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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
Commission file number 1-9330
INTELLIGENT SYSTEMS CORPORATION
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(Exact name of Registrant as specified in its charter)
GEORGIA 58-1964787
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
4355 SHACKLEFORD ROAD, NORCROSS, GEORGIA 30093
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (770) 381-2900
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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COMMON STOCK, $.01 PAR VALUE AMERICAN STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]
As of March 15, 2002, 4,495,530 shares of Common Stock were outstanding. The
aggregate market value of the Common Stock held by non-affiliates of the
registrant was $3,494,558 (computed using the closing price of the Common Stock
on March 15, 2002 as reported by the American Stock Exchange).
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the registrant's Proxy
Statement for the Annual Meeting of Shareholders to be held on May 23, 2002,
are incorporated by reference in Part III hereof.
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TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business...........................................................................................3
2. Properties.........................................................................................8
3. Legal proceedings..................................................................................8
4. Submission of matters to a vote of security holders................................................8
PART II
5. Market for the registrant's common equity and related stockholder matters..........................8
6. Selected financial data............................................................................9
7. Management's discussion and analysis of financial condition and results of operations..............9
7A. Quantitative and qualitative disclosures about market risk........................................13
8. Financial statements and supplementary data.......................................................14
9. Changes in and disagreements with accountants on accounting and financial disclosure..............14
PART III
10. Directors and executive officers of the registrant................................................14
11. Executive compensation............................................................................14
12. Security ownership of certain beneficial owners and management....................................14
13. Certain relationships and related transactions....................................................14
PART IV
14. Exhibits, financial statement schedules and reports on Form 8-K...................................15
Signatures ..................................................................................................18
PART I
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Form 10-K may contain
forward-looking statements relating to Intelligent Systems Corporation
(ISC). All statements, trend analysis and other information contained
in the following discussion relative to markets for our products and
trends in revenue, gross margins and anticipated expense levels, as
well as other statements including words such as "anticipate",
"believe", "plan", "estimate", "expect", "likely" and "intend", and
other similar expressions constitute forward-looking statements.
Prospective investors are cautioned that any such forward-looking
statements are not guarantees of future performance and involve risks
and uncertainties, and that actual results may differ materially from
those contemplated by such forward-looking statements. Among the
important factors that could cause actual results to differ materially
from those indicated by such forward-looking statements are delays in
product development, undetected software errors, competitive
pressures, technical difficulties, market acceptance, availability of
technical personnel, changes in customer requirements, changes in
financial markets, performance and financial condition of affiliate
companies, and general economic conditions. ISC undertakes no
obligation to update or revise its forward-looking statements to
reflect changed assumptions, the occurrence of unanticipated events or
changes in future operating results.
ITEM 1. BUSINESS
OVERVIEW
Intelligent Systems Corporation, a Georgia corporation, has operated either in
corporate or partnership form since 1973 and its securities have been publicly
traded since 1981. In this report, sometimes we use the terms "company", "we",
"ours" and similar words to refer to Intelligent Systems Corporation. We
operated as a master limited partnership from 1986 to 1991, when we merged into
the present corporation. Our executive offices are located at 4355 Shackleford
Road, Norcross, Georgia 30093 and our telephone number is (770) 381-2900.
Since the early 1980's, we have conducted our operations principally through
majority owned subsidiaries or minority owned affiliates to which we devote
extensive management resources. Frequent acquisitions of or investment in
promising early stage companies in the technology industry have long been
components of our overall strategy. Since most of our companies are early or
growth stage businesses, from time to time they may require funding, in excess
of what we can provide, from third parties or the public markets to support
their business plan. They may seek to be acquired or to merge with another
company in response to various market conditions or if circumstances indicate
that operating as a stand-alone company is not in their best interest. As a
result, our ownership position frequently changes from time to time. Moreover,
in the past several years, we have sold or discontinued several subsidiaries,
such as InterQuad Services and PsyCare America, generally in response to what
we believe to be unfavorable industry trends or prospects as stand-alone
companies. We anticipate that generally lower valuations for early stage
companies and our increased liquidity will allow us to increase the number of
companies we control and in which we are involved in day-to-day management of
their operations.
Our main focus is to help entrepreneurs build valuable companies by providing
operational and strategic management, practical business advice, early stage
equity capital, a network of business contacts and, in some cases, a proven
incubator program. Depending upon the needs of the partner company, we will
undertake a variety of roles which often include day-to-day management of
operations, board of director participation, financing, market planning,
strategic contract negotiations, personnel and administrative functions, etc.
Most of our partner companies are involved in the information technology
industry (principally software for business applications) although we are
involved in other industries as well (including industrial products,
biotechnology, and wireless).
INTELLIGENT SYSTEMS CORPORATION
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FINANCIAL REPORTING
We consolidate the results of operations of our partner companies in which we
own a majority interest or exert control. We account for investments in
affiliate companies in which we own 20 to 50 percent or in which we exert
significant influence by the equity method. In general, under the equity
method, we include our pro rata share of the income or loss generated by each
of these businesses as investment income (loss) on a quarterly basis. These
equity losses and income decrease or increase, respectively, our cost basis of
the investment. However, if there is no commitment for ISC to provide
additional funding to the company, to the extent losses exceed our cost, we do
not record a value below zero. Because of this equity method accounting
treatment, some of our affiliate companies may be recorded at zero on our
balance sheet but their estimated market value may be substantially higher.
Privately owned partner companies in which we own less than 20 percent of the
equity are carried at the lower of cost or market. We do not mark up the value
of privately-owned businesses even when they raise money at higher valuations.
We are often actively engaged in managing strategic and operational issues with
our non-consolidated companies and devote significant resources to the
development of the business.
RECENT ACQUISITION AND INDUSTRY SEGMENT OVERVIEW
On July 1, 2001, we increased our ownership in VISaer, Inc. from a 40 percent
interest to a 65 percent interest. The purchase was treated as a step
acquisition and we have consolidated the results of operations of VISaer, Inc.
since the date of the transaction. See Note 2 to the Consolidated Financial
Statements for details of the transaction and related purchase accounting. Our
consolidated companies operate in two industry segments: Information Technology
products and services, and Industrial Products. The Information Technology
segment includes our VISaer and QS Technologies subsidiaries and the Industrial
Products segment includes ChemFree. Prior to 2001, we reported information on
two segments: Technology and Health Care. In November 2000, we sold the
principal operating assets of our PsyCare subsidiary in response to unfavorable
market conditions in the managed health care environment. Therefore, we do not
have a Health Care industry segment in 2001. We also changed our segment
reporting to separate the ChemFree operations as our new Industrial Products
segment and renamed the Technology segment as the Information Technology
segment. We have restated segment data from prior reporting periods to
correspond to the current industry segments. All of our subsidiaries are
wholly-owned except for VISaer, in which our ownership is 65 percent.
Operations in the Information Technology segment are involved in the design,
development and marketing of application software products that are used by
business customers and government agencies to manage aspects of their
operations. Our software products are typically sold in competitive bids with
relatively long sales and implementation cycles. We receive software license
fees that vary depending upon the number of licensed users and the number of
software modules licensed with total contract revenue typically ranging from
$100,000 to more than a million dollars. We also derive service revenue from
implementation, customization, training and support services.
The Industrial Products segment includes the design, assembly and sale of
equipment and associated supplies that are used by commercial, industrial,
military and government agencies to maintain and service machinery or vehicles
used in their operations. Our assembled products are shipped to resellers or
direct to customer sites and do not require set-up or on-site support from us.
Unit pricing varies by model but typical end-user prices are less than $2,000.
Customers purchase replacement supplies from us after the sale.
Our individual operations in both segments are relatively small in size and are
subject to greater fluctuation in revenue and profitability than larger, more
established businesses. The business in our segments is not seasonal. In each
of the three years ended December 31, 2001, revenue related to ChemFree and QS
Technologies products have represented more than 15 percent each of
consolidated revenue. In 2001, revenue related to VISaer's products represented
more than 15 percent of consolidated revenue. For ease of comprehension, the
business discussion which follows contains information on products, markets,
competitors, research and development and manufacturing for our operating
subsidiaries, organized by industry segment and by company. For further
detailed financial information concerning our segments, see Notes 15 and 18 in
the accompanying Notes to the Consolidated Financial Statements.
INTELLIGENT SYSTEMS CORPORATION
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INDUSTRY SEGMENT: INFORMATION TECHNOLOGY PRODUCTS AND SERVICES
VISAER - VISaer develops, sells and supports software for the world-wide
commercial aviation industry. The VISaer software helps aviation customers
manage the extensive requirements and processes involved in their maintenance,
repair and overhaul (MRO) operations. Headquartered in Wilmington,
Massachusetts, VISaer also has operations in England and Ireland to support
product development and sales activities in Europe. VISaer is the successor
company of Visibility, Inc., a software company in the enterprise resource
planning market whose operations were sold in July 2000 to allow VISaer to
concentrate on the faster growing MRO software market. VISaer's current product
offering, VISaer 2.4, includes the following major components: technical
records planning and management, MRO operations, materials management,
production scheduling, commercial operations and financial management. Version
2.5, scheduled for release in the second half of 2002, will include additional
modules and features. VISaer expects to release Version 3.0, a fully Web-native
version of the complete MRO solution, in late 2002. In mid-2001, VISaer signed
a major contract with United Parcel Systems (UPS) for its Version 3.0 software
and has approximately $2.6 million in deferred revenue at December 31, 2001
associated with the contract. In addition, VISaer has a backlog of
approximately $3-4 million related mainly to this contract and annual support
contracts. Revenue related to the UPS contract will be recognized upon contract
completion which is anticipated in early 2003. The UPS contract has certain
non-competition and acceptance provisions that the company must comply with.
The general slow-down in the global economy and the terrorist attacks of
September 11, 2001 have had a significant negative impact on the commercial
aviation market. The company believes that some airlines have delayed or
canceled planned information technology projects and others may not have the
financial strength to weather the current downturn. However, regulatory
requirements dictate that airlines manage their MRO processes carefully and
there is increased pressure to improve and automate MRO record-keeping.
VISaer's software products provide a comprehensive, cost-effective way to do
so. VISaer expects that low-cost airlines, defense related aviation, MRO
service outsourcing companies, private airlines and emerging global markets
will provide additional sales opportunities beyond the larger commercial
airlines.
VISaer markets and sells its software products and related support and
maintenance services to customers in both domestic and foreign markets. In some
cases, it sells direct to the customer; in other cases, it sells through
re-sellers such as Unisys Corporation that represents the company on a
non-exclusive basis in several Pacific Rim markets. Sales through Unisys
represented 18 percent of consolidated revenue in 2001. In most cases, sales
are made in response to competitive bids and RFP's and have sales cycles of
6-18 months with implementation periods of 6-18 months. VISaer provides full
suite implementation services and post-sales support and maintenance activities
under annual contracts as well as ongoing professional services. VISaer has a
number of competitors, some of whom offer MRO software as part of an Enterprise
Resource Planning package and who have significantly more financial resources,
larger customer bases and greater market coverage than VISaer. Other
competitors are smaller players focused on MRO solutions with resources similar
to VISaer. The company competes on the basis of providing full product
functionality and integration, offering a complete software and service
solution, and providing software that runs on industry standard technology
platforms. VISaer expects that its Web-native software version will be a strong
competitive offering.
QS TECHNOLOGIES - QS Technologies operates from its Greenville, South Carolina
location, providing health and human services software products, maintenance
and support services to its installed customer base as well as new customers.
QS Technologies' products allow public health agencies to capture, analyze and
manage client information such as immunization, maternal health, and birth and
death records. The market includes local, state and federal public health
agencies nationwide as well as other government agencies, hospitals and
clinics. The market is fragmented and limited in size. QS Technologies competes
against a number of other software companies, many of which are small vendors
like itself and some of which are larger with access to greater resources. QS
Technologies competes on the basis of product functionality and value,
reputation for customer service and knowledge of market requirements acquired
through twenty years in the market. Sales are typically made in response to
competitive bids and may take six to twelve months to complete. Demand for
products and the timing of contract awards is impacted by general economic
conditions as well as customer-specific factors such as state and local budgets
and program priorities, over which QS has little control. Typically, QS
Technologies provides its customers with post-sales service and support under
annual contracts that often renew for multiple years after the initial software
license fee is earned. QS Technologies is engaged in new product
INTELLIGENT SYSTEMS CORPORATION
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development (including a web-based initiative) and enhanced sales activities to
expand its customer base and generate future revenue.
INDUSTRIAL PRODUCTS SEGMENT
CHEMFREE CORPORATION - Our only subsidiary in the Industrial Products segment
is ChemFree Corporation (ChemFree), one of our early incubator companies, that
designs, manufactures and markets a line of parts washers under the
SmartWasher(TM) trademark. SmartWashers use an advanced bio-remediation system
to clean automotive and machine parts without using hazardous, solvent-based
chemicals. SmartWashers consist of a molded plastic tub and sink, recirculating
pump, heater, control panel, filter with microorganisms, and aqueous based
degreasing solutions. Unlike traditional solvent-based systems, there are no
regulated, hazardous products used or produced in the process and the
SmartWasher system is completely self-cleaning. ChemFree sells replacement
fluid and filters to its customers on a regular basis after the initial parts
washer sale.
ChemFree's markets include the automotive, transportation, industrial and
military markets. The automotive market includes companies and governmental
agencies with fleets of vehicles to maintain; automobile manufacturers with
extensive service networks such as Chrysler, GM and BMW; and individual and
chains of auto repair shops and auto parts suppliers. The industrial market
includes customers with machinery that requires routine maintenance, such as in
the textile industry. Military applications include vehicle service depots in
all branches of the military. ChemFree sells its products directly to high
volume customers as well as through several distribution channels, including
international distributors in Europe and the Pacific Rim. ChemFree also sells
in competitive bid situations and under a GSA schedule to government agencies.
Because ChemFree sells in part through large national distributors such as NAPA
in the United States and exclusive distributors in certain international
markets, its results could be impacted negatively if one or more of such
customers discontinues distribution and sales of ChemFree products. One of
ChemFree's international distributors represented 10 percent of consolidated
revenue in each of the last two years. Part of ChemFree's revenue is derived
from multi-year contracts under which ChemFree provides SmartWashers and
supplies to large corporate customers, such as Firestone, at multiple corporate
sites.
ChemFree competes with larger, established companies that offer solvent-based
systems, other small companies using non-hazardous systems, and hazardous waste
hauling firms. Although smaller than the established solvent-based firms,
ChemFree believes it is competitive based on product features, positive
environmental impact, improved health and safety features, elimination of
regulatory compliance, and price.
Warranty service, typically covering a one-year period, is provided either by
ChemFree personnel or through its distributors and dealers. ChemFree
subcontracts the manufacturing of major sub-assemblies built to its
specifications to various vendors and performs final assembly and testing at
its own facility. While there are multiple sources available for subassemblies,
ChemFree frequently contracts with a single source for certain components in
order to benefit from lower prices and consistent quality.
INCUBATOR PROGRAM
For more than ten years, we have operated the Intelligent Systems Incubator at
our corporate facility in the suburbs of Atlanta, Georgia. We believe our
incubator program is one of the longest running and largest self-funded
incubator programs in the United States. In exchange for a monthly facility
fee, incubator companies have access to resources such as office space,
conference facilities, telecommunication and network infrastructure, business
advice and planning, a network of professional services, and, in some cases,
financial capital. Depending upon the experience and needs of the founding
entrepreneur, incubator companies will choose to use some or all of the
available resources. The incubator staff takes care of time-consuming
infrastructure issues so the entrepreneur can focus on driving business
development. Income from incubator companies reduces our total facility and
personnel costs. The incubator also provides us with the opportunity for
day-to-day involvement with emerging companies that may become partnership
companies, either as majority-owned subsidiaries or minority-owned affiliates.
In 1999, ChemFree Corporation, an incubator company and majority owned company,
was named Incubator Company of the Year (Manufacturing category) by the
National Business Incubation Association.
INTELLIGENT SYSTEMS CORPORATION
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We are equity partners in some but not all of the companies in our incubator
program. Because we have a large incubator facility, we can offer the benefits
of the incubator program to non-affiliate companies. Conversely, many of our
subsidiary and minority owned partner companies are not located in our
incubator. In attracting companies to our incubator program, we compete with
other sources of business assistance, facilities and financial capital that may
be available to the entrepreneur. These sources include other incubator
programs as well as angel and venture capital investors, corporate partner
relationships and merger/sale opportunities. We do not record revenue from
incubator lease income; rather such amounts are offset against the corporate
facility expenses.
AFFILIATED PARTNER COMPANIES
Part of our business strategy is to seek out and form relationships with
companies that we believe are involved in promising technologies or markets
with good growth potential. From time to time, we have acquired or invested in
such companies and expect to continue to do so as a regular part of our
strategy. When we become involved, these companies are privately held, early
stage companies in technology-related fields. We are often actively involved in
helping the companies develop and implement their business plans. Some examples
of our involvement are as follows:
- Initially, we owned a 40 percent equity position in VISaer, Inc., a
privately held company that designs, develops and markets software
products addressing the global aircraft maintenance, repair and
overhaul market. We increased our ownership in VISaer to 65 percent in
2001 and now consolidate its results.
- Initially we own a 27 percent interest in Delos Payment Systems, Inc.,
a development stage software company spun off from former affiliate
company, PaySys International, Inc. in April 2001. As of January 2002,
due to a default by Delos on an outstanding loan, we acquired control
of Delos, we are actively involved in managing the company at our
incubator facility and we will consolidate its results of operations.
Refer to Note 20 to the consolidated financial statements.
- A 25 percent interest in affiliate company CoreXpand, a software
company with an e-commerce application for promotional and incentive
product distributors. CoreXpand is part of the Intelligent Systems
Incubator program.
- An 18 percent interest in Cirronet Inc., a privately held and former
incubator company involved in wireless telecommunications products for
industrial and commercial markets as well as residential and small
business wireless Internet markets. Refer to Note 4 to the
Consolidated Financial Statements.
- A less than one percent position in Atherogenics, a pharmaceutical
company involved in novel drugs which address inflammatory diseases
such as cardiovascular disease and asthma. Atherogenics completed its
initial public offering in August 2000. We were part of the original
investor group of Georgia-based institutions supporting the company's
efforts to commercialize technology developed at Emory University.
- A three percent interest in RF Solutions, Inc., a start-up company
that is developing proprietary radio frequency integrated chips used
in broadband wireless products. The development stage company is
building on the founding team's world-renowned research at Georgia
Tech to develop commercial products.
RESEARCH AND DEVELOPMENT
The Company spent $3,371,000, $915,000 and $805,000 in the fiscal years ended
December 31, 2001, 2000 and 1999, respectively, on company sponsored research
and development. The Information Technology segment increased spending on
software development significantly in 2001 mainly due to an intensive effort
related to the VISaer 3.0 product line, which is expected to continue through
at least 2002.
PATENTS, TRADEMARKS AND TRADE SECRETS
The ChemFree subsidiary has several patents (both issued and pending) covering
certain aspects of its products and processes. It may be possible for
competitors to duplicate certain aspects of these products and processes even
though we regard such aspects as proprietary. We have registered with the US
Patent and Trademark Office
INTELLIGENT SYSTEMS CORPORATION
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and various foreign jurisdictions numerous trademarks and service marks for our
products. We believe that an active trademark and copyright protection program
is important in developing and maintaining brand recognition and protecting its
intellectual property. Our companies presently market their products under
trademarks and service marks such as SmartWasher, OzzyJuice, VISaer and others.
PERSONNEL
As of February 28, 2002, we had 145 full-time equivalent employees in our
majority-owned or controlled companies. Our employees are not represented by a
labor union, we have not had any work stoppages or strikes and we believe our
employee relations are good.
ITEM 2. PROPERTIES
At February 28, 2002, we have leases covering approximately 137,500 square feet
in Atlanta, GA, 6,100 square feet in Greenville, SC, and 21,400 square feet in
Wilmington, MA, as well as small offices in Warrington, England and in Dublin,
Ireland to house our product development, manufacturing, sales, service and
administration operations. We believe our leased facilities are adequate for
our existing and foreseeable business operations. A portion of the Atlanta
corporate facility is subleased to businesses in our technology business
incubator.
ITEM 3. LEGAL PROCEEDINGS
In 1999, a former consultant of the ChemFree subsidiary brought suit against
ChemFree and other third parties challenging the ownership of certain of
ChemFree's patents. ChemFree and other parties to the suit strongly deny the
allegations, have filed a counterclaim and are vigorously defending the suit,
which is pending in the Superior Court of Gwinnett County, Georgia. In 2001, we
were named as a co-defendant in a lawsuit filed by four former employees of
PaySys International, Inc. claiming certain rights to acquire shares of PaySys
stock that we acquired from PaySys founders in 1994. We strongly deny that any
valid claim exists and are vigorously defending the suit which is pending in
the Ninth Judicial Circuit in Orange County, Florida. In addition, we are party
to a small number of other legal matters arising in the ordinary course of
business. It is management's opinion that none of these other matters will have
a material adverse impact on our consolidated financial position or results of
operations. Refer to Note 10 to the consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matter to a vote of our shareholders during the fiscal
quarter ended December 31, 2001.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock is listed and traded on The American Stock Exchange ("AMEX")
under the symbol "INS". The following table sets forth, for the periods
indicated, the range of high and low sales prices for our common stock as
reported by AMEX.
YEAR ENDED DECEMBER 31, 2001 2000
HIGH LOW HIGH LOW
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1ST QUARTER 4.00 3.02 14.50 3.625
2ND QUARTER 4.92 3.30 10.25 3.50
3RD QUARTER 4.60 3.10 6.25 3.75
4TH QUARTER 3.35 2.95 6.00 2.875
We had 438 shareholders of record as of February 28, 2002. This number does not
include beneficial owners of our common stock whose shares are held in the
names of various dealers, clearing agencies, banks, brokers and other
fiduciaries. We paid a special cash dividend of $0.52 per common share on April
20, 2000. The company
INTELLIGENT SYSTEMS CORPORATION
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may pay cash dividends from time to time on an irregular
basis but has not in the past paid regular dividends and does not expect to do
so in the future.
ITEM 6. SELECTED FINANCIAL DATA
(in thousands except share amounts)
TWELVE MONTHS ENDED DECEMBER 31, 2001 2000 1999 1998 1997
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Net Sales $ 8,718 $ 7,027 $ 8,479 $ 18,253 $ 21,160
Net Income (Loss) 9,113a 8,215b 249c (1,548)d (7,176)e
Net Income (Loss) Per Share (Basic) 1.78 1.47 0.05 (.30) (1.41)
Total Assets 26,089 18,057 13,658 17,099 19,091
Working Capital 10,206 3,294 (48) (1,827) (1,068)
Long-term Debt -- -- 363 900 1,000
Stockholders' Equity 17,858 14,674 10,209 9,641 11,396
Cash Dividends Paid Per Common Share -- $ 0.52 -- -- --
Shares Outstanding at Year End 4,495,530 5,623,784 5,114,467 5,104,467 5,104,467
a. Includes investment gains of $19.9 million, $2.2 million in net losses
in equity of affiliates and non-recurring charges totaling $6.4
million related to acquisition.
b. Includes investment gains of $9.7 million and $771,000 in net losses
in equity of affiliates.
c. Includes investment gains of $2.2 million and $948,000 in net losses
in equity of affiliates.
d. Includes $944,000 charge for purchased in-process R&D, $955,000 charge
to discontinue product lines, $5.2 million gain on investments and
$593,000 income in equity of investments.
e. Includes $953,000 charge for purchased in-process R&D, $2.6 million
gain on investments, $3.0 million write-off of note receivable and
$2.3 million loss in equity of investments.
Please refer to Item 7. Management's Discussion and Analysis of Financial
Conditions and Results of Operations for a discussion of material acquisitions
or dispositions that may affect the comparability of this financial
information.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In addition to historical information, this Form 10-K may contain
forward-looking statements relating to Intelligent Systems Corporation
(ISC). All statements, trend analysis and other information contained
in the following discussion relative to markets for our products and
trends in revenue, gross margins and anticipated expense levels, as
well as other statements including works such as "anticipate",
"believe", "plan", "estimate", "expect", and "intend", and other
similar expressions constitute forward-looking statements. Prospective
investors are cautioned that any such forward-looking statements are
not guarantees of future performance and involve risks and
uncertainties, and that actual results may differ materially from
those contemplated by such forward-looking statements. Among the
important factors that could cause actual results to differ materially
from those indicated by such forward-looking statements are delays in
product development, undetected software errors, competitive
pressures, technical difficulties, market acceptance, availability of
technical personnel, changes in customer requirements, changes in
financial markets, performance and financial condition of affiliate
companies, and general economic conditions. ISC undertakes no
obligation to update or revise forward-looking statements to reflect
changed assumptions, the occurrence of unanticipated events or changes
in future operating results.
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated
financial statements and the notes to the consolidated financial statements
presented in this annual report.
OVERVIEW - Our consolidated subsidiaries during 2001 operate in two industry
segments: Information Technology and Industrial Products. Included in the
Information Technology sector are QS Technologies, Inc. (software for health
and human services) and, since July 1, 2001, VISaer, Inc. (software for
maintenance, repair and overhaul
INTELLIGENT SYSTEMS CORPORATION
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operations in the aerospace industry). The Industrial Products segment includes
ChemFree Corporation (bio-remediating parts washers). In prior years, we also
had a Health Care segment consisting of our PsyCare America subsidiary prior to
closing the operation in November 2000.
Net profit in 2001 was $9,113,000 compared to $8,215,000 in 2000. Included in
the 2001 results is a pre-tax gain of $17,770,000 on the sale of our ownership
in PaySys International, Inc. in April 2001. The results for 2000 reflect a
gain of $8,622,000 from the sale of most of our ownership of Risk Laboratories,
LLC. Both of these events are described more fully in Note 3 to the
consolidated financial statements. Our net loss from operations in 2001 was
$10,420,000 compared to a net loss of $976,000 in 2000. The current year
operating results include non-recurring charges totaling $6.4 million in the
third quarter of 2001 related to the acquisition of a controlling interest in
VISaer in July 2001, as more fully explained in Note 2 to the consolidated
financial statements. In addition, VISaer is incurring significant current
expenses for software development while revenue for related software licenses
is being deferred until the completed software product is delivered to
customers in early 2003.
In the past several years, a significant portion of our income has been derived
from sales of holdings in affiliate and other minority-owned companies. We also
recognize on a regular basis our pro rata share of the income or losses of
affiliate companies accounted for by the equity method. The timing and amount
of gain or loss recognized as a result of a sale or the amount of equity in the
income or losses of affiliates generally are not under our control and are not
necessarily indicative of future results. Occasionally, as in the case of
VISaer, we acquire a controlling interest in a company previously accounted for
by the equity method and consolidate its results as of the acquisition date.
Therefore, period-to-period comparisons of results of operations may not be
meaningful or indicative of future results.
SALES - Total revenue in 2001 was $8,718,000, an increase of 24 percent
compared to revenue of $7,027,000 in 2000. Revenue from products, which
includes sales of equipment in our Industrial Products segment as well as
software license fees related to the Information Technology segment, increased
10 percent year-to-year whereas revenue from services billed by the Information
Technology segment increased 54 percent year-to-year. The growth in both
revenue categories reflects mainly the benefit of the mid-year acquisition of
VISaer. We did not record service revenue in the Health Care segment in 2001
since we closed the PsyCare operation in 2000.
Net sales in 2000 declined by 17 percent compared to 1999, principally due to
lower service revenue in the Health Care segment, reflecting fewer
hospital-based treatment programs and the close of the PsyCare operation in
November 2000. Revenue in the Information Technology segment was down slightly
year-to-year while sales in Industrial Products in both domestic and
international markets grew slightly in 2000 compared to the prior year.
COST OF SALES - In 2001, total cost of sales was 47 percent of revenue,
compared to 42 percent in 2000 and 47 percent in 1999. Cost of product sales as
a percentage of product revenue was essentially the same in 2001 and 2000. Cost
of service sales in the Information Technology segment increased in 2001
compared to 2000 mainly due to the inclusion of VISaer costs following the
VISaer acquisition. VISaer professional services have a higher labor component
and cost than do services provided by QS Technologies. The decline in 2000
compared to 1999 reflects reduced personnel costs in the Information Technology
and Health Care segment as we scaled back the PsyCare operation and lower
direct material costs in the Industrial Products segment. Cost of product sales
is likely to decrease as a percentage of sales in future periods as a greater
portion of anticipated product revenue is derived from software license fees.
OPERATING EXPENSES - In 2001, marketing expenses more than doubled compared to
2000, reflecting the inclusion of VISaer expenses for six months in 2001 as
well as increased expenditures in the Industrial Products segment to support
new sales and marketing initiatives. General and administrative expenses
increased over 200 percent in 2001 compared to 2000, reflecting non-recurring
charges totaling $6 million to write-down goodwill associated with the VISaer
acquisition, the inclusion of VISaer expenses for six months and management
bonuses related to the sale of PaySys. Research and development expense in 2001
increased by 268 percent compared to 2000 mainly due to significant new product
development expense in the Information Technology segment as well as a
non-recurring charge of $425,000 to record in-process research and development
projects related to the acquisition of VISaer.
INTELLIGENT SYSTEMS CORPORATION
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In 2000, marketing expenses were down eight percent compared to the prior year,
mainly because the prior year amounts included expenses for an operation that
was sold in 1999. Marketing expenses for Industrial Products increased during
2000 to generate and support higher revenue levels. General and administrative
expenses were lower by almost $300,000 in 2000 compared to 1999. The reduction
is related to reduced personnel and facility expenses as the Health Care
segment wound down its operations, offset in part by higher legal costs to
protect intellectual property assets in the Industrial Products segment.
Corporate expenses, which are part of general and administrative expenses, were
also higher in 2000 compared to 1999 mainly due to management bonuses. Research
and development expenses in both Industrial Products and Information Technology
sectors increased in 2000 as compared to 1999 to support development of new and
enhanced product offerings.
INTEREST INCOME - In 2001, we recorded $1.0 million in interest income compared
to interest income of $434,000 in 2000 and interest expense of $88,000 in 1999.
The increase in 2001 compared to 2000 is mainly related to interest earned on a
$3.5 million, high-interest note through April 2001 and significant cash
balances since then, both related to our PaySys affiliate sale. In 2000 as
compared to 1999, we earned interest on substantially higher levels of cash
during the first half of 2000 and also earned interest on a higher level of
notes at higher rates of interest in 2000.
INVESTMENT INCOME - Investment income related to sales of affiliate companies
has been a major source of our profits in each of the last two years. In 2001,
the main components of investment income of $19.9 million are $17.8 million
from the sale of our interest in PaySys and a gain of $1.9 million on sales
related to Risk Laboratories. For 2000, we recorded a gain of $8.6 million on
the sale of part of our ownership in Risk Laboratories as well as investment
gains totaling $1.0 million related to sales of shares of common stock of
Primus and S1. In 1999, we recorded net investment income of $1.2 million on
the sale of equity holdings in three private software companies and a gain of
$995,000 on the sale of our holdings in MediaMetrix stock. Refer to Note 3 for
details on the sale transactions described in this section.
EQUITY LOSSES OF AFFILIATES - On a quarterly basis, we recognize our pro rata
share of the earnings or losses of affiliate companies that we record on the
equity method. These companies are typically early stage companies that incur
losses during their development and early revenue stages. We recorded $2.2
million of net equity losses in 2001, compared to $771,000 and $948,000 in net
equity losses in 2000 and 1999, respectively. In 2001, the majority of the
equity loss relates to Delos Payment Systems whereas the majority of the equity
loss in 2000 and in 1999 relates to VISaer.
OTHER INCOME - Other income/expense in each of the last three years consists of
miscellaneous, non-recurring sources of income and expense. Included in 2001 is
$961,000 of deferred gain related to a VISaer product line sale in July 2000.
In 1999, this category includes a non-recurring charge of $141,500 related to a
former subsidiary bankruptcy case.
TAXES - In 2001, we incurred income tax expense of $173,000, representing a tax
liability of $384,000 for alternative minimum tax on the PaySys transaction
(tax loss carryforwards offset 90 percent of the gain) and a tax benefit of
$211,000 recorded at the VISaer subsidiary. We incurred income tax expense
totaling $203,000 in 2000 relating to operating income at the QS Technologies
subsidiary and a small amount of investment income related to the Risk
Laboratories sale that could not be sheltered by tax loss carryforwards. We had
no income tax expense in 1999 because investment gains were offset by capital
loss carryforwards.
COMMON SHARES - In 2001, we repurchased 1,132,000 shares of our common stock,
including one million shares in the self-tender offer completed July 12, 2001.
In 2000, executive officers exercised options to acquire a total of 635,986
shares of common stock and surrendered a total of 101,769 shares of common
stock in partial payment of the exercise price. We also repurchased and retired
24,900 shares during 2000 pursuant to a stock repurchase plan announced in
August 2000.
LIQUIDITY AND CAPITAL RESOURCES
For the year ended December 31, 2001, our principal sources of cash were $17.8
million from the sale of our interest in PaySys, $4.3 million from repayment of
principal and interest related to a bridge loan to PaySys, $1.9 million from
the sale of our Risk units, $842,000 on sales of other investments and $195,000
in interest from other
INTELLIGENT SYSTEMS CORPORATION
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notes receivable and bank balances. During the year, our principal uses of cash
were $5.8 million to acquire and retire 1,132,000 shares of our common stock,
$1.5 million to retire our bank debt, $400,000 for bridge loans to investees,
$2.8 million for follow-on investments in technology companies and $2.0 million
for operations, principally to fund working capital needs at VISaer and the
corporate office.
Long-term investments decreased $3.0 million at December 31, 2001 compared to
the prior year-end. The main component of this amount is reclassification of
$2.9 million of the carrying value of VISaer when it was acquired in July 2001
and we began consolidating its results. The balance of the decline is a
combination of new investments in technology companies, equity losses of
affiliate companies, sales of investments and changes in market prices of
publicly held stocks. Increases year-to-year in the balances of accounts
receivable, accounts payable, other accrued liabilities, deferred revenue and
deferred gain are principally the result of consolidating the assets and
liabilities of VISaer since its acquisition. Inventories increased year-to-year
to support a higher level of sales at ChemFree.
As of December 31, 2001, we have cash of $12.0 million. We believe our cash
balances and available-for-sale securities will be adequate to support our
operations and plans for the foreseeable future. As we have in the past, we
expect to continue to identify opportunities for new and follow-on investments
or acquisitions and would expect to use some available cash for these purposes.
Since the terrorist attacks of September 11, 2001, our Information Technology
segment has experienced delays in contract awards and implementations which, if
they continue, may have a negative impact on results of operations and increase
the segment's cash requirements, which we intend to fund or arrange funding
for. However, we believe we have more than adequate cash reserves to meet any
such needs. We do not have off-balance sheet arrangements, relationships,
transactions or guarantees with third parties or related parties that would
affect our liquidity or results of operations.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amount of assets,
liabilities, revenues and expenses. We consider certain accounting policies
related to revenue recognition, valuation of acquired intangibles and
impairment of long-lived assets, and valuation of investments to be critical
policies due to the estimation processes involved in each. For a detailed
description on the application of these and other accounting policies, see Note
1 to the Consolidated Financial Statements beginning on page F-7.
Revenue Recognition. Our product revenue consists of fees from software
licenses and sales of equipment and supplies. Our service revenue consists of
fees for implementation, consulting, training, maintenance and support for
software products. A portion of our revenue is derived from software contracts
that contain significant production, modification and/or customization
requirements and license fees for such contracts are recognized using contract
accounting. We recognize revenue on a percentage of completion basis that
involves estimating our progress on the contract based on input measures. We
recognize revenue and the related costs in the same proportion that the amount
of labor hours incurred to date bears to the total estimated hours required for
contract completion. If reliable estimates cannot be determined or if there is
an acceptance clause in the contract, all revenue is deferred until the
customer has accepted the software and any refund rights have expired. If we do
not accurately estimate the resources required or the scope of work to be
performed, or we do not manage the contract properly, in future periods we may
need to restate revenues or to incur additional cost which would impact our
margins and reported results.
Valuation of Intangibles. Purchase accounting for an acquisition requires use
of accounting estimates and judgments to allocate the purchase price to the
fair market value of the assets and liabilities purchased. Our business
acquisitions typically result in goodwill and other intangible assets. The
determination of the value of such intangible assets requires management to
make estimates and assumptions that affect the amount of future period
amortization expenses and possible impairment expense that we will incur.
Periodically we review the values assigned to long-lived assets using an
estimate of the undiscounted cash flows of the entity over the remaining life
of the asset. Any resulting impairment could require a write-down that would
have a material adverse impact on our financial condition or results of
operations.
INTELLIGENT SYSTEMS CORPORATION
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Valuation of Investments. We hold minority interests in non-publicly traded
companies whose values are difficult to determine and are based on management's
estimate of realizability of the carrying value of the investment. Future
adverse changes in market conditions, poor operating results or lack of
progress of the underlying investment could result in losses or an inability to
recover the current carrying value of the investment. Our policy is to record
an impairment charge when we believe an investment has experienced a decline in
value that is other than temporary. Such charges could have a material adverse
impact on our financial condition or results of operations. We also hold
minority interests in several publicly-traded companies whose shares experience
price volatility and are thinly traded. The carrying value of these investments
reflects the market value of the shares at the balance sheet date. Future
values could increase or decrease and we may not be able to realize the current
carrying value due to changes in the market price of the stock or limited
liquidity of the stock.
FACTORS THAT MAY AFFECT FUTURE OPERATIONS
Future operations in both the Information Technology and Industrial Products
segments are subject to risks and uncertainties that may negatively impact our
results or projected cash requirements. In addition, the value of our
investments are impacted by a number of factors beyond our control. Among the
factors that may affect our consolidated results of operations are delays in
product development, undetected software errors, competitive pressures,
technical difficulties, market acceptance of our products, availability of
technical personnel, changes in customer requirements, delays in customer
payments, changes in financial markets, performance and financial condition of
affiliate or investee companies, and general economic conditions.
In 2001, we loaned $1.5 million to an affiliate company, Delos Payment Systems,
Inc., a development stage software company, under a secured loan agreement. The
affiliate loan was recorded as an equity investment and we subsequently
recorded $1.42 million in equity losses related to Delos, reducing the carrying
value of our investment to $80,000 at December 31, 2001. In early January 2002,
Delos defaulted on repayment of the loan, we acquired control of the Delos
board of directors and, consequently, we are consolidating the Delos operations
and our 27 percent ownership of common stock of Delos in 2002. We are providing
additional borrowings of $1.5 million to Delos under the loan and are
considering investing funds to increase our ownership to a significant majority
position. It will incur operating losses that we will consolidate and it will
require cash to operate in 2002. While we have no contractual requirement to
provide additional funding, we are likely to use part of our available cash
balances to support the Delos operations in the near-term. If Delos is
unsuccessful or if we decide to suspend funding, we may not recover all of
these funds.
As a result of consolidating Delos, we will record intangible assets upon
consolidation in the first quarter of 2002 in accordance with SFAS 141. It is
possible that the intangibles will be mainly in-process research and
development and goodwill and the goodwill may be impaired for a number of
reasons. Some of the factors that may negatively impact the value of the
goodwill are significant non-competition restrictions related to the sale of
PaySys in April 2001 that limit who Delos can sell its products to for varying
time periods through 2006, risks associated with completing and testing the
initial software application, lack of a proven business model and customers, a
limited operating history, and unproven market acceptance of the Delos software
features and architecture. If the company determines that the intangibles are
impaired, it will need to write-down their value to net realizable value in the
first quarter of 2002 in accordance with SFAS 142, resulting in a charge to
earnings of approximately $1 million. Despite the possible impairment charge,
we made the additional loan of $1.5 million to Delos to protect our investment
and future alternatives.
We have certain lease commitments, legal matters and contingent liabilities
described in detail in Note 10 to the consolidated financial statements. We are
not aware presently of any facts or circumstances related to these that are
likely to have a material negative impact on our results of operations or
financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any material market risk because we have no long-term
borrowings.
INTELLIGENT SYSTEMS CORPORATION
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section of this report.
See page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
No independent public accountant of the company has resigned, indicated any
intent to resign or been dismissed as the independent public accountant of the
company during the two years ended December 31, 2001 or at any time afterward.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Please refer to the subsection entitled "Proposal 1 - The Election of Directors
- Nominees" and "Proposal 1 - The Election of Directors - Executive Officers"
in our Proxy Statement for the Annual Meeting of Shareholders to be held on May
23, 2002 for information about those individuals nominated as directors and
about the executive officers of the company. This information is incorporated
into this Item 10 by reference. Information regarding compliance by directors
and executive officers of the company and owners of more than 10 percent of our
common stock with the reporting requirements of Section 16(a) of the Securities
Exchange Act of 1934, as amended, is contained under the caption "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Proxy Statement mentioned
above. This information is incorporated into this Item 10 by reference.
ITEM 11. EXECUTIVE COMPENSATION
Please refer to the subsection entitled "Proposal 1 - The Election of Directors
- Executive Compensation" in the Proxy Statement referred to in Item 10 for
information about management compensation. This information is incorporated
into this Item 11 by reference, except that we specifically do not incorporate
into this Item 11 the information in the subsections entitled "Proposal 1 - The
Election of Directors - Executive Compensation - Board Compensation Committee
Report on Executive Compensation" and "Performance Graph."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Please refer to the subsection entitled "Voting - Principal Shareholders,
Directors and Certain Executive Officers" in the Proxy Statement referred to in
Item 10 for information about the ownership of our $0.01 par value common stock
by certain persons. This information is incorporated into this Item 12 by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On January 5, 2000, three officers of the company exercised stock options and
issued to the company promissory notes bearing interest at the rate of seven
percent per annum in payment of the exercise price. J. Leland Strange,
President and Chief Executive Officer of the company and the beneficial owner
of greater than 5% of our common stock issued the company a promissory note for
$380,000 representing the total exercise price of his options. Bonnie L.
Herron, Vice President and Chief Financial Officer, and Francis A. Marks, Vice
President, each issued the company a promissory note for $258,750 representing
the total exercise price of their respective options. The loans were repaid at
various dates in 2000 and 2001 and no amounts are outstanding as of December
31, 2001.
In April 2001, J. Leland Strange, a director, and President and Chief Executive
Officer of the company, participated as a common stockholder in the sale of all
of the outstanding preferred and common stock of PaySys International, Inc., a
former affiliate company, to First Data Corporation ("FDC"). The company sold
its interest in PaySys to FDC for $17.8 million as part of the sale
transaction. Mr. Strange's shares, which he had owned since 1983 prior to the
company's investment in PaySys in 1994, represented less than one percent of
PaySys' outstanding shares. The proceeds from the sale of his PaySys stock were
$594,000, which was based on the same price per share paid to all common
shareholders of PaySys by FDC.
INTELLIGENT SYSTEMS CORPORATION
- 14 -
Each of the named officers of the company participated on a pro rata basis with
other shareholders of the company pursuant to the company's tender offer on
July 12, 2001. In addition, each officer sold shares of common stock to the
company at $4.20 per share (which was the closing price of the company's common
stock on July 20, 2001, the sale date) to meet the requirements of Section 302
of the Internal Revenue Code for capital gains treatment of shares sold by the
officers in the tender offer. J. Leland Strange, a director, President and
Chief Executive Officer, and the beneficial owner of more than 5 percent of the
company's common stock, sold 47,619 shares for a total sales price of $200,000;
Bonnie L. Herron, Vice President and Chief Financial Officer, sold 47,619
shares for a total sales price of $200,000; and Francis A. Marks, Vice
President, sold 18,500 shares for a total sales price of $77,700. The officers
previously reported these sale transactions on Forms 4 filed with the
Securities and Exchange Commission.
On March 14, 2002, the shareholders of Risk Laboratories, a former affiliate of
the company, sold their remaining ownership interests to the same buyer that
had purchased majority control of Risk in March of 2000. The company and J.
William Goodhew, a vice president of the company and minority shareholder in
Risk, each sold their respective ownership interests along with all other
minority shareholders in the $6 million transaction. Mr. Goodhew's pro rata
share of the sale proceeds was $429,600 and the company's pro rata share was
$474,000. The company previously sold most of its ownership in Risk in several
transactions totaling $10.7 million in proceeds.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) DOCUMENTS FILED AS PART OF THIS REPORT.
1. Financial Statements
The following consolidated financial statements and related reports of
independent public accountants are included in this report and are incorporated
by reference in Part II, Item 8 hereof. See the Index to Financial Statements
and Supplemental Schedules on page F-1 hereof.
Report of Independent Public Accountants
Consolidated Balance Sheets at December 31, 2001 and 2000
Consolidated Statements of Operations for the three years ended
December 31, 2001
Consolidated Statements of Changes in Stockholders' Equity and
Comprehensive Income for the three years ended December 31, 2001
Consolidated Statements of Cash Flow for the three years ended
December 31, 2001
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
We are including the financial statement schedules listed below in
this report. We omitted all other schedules required by certain applicable
accounting regulations of the Securities and Exchange Commission because the
omitted schedules are not required under the related instructions or do not
apply or because we have included the information required in the consolidated
financial statements or notes thereto. See the Index to Financial Statements
and Supplemental Schedules on page F-1 hereof.
Schedule II - Valuation and Qualifying Accounts and Reserves
Report of Independent Auditors for PaySys International, Inc.
Consolidated Balance Sheets of PaySys at December 31, 2000 and 1999
Consolidated Statements of Operations of PaySys for the three years
ended December 31, 2000
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
of PaySys for the three years ended December 31, 2000
Consolidated Statements of Cash Flow of PaySys for the three years
ended December 31, 2000
Notes to Consolidated Financial Statements of PaySys
INTELLIGENT SYSTEMS CORPORATION
- 15 -
Report of Independent Public Accountants for VISaer, Inc.
Consolidated Balance Sheet of VISaer, Inc. at December 31, 2000
Consolidated Statement of Operations of VISaer, Inc. for the year
ended December 31, 2000
Consolidated Statement of Comprehensive Loss of VISaer, Inc. for the
year ended December 31, 2000
Consolidated Statement of Redeemable Convertible Preferred Stock and
Stockholders' Deficit of VISaer, Inc. for the year ended December 31,
2000
Consolidated Statement of Cash Flow of VISaer, Inc. for the year ended
December 31, 2000
Notes to Consolidated Financial Statements of VISaer, Inc.
Report of Independent Public Accountants for VISaer (UK) Limited
Report of Independent Public Accountants for VISaer (IRL) Limited
Report of Independent Public Accountants for Visibility, Inc.
Consolidated Balance Sheets of Visibility at December 31, 1999
Consolidated Statements of Operations of Visibility for the year ended
December 31, 1999
Consolidated Statements of Changes in Stockholders' Equity of
Visibility for the year ended December 31, 1999
Consolidated Statements of Cash Flow of Visibility for the year ended
December 31, 1999
Notes to Consolidated Financial Statements of Visibility, Inc.
Report of Independent Public Accountants for Cirronet, Inc.
Balance Sheet of Cirronet, Inc. at December 31, 2001 (unaudited) and
December 31, 2000 (unaudited)
Statement of Operations of Cirronet, Inc. for the two years ended
December 31, 2001 (unaudited) and the year ended December 31, 1999
(audited)
Statement of Changes in Stockholders' Equity of Cirronet, Inc. for the
two years ended December 31, 2001 (unaudited) and the year ended
December 31, 1999 (audited)
Statement of Cash Flow of Cirronet, Inc. for the two years ended
December 31, 2001 (unaudited) and the year ended December 31, 1999
(audited)
Notes to Financial Statements of Cirronet, Inc.
3. Exhibits
We are filing the following exhibits with this report or incorporating
them by reference to earlier filings. Shareholders may request a copy of any
exhibit by contacting Bonnie L. Herron, Secretary, Intelligent Systems
Corporation, 4355 Shackleford Road, Norcross, Georgia 30093; telephone (770)
381-2900. There is a charge of $.50 per page to cover expenses of copying and
mailing.
3(i) Amended and Restated Articles of Incorporation of the Registrant dated
November 14,1991, as amended November 25, 1997. (Incorporated by
reference to Exhibit 3.1 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1991 and to Exhibit 3.1 to the
Registrant's Report on Form 8-K dated November 25, 1997.)
3(ii) Bylaws of the Registrant dated June 6, 1997. (Incorporated by
reference to Exhibit 3(ii) of the Registrant's Form 10-K/A for the
year ended December 31, 1997.)
4.1 Rights Agreement dated as of November 25, 1997 between the Registrant
and American Stock Transfer & Trust Company as Rights Agent.
(Incorporated by reference to Exhibit 4.1 of the Registrant's Report
on Form 8-K dated November 25, 1997 and filed on December 16, 1997.)
4.2 Form of Rights Certificate. (Incorporated by reference to Exhibit 4.2
of the Registrant's Report on Form 8-K dated November 25, 1997 and
filed on December 16, 1997.)
INTELLIGENT SYSTEMS CORPORATION
- 16 -
10.1 Lease Agreement dated March 11, 1985, between a subsidiary of the
Registrant and A.R. Weeks. (Incorporated by reference to Exhibit 10.1
to Intelligent Systems Corporation Annual Report on Form 10-K for the
fiscal year ended March 31, 1986.)
10.2 Second Amendment to Lease Agreement dated June 19, 1997 between a
subsidiary of the Registrant and A.R. Weeks. (Incorporated by
reference to Exhibit 10.2 of the Registrant's Form 10-K for the year
ended December 31, 1997.)
10.3 Management Compensation Plans and Arrangements:
(a) Intelligent Systems Corporation 1991 Stock Incentive Plan,
amended June 6, 1997.
(b) Intelligent Systems Corporation Change in Control Plan for
Officers.
(c) Intelligent Systems Corporation Outside Director's Retirement
Plan.
(d) Non-Employee Directors Stock Option Plan.
Item 10.3 (a) is incorporated by reference to Exhibit 4.1 of the
Registrant's Form S-8 dated July 25, 1997.
Items 10.3 (b) and (c) are incorporated by reference to Exhibit 10.4
to the Registrant's Form 10-K for the year ended December 31, 1993.
Item 10.3 (d) is incorporated by reference to Exhibit 10.3 to the
Registrant's Form 10-K for the year ended December 31, 2000.
10.4 Series A-1 Convertible Preferred Stock Purchase Agreement dated as of
July 1, 2001 by and between VISaer, Inc., Intelligent Systems
Corporation and other third parties.
10.5 7 X 24 Agreement dated as of June 26, 2001 between United Parcel
General Services Co. and VISaer, Inc.
10.6 Warrant to Purchase Common Stock of VISaer, Inc. dated December 7,
2001 issued to United Parcel General Services Co.
10.7 Software License Agreement dated as of April 27, 2001 by and between
PaySys International, Inc. and Delos Payment Systems, Inc.
10.8 Trade Secret License Agreement dated as of April 27, 2001 by and
between PaySys International, Inc. and Delos Payment Systems, Inc.
10.9 Non-Competition Agreement made as of April 27, 2001 by and between
First Data Corporation, J. Leland Strange and PaySys International,
Inc.
10.10 Subscription Agreement dated August 23, 2001 between the Registrant
and Delos Payment Systems, Inc.
21.1 List of subsidiaries of Registrant.
23.1 Consent of Arthur Andersen LLP.
23.2 Consent of Ernst and Young LLP.
23.3 Consent of Moody, Famiglietti and Andronico LLP.
23.4 Consent of Hacker Young.
23.5 Consent of Arthur Andersen.
23.6 Consent of Arthur Andersen LLP.
INTELLIGENT SYSTEMS CORPORATION
- 17 -
(B) REPORTS ON FORM 8-K.
We did not file any reports on Form 8-K during the quarter ended December 31,
2001.
(C) SEE ITEM 14(A)(3) ABOVE.
(D) SEE ITEM 14(A)(2) ABOVE.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Annual Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
INTELLIGENT SYSTEMS CORPORATION
Registrant
Date: March 22, 2002 By: /s/ J. Leland Strange
-------------------------------
J. Leland Strange
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
SIGNATURE CAPACITY DATE
/s/ J. Leland Strange Chairman of the Board, President, March 22, 2002
--------------------- Chief Executive Officer and Director
J. Leland Strange (Principal Executive Officer)
/s/ Bonnie L. Herron Chief Financial Officer March 22, 2002
--------------------- (Principal Accounting
Bonnie L. Herron and Financial Officer)
/s/ Donald A. McMahon Director March 22, 2002
---------------------
Donald A. McMahon
/s/ James V. Napier Director March 22, 2002
---------------------
James V. Napier
/s/ John B. Peatman Director March 22, 2002
---------------------
John B. Peatman
/s/ Parker H. Petit Director March 22, 2002
---------------------
Parker H. Petit
INTELLIGENT SYSTEMS CORPORATION
- 18 -
INTELLIGENT SYSTEMS CORPORATION
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULES
The following consolidated financial statements and schedules of the Registrant
and its subsidiaries are submitted herewith in response to Item 8:
FINANCIAL STATEMENTS:
Report of Independent Public Accountants.........................................................................F-2
Consolidated Balance Sheets - December 31, 2001 and 2000.........................................................F-3
Consolidated Statements of Operations -
Three Years Ended December 31, 2001...........................................................................F-4
Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income -
Three Years Ended December 31, 2001...........................................................................F-5
Consolidated Statements of Cash Flow -
Three Years Ended December 31, 2001...........................................................................F-6
Notes to Consolidated Financial Statements.......................................................................F-7
FINANCIAL STATEMENT SCHEDULES:
The following supplemental schedules of the Registrant and its subsidiaries are
submitted herewith in response to Item 14(a)(2):
Schedule II - Valuation and Qualifying Accounts and Reserves.....................................................S-1
Report of Independent Auditors for PaySys International, Inc.....................................................S-2
Consolidated Balance Sheets of PaySys at December 31, 2000 and 1999...........................................S-3
Consolidated Statements of Operations of PaySys for the three years ended December 31, 2000...................S-4
Consolidated Statements of Changes in Shareholders' Equity (Deficit) of PaySys for the three years
ended December 31, 2000.....................................................................................S-5
Consolidated Statements of Cash Flow of PaySys for the three years ended December 31, 2000....................S-6
Notes to Consolidated Financial Statements of PaySys..........................................................S-7
Report of Independent Public Accountants for VISaer, Inc........................................................S-32
Consolidated Balance Sheet of VISaer, Inc. at December 31, 2000..............................................S-33
Consolidated Statement of Operations of VISaer, Inc. for the year ended December 31, 2000....................S-34
Consolidated Statement of Comprehensive Loss of VISaer, Inc. for the year ended
December 31, 2000..........................................................................................S-35
Consolidated Statement of Redeemable Convertible Preferred Stock and Stockholders' Deficit of
VISaer, Inc. for the year ended December 31, 2000..........................................................S-36
Consolidated Statement of Cash Flow of VISaer, Inc. for the year ended December 31, 2000.....................S-37
Notes to Consolidated Financial Statements of VISaer, Inc. ..................................................S-38
Report of Independent Public Accountants for VISaer (UK) Limited................................................S-48
Report of Independent Public Accountants for VISaer (IRL) Limited...............................................S-49
Report of Independent Public Accountants for Visibility, Inc....................................................S-50
Consolidated Balance Sheets of Visibility at December 31, 1999...............................................S-51
Consolidated Statements of Operations of Visibility for the year ended December 31, 1999.....................S-52
Consolidated Statements of Changes in Stockholders' Equity of Visibility for the year ended
December 31, 1999......................................................................................S-53
Consolidated Statements of Cash Flow of Visibility for the year ended December 31, 1999......................S-54
Notes to Consolidated Financial Statements of Visibility, Inc................................................S-55
Report of Independent Public Accountants for Cirronet, Inc......................................................S-68
Balance Sheet of Cirronet, Inc. at December 31, 2001 and 2000 (unaudited)....................................S-69
Statement of Operations of Cirronet, Inc. for the two years ended December 31, 2001 (unaudited) and the
year ended December 31, 1999 (audited).....................................................................S-70
Statement of Changes in Shareholders' Equity of Cirronet, Inc. for the two years ended December 31, 2001
(unaudited) and the year ended December 31, 1999 (audited).................................................S-71
Statement of Cash Flow of Cirronet, Inc. for the two years ended December 31, 2001 (unaudited)
and the year ended December 31, 1999 (audited).............................................................S-72
Notes to Financial Statements of Cirronet, Inc...............................................................S-73
INTELLIGENT SYSTEMS CORPORATION
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO INTELLIGENT SYSTEMS CORPORATION:
We have audited the accompanying consolidated balance sheets of Intelligent
Systems Corporation (a Georgia corporation) and its subsidiaries as of December
31, 2001 and 2000, and the related consolidated statements of operations,
changes in stockholders' equity and comprehensive income, and cash flows for
each of the three years in the period ended December 31, 2001. These financial
statements and the schedule referred to below are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits. The summarized financial
data for PaySys International, Inc. contained in Note 4 are based on the
financial statements of PaySys International, Inc. which were audited by other
auditors. Their report has been furnished to us and our opinion, insofar as it
relates to the data in Note 4, is based solely on the report of the other
auditors. We did not audit the December 31, 2000 financial statements of
VISaer, Inc., an investment which is reflected in the accompanying financial
statements using the equity method of accounting. The investment in VISaer,
Inc. represents 16 percent of total assets in 2000, and the equity in 2000 net
loss represents 9 percent of consolidated net income for 2000. The statements
of PaySys International, Inc. and VISaer, Inc. were audited by other auditors
whose reports have been furnished to us and our opinion, insofar as it relates
to the amounts included for PaySys International, Inc. and VISaer, Inc., is
based solely on the reports of the other auditors.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits and the reports of
other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of the other auditors, the
financial statements referred to above present fairly, in all material
respects, the financial position of Intelligent Systems Corporation and its
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted
in the United States.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The supplemental Schedule II in Item
14(a)(2) is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in the
audit of the basic financial statements and, in our opinion, is fairly stated
in all material respects in relation to the financial data required to be set
forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
March 1, 2002
INTELLIGENT SYSTEMS CORPORATION
F-2
INTELLIGENT SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands except share amounts)
AS OF DECEMBER 31, 2001 2000
-----------------------------------------------------------------------------------------------------------------------
ASSETS
-----------------------------------------------------------------------------------------------------------------------
Current assets:
Cash $ 12,026 $ 594
Accounts receivable, net 2,297 1,253
Notes and interest receivable 424 4,088
Inventories 547 475
Other current assets 353 268
-----------------------------------------------------------------------------------------------------------------------
Total current assets 15,647 6,678
-----------------------------------------------------------------------------------------------------------------------
Long-term investments 7,476 10,504
Long-term notes receivable -- 378
Property and equipment, at cost less accumulated depreciation 664 482
Intangibles, net 2,271 --
Other assets, net 31 15
-----------------------------------------------------------------------------------------------------------------------
Total assets $ 26,089 $ 18,057
=======================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
-----------------------------------------------------------------------------------------------------------------------
Current liabilities:
Short-term borrowings $ -- $ 1,504
Accounts payable 1,013 357
Deferred revenue 1,536 661
Deferred gain 1,328 --
Accrued expenses and other current liabilities 1,564 861
-----------------------------------------------------------------------------------------------------------------------
Total current liabilities 5,441 3,383
-----------------------------------------------------------------------------------------------------------------------
Deferred revenue, net of current portion 2,596 --
Other long-term liabilities 80 --
-----------------------------------------------------------------------------------------------------------------------
Total long term liabilities 2,676 --
-----------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (note 10)
Redeemable preferred stock of subsidiary 114 --
-----------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Common stock, $.01 par value, 20,000,000 shares authorized, 4,495,530 and
5,623,784 issued and outstanding at December 31, 2001 and 2000, respectively 45 56
Paid-in capital 18,438 24,216
Accumulated other comprehensive loss (355) (215)
Accumulated deficit (270) (9,383)
-----------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 17,858 14,674
-----------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 26,089 $ 18,057
=======================================================================================================================
The accompanying notes are an integral part of these consolidated balance
sheets.
INTELLIGENT SYSTEMS CORPORATION
F-3
INTELLIGENT SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except share amounts)
YEAR ENDED DECEMBER 31, 2001 2000 1999
-------------------------------------------------------------------------------------------------------------------------------
Revenue
Products $ 5,321 $ 4,824 $ 4,856
Services 3,397 2,203 3,623
-------------------------------------------------------------------------------------------------------------------------------
Total revenue 8,718 7,027 8,479
-------------------------------------------------------------------------------------------------------------------------------
Cost of sales
Products 2,633 2,432 2,410
Services 1,439 542 1,573
-------------------------------------------------------------------------------------------------------------------------------
Total cost of sales 4,072 2,974 3,983
-------------------------------------------------------------------------------------------------------------------------------
Gross profit 4,646 4,053 4,496
Expenses
Marketing 2,090 942 1,021
General & administrative 9,605 3,172 3,469
Research & development 3,371 915 805
-------------------------------------------------------------------------------------------------------------------------------
Loss from operations (10,420) (976) (799)
-------------------------------------------------------------------------------------------------------------------------------
Other income
Interest income (expense), net 1,017 434 (88)
Investment income, net 19,902 9,665 2,170
Equity losses of affiliate companies (2,173) (771) (948)
Other income (loss), net 960 66 (76)
-------------------------------------------------------------------------------------------------------------------------------
Income before income tax provision and minority interest 9,286 8,418 259
-------------------------------------------------------------------------------------------------------------------------------
Income tax provision 173 203 --
-------------------------------------------------------------------------------------------------------------------------------
Income before minority interest 9,113 8,215 259
-------------------------------------------------------------------------------------------------------------------------------
Minority interest -- -- 10
-------------------------------------------------------------------------------------------------------------------------------
Net income $ 9,113 $ 8,215 $ 249
===============================================================================================================================
Basic net income per share $ 1.78 $ 1.47 $ 0.05
Diluted net income per share $ 1.77 $ 1.46 $ 0.05
===============================================================================================================================
Basic weighted average shares outstanding 5,108,413 5,606,715 5,106,134
Diluted weighted average shares outstanding 5,145,691 5,632,484 5,336,776
===============================================================================================================================
The accompanying notes are an integral part of these consolidated statements.
INTELLIGENT SYSTEMS CORPORATION
F-4
INTELLIGENT SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(in thousands except share amounts)
YEAR ENDED DECEMBER 31,
2001 2000 1999
---------------------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
COMMON STOCK, NUMBER OF SHARES, beginning of year 5,623,784 5,114,467 5,104,467
Exercise of options during year 3,334 635,986 10,000
Purchase and retirement of stock (1,131,588) (126,669) --
---------------------------------------------------------------------------------------------------------------------------------
End of year 4,495,530 5,623,784 5,114,467
---------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK, AMOUNT, beginning of year $ 56 $ 51 $ 51
Exercise of options during year -- 6 --
Purchase and retirement of stock (11) (1) --
---------------------------------------------------------------------------------------------------------------------------------
End of year 45 56 51
---------------------------------------------------------------------------------------------------------------------------------
PAID-IN CAPITAL, beginning of year 24,216 24,069 24,046
Proceeds from options exercised 14 1,085 23
Purchase and retirement of stock (5,792) (938) --
---------------------------------------------------------------------------------------------------------------------------------
End of year 18,438 24,216 24,069
---------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), beginning of year (215) 731 436
Foreign currency translation adjustment during year 4 -- 197
Change in accumulated other comprehensive income (loss) (144) (946) 98
---------------------------------------------------------------------------------------------------------------------------------
End of year (355) (215) 731
---------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED DEFICIT, beginning of year (9,383) (14,642) (14,891)
Dividends paid -- (2,956) --
Net income 9,113 8,215 249
---------------------------------------------------------------------------------------------------------------------------------
End of year (270) (9,383) (14,642)
---------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY $ 17,858 $ 14,674 $ 10,209
=================================================================================================================================
COMPREHENSIVE INCOME
Net income $ 9,113 $ 8,215 $ 249
Other comprehensive income:
Foreign currency translation adjustments 4 -- --
Unrealized gain (loss) (144) (946) 731
---------------------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 8,973 $ 7,269 $ 980
=================================================================================================================================
The accompanying notes are an integral part of these consolidated statements.
