the schools market” software products which incorporate certain Merit software. The complaint alleged that Siboney had sold software bundles incorporating certain Merit software under the name “Or
chard Home” outside of the “schools market,” allegedly breaching the licensing agreement and infringing
Merit’s alleged copyright in its software. The complaint also alleged other miscellaneous breaches of the licensing agreement, including failing to obtain Merit’s consent for certain changes to Merit’s software, and disputing the amount of royalties due. Siboney filed a counterclaim against Merit, seeking damages for breach of the licensing agreement by Merit and a declaratory judgment of noninfringement of Merit’s alleged copyright. Siboney believes that it has reached an agreement in principle with Merit to settle all claims in the lawsuit. The principal terms of this Agreement are as follows: none of the parties will admit liability for any of
the claims in the lawsuit; the software licensing agreement will be terminated as of a future date; Siboney will pay royalties due under the licensing agreement through its termination; Siboney will to pay to Merit $465,000 upon execution of the settlement agreement, plus additional payments of $100,000 for each of the next two years; and Merit will return a portion of the royalty payments previously made by Siboney of approximately $50,000.
Executive Overview
The Company’s principal subsidiary, Siboney Learning Group, Inc., publishes and distributes educational software, primarily for schools. The Company has 61 full-time employees.
The Company has served the educational market for more than 35 years. Since 1986, the Company’s principal business has been publishing educational software in reading, language arts, math, science and English as a Second Language for students and teachers in levels kindergarten through adult. The Company is best known for its software which is designed to motivate students to master key skills and keep track of student progress for teachers to review.
The Company’s growing portfolio of products now includes more than 190 active titles that focus on teaching basic skills and new concepts while meeting the different learning needs of all students through time-on-task instruction. Popular titles include Math Concepts, Phonics Mastery, Reading Concepts, Touchdown Math, Diascriptive Reading and Process Writing.
Siboney Learning Group currently offers five distinct product categories which are developed, marketed and supported by the same core team: Orchard Teacher’s Choice Software; Teacher Support Software; Educational Activities Software; Journey; and GAMCO Educational Software. These products allow the Company to offer a wide range of product selection to schools and adult education centers at a variety of budget levels.
Orchard Teacher’s Choice Software (“Orchard”) offers schools and school districts a broad curriculum-based solution with universal management and assessment. Orchard is sold through a network of dealers and direct and independent representatives who actively call on schools to sell larger curriculum- and technology-based learning solutions. Orchard includes universal management which tracks student progress across all programs, as well as pre- and post-test assessment that identifies problem areas and measures instructional gain. The Company believes that Orchard has become a recognized competitor in the growing Integrated Learning Systems market as a result of its motivating and balanced content designed for instructional improvement, strong correlation to major national tests and state objectives, and
its cost-effective pricing structure. The Company believes that its new Orchard For Your State versions will help maintain Orchard’s consistent growth in sales as schools look for proven ways to meet the new federal mandate for accountability in all states provided in the No Child Left Behind Act of 2001. Orchard For Your State offers schools and school districts state-specific versions of Orchard that are directly correlated to each state’s educational standards. The No Child Left Behind Act of 2001 will require all students in grades three to eight in all states to take important tests based upon each state’s standards starting in 2005. Orchard For Your State is
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
a direct response to, and solution for, the emerging critical need for state-specific accountability and instructional improvement. The Company has released 42 state-specific versions of Orchard For Your State and is planning to release three additional versions during the remainder of 2004.
The Teacher Support Software (“TSS”) product line, which was acquired in 2000, is best known for its popular tools for teachers, including Worksheet Magic, and its effective and comprehensive reading programs, including WordWorks. TSS products are sold through all of the Company’s sales channels as single-title solutions and as part of comprehensive Orchard solutions. The Company has actively upgraded older TSS products to be compatible with the computers a
nd networks found in schools today.
The Company’s Educational Activities Software (“EAS”) line, which was acquired in 2001, is best known for its Diascriptive Reading series, which is sold through a network of independent representatives to schools, community colleges, adult learning centers and correctional facilities. This line is the Company’s primary product offering for the adult learning market and allows the Company to achieve incremental sales growth in a growing market for instruction in basic skills for adults. The Company has committed software development resources to web enable selected EAS titles since the older learner market appears to be increasingly responsive to software delivered to students over the Internet. In addition, the Company sells selected EAS titles to its K-12 school customers and has released a new com
prehensive solution with universal management, called Real Achievement, based upon EAS titles and appropriate titles from the Company’s portfolio of other software.
