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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For Annual and Transition Reports
Pursuant to Sections 13 or 15(d) of the
Securities Exchange Act of 1934
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the fiscal year ended December 31, 2002 OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from_________ to ____________
Commission file number 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 (I.R.S. Employer Identification No.)
of incorporation or organization)
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]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes [ ] No [X]
As of March 14, 2003, 4,489,821 shares of Common Stock were outstanding. The
aggregate market value of the Common Stock held by non-affiliates of the
registrant on June 28, 2002 was $8,659,417 (computed using the closing price of
the Common Stock on June 28, 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 30, 2003, 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........................................14
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............................................................................15
12. Security ownership of certain beneficial owners and management and related stockholder matters....15
13. Certain relationships and related transactions....................................................15
14. Controls and procedures...........................................................................15
PART IV
15. Exhibits, financial statement schedules and reports on Form 8-K...................................15
Signatures ..................................................................................................18
Certification of Chief Executive Officer.......................................................................19
Certification of Chief Financial Officer.......................................................................20
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. Our
Internet address is www.intelsys.com. We publish our SEC-filed reports on our
website as soon as reasonably practicable after we file them with or furnish
them to the SEC, and shareholders may access and download these reports free of
charge.
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. From time to time, we may sell one of our
companies or we may increase our investment in a less-than-wholly owned company.
As a result, our ownership position in a given company may change from time to
time.
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.
Our subsidiary and affiliate 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.
FINANCIAL REPORTING
We consolidate the results of operations of companies in which we own a majority
interest or over which we exert control. We generally account for investments by
the equity method for minority owned companies (i) in which we own 20 to 50
percent and over which we do not exert control or (ii) entities that are
organized as partnerships or limited liability companies. In general, under the
equity method, we report our pro rata share of the income or loss generated by
each of these businesses as equity income/losses of affiliates on a quarterly
basis. These equity losses and income decrease or increase, respectively, the
cost basis of our investment. However, if there is no commitment for us to
provide additional funding to the affiliate 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 on our
balance sheet at values that may be less than their estimated market value.
Privately owned 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 their businesses.
INTELLIGENT SYSTEMS CORPORATION
-3-
INDUSTRY SEGMENT OVERVIEW
Our consolidated companies operate in two industry segments: Information
Technology Products and Services, and Industrial Products. The Information
Technology segment includes our VISaer, Inc., QS Technologies, Inc., and
CoreCard Software, Inc. subsidiaries and the Industrial Products segment
includes ChemFree Corporation. 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 and therefore we did not have a
Health Care industry segment in 2002 and 2001. We changed our segment reporting
in 2001 to separate the ChemFree operations as our Industrial Products segment
and renamed the Technology segment as the Information Technology segment. All
segment data from prior reporting periods corresponds to our current industry
segments. As of December 31, 2002, we own 100 percent of the ChemFree and QS
Technologies subsidiaries and 65 percent of each of CoreCard Software and
VISaer. As of January 2003, we increased our ownership in CoreCard Software to
approximately 87 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 over $1,000,000. 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
per unit. 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. Sales of ChemFree products have represented
approximately 50 percent of consolidated revenue in each of the last two years.
QS Technologies and VISaer have made up the balance of consolidated revenue,
with VISaer contributing slightly more revenue in each year than has QS
Technologies. CoreCard expects to begin to generate revenue in 2003. The
business in our segments is not seasonal. 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 Note 17 in the accompanying Notes to Consolidated Financial
Statements.
INDUSTRY SEGMENT: INFORMATION TECHNOLOGY PRODUCTS AND SERVICES
VISAER, INC. - VISaer develops, sells and supports software for the world-wide
aircraft maintenance and engineering industry. VISaer offers a fully integrated,
real time software solution that helps aviation customers efficiently and
cost-effectively manage the technical, commercial and operational aspects of
their maintenance, repair and overhaul ("MRO") operations while also meeting
regulatory requirements, such as those of the Federal Aviation Administration.
Headquartered in Wilmington, Massachusetts, VISaer also has operations in
England 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 product
offering includes the following major components: technical records planning and
management, MRO operations, materials management, production scheduling,
commercial operations and financial management. VISaer announced the first
release of Version 3.1, a fully Web-native version of its complete MRO solution,
in late 2002. VISaer has signed contracts with United Parcel Systems ("UPS") and
JetBlue Airlines for its Version 3 software and has approximately $4.8 million
in long-term deferred revenue at December 31, 2002 that will be recognized when
the final Version 3 software is delivered in 2004. In addition, VISaer has an
active sales and marketing program that has identified prospects for MRO license
sales, professional services and maintenance contracts.
The general slow-down in the economy, the terrorist attacks of September 11,
2001 and the threat of hostilities involving Iraq have had a significant
negative impact on the commercial aviation market, initially in the domestic
market and more recently in international markets as well. 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.
Significant sales opportunities exist in the Asian Pacific region, the Chinese
market, MRO service outsourcing companies, low-cost airlines, defense related
aviation, and small to mid-size regional airlines. However, we expect that the
initiation of the war against Iraq will have a negative effect, at least in the
short term, on VISaer's ability to close significant new business.
INTELLIGENT SYSTEMS CORPORATION
-4-
VISaer markets and sells its software in both domestic and international
markets. International customers were the largest component of VISaer sales in
2002 and are expected to be in 2003 as well. The markets for VISaer products
include both airline-owned maintenance and engineering shops as well as third
party MRO organizations. An increasing number of VISaer's sales are direct to
the customer with VISaer providing a turnkey solution that covers project
management, software, system implementation, training, consulting and support.
In the past, as VISaer was building its internal capacity, VISaer sold its
products through certain re-sellers on a non-exclusive basis in certain markets.
In most cases, sales are made in response to competitive bids and request for
proposals and have sales cycles of six to eighteen months with implementation
periods of an additional six to eighteen months. VISaer provides full suite
implementation services and post-sales support and maintenance activities under
annual contracts, as well as customization and professional services on an as
needed basis. 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. VISaer competes on the basis that
its software provides extensive product functionality using Web native
technology; provides low cost-of-ownership; includes integrated modules offering
a complete software and service solution; and runs on industry standard
technology platforms. VISaer believes that its new Web-native software version
will be a strong competitive offering.
QS TECHNOLOGIES, INC. - QS Technologies operates from its Greenville, South
Carolina location, providing health and human services software, maintenance and
support services to its installed customer base as well as to 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.
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 more than twenty years in the market. Sales
are typically made in response to competitive bids and may take six to twelve
months before contracts are awarded. 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 Technologies 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 has expanded its product line to include
vital records software and web-based capabilities. QS Technologies increased its
sales and marketing activities in 2002, resulting in an expansion of its
customer base, contract backlog and pipeline of potential future projects.
CORECARD SOFTWARE, INC. - CoreCard Software was spun off from our former
affiliate company, PaySys International, in April 2001. CoreCard designs,
develops and markets software to accounts receivable businesses, banks, credit
unions and retailers to manage their credit card, merchant and loan accounts.
After more than six years of extensive product development activity (including
prior to the spin-off), in late 2002 CoreCard completed the first installation
of its initial CoreISSUE(TM) product, based on its proprietary CoreENGINE(TM)
architecture. CoreCard products allow financial institutions and commercial
customers to optimize their account management systems, improve customer
retention, lower operating costs and create greater market differentiation.
CoreCard's feature rich, browser-based financial software allows customers to
automate, streamline and optimize business processes associated with the set-up,
administration and management of credit card, merchant and loan accounts, to
process transactions and to generate reports and statements for these accounts.
Because CoreCard's products are designed to run on PC-based servers, rather than
mini or mainframe computers, customers benefit from a lower overall
cost-of-ownership, faster implementations and increased flexibility to respond
to market conditions. CoreCard's product functionality includes embedded
multilingual, multi-currency support, web-based interface, real-time processing,
complex rules-based authorizations, unlimited account hierarchies, and flexible,
customer-defined pricing and payment terms.
CoreCard's initial target markets include accounts receivable businesses, small
and mid-size banks, and retail and private-label issuers, all in the United
States and in selected emerging international markets. CoreCard competes with
third-party card processors, larger and more established software suppliers, and
a number of software solution providers that offer more limited functional
modules. Certain of these competitors have significantly more financial,
marketing and development resources than does CoreCard and have large,
established customer bases often tied to long-term contracts. CoreCard believes
it can compete successfully in selected markets based on providing customers
with a next-generation technology platform, lower overall cost-of-ownership,
faster implementation cycles, greater system flexibility and more
customer-driven marketing options. As with most emerging software companies,
CoreCard's initial challenge is to establish a growing base of referenceable,
satisfied customers and to overcome customer reluctance to implement a business
critical system based on a new software product with limited installations.
CoreCard has certain non-compete restrictions related to the spin-off from
PaySys International, which limit for varying time periods the customers and
markets that CoreCard can solicit and serve. However, CoreCard believes that the
available worldwide market is substantial, even with these time-limited
restrictions.
INTELLIGENT SYSTEMS CORPORATION
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CoreCard intends to license its software products for either a one-time license
fee or a per transaction fee, depending on specific customer requirements and
preferences. It will provide maintenance and support services under annual
contracts, as well as professional services on an as needed basis for
customization, implementation and training activities. CoreCard expects to sell
its products directly to its initial customers although it may also use a small
number of resellers or third parties in selected markets to identify, sell and
support targeted opportunities. CoreCard intends to complete development of
several additional software modules, including CoreFraud(TM),
CoreCOLLECTIONS(TM) and CoreAcquire(TM), in 2003 as customer demand and CoreCard
resources allow.
INDUSTRIAL PRODUCTS SEGMENT
CHEMFREE CORPORATION - Our only subsidiary in the Industrial Products segment is
ChemFree Corporation, one of our early incubator companies. ChemFree designs,
manufactures and markets a line of parts washers under the SmartWasher(R)
trademark. SmartWashers(R) use an advanced bio-remediation system to clean
automotive and machine parts without using hazardous, solvent-based chemicals.
Typically, the SmartWasher(R) system consists of a molded plastic tub and sink,
recirculating pump, heater, control panel, filter with microorganisms, and
water-based degreasing solutions. Unlike traditional solvent-based systems,
there are no regulated, hazardous products used or produced in the process and
the SmartWasher(R) 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
under a General Services Administration 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 distributors stops
carrying ChemFree products. One of ChemFree's domestic distributors represented
14% of our consolidated revenue in 2002, whereas an international distributor
represented 10% of our consolidated revenue in 2001. Part of ChemFree's revenue
is derived from multi-year lease contracts under which ChemFree provides
SmartWashers(R) 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, desirable health and safety features, elimination of
regulatory compliance, and price. ChemFree expects to benefit from new
regulations from governmental agencies such as the Environmental Protection
Agency that prohibit or restrict the use of solvent-based products, with which
ChemFree's products compete.