INTELLIGENT SYSTEMS CORPORATION
F-5
INTELLIGENT SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOW
(in thousands)
YEAR ENDED DECEMBER 31,
2001 2000 1999
-------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY (USED FOR):
OPERATIONS:
Net income $ 9,113 $ 8,215 $ 249
Adjustments to reconcile net income to net cash
used for operating activities, net of
effects of acquisitions and dispositions:
Depreciation and amortization 6,595 314 347
Investment income, net (19,902) (9,665) (2,170)
Equity loss of affiliate companies 2,173 771 948
Changes in operating assets and liabilities, net of
effects of acquisition
Accounts receivable (33) 249 19
Inventories (72) (149) 279
Other current assets 126 66 290
Accounts payable (166) (87) (459)
Accrued expenses and other current liabilities 149 (124) 315
-------------------------------------------------------------------------------------------------------------------
Cash used for continuing operations (2,017) (410) (182)
===================================================================================================================
INVESTING ACTIVITIES:
Proceeds from sales of investments 20,540 10,291 2,365
Acquisition of company, net of cash acquired 81 -- --
Increase (decrease) in minority interests -- 5 (190)
Acquisitions of long-term investments (2,806) (3,628) (788)
Repayments under notes and interest receivable 5,105 377 38
Advances under notes and interest receivable (2,087) (4,533) (95)
Purchases of property and equipment, net (95) (111) (13)
-------------------------------------------------------------------------------------------------------------------
Cash provided by investing activities 20,738 2,401 1,317
===================================================================================================================
FINANCING ACTIVITIES:
Borrowings under short-term borrowing arrangements 889 1,503 262
Repayments under short-term borrowings arrangements (2,393) (763) (1,237)
Payment of dividends to stockholders -- (2,956) --
Purchase and retirement of stock (5,803) (112) --
Exercise of stock options 14 194 23
Foreign currency translation adjustment 4 -- 93
-------------------------------------------------------------------------------------------------------------------
Cash used for financing activities (7,289) (2,134) (859)
===================================================================================================================
Net increase (decrease) in cash 11,432 (143) 276
Cash at beginning of year 594 737 461
Cash at end of year $ 12,026 $ 594 $ 737
===================================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 52 $ 59 $ 159
Cash paid during the year for taxes 577 -- --
The accompanying notes are an integral part of these consolidated statements.
INTELLIGENT SYSTEMS CORPORATION
F-6
NOTE 1
ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization - Intelligent Systems Corporation, a Georgia corporation, was
formed in November 1991 to acquire through merger the business, net assets and
operations of Intelligent Systems Master, L.P. In this document, terms such as
the company, we, us, and ISC refer to Intelligent Systems Corporation.
Nature of Operations - Our business is to create, operate and invest in
businesses which we believe have promising growth potential. Consolidated
companies (in which we have majority ownership and control) are principally
engaged in two industries: information technology products and services and
industrial products. Operations in information technology products and
services, which include our VISaer and QS Technologies subsidiaries, include
development and sales of software licenses and related professional services
and software maintenance contracts. Operations in the industrial product
segment include the manufacture and sale of bio-remediating parts washers by
our ChemFree subsidiary. In prior periods, through November 2000, we also were
involved in health care services. These operations are explained in further
detail in Note 18. Our affiliate companies (in which we have a minority
ownership) are mainly involved in the information technology industry.
Use of Estimates - In preparing the financial statements in conformity with
accounting principles generally accepted in the United States, management makes
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements. These estimates and assumptions also affect amounts
of revenues and expenses during the reporting period. Actual results could
differ from these estimates.
Consolidation - The financial statements include the accounts of Intelligent
Systems Corporation and its majority owned and controlled U.S. and non-U.S.
subsidiary companies after elimination of material accounts and transactions
between our subsidiaries.
Investments - For entities in which we have 20 to 50 percent ownership interest
and do not exert control, we account for these investments by the equity
method. We account for investments of less than 20 percent in non-marketable
equity securities at the lower of cost or market. When calculating gain or loss
on the sale of an investment, we use the average cost basis of the securities.
Marketable securities are accounted for in accordance with Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" (SFAS No. 115). At December 31, 2001, the aggregate
fair market value of our available-for-sale securities consisted of equity
securities and totaled $2.0 million. At December 31, 2000, the aggregate fair
market value of our available-for-sale securities consisted of equity
securities and totaled $2.3 million. These amounts include net unrealized
holding losses of $359,000 and $215,000 as of December 31, 2001 and 2000,
respectively. These amounts are reflected as a separate component of
stockholders' equity.
Translation of Foreign Currencies - We consider that local currencies are the
functional currencies for foreign operations. We translate assets and
liabilities to U.S. dollars at period-end exchange rates. We translate income
and expense items at average rates of exchange prevailing during the period.
Translation adjustments are accumulated as a separate component of
stockholders' equity. Gains and losses that result from foreign currency
transactions are recorded in the consolidated statement of operations.
Cash - We consider all highly liquid instruments with maturities of less than
90 days to be cash.
Inventories - We state the value of inventories at the lower of cost or market
determined on a first-in first-out basis. Cost includes labor, materials and
production overhead. Market is defined as net realizable value.
Property and Equipment - Property and equipment are carried at cost less
accumulated depreciation. The cost of each major class of property and
equipment at December 31, 2001 and 2000 is as follows:
(in thousands) 2001 2000
-----------------------------------------------------------
Operating equipment $1,397 $974
Furniture and fixtures 199 117
Leasehold improvements 241 33
-----------------------------------------------------------
INTELLIGENT SYSTEMS CORPORATION
F-7
For financial reporting purposes, with the exception of the VISaer subsidiary
which uses the straight-line method, we depreciate these assets using the 150
percent declining balance method over the estimated lives of the assets, as
follows:
CLASSIFICATION USEFUL LIFE IN YEARS
--------------------------------------------------------
Operating equipment 3-5
Furniture & fixtures 5-7
Leasehold improvements 1-7
--------------------------------------------------------
Accumulated depreciation and amortization was $1.2 million and $642,000 at
December 31, 2001 and 2000, respectively. Depreciation expense was $307,000,
$316,000 and $332,000 in 2001, 2000 and 1999, respectively. These expenses are
included in general and administrative expenses.
Leased Equipment - In the Industrial Products segment, certain equipment is
leased to customers. At December 31, 2002, the cost and carrying value of
equipment leased to customers is $488,000 and $101,000, respectively, and
accumulated depreciation associated with leased equipment is $387,000. The
minimum future lease revenue under non-cancelable contracts is $1.25 million at
December 31, 2001. There is no contingent rental income under the leases.
Other Assets - Other assets are carried at cost net of related amortization.
Effective July 1, 2001, we account for acquisitions in accordance with
Statement of Financial Accounting Standards No. 141, "Accounting for Business
Combinations" (SFAS 141) and Statement of Financial Accounting Standards No.
142, "Accounting for Intangible Assets" (SFAS 142). Our policy is to write off
the asset and accumulated amortization for fully amortized intangibles.
Periodically we review the values assigned to long-lived assets to determine
whether they have been permanently impaired. To measure whether long-lived
assets are recoverable, we use an estimate of the undiscounted cash flows of
the applicable entity over the remaining life of the asset. At September 30,
2001, we determined the long-lived assets associated with our VISaer subsidiary
were impaired under SFAS 121 (see Note 2). Accordingly we expensed $6.0 million
related to goodwill in general and administrative expense which is reflected in
the statements of operations for the year ended December 30, 2001. The carrying
value of intangibles at December 31, 2001 is $2.3 million, of which $1.9
million is goodwill. Also in the year ended December 31, 2001, we expensed
$425,000 of purchased research and development related to the acquisition of
VISaer (see Note 2). In 2001, 2000 and 1999, we recorded total intangible
amortization expense of approximately $92,000, $29,000 and $15,000,
respectively. Accumulated amortization of intangibles totaled $92,000 and $0 at
December 31, 2001 and 2000, respectively.
Accrued Expenses and Other Liabilities - Accrued expenses and other liabilities
at December 31, 2001 and 2000 consist of the following:
(in thousands) 2001 2000
---------------------------------------------------------
Income taxes payable $ -- $ 203
Accrued payroll 761 242
Other accrued expenses 803 416
---------------------------------------------------------
Warranty Costs - We accrue the estimated costs associated with product
warranties as an expense in the period the related sales are recognized.
Revenue Recognition - Product revenue consists of fees from software licenses
and sales or leases of industrial products. Service revenue consists of fees
for implementation, consulting, training, maintenance and support for software
products and health care services.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance on applying generally accepted
accounting principles to revenue recognition issues. The Company has reviewed
its revenue recognition policies and determined that they are in compliance
with SAB 101.
We recognize revenue for industrial products when products are shipped, at
which time title transfers to the customer. There are no remaining future
obligations and delivery occurs upon shipment. We provide for estimated sales
returns in the period in which the sales are recorded. For leased equipment, we
recognize revenue monthly at the contracted monthly rate during the term of the
lease.
We recognize software fees in accordance with Statement of Position No. 97-2,
"Software Revenue Recognition" ("SOP 97-2"), as amended by Statement of
Position No. 98-9, "Software Revenue Recognition, With Respect to Certain
Transactions" ("SOP 98-9"). Under SOP 97-2, we recognize software license fees
when the following criteria are met: (1) a signed contract is obtained; (2)
delivery of the product has occurred; (3) the license fee is fixed or
determinable; and (4) collectibility is
INTELLIGENT SYSTEMS CORPORATION
F-8
probable. SOP 98-9 requires recognition of revenue using the "residual method"
when (1) there is vendor-specific objective evidence of the fair values of all
undelivered elements in a multiple-element arrangement that is not accounted
for using long-term contract accounting; (2) vendor-specific objective evidence
of fair value does not exist for one or more of the delivered elements in the
arrangement; and (3) all revenue-recognition criteria in SOP 97-2 other than
the requirement for vendor-specific objective evidence of the fair value of
each delivered element of the arrangement are satisfied. Under the residual
method, the fair value of the undelivered elements is deferred and the
remaining portion of the license fee is recognized as revenue. SOP 98-9 was
effective for transactions entered into after March 15, 1999, and we adopted
the residual method for such arrangements at that time. For those contracts
that contain significant production, modification and/or customization,
software license fees are recognized utilizing contract accounting (ARB No.
45), using the relevant guidance in SOP 81-1.
For percentage of completion contracts we measure the progress toward
completion and recognize the software license fees based upon input measures
(i.e. in the same proportion that the amount of labor hours incurred to date
bears to the total estimated labor hours required for the contract). If
reliable estimates cannot be determined, we follow the completed contract
method. Under the completed contract method, all revenue is deferred until the
customer has accepted the software and any refund rights have expired.
Service revenue related to implementation, consulting, training and healthcare
services is recognized when the services are performed. Service revenue related
to software maintenance and support contracts is recognized on a straight-line
basis over the life of the contract (typically one year).
Deferred Revenue - Deferred revenue, net of current portion, consists of
advance payments from one customer and is being accounted for on a
completed-contract basis. As of December 31, 2001, the Company had an
outstanding balance of $2,596,000. The Company does not anticipate any loss
under this contract.
Fair Value of Financial Instruments - The carrying value of cash, accounts
receivable, accounts payable and other financial instruments included in the
accompanying consolidated balance sheets approximates their fair value
principally due to the short-term maturity of these instruments.
Cost of Sales - Cost of sales for product revenue includes direct material,
direct labor, production overhead and third party license fees. Cost of sales
for service revenue includes direct cost of services rendered.
Software Development Expense - We have evaluated the establishment of
technological feasibility of our products in accordance with SFAS No. 86,
Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise
Marketed. We sell products in markets that are subject to rapid technological
change, new product development and changing customer needs; accordingly, we
have concluded that technological feasibility is not established until the
development stage of the product is nearly complete. We define technological
feasibility as the completion of a working model. The time period during which
cost could be capitalized, from the point of reaching technological feasibility
until the time of general product release, is very short and, consequently, the
amounts that could be capitalized are not material to our financial position or
results of operations. Therefore, we have charged all such costs to research
and development in the period incurred.
In accordance with AICPA SOP No. 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, we have expensed all cost
incurred in the preliminary project stage for software developed for internal
use. We capitalize all direct costs of materials and services consumed in
developing or obtaining internal use software. All costs incurred for upgrades,
maintenance and enhancements that do not result in additional functionality are
expensed. During the three years ended December 31, 2001, we did not capitalize
any internal use software costs.
New Accounting Pronouncements - In September 2000, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standard No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities - a Replacement of FASB Statement No. 125." This Statement
revises the standards for accounting for securitizations and other transfers of
financial assets and collateral. This statement is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring
after March 31, 2001. The adoption of this Statement did not have a significant
impact on our financial statements.
INTELLIGENT SYSTEMS CORPORATION
F-9
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 141, "Business Combinations" (SFAS 141). This
Statement requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. See Note 2 for the impact related to the
acquisition of VISaer, Inc. Also in July 2001, the Financial Accounting
Standards Board issued SFAS No. 142, "Goodwill and Other Intangible Assets"
(SFAS 142). This Statement requires that goodwill and certain intangible
assets, including those recorded in past business combinations, no longer be
amortized to earnings, but instead be tested for impairment at least annually.
The adoption of SFAS No. 142 by the Company did not have a significant impact
on our financial statements. For acquisitions completed after June 30, 2001,
the Statement requires that goodwill not be amortized to earnings beginning
immediately. Related to the acquisition of VISaer, Inc. (Note 2), we recorded
$1.86 million of goodwill, after related charges, of which no amortization
expense is reflected in the statement of operations.
In August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. This Statement
is effective for financial statements issued for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. We have
determined that the adoption of this Statement will not have an impact on our
financial statements.
NOTE 2
ACQUISITION
VISaer, Inc. - As of June 30, 2001, we owned 40% of VISaer, Inc. ("VISaer") and
accounted for our investment under the equity method of accounting. At that
date, we had a carrying value for VISaer of $2.86 million in long-term
investments and $1.68 million in principal and interest outstanding under
affiliate notes receivable from VISaer. VISaer, a software company that designs
and sells software that automates the maintenance, repair and overhaul (MRO)
operations of airlines, is the successor company of Visibility, Inc., an
enterprise resource planning (ERP) company whose operations were spun off a
year ago in June 2000. Effective July 1, 2001, in an unplanned restructuring
transaction involving all preferred shareholders of VISaer, we converted
$956,000 of our VISaer note receivable into a new series of preferred stock of
VISaer. In addition, VISaer repaid the balance of $725,000 owed to us shortly
after the restructuring was completed.
The debt to equity conversion in July resulted in ISC taking control of VISaer.
Our ownership of VISaer increased from 40% to 65%, and we account for the
transaction as a "step" acquisition. For financial reporting periods after July
1, 2001, we account for VISaer under the consolidation method. The accounting
treatment for the "step" acquisition and related purchase accounting of VISaer
had the result of immediately creating $8.8 million in intangible assets for
financial reporting purposes. In accordance with SFAS 141, based on third party
valuations, we identified and valued the following intangible assets: existing
software technology ($2.0 million), in-process research and development ($1.7
million) and a favorable lease contract ($200,000). At the time of the
acquisition we recorded 25% of such amounts to reflect the amount associated
with our acquisition of an additional 25% "step" of VISaer. The recorded amount
for existing software technology ($500,000) is being amortized over its
estimated useful life of three years and the recorded amount for the favorable
lease contract ($50,000) is being amortized over the remaining term of the
lease (through July 2004). We immediately expensed $425,000 (representing 4.8%
of the $8.8 million of total intangibles) related to purchased research and
development projects that had not reached technological feasibility and that
did not have an alternative future use. This amount is included in research and
development expense in the accompanying financial statements. The remaining
excess intangible value in the amount of $7.83 million was booked as goodwill
at July 1, 2001.
Post-acquisition Write-down of Goodwill - At September 30, 2001, as a result of
the terrorist attacks on September 11, 2001 which have directly impacted the
aerospace industry into which VISaer sells its software products, we evaluated
the extent to which the VISaer reporting unit might be impaired. An analysis by
a third party based on an undiscounted cash flow model determined that under
SFAS 121, the long-lived assets associated with VISaer were impaired. Based upon
this appraisal, we assessed the total fair value of VISaer at September 30, 2001
to be $3.7 million. Based on our 65% ownership, the value of our
INTELLIGENT SYSTEMS CORPORATION
F-10
ownership was $2.4 million. We expensed $6.0 million related to goodwill. The
one-time charge is included in general and administrative expense in the
consolidated financial statements for the year ended December 31, 2001. Despite
the write-down, we are committed to the VISaer business plan and have agreed to
assist VISaer with working capital needs, if any, during 2002.
NOTE 3
SALES OF ASSETS
PaySys International, Inc. - On April 27, 2001, we sold our 32 percent
ownership interest in PaySys, an affiliate company, to First Data Corporation.
In exchange for the sale of all of our shares of PaySys common stock, we
received cash proceeds of $17.8 million and recorded a pretax gain of $17.8
million. In addition, PaySys repaid $4.3 million in principal and interest
related to short-term bridge loans. In addition, an escrow fund totaling $20.0
million was set aside for potential liabilities that may arise after the
closing of the sale. The balance of the fund, after payment of any and all
claims, will be distributed pro rata to PaySys shareholders, including us, as
additional sale proceeds at various time periods over the next four years.
Immediately prior to the sale to First Data Corporation, PaySys spun off two
subsidiaries to its shareholders. Accordingly, we own approximately 27 percent
of Delos Payment Systems, Inc. and 31 percent of dbbAPPS, Inc., both
development stage companies that are continuing to develop and market a
proprietary software operating platform and application software that had been
under development by PaySys. We did not record a gain on the distribution to us
of an interest in these two companies. Rather, due to uncertainty regarding the
two early stage companies, we booked a valuation reserve equal to the net asset
value and goodwill associated with our pro rata share of the value of our
interest in Delos Payment Systems and dbbAPPS. In the fourth quarter of 2001,
in accordance with APB18, we classified a secured loan in the amount of $1.5
million to Delos Payment Systems as additional investment. At the same time, we
recaptured $1.42 million in losses related to our pro rata share of cumulative
unrecorded losses. This loss is recorded in equity loss in affiliates in the
consolidated statements of operations. The carrying value of Delos at year-end
is $80,000 and of dbbAPPS is zero.
HeadHunter.net - In the third quarter ended September 30, 2001, we sold 90,228
shares of common stock (representing all of our interest) of HeadHunter.net. We
originally acquired the shares in exchange for our holdings in privately held
MiracleWorker.net in August 2000. We received $821,000 cash and recognized a
gain of $471,000 on an original cost basis of $350,000.
PsyCare America, LLC - On November 1, 2000, we sold certain operating assets of
our subsidiary PsyCare America, LLC, consisting mainly of contracts and
intellectual property, and closed the remaining operations. We sold the assets
to iExalt, Inc. in exchange for 200,000 shares of common stock of iExalt, a
publicly traded company, and may receive additional shares based on the trading
price of the iExalt stock on the second anniversary of the transaction.
Risk Laboratories, LLC - On March 21, 2000, we sold part of our interest in
Risk Laboratories, LLC in a private transaction. We sold 2,310,000 units for
$8.8 million in cash and a gain of $8.6 million. On January 18, 2001, we sold
214,273 units of Risk to the same buyer for a total of $900,000 cash and
recorded a gain of $893,000 based on a cost basis of $7,000. At the same time,
we acquired 107,137 common units from Risk for a total acquisition price of
$450,000. Concurrent with the purchase of these units, we recaptured $450,000
in losses related to our pro rata share of cumulative unrecorded losses. This
loss is recorded in equity loss in affiliates in the accompanying consolidated
statement of operations for 2001. On May 3, 2001, we sold an additional 257,127
common units of Risk to the same buyer. We received $1.0 million cash and
recorded a second quarter gain of $1.0 million on a cost basis of zero. At
December 31, 2001, we retain 259,253 common units, representing approximately
2.7% of Risk.
Primus Knowledge System, Inc. - In January 2000, a company in which we held a
minority equity position was acquired by Primus Knowledge Solutions, Inc., a
publicly traded company. We received 66,431 shares of Primus common stock in
exchange for our interest in the acquired company. The shares were sold at
various times during 2000, resulting in a net gain of $775,000 and cash of $1.3
million.
S1 Corporation - At various times during 2000, we sold a total of 9,515 shares
of S1 Corporation common stock, which had been received as consideration for
our shares of stock in VerticalOne
INTELLIGENT SYSTEMS CORPORATION
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Corporation upon the merger of the two companies in 1999. We realized net gains
of $249,000 and cash of $296,000 on the sales of S1 stock.
MediaMetrix, Inc. - As a result of a merger between Relevant Knowledge (a
company in which we were a minority investor) and MediaMetrix in 1998, we
acquired shares of MediaMetrix stock. We sold the shares in the public market
on November 6, 1999, realizing a gain of $995,000 on the sale.
Novient, Inc. - In the first quarter of 1999, we sold 66,500 shares of
preferred stock of Novient, Inc., in a private transaction, recognizing a gain
of $233,000 and netting $286,000 in cash. At December 31, 2001 we hold 227,250
shares of preferred stock in the private company.
InterQuad Services - Effective February 1, 1999, we sold our ownership in the
InterQuad Services subsidiary. We sold our interest in return for a 19 percent
interest in a privately held U.K. company whose principal asset is a 49 percent
ownership in InterQuad Group. InterQuad Group is a privately held U.K. based
company that provides computer hardware, software, training and consulting
services to businesses.
Information Advantage, Inc. - In January 1999, we sold 95,449 shares of common
stock of Information Advantage (formerly IQ Software, an affiliate company
acquired by Information Advantage in 1998). We recorded a gain on the sale of
$814,000.
NOTE 4
INVESTMENTS IN AFFILIATES
PaySys International, Inc. - Prior to the sale of PaySys on April 27, 2001
(refer to Note 3), we owned a 32.6 percent interest in PaySys International,
Inc., a software company accounted for using the equity method of accounting.
In 1997, in accordance with the equity method of accounting, we recorded $3.0
million representing our pro rata share of PaySys losses, thus reducing the
carrying value of our $3.0 million investment to zero. In subsequent periods,
we did not record any additional losses or income related to PaySys operations.
No cash dividends were received from the affiliate during 2001 and 2000.
The following table contains the summarized financial information of PaySys.
-------------------------------------------------------
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
(in thousands) 2000 1999
-------------------------------------------------------
Current assets $ 8,747 $18,929
Current liabilities 31,992 18,947
Noncurrent assets 4,978 4,960
Noncurrent liabilities 12,730 16,370
Net sales $ 40,477 $50,068
Operating income (loss) (20,653) 902
Net loss (24,527) (1,706)
-------------------------------------------------------
* There is no data provided for 2001 because we sold our PaySys stock in
April 2001. See Note 3.
VISaer, Inc. - Prior to the acquisition of VISaer, Inc. (see Note 2), we owned
a 40.2 percent interest in VISaer, Inc. The investment was classified as an
affiliate and accounted for using the equity method of accounting because we
did not exert control over the company prior to the acquisition. Since the
acquisition, we have consolidated the results of VISaer. Our pro rata share of
VISaer loss was $(116,000) for the six months ended June 30, 2001 and
$(720,000) and $(1,418,000) for fiscal years 2000 and 1999, respectively. No
cash dividends were received from the affiliate in 2001 or 2000.
The following table contains the summarized financial information of VISaer.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
(in thousands) 2001* 2000** 1999**
-----------------------------------------------------------
Current assets $ 1,465 $ 1,036 $ 9,177
Current liabilities 5,184 7,794 16,862
Noncurrent assets 335 257 1,108
Noncurrent liabilities 2,677 2,632 1,972
Net sales $ 4,821 $11,752 $24,210
Operating loss (3,558) (2,757) (3,636)
Net loss (184) (583) (4,225)
-----------------------------------------------------------
* We have consolidated VISaer since July 1, 2001.
** Includes results of business line sold in July 2000.
Cirronet, Inc. - At December 31, 2001, we owned an 18.2 percent interest in
Cirronet, Inc. (formerly Digital Wireless Corporation), a private company
involved in wireless telecommunication products that is accounted for using the
cost method of accounting.
During 2000, we lost the ability to exert significant influence and therefore
converted from the equity to the cost method of accounting. Our pro rata share
of Cirronet's income (loss) in 2000 and 1999 was
INTELLIGENT SYSTEMS CORPORATION
F-12
($28,000) and $184,000, respectively. No dividends were received from the
affiliate in 2001 or 2000.
The following table contains the summarized financial information of Cirronet.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
2001 2000 1999
(in thousands) (unaudited) (unaudited) (audited)
-----------------------------------------------------------
Current assets $ 3,121 $3,279 $2,785
Current liabilities 576 911 439
Noncurrent assets 490 364 115
Noncurrent 166 84 103
liabilities
Net sales $8,821 $6,241 $4,471
Operating income 111 (117) 1,006
(loss)
Net income (loss) 199 (38) 794
-----------------------------------------------------------
NOTE 5
INVESTMENTS
The following summarizes our ownership interest in certain non-significant
companies included in our long-term investments. At December 31, 2001, our
ownership interest in each of the named companies was as follows: Alliance
Technology Ventures (<3%), NKD Enterprises (25%), Delos Payment Systems (27%),
Cirronet (18%) and Atherogenics (<1%). The ownership interests are classified
according to applicable accounting methods at December 31, 2001.
COST
BASIS
LESS
CARRYING DISTRI-
(in thousands) VALUE BUTIONS
---------------------------------------------------------
EQUITY METHOD
---------------------------------------------------------
Alliance Technology Ventures $595 $ 836
NKD Enterprises 949 1,250
Delos Payment Systems 80 80
COST METHOD
---------------------------------------------------------
Cirronet 740 525
---------------------------------------------------------
MARKETABLE SECURITIES - The carrying and estimated fair values of
available-for-sale securities at December 31, 2001 and 2000 are summarized as
follows:
(in thousands) 2001 2000
------------------------------------------------------------
Amortized cost $ 2,398 $ 2,469
Gross unrealized gains 792 795
Gross unrealized losses (1,151) (1,010)
------------------------------------------------------------
Estimated fair values $ 2,039 $ 2,254
------------------------------------------------------------
Of the estimated fair values above, Atherogenics represents $1.85 million and
$1.2 million at December 31, 2001 and 2000, respectively.
Our aggregate share of the undistributed earnings (losses) of 50 percent or
less owned companies accounted for by the equity method was $(432,000) at
December 31, 2001, the majority of which is related to Delos Payment Systems.
NOTE 6
ACCOUNTS RECEIVABLE AND CONCENTRATION OF CREDIT RISK
At December 31, 2001 and 2000, our allowance for doubtful accounts and sales
returns amounted to $45,000 and $46,000, respectively. Provisions for doubtful
accounts and sales returns were $8,500, $12,000 and $24,000 for the years ended
December 31, 2001, 2000 and 1999, respectively.
Our accounts receivable are subject to potential credit risk. Our subsidiaries
sell products direct to end-user customers and through channel resellers and
partners. If the financial condition of a significant channel reseller
deteriorates, it could have an adverse impact on the subsidiary and
consolidated operating results. One reseller customer of VISaer represents
approximately 23 percent of consolidated revenue in 2001 and 2 customers
represent 29 percent of accounts receivable as of December 31, 2001. One
customer of ChemFree represents approximately 10 percent of consolidated
revenue in 2001 and 10 percent of year-end accounts receivable. In 2000, one
reseller customer of ChemFree represented 10.4 percent of consolidated revenue
and 20 percent of accounts receivable at December 31, 2000.
INTELLIGENT SYSTEMS CORPORATION
F-13
NOTE 7
BORROWINGS AND LONG-TERM DEBT
Terms and borrowings under our credit facilities are summarized as follows:
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
(in thousands) 2001 2000
------------------------------------------------------------
Maximum outstanding (month-end) $1,933 $1,504
Outstanding at year end -- $1,504
Average interest rate at year end -- 9.5%
Average borrowings during the year $ 509 $ 197
Average interest rate 8.2% 9.2%
------------------------------------------------------------
Our credit facility expired in May 2001 at which time we paid the outstanding
balance in full.
Interest paid on debt during 2001, 2000 and 1999 amounted to $52,000, $59,000
and $159,000, respectively.
NOTE 8
DEFERRED GAIN
In connection with the sale of our VISaer subsidiary's product line in July
2000, the buyer assumed the liabilities of the purchased line of business.
VISaer did not obtain releases from creditors for a portion of these
liabilities and contracts and, accordingly, remains contingently liable for
these obligations. VISaer recorded these liabilities as deferred gain. As of
December 31, 2001, the balance of deferred gain consisted of $562,000 in
accounts payable and accrued expenses, $711,000 related to a bank line of
credit and $55,000 in capital lease obligations. In accordance with SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities", VISaer recognizes the deferred gain when the
liability is paid and the company is relieved of its obligation. Since our
acquisition of VISaer on July 1, 2001, approximately $961,000 of the deferred
gain has been recognized in the component of other income/expense in the
consolidated statements of operations for the year ended December 31, 2001. In
January 2002, the buyer paid the bank line of credit in full.
NOTE 9
INCOME TAXES
The income tax provision consists of the following:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
(in thousands) 2001 2000 1999
---------------------------------------------------------
Current $173 $203 $ --
=========================================================
Following is a reconciliation of estimated income taxes at the blended
statutory rate to estimated tax expense as reported:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
2001 2000 1999
-----------------------------------------------------------
Statutory rate, blended 34% 34% 34%
Change in valuation
allowance (32%) (32%) (34%)
-----------------------------------------------------------
Effective rate 2% 2% 0%
===========================================================
At December 31, 2001, our subsidiaries had net operating loss carryforwards
totaling $7.2 million. The net operating loss carryforwards, if unused as
offsets to future taxable income, will expire by 2021. At December 31, 2001, we
had federal and state tax credit carryforwards of approximately $1.1 million
and $940,000, respectively. We may not be able to use these carryforwards
because, in some cases, they are limited to taxable income of a particular
subsidiary or may be subject to annual limitation under the Internal Revenue
Code if there is a greater than 50 percent change in ownership as defined under
Section 382.
We account for income taxes using SFAS 109, "Accounting for Income Taxes". We
have a deferred tax benefit of approximately $9.3 million at December 31, 2001
and $8.0 million at December 31, 2000. Since our ability to realize the
deferred tax asset is uncertain, the amount is offset in both 2001 and 2000 by
a valuation allowance of an equal amount. The deferred tax benefit at December
31, 2001 and 2000 relates primarily to net operating loss carryforwards.
Income taxes paid during 2001 were $577,000. No income taxes were paid in 2000
and 1999.
INTELLIGENT SYSTEMS CORPORATION
F-14
NOTE 10
COMMITMENTS AND CONTINGENCIES
Leases - We have noncancellable operating leases expiring at various dates
through June 2004. Future minimum lease payments are as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
(in thousands)
-------------------------------------------------------
2002 $1,049
2003 297
2004 153
-------------------------------------------------------
Total minimum lease payments $1,499
=======================================================
Rental expense for leased facilities and equipment related to operations
amounted to $1.0 million, $948,000 and $995,000, for the years ended December
31, 2001, 2000 and 1999, respectively.
Legal Matters - In 1999, a suit was brought against our ChemFree subsidiary and
two other parties by a former consultant of ChemFree. The suit challenges the
ownership of various intellectual property assets of ChemFree. ChemFree and the
other parties to the litigation strongly deny the allegations, have filed cross
claims against another entity and intend to vigorously defend the suit. The
case is pending in the Superior Court of Gwinnett County, Georgia. While the
company believes ChemFree has sufficient evidence to refute the claims made,
there can be no assurance that the case will be resolved in favor of ChemFree.
In 2001, Intelligent Systems was named as co-defendant in a lawsuit filed in
the Circuit Court of the Ninth Judicial Circuit in Orange County, Florida by
four former employees of PaySys International, Inc. The suit alleges that the
former employees hold warrants to purchase up to 142,500 shares of common stock
of PaySys owned by us. The plaintiffs allege the warrants were issued to them
by a former officer of PaySys, from whom we acquired shares in 1994. We filed
an initial response to the suit and deny that any valid warrants exist. While
we believe the initial discovery process supports our position and there exist
sufficient evidence and legal grounds to refute the claims made, the ultimate
outcome of this claim cannot be determined currently.
In addition, we are party to a small number of legal matters arising in the
ordinary course of business. It is management's opinion that none of these
matters will have a material adverse impact on our consolidated financial
position or results of operations.
Investment Company Act - The Investment Company Act of 1940 broadly defines an
investment company generally as any issuer that is primarily engaged in, or
proposes to engage in, the business of investing, reinvesting, owning, holding
or trading in securities and owns or proposes to acquire investment securities
having a value exceeding 40% of the issuer's total assets. We do not intend to
be and do not consider that we are an investment company and have relied on
Rule 3a-1 of the 1940 Act which provides that a company is not deemed to be an
investment company if not more than 45 percent of the value of its assets and
no more that 45 percent of its net income in the last four quarters is derived
from securities of companies it does not control. In the quarter ended March
31, 2001, we may technically have triggered the definition related to net
income because of gains generated from the sale of non-control securities in
the past four quarters. However, at that time and to the extent necessary to do
so, we elected to rely on safe harbor from the definition of an investment
company for transient investment companies contained in Rule 3a-2 under the
Investment Company Act. Rule 3a-2 provides a conditional one year exclusion
from the investment company definition for an issuer that, among other things,
has a bona fide intent not to be an investment company as soon as reasonably
practical. At December 31, 2001, we were in compliance with the requirements of
Rule 3a-1 of the 1940 Act within the one-year exemption period. We believe we
will continue to be in compliance but if we fail to do so within the next two
years, we may not be able to rely on the safe harbor provision of Rule 3a-2.
NOTE 11
POST-RETIREMENT BENEFITS
Effective January 1, 1992, we adopted the Outside Directors' Retirement Plan
which provides that each nonemployee director, upon resignation from the Board
after reaching the age of 65, will receive a lump sum cash payment equal to
$5,000 for each full year of service as a director of the company (and its
predecessors and successors) up to $50,000. We have accrued $100,000 to date
for anticipated future payments under the plan.
INTELLIGENT SYSTEMS CORPORATION
F-15
NOTE 12
REDEEMABLE PREFERRED STOCK OF SUBSIDIARY
This amount relates to our VISaer subsidiary's obligation to a minority
shareholder of VISaer pursuant to the redemption provision of the preferred
stock of VISaer. The amount related to the VISaer obligation to Intelligent
Systems pursuant to the redemption provision is eliminated in consolidation.
Intelligent Systems has not guaranteed payment of this obligation.
NOTE 13
STOCKHOLDERS' EQUITY
We have authorized 20,000,000 shares of Common Stock, $.01 par value per share,
and 2,000,000 shares of Series A Preferred Stock, $.10 par value per share. No
shares of Preferred Stock have been issued; however, we adopted a Rights
Agreement on November 25, 1997, which provides that, under certain
circumstances, shareholders may redeem the Rights to purchase shares of
Preferred Stock. The Rights have certain anti-takeover effects. The Board of
Directors has authorized stock repurchases at various times in the past. On
July 17, 2001, we repurchased and retired one million shares of our common
stock at $5.25 per share pursuant to a self-tender offer. We repurchased and
retired an additional 132,000 shares at fair market value during the year ended
December 31, 2001. In the year ended December 31, 2000, we repurchased and
retired 126,669 shares of common stock at fair market value but made no
repurchases during 1999.
NOTE 14
STOCK OPTION PLAN
We instituted the 1991 Incentive Stock Plan (the "Plan") in December 1991 and
amended it in 1997 to increase the number of shares authorized under the Plan
to 925,000. The Plan expired in December 2001, with 148,000 shares ungranted.
The Plan provides shares of common stock that may be sold to officers and key
employees. In August 2000, we instituted a Non-Employee Directors' Stock Option
Plan (the "Directors' Plan") that authorizes the issuance of up to 200,000
shares of common stock to non-employee directors. Upon adoption of the
Directors' Plan, each non-employee director was granted an option to acquire
5,000 shares. At each annual meeting, each director receives a grant of 4,000
shares. Stock options under both plans are granted at fair market value on the
date of grant. As of December 31, 2001, a total of 813,000 options under both
plans have been granted, 724,320 have been exercised and 38,014 options are
fully vested and exercisable at a weighted average price per share of $3.53.
All options expire ten years from their respective dates of grant. At December
31, 2001, the weighted average remaining contractual life of the outstanding
options is 7.86 years. Stock option transactions during the three years ended
December 31, 2001 were as follows:
2001 2000 1999
--------------------------------------------------------------------------------------------
Options outstanding
at Jan. 1 76,014 655,000 665,000
Options granted 16,000 57,000 --
Options exercised 3,334 635,986 10,000
Options canceled -- -- --
Options outstanding
at Dec. 31 88,680 76,014 655,000
Options available for
grant at Dec. 31 164,000 328,000 185,000
Option price ranges per share:
Granted $ 4.26 $4.00 - --
4.25
Exercised $ 4.25 $.875 - $ 2.25
2.9375
Canceled -- -- --
Weighted average option price per share:
Granted $ 4.26 $ 4.16 --
Exercised $ 4.25 $ 1.72 $ 2.25
Canceled -- -- --
Outstanding at
Dec. 31 $ 3.91 $ 3.86 $ 1.75
--------------------------------------------------------------------------------------------
We account for the Plan under the provisions of Accounting Principles Board
Opinion No. 25. The following pro forma information is based on estimating the
fair value of grants under the Plan based upon the provisions of SFAS No. 123,
"Accounting for Stock Based Compensation". The fair value of each option
granted in 2001 and 2000 has been estimated as of the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
INTELLIGENT SYSTEMS CORPORATION
F-16
- risk free interest rate of 4 percent
- expected life of the option of 7.86 years
- expected dividend yield rate of 0 percent
- expected volatility of 51 percent
Under these assumptions, the weighted average fair value of options granted in
2001 and 2000 was $1.71 and $3.15 per share, respectively. There were no awards
under the Plan in 1999. The fair value of the grants would be amortized over
the vesting period for the options. Accordingly, our pro forma net income and
net income per common share assuming compensation cost as determined under SFAS
No. 123 would have been the following:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
(in thousands except
per share data) 2001 2000 1999
--------------------------------------------------------
Net income $9,086 $8,215 $ 249
Net income per
common share basic $ 1.78 $ 1.47 $0.05
--------------------------------------------------------
Net income per
common share diluted $1.77 $1.46 $0.05
--------------------------------------------------------
NOTE 15
FOREIGN SALES AND OPERATIONS
Aggregate export and foreign sales were $2.87 million, $805,000 and $1.3
million for the years ended December 31, 2001, 2000 and 1999, respectively.
Export and foreign sales were made principally in Europe and the Pacific Rim.
Sales in these geographic areas are as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
(in thousands) 2001 2000 1999
-----------------------------------------------------------
Europe $2,499 $733 $1,317
Pacific Rim 258 72 22
South America 118 -- --
-----------------------------------------------------------
With the acquisition of VISaer on July 1, 2001, we acquired foreign
subsidiaries in the United Kingdom and Ireland. Previously, in February 1999,
we had sold our only foreign subsidiary, InterQuad. For the years ended
December 31, 2001, 2000 and 1999, income (loss) before provision for income
taxes derived from foreign subsidiaries approximated $63,000, $0 and
$(109,000), respectively.
At December 31, 2001 and 2000, foreign subsidiaries had assets of $595,000 and
$0 respectively, and total liabilities of $498,000 and $0, respectively.
There are no currency exchange restrictions related to our foreign subsidiaries
that would affect our financial position or results of operations.
Refer to Note 1 for a discussion regarding how we account for translation of
non-US currency amounts.
NOTE 16
EARNINGS PER SHARE
For the years ended December 31, 2001, 2000 and 1999, our diluted weighted
average shares outstanding include the assumed conversion of stock options.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
(in thousands except
per share data) 2001 2000 1999
-------------------------------------------------------------
Net income $9,113 $8,215 $ 249
Basic earnings
per share $1.78 $1.47 $0.05
Basic weighted
average shares 5,108 5,607 5,106
Diluted earnings
per share $1.77 $1.46 $0.05
Diluted weighted
average shares 5,146 5,632 5,337
NOTE 17
HUMANSOFT SUBSIDIARY REORGANIZATION UNDER CHAPTER 11
On November 18, 1999, the United States Bankruptcy Court for the Northern
District of Georgia confirmed a Plan of Reorganization for a former subsidiary.
The plan provided for payment of a fixed percent of the allowed claims for
certain trade creditors and customers as well as payment of the administrative
expenses. The first payments were made immediately following the confirmation,
a second payment was made in November 2000 and the final payment was made in
November 2001.
INTELLIGENT SYSTEMS CORPORATION
F-17
NOTE 18
INDUSTRY SEGMENTS
Our consolidated subsidiaries were involved in three industry segments:
information technology products and services, industrial products and health
care services. Operations in information technology products and services,
which include our VISaer and QS Technologies subsidiaries, include development
and sales of software licenses and related professional services and software
maintenance contracts. Operations in the industrial product segment include the
manufacture and sale of bio-remediating parts washers by our ChemFree
subsidiary. Operations in health care services, which consisted of the PsyCare
subsidiary prior to its sale in November 2000, involved mental health and
substance abuse treatment programs. Total revenue by industry segment includes
sales to unaffiliated customers. Sales between our industry segments are not
material. Operating profit (loss) is total revenue less operating expenses.
None of the corporate overhead expense is allocated to the individual industry
segments. Identifiable assets by industry segment are those assets that are
used in our subsidiaries in each industry segment. Corporate assets are
principally cash, notes receivable and investments. The table following
contains segment information for the years ended December 31, 2001, 2000 and
1999.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
(in thousands) 2001 2000 1999
-------------------------------------------------------------------
Information Technology
Revenue $ 4,353 $ 1,828 $ 2,601
Operating Income (loss) (4,754) 219 (102)
Depreciation and
amortization 2,527 51 61
Capital expenditures 189 32 23
Identifiable assets 4,792 528 950
Industrial Products
Revenue 4,365 4,269 4,092
Operating Income (loss) (227) 85 138
Depreciation and
amortization 157 176 152
Capital expenditures 83 145 165
Identifiable assets 1,730 1,792 1,841
Healthcare Services
Revenue -- 930 1,786
Operating Income (loss) -- (17) 64
Depreciation and
amortization -- 42 76
Capital expenditures -- -- 7
Identifiable assets -- 61 497
Consolidated Segments
Revenue $ 8,718 $ 7,027 $ 8,479
Operating Income (loss) (4,981) 287 100
Depreciation and
amortization 2,684 270 289
Capital expenditures 272 177 195
Identifiable assets 6,522 2,381 3,288
A reconciliation of consolidated segment data above to consolidated income
(loss), depreciation and amortization, capital expenditures and assets follows:
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
(in thousands) 2001 2000 1999
------------------------------------------------------------
Consolidated segments
operating income (loss) $(4,981) $ 287 $ 100
Corporate expenses (5,439) (1,264) (899)
------------------------------------------------------------
Consolidated operating
loss (10,420) (976) (799)
Interest income (expense) 1,017 434 (88)
Investment income 19,902 9,665 2,170
Equity of affiliates (2,173) 771 (948)
Other income (expense) 960 66 (76)
------------------------------------------------------------
Income before taxes 9,286 8,418 259
Income taxes 173 203 --
Minority interest -- -- 10
------------------------------------------------------------
Net income $ 9,113 $ 8,215 $ 249
============================================================
Depreciation and
amortization
Consolidated segments $ 2,684 $ 270 $ 289
Corporate 3,911 44 58
------------------------------------------------------------
Consolidated $ 6,595 $ 314 $ 347
============================================================
Capital Expenditures
Consolidated segments $ 272 $ 177 $ 195
Corporate 25 26 43
------------------------------------------------------------
Consolidated $ 297 $ 203 $ 238
============================================================
Assets
Consolidated segments
identifiable assets $ 6,522 $ 2,381 $ 3,288
Corporate 19,567 17,634 10,370
------------------------------------------------------------
Consolidated $26,089 $18,057 $13,658
============================================================
INTELLIGENT SYSTEMS CORPORATION
F-18
NOTE 19
QUARTERLY FINANCIAL DATA (unaudited)
The table following contains a summary of selected quarterly data for the years
ended December 31, 2001 and 2000.
FOR QUARTERS ENDED
(in thousands except
per share data) MAR. 31 JUNE 30 SEPT. 30 DEC.31
--------------------------------------------------------------------------------------
2001
Net sales $1,694 $ 1,519 $ 2,257 $ 3,249
Operating (loss) (234) (588) (8,350)c (1,248)
Net income (loss) 749a 17,931b (7,672) (1,895)d
Basic income (loss)
per share 0.13 3.19 (1.63) (0.42)
Diluted income (loss)
per share 0.13 3.19 (1.63) (0.42)
2000
Net sales $2,007 $ 1,988 $ 1,630 $ 1,402
Operating income
(loss) (309) 50 (275) (442)
Net income (loss) 8,384e (132)f 145g (182)h
Basic income (loss)
per share 1.48 (0.02) 0.03 (0.03)
Diluted income (loss)
per share 1.48 (0.02) 0.03 (0.03)
a. Includes gains of $845,000 and $306,000 loss in equity of affiliates.
b. Includes gains of $18.8 million and $183,000 loss in equity of
affiliates.
c. Includes non-recurring charges of $6.4 million.
d. Includes $1.6 million loss in equity of affiliates and recognition of
deferred gain of $673,000.
e. Includes gains of $8.8 million on investments and $195,000 loss in
equity of affiliates.
f. Includes $284,000 loss in equity of affiliates.
g. Includes gains of $826,000 on investments and $247,000 loss in equity
of affiliates.
h. Includes $44,000 loss in equity of affiliates.
NOTE 20
SUBSEQUENT EVENT
In 2001, we loaned $1.5 million to Delos Payment Systems, Inc. ("Delos"), an
affiliate company accounted for under the equity method. We acquired our 27
percent interest in Delos as a result of the spin-off of Delos to the
shareholders of PaySys prior to its sale, as explained in Note 3 to the
consolidated financial statements. The carrying value of the loan on our
balance sheet at December 31, 2001 was $80,000 due to recording our pro rata
share of Delos losses during 2001 under equity accounting. As a result of the
loan default in January 2002, we acquired control of the Delos board of
directors and we will consolidate the Delos operations in 2002. We are
providing additional borrowings of $1.5 million to Delos under the loan and are
performing due diligence to decide whether to make an investment in Delos to
increase our ownership to a significant majority position. The loan eliminates
in consolidation.
As a result of consolidating Delos, we expect to record an intangible asset
upon consolidation in the first quarter of 2002 in accordance with SFAS 141. It
is possible that the intangible will be mainly in-process research and
development and goodwill and that the goodwill may be impaired for a number of
reasons. If we determine that the intangibles are impaired, we will need to
write-down the value to net realizable value in the first quarter of 2002 in
accordance with SFAS 141, resulting in a charge to earnings, which is estimated
to be approximately $1 million. Some of the factors that may negatively impact
the value of the goodwill are significant non-competition restrictions related
to the sale of PaySys in April 2001 that limit who Delos can sell its products
to for varying time periods through 2006, risks associated with completing and
testing the initial software application, lack of a proven business model and
customers, a limited operating history, and unproven market acceptance of the
Delos software features and architecture.
Despite the possible impairment charge, we have made the additional loan to
Delos to protect our investment and future alternatives.
INTELLIGENT SYSTEMS CORPORATION
F-19
SCHEDULE II
INTELLIGENT SYSTEMS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS(a) RECLASSIFICATION(c) PERIOD
-------------------------------------------------------------------------------------------------------------------------
ALLOWANCE FOR
DOUBTFUL ACCOUNTS(b)
Year Ended December 31, 1999 $1,187,568 $23,375 $1,156,523 $3,238 $57,658
Year Ended December 31, 2000 57,658 11,594 23,348 -- 45,904
Year Ended December 31, 2001 45,904 8,591 (9,511) -- 44,984
(a) Write-offs of accounts receivable against allowance accounts.
(b) This includes the combination of the Allowance for Sales Returns with
the Allowance for Doubtful Accounts.
(c) Reclassification of unearned revenue to Allowance for Doubtful
Accounts.
S-1
Report of Independent Auditors
Board of Directors
PaySys International, Inc.
We have audited the accompanying consolidated balance sheets of PaySys
International, Inc. and subsidiaries (the "Company") as of December 31, 2000 and
1999, and the related consolidated statements of operations, shareholders'
equity (deficit), and cash flows for each of the three years in the period ended
December 31, 2000. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of PaySys
International, Inc. and subsidiaries at December 31, 2000 and 1999 and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note 1, the
Company has incurred recurring operating losses and has a working capital
deficiency. In addition, the Company has $8,000,000 of Short Term Notes Payable
that become due on demand on or after February 28, 2001 that have not been
renegotiated. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 1. The financial statements do not include
any adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.
/s/ Ernst and Young LLP
February 16, 2001
except for the third paragraph of Note 11,
which is dated March 17, 2001
Atlanta, Georgia
S-2
PaySys International, Inc. and Subsidiaries
Consolidated Balance Sheets
DECEMBER 31
2000 1999
--------------------------------------------
(In thousands, except share data)
ASSETS
Current assets:
Cash and cash equivalents $ 881 $ 3,974
Accounts receivable, less allowance for bad debts of $1,000 and 4,824
$2,266 at December 31, 2000 and 1999, respectively 9,450
Unbilled receivables 2,439 4,837
Prepaid expenses and other current assets 603 668
--------------------------------------------
Total current assets 8,747 18,929
Furniture and equipment, net 3,304 2,936
Computer software costs, net of accumulated amortization of $1,616 1,273
and $1,204 at December 31, 2000 and 1999, respectively
1,685
Deposits and other assets 401 339
--------------------------------------------
$ 13,725 $ 23,889
============================================
Liabilities and shareholders' equity (deficit)
Current liabilities:
Accounts payable $ 2,746 $ 1,821
Accrued employee compensation 1,943 2,415
Deferred revenues 17,102 10,728
Current portion of long-term debt and capital lease obligations 100 733
Short Term Notes Payable 8,000 --
Accrued interest 923 --
Other current liabilities 1,178 3,250
--------------------------------------------
Total current liabilities 31,992 18,947
Other liabilities -- 226
Long-term debt and capital lease obligations, less current portion 12,719 12,378
Deferred rent expense 11 183
--------------------------------------------
44,722 31,734
Redeemable stock purchase warrants -- 3,583
Shareholders' equity (deficit):
Preferred stock, $.01 par value; 10,000,000 shares authorized; 28
2,779,689 shares issued and outstanding; liquidation preference
of $15,900 at December 31, 2000 and 1999 28
Common stock, $.01 par value; 30,000,000 shares authorized; 84
8,371,254 and 6,976,644 shares issued and outstanding at
December 31, 2000 and 1999, respectively 70
Additional paid-in capital 21,112 16,282
Notes receivable - officers (3,423) (3,423)
Deferred stock compensation -- (3)
Accumulated deficit (48,380) (24,123)
Cumulative translation adjustments (418) (259)
--------------------------------------------
(30,997) (11,428)
--------------------------------------------
$ 13,725 $ 23,889
============================================
See accompanying notes.
S-3
PaySys International, Inc. and Subsidiaries
Consolidated Statements of Operations
YEAR ENDED DECEMBER 31
2000 1999 1998
----------------------------------------------------------
(In thousands)
Revenues:
License fees $ 12,215 $19,789 $18,385
Services 28,262 30,279 27,520
----------------------------------------------------------
Total revenues 40,477 50,068 45,905
Cost of revenues:
License fees 649 998 1,934
Services 22,391 21,552 20,608
----------------------------------------------------------
Total cost of revenues 23,040 22,550 22,542
Gross margin 17,437 27,518 23,363
Operating expenses:
Sales and marketing 11,239 7,691 6,240
Research and development 17,994 12,424 11,804
General and administrative 8,857 6,501 4,793
Royalty termination settlement -- -- 4,340
----------------------------------------------------------
Total operating expenses 38,090 26,616 27,177
(Loss) income from operations (20,653) 902 (3,814)
Interest income (expense):
Interest income 369 217 118
Interest expense (3,978) (2,555) (1,279)
----------------------------------------------------------
(3,609) (2,338) (1,161)
----------------------------------------------------------
Loss before income taxes (24,262) (1,436) (4,975)
Income tax (benefit) expense (5) 270 188
----------------------------------------------------------
Net loss $(24,257) $(1,706) $ (5,163)
==========================================================
See accompanying notes.
S-4
PaySys International, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity (Deficit)
PREFERRED STOCK COMMON STOCK
------------------------------------------------------------- ADDITIONAL
NUMBER NUMBER PAID-IN
OF SHARES AMOUNT OF SHARES AMOUNT CAPITAL
-------------------------------------------------------------------------------
Balance at December 31, 1997 -- $-- 7,131,825 $ 71 $ 5,398
Comprehensive loss:
Net loss -- -- -- -- --
Foreign currency translation adjustment -- -- -- -- --
Comprehensive loss
Noncash compensation from stock purchase
warrants and stock options -- -- -- -- --
Exercise of stock options -- -- 8,335 -- 26
Issuance of preferred stock and
repurchase and retirement of
common stock 2,779,689 28 (1,342,626) (13) 7,358
-------------------------------------------------------------------------------
Balance at December 31, 1998 2,779,689 28 5,797,534 58 12,782
Comprehensive loss:
Net loss -- -- -- -- --
Foreign currency translation adjustment -- -- -- -- --
Comprehensive loss
Noncash compensation from stock
purchase warrants and stock options -- -- -- -- --
Exercise of stock options -- -- 75,000 1 88
Issuance of common stock for notes
receivable from officers 2,779,689 28 1,104,110 11 3,412
-------------------------------------------------------------------------------
Balance at December 31, 1999 2,779,689 28 6,976,644 70 16,282
Comprehensive loss:
Net loss -- -- -- -- --
Foreign currency translation -- -- -- -- --
adjustment
Comprehensive loss (24,416)
Exercise of stock purchase warrants -- -- 1,091,058 11 3,572
Exercise of stock purchase warrants --
officers -- -- 52,675 -- 31
Beneficial conversion feature of
convertible Short Term Notes Payable -- -- -- -- 890
Noncash compensation from stock
purchase warrants and stock options -- -- -- -- --
Exercise of stock options -- -- 250,877 3 337
Balance at December 31, 2000 2,779,689 $28 8,371,254 $ 84 $21,112
===============================================================================
NOTES DEFERRED CUMULATIVE
RECEIVABLE - STOCK ACCUMULATED TRANSLATION
OFFICERS COMPENSATION DEFICIT ADJUSTMENTS TOTAL
-------------------------------------------------------------------------------
Balance at December 31, 1997 $ -- $(67) $ (17,254) $ (71) $ (11,923)
Comprehensive loss:
Net loss -- -- (5,163) -- (5,163)
Foreign currency translation adjustment -- -- -- (92) (92)
---------
Comprehensive loss (5,255)
Noncash compensation from stock
purchase warrants and stock options -- 26 -- -- 26
Exercise of stock options -- -- -- -- 26
Issuance of preferred stock and
repurchase and retirement of
common stock -- -- -- -- 7,373
-------------------------------------------------------------------------------
Balance at December 31, 1998 -- (41) (22,417) (163) (9,753)
Comprehensive loss:
Net loss -- -- (1,706) -- (1,706)
Foreign currency translation adjustment -- -- -- (96) (96)
---------
Comprehensive loss (1,802)
Noncash compensation from stock
purchase warrants and stock options -- 38 -- -- 38
Exercise of stock options -- -- -- -- 89
Issuance of common stock for notes
receivable from officers (3,423) -- -- -- --
-------------------------------------------------------------------------------
Balance at December 31, 1999 (3,423) (3) (24,123) (259) (11,428)
Comprehensive loss:
Net loss -- -- (24,257) -- (24,257)
Foreign currency translation adjustment -- -- (159) (159)
---------
Comprehensive loss (24,416)
Exercise of stock purchase warrants -- -- -- -- 3,583
Exercise of stock purchase warrants
- officers -- -- -- -- 31
Beneficial conversion feature of
convertible Short Term Notes -- -- -- -- 890
Payable
Noncash compensation from stock
purchase warrants and stock options -- 3 -- -- 3
Exercise of stock options -- -- -- -- 340
Balance at December 31, 2000 $ (3,423) $ -- $ (48,380) $(418) $ (30,997)
===============================================================================
See accompanying notes.
S-5
PaySys International, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31
2000 1999 1998
-------------------------------------------------
(In thousands)
OPERATING ACTIVITIES
Net loss $ (24,257) $ (1,706) $ (5,163)
Add (deduct) adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Revised joint venture agreement (550) -- --
Depreciation 1,525 1,294 1,480
Amortization of computer software costs 412 434 391
Amortization of discounts on debt 443 353 118
Interest expense associated with beneficial conversion
feature of convertible Short Term Notes Payable 890 -- --
Provision for doubtful accounts and concession (1,266) 1,915 1,940
Accrued rent expense (172) (337) (308)
Noncash compensation 3 38 26
Changes in operating assets and liabilities:
Accounts receivable and unbilled receivables 8,290 (3,482) (5,361)
Deposits and other assets 3 (528) (48)
Accounts payable 925 87 (1,321)
Accrued employee compensation (472) 415 (483)
Deferred revenues 6,374 1,142 199
Other liabilities (1,375) 1,468 (3,639)
-------------------------------------------------
Net cash (used in) provided by operating activities (9,227) 1,093 (12,169)
INVESTING ACTIVITIES
Purchases of furniture and equipment (1,893) (1,721) (1,224)
Purchased computer software rights -- (1,818) --
-------------------------------------------------
Net cash used in investing activities (1,893) (3,539) (1,224)
FINANCING ACTIVITIES
Proceeds from issuance of preferred stock -- -- 7,373
Exercise of options and warrants 371 89 172
Proceeds from short-term notes payable 8,000 15,016 9,735
Principal payments on long-term debt, capital lease
obligations (185) (10,435) (3,023)
-------------------------------------------------
Net cash provided by financing activities 8,186 4,670 14,257
-------------------------------------------------
Effect of foreign currency translation on cash and cash
equivalents (159) (96) (92)
-------------------------------------------------
(Decrease) increase in cash and cash equivalents (3,093) 2,128 772
Cash and cash equivalents at beginning of period 3,974 1,846 1,074
-------------------------------------------------
Cash and cash equivalents at end of period $ 881 $ 3,974 $ 1,846
=================================================
See accompanying notes.
S-6
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2000
1. SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
PaySys International, Inc. (the Company) is a global provider of credit card
transaction processing software to banks, retailers and third party processors.
PaySys' flagship software product, VisionPLUS(R), is a customizable software
system consisting of a range of integrated application modules for processing
both bank and retail credit card transactions. Additionally, the Company has
developed a new transaction payment software engine that is an internet-enabled,
diversified billing and customer management system that serves
business-to-business e-commerce. This new engine will enable commercial users to
integrate a highly flexible payment system into their e-commerce systems.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany balances,
transactions, and profits and losses have been eliminated.
BASIS OF PRESENTATION
The Company's financial statements are prepared and presented on a basis
assuming it will continue as a going concern. At December 31, 2000, the Company
had an accumulated deficit of $48,380,000 and negative working capital of
$24,245,000 and incurred a net loss of $24,257,000 for the year ended December
31, 2000. The Company has total cash and cash equivalents of $881,000 at
December 31, 2000, which are not sufficient for the Company to fund operations
through December 31, 2001. Management believes that sufficient funds will be
available from either the sale of the Company's operations or obtaining
additional financing to support planned operations through December 31, 2001.
The Company intends to raise additional funds through the sale of a portion of
the operations to outside investors (see Note 11). There can be no assurance
that the Company will be able to raise additional funds on terms favorable to
the Company, or at all. These conditions raise substantial doubt about the
Company's ability to continue as a going concern through at least December 31,
2001. These financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classification of liabilities that may result from the outcome
of this uncertainty.
S-7
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
REVENUE RECOGNITION
Revenues are derived from sales of software licenses and related services.
The Company recognizes revenue in accordance with Statement of Position (SOP)
97-2, "Software Revenue Recognition". Under SOP 97-2, license and professional
service fee revenues from contracts that require significant production or
modification are recognized under contract accounting on a percentage of
completion basis as services are performed. For contracts which do not require
significant production or modification, fees are allocated to the various
contract elements based on the fair value of each element and are recognized as
follows; software license revenue upon delivery of the software and related
documentation when the fees are fixed and determinable and collectibility is
assessed as probable; professional services revenue as the services are
performed; and post-contract customer support over the term of the arrangement.
Revenue related to research and development agreements is recognized as services
are performed over the related funding period for each contract. Such revenue is
included in license revenue. Service fees received from the sales of software
maintenance and support contracts and sales of other professional services were
recognized over the period the services were provided or as the services were
performed.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial
Statements, which provided guidance on revenue recognition matters. The Company
adopted the provisions of SAB 101 effective January 1, 2000. The adoption of SAB
101 did not have a material impact on the Company's revenue recognition
policies, financial condition or results of operations.
S-8
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
The Company's revenues consist primarily of license and service revenues from
large companies in the United States, Canada, South America, Europe, Australia,
China and South Africa. The Company does not obtain collateral against its
outstanding receivables. The Company maintains reserves for potential credit
losses for both billed and unbilled receivables. Bad debt expense was $363,000,
$240,000, and $240,000 during the years ended 2000, 1999 and 1998, respectively.
During 2000, revenues from one customer accounted for 11% of the Company's
revenue. During 1999 and 1998, no individual customer exceeded 10% of revenues.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of three
months or less when purchased to be cash equivalents. The Company maintains
deposits with a bank and invests its excess cash in overnight funds.
FURNITURE AND EQUIPMENT
Furniture and equipment are carried at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives (generally 3 to 5 years). Amortization of computer equipment under
capital lease is recorded over the term of the lease and is included in
depreciation expense. Expenditures for repairs and maintenance are charged to
operations as incurred.
INTERNAL USE SOFTWARE
Under the provisions of SOP 98-1 "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use", the Company capitalizes costs incurred
in developing or obtaining internal use software. No software has been developed
internally for internal use. At December 31, 2000 unamortized software costs
from purchased software totaled $600,000, net of accumulated amortization of
$253,000, which is included in furniture and equipment (see Note 2).
S-9
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SOFTWARE COMPUTER COSTS
The Company conforms with the requirements of Statement of Financial Accounting
Standards (SFAS) No. 86, "Accounting for the Costs of Computer Software to Be
Sold, Leased or Otherwise Marketed", which requires capitalization of costs
incurred in developing new software products once technological feasibility, as
defined, has been achieved. Costs of maintaining existing software and research
and development costs are otherwise expensed as incurred. No software
development costs were capitalized in 2000, 1999 or 1998. The Company records
amortization of capitalized software development costs using the greater of 1)
the ratio of current sales to total expected sales for a product or 2) the
straight-line method over the estimated economic life of the related product
(currently three years). Amortization of software development costs totaled
$48,000, $252,000, and $357,000 for the years ended December 31, 2000, 1999 and
1998, respectively.
SFAS No. 86 also allows for the capitalization of purchased software. In 1999,
the Company entered into an agreement to terminate a previously existing royalty
agreement. The original agreement provided for royalty payments based on the
sale of a particular component of the Company's product. The termination
agreement assigns all rights to that component to the Company. The net amount of
the agreement, $1,818,000, is included in computer software costs and is being
amortized over five years, the estimated economic life of the product.
Amortization of such costs totaled $364,000 and $182,000 for the years ended
December 31, 2000 and 1999, respectively, and is included in Cost of License
Fees.
INCOME TAXES
The Company follows the liability method of accounting for income taxes.
Deferred income taxes relate to the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
S-10
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK-BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation", provides an alternative
to Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB 25), in accounting for stock-based compensation issued to
employees. The Company accounts for stock option grants in accordance with APB
25 and has elected the pro forma disclosure alternative of the effect of SFAS
No. 123.
ADVERTISING COSTS
During 2000, 1999, 1998 the Company expensed advertising costs of $359,000,
$143,000, and $143,000, respectively. Advertising costs are expensed as
incurred.
RECLASSIFICATION
Certain amounts reported in the 1998 and 1999 financial statements have been
reclassified to conform to the 2000 financial statement presentation.
2. FURNITURE AND EQUIPMENT
Furniture and equipment consists of the following:
DECEMBER 31
2000 1999
------------------------------------------
(In thousands)
Furniture and equipment:
Office furniture and equipment $ 1,974 $ 1,313
Computer equipment and software 5,983 4,808
Computer equipment under capital lease 1,560 1,565
------------------------------------------
9,517 7,686
Less allowances for depreciation and
amortization (6,213) (4,750)
------------------------------------------
$ 3,304 $ 2,936
==========================================
S-11
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company considers its cash and cash equivalents, accounts receivable,
short-term and long-term debt and capital lease obligations to be its only
significant financial instruments and believes that the carrying amounts of
these instruments approximate their fair value. The carrying amount of long-term
debt approximates fair value based on current interest rates available to the
Company for debt instruments with similar terms, degree of risk and remaining
maturities. The remaining financial instruments approximate fair value based on
their short-term nature.
4. LONG-TERM DEBT AND LEASES
Long-term debt and capital lease obligations consist of the following:
DECEMBER 31
2000 1999
-----------------------------------
(In thousands)
12.5% Note payable due May 15, 2006 (1) $15,000 $15,000
Less discount (2,342) (2,785)
-----------------------------------
12,658 12,215
Loan from product development joint venture due
August 31, 2002, no interest (2) -- 550
Other debt -- 52
Capital lease obligations, various imputed interest rates and
monthly payments 161 294
-----------------------------------
12,819 13,111
Less current portion (100) (733)
-----------------------------------
$12,719 $12,378
===================================
S-12
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
4. LONG-TERM DEBT AND LEASES (CONTINUED)
(1) This note is secured by a lien on equipment, accounts receivable and
software and related material. The lender was granted warrants to purchase
999,563 shares of the Company's common stock, exercisable at $.01 per share
(see Note 7). The stated interest rate combined with the amortization of
discount allocated to the fair value of the warrants results in a 15.5%
effective interest rate. Beginning in June 2003 and continuing each quarter
through March 2006, the Company must redeem $1,250,000 in aggregate
principal plus accrued and unpaid interest. Redemption of the outstanding
principal amount of the note, including accrued and unpaid interest, is
required upon the closing of an initial public offering resulting in at
least $25 million in proceeds, a change in control or a qualified
disposition, as defined by the note. In January of 2000 the lender
exercised the referenced warrants and received 996,338 shares of the
Company's common stock (net of exercise costs settled in shares).
(2) In 1999, the Company entered into a software development joint venture
agreement for a specific project, whereby the Company could borrow fifty
percent of the associated development cost, up to $600,000, from the
co-developer. The loan was non-interest bearing and repayment was due by
the earlier of August 31, 2002 or as future revenue was recognized from the
sales of the jointly developed product. In December 2000, this agreement
was modified whereby the third party provided for 100% funding for all
development costs up to $1,200,000, thus relieving this loan obligation.
The modification requires the Company to be responsible for all additional
development costs. In addition, revised revenue sharing methodology was
established concurrently. As of December 31, 2000, approximately $3,400,000
has been incurred on this project. The $600,000 and $600,000 received from
the third-party in the years ended 2000 and 1999, respectively, is
reflected in the statement of operations as license revenue.
S-13
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
4. LONG-TERM DEBT AND LEASES (CONTINUED)
The Company's notes payable and long-term debt agreements contain covenants
restricting additional borrowings, the incurrence of liens on assets, the
acquisition and disposition of assets, capital expenditures, distributions to
shareholders and certain financial restrictions.
Under a sublease agreement, the Company leases office space from Quadram
Corporation ("Quadram"), a wholly owned subsidiary of Intelligent Systems
Corporation (ISC). ISC and the chairman of ISC are shareholders of the Company.
The lease began in 1996 and ends November 2002 (subject to earlier termination
if Quadram's lease is terminated). Rental expense under this agreement was
$460,000, $342,000, and $310,000 for 2000, 1999, and 1998, respectively.
Total rental expense was $3,214,000, $2,861,000, and $2,784,000 for 2000, 1999,
and 1998, respectively.
Required payments by year for long-term debt, capital leases and non-cancelable
operating leases with initial or remaining terms in excess of one year at
December 31, 2000, were as follows:
LONG-TERM CAPITAL OPERATING
YEAR ENDING DECEMBER 31, DEBT LEASES LEASES
------------------------------------------------------------------------------------------------------
(In thousands)
2001 $ -- $112 $2,429
2002 -- 62 1,502
2003 3,750 -- 133
2004 5,000 -- 112
2005 and beyond 6,250 -- 159
-----------------------------------------------------
15,000 174 4,335
Less amounts representing interest and discounts
(2,342) (13) --
-----------------------------------------------------
$12,658 $161 $4,335
=====================================================
S-14
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. COMMITMENTS AND CONTINGENCIES
LINE OF CREDIT
On October 19, 1999, the Company entered into a $5 million revolving line of
credit facility with a financial institution. Borrowings under the facility at
December 31, 1999 were $1,067,000 and are included in other current liabilities
due to the revolving nature of repayment. In December 2000, the revolving line
of credit facility was cancelled and the outstanding amount on the line of
credit was repaid in full through proceeds from the $1,500,000 promissory note
from existing investors as described under Short Term Notes Payable.
SHORT TERM NOTES PAYABLE
In July 2000, the Company issued convertible subordinated notes ("Notes") to a
group of existing investors for a total of $4,500,000 in cash. The Notes bear
interest at 8% per annum. Interest and principal were due on the earlier of
December 31, 2000, the closing date of Maker's first Triggering Financing (as
defined in the Notes), or the occurrence of an Event of Default (as defined in
the Notes). The Notes were convertible into the Company's Series A-2 preferred
stock upon a Triggering Event (as defined in the Note Purchase Agreement) on or
before December 31, 2000 in an amount equal to the Conversion Amount divided by
the Alternative Per Share Price (as defined in the Note Purchase Agreement), or
if A-2 preferred shares are not available or designated at the conversion date,
the Notes may be converted into notes bearing interest of 12% beginning
January 1, 2001. The stated interest rate combined with the amortization of
discount allocated to fair value of the beneficial conversion feature (see
Note 7) results in a 50% effective interest rate.
In January 2001, the Company cancelled the Note Purchase Agreement and the Notes
and issued revised notes and a revised Note Purchase Agreement effective July
2000 ("New Notes"), whereby the interest rate was retroactively increased to 50%
per annum from the effective date of the original convertible subordinate notes
and the conversion feature of the Notes was cancelled (see Note 11). Principal
and interest on the New Notes are due on demand on or after February 28, 2001,
subject to the terms in the amended Note Purchase Agreement.
S-15
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
SHORT TERM NOTES PAYABLE (CONTINUED)
In September 2000, the Company issued a promissory note to an existing investor
("the Investor") in exchange for $2,000,000 in cash. Interest is accrued at 12%
per annum and accrued interest and principal are due on demand on or after
October 31, 2000. In December 2000, the Company issued an additional promissory
note to the Investor in exchange for $1,500,000 in cash. Interest is accrued at
50% per annum and accrued interest and principal are due on demand on or after
January 12, 2001. In January 2001, the Company cancelled the two promissory
notes and reissued revised promissory notes effective on the original promissory
notes respective issuance dates, whereby interest is accrued at 50% and
principal and accrued interest are due on demand on or after February 28, 2001
(see Note 11).
ROYALTY AGREEMENT
In 1998, the Company executed an agreement to terminate a royalty agreement that
had previously been in place as a result of a software development agreement
entered into by the Company and a customer.
The Company had been required in the initial period of the original agreement to
pay 10% of any sale, license or other grant of right to use the product that
totaled less than $1,000,000 and 15% of any sale, license or other grant of
right to use the product that totaled more than $1,000,000. The fees were to
increase incrementally each year until paid in full. The entire amount that
would have been owed was capped at $6,027,000. In settlement, the Company issued
a note payable of $4,694,000 and incurred a one-time expense in 1998 of $4.3
million. The outstanding balance at December 31, 1998 of $4,444,000 was repaid
in 1999.
S-16
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
SOFTWARE LICENSE AGREEMENT
In 1999, the Company entered into a software license agreement whereby the
Company purchased approximately $675,000 of software for internal use. The terms
of the agreement require the Company to pay for the license in equal monthly
installments through August 31, 2001. As of December 31, 2000 the remaining
balance of $196,000 is included in the balance sheet in other current
liabilities.
DEVELOPMENT AND DISTRIBUTION AGREEMENT
In 2000, the Company entered into a development and distribution agreement
whereby the Company purchased approximately $93,000 of software for internal
use. The terms of the agreement require the Company to pay an annual
distribution fee of $30,000 annually for four year effective March 31, 2001.
LEGAL MATTERS
The Company is a party to various legal proceedings and is involved in various
unasserted claims and assessments that have arisen in the normal course of its
business. In the opinion of management, these actions will not have a material
adverse effect on the Company's consolidated financial statements.
S-17
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. INCOME TAXES
The provisions for income taxes for 2000, 1999 and 1998 are as follows:
YEAR ENDED DECEMBER 31
2000 1999 1998
-------------------------------
(In thousands)
Current tax expense:
Federal $ -- $ -- $ --
Foreign (5) 270 188
State -- -- --
-------------------------------
Total current (5) 270 188
Deferred tax expense (benefit):
Federal -- -- --
Foreign -- -- --
State -- -- --
-------------------------------
Total deferred -- -- --
-------------------------------
$ (5) $270 $188
===============================
Income tax expense for the year ended December 31, 2000 relates to a foreign tax
credit. No additional income tax expense has been recorded for the year ended
December 31, 2000 due to the Company's loss for the period and the related net
operating loss carryforward position.
S-18
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
A reconciliation of the statutory U.S. income tax rate to the effective income
tax rate is as follows:
YEAR ENDED DECEMBER 31
2000 1999 1998
---------------------------------
(In thousands)
Tax (benefit) at statutory federal rate $(8,234) $ (488) $(1,692)
State taxes, net of federal benefit (264) (38) (131)
Foreign tax credits (23) (270) (274)
Foreign withholding taxes 17 190 188
Foreign operations not subject to U.S. tax 69 80 50
Meals and entertainment 112 40 74
Increase in other tax credits (530) (423) --
Other-net 63 (144) (189)
Change in valuation allowance 8,785 1,323 2,162
---------------------------------
Total income tax (benefit) expense $ (5) $ 270 $188
=================================
S-19
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
Components of U.S. deferred tax assets (liabilities) are as follows:
DECEMBER 31
2000 1999 1998
-----------------------------------
(In thousands)
Deferred tax assets:
Net operating loss carryforwards $ 14,859 $ 6,217 $ 5,591
Accruals not deductible for tax purposes 2,254 2,532 2,629
General business credit carryforwards 2,578 2,070 1,567
Foreign tax credit carryforwards 491 506 316
Minimum tax credit carryforwards 213 213 213
Property and equipment, principally due to
depreciation -- 15 9
---------------------------------
Total gross deferred tax assets 20,395 11,553 10,325
Deferred tax liability:
Property and equipment, principally due to
depreciation (75) -- --
Amortization of intangibles -- (18) (113)
---------------------------------
Total gross deferred tax liabilities (75) (18) (113)
Less valuation allowance (20,320) (11,535) (10,212)
---------------------------------
Net deferred tax asset $ -- $ -- $ --
=================================
At December 31, 2000, the Company had general business and foreign tax
carryforwards which expire in 2001 through 2015 and AMT credit carryforwards
available to offset future federal income tax liabilities totaling approximately
$213,000. The Company has net federal loss carryforwards of $37,477,000
generated through December 31, 2000 for federal income tax purposes that expire
at various dates between 2012 through 2020.
S-20
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
In addition, the Company's foreign subsidiaries had cumulative losses of
$3,350,000 at December 31, 2000. The tax benefits of these credit carryforwards
and net operating loss carryforwards can be realized only through their
application to taxable income arising from future successful operations of the
Company. These credit and net operating loss carryforwards may be subject to
certain limitations under Section 382 in the event of an ownership change. Due
to the uncertainty of the Company's ability to fully realize the benefits of the
credit and net operating loss carryforwards, a valuation allowance has been
recorded against net deferred tax assets. When recognized, the tax benefit of
those items will be applied to reduce future income tax amounts.
7. SHAREHOLDERS' EQUITY
WARRANTS
In connection with a financing agreement entered into with Capital Resource
Partners IV, L.P. and CRP Investment Partners IV, L.L.C. on April 15, 1999, the
Company issued warrants to purchase an aggregate of 999,563 shares of the
Company's common stock at an exercise price of $.01 per share. In the event of a
change in control or an event of default, as defined, or within one year of the
redemption of all outstanding shares of Series A-1 Preferred Stock, the holder
or holders of the warrants have the right to put the warrants to the Company at
the then current fair market value of the shares underlying the warrants. The
warrants were valued at approximately $3.1 million, which has been recorded as a
discount to the related debt and redeemable stock purchase warrants. The
discount is amortized to interest expense over eighty-four months, the term of
the debt. The related interest expense in 2000 and 1999 was approximately
$445,000 and $300,000, respectively. Warrants issued under the agreement expire
on the earlier of (a) a qualified IPO or (b) the later of April 15, 2006 or such
time as all principal and interest on the notes is paid in full. The warrants
may either be exercised in full, partially, or through a net issue election, as
defined. Warrant holders have certain rights to purchase future subordinated
debt issued by the Company, according to their pro-rata holdings of warrants and
warrant shares to total stock outstanding. In January 2000, these warrants were
exercised and 994,346 shares of common stock were issued (net of exercise price
settled in shares).
S-21
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. SHAREHOLDERS' EQUITY (CONTINUED)
WARRANTS (CONTINUED)
In connection with a financing agreement entered into with Sirrom Capital, L.P.
(Sirrom) on September 26, 1997, the Company issued warrants to purchase 37,660
shares of the Company's common stock at an exercise price of $.002 per share
which were fully exercisable and outstanding at December 31, 1997. The warrant
was valued at approximately $307,000. If the debt remained outstanding for
certain periods during the term of the financing arrangement the Company was
required to issue warrants to purchase additional shares of common stock. During
1999 and 1998, the Company issued warrants to purchase 9,560 and 47,500,
respectively additional shares at $0.002 per share and valued these additional
warrants at approximately $30,000 and $147,000, respectively. Of the additional
warrants 57,060 were fully exercisable and outstanding during 2000 and 1999,
respectively. Warrants issued under this financing agreement provide the holder
of the warrant the right and option to sell to the Company the warrants for a
period of thirty days immediately prior to the expiration of the warrant, at a
purchase price equal to the fair market value of the shares of common stock that
would be issued upon exercise of the warrant. In December 2000, 94,720 warrants
were exercised by Sirrom in exchange for an equal amount of shares of the
Company's common stock.
BENEFICIAL CONVERSION FEATURE OF SHORT TERM NOTES PAYABLE
The Notes described in Note 4 included a beneficial conversion feature for
conversion into capital stock. The $890,000 value of the beneficial conversion
feature has been recorded as a discount on the Notes and was amortized to
interest expense over the terms of the notes payable.
STOCK-BASED AWARDS TO EMPLOYEES
The Company has elected to follow APB 25 and related interpretations in
accounting for its stock-based awards to employees because, as discussed below,
the alternative fair value accounting provided for under SFAS No. 123 requires
use of option valuation models that were not developed for use in valuing
stock-based awards to employees. Under APB 25, no compensation expense is
recognized for stock-based awards with an exercise price equal to the fair value
of the underlying stock on the date of grant.
S-22
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. SHAREHOLDERS' EQUITY (CONTINUED) (CONTINUED)
STOCK-BASED AWARDS TO EMPLOYEES (CONTINUED)
Pro forma information regarding net income (loss) is required by SFAS No. 123,
which also requires that the information be determined as if the Company has
accounted for its stock-based awards to employees granted subsequent to December
31, 1994 under the fair value method prescribed by that statement. The fair
value for these awards were estimated at the date of grant using the minimum
value method with the following weighted-average assumptions for 2000, 1999 and
1998: risk-free interest rate of 5.5% for 1998, 6.0% for 1999; and 6.4% for
2000, no dividend yield; and a weighted-average expected life of the awards of 7
years. The weighted average fair value of awards granted during 2000, 1999 and
1998 was $.67, $1.10, and $.93 per share, respectively.
The option valuation models require the input of highly subjective assumptions.
Because the Company's stock-based awards to employees have characteristics
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee awards.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information is as follows:
DECEMBER 31
2000 1999 1998
--------------------------------------------
(In thousands)
Net loss $24,387 $(1,824) $(5,255)
S-23
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. SHAREHOLDERS' EQUITY (CONTINUED) (CONTINUED)
STOCK-BASED AWARDS TO EMPLOYEES (CONTINUED)
The 1995 Stock Incentive Plan (the "1995 Plan") allows for the granting of
options for up to 1,088,750 shares of common stock to employees and directors.
Stock options granted under the Plan may be either incentive stock options or
nonqualified stock options. Incentive stock options may be granted with exercise
prices of no less than the fair market value. The options expire 10 years from
the date of grant. Options may be granted with different vesting terms but
generally provide for vesting equally over a four-year period.
In October 1997, the Company adopted the 1997 Stock Incentive Plan (the "1997
Plan"). The 1997 Plan allowed for the granting of options for up to 411,250
shares of common stock to employees, non-employee directors, consultants and
other vendors. In 1999, the 1997 Plan was amended to increase the number of
options by 932,835, or a total of 1,344,085. Stock options granted under the
Plan may be either incentive stock options or nonqualified stock options.
Incentive stock options may be granted with exercise prices of no less than the
fair market value. The options expire 10 years from the date of grant. Options
may be granted with different vesting terms but generally provide for vesting
equally over a four-year period.
S-24
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. SHAREHOLDERS' EQUITY (CONTINUED)
STOCK-BASED AWARDS TO EMPLOYEES (CONTINUED)
The following table summarizes option activity for 2000, 1999 and 1998 under the
Company's stock option plans.
WEIGHTED
EXERCISE PRICE AVERAGE
SHARES RANGE EXERCISE PRICE
---------------------------------------------
Outstanding at December 31, 1997 1,058,085 $0.80-3.10 $1.30
Granted 339,000 3.10 3.10
Exercised (8,335) 3.10 3.10
Expired (81,250) 3.10 3.10
---------------------------------------------
Outstanding at December 31, 1998 1,307,500 $0.80-3.10 $1.64
Granted 193,500 3.10 3.10
Exercised (75,000) 0.80-3.10 1.11
Expired (153,938) 3.10 3.10
---------------------------------------------
Outstanding at December 31, 1999 1,272,062 $0.80-3.10 $1.72
Granted 889,000 3.10 3.10
Exercised (250,877) 3.10 3.10
Expired (233,727) 3.10 3.10
---------------------------------------------
Outstanding at December 31, 2000 1,676,458 $0.80-3.10 $2.48
=============================================
Exercisable at December 31, 1998 796,581 $0.80-$3.10 $1.24
Exercisable at December 31, 1999 844,859 $0.80-$3.10 $1.47
Exercisable at December 31, 2000 775,185 $0.80-$3.10 $1.88
Options outstanding at $.80 per share totaled 572,020 of which 410,080 were
exercisable at December 31, 2000. The weighted average remaining contractual
life of options exercisable at $.80 per share was five years at December 31,
2000. Options outstanding at $3.10 per share totaled 1,104,438 of which 365,105
were exercisable at December 31, 2000. The weighted average remaining
contractual life of options exercisable at $3.10 per share was nine years at
December 31, 2000.
S-25
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. SHAREHOLDERS' EQUITY (CONTINUED)
STOCK-BASED AWARDS TO EMPLOYEES (CONTINUED)
In addition to the stock option plans described above, the Company has issued
warrants to purchase common stock to employees. During 1995, the Company issued
to each of two individuals warrants to purchase 52,675 shares of common stock at
an exercise price of $.60 per share. These warrants, which expire in December
2005, become exercisable equally over a two-year and three-year vesting period.
In April and June 1997, 35,000 shares of common stock were issued pursuant to
the partial exercise of one of these warrants and the remainder of the warrant
to purchase 17,675 shares of common stock was canceled in September 1997. In
March 2000, the remaining warrants were exercised and 52,675 shares of common
stock were issued.
In 1996, the Company issued warrants to two employees to purchase 1,104,110
shares of common stock exercisable at a price per share based on $50,000,000
divided by the number of shares outstanding at the exercise date. These warrants
were exercisable upon achievement of certain milestones and expire in February
2003. Effective August 5, 1997, the Company amended these warrants. The
amendment fixed the exercise price of the warrants at $4.80 per share, and the
warrants became fully exercisable as of the amendment date. As a result of
amending the warrants, the Company recorded compensation expense of $3,708,000
in 1997 for the difference between the exercise price and estimated fair value
per share at the amendment date. In 1999, these warrants were canceled in
exchange for full recourse notes receivable, totaling $3,423,000, and the
issuance of 1,104,110 shares of common stock. The notes bear interest at 5% per
annum payable on April 30, 2001 and annually thereafter. The notes are due on
the earlier of (a) September 30, 2004 or (b) one year after the date of an
initial public offering or any other sale or transfer of securities of the
Company, as defined in the agreement. The December 31, 2000 notes receivable
balance is included in shareholders' equity.
At December 31, 2000, a total of 4,878,311 shares of the Company's common stock
were reserved for the exercise of outstanding stock options and conversion of
convertible preferred stock.
S-26
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. SHAREHOLDERS' EQUITY (CONTINUED)
PREFERRED STOCK
In 1998 the Company amended and restated its Articles of Incorporation to
authorize 10,000,000 shares of preferred stock and designate 2,779,689 shares as
Series A-1 Convertible Participating Preferred Stock. Each share of Series A-1
Preferred Stock is convertible at any time after the date of issuance into a
number of shares of common stock, determined by dividing the Series A-1 original
cost by the Series A-1 conversion price that is currently in effect. Upon
issuance, the conversion price is deemed to be the original price. Each share of
Series A-1 Preferred Stock entitles it's holder to voting rights equivalent to
those that would exist if the holder were to convert to common stock and to
receive $5.72 per share plus accrued dividends in the event of involuntary or
voluntary liquidation, adjusted for any combinations, consolidations, stock
splits, or stock distributions or dividends. The collective Series A-1 Preferred
Stock shareholders have the right to appoint and remove, at their discretion,
one member of the Company's Board of Directors. In 1998 the Company issued
2,779,689 shares of Series A-1 Preferred Stock in exchange for $7.5 million in
cash (less issuance costs) and 1,342,626 shares of previously outstanding shares
of common stock that were retired.
8. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) Profit Sharing Plan (the "Plan") for the benefit of
eligible employees and their beneficiaries. All employees are eligible to
participate in the Plan on the first day of the month following hire. Effective
July 1, 1998 the Company amended the plan to provide for an employer matching
contribution equal to 20% of up to 6% of eligible compensation deferred by the
employee. Prior to this amendment, employer contributions were discretionary.
Effective January 1, 2000 the Company amended the plan to provide for an
employer matching contribution equal to 100% of up to 3% of the eligible
compensation deferred by the employee. The Company's contribution vests in even
increments over a five-year period. Contribution expense related to the Plan
during 2000, 1999 and 1998 was $480,000, $219,000 and $194,000 respectively.
S-27
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. SEGMENTS AND GEOGRAPHICAL INFORMATION
The Company is organized around two geographic areas; the United States and
foreign operations. Foreign operations primarily consist of Australia, Ireland,
Singapore, and South Africa.
The foreign locations principally function as service providers for the products
developed by the Company in the United States. The accounting policies as
described in the summary of significant accounting policies are applied
consistently across the two segments. Foreign revenues are based on intercompany
transfer prices to provide a reasonable margin upon distribution.
S-28
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. SEGMENTS AND GEOGRAPHICAL INFORMATION (CONTINUED)
Information about the Company's operations by geographic area is as follows:
2000 1999 1998
----------------------------------------
(In thousands)
UNITED STATES
Revenues:
License fees $ 12,215 $ 19,789 $ 18,385
Service 21,542 25,144 23,443
----------------------------------------
Total revenues 33,757 44,933 41,828
Interest income 361 211 108
Interest expense (3,978) (2,554) (1,279)
Depreciation and amortization (1,870) (1,577) (1,783)
Income tax expense (17) -- $ --
Income (loss) before income taxes (24,441) (1,150) $ (4,826)
Long-lived assets 4,423 4,593 $ 2,571
Total segment assets 12,637 22,702 $ 17,148
Expenditures for long-lived assets 1,536 3,371 $ 757
FOREIGN OPERATIONS
Revenues:
License fees -- -- $ --
Service 6,720 5,135 4,077
----------------------------------------
Total revenues 6,720 5,135 $ 4,077
Interest income 8 8 $ 10
Interest expense -- (1) $ --
Depreciation and amortization (67) (151) $ (88)
Income tax benefit (expense) 22 (270) $ (188)
Income (loss) before income taxes 179 (286) $ (149)
Long-lived assets 555 367 $ 434
Total segment assets 1,088 1,187 $ 709
Expenditures for long-lived assets 357 168 $ 467
S-29
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. SEGMENTS AND GEOGRAPHICAL INFORMATION (CONTINUED)
Export sales were $28.3 million, $30.6 million, and $27.6 million in 2000, 1999,
and 1998, respectively. Such revenues were derived principally from Australia,
New Zealand, Canada, Europe, West Indies, South Africa and South America.
Accounts receivable (billed and unbilled) arising from foreign revenues total
$7.2 million and $8.1 million as of December 31, 2000 and 1999, respectively.
10. SUPPLEMENTAL CASH FLOW INFORMATION
The following is a summary of non-cash transactions and additional cash flow
information:
FOR THE YEAR ENDED DECEMBER 31
2000 1999 1998
----------------------------------
(In thousands)
Furniture and equipment acquired under
capital lease obligations $ -- $ 46 $ 382
==================================
Relief of loan from negotiated cost-sharing
agreement
$ 550 $ -- $ --
==================================
Cash paid for interest $1,723 $2,010 $1,303
==================================
Cash paid for income taxes $ 17 $ 247 $ 188
==================================
11. SUBSEQUENT EVENTS
On January 11, 2001 the existing $4,500,000 of convertible notes and Note
Purchase Agreement and $3,500,000 of demand notes described in Note 5 under the
subheading Short Term Financing were cancelled and exchanged for unsubordinated,
non-convertible demand notes with an interest rate of 50%. The notes described
above have the same principal amount and issuance date of the originally issued
notes. Principal and accrued interest are due on demand on or after February 28,
2001.
As part of the revised Note Purchase Agreement dated January 11, 2001, an
additional $4,000,000 of notes were issued on January 11, 2001. Interest accrues
at 50%. Principal and accrued interest are due on demand on or after February
28, 2001.
S-30
PaySys International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
11. SUBSEQUENT EVENTS (CONTINUED)
On March 17, 2001 the Company signed a definitive agreement to be acquired in a
cash transaction for $135 million including payment of debt. Certain proprietary
technology will be spun out to shareholders immediately prior to the
acquisition. Several contractual modifications, assignments, and dispute
resolutions need to be completed as conditions to closing. In addition, certain
governmental approvals, corporate governance transactions, personnel and
shareholder-related actions are required.
S-31
To the Board of Directors
VISaer, Inc. and Subsidiaries
100 Fordham Road
Wilmington, Massachusetts 01887
INDEPENDENT AUDITORS' REPORT
We have audited the accompanying consolidated balance sheet of VISaer, Inc. and
Subsidiaries (the Company) as of December 31, 2000 and the related consolidated
statements of operations, comprehensive loss, redeemable convertible preferred
stock and stockholders' deficiency, and cash flows for the year then ended.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit. We did not audit the financial
statements of VISaer (UK) Ltd. and VISaer (IRL) Ltd., wholly owned subsidiaries,
which statements reflect total assets of $817,198 and $6,198 as of December 31,
2000, respectively, and total revenues of $488,841 and $249,360, for the five
months and year then ended, respectively. Those statements were audited by other
auditors whose reports have been furnished to us, and our opinion, insofar as it
relates to the amounts included for VISaer (UK) Ltd. and VISaer (IRL) Ltd.,
which have been reconciled by us to accounting principles generally accepted in
the United States of America in the accompanying consolidated financial
statements, is based solely on the reports of the other auditors.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, based on our audit and the reports of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of VISaer, Inc. and Subsidiaries as of
December 31, 2000, and the results of their operations and their cash flows for
the year then ended, in conformity with accounting principles generally accepted
in the United States of America.
Moody, Famiglietti & Andronico, LLP
March 20, 2002
S-32
CONSOLIDATED BALANCE SHEET VISAER, INC. AND SUBSIDIARIES
==================================================================================================================================
DECEMBER 31 2000
----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets:
Cash $ 168,926
Accounts Receivable, Net of Allowance for Doubtful Accounts of $15,000 837,927
Prepaid Expenses and Other Current Assets 29,314
----------------------------------------------------------------------------------------------------------------------------------
Total Current Assets 1,036,167
Property and Equipment, Net of Accumulated Depreciation (Note 2) 206,647
Other Assets 50,577
----------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 1,293,391
============
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIENCY
Current Liabilities:
Notes Payable - Stockholders (Note 12) $ 263,750
Accounts Payable 824,189
Accrued Expenses 1,067,183
Deferred Revenues 1,017,601
Deferred Gain (Note 7) 4,564,325
Current Maturities of Capital Lease Obligations (Note 3) 57,137
----------------------------------------------------------------------------------------------------------------------------------
Total Current Liabilities 7,794,185
Notes Payable - Stockholders (Note 12) 2,267,856
Capital Lease Obligations, Net of Current Maturities (Note 3) 44,606
Deferred Rent 108,231
Deferred Income Taxes (Note 4) 211,525
----------------------------------------------------------------------------------------------------------------------------------
Total Liabilities 10,426,403
----------------------------------------------------------------------------------------------------------------------------------
Redeemable Convertible Preferred Stock:
Series A Redeemable Convertible Preferred Stock: $0.001 Par Value;
1,881,721 Shares Authorized; 1,523,298 Shares Issued and Outstanding
at Redemption Value; Liquidation Preference of $4,250,000 (Note 10) 4,250,000
Series B Redeemable Convertible Preferred Stock: $0.001 Par Value;
1,628,700 Shares Authorized, Issued and Outstanding at Redemption
Value; Liquidation Preference of $879,500 (Note 10) 879,500
Series C Redeemable Convertible Preferred Stock: $0.001 Par Value;
337,331 Shares Authorized, No Shares Issued and Outstanding (Note 10) -
Series D Redeemable Convertible Preferred Stock: $0.001 Par Value;
369,125 Shares Authorized; 33,556 Shares Issued and Outstanding at Redemption
Value, Net of Unaccreted Discount of $20,294; Liquidation Preference
of $49,327 (Note 10) 29,033
----------------------------------------------------------------------------------------------------------------------------------
Total Redeemable Convertible Preferred Stock 5,158,533
----------------------------------------------------------------------------------------------------------------------------------
Stockholders' Deficiency:
Common Stock: $0.001 Par Value; 15,000,000 Shares Authorized;
965,189 Shares Issued and Outstanding 965
Additional Paid-in Capital 4,689,522
Accumulated Deficit (18,934,603)
Accumulated Other Comprehensive Deficit (47,429)
----------------------------------------------------------------------------------------------------------------------------------
Total Stockholders' Deficiency (14,291,545)
----------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIENCY $ 1,293,391
============
The accompanying notes are an integral part of these consolidated financial
statements.
S-33
CONSOLIDATED STATEMENT OF OPERATIONS VISAER, INC. AND SUBSIDIARIES
==================================================================================================================================
FOR THE YEAR ENDED DECEMBER 31 2000
----------------------------------------------------------------------------------------------------------------------------------
Revenues:
Software Licenses $ 3,113,159
Maintenance and Support Services 8,094,870
Hardware Equipment Sales 544,118
----------------------------------------------------------------------------------------------------------------------------------
Total Revenues 11,752,147
----------------------------------------------------------------------------------------------------------------------------------
Cost of Revenues:
Software Licenses 680,477
Maintenance and Support Services 4,619,525
Hardware Equipment Sales 445,975
----------------------------------------------------------------------------------------------------------------------------------
Total Cost of Revenues 5,745,977
----------------------------------------------------------------------------------------------------------------------------------
Gross Profit 6,006,170
----------------------------------------------------------------------------------------------------------------------------------
Operating Expenses:
Research and Development 3,415,907
Selling and Marketing 3,206,936
General and Administrative 2,140,493
----------------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 8,763,336
----------------------------------------------------------------------------------------------------------------------------------
Loss from Operations (2,757,166)
----------------------------------------------------------------------------------------------------------------------------------
Other Income (Expense):
Gain on Sale of Product Line (Note 7) 2,926,114
Interest Expense (708,504)
Other Expense (69,297)
Other Income 26,154
----------------------------------------------------------------------------------------------------------------------------------
Total Other Income 2,174,467
----------------------------------------------------------------------------------------------------------------------------------
Net Loss $ (582,699)
==============
The accompanying notes are an integral part of these consolidated financial
statements.
S-34
CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS VISAER, INC. AND SUBSIDIARIES
==================================================================================================================================
FOR THE YEAR ENDED DECEMBER 31 2000
----------------------------------------------------------------------------------------------------------------------------------
Net Loss $ (582,699)
Other Comprehensive Loss:
Foreign Currency Translation Adjustment (52,778)
----------------------------------------------------------------------------------------------------------------------------------
Total Comprehensive Loss $ (635,477)
=============
The accompanying notes are an integral part of these consolidated financial
statements.
S-35
CONSOLIDATED STATEMENT OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIENCY VISAER, INC. AND SUBSIDIARIES
===================================================================================================================================
REDEEMABLE CONVERTIBLE PREFERRED STOCK
-----------------------------------------------------------------------------------------------
CONVERTIBLE PREFERRED CONVERTIBLE PREFERRED CONVERTIBLE PREFERRED CONVERTIBLE PREFERRED
SERIES A SERIES B SERIES C SERIES D
----------------------- ----------------------- ----------------------- -----------------------
NUMBER $.001 PAR NUMBER $.001 PAR NUMBER $.001 PAR NUMBER $.001 PAR
OF SHARES VALUE OF SHARES VALUE OF SHARES VALUE OF SHARES VALUE
---------- ---------- ---------- ----------- --------- ------------ --------- ------------
Balance as of December 31, 1999 1,881,721 $5,250,000 1,628,700 $ 879,500 337,331 $2,250,000 369,125 $ 790,768
Exercise of Stock Options - - - - - - - -
Accretion of Series D
Convertible Preferred Stock - - - - - - - 287,250
Repurchase of Convertible
Preferred Stock (358,423) (1,000,000) - - (337,331) (2,250,000) (335,569) (1,048,985)
Issuance of Common Stock
Warrants - - - - - - - -
Net Loss - - - - - - - -
Foreign Currency Translation
Adjustment - - - - - - - -
---------- ---------- ---------- ----------- --------- ------------ --------- ------------
Balance as of December 31, 2000 1,523,298 $4,250,000 1,628,700 $ 879,500 - $ - 33,556 $ 29,033
========== ========== ========== =========== ========= ============ ========= ============
STOCKHOLDERS' DEFICIENCY
-------------------------------------------------------------------------------
COMMON STOCK FOREIGN
---------------------- ADDITIONAL CURRENCY TOTAL
NUMBER $.001 PAR PAID-IN TRANSLATION ACCUMULATED STOCKHOLDERS'
OF SHARES VALUE CAPITAL ADJUSTMENT DEFICIT DEFICIENCY
---------- ---------- ----------- ------------ ------------ ------------
Balance as of December 31, 1999 958,146 $ 958 $ 318,677 $ 5,349 $(18,064,654) $(17,739,670)
Exercise of Stock Options 7,043 7 2,218 - - 2,225
Accretion of Series D
Convertible Preferred Stock - - - - (287,250) (287,250)
Repurchase of Convertible
Preferred Stock - - 4,298,984 - - 4,298,984
Issuance of Common Stock
Warrants - - 69,643 - - 69,643
Net Loss - - - - (582,699) (582,699)
Foreign Currency Translation
Adjustment - - - (52,778) - (52,778)
---------- ---------- ----------- ------------ ------------ ------------
Balance as of December 31, 2000 965,189 $ 965 $4,689,522 $ (47,429) $(18,934,603) $(14,291,545)
========== ========== =========== ============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
S-36
CONSOLIDATED STATEMENT OF CASH FLOWS VISAER, INC. AND SUBSIDIARIES
===================================================================================================================================
FOR THE YEAR ENDED DECEMBER 31 2000
----------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net Loss $ (582,699)
Adjustments to Reconcile Net Loss to Net Cash Used in
Operating Activities:
Depreciation and Amortization 399,319
Gain of Sale of Product Line (2,926,114)
Deferred Income Taxes (106,000)
Interest Expense Capitalized to Debt 205,070
Non-Cash Amortization of Debt Discount 191,803
Decrease in Accounts Receivable 4,342,214
Increase in Prepaid Expenses and Other Current Assets (226,323)
Increase in Other Assets (50,577)
Increase in Accounts Payable 1,145,298
Decrease in Accrued Expenses (539,585)
Decrease in Deferred Revenues (2,854,414)
Decrease in Deferred Rent (15,854)
----------------------------------------------------------------------------------------------------------------------------------
Net Cash Used in Operating Activities (1,017,862)
----------------------------------------------------------------------------------------------------------------------------------
Cash Flows Used in Investing Activities:
Acquisition of Property and Equipment (76,978)
----------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Proceeds from Issuance of Notes Payable - Stockholders 905,000
Repayments Under Line of Credit (356,831)
Principal Repayments of Capital Lease Obligations (49,356)
Proceeds from Issuance of Common Stock 2,225
----------------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Financing Activities 501,038
----------------------------------------------------------------------------------------------------------------------------------
Effect of Foreign Currency Exchange Rate Changes on Cash 24,657
----------------------------------------------------------------------------------------------------------------------------------
Net Decrease in Cash (569,145)
----------------
Cash, Beginning 738,071
----------------
Cash, Ending $ 168,926
================
Supplemental Disclosures of Cash Flow Information:
Cash Paid During the Year for:
Interest $ 289,251
Supplemental Disclosure of Non-Cash Investing and Financing Activities:
During the year ended December 31, 2000, the Company financed the
acquisition of certain property and equipment with capital lease
obligations in the amount of $48,735.
See Notes 7 and 12 for additional disclosure of non-cash investing and financing
activities.
The accompanying notes are an integral part of these consolidated financial
statements.
S-37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS VISAER INC. AND SUBSIDIARIES
===============================================================================
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation: The consolidated financial statements include the
accounts of VISaer, Inc. (the Parent) and its wholly owned subsidiaries, VISaer
(UK) Ltd., VISaer (IRL) Ltd., Visibility, Ltd. and Visibility Europe Ltd. (the
Subsidiaries). On July 28, 2000, under the terms of a share purchase agreement
(the Share Purchase Agreement) with a third party, the Parent effectively sold
its net assets, operations and contracts relating to its Engineer-to-Order (ETO)
product line of business, which included the sale of Visibility Europe, Ltd.
(Note 7). Accordingly, the consolidated financial statements include the
activity of Visibility Europe Ltd. and the Parents' ETO product line of business
operations only through July 28, 2000. Under the terms of the Share Purchase
Agreement, the Parent also sold its rights to the "Visibility" name and, as
such, the Parent's name was changed from Visibility, Inc. to VISaer, Inc.,
effective on August 1, 2000. All significant inter-company balances and
transactions of the Parent and Subsidiaries (the Company) have been eliminated
in consolidation.
Reporting Entity: VISaer Inc. was originally incorporated in 1979 as a
Massachusetts corporation and, effective October 25, 1996, became incorporated
as a Delaware corporation. VISaer (UK), Ltd. was incorporated on June 27, 2000,
as an English corporation. VISaer (IRL) Ltd. was incorporated on August 16,
1994, as an Irish corporation. Visibility, Ltd. was incorporated on May 15,
1985, as a Canadian corporation. Visibility Europe Ltd. was incorporated on
September 18, 1996, as an English corporation. Through July 28, 2000, the
principal business activities of the Company included the development,
marketing, sale and support of an integrated line of business application
software for manufacturers and aviation maintenance, repair and overhaul
companies. Subsequent to the Parent's sale of its ETO product line of business
on July 28, 2000 (Note 7), the Company's business activities are focused
primarily toward the development, marketing, sale and support of the "VISaer",
an integrated, enterprise resource planning (ERP) system suited to the specific
"Service-to-Order" needs of aerospace maintenance, repair and overhaul (MRO)
companies, as well as various technical records management and other consulting
services. The Company's customers are located worldwide.
The Company is subject to a number of risks similar to those of other companies
in a similar stage of development, such as the need to obtain adequate
financing, dependence on key individuals, the need for products, and competition
from other companies.
The Company has experienced losses from operations, reduction in liquidity and
is in an accumulated deficit and negative working capital position. The Company
also remains primary obligor as of December 31, 2000 on certain liabilities in
the amount of approximately $4,500,000 assumed by a third party (the Buyer)
under the Share Purchase Agreement, including certain liabilities in litigation
as of December 31, 2000 (Note 7). Included in the liabilities assumed by the
Buyer was the Parent's line of credit arrangement with a financial institution
with a balance outstanding as of December 31, 2000 in the amount of
approximately $1,600,000. This line of credit is currently in default and has
been terminated by the financial institution effective March 30, 2001, at which
time all outstanding obligations under the line of credit are to become due and
payable (Note 8).
In regard to these conditions, the Buyer and the Company are working toward
arranging a renegotiated payment plan with the financial institution for the
Buyer to repay the balance outstanding under the line of credit. Also, the
Company may attempt to seek a new relationship with a bank to provide the
Company with additional working capital. However, there can be no assurance that
the Company and the Buyer will be successful in renegotiating the terms of the
line of credit, or that additional bank financing will be available or on terms
favorable to the Company. Management estimates the Company's backlog as of
February 27, 2001, to be approximately $2,000,000 (unaudited), which represents
contracts for full systems implementations, including licensed software,
services and software maintenance. The Company has developed an operating plan
designed to control operating costs, increase revenues, sustain gross margins
and provide for additional procedures to monitor and manage the payment of
liabilities assumed by the Buyer. Through December 31, 2000, the Company's
largest investors have provided funding to the Company under various equity and
debt financings and have stated that they have the positive ability, intent and
commitment to continue to fund or arrange sufficient funding for cash
requirements that the Company may have through at least December 31, 2001.
Property and Equipment: Property and equipment are recorded at cost.
Depreciation is calculated using straight-line and accelerated methods for both
financial and income tax reporting purposes over the estimated useful and
statutory lives of the related assets, respectively.
S-38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
VISAER INC. AND SUBSIDIARIES
================================================================================
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Software Development Costs: The Company capitalizes software development costs
after technological feasibility of the product has been established. Costs
incurred prior to the establishment of technological feasibility are charged to
research and development expense. The Company did not capitalize software
development costs during the year ended December 31, 2000, as the costs incurred
after reaching technological feasibility was established were immaterial.
Deferred Rent: The Company records rent expense related to non-cancelable lease
agreements based on a constant periodic rent over the term of the lease. The
excess of the cumulative rent expense incurred over the cumulative amounts due
under the lease agreement is deferred and recognized over the term of the
non-cancelable lease.
Revenue Recognition: The Company reports under the provisions of Statement of
Position (SOP) No. 97-2, "Software Revenue Recognition". In accordance with SOP
No. 97-2, the Company recognizes revenue from non-cancelable software licenses
upon delivery, provided evidence of an arrangement exists, the fee is fixed and
determinable, collection is probable and no further significant obligations
remain at the time of delivery. Post contract maintenance and support service
fees are typically billed separately and are recognized on a straight-line basis
over the life of the applicable agreement. Revenues from consulting services are
recognized upon performance of the services. Revenues from equipment sales are
recognized when the products are shipped. Revenues from long-term service and
development contracts are recognized on the percentage of completion method.
Income Taxes: The Company reports under the provisions of Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109), which
require an asset and liability approach to financial accounting and reporting
for income taxes. Deferred income tax assets and liabilities are computed
annually for differences between the financial statement and tax bases of assets
and liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected
to be realized. Income tax expense is the tax payable or refundable for the
period plus or minus the change during the period in deferred tax assets and
liabilities.
Research and Development: The Company expenses all research and development
expenses as incurred.
Foreign Currency Translation: The financial statements of VISaer, (UK) Ltd. and
Visibility Europe, Ltd. are translated into United States dollars in accordance
with SFAS No. 52, "Foreign Currency Translation." Assets and liabilities are
translated at the current exchange rates in effect as of the balance sheet date.
Common stock and additional paid-in capital are translated at historical
exchange rates. Income statement accounts are translated at the average exchange
rates for the related periods. Translation adjustments arising from differences
in exchange rates are recorded as a separate component of stockholders'
deficiency. Transaction gains and losses are recorded in the consolidated
statement of operations. The functional currency of the Parent's other foreign
subsidiaries, VISaer (IRL) Ltd. and Visibility, Ltd., is the U.S. dollar. Gains
and losses for these subsidiaries resulting from the remeasurement of foreign
currencies into U.S. dollars are recorded in the consolidated statement of
operations and such amounts are immaterial.
Advertising Costs: The Company expenses advertising costs as incurred.
Advertising expense incurred by the Company during the year ended December 31,
2000, amounted to $99,798.
Comprehensive Loss: Comprehensive loss consists of changes in stockholders'
deficiency not related to transactions with stockholders. They include net loss
and certain other comprehensive loss items that are not presented in the
consolidated statement of operations, but which are recorded as a separate
component of stockholders' deficiency, net of the related tax effect. As of
December 31, 2000, these items of other comprehensive loss include foreign
currency translation adjustments.
Use of Estimates: Management has used estimates and assumptions relating to the
reporting of assets and liabilities and the disclosure of contingent assets and
liabilities in its preparation of the consolidated financial statements in
accordance with generally accepted accounting principles. Actual results
experienced by the Company may differ from those estimates.
S-39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
VISAER INC. AND SUBSIDIARIES
================================================================================
2. PROPERTY AND EQUIPMENT:
As of December 31, 2000, property and equipment consists of the following:
Computer Equipment $ 248,620
Leasehold Improvements 176,104
Telephone System 159,021
Purchased Software 100,293
Furniture and Fixtures 29,281
-----------
713,319
Less: Accumulated
Depreciation 506,672
-----------
$ 206,647
=============
3. CAPITAL LEASE OBLIGATIONS:
The Parent is a party to various non-cancelable capital lease agreements, which
expire at various dates through October, 2003. As of December 31, 2000, the
total future minimum and present value lease payments due under these agreements
are as follows:
YEAR ENDED
DECEMBER 31,
------------
2001 $ 67,008
2002 35,061
2003 13,616
--------------
115,685
Less: Amount Representing Interest 13,942
--------------
Present Value of Net Minimum Lease
Payments 101,743
Current Maturities of Capital Lease
Obligations 57,137
--------------
Capital Lease Obligations, Net of
Current Maturities $ 44,606
==============
4. INCOME TAXES:
The provision for income taxes during the year ended December 31, 2000, consists
of the following:
Current $ 106,000
Deferred (106,000)
-------------
$ -
=============
As discussed in Note 1, the Company reports under the provisions of SFAS 109.
Deferred income taxes reflect the impact of temporary differences between the
amounts of assets and liabilities for financial reporting purposes and such
amounts as measured by tax laws. The temporary differences, which give rise to a
significant portion of the Company's deferred income taxes as of December 31,
2000, are as follows:
Deferred Tax Liabilities $ 211,525
=============
Deferred Gain $ 1,845,000
Net Operating Loss Carryforwards 2,331,000
Tax Credits 1,494,000
Deferred Rent 44,000
Other Deferred Tax Assets 34,000
-------------
5,748,000
Less: Valuation Allowance (5,748,000)
-------------
Total Deferred Tax Assets $ -
=============
The valuation allowance as of December 31, 2000, relates to the uncertainty of
realizing the tax benefits of the deferred tax assets. Nonetheless, some, if not
all, of these deferred tax assets may be available to offset any deferred tax
liabilities as they become otherwise payable.
As of December 31, 2000, the Company has federal and foreign net operating loss
carryforwards of approximately $4,300,000 and $2,700,000, respectively. The
Parent also has federal and state tax credit carryforwards of approximately
$949,000 and $825,000, respectively. Section 382 of the Internal Revenue Code
and the tax laws of certain foreign jurisdictions contain provisions that could
place limitations on the utilization of these net operating loss carryforwards
and tax credits in the event of a change in ownership, as defined.
S-40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
VISAER INC. AND SUBSIDIARIES
================================================================================
5. RETIREMENT PLAN:
The Parent maintains a 401(k) retirement plan covering substantially all of its
employees. The plan allows each employee participant an election to defer a
percentage of their compensation up to the maximum allowed for federal income
tax purposes. The Parent contributes 25% of the employee's contribution, up to a
maximum of 6% of each participant's salary. Contributions may be suspended at
the option of the Parent's Board of Directors. During the year ended December
31, 2000, the Parent contributed approximately $64,000 into the plan.
6. OPERATING LEASE COMMITMENTS:
The Company leases certain facilities, vehicles and equipment under
non-cancelable lease agreements expiring through July 2004, as well as certain
facilities under tenant-at-will agreements. The Parent subleases certain space
in its Wilmington, Massachusetts facility under a tenant-at-will agreement.
During the year ended December 31, 2000, lease expense incurred by the Company
under these lease agreements, net of sublease rental income, amounted to
$391,638.
Future minimum lease payments due under these non-cancelable lease agreements as
of December 31, 2000, are as follows:
YEAR ENDED
DECEMBER 31,
------------
2001 $ 332,953
2002 320,569
2003 313,465
2004 153,182
-------------
$ 1,120,169
7. SALE OF PRODUCT LINE:
On July 27, 2000, the Parent formed a new wholly owned subsidiary, ETO, Inc. and
on June 27, 2000, it's former wholly owned subsidiary, Visibility Europe, Ltd.
also formed a new subsidiary, Tribonium, Inc. In connection with the formation
of ETO, Inc., the Parent contributed, at book value, all of its operational
assets and liabilities relating to its ETO product line of business into ETO,
Inc. In connection with the formation by Visibility Europe, Ltd. of Tribonium,
Inc., Visibility Europe, Ltd. contributed, at book value, all of its non-ETO
product line of business operational assets and liabilities into Tribonium, Inc.
Subsequent to such transfer of assets and liabilities, 100% of the stock of
Tribonium, Inc. was spun off from Visibility Europe, Ltd. to the Parent. On July
27, 2000, the name of Tribonium, Inc. was changed to VISaer (UK) Ltd.
On July 28, 2000, under the Share Purchase Agreement, the Parent sold 100% of
its shares in ETO, Inc. and Visibility Europe, Ltd. (the Sold Subsidiaries),
containing all of its net assets, operations and contracts relating to its ETO
product line of business, to the Buyer. The consideration received by the Parent
under this sale transaction consisted solely of the assumption by the buyer of
all of the liabilities contained in the Sold Subsidiaries.
The book value of net assets included in the Sold Subsidiaries on July 28, 2000
consisted of the following:
Accounts Receivable $ 2,642,518
Other Current Assets 637,247
Property and Equipment, Net 621,703
Accounts Payable and Accrued Expenses (4,706,874)
Line of Credit, Plus Accrued Interest (1,580,239)
Note Payable, Plus Accrued Interest (1,270,628)
Deferred Revenues (3,953,247)
Capital Lease Obligations (254,448)
------------
Excess of Liabilities over Book Value of
Net Assets Included in Sold Subsidiaries $ (7,863,968)
=============
The Parent did not obtain releases from creditors for a substantial portion of
the liabilities and contracts assumed by the Buyer and, consequently, remains
the primary obligor for any such obligations outstanding as of December 31,
2000. Accordingly, the Parent has not derecognized liabilities assumed by the
Buyer for which the Parent continues to be the primary obligor as of December
31, 2000 and has classified them on the accompanying consolidated balance sheet
as "deferred gain." As of December 31, 2000, the balance of deferred gain
consisted of the following liabilities:
Accounts Payable and Accrued
Expenses $ 2,020,966
Line of Credit, Plus Accrued
Interest (Note 8) 1,618,505
Note Payable, Plus Accrued
Interest 595,626
Deferred Revenues 124,976
Capital Lease Obligations 204,252
-------------
Total Deferred Gain as of
December 31, 2000 $ 4,564,325
=============
S-41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
VISAER INC. AND SUBSIDIARIES
================================================================================
7. SALE OF PRODUCT LINE (CONTINUED):
During the year ended December 31, 2000, the gain recognized by the Parent on
the sale of the ETO product line of business consisted of the following:
Excess of Liabilities over Book Value of
Net Assets Included in Sold Subsidiaries $ 7,863,968
Less: Deferred Gain as of
December 31, 2000 (4,564,325)
Transaction Costs (373,529)
-------------
Gain on Sale of Product Line $ 2,926,114
=============
In connection with the Share Purchase Agreement, the Buyer assumed a
subordinated, unsecured note payable agreement between the Parent and Mentec
Limited (Mentec), at which time the outstanding balance, plus accrued interest,
amounted to 1,270,628. The note bears interest at 8% per annum. In connection
with the issuance of this note, the Parent issued 50,000 common stock warrants
at an exercise price of $6.67 per share. The fair value of the warrants was
immaterial. The warrants expire upon the repayment of the note. As of December
31, 2000, the remaining balance outstanding under the note, including accrued
interest and certain expenses, amounted to $595,626. This balance has been
included as deferred gain in the accompanying consolidated balance sheet. During
January 2001, the Parent and the Buyer entered into a settlement agreement with
Mentec, such that the outstanding balance due as of December 31, 2000 would be
repaid by the Buyer in two $200,000 installments on January 25, 2001 and
February 22, 2001, with a third and final installment due on March 22, 2001, for
the remaining balance due. During January and February 2001, the Buyer made
payments in accordance with the terms of the January, 2001 settlement agreement.
During July 2000, a vendor of the Parent filed a lawsuit in the U.S. District
Court, District of Massachusetts for a claim in the amount of $291,567, plus
certain damages and expenses. The lawsuit claims that payment had not been made
for certain invoices provided to the Parent for services performed by the vendor
during 1999. This liability was assumed by the Buyer under the Share Purchase
Agreement and remains outstanding as of December 31, 2000. The outstanding
balance of this liability as of December 31, 2000 in the amount of $291,567 has
been included in the deferred gain - accounts payable in the accompanying
consolidated balance sheet.
8. DEFERRED GAIN - LINE OF CREDIT:
During March 2000, the Parent entered into a line of credit agreement with a
financial institution, the initial proceeds from which were used to repay and
terminate the Parent's then existing line of credit agreement. The Parent
continues to have 71,685 common stock warrants outstanding with the financial
institution that provided the previous line of credit, which warrants have an
exercise price of $2.79 per share and expire during June 2004. Under the terms
of the new line of credit agreement, borrowings were limited to the lesser of
85% of worldwide eligible accounts receivable or $4,000,000. The line of credit
is collateralized by a first security interest in substantially all assets of
the Parent. Interest on the outstanding balance was calculated at the prime rate
in effect during the borrowing term plus 2%, with a minimum monthly interest
charge of $4,150.
In connection with this line of credit agreement, the Parent issued to the
financial institution 55,363 common stock warrants with an exercise price of
$5.78 per share and an expiration date of March 30, 2007. The fair value of
these warrants was not material.
In connection with the Parent's sale of its ETO product line operations during
July 2000 (Note 7), the Buyer assumed the line of credit, at which time the
outstanding balance, plus accrued interest, amounted to $1,580,239. The Parent
did not obtain a release from the financial institution for the assumption of
this obligation by the Buyer and, accordingly, it remains the primary obligor
under the original agreement. As of December 31, 2000, the outstanding balance
under the line of credit, plus accrued interest, amounted to $1,618,505, and has
been included as deferred gain in the accompanying consolidated balance sheet
(Note 7). As of December 31, 2000, the Parent, as primary obligor, was in
default of its obligations to the financial institution for, among other things,
changes in the nature of its business and the sale of assets under the Share
Purchase Agreement. The default interest rate under the line of credit is prime
plus 4%. Based on the defaults under the line of credit agreement, during
January 2001, the financial institution terminated the line of credit agreement
effective on its maturity date of March 30, 2001, at which time all outstanding
obligations under the line of credit are to become due and payable. The Buyer
and the Company are working toward arranging a renegotiated payment plan for the
Buyer to repay the balance outstanding under the line of credit. However, there
can be no assurance that the Company and the Buyer will be successful in
renegotiating the terms of the line of credit.
S-42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
VISAER INC. AND SUBSIDIARIES
================================================================================
9. CROSS LICENSE, NON-COMPETITION AND NON-DISCLOSURE AGREEMENT:
In connection with the closing of the Share Purchase Agreement (Note 7), the
Parent entered into a cross license, non-competition and non-disclosure
agreement with the Buyer. Both, the software products under the ETO line of
business sold under the Share Purchase Agreement and the software products under
the MRO line of business retained by the Parent, generally share much of the
same source code contained in the ETO software products. Accordingly, the Buyer
granted the Parent an exclusive, royalty-free, worldwide, perpetual right to
license the ETO software for use solely in connection with the MRO line of
business, which provides that the Buyer and the Parent do not license products
to distributors that are in direct competition with each other. The Parent
retained exclusive ownership and all rights to the MRO software products. This
agreement also provides for, among other things, the licensing of certain
additional products and potential royalties thereon based on which parties are
involved in the future development of such products, as defined. In addition,
this agreement provides that, among other matters, the Buyer and the Parent will
generally not compete within each other's lines of businesses for a period of
five years.
10. PREFERRED STOCK:
SERIES A, B, C AND D REDEEMABLE CONVERTIBLE PREFERRED STOCK:
Series D: Series D preferred stock consists of 335,569, 16,778 and 16,778
authorized shares of Series D-1, D-2 and D-3 redeemable convertible preferred
stock, respectively. As of December 31, 2000, 16,778 shares of each of Series
D-2 and D-3 redeemable convertible preferred stock are outstanding.
Dividends: All classes of preferred stockholders are entitled to receive
dividends or other distributions equal to the dividend or distributions that
would be received had the preferred stockholders converted their shares into
common stock.
Voting: All classes of preferred stockholders are entitled to vote on an
as-converted basis together with common stockholders as one class.
Conversion: All classes of preferred stockholders are entitled to convert, at
the option of the holder, each share of preferred stock into one share of common
stock, adjusted for certain dilutive events, as defined. In the event of an
initial public offering with a per share price of less than $15.00, each holder
of the preferred stock will receive a cash payment equal to the liquidation
preference (the IPO Preference Amount) and all shares will then convert
automatically into common stock. In the event of a qualified offering with a per
share price greater than or equal to $15.00, the preferred shares automatically
convert into common stock without any IPO Preference Amount.
Liquidation: In the event of a voluntary or involuntary liquidation, dissolution
or winding up of the Parent, the holders of Series A, B and C redeemable
convertible preferred stock are entitled to receive a $2.79, $.54 and $6.67 per
share liquidation preference, respectively, plus accrued and unpaid dividends.
The holders of Series D-1, D-2 and D-3 redeemable convertible preferred stock
are entitled to receive a $5.78, $.54 and $2.40 per share liquidation
preference, respectively, plus accrued and unpaid dividends. If the assets
available for distribution are insufficient to permit payment of the liquidation
preference amount, then the holders of the preferred stock shall share ratably
in any distributions, as defined. After distribution to the preferred
stockholders of the full liquidation preference amount, any remaining assets
available for distribution are distributed both to holders of common stock and
preferred stock on a pro rata basis, with the exception of holders of Series D
redeemable convertible preferred stock, assuming the preferred stock is
converted into common stock. Any dissolution or liquidation resulting from an
event of sale, as defined, with proceeds of greater than or equal to $15.00 per
share on an as-converted basis, will not result in distributions in accordance
with the foregoing; rather, all preferred stock will be converted into common
stock and shareholders will participate in the proceeds on a pro rata basis.
Redemption: As of March 31, 2003, the preferred stockholders may require the
Parent, with written notice of at least 30 days, to redeem the outstanding
preferred stock. The redemption price equals the liquidation preference of the
series held, plus all accrued but unpaid dividends.
S-43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
VISAER INC. AND SUBSIDIARIES
================================================================================
10. PREFERRED STOCK (CONTINUED):
Other Restrictions: The Parent is restricted, without the approval of 51% of the
holders of preferred stock, from issuing additional shares of preferred stock,
common stock or convertible debt, altering the terms of outstanding preferred
stock, amending its articles of incorporation, selling or otherwise disposing of
all or substantially all of its assets, or voluntarily dissolving or otherwise
liquidating the Company.
Accretion: In connection with the issuance of notes payable to certain
stockholders of the Parent in the aggregate amount of $1,100,000 (Note 12), the
Parent allowed such stockholders to convert 369,125 shares of common stock held
by them into 335,569, 16,778 and 16,778 shares of Series D-1, D-2 and D-3
redeemable convertible preferred stock, respectively, and issued 415,847 common
stock warrants to those stockholders. The warrants expire during September 2002,
have an exercise price of $.60 and were valued using the Black-Scholes option
pricing model. The value of the consideration was allocated to the debt and
equity securities based on their relative fair values. The discount on preferred
stock is being accreted over the term of the securities. The unaccreted discount
on Series D-2 and D-3 redeemable convertible preferred stock outstanding as of
December 31, 2000, amounted to $20,294.
Repurchase of Preferred Stock: During September 2000, the Parent repurchased
358,423, 337,331 and 335,569 shares of its Series A, C and D-1 redeemable
convertible preferred stock, respectively, and 654,952 of its common stock
warrants, all of which had an exercise price of $.60, for aggregate
consideration in the amount of $1. In connection with this transaction, the
Parent reduced the balance of its redeemable convertible preferred stock, net of
unaccreted discount, with a corresponding increase to additional paid-in capital
in the aggregate amount of $4,298,984.
11. CONTINGENCIES:
During January 2001, a vendor filed a lawsuit against the Parent and the Buyer
for a claim in the amount of $137,397, plus certain damages and expenses.
Obligations under the Parent's contract with this vendor were assumed by the
Buyer under the Share Purchase Agreement. The lawsuit claims that the Parent
breached its contract with the vendor for failing to make license fee payments
due under the terms of the Parent's contract with the vendor in the amount of
$137,397 and that the Parent wrongfully transferred its rights and obligations
under that contract to the Buyer under the Share Purchase Agreement. The Parent
and the Buyer are defending this lawsuit and the management of the Parent is of
the opinion that the outcome of this litigation will not have a material adverse
effect on the accompanying consolidated balance sheet.
S-44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
VISAER INC. AND SUBSIDIARIES
================================================================================
12. NOTES PAYABLE - STOCKHOLDERS:
As of December 31, 2000, notes payable - stockholders consists of the following:
Seven, prime plus 2% unsecured notes payable to certain stockholders in the
amount of $1,100,000, plus aggregate accrued interest in the amount of $152,206.
During May 2000, maturities were extended from January 2001 to May 2003. In
connection with the issuance of these notes and the conversion of 369,125 shares
of common stock held by such stockholders into 335,569, 16,778 and 16,778 shares
of Series D-1, D-2 and D-3 redeemable convertible preferred stock, respectively,
during 1999, the Parent issued 415,847 common stock warrants to such
stockholders. The warrants, which expire during September 2002, have an exercise
price of $.60, and were valued using the Black-Scholes option pricing model. The
value of the consideration received was allocated to the debt and equity
instruments based on their relative fair values. The original debt discount on
these notes in the amount of $478,907 is being amortized over the extended term
of the notes to interest expense. Amortization of the debt discount on these
notes during the year ended December 31, 2000 amounted to $177,875. The
aggregate balance outstanding under these notes as of December 31, 2000, is net
of unamortized debt discount of $174,861. During September 2000, the Parent
repurchased 277,231 of the common stock warrants originally issued with these
notes (Note 10). $ 1,077,345
Nine, prime plus 2% unsecured notes payable to certain stockholders in the
amount of $650,000, plus aggregate accrued interest in the amount of $42,712,
mature in May 2003. In connection with the issuance of these notes, the Parent
issued 818,396 common stock warrants. The warrants, which expire during May
2003, have an exercise price of $.60, and were valued using the Black-Scholes
option pricing model. The value of the consideration received was allocated to
the debt and equity instruments based on their relative fair values. The
original debt discount on these notes in the amount of $69,643 is being
amortized over the term of the notes to interest expense. Amortization of the
debt discount on these notes during the year ended December 31, 2000 amounted to
$13,928. The aggregate balance outstanding under these notes as of December 31,
2000, is net of unamortized debt discount in the amount of $55,715. During
September 2000, the Parent repurchased 377,721 of the common stock warrants
originally issued with these notes (Note 10). 636,997
Two, 10% notes payable to certain stockholders, in the amount of $402,555, plus
aggregate accrued interest in the amount of $150,959. During May 2000,
maturities were extended from January 2001 to May 2003. The notes are
collateralized by the Parent's accounts receivable. 553,514
S-45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
VISAER INC. AND SUBSIDIARIES
================================================================================
12. NOTES PAYABLE - STOCKHOLDERS (CONTINUED):
Five, 12% unsecured notes payable to certain stockholders in the amount of
$255,000, plus aggregate accrued interest in the amount of $8,750, due upon
demand. 263,750
---------------
Total Notes Payable - Stockholders 2,531,606
Less: Current Portion 263,750
---------------
Long-Term Portion of Notes Payable - Stockholders $ 2,267,856
===============
Maturities of notes payable - stockholders as of December 31, 2000, consist of
the following:
YEAR ENDED
DECEMBER 31,
------------
2001 $ 263,750
2002 -
2003 2,498,432
---------------
$ 2,762,182
===============
13. FOREIGN OPERATIONS:
Condensed audited information of the Parent's European Subsidiaries as of and
for the year ended December 31, 2000, is summarized as follows:
Revenues $ 2,981,758
Net Loss $(1,390,119)
Total Assets $ 823,396
Stockholders' Deficiency $(2,883,649)
Activity in the Canadian subsidiary, Visibility, Ltd., was not material during
the year ended December 31, 2000.
S-46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
VISAER INC. AND SUBSIDIARIES
================================================================================
14. STOCK OPTION PLANS:
As of December 31, 2000, 1,252,500 shares of the Parent's common stock are
reserved for issuance or grant under the Parent's 1996 and 1994 stock option
plans. The options may be granted to certain employees and directors of the
Parent and Subsidiaries at exercise prices not less than the fair market value
of the stock on the date of grant. The fair market value, rate of exercisability
and expiration dates of the options granted are determined by the Board of
Directors at the time of the grant. Options generally vest over a period
determined by the Board of Directors and expire ten years from the date of
grant.
Stock option activity during the year ended December 31, 2000, is as follows:
Weighted
Exercise Average
Number of Price Range Exercise Price Expiration
Shares Per Share Per Share Dates
------------------------------------------------------------------------------------------------------------------------------
Outstanding as of December 31, 1999 895,001 $0.20 - $1.67 $0.46 2004-2009
Stock Options Granted 55,800 $0.60 $0.60 2010
Stock Options Exercised (7,043) $0.20 - $0.60 $0.48 2007-2008
--------------------------------------------------------------------
Outstanding as of December 31, 2000 943,758 $0.20 - $1.67 $0.47 2002-2010
====================================================================
Exercisable as of December 31, 2000 463,529 $0.20 - $1.67 $0.47 2002-2010
====================================================================
During the year ended December 31, 2000, the employment of certain employees of
the Parent was terminated as a result of the transaction under the Share
Purchase Agreement discussed in Note 7. The expiration dates of 66,509 vested
options held by such terminated employees were extended by the Board of
Directors from three months to eighteen months after the termination of
employment. The weighted average exercise price of these extended options was
$.89 per share.
During 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation". As permitted by SFAS No. 123, the
Company has elected to continue following the guidance of Accounting Principles
Board (APB) No. 25 for measurement and recognition of stock-based transactions
with employees and to adopt the disclosure only provisions of SFAS No. 123. If
the Company had elected to recognize compensation costs for stock-based
compensation plans with employees based on the fair market value at the grant
dates for awards under those plans consistent with the method prescribed under
SFAS No. 123, such compensation expense would not have been material to the
consolidated statement of operations during the year ended December 31, 2000.
The fair value of the stock options, at the date of grant used to compute such
additional compensation was calculated under the Black-Scholes option pricing
model as described in SFAS No. 123 using the following assumptions: (i)
risk-free interest rate of 5.75% (ii) expected life of five years; (iii) no
dividend yield and (iv) no volatility. The weighted average fair value at the
date of grant for options granted during the year ended December 31, 2000, was
$0.15 per option.
15. CONCENTRATION OF CREDIT RISK:
Financial instruments that potentially expose the Company to concentrations of
credit risk include trade accounts receivable. To minimize this risk, ongoing
credit evaluations of customers' financial condition are performed, although
collateral is not required. The Company maintains reserves for potential credit
losses.
As of December 31, 2000, three customers represented approximately 25%, 16% and
13%, respectively, of gross accounts receivable.
S-47
INDEPENDENT AUDITORS' REPORT
TO THE MEMBERS OF VISAER (UK) LIMITED
We have audited the accompanying balance sheet of VISaer (UK) Limited as of 31
December 2000 and the related profit and loss account for the period then ended.
These financial statements are the responsibility of the company's directors.
Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of VISaer (UK) Limited as of 31
December 2000 and the results of its operations for the period then ended in
conformity with accounting principles generally accepted in the United Kingdom.
/S/ HACKER YOUNG
Manchester, England
20 March 2002
S-48
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders,
Visaer (Irl) Limited
We have audited the accompanying balance sheet of Visaer (Irl) Limited as of
December 31, 2000, and the related profit and loss account for the year then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Visaer (Irl) Limited as of
December 31, 2000, and the results of its operations for the year then ended in
conformity with accounting principles generally accepted in Ireland.
/s/Arthur Andersen
Dublin, Ireland
March 20, 2002
S-49
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Visibility Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Visibility Inc.
(a Delaware corporation) and subsidiaries as of December 31, 1999 and the
related consolidated statements of operations, redeemable convertible preferred
stock and stockholders' deficit and cash flows for each of the two years in the
period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Visibility Inc. and
subsidiaries as of December 31, 1999 and the results of their operations and
their cash flows for each of the two years in the period ended December 31, 1999
in conformity with accounting principles generally accepted in the United
States.
/s/ Arthur Andersen LLP
Boston, Massachusetts
March 15, 2000
S-50
VISIBILITY INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1999
ASSETS 1999
Current Assets:
Cash and cash equivalents $ 738,071
Accounts receivable, net of allowance for doubtful accounts of $373,861 7,977,903
Prepaid expenses and other current assets 461,377
------------
Total current assets 9,177,351
Property and Equipment, net 1,063,573
Other Assets 44,734
------------
Total assets $ 10,285,658
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Short-term debt $ 2,923,370
Current portion of capital lease obligations 135,368
Accounts payable 3,374,419
Accrued expenses 2,647,204
Deferred revenue 7,801,751
------------
Total current liabilities 16,882,112
Notes Payable to Shareholders 1,299,373
Capital Lease Obligations 221,444
Deferred Rent 124,085
Deferred Income Taxes 328,046
------------
Total liabilities 18,855,060
------------
Commitments and Contingencies (Note 10)
Redeemable Convertible Preferred Stock
Series A redeemable convertible preferred stock, $0.001 par value-
Authorized, issued and outstanding--1,881,721 shares, at redemption value
(liquidation preference of $5,250,000) 5,250,000
Series B redeemable convertible preferred stock, $0.001 par value-
Authorized, issued and outstanding--1,628,700 shares, at redemption value
(liquidation preference of $879,500) 879,500
Series C redeemable convertible preferred stock, $0.001 par value-
Authorized, issued and outstanding--337,331 shares, at redemption value
(liquidation preference of $2,250,000) 2,250,000
Series D redeemable convertible preferred stock, $0.001 par value-
Authorized, issued and outstanding--369,125 shares (redemption value and
liquidation preference of $1,988,916) 790,768
------------
Total redeemable convertible preferred stock 9,170,268
Stockholders' Deficit
Common stock, $0.001 par value-
Authorized--15,000,000 shares
Issued and outstanding--958,147 shares 958
Additional paid-in capital 318,677
Accumulated deficit (18,064,654)
Accumulated other comprehensive income 5,349
------------
Total stockholders' deficit (17,739,670)
------------
Total liabilities, redeemable convertible preferred stock and stockholders' deficit $ 10,285,658
============
The accompanying notes are an integral part of these consolidated financial
statements.
S-51
VISIBILITY INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Years Ended December 31, 1999 and 1998
1999 1998
Revenues:
Software licenses $ 7,088,950 $10,580,620
Maintenance and support services 14,504,997 15,648,548
Hardware equipment sales 2,616,061 3,963,723
------------ -----------
24,210,008 30,192,891
------------ -----------
Cost of Revenues:
Software licenses 942,403 2,140,600
Maintenance and support services 9,050,259 8,874,150
Hardware equipment sales 2,129,342 3,208,613
------------ -----------
12,122,004 14,223,363
------------ -----------
Gross profit 12,088,004 15,969,528
Operating Expenses:
Selling and marketing 7,757,451 5,928,999
Research and development 5,511,591 6,628,824
General and administrative 2,455,290 2,372,088
------------ -----------
15,724,332 14,929,911
------------ -----------
(Loss) income from operations (3,636,328) 1,039,617
Interest Expense, net (includes amortization of debt discount of (553,384)
$126,171 in 1999 (Note 7)) (315,392)
Other (Expense) Income, net (35,435) 19,751
------------ -----------
(Loss) income before provision for income taxes (4,225,147) 743,976
Provision for Income Taxes -- 65,000
------------ -----------
Net (loss) income $ (4,225,147) $ 678,976
============ ===========
The accompanying notes are an integral part of these consolidated financial
statements.
S-52
VISIBILITY INC. AND SUBSIDIARIES
Consolidated Statements of Redeemable Convertible Preferred Stock and
Stockholders' Deficit
For the Years Ended December 31, 1999 and 1998
CONVERTIBLE CONVERTIBLE CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK
SERIES A SERIES B SERIES C
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
Balance, December 31, 1997 1,881,721 5,250,000 1,628,700 879,500 337,331 2,250,000
Comprehensive loss -- -- -- -- -- --
Net loss -- -- -- -- -- --
Foreign currency translation adjustment -- -- -- -- -- --
Comprehensive loss -- -- -- -- -- --
--------- ---------- --------- -------- ------- ----------
Balance, December 31, 1998 1,881,721 5,250,000 1,628,700 879,500 337,331 2,250,000
Exercise of stock options -- -- -- -- -- --
Conversion of common stock to Series D
convertible preferred stock -- -- -- -- -- --
Accretion of Series D convertible preferred stock -- -- -- -- -- --
Issuance of common stock warrants -- -- -- -- -- --
Comprehensive loss -- -- -- -- -- --
Net loss -- -- -- -- -- --
Foreign currency translation adjustment -- -- -- -- -- --
Comprehensive loss -- -- -- -- -- --
--------- ---------- --------- -------- ------- ----------
Balance, December 31, 1999 1,881,721 $5,250,000 1,628,700 $879,500 337,331 $2,250,000
========= ========== ========= ======== ======= ==========
CONVERTIBLE
PREFERRED STOCK ADDITIONAL
SERIES D COMMON SHARES PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
Balance, December 31, 1997 -- -- 1,189,669 1,190 452,397
Comprehensive loss -- -- -- -- --
Net loss -- -- -- -- --
Foreign currency translation adjustment -- -- -- -- --
Comprehensive loss -- -- -- -- --
------- -------- ---------- ------- ---------
Balance, December 31, 1998 -- -- 1,189,669 1,190 452,397
Exercise of stock options -- -- 137,603 137 30,562
Conversion of common stock to Series D
convertible preferred stock 369,125 643,558 (369,125) (369) (221,106)
Accretion of Series D convertible preferred stock -- 147,210 -- -- --
Issuance of common stock warrants -- -- -- -- 56,824
Comprehensive loss -- -- -- -- --
Net loss -- -- -- -- --
Foreign currency translation adjustment -- -- -- -- --
Comprehensive loss -- -- -- -- --
------- -------- ---------- ------- ---------
Balance, December 31, 1999 369,125 $790,768 958,147 $ 958 $ 318,677
======= ======== ========== ======= =========
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE COMPREHENSIVE ACCUMULATED STOCKHOLDERS'
INCOME (LOSS) INCOME (LOSS) DEFICIT DEFICIT
Balance, December 31, 1997 (4,240) (14,371,273) (13,921,926)
Comprehensive loss -- -- --
Net loss $ 678,976 -- 678,976 678,976
Foreign currency translation adjustment 6,054 6,054 -- 6,054
-------------
Comprehensive loss $ 685,030 -- -- --
============= ------ ------------ ------------
Balance, December 31, 1998 1,814 (13,692,297) (13,236,896)
Exercise of stock options -- -- 30,699
Conversion of common stock to Series D
convertible preferred stock -- -- (221,475)
Accretion of Series D convertible preferred stock -- (147,210) (147,210)
Issuance of common stock warrants -- -- 56,824
Comprehensive loss -- -- --
Net loss $ (4,225,147) -- (4,225,147) (4,225,147)
Foreign currency translation adjustment 3,535 3,535 -- 3,535
-------------
Comprehensive loss $ (4,221,612) -- -- --
============= ------ ------------ ------------
Balance, December 31, 1999 $5,349 $(18,064,654) $(17,739,670)
====== ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
S-53
VISIBILITY INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 1999 and 1998
1999 1998
Cash Flows from Operating Activities:
Net (loss) income $(4,225,147) $ 678,976
Adjustments to reconcile net income (loss) to net cash used in
operating activities-
Depreciation and amortization 781,716 734,440
Interest expense capitalized to debt 162,459 76,925
Noncash amortization of debt discount 126,171 --
Changes in assets and liabilities, net of assets acquired-
Accounts receivable, net 585,998 (4,743,798)
Prepaid expenses and other current assets 48,227 (204,607)
Accounts payable 153,906 1,063,590
Accrued expenses (859,601) 272,695
Deferred revenue 1,815,373 1,269,554
Deferred rent 5,274 26,402
----------- -----------
Net cash used in operating activities (1,405,624) (825,823)
----------- -----------
Cash Flows from Investing Activities:
Acquisition, net of cash acquired -- (126,000)
Purchases of fixed assets (588,162) (206,878)
Other assets 35,609 (3,078)
----------- -----------
Net cash used in investing activities (552,553) (335,956)
----------- -----------
Cash Flows from Financing Activities:
Proceeds from issuance of common stock 30,700 --
Proceeds from issuance of Series A preferred stock -- --
Proceeds from issuance of notes payable and Series D preferred stock 1,100,000 --
Proceeds from short-term bank loans, net 423,370 --
Repayment of notes payable -- --
Payment of capital lease obligation (23,962) (311,395)
Payments of short-term bank loans, net -- --
----------- -----------
Net cash provided by (used in) by financing activities 1,530,108 (311,395)
----------- -----------
Foreign Exchange Impact on Cash 3,535 6,054
----------- -----------
Net (Decrease) Increase in Cash and Cash Equivalents (424,534) (1,467,120)
Cash and Cash Equivalents, beginning of year 1,162,605 2,629,725
----------- -----------
Cash and Cash Equivalents, end of year $ 738,071 $ 1,162,605
=========== ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for interest $ 433,334 $ 242,771
=========== ===========
Supplemental Disclosure of Noncash Financing and Investing Activities:
Acquisition of equipment under capital lease $ 197,352 $ 283,731
=========== ===========
Conversion of 369,125 shares of common stock into 369,125 shares of Series D
redeemable convertible preferred stock, net of discount (Note 12) $ 643,558 $ --
=========== ===========
Conversion of notes payable into 627,240 shares of Series A redeemable convertible
preferred stock $ -- $ --
=========== ===========
Discount on issuance of note payable to shareholders $ 478,907 $ --
=========== ===========
Acquisition of certain assets of the former European distributor-
Fair value of assets acquired-
Equipment $ -- $ --
Goodwill and other intangible assets -- 126,000
----------- -----------
-- 126,000
Forgiveness of Visibility debt, net -- --
----------- -----------
Cash payment for acquisition $ -- $ 126,000
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
S-54
VISIBILITY INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999
(1) NATURE OF THE BUSINESS
Visibility Inc., a Delaware corporation, and subsidiaries (the
Company), develops, markets, sells and supports an integrated line of
business application software for manufacturers and aviation
maintenance, repair and overhaul companies. The Company is subject to a
number of risks similar to those of other companies in a similar stage
of development. Principal among these risks are the need to obtain
adequate financing, dependence on key individuals, the need for
successful development and marketing of services and products, and
competition from other companies.
Management believes that its current cash and available borrowings
under the Company's current and future bank lines of credit (see Note
6) will provide sufficient capital to finance the Company through
December 31, 2000. The Company may attempt to raise additional capital
during 2000 in order to fund operations, product marketing and
development, and working capital requirements. There can be no
assurance that additional financing will be available or on terms
favorable to the Company. The Company's largest investors have stated
that they continue to support the Company and that they have the
positive ability, intent and commitment to fund or arrange funding of
any cash requirements that Visibility may have, resulting from
operating losses or other uses of cash required in the ordinary course
of business, through at least December 31, 2000.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the Company's significant accounting policies follows:
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
RECLASSIFICATIONS
Certain prior-year balances have been reclassified in order to conform
with the current year's presentation.
PRINCIPLES OF CONSOLIDATION
The accompanying financial statements include the accounts of the
Company and its wholly owned subsidiaries after elimination of
intercompany accounts and transactions.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents. The carrying
amounts of cash and cash equivalents approximate their fair value due
to the short-term maturities of these investments.
S-55
FOREIGN CURRENCY TRANSLATION
The functional currency for the Company's United Kingdom subsidiary is
the British pound sterling. Gains (losses) from foreign currency
translations of the United Kingdom subsidiary are credited or charged
to accumulated other comprehensive income (loss), which is included as
a component of stockholders' equity in the accompanying consolidated
balance sheets. The functional currency of the Company's other foreign
operations is the U.S. dollar. Gains and losses for these subsidiaries
resulting from the remeasurement of foreign currencies into U.S.
dollars are included in the results of operations and the amounts are
insignificant.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist primarily of cash and cash
equivalents, accounts receivable, accounts payable and long-term debt.
The carrying amounts of the Company's cash and cash equivalents,
accounts receivable and accounts payable approximate fair value due to
their short-term nature. See Note 6 for fair value information
pertaining to the Company's long-term debt.
REVENUE RECOGNITION
In accordance with the provisions of Statement of Position (SOP) No.
97-2, Software Revenue Recognition, the Company recognizes revenue from
noncancelable software licenses upon product shipment, provided
collection is probable and no significant vendor and postcontract
customer obligations remain at the time of shipment. Sales of the
Company's products do not require significant production, modification
or customization of software. Installation of the software is routine,
requires insignificant effort and is not essential to the functionality
of the system or software. The Company accounts for insignificant
vendor obligations by deferring a portion of the revenue and
recognizing it when the related services are performed. Postcontract
support (maintenance) service fees are typically billed separately and
are recognized on a straight-line basis over the life of the applicable
agreement. The Company recognizes service revenues from consulting and
implementation services, including training, provided by both its own
personnel and by third parties, upon performance of the services.
Long-term service and development contracts are recognized using the
percentage-of-completion method. Revenue from equipment sales is
recognized upon shipment of the equipment.
SOFTWARE DEVeLOPMENT COSTS
The Company capitalizes certain software development costs after
technological feasibility of the product has been established. Costs
incurred prior to the establishment of technological feasibility are
charged to research and development expense. The Company capitalized no
software development costs during 1999 and 1998, as the costs incurred
after technological feasibility was established were deemed to be
immaterial. Capitalized software costs are amortized ratably over the
useful life of the product, generally two years, and are charged to
cost of revenues. There was no amortization expense for the year ended
December 31, 1999 relating to capitalized software.
S-56
INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes. Under this method, deferred tax assets and
liabilities are recognized for the expected future tax consequences,
utilizing current tax rates, of temporary differences between the
carrying amounts and the tax bases of assets and liabilities.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement requires companies
to record derivatives on the balance sheet as assets or liabilities,
measured at fair value. Gains or losses resulting from changes in the
values of those derivatives would be accounted for depending on the use
of the derivative and whether it qualifies for hedge accounting. In
June 1999, the FASB issued SFAS No. 137, Accounting for Derivative
Financial Instruments and Hedging Activities--Deferral of the Effective
Date of FASB Statement No. 133. Consequently, SFAS No. 133 will be
effective for the Company's year ending December 31, 2001. Management
believes that this statement will not have a significant impact on the
Company.
(3) ACQUISITION
On May 15, 1997, the Company established a wholly owned UK subsidiary,
Visibility Europe Ltd. (the Subsidiary), which acquired certain
equipment and intangible assets of the Company's then European
distributor, whose parent company was formerly also a minority
stockholder of the Company, for $250,000. The purchase price was
allocated $109,135 to equipment and $140,865 to goodwill and other
intangibles, which are being amortized on a straight-line basis over
three years. This acquisition was accounted for as a purchase.
Additional purchase price was contingent on the Subsidiary achieving
certain profitability levels for 1997 and 1998, which the Company did
not achieve in 1997. The Company achieved the 1998 targeted
profitability, resulting in an additional $117,000 of contingent
consideration. This payment has been accounted for as an addition to
goodwill. $87,677 of goodwill amortization was recorded as an expense
in 1999. Pro forma information for this acquisition has not been
presented, as the impact was not material.
(4) ACCOUNTS RECEIVABLE; ALLOWANCE FOR DOUBTFUL ACCOUNTS
BALANCE AT PROVISION NET DEDUCTIONS
BEGINNING OF CHARGED TO FROM BALANCE AT
PERIOD OPERATIONS ALLOWANCE(1) END OF PERIOD
Year Ended December 31, 1999 $424 $55 $(105) $374
Year Ended December 31, 1998 484 40 (100) 424
(1) Accounts deemed uncollectable, net of recoveries.
S-57
(5) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost and depreciated
using the straight-line method over the estimated useful lives of the
assets. Maintenance and repair costs are charged to expense as
incurred.
Fixed assets consist of the following at December 31, 1999:
ESTIMATED
USEFUL LIVES 1999
Furniture and fixtures 5 years $ 708,980
Equipment 1-3 years 3,503,784
Computer software 3 years 636,493
Leasehold improvements 2-10 years 352,207
----------
5,201,464
Less--Accumulated depreciation and amortization 4,137,891
----------
$1,063,573
==========
Included above is equipment held under capital leases with a cost of
$477,494 and accumulated amortization of $149,319 at December 31, 1999.
(6) SHORT-TERM DEBT
LINE OF CREDIT
The Company has two line of credit facilities with a bank which allow
the Company to borrow up to $3,125,000 as of December 31, 1999.
Borrowings are secured by substantially all of the Company's assets
under these two facilities. Aggregate borrowings under these facilities
at December 31, 1999 totaled $1,923,370. The facilities expire on March
31, 2000.
The first facility allows the Company to borrow against 80% of factored
U.S. accounts receivable up to a maximum of $2,125,000. Interest
accrues at the bank's prime rate (8.5% at December 31, 1999) plus 1.5%
points. In addition, a 0.5% administrative fee is due on the value of
each factored account receivable when it is collected. The facility has
certain covenants that pertain to the Company's profitability, as
defined, which the Company was in compliance with at December 31, 1999.
$1,673,370 was outstanding under this facility at December 31, 1999.
The second facility was entered into on October 1, 1999 and established
a line of credit in the maximum principal amount of $1,000,000
guaranteed by the U.S. Export-Import Bank (EXIM). This facility allowed
the Company to borrow the lesser of a borrowing base calculation based
on certain percentages of accounts receivable originating outside the
U.S., primarily from the U.K., as defined, or $1,000,000. As of
December 31, 1999, the Company had borrowed $250,000 under this
facility. During 1999, the interest rate under this facility was the
bank's prime rate (8.5% at December 31, 1999) plus 2% points. The
facility has certain covenants that include the Company's profitability
and quick ratios, as defined. At December 31, 1999, the
S-58
Company was not in compliance with these covenants. During 2000, the
Company is obligated to pay down the borrowings in $125,000
installments on the 15th and last day of each month, beginning in
February. The bank applied the February payments to the $250,000 EXIM
loan that has settled this facility.
In connection with the November 1997 amendment of the credit line
agreement with the bank, the Company issued the bank a warrant to
purchase 71,685 shares of common stock at an exercise price of $2.79
per share. The fair value of this warrant was immaterial. In connection
with the April 1998 amendment of the agreement with the bank, the bank
will be issued a warrant to purchase 10,526 shares of common stock at
an exercise price of $4.75 per share in the event that the Company
defaults on its payment obligations to the bank and it is not cured
within two business days. To date, warrants have not been issued since
the Company has not defaulted on its payments to the bank.
The Company has executed a Commitment Letter offered by a commercial
credit corporation that offers a $4 million credit line effective March
31, 2000. Borrowings under the credit line would be advanced against a
borrowing base calculation and would allow the lesser of 85% of
worldwide accounts receivable or $4 million. To secure the loans, the
lender would be granted a first priority security interest in all the
assets of the Company. Interest would accrue at the commercial credit
corporation's prime lending rate plus 2% points and a 1% commitment fee
has been paid subsequent to year-end. Minimum monthly interest charges
would be $4,150. The Company would grant to the lender warrants to
purchase 55,363 shares of the Company's common stock at an exercise
price of $5.78 per share which would be exercisable for seven years
from the date of issuance. The credit line period is one year and is
automatically renewable. There are no profitability or financial ratio
covenants associated with the credit line. The Company expects that
this credit line would be sufficient to provide for its working capital
needs through December 31, 2000.
NOTE PAYABLE TO OTHERS
The Company has $1,000,000 of borrowings under a senior subordinated
note agreement due to a former shareholder, the parent company of its
former European distributor. The note plus accrued interest is
reflected as short-term debt in the accompanying 1999 balance sheet and
is due on May 15, 2000. The note is subject to acceleration provisions
upon the closing of an initial public offering, sale or other
disposition, as defined. The note accrues interest at 8% per annum,
payable upon maturity, and is unsecured. As part of the financing, the
Company also issued a warrant for the purchase of up to 50,000 shares
of common stock at $6.67 per share. The fair value of the warrant was
not material. The warrant expires upon repayment of the senior
subordinated note.
Interest expense on this note for 1999 and 1998 was $80,000 for each
year.
(7) LONG-TERM DEBT
The Company has $402,555 of notes outstanding to a stockholder as of
December 31, 1999. The notes accrue interest at 10% per annum. During
1999, the maturity date was extended to January 1, 2000. Subsequent to
year-end, the maturity date was further extended to January 31, 2001
and, accordingly, the outstanding
S-59
borrowings and accrued interest of $509,904 at December 31, 1999 are
reflected as noncurrent in the accompanying balance sheet. The
borrowings are secured by the Company's accounts receivable.
On September 17, 1999, the Company entered into several stockholder
note agreements totaling $1,100,000. These notes accrue interest at a
rate of 10% per annum and are unsecured. The original maturity date was
March 31, 2000 but subsequent to year-end this was extended to January
31, 2001. Accordingly, the outstanding borrowings and accrued interest
are reflected as noncurrent in the accompanying balance sheet. The debt
is carried in the financial statements net of unamortized discount,
based on the relative fair values of securities issued in connection
with the notes (see Note 12 (a)). The original debt discount of
$478,907 is being amortized over the term of the debt as additional
noncash interest expense. This noncash interest expense amounted to
$126,171 in 1999.
Interest expense, including amortized debt discount, for 1999 and 1998
on these notes payable to stockholders totaled $208,631 and $40,255,
respectively.
The fair value of the Company's debt approximates its carrying value
based on the current rate offered to the Company for obligations of the
same remaining maturities.
(8) BENEFIT PLAN
The Company has a defined contribution plan, which is qualified under
Section 401(k) of the Internal Revenue Code. The plan covers
substantially all employees who meet minimum age and service
requirements and allows participants to defer a portion of their
salary. After one year of employment, the Company contributes 25% of
the employee's contribution, up to a maximum of 6% of the employee's
salary. Employer contributions may be suspended at the option of the
Board of Directors. The Company's contributions to the plan for the
years ended December 31, 1999 and 1998 were approximately $100,000 and
$100,000, respectively.
(9) INCOME TAXES
(Loss) income before income taxes for domestic and foreign operations
is as follows:
1999 1998
Domestic $(2,932,507) $1,649,938
Foreign (1,292,640) (905,962)
---------- ---------
$(4,225,147) $ 743,976
========== =========
S-60
The provision for income taxes consists of the following for 1999 and
1998:
1999 1998
Current tax expense-
Federal $ -- $ 38,000
State -- 27,000
Foreign -- --
---------- ----------
$ -- $ 65,000
========== ==========
The 1998 federal tax expense represents alternative minimum taxes
payable and the 1998 state provision represents minimum and other
non-income-measured taxes. The Company utilized $1,655,000 of federal
and state net operating loss carryforwards in 1998 and reduced the
valuation allowance accordingly.
A reconciliation of the federal statutory rate to the Company's
effective tax rate is as follows:
1999 1998
Income tax provision (benefit) at
statutory rate (34)% 34%
State tax provision (benefit) (5) 10
Impact of foreign tax rates (benefit) 2 9
(Decrease) increase in valuation allowance 45 (59)
Other (8) 15
----- -----
--% 9%
===== =====
The Company has approximately $9,000,000 of U.S. federal net operating
loss carryforwards available to reduce future taxable income, if any.
These net operating loss carryforwards expire in varying amounts
through 2019 and are subject to the review and possible adjustment by
the Internal Revenue Service. The Company has $4,915,000 of foreign net
operating loss carryforwards available to reduce future taxable income
in the foreign jurisdictions, if any.
Section 382 of the Internal Revenue Code and the tax laws of certain
foreign jurisdictions also contain provisions that could place annual
limitations on the utilization of these net operating loss
carryforwards in the event of a change in ownership, as defined.
S-61
Significant components of deferred income taxes are as follows:
1999
Deferred tax liabilities $ 328,046
-----------
Deferred tax assets-
Net operating loss carryforwards $ 4,652,900
Allowance for doubtful accounts 117,035
Deferred rent 50,875
Accrued benefits 112,503
Tax credits 617,934
Other 44,038
-----------
5,595,285
Valuation allowance (5,595,285)
-----------
Total deferred tax assets $ --
===========
The valuation allowance at December 31, 1999 relates to the uncertainty
of realizing the tax benefits of the deferred tax assets. Nonetheless,
some, if not all, of these deferred tax assets may be available to offset
any deferred income tax liabilities as they become otherwise payable.
(10) COMMITMENTS AND CONTINGENCIES
The Company leases facilities under various operating leases. The Company
also leases certain equipment under noncancelable capital and operating
leases. Future minimum lease commitments under all noncancelable
operating and capital leases at December 31, 1999 are as follows:
OPERATING CAPITAL
LEASES LEASES
2000 $ 534,380 $ 187,290
2001 514,943 198,744
2002 445,416 52,404
2003 425,699 --
2004 282,422
Thereafter 1,292,400 --
---------- ----------
Total minimum lease payments $3,495,260 438,438
==========
Less--Amount representing interest 81,626
----------
Present value of minimum lease payments
(including current portion of $135,368) $ 356,812
==========
Total rent expense under noncancelable operating leases was approximately
$493,000 and $464,000 for the years ended December 31, 1999 and 1998,
respectively.
S-62
(11) CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially expose the Company to
concentrations of credit risk include trade accounts receivable. To
minimize this risk, ongoing credit evaluations of customers' financial
condition are performed, although collateral is not required. The
Company maintains reserves for potential credit losses.
No one customer accounted for 10% or more of gross accounts receivable
at December 31, 1999. One customer accounted for 13% of total revenues
in 1999. No customer accounted for 10% or more of total revenues in
1998.
(12) STOCKHOLDERS' EQUITY
(A) PREFERRED STOCK
On October 6, 1997, the Company amended and restated its
Certification of Incorporation, whereby the Company's
authorized shares of $0.001 par value common stock was
increased to 15,000,000. The Company also authorized the
issuance of 3,847,752 shares of $0.001 par value preferred
stock, of which 1,881,721 shares are designated as Series A
Preferred Stock, 1,628,700 shares are designated as Series B
Preferred Stock and 337,331 shares are designated as Series C
Preferred Stock.
The Company issued 1,881,721 shares of Series A Redeemable
Convertible Preferred Stock in exchange for $3,500,000 of cash
plus the conversion of the $1,750,000 notes payable issued in
1997 and 1996. In 1997, the Company also allowed common
stockholders to convert 1,966,031 shares of common stock into
1,628,700 shares of Series B Redeemable Convertible Preferred
Stock and 337,331 shares of Series C Redeemable Convertible
Preferred Stock.
On September 10, 1999, the Company further amended and
restated the Amended and Restated Certification of
Incorporation to provide for the authorization and issuance of
369,125 additional shares of $0.001 par value preferred stock,
335,569 shares to be designated as Series D-1 Preferred Stock,
16,778 shares to be designated as Series D-2 Preferred Stock,
16,778 shares to be designated as Series D-3 Preferred Stock
(collectively, the Series D Preferred Stock).
In connection with the September 17, 1999 stockholder debt
financing discussed in Note 7, the Company allowed certain
common stockholders who participated in the debt financing to
convert 369,125 shares of common stock into 335,569 shares of
Series D-1 Redeemable Convertible Preferred Stock, 16,778
shares of Series D-2 Redeemable Convertible Preferred Stock
and 16,778 shares of Series D-3 Redeemable Convertible
Preferred Stock. Warrants to purchase 415,847 shares of common
stock were also issued to the investors who participated in
the debt financing. The warrants expire on September 17, 2002,
have an exercise price of $0.60, and were valued using the
Black-Scholes option pricing model. The value of the
consideration received has been allocated to the debt and
equity instruments based on their relative fair values. The
resulting discount is being accreted over the term of the
securities.
S-63
The Series A, Series B Series C and Series D redeemable convertible
preferred stock have the following rights and preferences:
VOTING
Preferred stockholders are entitled to vote on an as-converted
basis together with common stockholders as one class.
DIVIDENDS
The preferred stockholders are entitled to receive dividends
or other distributions equal to the dividend or distribution
that would be received had the preferred stockholders
converted their shares into common stock.
LIQUIDATION
In the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Company, the holders of
Series A, B and C redeemable convertible preferred stock are
entitled to receive a $2.79, $.54 and $6.67 per share
liquidation preference, respectively, plus accrued or unpaid
dividends. The holders of Series D-1, D-2 and D-3 redeemable
convertible preferred stock are entitled to receive a $5.78,
$0.54 and $2.40 per share liquidation preference,
respectively, plus accrued or unpaid dividends. If the assets
available for distribution are insufficient to permit payment
of the liquidation preference amount, then the holders of the
preferred stock shall share ratably in any distribution, as
defined. After distribution to the preferred stockholders of
the full liquidation preference amount, any remaining assets
available for distribution are distributed both to holders of
common stock and preferred stock on a pro rata basis, with the
exception of holders of Series D redeemable convertible
preferred stock, assuming the preferred stock is converted
into common stock. Any dissolution or liquidation resulting
from an event of sale, as defined, with proceeds of greater
than or equal to $15.00 per share on an as-converted basis,
will not result in distributions in accordance with the
foregoing; rather, all preferred stock will be converted into
common and share in the proceeds on a pro rata basis.
CONVERSION
Each share of preferred stock is convertible, at the option of
the holder, into one share of common stock, adjusted for
certain dilutive events, as defined. In the event of an
initial public offering with a per share price of less than
$15.00, each holder of the preferred stock will receive a cash
payment equal to the liquidation preference (the IPO
Preference Amount) and all shares shall convert automatically
into common stock. The shares automatically convert upon the
occurrence of a qualified offering with a per share price
greater than or equal to $15.00 without any IPO Preference
Amount.
S-64
REDEMPTION
As of March 31, 2003, the holders of the preferred
stock may require the Company, with 30 days' written
notice, to redeem outstanding preferred stock. The
redemption price equals the liquidation preference
plus all accrued but unpaid dividends.
OTHER RESTRICTIONS
The Corporation is restricted, without the approval
of 51% of the holders of preferred stock, from
issuing additional shares of preferred stock, common
stock or convertible debt, altering the terms of
outstanding preferred stock, amending its articles of
incorporation, selling or otherwise disposing of all
or substantially all of its assets, or voluntary
dissolving or otherwise liquidating the Company.
(B) STOCK OPTION PLANS
In 1994, the Company adopted the Visibility Inc. and
Subsidiaries Stock Option Plan (the 1994 Plan), which is
administered by the Board of Directors. The 1994 Plan provides
for the issuance to key employees and directors of the Company
options to purchase shares of common stock. The maximum number
of shares of common stock that may be issued under the 1994
Plan is 202,500 shares. Options are granted under the 1994
Plan at exercise prices not less than the fair value of the
stock on the date of grant. The options are exercisable over
periods determined by the Board of Directors and expire after
10 years from the date of grant.
On February 2, 1996, the Company adopted the Visibility Inc.
and Subsidiaries 1996 Stock Plan (the Plan), which is
administered by the Board of Directors. The Plan provides for
the issuance of incentive and nonqualified options to purchase
shares of common stock to key employees and directors of the
Company. The maximum number of shares of common stock that may
be issued under the Plan is 1,050,000 shares. Incentive stock
options may be granted under the Plan at exercise prices not
less than the fair value of the stock on the date of grant.
The options are exercisable over periods determined by the
Board of Directors and expire 10 years from the date of grant.
S-65
The following summarizes the stock option activity
under the Company's stock option plans:
WEIGHTED
OUTSTANDING AVERAGE
OPTIONS EXERCISE PRICE
Balance, December 31, 1997 1,152,550 0.40
Granted 196,300 0.40
Exercised -- --
Canceled (162,499) 0.25
------------
Balance, December 31, 1998 1,186,351 0.42
Granted 344,000 0.58
Exercised (137,603) 0.22
Canceled (495,797) 0.52
------------
Balance, December 31, 1999 896,951 $ 0.46
============ ============
At December 31, 1999 and 1998, options to purchase 457,122 and 549,162
shares were exercisable, respectively. The options exercisable at
December 31, 1999 and 1998 had a weighted average exercise price of
$0.46 and $0.49, respectively. Options generally vest over three to
four years. At December 31, 1999, 127,946 shares were available for
future option grants.
During 1995, the Financial Accounting Standards Board issued SFAS No.
123, Accounting for Stock-Based Compensation, which defines a fair
value-based method of accounting for employee stock options or similar
equity instruments and encourages all entities to adopt that method of
accounting for all their employee stock compensation plans. However, it
also allows an entity to continue to measure compensation costs for
those plans using the intrinsic method of accounting prescribed by APB
Opinion 25. Entities electing to remain with the accounting in APB
Opinion 25 must make pro forma disclosures of net income as if the
fair-value-based method of accounting defined in SFAS No. 123 has been
applied. The Company has elected to account for its stock-based
compensation plans under APB Opinion 25.
Had compensation costs for the stock option plan been determined using
the fair value-based method as prescribed by SFAS No. 123, the
Company's 1999 net loss and 1998 net income would have been increased
and decreased, respectively, to the following pro forma amounts:
1999 1998
Net (loss) income-
As reported $ (4,225,147) $ 678,976
Pro forma (4,228,464) 665,174
Consistent with SFAS No. 123, pro forma compensation cost has not been
calculated for options granted prior to January 1, 1995. Pro forma
compensation cost may not be representative of that to be expected in
future years.
The weighted average per share fair values of options granted during
1999 and 1998 were $0.10 and $0.09, respectively. The values were
estimated on the date of grant using the following weighted average
assumptions for grants in 1999 and 1998: risk-
S-66
free interest rate of 5.50 % and 5.17%; expected life of five years;
expected dividend yield of 0% and volatility factor of 0%.
The weighted average remaining contractual life of outstanding options
was 7.67 years and the range of exercise prices was $0.20 to $1.67 at
December 31, 1999.
(13) FOREIGN OPERATIONS
The following table summarizes the Company's operations by geographic
area:
1999 1998
Revenues-
North America $ 19,664,679 $ 24,022,301
Europe 4,545,329 6,170,590
------------ ------------
Consolidated total $ 24,210,008 $ 30,192,891
============ ============
(Loss) income from operations-
North America $ (2,932,507) $ 1,964,561
Europe (1,292,640) (924,944)
------------ ------------
Consolidated total $ (4,225,147) $ 1,039,617
============ ============
Identifiable assets-
North America $ 8,061,279 $ 7,872,620
Europe 2,224,379 3,700,960
------------ ------------
Consolidated total $ 10,285,658 $ 11,573,580
============ ============
Export sales were not material in 1999 and 1998.
S-67
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Digital Wireless Corporation:
We have audited the accompanying balance sheet of Digital Wireless Corporation
as of December 31, 1999, and the related statements of operations, changes in
stockholders' equity, and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Digital Wireless Corporation as
of December 31, 1999, and the results of its operations and its cash flows for
the year then ended in conformity with accounting principles generally accepted
in the United States.
Atlanta, Georgia ARTHUR ANDERSEN LLP
February 18, 2000
S-68
CIRRONET INC.
Balance Sheets
December 31, 2001 and 2000
ASSETS 2001 2000
----------- -----------
(unaudited) (unaudited)
Current assets:
Cash and cash equivalents $ 630,085 333,274
Accounts receivable, less allowance for doubtful accounts
of $9,055 and 24,980, respectively 966,132 1,292,741
Inventories 1,371,608 1,425,605
Income tax refund receivable 39,366 152,855
Deferred income tax assets 37,757 41,961
Prepaid expenses and other current assets 76,334 10,001
----------- ----------
Total current assets 3,121,282 3,256,437
Property and equipment, net 370,165 315,365
Deferred income tax assets 77,388 --
Other assets 42,611 48,728
----------- ----------
Total assets $ 3,611,446 3,620,530
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 326,152 579,135
Accrued expenses 222,454 171,993
Current maturities of obligations under capital leases
and long-term debt 27,472 136,688
----------- ----------
Total current liabilities 576,078 887,816
Obligations under capital leases and long-term debt
excluding current maturities 165,877 66,156
Deferred income tax liabilities -- 18,266
----------- ----------
Total liabilities 741,955 972,238
----------- ----------
Stockholders' equity:
Common stock, $.001 par value; 40,000,000 shares authorized;
7,359,458 and 7,335,050 shares issued and outstanding, respectively 73,590 73,350
Additional paid-in capital 1,862,557 1,831,788
Retained earnings 1,079,362 880,419
Note receivable from employee for stock options (146,018) (137,265)
----------- ----------
Total stockholders' equity 2,869,491 2,648,292
Commitments and contingencies
----------- ----------
Total liabilities and stockholders' equity $ 3,611,446 3,620,530
=========== ==========
See accompanying notes to financial statements.
S-69
CIRRONET INC.
Statements of Operations
Years ended December 31, 2001, 2000 and 1999
2001 2000 1999
----------- ----------- -----------
(unaudited) (unaudited) (audited)
Revenues:
Product sales and service revenues $ 8,760,866 5,975,684 4,118,153
Development contracts 60,000 265,067 352,700
----------- ----------- -----------
Total revenues 8,820,866 6,240,751 4,470,853
Costs of revenues 4,921,757 3,059,098 1,912,709
----------- ----------- -----------
Gross profit 3,899,109 3,181,653 2,558,144
Operating expenses:
Research and development 1,250,026 857,347 520,720
Sales and marketing 1,593,835 1,133,739 656,285
General and administrative 943,789 836,806 375,447
Compensation charge for warrants -- 471,200 --
----------- ----------- -----------
Total operating expenses 3,787,650 3,299,092 1,552,452
----------- ----------- -----------
Operating (loss) income 111,459 (117,439) 1,005,692
Other income (expense):
Interest income 11,232 33,309 23,921
Interest expense (32,551) (14,886) (9,387)
Other (expense) income 540 (7,053) 13,487
----------- ----------- -----------
Total other income (expense) (20,779) 11,370 28,021
----------- ----------- -----------
Income (loss) before income tax expense and
cumulative effect of accounting change 90,680 (106,069) 1,033,713
Income tax (benefit) expense (108,263) (67,748) 274,208
----------- ----------- -----------
Net income (loss) before cumulative effect of
accounting change 198,943 (38,321) 759,505
Cumulative effect of accounting change, less applicable
income taxes of $-0-, $-0- and $22,980 in 2001, 2000
and 1999, respectively -- -- 34,469
----------- ----------- -----------
Net income (loss) $ 198,943 (38,321) 793,974
=========== =========== ===========
See accompanying notes to financial statements.
S-70
CIRRONET INC.
Statements of Stockholders' Equity
Years ended December 31, 2001, 2000 and 1999
NOTE
COMMON STOCK ADDITIONAL RECEIVABLE TOTAL
---------------------- PAID-IN RETAINED FROM EMPLOYEE STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS FOR STOCK OPTIONS EQUITY
---------- ---------- ---------- ---------- ----------------- -------------
Balances at Dec. 31, 1998 (audited) 6,258,880 $ 62,588 1,335,513 124,766 -- 1,522,867
Conversion of subordinated debentures
into common stock 80,000 800 39,920 -- -- 40,720
Net income -- -- -- 793,974 -- 793,974
---------- ---------- ---------- ---------- ----------------- -------------
Balances at Dec. 31, 1999 (audited) 6,338,880 63,388 1,375,433 918,740 -- 2,357,561
Note receivable from employee
for stock options exercise 346,500 3,465 130,815 -- (134,280) --
Interest on note receivable -- -- 2,985 -- (2,985) --
Issuance of stock in exchange for
warrants 620,000 6,200 303,800 -- -- 310,000
Exercise of stock options 29,670 297 2,670 -- -- 2,967
Issuance of stock options for
services compensation -- -- 16,085 -- -- 16,085
Net loss -- -- -- (38,321) -- (38,321)
Balances at Dec. 31, 2000 (unaudited) 7,335,050 73,350 1,831,788 880,419 (137,265) 2,648,292
Issuance of stock to non-employee
for services 24,408 240 11,963 -- -- 12,203
Interest on note receivable -- -- 8,753 -- (8,753) --
Issuance of stock options to
non-employee for services -- -- 10,053 -- -- 10,053
Net income -- -- -- 198,943 -- 198,943
---------- ---------- ---------- ---------- ----------------- -------------
Balances at December 31, 2001(unaudited) 7,359,458 73,590 1,862,557 1,079,362 (146,018) 2,869,491
========== ========== ========== ========== ================= =============
See accompanying notes to financial statements.
S-71
CIRRONET INC.
Statements of Cash Flows
Years ended December 31, 2001, 2000 and 1999
2001 2000 1999
---------- ---------- ----------
(unaudited) (unaudited) (audited)
Cash flows from operating activities:
Net (loss) income $ 198,943 (38,321) 793,974
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 111,095 62,676 (27,941)
Provision for doubtful accounts receivable and returns 55,893 41,129 20,109
Provision for inventory obsolescence 20,000 30,000 --
Deferred income tax (benefit) expense (91,450) (45,503) 21,460
Stock compensation expense 22,256 324,845 --
Loss on disposal of property and equipment 6,785 -- --
(Increase) decrease in:
Accounts receivable 270,716 (738,817) (138,847)
Inventories 33,997 (205,593) (307,098)
Income tax receivable 113,489 (152,855) --
Other assets (62,533) (26,158) --
Increase (decrease) in:
Accounts payable (252,983) 420,970 62,432
Accrued expenses 50,461 (44,878) 12,775
Advance billings -- -- (102,060)
---------- ---------- ----------
Net cash (used in) provided by operating activities 476,669 (372,505) 334,804
---------- ---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (36,419) (164,054) (28,085)
Increase in other assets -- (15,434) --
---------- ---------- ----------
Net cash used in investing activities (36,419) (179,488) (28,085)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from long-term debt 135,000 41,900 123,049
Payments on convertible subordinated debentures -- -- (143,557)
Payments on long-term debt (121,538) (43,411) (17,742)
Payments on obligations under capital leases (156,901) (34,558) (34,916)
Proceeds from exercise of stock options -- 2,967 --
Proceeds from exercise of stock warrants -- 1,240 --
---------- ---------- ----------
Net cash used in financing activities (143,439) (31,862) (73,166)
---------- ---------- ----------
Net (decrease) increase in cash and cash equivalents 296,811 (583,855) 233,553
Cash and cash equivalents at beginning of year 333,274 917,129 683,576
---------- ---------- ----------
Cash and cash equivalents at end of year $ 630,085 333,274 917,129
========== ========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 29,153 13,536 19,757
Income taxes $ -- 137,880 239,899
Supplemental disclosures of noncash operating and investing
activities:
Issuance of stock options for services $ 22,256 16,085 --
Issuance of stock warrant -- 308,760
Capital lease obligations incurred for the purchase of
property and equipment $ 133,944 115,864 --
Note receivable and interest from employee for stock
option exercise $ 8,753 137,265 --
========== ========== ==========
The accompanying notes are an integral part of these statements.
S-72
(1) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Cirronet Inc., formerly known as Digital Wireless Corporation
(the "Company"), designs, manufactures, and markets wireless
telecommunications products for industries that provide a
wireless pathway for information. The Company has expertise in
a wide range of wireless technologies, including wireless
system architecture, application-specific integrated circuit
design, data communications software, protocols, and hardware.
The Company focuses exclusively on products for the industrial
and commercial markets. Additionally, the Company holds a
patent on a wireless system called Recombinant Spread Spectrum
that minimizes dropout or data transfer errors in wireless
data transmission.
The Company's customers are spread across the United States
and Europe. However, the Company derives a substantial portion
of its revenue from one product. Typical product lives for
wireless telecommunications products are three to five years.
The markets for the Company's telecom products are
characterized by significant risk as a result of rapid changes
in technology, competitors with significant financial
resources, frequent new product and service introductions, and
mergers and acquisition activity in the telecom industry.
Furthermore, the Company's business is also subject to
additional significant risks such as availability of capital,
dependency on major suppliers, protection of intellectual
property rights, dependence on key personnel, and new laws or
regulations affecting the telecom industry. As a result,
negative developments in the Company's markets or in managing
these additional risks could have an adverse effect on the
Company's financial position, results of operations, and
liquidity.
(B) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with
original maturities of three months or less to be cash
equivalents.
(C) INVENTORIES
Inventories are stated at lower of cost or market. Cost is
determined using the first-in, first-out (FIFO) method.
(D) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated
depreciation. Depreciation on property and equipment are
provided using the straight-line method over the estimated
useful lives of the assets as follows:
Computer software and equipment 3-5 years
Furniture and fixtures 5-7 years
Vehicles 5 years
Equipment 5-7 years
S-73
(E) REVENUE RECOGNITION
Revenue from the sale of products is recognized at the time of
shipment. Revenues from services and development contracts are
recognized as services are performed.
(F) INCOME TAXES
Income taxes are accounted for under the asset and liability
method. Deferred income tax assets and liabilities are
recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards.
Deferred income tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be
recovered or settled. The effect on deferred income tax assets
and liabilities of a change in tax rates is recognized in the
consolidated statement of operations in the period that
includes the enactment date.
(G) STOCK OPTION PLAN
The Company accounts for its stock option plans in accordance
with Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation ("SFAS No. 123"),
which encourages entities to recognize as compensation expense
over the vesting period the fair value of all stock-based
awards on the date of grant. Alternatively, SFAS No. 123
allows entities to continue to apply the provisions of
Accounting Principles Board ("APB") Opinion No. 25 and provide
pro forma disclosures for employee stock-based awards as if
the fair-value based method of SFAS No. 123 had been applied.
As such, compensation expense would be recorded only if the
current market price of the underlying stock as of the date of
grant exceeded the exercise price. The Company has elected to
continue applying the provisions of APB Opinion No. 25 and
include the pro forma disclosures required under SFAS No. 123.
(H) USE OF ESTIMATES
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States
of America requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
(I) COMPREHENSIVE INCOME (LOSS)
No statements of comprehensive income (loss) have been
included in the accompanying financial statements since
comprehensive income (loss) and net income (loss) presented in
the accompanying statements of operations would be the same.
(J) RESEARCH AND DEVELOPMENT
Research and development costs consist principally of
compensation and benefits paid to the Company's employees and
certain allocated indirect costs. All research and development
costs are expensed as incurred.
S-74
(K) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts
receivable, income tax refund receivable, accounts payable,
accrued expenses, income taxes payable, and obligations under
capital leases approximate fair value because of the short
maturity of these instruments. The Company also believes that
the carrying values of its long-term debt approximates fair
value because of the floating interest rate terms applicable
to the Company's long-term financing arrangements.
(L) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE
DISPOSED OF
The Company accounts for long-lived assets in accordance with
the provisions of SFAS No. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of ("SFAS No. 121"). SFAS No. 121 requires that long-lived
assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to
future net cash flows expected to be generated by the asset.
If such assets are considered to be impaired, the impairment
to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the
assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.
(M) RECLASSIFICATIONS
Reclassifications were made to certain amounts in the 1999
financial statements to conform with the presentation in the
2000 financial statements.
(2) RELATED PARTY TRANSACTIONS
The Company leased space under an operating lease and purchased certain
services from a company controlled by one of its stockholders. During
2000 and 1999, the Company paid approximately $107,000 and $95,000,
respectively, for rent and other services to this related company. The
lease expired in September 2000. In management's opinion, the amounts
paid were reasonable and equivalent to what it would have paid an
unrelated party for the facility rental and services. At December 31,
2000 and 1999, no amounts were owed to the related company.
(3) INVENTORIES
Inventories consist of the following at December 31, 2000 and 1999:
2000 1999
------------ ----------
(unaudited) (audited)
Raw materials and purchased parts $ 628,962 688,863
Work in process 402,310 338,240
Finished goods 424,333 222,909
------------ ----------
1,455,605 1,250,012
Less valuation allowances (30,000) --
------------ ----------
Total inventories $ 1,425,605 1,250,012
============ ==========
S-75
(4) PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 2000
and 1999:
2000 1999
------------ ----------
(unaudited) (audited)
Vehicles $ 25,496 --
Furniture and fixtures 76,101 3,344
Equipment 359,395 267,026
Computer software and equipment 174,662 85,366
------------ ----------
635,654 355,736
Less accumulated depreciation and amortization 320,289 259,552
------------ ----------
$ 315,365 96,184
============ ==========
Depreciation and amortization relating to property and equipment for
the years ended December 31, 2000 and 1999 was approximately $60,737
and $28,009, respectively.
(5) NOTE PAYABLE TO BANK
The Company maintains a revolving credit facility with a commercial
bank whereby it may borrow the lesser of $300,000 or 80% of eligible
accounts receivable, as defined. The facility is secured by all assets
of the Company and expires on March 31, 2001. Outstanding advances
under the line accrue interest at the prime rate plus .75%. The Company
has borrowed no monies under the revolving line of credit as of
December 31, 2000 and 1999.
(6) LONG-TERM DEBT
The Company also maintained two equipment lines of credit during the
years ended December 31, 2000 and 1999. Equipment line No. 1 was used
to finance property and equipment purchases up to a maximum of
$200,000. Advances accrue interest at the prime rate plus 1.25%.
Interest accrued from the date of each advance and was payable monthly
until June 1, 1999. On June 1, 1999, the balance outstanding under the
line of $123,049 was converted to a term note, payable in 42 equal
monthly installments of principal and accrued interest through 2002.
The outstanding balance of the notes accrues interest at the rate of
10.75% as of December 31, 2000. The note is secured by all the assets
of the Company.
In connection with a March 2000 amendment to the credit facility, the
bank extended the Company another equipment line credit ("Line No. 2").
Line No. 2 was used to finance the purchase of property and equipment
up to a maximum of $100,000. Advances accrue interest at the prime rate
plus 1.00%. Interest accrued from the date of each advance and was
payable monthly until October 31, 2000. On October 31, 2000, the
outstanding balance of advances of $41,900 was converted to a term
note, payable in 35 equal monthly installments of principal plus
accrued interest beginning on November 31, 2000 through 2002. The
outstanding balance of the note accrues interest at the rate of 10.50%
as of December 31, 2000. The note is secured by all the assets of the
Company.
S-76
Future minimum principal payments are as follows:
YEAR ENDING DECEMBER 31, AMOUNT
------------------------ ----------
2001 $ 55,382
2002 66,156
----------
$ 121,538
==========
(7) CONVERTIBLE SUBORDINATED DEBENTURES
At December 31, 1998, the Company had outstanding convertible
subordinated debentures amounting to $183,557. These debentures
included interest at varying rates from 8% to 10% and were convertible
into common stock at a conversion rate of $0.50 in debentures for one
share of common stock. The debentures matured on May 31, 1999. Interest
accrued and was payable annually on May 31. The debentures were
convertible any time until maturity, at the option of the holder. The
debentures were subordinated to current and future obligations due to
financial institutions and/or certain other traditional lending
institutions. During 1999, $40,000 of debentures were converted into
80,000 shares of common stock of the Company. The Company used existing
financing facilities to retire the remaining debentures during 1999.
(8) INCOME TAXES
The components of the income tax expense (benefit) for the years ended
December 31, 2000 and 1999 are as follows:
2000 1999
----------- --------
(unaudited) (audited)
Current Federal and state income taxes $ (22,245) 240,706
Deferred Federal and state income taxes (45,503) 33,502
---------- --------
Total provision for income taxes $ (67,748) 274,208
========== ========
The following is a summary of the items that caused recorded income
taxes to differ from income taxes computed using the statutory Federal
income tax rate for the years ended December 31, 2000 and 1999:
2000 1999
----------- ---------
(unaudited) (audited)
Computed "expected" income taxes $ (36,063) 351,462
Increase (decrease) in income taxes resulting from:
State income taxes, net of Federal income taxes (3,889) 41,349
Research and development credits (30,470) (82,697)
Decrease in valuation allowance -- (63,906)
Nondeductible items 2,676 28,000
---------- --------
$ (67,748) 274,208
========== ========
s-77
Deferred income tax assets and liabilities are determined based on the
difference between the financial accounting and tax bases of assets and
liabilities. Significant components of the Company's deferred income
tax assets and liabilities as of December 31, 2000 and 1999 are as
follows:
2000 1999
----------- ---------
(unaudited) (audited)
Deferred income tax assets - accrued expenses
and reserve accounts $ 42,309 --
Deferred income tax liabilities - differences in the
book and tax bases of depreciable fixed assets (18,614) (21,460)
---------- --------
Net deferred income tax assets $ 23,695 (21,460)
========== ========
The net decrease in the valuation allowance for deferred income tax
assets 2000 and 1999 was $-0- and $63,906, respectively. In assessing
the realizability of deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred
income tax assets will not be realized. The ultimate realization of
deferred income tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences
become deductible. Management considers the scheduled reversal of
deferred income tax liabilities, projected future taxable income, and
tax planning strategies in making this assessment.
The Company utilized $3,470 and $90,630 of available research and
experimentation credits during the years ended December 31, 2000 and
1999, respectively. At December 31, 2000, the Company has no research
and experimentation credits available for carryforward to future
taxable years.
(9) STOCKHOLDERS' EQUITY
(A) WARRANTS
On December 31, 1995 and January 1, 1996, the Company issued
to various long-term employees stock warrants to purchase a
total of 620,000 shares of the Company's common stock at $.002
per share. The warrants vested over a two-year period and were
fully vested and exercisable as of December 31, 1997. During
the year ended December 31, 2000, the Company agreed to waive
the exercise price and provide the holders with cash bonuses
to cover their income tax liabilities. As a result, the
Company recorded a compensation charge equal to the fair value
of the common stock issued pursuant to the warrants price.
(B) STOCK SPLIT
On October 31, 2000, the Company effected a 10-for-1 stock
split which became effective immediately. All common stock and
stockholders' equity amounts have been retroactively adjusted
to reflect the stock split.
S-78
(C) STOCK OPTIONS
The Company has an incentive stock option plan and outstanding
nonqualified stock options for the benefit of directors,
shareholders, officers, and employees. Options are granted at
fair value at the time of grant as determined by the Company's
board of directors.
The following summarizes stock option activity for the years
ended December 31, 2000 and 1999:
WEIGHTED-
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
---------- ---------
Outstanding at December 31, 1998 2,723,260 $ .420
Granted 145,500 .479
Exercised -- --
Canceled or expired (26,000) .308
---------- -------
Outstanding at December 31, 1999 2,842,760 .424
Granted 1,077,500 .500
Exercised (376,170) .365
Canceled or expired (97,000) .331
---------- -------
Outstanding at December 31, 2000 3,447,090 $ .457
========== =======
At December 31, 2000 and 1999, the number of options
exercisable was 2,031,420 and 1,709,760, respectively.
The following table summarizes information about stock options
outstanding at December 31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- ---------------------------
NUMBER WEIGHTED- NUMBER
OUTSTANDING AVERAGE WEIGHTED- OUTSTANDING WEIGHTED-
RANGE OF AT REMAINING AVERAGE AT AVERAGE
EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
PRICES 2000 LIFE PRICE 2000 PRICE
------------- ------------ ----------- --------- ------------ ---------
$ 0.11 - 0.20 48,760 1.89 0.15 48,760 0.15
0.31 - 0.44 1,870,330 6.50 0.41 1,515,330 0.41
0.50 - 0.70 1,528,000 8.14 0.53 467,330 0.59
------------- ---------- ----- ----- ---------- -----
$ 0.11 - 0.70 3,447,090 7.17 0.46 2,031,420 0.44
============= ========== ===== ===== ========== =====
S-79
The Company applies APB Opinion No. 25 in accounting for its
stock option plans and, accordingly, no compensation cost has
been recognized for stock options issued with exercise prices
at fair value in the consolidated financial statements. Had
the Company determined compensation cost based on the fair
value at the grant date for its stock options under SFAS No.
123, the Company's net loss would have been adjusted to the
pro forma amounts indicated below.
YEAR ENDED DECEMBER 31,
--------------------------------
2000 1999
------------ ---------
(unaudited) (audited)
Net (loss) income As reported $ (38,321) 793,974
Pro forma (187,426) 778,160
Pro forma net loss reflects only options granted during the
years ended December 31, 2000 and 1999. Therefore, the full
impact of calculating compensation cost for stock options
under SFAS 123 is not reflected in the pro forma loss amounts
presented above because compensation cost is reflected over
the options' vesting periods ranging from three to four years
and compensation cost for options granted prior to January 1,
1999 is not considered.
(D) NOTE RECEIVABLE FROM EMPLOYEE
Note receivable from employee for stock option resulted from
the exercise of stock options for a full-recourse promissory
note during the year ended December 31, 2000.
(E) STOCK OPTIONS FOR SERVICES
The Company has an arrangement whereby they are compensating a
nonemployee for services provided to the Company. During the
year ended December 31, 2000, the Company has issued a stock
option for 20,000 shares under this agreement at an exercise
price of $.50 per share. At the time of issuance, the Company
recorded a compensation charge of $16,085 to reflect the fair
value of the stock option granted using the Black-Scholes
option pricing model. At December 31, 2000, all of these
options remain outstanding.
(10) COMMITMENTS AND CONTINGENCIES
(A) EMPLOYEE COMPENSATION AGREEMENT
The Company has a compensation agreement with an
officer/employee of the Company. Under the agreement, the
employee is entitled to a base salary and bonuses based on
increases in revenues and operating profit and the success of
raising capital during 2001.
The employee was granted stock options to purchase 360,000
shares of the Company's common stock at $.44 per share during
1998. Vesting for the 360,000 shares occurred over a two-year
period. During December 2000, the employee was awarded options
for 2000, 2001, and 2002, to purchase 350,000, 250,000, and
140,000 shares, respectively, of the Company's common stock at
$.50 per share. The options have four-year vesting periods
from the year for which the options were granted. All of the
options will be fully vested on December 31, 2005.
S-80
(B) 401(K) PLAN
The Company maintains a tax-qualified defined contribution
plan under Section 401(k) of the Internal Revenue Code (the
"401(k) Plan"). Employees are eligible to participate the
first of the month following their date of hire. The 401(k)
Plan allows participants to contribute by salary reduction up
to 20% of eligible compensation, subject to Internal Revenue
Service limitations. The 401(k) Plan also provides for
discretionary employer matching contributions.
The Company made $-0- and $40,000 in contributions to the Plan
for the years ended December 31, 2000 and 1999, respectively.
(C) LEASES
The Company leases office and warehouse facilities as well as
certain other equipment under noncancelable operating lease
agreements which expire in 2005.
Rental expense under all lease agreements for the years ended
December 31, 2000 and 1999 was approximately $43,000 and
$59,340, respectively.
The Company has also entered into capital lease arrangements
for equipment.
Future minimum lease payments under non-cancelable operating
leases (with initial or remaining lease terms in excess of one
year) and future minimum lease payments under capital lease
arrangements as of December 31, 2000 are as follows:
YEAR ENDING CAPITAL OPERATING
DECEMBER 31, LEASES LEASES
---------------------------- ---------- ----------
2001 $ 86,400 122,000
2002 -- 121,000
2003 -- 121,000
2004 -- 121,000
2005 -- 80,000
---------- ----------
Total future minimum lease payments 86,400 $ 565,000
==========
Less amount representing interest (at a rate
of 12.0%) 5,094
----------
Present value of future minimum
capital lease payments 81,306
Less current maturities of obligations
under capital leases 81,306
----------
Obligations under capital leases,
excluding current maturities $ --
==========
At December 31, 2000, the gross amount of property and
equipment under capital leases and related accumulated
amortization was $119,000 and $10,270, respectively.
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(11) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
During 1999, the Company changed its method of depreciating property
and equipment from the declining-balance method to the straight-line
method. The Company believes that using the straight-line method over
the estimated useful lives is a more accurate and conservative approach
to depreciating the assets. The effect of this change was to increase
income before provision for income taxes and cumulative effect of
accounting change and net income for 1999 by $57,449 and $34,469,
respectively.
(12) MAJOR CUSTOMERS, SUPPLIERS, AND INTERNATIONAL SALES
Sales derived from major customers (those customers representing more
than 10% of total sales) as a percentage of total sales for the year
ended December 31, 2000 were Customer A - 16%, Customer B - 15%,
Customer C - 12%, and Customer D - 11%.
The Company had international sales that represented approximately 30%
of sales for the year ended December 31, 2000.
The Company had purchases from two suppliers representing 52% and 21%
of purchases for the years ended December 31, 2000 and 1999,
respectively.
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