Journey, the comprehensive software product line acquired in 2001, is being upgraded to be competitive with other structured comprehensive solutions. The Company believes that Journey is an attractive complementary product for Orchard due to its structured and sequenced content that adapts to individual learning needs.
GAMCO Educational Software (“GAMCO”), the Company’s original product, provides schools with single titles and series which the Company believes are highly motivating. GAMCO products are sold through major national and regional school software dealers, the Company’s inside sales force and its direct catalog and promotions. All GAMCO titles include management features that track student progress and allow teachers to modify the instruction to meet individual learning needs.
The Company also has generated sales of select products through a direct-to-the-home marketer of educational software. This alliance allows the Company to reach families in their homes without relying on expensive retail distribution.
The Company also has certain natural resources interests, including coal, oil and gas, through Siboney Coal Company, Inc. and several other subsidiaries which are not believed to be material to the Company’s ongoing results of operations or financial condition.
Results of Operations
The following is management’s discussion and analysis of certain significant factors which have affected the Company’s financial position and operating results during the periods covered by the accompanying condensed consolidated financial statements.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Three Months Ended September 30, 2004 Compared To September 30, 2003
Total revenues increased 24.6% or $381,539 to $1,930,092 from $1,548,553 during the three-month period ended September 30, 2004 compared to the third quarter of 2003, reflecting increased sales of Siboney Learning Group. Sales of the Company’s Orchard Software increased 48% during the third quarter of 2004 compared to the third quarter of 2003.
Cost of product sales decreased 7.1% or $32,818 to $429,001 from $461,819 during the third quarter of 2004 compared to the third quarter of the previous year. This decrease was primarily due to the adjustment of previously accrued estimated royalty payments compared to actual payments made. Cost of product sales as a percentage of revenue decreased from 29.8% for the third quarter of 2003 to 22.2% for the third quarter of 2004 also primarily due to adjustment of the accrual for estimated royalties.
Selling, general and administrative expenses increased 30.6% or $469,974 to $2,003,819 from $1,533,845 during the quarter ended September 30, 2004 compared to the third quarter of 2003 primarily due to increased salary and payroll-related expenses, increased commissions paid as the result of increased sales and higher professional fees.
Litigation settlement expense of $615,000 for the quarter ended September 30, 2004 represents the pending settlement of a previously filed suit against the Company by Merit Software. The Company decided to settle the litigation to avoid the expense, uncertainty and management distraction of continued proceedings.
The Company’s net loss for the third quarter of 2004, primarily for the reasons described above, was $664,677 after income tax benefit of $444,193 compared to a net loss of $274,604 after income tax benefit of $172,000 for the third quarter of 2003 representing an increase of 142%. Loss per common share, basic and diluted, was $0.04 for the third quarter of 2004 compared to $0.02 for the third quarter of 2003.
Nine Months Ended September 30, 2004 Compared To September 30, 2003
Total revenues increased 28.4% or $1,821,819 to $8,235,729 from $6,413,910 during the nine-month period ended September 30, 2004 compared to the same period of 2003, reflecting increased sales of Siboney Learning Group. Sales of the Company’s Orchard Software increased 37% during the nine-month period of 2004 compared to the same period of 2003 while sales of the Company’s other product categories increased 11% compared to the corresponding period of 2003. Two large district-wide orders for Orchard For Your State were primarily responsible for the increase in Orchard sales. The Company believes Orchard’s success in improving student achievement in individual school buildings has led to district-wide orders in school districts facing increasing demands for Adequate Yearly Progress as mandated by the No Ch
ild Left Behind Act. Revenues from the other product categories increased due to increased sales of professional development and premium technical support and installation.