Customer and 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 manufacturers 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 a suburb 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 from
Intelligent Systems. 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 a part of our
company, either as majority-owned subsidiaries or minority-owned affiliates. In
1999, ChemFree was named Incubator Company of the Year (Manufacturing category)
by the National Business Incubation Association. In 2002, our incubator was
ranked as one of the top ten technology incubators in an independent national
study.
INTELLIGENT SYSTEMS CORPORATION
-6-
We invest 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 subsidiaries and
minority owned 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.
MINORITY-OWNED PARTNER COMPANIES
Part of our business strategy is to seek to own a minority interest in companies
that we believe are involved in promising technologies or markets with good
growth potential. From time to time, we have acquired an investment in such
companies and expect to continue to do so as a regular part of our strategy.
Typically, 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:
- An 18 percent interest in Horizon Software International, Inc., a
leading provider of software and systems to manage the food service
operations of primary and secondary education, college, medical and
military facilities.
- A 25 percent interest in NKD Enterprises, LLC (aka CoreXpand), a
software services 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
Intelligent Systems incubator company involved in wireless
telecommunications products for industrial, medical and commercial
markets as well as residential and small business wireless Internet
markets.
- A 27 percent interest in MediZeus, Inc., an early stage company that
has developed artificial intelligence software to help radiologists
improve the accuracy of reading mammograms. MediZeus has submitted test
results to the FDA for approval to market its products.
RESEARCH AND DEVELOPMENT
We spent $9.8 million, $3.4 million, and $915,000 in the fiscal years ended
December 31, 2002, 2001 and 2000, respectively, on company sponsored research
and development. The Information Technology segment increased spending on
software development by $6.4 million in 2002 mainly due to an intensive effort
related to the VISaer Series 3.0 product line and the initial software offering
by CoreCard Software. Approximately 50 percent of the 2002 expense relates to
VISaer product development and 33 percent relates to CoreCard with the balance
spent mainly for ongoing software projects at QS Technologies. VISaer expects to
complete software releases and modules at various times in the second half of
2003 and early 2004. Certain customer contracts tie cash payments to delivery
dates of various software deliverables. Presently VISaer expects to meet these
milestones but delays could cause customers to delay payments and increase
VISaer's need for cash during 2003. Also our ability to recognize deferred
revenue reflected on the balance sheet will depend on VISaer delivering and the
customer accepting the final software deliverables in late 2003 and 2004. We are
not aware of any material risk to successfully performing under these contracts.
In 2003, CoreCard Software will continue to develop additional software modules
and to develop further enhancements to its initial products. We estimate that
total R&D expenses in 2003 will be lower than in 2002.
PATENTS, TRADEMARKS AND TRADE SECRETS
Our ChemFree subsidiary has 10 US patents issued and a number of patents in
foreign jurisdictions issued and pending covering certain aspects of its
products and processes. CoreCard has filed several patent applications covering
aspects of its core software engine. 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 and various foreign jurisdictions numerous trademarks and service marks
for our products. We believe that an active trade secret, trade name, 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(R), OzzyJuice(TM), VISaer(TM), CoreENGINE(TM), CoreISSUE(TM) and
others.
INTELLIGENT SYSTEMS CORPORATION
-7-
PERSONNEL
As of February 28, 2003, we had 166 full-time equivalent employees in our
company as well as in our majority-owned 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.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
Refer to Note 15 to the Consolidated Financial Statements for financial
information in response to this item. We do not believe there are any specific
risks attendant to our foreign operations that are significantly different than
the general business risks discussed elsewhere in this annual report.
ITEM 2. PROPERTIES
At February 28, 2003, we have leases covering approximately 137,500 square feet
in Norcross, 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 Norcross
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 deny the allegations,
have filed a counterclaim and are vigorously defending the suit, which is
pending in the Superior Court of Gwinnett County, Georgia. ChemFree has filed a
suit in Federal court seeking a judgment against the former consultant. In
addition, from time to time we are or may become a party to a 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.
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, 2002.
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, 2002 2001
HIGH LOW HIGH LOW
------- ------- ------- -------
1ST QUARTER $ 3.28 $ 2.95 $ 4.00 $ 3.02
2ND QUARTER 3.25 2.85 4.92 3.30
3RD QUARTER 3.00 1.60 4.60 3.10
4TH QUARTER 1.92 1.45 3.35 2.95
We had 399 shareholders of record as of February 28, 2003. 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. The
company 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.
INTELLIGENT SYSTEMS CORPORATION
-8-
ITEM 6. SELECTED FINANCIAL DATA
TWELVE MONTHS ENDED DECEMBER 31,
(in thousands except share and
per share amounts) 2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ ------------
Net Sales $ 10,741 $ 8,718 $ 7,027 $ 8,479 $ 18,253
Net Income (Loss) (12,257)a 9,113b 8,215c 249d (1,548)e
Net Income (Loss) Per Share (Basic) (2.73) 1.78 1.47 0.05 (.30)
Net Income (Loss) Per Share (Diluted) (2.73) 1.77 1.46 0.05 (.30)
Total Assets 17,860 26,089 18,057 13,658 17,099
Working Capital 1,490 10,206 3,294 (48) (1,827)
Long-term Debt -- -- -- 363 900
Stockholders' Equity 5,894 17,858 14,674 10,209 9,641
Cash Dividends Paid Per Common Share -- -- 0.52 -- --
Shares Outstanding at Year End 4,491,779 4,495,530 5,623,784 5,114,467 5,104,467
Basic Weighted Average Shares Outstanding 4,495,058 5,108,413 5,606,715 5,106,134 5,104,467
Diluted Weighted Average Shares Outstanding 4,495,058 5,145,691 5,632,484 5,336,776 5,104,467
a. Includes net investment losses of $934,000, $235,000 in net losses in
equity of affiliates and $900,000 other income.
b. 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 of VISaer.
c. Includes investment gains of $9.7 million and $771,000 in net losses in
equity of affiliates.
d. Includes investment gains of $2.2 million and $948,000 in net losses in
equity of affiliates.
e. Includes $953,000 charge for purchased in-process research and
development, $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
Condition and Results of Operations and Notes to Consolidated Financial
Statements 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
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and the Notes to Consolidated Financial Statements
presented in this annual report.
OVERVIEW - Our consolidated subsidiaries during 2002 and 2001 operate in two
industry segments: Information Technology and Industrial Products. Included in
the Information Technology sector are QS Technologies, Inc. (software for public
health and human services), VISaer, Inc. (software for maintenance, repair and
overhaul operations in the commercial aviation industry) and CoreCard Software,
Inc. (software for managing credit and debit cards). The Industrial Products
segment includes ChemFree Corporation (bio-remediating parts washers). In 2000,
we had a Health Care segment consisting of our PsyCare America subsidiary, but
we discontinued these operations in November 2000.
Period-to-period comparisons of results of operations may not be meaningful or
indicative of future results for a number of reasons. In 2002, we acquired a
controlling interest in CoreCard Software and in mid 2001, we acquired a
controlling interest in VISaer. Consequently, we consolidated the results of
operations of those companies from the dates of acquisition but not for prior
periods. Also, from time to time, we may derive income from sales of holdings in
affiliate and other minority-owned companies or record a charge if we believe
the value of such non-consolidated companies is impaired. 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, either on a quarterly or annual basis.
2002 COMPARED TO 2001
SALES - Total revenue for the year ended December 31, 2002 was $10.7 million, an
increase of 23 percent compared to the same period in 2001. Revenue from product
sales, which includes sales of equipment in our Industrial Products segment as
well as software license fees
INTELLIGENT SYSTEMS CORPORATION
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related to the Information Technology segment, increased 18 percent year-to-year
whereas revenue from services billed by the Information Technology segment
increased 29 percent year-to-year. The increase in product revenue is mainly due
to a greater number of units sold by the ChemFree subsidiary due to an increase
in domestic demand for its products. The increase in service revenue
year-to-year reflects mainly the fact that we included the results of VISaer for
the full 12 months in 2002 but only for six months in 2001. CoreCard expects to
begin generating revenue from software license fees and services in 2003.
Approximately two thirds of our service revenue in 2002 was generated by VISaer
for professional services with the balance coming mainly from software
maintenance contracts at the QS Technologies subsidiary. We expect that VISaer's
software license revenue that is being deferred until the completed software
product is delivered will be recognized beginning in late 2003 and 2004. At
December 31, 2002, long-term deferred revenue was $4.8 million, related to
VISaer's UPS contract which it expects to realize beginning in 2004.
COST OF SALES - In 2002, total cost of sales was 55 percent of revenue compared
to 47 percent of revenue in 2001. Cost of product sales as a percentage of
product revenue was 48 percent in 2002 compared to 49 percent in 2001,
reflecting mainly a reduction in the unit cost of producing ChemFree products
because fixed production overhead was spread across a higher volume of goods
produced. Cost of service sales almost doubled in 2002 as compared to 2001 and
represented 64 percent of services revenue in 2002 as compared to 42 percent in
2001. Approximately $1.0 million of the year-to-year increase in costs of
service sales is attributed to including VISaer costs for the full 12 months in
2002 as compared to only six months in 2001. Typically, costs associated with
VISaer service revenue involve higher labor costs than do costs associated with
QS Technologies services.
OPERATING EXPENSES - In 2002, marketing expenses increased by $870,000 (42
percent) compared to 2001. Of the increase, approximately $330,000 is due to the
inclusion of VISaer expenses for 12 months in 2002, $283,000 is due to increased
expenditures at the ChemFree subsidiary to support a direct sales initiative in
selected markets, and the balance of $257,000 reflects mainly the inclusion of
CoreCard expenses in 2002. General and administrative expenses were 53 percent
lower in 2002 than in 2001, mainly reflecting the fact that 2001 expenses
included non-recurring charges totaling $6.0 million related to the write-down
of goodwill associated with the VISaer acquisition in 2001. Excluding these
non-recurring charges, general and administrative expenses increased by
approximately $950,000 year-to-year mainly because we include the expenses of
VISaer for the full 12 months in 2002 as compared to only six months in 2001. An
increase in legal expenses in 2002 at ChemFree of approximately $140,000 related
to intellectual property protection was offset by a reduction in G&A personnel
expenses at the QS Technologies subsidiary. Research and development expense
increased by $6.4 million (191 percent) in 2002 as compared to 2001.
Approximately one-half of the increase is attributable to each of VISaer and
CoreCard due to the inclusion for the full year of their respective expenses to
support significant new product development initiatives. We expect new product
development expenses to decline in 2003 in absolute dollars and as a percentage
of revenue as we complete new product releases and increase license and services
revenue at our software subsidiaries.
INTEREST INCOME - In 2002, we earned $129,000 in interest income compared to
$1.0 million in 2001. The reduced interest income is because we earned
significant interest on a high-interest loan to PaySys in 2001 before PaySys was
sold and the loan repaid. In 2002, we also had lower average cash balances and
notes receivable balances than in 2001 and we earned interest at a lower rate
than in 2001.
INVESTMENT INCOME/LOSS - In 2002, we had a net investment loss of $934,000
compared to net investment income of $19.9 million in 2001, of which $17.8
million was derived from the sale of our PaySys affiliate in 2001. In 2002, we
recorded investment gains of $1.1 million on the sale of our holdings in
Atherogenics stock and $474,000 on the sale of our remaining interest in Risk
Laboratories. Offset against these gains were charges totaling $1.1 million to
reduce the carrying value of our investments in Nutec Sciences, Lumenor, and
Novient, three privately-held software companies, and a charge of $1.3 million
to recognize the accumulated loss on our holdings in publicly traded Daw
Technologies, Inc. and Ixalt, Inc. Refer to Note 3 for more details regarding
these write-downs. The timing and amounts of asset sales or writedowns, if any,
vary on an annual and quarterly basis and are generally not predictable by us in
advance.
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. In 2002, we recorded
equity losses of $235,000 related to four affiliate companies compared to equity
losses in 2001 of $2.2 million related to seven affiliate companies. The main
difference between years is that we consolidated VISaer and CoreCard for the
full year in 2002 but in 2001, we consolidated VISaer only for the last half of
the year and we accounted for CoreCard under the equity method for the entire
year.
OTHER INCOME - In 2002, other income consists mainly of $813,000 of deferred
gain related to a VISaer product line sale in July 2000, compared to the
recognition of $961,000 of deferred gain related to the product line sale in
2001. Refer to Note 8 for detail on the deferred gain.
INTELLIGENT SYSTEMS CORPORATION
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INCOME TAXES - In 2002, we recorded an income tax benefit of $343,000 reflective
of a refund of alternate minimum taxes paid in 2001. The difference between our
effective and statutory income tax rate is caused by our valuation allowance on
our deferred tax assets. We expect to keep this allowance in place until it
becomes more likely than not that we will realize the benefits of these assets.
We currently have net operating loss carryforwards of approximately $201,000
which can be used to offset future taxable income. The loss carryforwards, if
unused, expire beginning in 2007. In 2001, we incurred a net income tax expense
of $173,000, representing a tax liability of $343,000 for alternative minimum
tax on the PaySys transaction and a tax benefit of $211,000 recorded at the
VISaer subsidiary.
2001 COMPARED TO 2000
SALES -Total revenue in 2001 was $8.7 million, an increase of 24 percent
compared to revenue of $7.0 million in 2000. Revenue from products sold by the
Information Technology and Industrial Products segments 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.
COST OF SALES - In 2001, total cost of sales was 47 percent of revenue, compared
to 42 percent in 2000. 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.
OPERATING EXPENSES - In 2001, marketing expenses more than doubled to $2.1
million compared to $942,000 in 2000. Approximately $800,000 of the increase
reflects the inclusion of VISaer expenses for six months in 2001 and the balance
is mainly due to increased expenditures in the Industrial Products segment to
support new sales and marketing initiatives. General and administrative expenses
increased $6.4 million (over 200 percent) in 2001 compared to 2000, reflecting
mainly non-recurring charges totaling $6.0 million to write-down goodwill
associated with the VISaer acquisition, the inclusion of VISaer expenses for six
months and $175,000 in non-recurring management bonuses related to the sale of
PaySys. Research and development expense in 2001 increased by $2.5 million (268
percent) compared to 2000 mainly due to the inclusion of VISaer product
development expenses for six months as well as a non-recurring charge of
$425,000 to record in-process research and development projects related to the
acquisition of VISaer.
INTEREST INCOME - In 2001, we recorded $1.0 million in interest income compared
to interest income of $434,000 in 2000. 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 for the remainder of the year 2001,
both related to our PaySys affiliate sale.
INVESTMENT INCOME - Investment income related to sales of affiliate companies
has been a major source of profits in both 2001 and 2000. In 2001, the main
components of $19.9 million of investment income are $17.8 million from the sale
of our interest in PaySys and a gain of $1.9 million on several sales involving
our interest in 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. Refer to Note 3 for additional details of these transactions.
EQUITY LOSSES OF AFFILIATES - We recorded $2.2 million of net equity losses in
2001, compared to $771,000 in net equity losses in 2000. In 2001, the majority
of the equity loss relates to CoreCard Software (before we began to consolidate
the company in 2002) whereas most of the equity loss in 2000 relates to VISaer.
OTHER INCOME - Other income/expense 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.
INCOME 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.
COMMON SHARES - In 2001, we repurchased and retired 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.
INTELLIGENT SYSTEMS CORPORATION
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LIQUIDITY AND CAPITAL RESOURCES
Our cash balance at December 31, 2002 was $2.6 million, which is $9.4 million
lower than at the prior year-end. During the year ended December 31, 2002, our
principal sources of cash were $2.1 million from sales of our holdings of
Atherogenics common stock at various times and market prices during 2002 and
$474,000 from the sale of our remaining interest in Risk Laboratories. During
the year, our principal uses of cash were $9.1 million for operations,
principally to fund significant new product development projects at VISaer and
CoreCard and to cover expenses of the corporate office; $2.9 million for
investments, including an investment in Horizon Software International, Inc.,
and follow-on investments in four privately held technology companies; and
$335,000 for purchases of property and equipment.
Cash used for operations in 2002 included a 32 percent increase in accounts
receivable reflecting higher sales levels at both ChemFree and QS Technologies
as well as contract progress billings at VISaer. We also used cash in operations
to increase inventory levels of demonstration products to support a new direct
sales initiative by ChemFree. Cash provided by increases in accounts payable
relates to purchases at ChemFree to support forecasted inventory and sales
requirements, coupled with longer payment cycles.
As of December 31, 2002, we had cash of $2.6 million. In the first quarter of
2003, we received $4.2 million cash in settlement of the escrow funds related to
the sale of PaySys International, Inc. in 2001 and we expect to receive
approximately $230,000 in additional funds pending the finalization of legal
expenses. See Note 19 to Consolidated Financial Statements for more details
describing the settlement of the PaySys escrow fund. We have other potential
sources of cash which include potential sale(s) of investments. The amount and
timing of such events cannot be predicted with certainty at this time. Our
budgeted cash requirements for 2003 are substantially lower than for 2002 based
on new and pending software license contracts at our Information Technology
subsidiaries, anticipated software customer payments based on milestone
achievements, and lower product development costs at VISaer and CoreCard. We
believe our cash balances and the escrow funds will be adequate to support our
operations and plans during 2003. It is unclear what impact, if any, will result
from the war against Iraq, potential further terrorist attacks either in the
United States or abroad, or other general economic conditions, particularly with
respect to VISaer's and ChemFree's international business, which totaled $3.5
million in 2002 (approximately 33 percent of consolidated revenue). We expect
the impact to be more severe at VISaer, at least in the short-term.
Unanticipated delays in contract awards and implementations may have a negative
impact on results of operations and increase our cash requirements. 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-8.
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. In some situations, 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
may result in the allocation of a portion of the purchase price to 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
INTELLIGENT SYSTEMS CORPORATION
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expense that we will incur. On at least an annual basis, 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.
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, lack of progress
of the underlying investment or inability to raise capital to support the
business plan could result in losses or an inability to recover the current
carrying value of the investment. Our policy with respect to minority interests
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 and
are not predictable or quantifiable in advance.
LONG-TERM CONTRACTUAL OBLIGATIONS
Our long-term contractual obligations consist of operating leases as shown
below:
Future minimum lease payments
Year ended December 31, 2003 $ 614,000
Year ended December 31, 2004 345,000
Year ended December 31, 2005 59,000
------
$1,018,000
==========
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 or financial
condition are delays in product software development, undetected software
errors, competitive pressures (including pricing), inability to establish
referenceable customers by CoreCard and VISaer, failure of our product
specifications and features to achieve market acceptance, changes in customer
requirements and preferences, delays in anticipated customer payments, declines
in performance, financial condition or valuation of minority-owned companies,
the war against Iraq and its impact on the commercial aviation industry
worldwide, and other general economic conditions particularly those which may
cause business and government customers to delay or cancel software purchase
decisions.
Both VISaer and CoreCard will incur operating losses in 2003 although their cash
requirements are expected to be less than their reported losses because of
scheduled customer payments based on milestone achievements in advance of being
able to recognize license revenue. CoreCard and VISaer will require cash to
operate in 2003, although at significantly lower levels than in 2002. We
anticipate that our other subsidiaries and corporate office will be cash neutral
in 2003 in the aggregate. If either CoreCard or VISaer is unsuccessful or if we
decide to suspend funding, we may not recover our investment. Furthermore, if
VISaer or CoreCard fails to meet product development milestones in 2003, cash
payments from customers may be delayed until the milestones are met, resulting
in increased cash requirements. We may establish a back-up line of credit with a
financial institution but do not expect to utilize the line in 2003, based on
current plans.
We have certain lease commitments, legal matters and contingent liabilities
described in detail in Note 10 to 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard ("SFAS") No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 requires that a
liability for costs associated with an exit or disposal activity be recognized
and measured initially at fair value only when the liability is incurred. SFAS
No. 146 is effective for exit or disposal activities that are initiated after
December 31, 2002. We have determined that the adoption of SFAS No. 146 will not
have an impact on our financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based
Compensation - Transition and Disclosure - an Amendment to SFAS 123." SFAS No.
148 provides two additional transition methods for entities that adopt the
preferable method of accounting for stock based compensation. Further, the
statement requires disclosure of comparable information for all companies
INTELLIGENT SYSTEMS CORPORATION
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regardless of whether, when, or how an entity adopts the preferable, fair value
based method of accounting. These disclosures are now required for interim
periods in addition to the traditional annual disclosure. The amendments to SFAS
No. 123, which provides for additional transition methods, are effective for
periods beginning after December 15, 2002, although earlier application is
permitted. The amendments to the disclosure requirements are required for
financial reports containing condensed financial statements for interim periods
beginning after December 15, 2002. We have not determined as yet whether or when
we will adopt the fair value based method of accounting but we will meet the
disclosure requirements as of the 2002 effective date.
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", which clarifies disclosure and
recognition/measurement requirements related to certain guarantees. The
disclosure requirements are effective for financial statements issued after
December 15, 2002 and the recognition/measurement requirements are effective on
a prospective basis for guarantees issued or modified after December 31, 2002.
The application of the requirements of FIN 45 did not have a material impact on
our financial position or result of operations.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities". FIN 46 clarifies the application of Accounting Research Bulletin No.
51, "Consolidated Financial Statements," to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN 46 is
applicable immediately for variable interest entities created after January 31,
2003. For variable interest entities created prior to January 31, 2003, the
provisions of FIN 46 are applicable no later than July 1, 2003. We have
identified no variable interest entities and do not expect FIN 46 to have an
effect on our consolidated financial statements.
CERTIFICATIONS UNDER SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In accordance with guidance recently issued by the SEC, we have submitted the
certifications of our Chief Executive Officer and our Chief Financial Officer
required by section 906 of the Sarbanes-Oxley Act of 2002 as Exhibits 99.1 and
99.2, respectively, accompanying this report. Pursuant to this SEC guidance,
such exhibits shall not be deemed to be "filed" as part of this report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any material market risk because we have no long-term borrowings.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section of this report. See
the Consolidated Financial Statements and Note 18 to the Consolidated Financial
Statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On May 10, 2002, we dismissed Arthur Andersen LLP as our independent public
accountants. Effective July 3, 2002, our Board of Directors, upon the
recommendation of the Audit Committee, appointed BDO Seidman, LLP as our new
independent accountants.
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 30,
2003 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 this Proxy Statement. This
information is incorporated into this Item 10 by reference.
INTELLIGENT SYSTEMS CORPORATION
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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 AND
RELATED STOCKHOLDER MATTERS
Please refer to the subsections entitled "Voting - Principal Shareholders,
Directors and Certain Executive Officers" and "Voting - Securities Authorized
for Issuance Under Equity Compensation Plan" 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 and securities authorized for issuance under our equity
compensation plans. This information is incorporated into this Item 12 by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
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.
ITEM 14. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Within 90 days prior to the filing of this report on Form 10-K, management of
the company conducted an evaluation, under the supervision and with the
participation of ISC's management, including our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based on this evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective in ensuring that information required to
be disclosed by ISC in the reports it files or submits under the Securities and
Exchange Act of 1934 is recorded, processed, summarized and reported in the time
periods specified by the Securities and Exchange Commission's rules and forms.
CHANGES IN INTERNAL CONTROLS
ISC's management, including our Chief Executive Officer and Chief Financial
Officer, evaluated our internal controls, and there have been no significant
changes in our internal controls or in other factors that could significantly
affect those controls subsequent to the date of our last evaluation.
PART IV
ITEM 15. 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
Report of Previous Independent Public Accountants
Consolidated Balance Sheets at December 31, 2002 and 2001
Consolidated Statements of Operations for the three years ended
December 31, 2002
INTELLIGENT SYSTEMS CORPORATION
-15-
Consolidated Statements of Changes in Stockholders' Equity and
Comprehensive Income (Loss) for the three years ended December 31,
2002
Consolidated Statements of Cash Flow for the three years ended December
31, 2002
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
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
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.)
10.1 Lease Agreement dated November 26, 2002, between the Registrant and
Duke Realty Limited Partnership.
INTELLIGENT SYSTEMS CORPORATION
-16-
10.2 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
Exhibit 10.2 (a) is incorporated by reference to Exhibit 4.1 of the
Registrant's Form S-8 dated July 25, 1997.
Exhibits 10.2 (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.
Exhibit 10.2 (d) is incorporated by reference to Exhibit 10.3 to the
Registrant's Form 10-K for the year ended December 31, 2000.
10.3 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. (Incorporated by reference to
Exhibit 10.4 to the Registrant's Form 10-K for the year ended December
31, 2001.)
10.4 Software License Agreement dated as of April 27, 2001 by and between
PaySys International, Inc. and Delos Payment Systems, Inc.
(Incorporated by reference to Exhibit 10.7 to the Registrant's Form
10-K for the year ended December 31, 2001.)
10.5 Trade Secret License Agreement dated as of April 27, 2001 by and
between PaySys International, Inc. and Delos Payment Systems, Inc.
(Incorporated by reference to Exhibit 10.8 to the Registrant's Form
10-K for the year ended December 31, 2001.)
10.6 Non-Competition Agreement made as of April 27, 2001 by and between
First Data Corporation, J. Leland Strange and PaySys International,
Inc. (Incorporated by reference to Exhibit 10.9 to the Registrant's
Form 10-K for the year ended December 31, 2001.)
21.1 List of subsidiaries of Registrant.
23.1 Consent of BDO Seidman, LLP.
23.2 Consent of Ernst and Young LLP.
23.3 Consent of Moody, Famiglietti and Andronico LLP.
23.4 Consent of Hacker Young.
99.1 Certification of Chief Executive Officer Under Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer Under Section 906 of the
Sarbanes-Oxley Act of 2002.
(B) REPORTS ON FORM 8-K.
We did not file any reports on Form 8-K during the quarter ended December 31,
2002.
(C) SEE ITEM 15(A)(3) ABOVE.
(D) SEE ITEM 15(A)(2) ABOVE.
INTELLIGENT SYSTEMS CORPORATION
-17-
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: April 1, 2003 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, April 1, 2003
--------------------- Chief Executive Officer and Director
J. Leland Strange (Principal Executive Officer)
/s/ Bonnie L. Herron Chief Financial Officer April 1, 2003
--------------------
Bonnie L. Herron (Principal Accounting and Financial Officer)
/s/ Donald A. McMahon Director April 1, 2003
----------------------
Donald A. McMahon
/s/ James V. Napier Director April 1, 2003
--------------------
James V. Napier
/s/ John B. Peatman Director April 1, 2003
--------------------
John B. Peatman
/s/ Parker H. Petit Director April 1, 2003
--------------------
Parker H. Petit
INTELLIGENT SYSTEMS CORPORATION
-18-
CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, J. Leland Strange, the Chief Executive Officer of Intelligent Systems
Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Intelligent Systems
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: April 1, 2003
/S/ J. LELAND STRANGE
---------------------------------------
J. Leland Strange
Chief Executive Officer and President
INTELLIGENT SYSTEMS CORPORATION
-19-
CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Bonnie L. Herron, the Chief Financial Officer of Intelligent Systems
Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Intelligent Systems
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: April 1, 2003
/S/ BONNIE L. HERRON
---------------------------------------
Bonnie L. Herron
Chief Financial Officer
INTELLIGENT SYSTEMS CORPORATION
-20-
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
Report of Previous Independent Public Accountants................................................................F-3
Consolidated Balance Sheets - December 31, 2002 and 2001.........................................................F-4
Consolidated Statements of Operations -
Three Years Ended December 31, 2002...........................................................................F-5
Consolidated Statements of Changes in Stockholders' Equity and Comprehensive (Loss) Income -
Three Years Ended December 31, 2002...........................................................................F-6
Consolidated Statements of Cash Flow -
Three Years Ended December 31, 2002...........................................................................F-7
Notes to Consolidated Financial Statements.......................................................................F-8
FINANCIAL STATEMENT SCHEDULES:
The following supplemental schedules of the Registrant and its subsidiaries are
submitted herewith in response to Item 14(a)(2) and 15(a):
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 Flows 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
INTELLIGENT SYSTEMS CORPORATION
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Intelligent Systems Corporation:
We have audited the accompanying consolidated balance sheet of Intelligent
Systems Corporation and subsidiaries (the "Company") as of December 31, 2002 and
the related consolidated statements of operations, shareholders equity and
comprehensive (loss) income and cash flows for the year then ended. We have also
audited the financial statement schedule for the year ended December 31, 2002
listed in the accompanying index. These financial statements and schedule are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and schedule based on our audit. The
Company's consolidated financial statements and financial statement schedule as
of December 31, 2001, and for each of the two years in the period ended December
31, 2001, were audited by other auditors who have ceased operations. Those
auditors expressed an unqualified opinion on those consolidated financial
statements and schedule in their report dated March 1, 2002.
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 financial
statements and schedule are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and schedule. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement and schedule presentation. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Intelligent Systems
Corporation and subsidiaries as of December 31, 2002 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.
Also, in our opinion, the 2002 schedule presents fairly, in all material
respects, the information set forth therein.
As discussed in Note 1 of Consolidated Financial Statements, during the year
ended December 31, 2002 the Company changed the manner in which it records
reimbursement of out-of-pocket expenses upon the adoption of the accounting
standards in Emerging Issues Task Force Issue ("EITF") 01-14, Income Statement
Characterization of Reimbursements Received for "Out-of-Pocket" Expenses
Incurred.
/s/ BDO Seidman, LLP
Atlanta, Georgia
March 28, 2003
INTELLIGENT SYSTEMS CORPORATION
F-2
THE FOLLOWING REPORT IS A COPY OF A PREVIOUSLY ISSUED REPORT BY ARTHUR
ANDERSEN LLP AND IT HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP.
ARTHUR ANDERSEN LLP HAS NOT CONSENTED TO ITS INCORPORATION BY REFERENCE
INTO INTELLIGENT SYSTEMS CORPORATION'S PREVIOUSLY FILED REGISTRATION
STATEMENTS FILE NOS: 33-99432, 333-32157 AND 333-58134. THEREFORE, AN
INVESTOR'S ABILITY TO RECOVER ANY POTENTIAL DAMAGE MAY BE LIMITED.
REPORT OF PREVIOUS 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
* The 2000 Consolidated Balance Sheet and the 1999 Consolidated Statement
of Operations, Shareholders' Equity and Cash Flows are not required to be
present in the 2002 Annual Report.
INTELLIGENT SYSTEMS CORPORATION
F-3
INTELLIGENT SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
AS OF DECEMBER 31, 2002 2001
---------- ----------
ASSETS
Current assets:
Cash $ 2,644 $ 12,026
Accounts receivable, net 3,025 2,297
Notes and interest receivable 205 424
Inventories 671 547
Other current assets 213 353
---------- ----------
Total current assets 6,758 15,647
---------- ----------
Long-term investments 7,145 7,476
Property and equipment, at cost less accumulated depreciation 761 664
Goodwill 2,380 1,813
Other intangibles, net 788 458
Other assets, net 28 31
---------- ----------
Total assets $ 17,860 $ 26,089
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,301 $ 1,013
Deferred revenue 1,697 1,536
Deferred gain 515 1,328
Accrued expenses and other current liabilities 1,755 1,564
---------- ----------
Total current liabilities 5,268 5,441
---------- ----------
Deferred revenue, net of current portion 4,813 2,596
Other long-term liabilities 27 80
---------- ----------
Total long term liabilities 4,840 2,676
---------- ----------
Commitments and contingencies (note 10)
Minority interest 1,516 --
Redeemable preferred stock of subsidiary 342 114
---------- ----------
Stockholders' equity:
Common stock, $0.01 par value, 20,000,000 shares authorized, 4,491,779 and
4,495,530 issued and outstanding at December 31, 2002 and 2001, respectively 45 45
Paid-in capital 18,432 18,438
Accumulated other comprehensive loss (56) (355)
Accumulated deficit (12,527) (270)
---------- ----------
Total stockholders' equity 5,894 17,858
---------- ----------
Total liabilities and stockholders' equity $ 17,860 $ 26,089
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
INTELLIGENT SYSTEMS CORPORATION
F-4
INTELLIGENT SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
YEAR ENDED DECEMBER 31, 2002 2001 2000
------------- ------------- -------------
Revenue
Products $ 6,296 $ 5,321 $ 4,824
Services 4,445 3,397 2,203
------------- ------------- -------------
Total revenue 10,741 8,718 7,027
------------- ------------- -------------
Cost of sales
Products 3,019 2,633 2,432
Services 2,862 1,439 542
------------- ------------- -------------
Total cost of sales 5,881 4,072 2,974
------------- ------------- -------------
Expenses
Marketing 2,960 2,090 942
General & administrative 4,562 9,605 3,172
Research & development 9,798 3,371 915
------------- ------------- -------------
Loss from operations (12,460) (10,420) (976)
------------- ------------- -------------
Other income
Interest income, net 129 1,017 434
Investment income (expense), net (934) 19,902 9,665
Equity in losses of affiliate companies (235) (2,173) (771)
Other income, net 900 960 66
------------- ------------- -------------
Income (loss) before income tax provision (benefit) (12,600) 9,286 8,418
------------- ------------- -------------
Income tax provision (benefit) (343) 173 203
------------- ------------- -------------
Net income (loss) $ (12,257) $ 9,113 $ 8,215
============= ============= =============
Basic net income (loss) per share $ (2.73) $ 1.78 $ 1.47
Diluted net income (loss) per share $ (2.73) $ 1.77 $ 1.46
============= ============= =============
Basic weighted average shares outstanding 4,495,058 5,108,413 5,606,715
Diluted weighted average shares outstanding 4,495,058 5,145,691 5,632,484
============= ============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
INTELLIGENT SYSTEMS CORPORATION
F-5
INTELLIGENT SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
(in thousands, except share amounts)
YEAR ENDED DECEMBER 31,
STOCKHOLDERS' EQUITY 2002 2001 2000
------------- ------------- -------------
COMMON STOCK, NUMBER OF SHARES, beginning of year 4,495,530 5,623,784 5,114,467
Exercise of options during year -- 3,334 635,986
Purchase and retirement of stock (3,751) (1,131,588) (126,669)
------------- ------------- -------------
End of year 4,491,779 4,495,530 5,623,784
------------- ------------- -------------
COMMON STOCK, AMOUNT, beginning of year $ 45 $ 56 $ 51
Exercise of options during year -- -- 6
Purchase and retirement of stock -- (11) (1)
------------- ------------- -------------
End of year 45 45 56
------------- ------------- -------------
PAID-IN CAPITAL, beginning of year 18,438 24,216 24,069
Proceeds from options exercised -- 14 1,085
Purchase and retirement of stock (6) (5,792) (938)
------------- ------------- -------------
End of year 18,432 18,438 24,216
------------- ------------- -------------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), beginning of year (355) (215) 731
Foreign currency translation adjustment during year 4 4 --
Change in accumulated other comprehensive income (loss) 295 (144) (946)
------------- ------------- -------------
End of year (56) (355) (215)
------------- ------------- -------------
ACCUMULATED DEFICIT, beginning of year (270) (9,383) (14,642)
Dividends paid -- -- (2,956)
Net income (loss) (12,257) 9,113 8,215
------------- ------------- -------------
End of year (12,527) (270) (9,383)
------------- ------------- -------------
TOTAL STOCKHOLDERS' EQUITY $ 5,894 $ 17,858 $ 14,674
============= ============= =============
COMPREHENSIVE INCOME (LOSS)
------------- ------------- -------------
Net income (loss) $ (12,257) $ 9,113 $ 8,215
Other comprehensive income:
Foreign currency translation adjustments 4 4 --
Unrealized gain (loss) 295 (144) (946)
------------- ------------- -------------
Comprehensive income (loss) $ (11,958) $ 8,973 $ 7,269
============= ============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
INTELLIGENT SYSTEMS CORPORATION
F-6
INTELLIGENT SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOW
(in thousands)
YEAR ENDED DECEMBER 31,
2002 2001 2000
---------- ---------- ----------
OPERATIONS:
Net income (loss) $ (12,257) $ 9,113 $ 8,215
Adjustments to reconcile net income (loss) to net cash
used for operating activities, net of
effects of acquisitions and dispositions:
Depreciation and amortization 1,031 6,595 314
Deferred gain recognized (813) (961) --
Investment (income) loss, net 934 (19,902) (9,665)
Equity in loss of affiliate companies 235 2,173 771
Changes in operating assets and liabilities, net of effects
of acquisition
Accounts receivable (728) (33) 249
Inventories (124) (72) (149)
Other current assets (24) 126 66
Accounts payable 287 (166) (87)
Accrued expenses and other current liabilities 2,378 1,110 (124)
---------- ---------- ----------
Cash used for operating activities (9,081) (2,017) (410)
---------- ---------- ----------
INVESTING ACTIVITIES:
Proceeds from sales of investments 2,659 20,540 10,291
Acquisition of company, net of cash acquired 39 81 --
Increase (decrease) in minority interests -- -- 5
Acquisitions of long-term investments (2,880) (2,806) (3,628)
Repayments under notes receivable 4,902 5,105 377
Advances under notes receivable (4,684) (2,087) (4,533)
Purchases of property and equipment, net (335) (95) (111)
---------- ---------- ----------
Cash provided by (used for) investing activities (299) 20,738 2,401
---------- ---------- ----------
FINANCING ACTIVITIES:
Borrowings under short-term borrowing arrangements -- 889 1,503
Repayments under short-term borrowings arrangements -- (2,393) (763)
Payment of dividends to stockholders -- -- (2,956)
Purchase and retirement of stock (6) (5,803) (112)
Exercise of stock options -- 14 194
---------- ---------- ----------
Cash used for financing activities (6) (7,293) (2,134)
---------- ---------- ----------
Effects of exchange rate changes on cash 4 4 --
---------- ---------- ----------
Net increase (decrease) in cash (9,382) 11,432 (143)
Cash at beginning of year 12,026 594 737
Cash at end of year $ 2,644 $ 12,026 $ 594
========== ========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ -- $ 52 $ 59
Cash paid (received) during the year for income taxes (362) 577 --
The accompanying notes are an integral part of these consolidated financial
statements.
INTELLIGENT SYSTEMS CORPORATION
F-7
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 - We create, operate and invest in businesses, principally
in the information technology sector. Consolidated companies (in which we have
majority ownership and control) are engaged in two industries: Information
Technology products and services and Industrial Products. Operations in
Information Technology products and services, which consist of our VISaer, QS
Technologies and CoreCard Software 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 washer systems by our ChemFree subsidiary. In
prior periods, through November 2000, we were involved in Healthcare Services as
well. Our operations are explained in further detail in Note 17. 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. Some areas where we use estimates and make assumptions
are to determine our allowance for doubtful accounts, valuation allowances on
our investments, depreciation and amortization expense and accrued expenses.
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 - We account for investments by the equity method for (i) entities
in which we have a 20 to 50 percent ownership interest and over which do not
exert control or (ii) entities that are organized as partnerships or limited
liability companies. We account for investments in corporations of less than 20
percent in non-marketable equity securities of corporations 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 ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity Securities". At
December 31, 2002 and 2001, the aggregate fair market value of our
available-for-sale securities consisted of equity securities totaling $36,000
and $2.0 million, respectively. These amounts include net unrealized holding
losses of $64,000 and $359,000 as of December 31, 2002 and 2001, 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. 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, 2002 and 2001 is as follows:
(in thousands) 2002 2001
--------- ---------
Operating equipment $ 2,616 $ 1,397
Furniture and fixtures 216 199
Leasehold improvements 448 241
For financial reporting purposes, we use a combination of the straight-line
method and 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 - 3
Accumulated depreciation was $2.5 million and $1.2 million at December 31, 2002
and 2001, respectively. Depreciation
INTELLIGENT SYSTEMS CORPORATION
F-8
expense was $721,000, $307,000 and $316,000 in 2002, 2001 and 2000,
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 $657,000 and $176,000, respectively, and
accumulated depreciation associated with leased equipment is $481,000. At
December 31, 2001, the cost and carrying value of equipment leased to customers
was $488,000 and $101,000, respectively, and accumulated depreciation associated
with leased equipment was $387,000. The minimum future lease revenue under
non-cancelable contracts through August 2004 is $783,000 at December 31, 2002.
There is no contingent rental income under the leases. These assets are included
in Property and Equipment at December 31, 2002 and 2001.
Other Assets - Other assets are carried at cost net of related amortization.
Effective July 1, 2001, we account for acquisitions in accordance with SFAS No.
141, "Accounting for Business Combinations" and SFAS No. 142, "Accounting for
Intangible Assets". Our policy is to write off the asset and accumulated
amortization for fully amortized intangibles. In accordance with SFAS No. 142,
we periodically, but at least annually, assess our intangible assets, including
goodwill, for indicators of impairment. When circumstances indicate that an
intangible asset other than goodwill may be impaired, we utilize the guidance
provided by SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets". For the year ended December 31, 2002, no impairment was
identified. Prior to the adoption of SFAS No. 142, we periodically assessed the
impairment of enterprise level intangibles pursuant to the provisions of APB No.
17, "Intangible Assets" and SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of". At September 30,
2001, we determined the long-lived assets associated with our VISaer subsidiary
were impaired under SFAS No. 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.
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). The
carrying value of intangibles at December 31, 2002 is $3.2 million, of which
$2.4 million is goodwill. The carrying value of intangibles at December 31, 2001
was $2.3 million, of which $1.8 million was goodwill. As explained in more
detail in Note 2, in 2002 goodwill increased by $339,000 and other intangibles
increased by $642,000 in connection with the acquisition of CoreCard. Goodwill
also increased by $228,000 in 2002 reflecting the accretion of the redeemable
preferred stock of VISaer owned by minority stockholders of VISaer. In fiscal
years 2002, 2001 and 2000, we recorded total intangible amortization expense of
approximately $310,000, $92,000 and $29,000, respectively. Accumulated
amortization of intangibles totaled $403,000 and $92,000 at December 31, 2002
and 2001, respectively. We had no goodwill amortization expense in periods
presented herein. Annual amortization expense for the following five years is
expected to be approximately $300,000, $220,000, $140,000, $128,000 and $0 for
the years ending December 31, 2003 through 2007, respectively.
Accrued Expenses and Other Current Liabilities - Accrued expenses and other
liabilities at December 31, 2002 and 2001 consist of the following:
(in thousands) 2002 2001
---- ----
Income taxes payable $ 7 $ --
Accrued payroll 869 761
Other accrued expenses 879 803
---- ----
Stock Based Compensation - At December 31, 2002 we had two stock-based
compensation plans which are more fully described in Note 14. We account for
the plans under the intrinsic value recognition and measurement principles of
Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. The intrinsic value recognition is
measured by the difference between the exercise price and the market value of
the underlying securities. Based on the additional disclosure requirements of
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure - an Amendment to SFAS No. 123", the following table illustrates the
effect of net income and earnings (loss) per share if we had applied the fair
value recognition provisions of SFAS No. 123, "Accounting for Stock Based
Compensation".
YEAR ENDED DECEMBER 31,
-----------------------
(in thousands except
per share data) 2002 2001 2000
------------------- --------- --------- ---------
Net income (loss), reported $ (12,257) $ 9,113 $ 8,215
Add: stock-based employee
compensation included in
reported net income (loss),
net of related tax effect -- -- --
Deduct: stock-based
compensation expense
determined under fair
value based method for all
awards, net of related tax effect (14) (27) --
--------- --------- ---------
Proforma net income (loss) $ (12,271) $ 9,086 $ 8,215
========= ========= =========
Proforma net income (loss)
per common share basic $ (2.73) $ 1.78 $ 1.47
--------- --------- ---------
Proforma net income (loss)
per common share diluted $ (2.73) $ 1.77 $ 1.46
--------- --------- ---------
Warranty Costs - We accrue the estimated costs associated with product
warranties as an expense in the period the related sales are recognized. The
warranty accrual is included in accrued expenses and other current liabilities
at December 31, 2002 and 2001.
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,
INTELLIGENT SYSTEMS CORPORATION
F-9
training, reimbursable expenses, maintenance and support for software products
and, in 2000, healthcare services.
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. As an alternative to selling the
product, on occasion we may lease our equipment. 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 ("SOP") No.
97-2, "Software Revenue Recognition", as amended by SOP No. 98-9, "Software
Revenue Recognition, With Respect to Certain Transactions". 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 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 Accounting Research Bulletin ("ARB") No. 45, "Long-term
Construction Type Contracts", using the relevant guidance in SOP 81-1,
"Accounting for Performance of Construction Type and Certain Production Type
Contracts".
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).
Reimbursable Expenses - Prior to January 1, 2002, we recorded reimbursement by
our customers for out-of-pocket expenses as a decrease to cost of services. Our
results of operations for the year ended December 31, 2002 has been reclassified
in accordance with the Emerging Issues Task Force ("EITF") release 01-14,
"Income Statement Characterization of Reimbursement Received for Out of Pocket
Expenses Incurred". The effect of this reclassification was to increase both
services revenues and cost of services by $75,000 for the year ended December
31, 2002. The effects of the aforementioned adjustment was immaterial for the
years ended December 31, 2001 and 2000.
Deferred Revenue - Current deferred revenue consists primarily of advance
payments by software customers for annual maintenance and support services.
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, 2002, we had an outstanding balance of deferred revenue of $4.8
million. We do not anticipate any loss under this contract.
Fair Value of Financial Instruments - The carrying value of cash, accounts
receivable, accounts payable and certain 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, including
reimbursed expenses.
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 has generally not been 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.
INTELLIGENT SYSTEMS CORPORATION
F-10
In accordance with 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, 2002, we did not capitalize any
internal use software costs.
Income Taxes - In accordance with SFAS No. 109, "Accounting for Income Taxes",
we utilize the asset and liability method of accounting for income taxes. Under
the asset and liability method of SFAS No. 109, deferred tax assets and
liabilities are established to recognize the future tax consequences
attributable to differences between the financial statement carrying amounts of
the existing assets and liabilities and their respective tax bases.
Reclassifications - It is our policy to reclassify prior year amounts to conform
with current year financial statements presentation when necessary.
Accounts Receivable and Allowance for Doubtful Accounts - Accounts receivable
are customer obligations due under normal trade terms. We sell our products to
distributors and end users involved in a variety of industries including
automotive, aircraft operators and maintenance providers, and government
entities. We perform continuing credit evaluations of our customers' financial
condition and we generally do not require collateral.
Senior management reviews accounts receivable on a monthly basis to determine if
any receivables will potentially be uncollectable. We included any accounts
receivable balances that are determined to be uncollectable, along with a
general reserve, in our overall allowance for doubtful accounts. After all
attempts to collect a receivable have failed, the receivable is written off
against the allowance. Based on the information available to us, we believe our
allowance for doubtful accounts as of December 31, 2002 is adequate. However,
actual write-offs might exceed the recorded allowance.
New Accounting Pronouncements - In July 2002, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 146, "Accounting for Costs Associated with Exit
or Disposal Activities". SFAS No. 146 requires that a liability for costs
associated with an exit or disposal activity be recognized and measured
initially at fair value only when the liability is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002. We have determined that the adoption of SFAS No. 146 will not have an
impact on our financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based
Compensation - Transition and Disclosure - an Amendment to SFAS 123". SFAS No.
148 provides two additional transition methods for entities that adopt the
preferable method of accounting for stock based compensation. Further, the
statement requires disclosure of comparable information for all companies
regardless of whether, when, or how an entity adopts the preferable, fair value
based method of accounting. These disclosures are now required for interim
periods in addition to the traditional annual disclosure. The amendments to SFAS
No. 123, which provides for additional transition methods are effective for
periods ending after December 15, 2002, although earlier application is
permitted. The amendments to the disclosure requirements are required for
financial reports containing condensed financial statements for interim periods
beginning after December 15, 2002. We have not determined as yet whether or when
we will adopt the fair value based method of accounting but we will meet the
disclosure requirements as of the effective date.
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", which clarifies disclosure and
recognition/measurement requirements related to certain guarantees. The
disclosure requirements are effective for financial statements issued after
December 15, 2002 and the recognition/measurement requirements are effective on
a prospective basis for guarantees issued or modified after December 31, 2002.
The application of the requirements of FIN 45 did not have a material impact on
our financial position or result of operations.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities". FIN 46 clarifies the application of Accounting Research Bulletin No.
51, "Consolidated Financial Statements", to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN 46 is
applicable immediately for variable interest entities created after January 31,
2003. For variable interest entities created prior to January 31, 2003, the
provisions of FIN 46 are applicable no later than July 1, 2003. We have not
identified any variable interest entities and do not expect FIN 46 to have an
effect on our consolidated financial statements.
INTELLIGENT SYSTEMS CORPORATION
F-11
NOTE 2
ACQUISITIONS
CoreCard Software, Inc. - We acquired 360,639 shares of common stock of
CoreCard, representing a 30.7% interest in CoreCard Software, Inc. (formerly
Delos Payment Systems, Inc.) ("CoreCard") as a result of the spin-off of
CoreCard to the shareholders of PaySys prior to its sale in April 2001. CoreCard
is an emerging stage company that develops software to handle account management
and processing of card systems (such as credit and debit cards) for financial
and commercial institutions. In 2001, we loaned $1.5 million to CoreCard. As a
result of a default on the loan during 2002, we acquired the right to and
elected a majority of the CoreCard board of directors and obtained the right to
and converted our loans into what resulted in a controlling interest. Therefore
we began to consolidate the CoreCard operations during 2002.
We recorded intangible assets upon consolidation in the first quarter of 2002 in
accordance with SFAS No. 141. Of the intangibles acquired, $642,000 was
allocated to our pro rata share of CoreCard's acquired software which will be
amortized at a rate of $128,400 annually over a five-year period, and $287,000
was recorded as goodwill. Of the goodwill amount, none is deductible for tax
purposes.
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of the acquisition.
AT JANUARY 1, 2002
------------------
(in thousands)
--------------
Current assets $ 138
Property, plant, and 472
equipment
Intangible assets 642
Goodwill 287
--------
Total assets acquired 1,539
Current liabilities 124
Long-term debt 1,415
--------
Total liabilities assumed $ 1,539
--------
During 2002, we converted $3.2 million of principal and interest outstanding
under the loans to CoreCard into 3,734 shares of Series B Convertible Preferred
Stock of CoreCard, at the same time as two other minority investors converted
their loans to Series B Preferred Stock of CoreCard. As a result, our ownership
interest increased to 65% of the outstanding shares of CoreCard on an as-if
converted basis. We provided additional funds in the amount of $2.6 million to
CoreCard under a secured loan to fund working capital in the second half of
2002. The loan is eliminated in consolidation. Effective January 2003, we
converted $2.5 million of CoreCard's indebtedness to us into additional 10,137
shares of Series B Convertible preferred Stock, increasing our ownership to 87%
of the outstanding shares of CoreCard.
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 $2.9 million in long-term
investments and $1.7 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 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 2001 resulted in our taking control of
VISaer. Our ownership of VISaer increased from 40% to 65%, and we accounted 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 No. 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 for the year ended
December 31, 2001. The remaining excess intangible value in the amount of $7.8
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 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
INTELLIGENT SYSTEMS CORPORATION
F-12
by a third party based on an undiscounted cash flow model determined that under
SFAS No. 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 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. We loaned additional
funds to VISaer in the amount of $4.4 million for working capital needs during
2002. These loans eliminate in consolidation.
NOTE 3
SALES AND WRITE-DOWNS OF ASSETS
Atherogenics, Inc. - At various times in 2002, we sold all of our interest in
Atherogenics, Inc. [NASDAQ:AGIX], a company in which we were a seed-stage
investor. The average price per share for the 306,859 shares sold in 2002 was
$7.22. We received a total of $2.1 million cash from the sales and recorded a
gain of $1.1 million in the year ended December 31, 2002.
Daw Technologies, Inc. - In the second quarter of 2002, we wrote off $1.2
million related to our holdings in Daw Technologies, Inc. ("Daw"). We had
acquired the Daw common stock in a prior sale of a subsidiary to Daw and had
accumulated $1.2 million of unrealized loss as of June 30, 2002 as a result of a
decline in the market price of Daw stock. We determined that the value of our
Daw stock was permanently impaired due to Daw's delisting from NASDAQ and poor
financial condition. Consequently we took a charge of $1.2 million to write off
the unrealized loss and to reserve against the remaining carrying value of the
investment. We sold our interest in the fourth quarter of 2002 for a minimal
amount.
Novient, Inc. - In 2002, we sold our remaining interest in Novient, Inc., a
privately held software company, for $10,000 cash in a merger transaction
between Novient and a foreign corporation, recognizing a loss of $187,000 on the
sale. Previously, in 1999, we had sold part of our holdings in Novient in a
private transaction, recognizing a gain of $233,000 and netting $286,000 in
cash.
PaySys International, Inc. - On April 27, 2001, we sold our 32% 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. Furthermore, 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 and gain at various time periods over the four years after the sale.
First Data Corporation has asserted claims against part of the escrow fund and
the PaySys shareholders are disputing the claimed amount.
Immediately prior to the sale to First Data Corporation, PaySys spun off two
subsidiaries to its shareholders. Accordingly, at that time we owned
approximately 31 percent of Delos Payment Systems, Inc. (now CoreCard Software)
and 31 percent of dbbAPPS, Inc. 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 CoreCard and dbbAPPS. In the fourth quarter of 2001, in accordance
with Accounting Principles Board ("APB") No. 18, "The Equity Method of
Accounting for Investments in Common Stock", we classified a secured loan in the
amount of $1.5 million to CoreCard 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 for the year ended December 31,
2001. As explained in Note 2, we acquired a controlling interest in CoreCard
effective January 2002 and consolidate its results of operations since that
date. The carrying value of dbbAPPS at December 31, 2001 and 2002 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.com in August 2000. We received $821,000 cash and recognized a
gain of $471,000 on an original cost basis of $350,000.
Lumenor, Inc - In 2002, we took a write-down of $500,000 against the original
$500,000 cost of our minority investment in Lumenor, Inc. based on the failure
of the business to raise new financing.
Nutec Sciences, Inc. - In 2002, we recorded an investment loss of $444,000 on
the sale of our minority interest in Nutec Sciences, Inc., in a transaction in
which we received cash of $56,000 on an original cost basis of $500,000.
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. The
carrying value of the common stock of iExalt at December
INTELLIGENT SYSTEMS CORPORATION
F-13
31, 2002 is zero as a result of iExalt's delisting and poor financial condition.
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. On March 14, 2002,
we sold our remaining interest in Risk for a total of $474,000 cash, recording a
gain of $474,000 on a cost basis of zero.
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 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.
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 % interest in PaySys International, Inc., a
software company accounted for using the equity method of accounting. No cash
dividends were received from the affiliate in 2001 or 2000.
The following table contains the summarized financial information of PaySys.
YEAR ENDED DECEMBER 31,
-----------------------
(in thousands) 2000
-------------- --------
Current assets $ 8,747
Current liabilities 31,992
Noncurrent assets 4,978
Noncurrent liabilities 12,730
Net sales $ 40,477
Operating income (loss) (20,653)
Net loss (24,527)
--------
There is no data provided for 2002 and 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% interest in VISaer. The investment was classified as an affiliate and
accounted for using the equity method of accounting because we owned less than
50% of the company and did not exert control over the company prior to the
acquisition. Since the acquisition in July 2001, we have consolidated the
results of VISaer. Our pro rata share of VISaer's loss was $116,000 for the six
months ended June 30, 2001 and $720,000 for the fiscal year 2000. 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**
---------------------- ------- --------
Current assets $ 1,465 $ 1,036
Current liabilities 5,184 7,794
Noncurrent assets 335 257
Noncurrent liabilities 2,677 2,632
Net sales $ 4,821 $ 11,752
Operating loss (3,558) (2,757)
Net loss (184) (583)
------------------------- ------- --------
* We have consolidated VISaer since July 1, 2001.
** Includes results of business line sold in July 2000
NOTE 5
INVESTMENTS
The following summarizes our ownership interest in certain non-significant
companies included in our long-term investments. At December 31, 2002, our
ownership interest in each of the named companies was as follows: NKD
Enterprises (25%), MediZeus (27%), Horizon Software (18%), Cirronet (18%) and RF
Solutions (3%). The material ownership interests are classified below according
to applicable accounting methods at December 31, 2002.
INTELLIGENT SYSTEMS CORPORATION
F-14
COST BASIS
CARRYING BEFORE
(in thousands) VALUE DISTRIBUTIONS
------------------------------ -------- -------------
EQUITY METHOD
NKD Enterprises $ 862 $ 1,286
Horizon Software 2,613 2,500
MediZeus 615 843
-------- --------
COST METHOD
-------- --------
Cirronet $ 740 $ 525
RF Solutions 600 600
-------- --------
The following table presents summarized combined financial information for the
Company's 50% or less owned investments named above.
AS OF AND FOR THE
YEAR ENDED
(in thousands) DECEMBER 31, 2002
-------------- ------------------
Revenues $23,446
Operating Loss (6,619)
Net Loss (7,227)
Current Assets 8,166
Non-current Assets 7,410
Current Liabilities 6,813
Non-current Liabilities 1,405
Stockholders Equity 7,358
Marketable Securities - The carrying and estimated fair values of
available-for-sale securities at December 31, 2002 and 2001 are summarized as
follows:
(in thousands) 2002 2001
------------- ----- -------
Cost $ 100 $ 2,398
Gross unrealized gains -- 792
Gross unrealized losses (64) (1,151)
----- -------
Estimated fair values $ 36 $ 2,039
----- -------
Of the estimated fair values above, Matria Healthcare [NASDAQ:MATR] represents
$36,000 at December 31, 2002 and Atherogenics [NASDAQ:AGIX] represents $1.9
million at December 31, 2001.
Our aggregate share of the undistributed earnings (losses) of 50 percent or less
owned companies accounted for by the equity method was $(624,000) and $(432,000)
at December 31, 2002 and 2001, respectively. The majority of such undistributed
earnings (losses) relates to MediZeus for 2002 and CoreCard for 2001.
NOTE 6
ACCOUNTS RECEIVABLE, NOTES RECEIVABLE
AND CONCENTRATION OF CREDIT RISK
At December 31, 2002 and 2001, our allowance for doubtful accounts and sales
returns amounted to $63,000 and $45,000, respectively. Provisions for doubtful
accounts and sales returns were $49,000, $8,500 and $12,000 for the years ended
December 31, 2002, 2001 and 2000, respectively.
At December 31, 2002, notes receivable include $163,000 from RF Solutions, Inc.,
an early stage company in which we own a minority interest accounted for on the
cost basis. The convertible bridge loan bears interest at the rate of 8% per
annum and principal and accrued interest are due on March 1, 2003. RF Solutions
is in default on the note repayment, pending a plan to the sell the company and
repay the note at the time of the transaction.
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 or
customer deteriorates, it could have an adverse impact on the subsidiary and
consolidated operating results. One VISaer customer represents 12% of
consolidated revenue in 2002 and two VISaer customers represent 15% and 21%,
respectively, of consolidated accounts receiveable at December 31, 2002. In
2001, one VISaer customer represented 23% of consolidated revenue and two VISaer
customers represented 18% and 21%, respectively, of consolidated accounts
receivable at December 31, 2001. One customer of Chemfree represents
approximately 14% of consolidated revenue in 2002. Another customer of ChemFree
represented approximately 10% of consolidated revenue in 2001 and 10% of
consolidated accounts receivable at December 31, 2001.
NOTE 7
BORROWINGS AND LONG-TERM DEBT
Terms and borrowings under our credit facilities are summarized as follows:
YEAR ENDED DECEMBER 31,
-----------------------
(in thousands) 2002 2001
------------- ------- ------
Maximum outstanding (month-end) -- $1,933
Outstanding at year end --
Average interest rate at year end -- --
Average borrowings during the year -- $ 509
Average interest rate N/A 8.2%
------- ------
Our credit facility expired in May 2001 at which time we paid the outstanding
balance in full.
Interest paid on debt during 2002, 2001 and 2000 amounted to $0, $52,000, and
$59,000, respectively.
INTELLIGENT SYSTEMS CORPORATION
F-15
NOTE 8
DEFERRED GAIN
In connection with the sale of one of our VISaer subsidiary's product lines 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, 2002, the balance of deferred gain consisted of $512,000 in accounts payable
and accrued expenses and $3,000 in capital lease obligations. In accordance with
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities, a replacement of FASB Statement 125", VISaer
recognizes the deferred gain when the liability is paid and the company is
relieved of its obligation. We recognized $813,000 and $960,000, respectively,
of the deferred gain in the component of other income/expense in the
consolidated statements of operations for the years ended December 31, 2002 and
2001.
NOTE 9
INCOME TAXES
The income tax provision (benefit) consists of the following:
YEAR ENDED DECEMBER 31,
-----------------------
(in thousands) 2002 2001 2000
---------- ---------- --------
Current $ (343) $ 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, 2002 2001 2000
----------------------- ---------- ---------- --------
Statutory rate, blended 34% 34% 34%
Change in valuation
Allowance (34)% (32)% (32)%
Other (3)% -- --
---------- ---------- --------
Effective rate (3)% 2% 2%
=================================== ========== ========== ========
At December 31, 2002, our subsidiaries had net operating loss carryforwards
totaling $201,000. The net operating loss carryforwards, if unused as offsets to
future taxable income, will expire by 2023. At December 31, 2002, we had a
capital loss carryforward of $847,000. The capital loss carryforward, if unused
to offset future capital gains, will expire in 2007.
We account for income taxes using SFAS No. 109, "Accounting for Income Taxes".
We have a deferred tax asset of approximately $13.6 million and $9.3 million at
December 31, 2002 and 2001, respectively. Since our ability to realize the
deferred tax asset is uncertain, the amount is offset in both 2002 and 2001 by a
valuation allowance of an equal amount. The deferred tax asset at December 31,
2002 and 2001 relates to losses at the VISaer and CoreCard subsidiaries which
are not consolidated for tax purposes; most of which is limited due to Federal
income tax regulations.
Income taxes paid (refunded) during 2002 and 2001 were ($362,000) and $577,000,
respectively. No income taxes were paid in 2000.
NOTE 10
COMMITMENTS AND CONTINGENCIES
Leases - We have noncancellable operating leases expiring at various dates
through July 2005. Future minimum lease payments are as follows:
YEAR ENDED DECEMBER 31,
-----------------------
(in thousands)
-----------------------
2003 $ 614,000
2004 345,000
2005 59,000
------------
Total minimum lease payments $ 1,018,000
============
Rental expense for leased facilities and equipment related to operations
amounted to $1.2 million, $1.0 million and $948,000, for the years ended
December 31, 2002, 2001 and 2000, respectively. Companies in Intelligent Systems
Incubator sublease space from the company. For the year ended December 31, 2002,
2001 and 2000, the company received $444,000, $484,000 and $515,000,
respectively, in sublease rental income which reduces the company's rental
expense during these years.
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. ChemFree has filed
suit in Federal court seeking a judgment against the consultant. 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 addition, from time to time 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
INTELLIGENT SYSTEMS CORPORATION
F-16
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 practicable.
No issuer may rely on Rule 3a-2 more frequently than once in any three-year
period. We were in compliance with the requirements of Rule 3a-1 of the 1940 Act
within the one-year exemption period and have been in compliance since that
time. We believe we will continue to be in compliance but if we fail to do so
before March 2004, we will 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. At December 31, 2002 and 2001, we
have accrued $150,000 and $100,000, respectively for future payments under the
plan.
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.
On March 28, 2003, the holders of preferred stock of VISaer consented to a
permanent waiver of their redemption rights.
NOTE 13
STOCKHOLDERS' EQUITY
We have authorized 20,000,000 shares of Common Stock, $0.01 par value per share,
and 2,000,000 shares of Series A Preferred Stock, $0.10 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 from time to time. At various times
during the year ended December 31, 2002, we repurchased and retired 3,751 shares
of our common stock at prevailing market prices. 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.
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 provided 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, 2002, a total of 829,000 options under both
plans have been granted, 724,320 have been exercised and 68,349 options are
fully vested and exercisable at a weighted average price per share of $4.59. All
options expire ten years from their respective dates of grant. At December 31,
2002, the weighted average remaining contractual life of the outstanding options
is 7.3 years. Stock option transactions during the three years ended December
31, 2002 were as follows:
INTELLIGENT SYSTEMS CORPORATION
F-17
2002 2001 2000
--------- --------- --------------
Options outstanding
at Jan. 1 88,680 76,014 655,000
Options granted 16,000 16,000 57,000
Options exercised -- 3,334 635,986
Options canceled -- -- --
--------- --------- --------------
Options outstanding
at Dec. 31 104,680 88,680 76,014
========= ========= ==============
Options available
for grant at Dec. 31 148,000 164,000 328,000
========= ========= ==============
Options exercisable
at Dec. 31 68,349 38,014 19,014
========= ========= ==============
Option price ranges
per share:
Granted $ 3.15 $ 4.26 $ 4.00 - 4.25
Exercised -- $ 4.25 $ 0.875 - 2.94
Canceled -- -- --
Weighted average
option price per
share:
Granted $ 3.15 $ 4.26 $ 4.16
Exercised -- $ 4.25 $ 1.72
Canceled -- -- --
--------- --------- --------------
Outstanding at
Dec. 31 $ 3.80 $ 3.91 $ 3.86
========= ========= ==============
Exercisable at
Dec. 31 $ 4.59 $ 3.53 $ 2.94
========= ========= ==============
We account for the Plan under the provisions of APB 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. The fair value of each option granted
in each of the last three years has been estimated as of the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions:
YEAR ENDED DECEMBER 31, 2002 2001 2000
----------------------- --------- --------- --------------
Risk free rate 4% 4% 6%
Expected life of option
in years 7.3 7.9 9.0
Expected dividend yield 0% 0% 0%
rate
Expected volatility 47% 51% 114%
------------------------------ --------- --------- --------------
Under these assumptions, the weighted average fair value of options granted in
2002, 2001 and 2000 was $1.72, $1.71 and $3.15 per share, respectively. The fair
value of the grants would be amortized over the vesting period for the options.
NOTE 15
FOREIGN SALES AND OPERATIONS
Foreign sales are based on the location of the customer. Sales to customers by
geographic areas for three years ended December 31, 2002 are as follows:
YEAR ENDED DECEMBER 31,
-----------------------
(in thousands) 2002 2001 2000
--------------- --------- --------- --------
Foreign Countries:
United Kingdom $ 2,846 $ 2,429 $ 733
China 294 244 72
Other 434 253 --
--------- --------- --------
Subtotal 3,574 2,926 805
United States 7,167 5,792 6,222
--------- --------- --------
Total $ 10,741 $ 8,718 $ 7,027
--------- --------- --------
With the acquisition of VISaer on July 1, 2001, we acquired foreign subsidiaries
in the United Kingdom and Ireland. For the years ended December 31, 2002, 2001,
and 2000, income before provision for income taxes derived from foreign
subsidiaries approximated $20,000, $63,000 and $0, respectively. Substantially
all long-lived assets are in the United States.
At December 31, 2002 and 2001, foreign subsidiaries had assets of $356,000 and
$595,000, respectively, and total liabilities of $464,000 and $498,000,
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 (LOSS) PER SHARE
Basic and diluted earnings (loss) per share were computed in accordance with
SFAS No. 128 "Earnings per Share". Basic net earnings (loss) per share are
computed by dividing net earnings (loss) (numerator) by the weighted average
number of common shares outstanding (denominator) during the period and exclude
the dilutive effect of stock options. Diluted net earnings per share gives
effect to all dilutive potential common shares outstanding during a period. In
computing diluted net earnings per share, the average stock price for the period
is used in determining the number of shares assumed to be reacquired under the
treasury stock method for the hypothetical exercise of stock options.
The following tables represent required disclosure of the reconciliation of the
earnings (loss) and the shares used in the basic and diluted net earnings (loss)
per share computation:
INTELLIGENT SYSTEMS CORPORATION
F-18
YEAR ENDED DECEMBER 31,
(in thousands except per share data) 2002 2001 2000
--------- -------- ----------
BASIC
Net earnings (loss) $(12,257) $ 9,113 $ 8,215
Weighted average shares
outstanding 4,495 5,108 5,607
-------- -------- ----------
Net earnings (loss)
per share $ (2.73) $ 1.78 $ 1.47
======== ======== ==========
DILUTED
Net earnings (loss) $(12,257) $ 9,113 $ 8,215
Weighted average shares
outstanding 4,495 5,108 5,607
Effect of dilutive potential
common shares:
Stock options -- 38 25
-------- -------- ----------
Total 4,495 5,146 5,632
Net earnings (loss) per share $ (2.73) $ 1.77 $ 1.46
======== ======== ==========
NOTE 17
INDUSTRY SEGMENTS
In 2002 and 2001, our consolidated subsidiaries were involved in two industry
segments: Information Technology products and services and Industrial Products.
In 2000, we were also involved in a third industry segment, Healthcare Services.
Operations in Information Technology products and services, which include our
VISaer, QS Technologies and CoreCard 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 Healthcare 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 three
years ended December 31, 2002.
YEAR ENDED DECEMBER 31,
-------------------------------------- ---------- ----------
(in thousands) 2002 2001 2000
--------- --------- ---------
Information Technology
Revenue $ 5,456 $ 4,353 $ 1,828
Operating income (loss) (11,096) (4,754) 219
Depreciation and
amortization 858 2,527 52
Capital expenditures 116 189 32
Identifiable assets 6,334 4,792 528
Goodwill 2,380 1,813 --
Industrial Products
Revenue 5,285 4,365 4,269
Operating income (loss) (340) (227) 85
Depreciation and
amortization 136 157 176
Capital expenditures 219 83 145
Identifiable assets 1,944 1,730 1,792
Goodwill -- -- --
Healthcare Services
Revenue -- -- 930
Operating income (loss) -- -- (17)
Depreciation and
amortization -- -- 42
Capital expenditures -- -- --
Identifiable assets -- -- 61
Goodwill -- -- --
Consolidated Segments
Revenue $ 10,741 $ 8,718 $ 7,027
Operating income (loss) (11,436) (4,981) 287
Depreciation and
amortization 994 2,684 270
Capital expenditures 335 272 177
Identifiable assets 8,278 6,522 2,381
Goodwill 2,380 1,813 --
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) 2002 2001 2000
-------------- ---------- ---------- ----------
Consolidated segments
operating income (loss) $ (11,436) $ (4,981) $ 287
Corporate expenses (1,024) (5,439) (1,263)
---------- ---------- ----------
Consolidated operating
loss (12,460) (10,420) (976)
Interest income 129 1,017 434
Investment income (loss) (934) 19,902 9,665
Equity of affiliates (235) (2,173) (771)
Other income 900 960 66
---------- ---------- ----------
Income (loss) before (12,600) 9,286 8,418
taxes
Income taxes (343) 173 203
---------- ---------- ----------
Net income (loss) $ (12,257) $ 9,113 $ 8,215
========== ========== ==========
Depreciation and
amortization
Consolidated segments $ 994 $ 2,684 $ 270
Corporate 37 3,911 44
---------- ---------- ----------
Consolidated $ 1,031 $ 6,595 $ 314
========== ========== ==========
Capital Expenditures
Consolidated segments $ 335 $ 272 $ 177
Corporate 12 25 26
---------- ---------- ----------
Consolidated $ 347 $ 297 $ 203
========== ========== ==========
Assets
Consolidated segments
identifiable assets $ 8,278 $ 6,522 $ 2,381
Corporate 9,582 19,567 15,676
---------- ---------- ----------
Consolidated $ 17,860 $ 26,089 $ 18,057
========== ========== ==========
INTELLIGENT SYSTEMS CORPORATION
F-19
NOTE 18
QUARTERLY FINANCIAL DATA (unaudited)
The table following contains a summary of selected quarterly data for the years
ended December 31, 2002 and 2001.
(in thousands except FOR QUARTERS ENDED
per share data) MAR. 31 JUNE 30 SEPT. 30 DEC.31
--------- --------- --------- -------
2002
----
Net sales $ 2,168 $ 2,213 $ 2,973 $ 3,387
Operating loss (3,617) (3,512) (2,885) (2,446)
Net loss (2,122)a (4,708)b (2,697)c (2,730)
Basic loss
per share (0.47) (1.05) (0.60) (0.61)
Diluted loss
per share (0.47) (1.05) (0.60) (0.61)
2001
-------
Net sales $ 1,694 $ 1,519 $ 2,257 $ 3,249
Operating (loss) (234) (588) (8,350)f (1,248)
Net income (loss) 749d 17,931e (7,672) (1,895)g
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)
a. Includes gains of $797,000 and $751,000 deferred gain.
b. Includes $1.3 million write-down of investment.
c. Includes net investment losses of $360,000.
d. Includes gains of $845,000 and $306,000 loss in equity of affiliates.
e. Includes gains of $18.8 million and $183,000 loss in equity of
affiliates.
f. Includes non-recurring charges of $6.4 million.
g. Includes $1.6 million loss in equity of affiliates and recognition of
deferred gain of $673,000.
NOTE 19
SUBSEQUENT EVENT
CoreCard Software - On January 2, 2003, we converted $2.5 million of outstanding
principal and accrued interest owed to us pursuant to a secured loan to our
CoreCard subsidiary into additional shares of Series B Convertible Preferred
Stock of CoreCard. As a result, our ownership interest in CoreCard increased
from 65% to 87%.
PaySys Escrow Release - On March 21, 2003, the former shareholders of PaySys
International, Inc. (including ISC) entered into a Settlement Agreement with
First Data Corporation related to the funds that had been held in escrow to
resolve any claims related to the sale of PaySys in April 2001, as explained in
Note 3 to Consolidated Financial Statements. As a result of the Settlement
Agreement, we will receive our pro rata share (30.7%) of the amount released
from the escrow funds. Our estimated share of the cash proceeds will be
approximately $4.4 million and will result in investment income, which will be
recorded in the first quarter of 2003.
INTELLIGENT SYSTEMS CORPORATION
F-20
SCHEDULE II
INTELLIGENT SYSTEMS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS a. PERIOD
----------- ---------- ---------- ------------- --------
ALLOWANCE FOR
DOUBTFUL ACCOUNTS b.
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
Year Ended December 31, 2002 44,984 48,717 31,195 62,506
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.
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
The following report is a copy of a previously issued report by Arthur Andersen
and it has not been reissued by Arthur Andersen. Arthur Andersen LLP has not
consented to its incorporation by reference into Intelligent Systems
Corporation's previously filed registration statements file nos: 33-99432,
333-32157 and 333-58134. Therefore an investor's ability to recover any
potential damage may be limited.
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