Cost of product sales increased 12.6% or $184,932 to $1,654,717 from $1,469,785 during the nine-month period of 2004 compared to the corresponding period of the previous year. This increase was primarily due to increased sales at Siboney Learning Group. Cost of product sales as a percentage of revenue decreased from 22.9% for the period ended September 30, 2003 to 20.1% due to increased sales of higher margin Orchard Software.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Selling, general and administrative expenses increased 22% or $983,707 to $5,460,332 from $4,476,625 during the period ended September 30, 2004 compared to the corresponding period of 2003 primarily due to increased salary and payroll-related expenses, increased commissions paid as the result of increased sales and higher professional fees.
Litigation settlement expense of $615,000 for the nine-month period ended September 30, 2004 represents the pending settlement of a previously filed suit against the Company by Merit Software.
During the first quarter of 2004, the Company became aware that a new residential subdivision being developed in Johnson County, Kentucky encroaches on property owned by Siboney Coal Company, a subsidiary. In the second quarter of 2004, the Company negotiated a settlement agreement with the developer and signed a Quitclaim Deed transferring approximately 82 acres to the developers of the subdivision in return for $219,780 which was recognized as gain on the sale of an asset.
The Company’s net income for the nine-month period of 2004, primarily for the reasons above, was $463,781 after income tax expense of $271,234 compared to net income of $276,437 after income tax expense of $178,000 for the same period of 2003 representing an increase of 68%. Earnings per common share, basic and diluted, were $0.02 for the nine-month period of 2004 and 2003.
Liquidity and Capital Resources
Cash increased 70.2% or $773,854 to $1,876,462 at September 30, 2004 compared to $1,102,608 at December 31, 2003 reflecting increased sales of Siboney Learning Group and the sale of real estate by Siboney Coal Company.
Accounts receivable decreased 29.6% or $454,752 at September 30, 2004 compared to December 31, 2003 due to decreased sales during August and September 2004 compared to November and December 2003.
Prepaid income taxes increased to $437,380 as estimated tax payments remitted in prior quarters became refundable as a result of the tax-basis operating loss incurred in the three-month period ended September 30, 2004.
Accrued litigation liability increased $615,000 at September 30, 2004 compared to December 31, 2003 as a result of the pending settlement of a previously filed suit against the Company by Merit Software. The Company expects to pay $415,000 of the amount during the fourth quarter of 2004.
The Company has financed its business primarily with cash generated from operating activities, accessing its bank revolving line of credit and purchase money financing provided by the sellers of companies acquired. The line of credit agreement, which matures in April 2005 provides for maximum borrowings of $1.0 million and is secured by the Company’s accounts receivable, equipment and inventory. The loan agreement requires the Company to maintain a net worth of at least $2.5 million. As of September 30, 2004, the Company reported a net worth of $5.4 million and there was no balance outstanding under the Company’s line of credit. The Company believes that it will be able to renew its line of credit and that its available capital resources are adequate to support its current business levels.
The Company presently does not use any derivative financial instruments to hedge its exposure to adverse fluctuations in interest rates, foreign exchange rates, fluctuations in commodity prices or other market risks, nor does the Company invest in speculative financial instruments. Borrowings with the bank bear interest at prime rate and 0.25% above prime rate.
Due to the nature of the Company’s borrowings, it has concluded that there is no material market risk exposure and, therefore, no quantitative tabular disclosures are required.
Based on their evaluation as of the end of the period covered by this report, Timothy J. Tegeler, the Company’s Chief Executive Officer and William D. Edwards, Jr., the Company’s Chief Financial Officer, have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) are effective. There have been no changes in internal controls over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
***
This report contains “forward-looking statements” as that term is defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Any forward-looking statements are necessarily subject to significant uncertainties and risks. When used in this report, the words “believes,” “anticipates,” “intends,” “expects” and similar expressions are intended to identify forward-looking statements. Actual results could be materially different as a result of various possibilities.
Factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to, the following: (1) the Company’s ability to enhance its existing products and introduce new products; (2) a delay or reduction in school purchases of the Company’s products due to governmental budgetary and funding constraints resulting in a reduction in the funds available to the Company’s school customers; (3) acceptance and demand for new educational products; (4) an overall decline in sales of the Company’s Orchard product category, which accounts for a significant portion of the Company’s revenue; (5) the impact of competitive products and pricing; (6) the Company’s ability to establish and protect its copyrights, licenses and other intellectual property ri
ghts, including the resolution of disputes regarding licensed software; (7) seasonal variations due to, among other things, the budget and school year cycles of the Company’s school customers; and (8) the risks detailed from time to time in the Company’s filings with the Securities and Exchange Commission.
No assurances can be given that the results contemplated in any forward-looking statements will be achieved or will be achieved in any particular timetable. The Company assumes no obligation to publicly correct or update any forward-looking statements as a result of events or developments subsequent to the date of this report. The reader is advised, however, to consult any further disclosures the Company makes on related subjects in reports to the SEC.
PART II - OTHER INFORMATION
On June 25, 2004, Merit Audio Visual, Inc. d/b/a Merit Software (“Merit”) filed a lawsuit in the Federal District Court for the Eastern District of Missouri against Siboney Corporation, Siboney Learning Group, Inc., and Ernest R. Marx (collectively “Siboney”), alleging copyright infringement and breach of contract and seeking damages of $3,450,000, injunctive relief, attorney’s fees, and costs. The lawsuit arose from a long-term relationship between the parties established in 1996 with a licensing agreement which grants Siboney the right to “create, market, sell, lease and distribute in the schools market” software products which incorporate certain Merit software. The complaint alleged that Siboney had sold software bundles incorporating certain Merit software under the name “Or
chard Home” outside of the “schools market,” allegedly breaching the licensing agreement and infringing Merit’s alleged copyright in its software. The complaint also alleged other miscellaneous breaches of the licensing agreement, including failing to obtain Merit’s consent for certain changes to Merit’s software, and disputing the amount of royalties due. Siboney filed a counterclaim against Merit, seeking damages for breach of the licensing agreement by Merit and a declaratory judgment of noninfringement of Merit’s alleged copyright. Siboney believes that it has reached an agreement in principle with Merit to settle all claims in the lawsuit. The principal terms of this Agreement are as follows: none of the parties will admit liability for any of the claims in the lawsuit; the software
licensing agreement will be terminated as of a future date; Siboney will pay royalties due under the licensing agreement through its termination; Siboney will to pay to Merit $465,000 upon execution of the settlement agreement, plus additional payments of $100,000 for each of the next two years; and Merit will return a portion of the royalty payments previously made by Siboney of approximately $50,000.
Issuer Purchases of Equity Securities
The following table presents information with respect to purchases of common stock made during the three months ended September 30, 2004 by the Company.
| |
|
|
|
|
|
Period |
(a)
Total
Number of
Shares
Purchased |
(b)
Average
Price Paid
per Share |
(c)
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs(1) |
(d)
Maximum Number of
Shares that May Yet
Be Purchased Under the
Plans or Programs |
|
Month #1
(July 1, 2004 -
July 31, 2004) |
25,000 |
$0.39 |
25,000 |
945,000 |
|
Month #2
(August 1, 2004 -
August 31, 2004) |
0 |
|
|
945,000 |
|
Month #3
(September 1, 2004 -
September 30, 2004) |
100,000 |
$0.44 |
100,000 |
845,000 |
|
Total |
125,000 |
$0.43 |
125,000 |
845,000 |
| |
|
|
|
|
|
| |
|
|
|
|
|
| |
(1) |
On March 8, 2004, the Board of Directors authorized a stock repurchase program under which the Company may purchase up to 1,000,000 shares of the Company’s common stock from time to time in the open market or in privately negotiated transactions. |
(a) Exhibits: Exhibits required as part of this report are listed in the index appearing on page 16.
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.
| |
SIBONEY CORPORATION |
| |
|
| |
|
| |
By: /s/ William D. Edwards, Jr. |
| |
William D. Edwards, Jr. |
| |
Executive Vice President and |
| |
Chief Financial Officer |
|
|
(Authorized officer and principal financial officer) |
November 15, 2004
Exhibits
|
31.1 |
Certification by Chief Executive Officer pursuant to Rule 13a - 14(a) or Rule 15d - 14(a) of the Securities Exchange Act of 1934 |
| |
|
|
31.2 |
Certification by Chief Financial Officer pursuant to Rule 13a - 14(a) or Rule 15d - 14(a) of the Securities Exchange Act of 1934 |
| |
|
|
32.1 |
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| |
|
|
32.2 |
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |