-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, H9SxGweBN3igkKZCeifpAh7X2szgz9tr+ea14db2FbPrGY4+PfjQliU9+CFpL7Ev v+U9n2kwTY9EqygmuQHs8A== 0000950144-99-004842.txt : 19990423 0000950144-99-004842.hdr.sgml : 19990423 ACCESSION NUMBER: 0000950144-99-004842 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990422 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTELLIGENT SYSTEMS CORP CENTRAL INDEX KEY: 0000320340 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-HOSPITALS [8060] IRS NUMBER: 581964787 STATE OF INCORPORATION: GA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-09330 FILM NUMBER: 99599268 BUSINESS ADDRESS: STREET 1: 4355 SHACKLEFORD RD CITY: NORCROSS STATE: GA ZIP: 30093 BUSINESS PHONE: 4043812900 MAIL ADDRESS: STREET 1: 4355 SHACKLEFORD ROAD CITY: NORCROSS STATE: GA ZIP: 30093 10-K405 1 INTELLIGENT SYSTEMS CORPORATION 1 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 Commission file number 1-9330 INTELLIGENT SYSTEMS CORPORATION - ------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) GEORGIA 58-1964787 - ---------------------------------------------------------------------------------------------------------------------------------- (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 4355 SHACKLEFORD ROAD, NORCROSS, GEORGIA 30093 - ---------------------------------------------------------------------------------------------------------------------------------- (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 ------------------- ----------------------------------------- COMMON STOCK, $.01 PAR VALUE AMERICAN STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 31, 1999, 5,104,467 shares of Common Stock were outstanding. The aggregate market value of the Common Stock held by non-affiliates of the registrant was $8,763,000 (computed using the closing price of the Common Stock on March 31, 1999 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 June 11, 1999 are incorporated by reference in Part III hereof. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 2 TABLE OF CONTENTS
PAGE PART I Item 1. Business........................................................................................3 2. Properties......................................................................................8 3. Legal proceedings...............................................................................8 4. Submission of matters to a vote of security holders.............................................8 PART II 5. Market for the registrant's common equity and related stockholder matters.......................8 6. Selected financial data.........................................................................9 7. Management's discussion and analysis of financial condition and results of operations...........9 7A. Quantitative and qualitative disclosures about market risk.....................................13 8. Financial statements and supplementary data....................................................13 9. Changes in and disagreements with accountants on accounting and financial disclosure...........13 PART III 10. Directors and executive officers of the registrant.............................................13 11. Executive compensation.........................................................................13 12. Security ownership of certain beneficial owners and management.................................14 13. Certain relationships and related transactions.................................................14 PART IV 14. Exhibits, financial statement schedules and reports on Form 8-K................................14 Signatures ...............................................................................................16
3 PART I FORWARD-LOOKING STATEMENTS In addition to historical information, this Annual Report may contain forward-looking statements relating to Intelligent Systems Corporation (ISC). 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 and general economic conditions. ISC undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results. ITEM 1. BUSINESS HISTORICAL 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 website address is www.intelsys.com. Our companies operate in two industry segments (which are defined by the product or service provided rather than the market served): technology related products and services, and health care services. For the past three years, our majority-owned and controlled operating subsidiaries in the technology sector have included InterQuad Services (training/education for software products), ChemFree Corporation (bio-remediating parts washers for automotive and industrial applications), Intelligent Enclosures (mini-environment systems for ultraclean manufacturing) and HumanSoft LLC (health and human services software for public health agencies). In the health care services segment, our operations involve the PsyCare America subsidiary (psychiatric treatment programs for the Christian community). Our operating subsidiaries are relatively small in size and subject to greater fluctuation in revenue and profitability than larger, more established businesses would be. RECENT DEVELOPMENTS. In 1998, several changes occurred that affect our ongoing consolidated operations. In April 1998, we sold the assets and business operations of our Intelligent Enclosures subsidiary to Daw Technologies. Later in the year, our HumanSoft subsidiary discontinued operations related to two of its three main product lines and subsequently filed a petition for relief under Chapter 11 of the federal bankruptcy laws. While HumanSoft is reorganizing under Chapter 11, its QS Technologies' subsidiary continues to operate independently, providing its customers with the same products and services as it did prior to the HumanSoft actions. Please refer to Note 17 to the Consolidated Financial Statements for a more detailed description of HumanSoft's present status. Finally, in early 1999, we sold our interest in our InterQuad Services subsidiary in a transaction described in more detail in Note 18 to the Consolidated Financial Statements. As a result of these transactions our ongoing consolidated operations will consist primarily of ChemFree Corporation, the QS Technologies operation of HumanSoft, and PsyCare America. Therefore, in reviewing the following business description, readers should remember that some of the businesses in which we were historically involved are no longer part of our current consolidated companies. We will also discuss some of our more significant and other minority-owned companies in the section titled "Affiliated Partner Companies" beginning on page 7 of this report. Our main focus is to create and manage growing companies through flexible partnership arrangements. We actively explore opportunities, principally in the technology area, to develop partnerships with promising domestic companies or to start new businesses. Depending upon the needs of the partner company, we may be the sole, majority or minority owner of the business and will undertake a variety of roles which often include day-to-day management of operations, board of director INTELLIGENT SYSTEMS CORPORATION -3- 4 participation, financing, market planning, strategic contract negotiations, personnel and administrative functions, etc. We do not consolidate the results of operations of companies in which we own less than a majority interest or in which we are not considered the controlling shareholder. We account for investments in which we own 20 to 50 percent by the equity method. In general, under the equity method, we include our pro rata share of the income or loss generated by each of these businesses as investment income (loss) on a quarterly basis. These equity losses and income decrease or increase, respectively, our cost basis of the investment. However, if there is no commitment for ISC to provide additional funding to the company, to the extent losses exceed our cost, we do not record a value below zero. Thus, because of this accounting treatment, some of our investments such as PaySys are shown as zero on our balance sheet but their real value is substantially higher, we believe. We may be actively engaged in managing strategic and operational issues with these companies and devote significant resources to the development of the business. From time to time, we may increase or decrease our ownership in the company, the business may become a stand-alone public company or it may be sold to another entity. We operate the Shared Resource Technology Center, a small business incubator, at our corporate facility. The Center permits us to reduce overhead expense by subleasing excess capacity to small businesses that benefit from flexible, shared resources. At the same time, we have the opportunity for day-to-day contact with emerging companies that may become partnership companies, either as majority-owned subsidiaries or minority-owned affiliates. Additionally, the incubator increases the number of business and investment opportunities that we are presented with. Recently, we launched an internet incubator program at our facility to support our plan to become more active in companies tied to internet-related applications, tools or services. We regularly discuss with interested parties possible investments, acquisitions, sales, or business combinations involving our operations, related businesses or new business opportunities. However, these discussions may not result in any completed transactions. For ease of comprehension, the business discussion which follows contains information on products, markets, competitors, research and development and manufacturing for our ongoing operating subsidiaries, organized by industry sector and by company. For further information concerning our historical domestic and foreign operations, see Notes 13 and 15 in the accompanying Notes to the Consolidated Financial Statements. INDUSTRY SEGMENT: TECHNOLOGY RELATED PRODUCTS AND SERVICES CHEMFREE CORPORATION - ChemFree Corporation (ChemFree) designs, manufactures and markets a line of parts washers under the SmartWasher(tm) trademark that use an advanced bio-remediation system to clean automotive and machine parts without using hazardous, solvent-based chemicals. SmartWashers consist of a molded plastic tub and sink, recirculating pump, heater, control panel, filter with microorganisms, and aqueous based degreasing solutions. Unlike traditional solvent based systems, there are no regulated, hazardous products used or produced in the process and the SmartWasher system is completely self-cleaning. ChemFree sells replacement fluid and filters to its customers on a regular basis after the parts washer sale. ChemFree's markets include the automotive, transportation, industrial and military markets. The automotive market includes companies 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. Numerous public transport systems use the SmartWasher in maintenance facilities. 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 internationally in Europe, the Pacific Rim, Canada and Mexico. ChemFree sells its products direct to high volume customers as well as through several distribution channels: distributors to the automotive aftermarket (e.g. NAPA); environment/pollution control equipment distributors; automobile manufacturers dealer equipment and service organizations (e.g. GM, Chrysler and BMW); and industrial product distributors. Distributors serving specific countries address international markets. ChemFree also sells in competitive bid situations, such as military procurements, and under a GSA schedule to government agencies. Marketing activities include trade show participation, INTELLIGENT SYSTEMS CORPORATION -4- 5 public and press relations, advertisements in trade publications, and evaluation programs. The ChemFree business is not seasonal and would not be impacted significantly by the loss of one customer. ChemFree competes with larger, established companies using solvent-based systems that require special handling and hauling of regulated material, other small companies using non-hazardous systems, and hazardous waste hauling firms. Although smaller than the established solvent-based firms, ChemFree believes it is competitive based on product features, positive environmental impact, improved health and safety features, elimination of regulatory compliance, and price. Warranty service, typically covering a one-year period, is provided by ChemFree personnel or through its distributors and dealers. In 1998, ChemFree expanded its product line to include brake washers, more SmartWasher models with different sizes and features, and new formulations of degreasing fluid for specific applications. ChemFree subcontracts the manufacturing of major sub-assemblies built to its specifications to various vendors and performs final assembly and testing at its own facility. There are multiple sources available for subassemblies. HUMANSOFT LLC - Historically, the HumanSoft subsidiary has specialized in the design, manufacture and sale of software programs which permit public health agencies to capture, analyze and manage client information. Within the past 18 months, HumanSoft acquired two former competitors, QS, Inc. and JK, Inc., with the goal of achieving the dominant position in a fragmented market. A key part of the strategy was to migrate the software offerings of the various companies to one platform that could be sold and supported on a profitable basis. Unfortunately, despite a substantial commitment of time and expense, a variety of circumstances prevented this software migration without a very significant development investment, which could not be justified on an economic basis. As a result, HumanSoft determined that it did not have the financial resources to continue to support two of its three product lines and was forced to take the actions that ultimately resulted in filing a petition for relief under Chapter 11 of the bankruptcy code. Refer to Note 17 to the Consolidated Financial Statements. Despite the uncertainty surrounding the outcome of HumanSoft's plan to reorganize under Chapter 11, the QS Technologies subsidiary of HumanSoft continues to operate from its Greenville, South Carolina based location, providing software products, maintenance and support services principally to its installed customer base. The market includes local, state and federal public health agencies nationwide as well as other government agencies, hospitals and clinics. The market is fragmented and not particularly large. 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. Typically, QS Technologies provides its customers with service and support under annual contracts. It is engaged in limited new product development and sales activities to expand its customer base and generate future revenue. INTERQUAD SERVICES - Historically, our UK based subsidiary, InterQuad Services, provided technical training and skills development programs for popular microcomputer software and network products. Some of the most popular offerings were courses for networking products from Novell Inc. and Microsoft Corporation. InterQuad Services competed with a number of similar-sized training/education companies on the basis of quality of training staff, comprehensive and up-to-date course offerings, price and accessibility of training facilities. The market was extremely price competitive and had been undergoing a consolidation in the past few years. These market characteristics and high fixed costs for training staff and facilities contributed to InterQuad Services inability to sustain profitable operations and to its declining financial condition. Therefore, in early 1999, we sold our majority interest in InterQuad Services in exchange for a minority (19%) ownership in ISC Group. ISC Groups' principal asset is a 49% interest in a business named InterQuad Group that provides technical training, consulting, hardware and software products to business customers. At the time of the sale, InterQuad Group received an infusion of capital from a new investor group. Following the sale of InterQuad Services, we will record our minority ownership by the cost method. Refer to Note 18 to the Consolidated Financial Statements for more details. INTELLIGENT ENCLOSURES - As noted earlier, we sold the assets and business operations of our Intelligent Enclosures subsidiary in April 1998 and have not included the results of its operations since the sale date. Historically, Intelligent Enclosures (iE) designed, manufactured and marketed mini-environments used in ultra-clean manufacturing applications such as INTELLIGENT SYSTEMS CORPORATION -5- 6 semiconductor fabrication. iE competed against traditional clean-room companies and other enclosure manufacturers that provided a variety of custom and standard products. However, the increasing preference of customers to buy enclosures as part of a full system implementation coupled with the generally unfavorable outlook for the semiconductor facility market made the sale of iE to a larger industry participant attractive. INDUSTRY SEGMENT: HEALTH CARE SERVICES PsyCare provides specialty treatment programs for individuals with psychiatric and psychological disorders, including depression and substance abuse. The programs are conducted under PsyCare's Rapha(R) trademark and are directed toward individuals who prefer a treatment approach that integrates their physical and psychological needs with their Christian beliefs. PsyCare's programs are principally in-patient hospital programs. PsyCare presently has 7 program sites in 7 states. The number of programs has declined significantly in the past two years for reasons noted below. Hospitals in mid to large size metropolitan areas contract with PsyCare to conduct a Rapha treatment program in the hospital. PsyCare provides medical and program directors as well as therapists and maintains control over all aspects of the treatment, while the hospital provides the physical facility, administrative services, billing and nursing staff. The market for PsyCare's treatment programs includes adults and adolescents suffering from illnesses such as depression, addiction and behavioral disorders. The program's integrated approach appeals particularly to individuals affiliated with churches and other organizations with a Christian basis. In the health care services business, the number of patients tends to decline during the summer months and prior to holidays. In addition, there are a number of fundamental changes taking place in the industry. In the past few years, the average length of stay for in-hospital treatment has declined dramatically. At the same time, managed care payors are reimbursing treatment providers and hospitals at much lower rates. Furthermore, managed care is also placing increased emphasis on drug-based treatment programs, with little or no hospital stay, rather than hospital-based behavioral modification programs such as those offered by PsyCare. The impact of these trends means that PsyCare must treat many more patients for shorter periods of stay while keeping strict control over expenses. The total number of inpatient programs declined in 1998 and 1997 compared to 1996 because of intense pressure by service providers to restrict hospital stay for mental health treatment, which made the Rapha programs less attractive to hospitals. Given these trends, PsyCare has reduced overhead and other costs and explored alternative business models. Although it was successful in maintaining profitability in 1998, it is uncertain whether its strategy will be effective long-term. In 1996, we derived approximately 37 percent of consolidated revenue from programs associated with one chain of psychiatric hospitals. This percentage declined to 13.5 percent in 1997 and 10.6 percent in 1998 as the number of programs declined. In some cases, replacement programs were opened at alternative hospitals. PsyCare's competitors include individual and group practices, private hospital-affiliated treatment programs, and other independent treatment programs with a religious component. With the advent of managed care and the restrictions on in-hospital treatment, PsyCare also competes with outpatient programs and drug-based therapies. PsyCare contracts with hospital facilities to provide the Rapha program in their hospital. This strategy reduces PsyCare's fixed costs but makes it dependent upon decisions made by the hospital over which PsyCare has little control. Among PsyCare's strengths are the consistent content and quality of its programs and the strong network of Christian organizations that support the program's focus. However, unless there are significant positive changes in the healthcare environment, or a new business model proves feasible, PsyCare is unlikely to see its business prospects improve beyond current breakeven status. PATENTS, TRADEMARKS AND TRADE SECRETS The ChemFree subsidiary has several patents (both issued and pending) covering certain aspects of its products and processes. It may be possible for competitors to duplicate certain aspects of these products and processes even though we regard such aspects as proprietary. We have registered with the US Patent and Trademark Office and various foreign jurisdictions numerous trademarks and service marks for our products. We believe that an active trademark and copyright protection program is important in developing and maintaining brand recognition and protecting its intellectual property. Our companies presently market their products under trademarks and service marks such as Rapha, SmartWasher, OzzyJuice and others. INTELLIGENT SYSTEMS CORPORATION -6- 7 PERSONNEL As of February 28, 1999, we had 75 full-time equivalent employees. 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. AFFILIATED PARTNER COMPANIES An important part of our business is to evaluate products and companies that we believe are involved in promising technologies or markets with good growth potential. From time to time, we have acquired or invested in such products, product rights or companies and expect to continue to do so as a regular part of our strategy. We hold investment positions in various growth stage companies, most of which are in technology-related fields and privately held. Because of the accounting treatment of non-consolidated companies, our balance sheet carrying cost of investments may not reflect their underlying value. For instance, we do not mark up the value of privately-owned businesses even when they raise money at higher valuations. Also, under equity method accounting, the carrying value of an investment in which we own 20 to 50 percent of the company may be reduced to zero because we record our pro rata share of the losses of the developing business against our cost basis. Consequently, the underlying value of the business and our investment in it may be substantially higher than our carrying value. Some examples of our involvement as of December 31, 1998 are as follows: - - A significant equity position in PaySys International, Inc. (PaySys), a leading software company involved in payment processing software systems. We own a 42 percent common stock interest in PaySys (which is approximately 30 percent on a fully-diluted basis). Revenue at PaySys grew 40 percent last year, reaching $46 million in 1998. PaySys has spent significant amounts on new product development during the same time period to maintain its technological leadership. During the past two years, PaySys has raised equity capital from several large venture capital firms at valuations higher than our original investment basis. On both occasions, we sold a small portion of our holdings as part of the investment transactions, recognizing significant gains. Our investment in PaySys is recorded at zero on our balance sheet. Refer to Note 3 to the Consolidated Financial Statements. - - A 34 percent equity position in Visibility, Inc., a privately held company involved in engineer-to-order software for large customers selling and managing complex products. Visibility's revenue has grown in each of the past three years, reaching $30.2 million in 1998. The company added a new product line in 1998 allowing it to address a sizable new market. - - An approximately 30 percent equity position in Risk Laboratories, a privately held company involved in risk management software for corporate risk departments. In its first full year of product sales, Risk secured license and service contracts with a number of large corporate clients and is in the process of rounding out its management team to address the market opportunity aggressively. Our investment in Risk is recorded at zero on our balance sheet. - - A minority equity position in BT Squared Technologies, a privately held company involved in sales and order configuration software. BT Squared just completed a successful year of product sales and raised a new round of venture capital. - - A minority equity position in InfoWave Technologies, a privately held company involved in web-based resource and revenue management solutions for the professional services market. InfoWave has just raised a round of venture capital. - - A small investment in Media Metrix, a leader in providing statistically valid tools and methodology to measure Internet use and user demographics, an important component underlying the growth in Internet advertising and electronic business. Media Metrix recently filed a registration statement for an initial public offering. - - We recently completed the sale of the last of our holdings in Information Advantage, Inc., (formerly IQ Software Corporation), a software company in which we had been involved since prior to its initial public offering in 1992. INTELLIGENT SYSTEMS CORPORATION -7- 8 - - We held a 23.5 percent equity position in Paragon Interface, a privately held company involved in data mapping and translation software, until we sold our interest in April 1998, doubling our investment in less than two years. ITEM 2. PROPERTIES At February 28, 1999, to house our manufacturing, sales, service and administration operations, we have leases covering approximately 144,000 square feet in two facilities in Atlanta, GA and 6,100 square feet in Greenville, SC. We believe our leased facilities are adequate for our existing and foreseeable business operations. A portion of the Atlanta corporate facility is subleased to businesses in the small business incubator. ITEM 3. LEGAL PROCEEDINGS As noted earlier, our HumanSoft subsidiary has filed for relief under Chapter 11 of the federal bankruptcy code. While we believe we have taken adequate reserves for this situation, there can be no assurance that unanticipated claims or expenses related to this proceeding will not arise. We are party to a small number of other legal matters arising in the ordinary course of business. It is management's opinion that none of these 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, 1998. 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, 1998 1997 HIGH LOW HIGH LOW - ----------------------------------------------------- ------------ ------------ ----------- ------------- ---------- 1ST QUARTER 5 1/8 3 3/8 4 3 2ND QUARTER 4 5/8 2 7/8 6 1/2 2 7/8 3RD QUARTER 3 3/4 2 3/16 6 1/4 4 1/2 4TH QUARTER 3 1 3/8 7 15/16 4
We had 512 shareholders of record as of February 26, 1999. We did not declare or pay any cash dividends in the two-year period ended December 31, 1998 nor do we intend to pay dividends in the foreseeable future. INTELLIGENT SYSTEMS CORPORATION -8- 9 ITEM 6. SELECTED FINANCIAL DATA
(in thousands except share amounts) TWELVE MONTHS ENDED DECEMBER 31, 1998 1997 1996 1995 1994 F - ------------------------------------------ ------------- -------------- ------------ ------------- ------------- Net Sales ..................... $ 18,253 $ 21,160 $ 23,678 $ 28,240 $ 21,364 Net Income (Loss): Continuing Operations ....... (1,548)(a) (7,176)(b) 4,239(c) 147(d) (6,226)(e) Discontinued Operations ..... -- -- -- -- (1,505) ----------- ----------- ---------- ---------- ----------- Net Income (Loss) ......... (1,548) (7,176) 4,239 147 (7,731) Net Income (Loss) Per Share: Continuing Operations ....... (.30) (1.41) 0.80 0.03 (1.05) Discontinued Operations ..... -- -- -- -- (0.25) ----------- ----------- ---------- ---------- ----------- Net Income (Loss) Per Share (.30) (1.41) 0.80 0.03 (1.30) Total Assets .................. 17,099 19,091 24,927 23,330 22,755 Working Capital ............... (1,827) (1,068) 8,554 4,092 6,089 Long-term Debt ................ 900 1,000 -- 50 -- Stockholders' Equity .......... 9,641 11,396 21,630 18,725 19,192 Shares Outstanding at Year End 5,104,467 5,104,467 5,126,767 5,312,867 5,575,767
a. Includes $944,000 charge for purchased in-process R&D, $955,000 charge to discontinue product lines, $5.2 million gain on investments and $593,000 income in equity of investments. b. Includes $953,000 charge for purchased in-process R&D, $2.6 million gain on investments, $3.0 million write-off of note receivable and $2.3 million loss in equity of investments. c. Includes net gains of $6.9 million on investments and non-recurring charges of $1.25 million. d. Includes $818,000 gain on investment and $1.3 million gain on sale of ISJ. e. Includes $2.2 million write-off of intangibles, $.6 million expense allocated to purchase price of 1994 acquisitions and $1.5 million gain on sale of note. f. Data for 1994 reflects the reclassification of our European Distribution Business as a discontinued operation. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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," and "intend" and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business and economic risks and uncertainties, and our actual results of operations may differ materially from those contained in the forward-looking statements. Effective July 1, 1997, we acquired QS, Inc. and on January 1, 1998, we acquired JK, Inc. In both cases, we have included their results of operations in our consolidated results since the acquisition date. Effective April 1, 1998, we sold our Intelligent Enclosures' business and have not included its results since the sale date. In August 1998, our HumanSoft subsidiary discontinued certain product lines and, in November, filed a petition for relief under Chapter 11 of the federal bankruptcy code. A significant amount of the variance in operating results in the past two years can be attributed to these transactions and events. Note 18 to the Consolidated Financial Statements explains that on February 1, 1999, we completed the sale of our InterQuad Services company. Consequently, in future periods, our principal consolidated businesses will be ChemFree Corporation, INTELLIGENT SYSTEMS CORPORATION -9- 10 the QS Technologies subsidiary of HumanSoft, and PsyCare America, along with the corporate holding company. As a result, our performance in past periods is not likely to be indicative of operating results to be expected in future periods. RESULTS OF OPERATIONS Net sales are derived from two major areas: technology-related products and services and health care services. Historically, our principal consolidated subsidiaries in the technology segment were InterQuad Services (software training programs), ChemFree Corporation (bio-remediating parts washers), Intelligent Enclosures (mini-environment systems) and HumanSoft LLC, which includes the QS Technologies and JK operations (health and human services software). Our consolidated subsidiary in the health care segment is PsyCare America (specialty psychiatric treatment programs). The net loss in 1998 was lower than in 1997 principally because we recorded investment income of $5.8 million, which offset to a large extent the operating losses of our consolidated businesses. SALES - Net sales in 1998 were $18,253,000, a decline of 14 percent compared to 1997. The decrease is related to the sale of the Intelligent Enclosures business in early 1998 and the continued decline in revenue derived from the PsyCare operations, offset in part by an increased volume of products and services at ChemFree and InterQuad. In the last quarter of 1998, HumanSoft's contribution to our revenue was substantially lower than in prior periods as a result of discontinuing two product lines and the Chapter 11 bankruptcy filing. Only the QS Technologies subsidiary of HumanSoft continues to generate license and maintenance revenue from software products. Net sales in 1997 were $21,160,000 compared to $23,678,000 in 1996. Although each of the technology sector companies experienced revenue increases ranging from 11 percent to almost 100 percent, the 11 percent decline overall is attributed to a decrease of more than 45 percent in revenue derived from the PsyCare operations. PsyCare had fewer inpatient programs in 1997 than in 1996 and the contract reimbursement rates were lower in 1997 than in 1996. In the technology sector, the companies sold a greater volume of products and services in 1997 than in 1996. We also benefited from the acquisition of QS on July 1, 1997. Health care services represent 23 percent, 29 percent and 55 percent of revenue in 1998, 1997 and 1996, respectively. The sharp decline in the contribution of the health care services is due to fewer inpatient programs and lower reimbursement rates at the PsyCare subsidiary. Revenue derived from international sales was 39 percent in 1998, compared to 33 percent in 1997 and 25 percent in 1996. The increase in each of the past two years was due to higher sales volume at the InterQuad subsidiary coupled with a decrease in PsyCare's revenues, which are all domestic. COST OF SALES - Cost of sales in 1998 was 68 percent of revenue compared to 62 percent in 1997. Although ChemFree, InterQuad and PsyCare reduced their respective cost of sales as a percentage of revenue in 1998 as compared to 1997, HumanSoft's cost of sales increased dramatically. For much of 1998, HumanSoft's expenses increased significantly for technical personnel to develop, install and support software for which the company was unable to record sufficient new revenue. Cost of sales in 1997 was 62 percent of revenue compared to 54 percent of revenue in 1996. Cost of sales differs for each of our subsidiaries, ranging in 1997 from 50 to 72 percent of revenue. The overall increase in cost of sales as a percentage of revenue relates mainly to higher cost of services at the InterQuad subsidiary due to increased use of high paid contractors to conduct training classes for part of the year as a result of a shortage of qualified employees. In addition, PsyCare experienced lower average rates on contract reimbursement for inpatient programs. OPERATING EXPENSES - In 1998, marketing expenses declined in absolute terms but increased as a percentage of revenue compared to 1997. This change represents the net effect of increased expenditures in the technology sector to support more customers and higher revenue levels offset by a decline in marketing spending at PsyCare due to a decline in in-patient hospital programs. Furthermore, in contrast to the prior period, in 1998 we include the operating expenses related to two acquired companies, JK and QS, for the full year. General and administrative expenses were $7.3 million in 1998 compared to $7.6 million in the prior year. PsyCare reduced expenses significantly through lower staffing levels and expense control, INTELLIGENT SYSTEMS CORPORATION -10- 11 as did our corporate group. At the same time, however, general and administrative expenses at HumanSoft increased significantly. The increase includes a third-quarter charge of $955,000 to discontinue two product lines, a $191,000 restructuring charge in the first quarter following the JK acquisition, and increased amortization expense related to the acquisitions. The $955,000 charge includes a goodwill write-off of $558,000. Research and development expense for 1998 includes a one-time expense of $944,000 to allocate a portion of the JK purchase price to in-process research and development as well as increased new product development spending in the first 8 months of this year. By comparison, in 1997, R&D expense includes a one-time charge of $953,000 to allocate a portion of the QS purchase price to in-process research and development. In 1997, marketing and general and administrative expenses declined by approximately 17 percent and 4 percent, respectively, compared to 1996 on an 11 percent decline in revenue. PsyCare reduced its marketing expenses significantly in line with lower revenue levels, while activities to generate and support higher sales volume increased expenses at certain technology subsidiaries. General and administrative expenses declined in absolute values year-to-year but increased slightly as a percentage of revenue in 1997 compared to 1996. The acquisition of QS increased overhead expenses in the second half of the year. Research and development expense was $$1.5 million in 1997 compared to $286,000 in 1996. The difference is due principally to a non-recurring charge of $953,000 booked in the third quarter of 1997 related to the allocation of a portion of the QS purchase price to in-process research and development. New product development at the HumanSoft operation contributed to the remaining increase. INTEREST INCOME - In 1998, we recorded net interest expense of $289,000 compared to net interest income of $350,000 in the prior year. In 1998, we had interest expense on notes payable principally to the sellers of QS and JK as well as interest on a higher level of bank debt in 1998 than in 1997. We also earned less interest on interest-bearing notes receivable because some of the notes were repaid early in 1998. Net interest income in 1997 of $350,000 was 30 percent lower than in 1996. Higher interest expense in 1997 as well as a reduction in interest-bearing notes receivable contributed to the lower income level. INVESTMENT INCOME - In 1998, we recorded a net gain of $5.8 million on investments compared to a net loss of $2.6 million in 1997. The main components of 1998 investment income include a gain of $1.0 million on the sale of IQ Software common stock, a gain of $2.5 million on the sale of PaySys stock, a gain of $457,000 on the sale of Paragon Interface stock, a gain of $1.2 million on the sale of the IE business, and $593,000 in net gains in the equity of investments accounted for by the equity method. Refer to Note 3 for details on the transactions mentioned in this section. In 1997, we recorded a net loss of $2.6 million on investments compared to net investment income of $5.8 million in 1996. In 1997, the principal components of this category include a gain of $1.9 million on the sale of PaySys stock (see Note 3), a gain of $469,000 on the sale of an investment in Astra Communications, a gain of $217,000 on the sale of OrCAD stock (see Note 3), a $3.0 million write-off of a note receivable from DayStar Digital, Inc. and $2.3 million in net losses in the equity of investments accounted for by the equity method. In 1996, we recorded gains of $6.6 million on aggregate sales of 315,000 shares of common stock of IQ Software Corporation. We also recorded a gain, net of taxes, of $337,000 on the sale of 104,484 shares of OrCAD, Inc. common stock in OrCAD's initial public offering (see Note 3). In the fourth quarter of 1996, we incurred a charge of $1.0 million to reduce the carrying value of its minority equity investment in DayStar. OTHER INCOME - Other income/expense in each of the last three years consists mainly of various minor, non-recurring sources of income and expense. TAXES - We recognized a tax benefit in 1998 due to a net operating loss carryback at the JK, Inc. subsidiary. Taxes payable in 1997 relate to the operations of the QS, Inc. subsidiary acquired in 1997. COMMON SHARES - We repurchased common shares in 1996 and 1997 under a stock repurchase program. The repurchases resulted in 5,104,467 shares outstanding at December 31, 1998 and 1997 and 5,126,767 shares outstanding at December 31, 1996. INTELLIGENT SYSTEMS CORPORATION -11- 12 YEAR 2000 READINESS - We are in the process of analyzing potential problems arising from the inability of certain computer programs to correctly interpret dates designated as "00" as the year 2000 rather than the year 1900. We have reviewed our internal computer-based systems, have inquired of our key vendors and suppliers as to their Year 2000 readiness and anticipated problems, if any, and have received favorable responses. We intend to upgrade any non-compliant internal systems by September 1999 using our employees and readily available software. Our QS Technologies subsidiary licenses software to its customers and has either migrated its customers to software versions that we believe are Year 2000 compliant or has previously informed customers that certain older software versions would no longer be supported. We anticipate the cost to address internal compliance updates to be less than $100,000. Presently, we do not anticipate a material impact on our operations or financial position. However, we have investments in a number of companies over which we do not exercise control. To the extent that any company in which we have a significant investment experiences a material negative impact on its business, the long-term value of our investment could be reduced. There can be no assurance that QS Technologies' software products that are designed to be Year 2000 compliant contain all necessary date code changes or that we will not be exposed to potential claims resulting from system problems associated with the century change. In addition, Year 2000 non-compliance in our internal IT systems or by our business partners may have an adverse impact on our business, financial condition or results of operations. Because we have not yet identified any business function that is materially at risk of Year 2000 related disruption, we have not yet developed a contingency plan specific to Year 2000 events. We are prepared for the possibility, however, that we may identify risks in certain business functions, and we plan to develop contingency plans for these business functions when and if we identify them as being at risk. RECENT ACCOUNTING PRONOUNCEMENTS - In June 1997, the Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income". The Statement requires companies to report comprehensive income and its components in its financial statements. Comprehensive income is the total of net income and all other nonowner changes in equity in a period. We adopted the disclosure requirements of this statement in March 1998. In June 1997, the Financial Accounting Standards Board issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information". The Statement requires a management approach to be used when reporting business segments. Reportable segments are based on products and services, geography, legal structure or management structure. We adopted the disclosure requirements of this statement in March 1998. Refer to Note 15. In October 1997, the AICPA issued Statement of Position 97-2, "Software Revenue Recognition". SOP 97-2 clarifies and changes some software recognition practices and supersedes the existing guidance of SOP 91-1. We adopted SOP 97-2 effective January 1, 1998. Adopting SOP 97-2 did not have a material impact on our financial position or results of operations. LIQUIDITY AND CAPITAL RESOURCES In 1998, we derived most of our cash from the sale of common stock of IQ Software (now Information Advantage) for $1.2 million, the sale of our interest in Paragon Software and payment of a Paragon note for a total of $989,000, the sale of shares of common stock of PaySys for $2.5 million, advances of $750,000 under a bank loan at the InterQuad subsidiary, and a net cash return of $589,000 on another minority investment. Details on these sales are found in Note 3. We used approximately $5.3 million cash in 1998 to fund operating losses at certain subsidiaries (the majority of which relates to the HumanSoft operation), $200,000 for the initial payment related to the acquisition of JK, $700,000 to repay a domestic bank line, and $500,000 for a principal payment on a note related to the acquisition of QS. Accounts receivable are lower at December 31, 1998 than at December 31, 1997 mainly because of improved collection activity, lower revenue levels at the PsyCare subsidiary and reserves taken at the HumanSoft subsidiary related to the decision to discontinue certain product lines. In 1997, our main sources of cash were $2.0 million from the sale of PaySys shares (see Note 3), $1.7 million from the sale of investments in OrCAD and Astra Communications, advances totaling approximately $700,000 under bank lines of credit, advances under short-term notes totaling $778,000, the maturity of certificates of deposit totaling $1.1 million and INTELLIGENT SYSTEMS CORPORATION -12- 13 approximately $1.0 million generated from operations. We used approximately $870,000 to fund the acquisition of QS (see Note 2), $4.6 million to acquire a 34 percent equity position in Visibility, Inc. (a privately held software company), $1.7 million to increase our long-term investments in several small, privately-held technology companies, $1.2 million in net advances under loans to companies in which we hold long-term investments and $1.2 million to acquire property and equipment mainly for new facilities at the InterQuad subsidiary. Notes payable and long-term debt at December 31, 1997 are comprised of $700,000 in bank debt, $1.5 million in notes payable to the sellers of QS, and $778,000 in notes related to two acquisitions of long-term investments. Early in 1999, we sold our remaining 95,449 shares of Information Advantage stock, generating $902,000 cash. We expect to need less cash to support subsidiary operating losses in 1999 than in 1998. Although our cash position will limit new investments in the near future, presently we believe we have adequate access to capital through bank borrowings or sale of assets to support current operations and plans. As explained in Note 1 to the Consolidated Financial Statements, a substantial deterioration in the financial condition of companies in which we have significant long-term investments could have an adverse effect on the company. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The response to this item is submitted as a separate section of this report. See page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE No independent public accountant of the company has resigned, indicated any intent to resign or been dismissed as the independent public accountant of the company during the two years ended December 31, 1998 or at any time afterward. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Please refer to the subsection entitled "Proposal 1 - The Election of Directors - - Nominees" and "Proposal 1 - The Election of Directors - Executive Officers" in our Proxy Statement for the Annual Meeting of Shareholders to be held on June 11, 1999 for information about those individuals nominated as directors and about the executive officers of the company. This information is incorporated into this Item 10 by reference. Information regarding compliance by directors and executive officers of the company and owners of more than 10 percent of our common stock with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, is contained under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement mentioned above. This information is incorporated into this Item 10 by reference. ITEM 11. EXECUTIVE COMPENSATION Please refer to the subsection entitled "Proposal 1 - The Election of Directors - - Executive Compensation" in the Proxy Statement referred to in Item 10 for information about management compensation. This information is incorporated into this Item 11 by reference, except that we specifically do not incorporate into this Item 11 the information in the subsections INTELLIGENT SYSTEMS CORPORATION -13- 14 entitled "Proposal 1 - The Election of Directors - Executive Compensation - Board Compensation Committee Report on Executive Compensation" and "Performance Graph." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Please refer to the subsection entitled "Voting - Principal Shareholders, Directors and Certain Executive Officers" in the Proxy Statement referred to in Item 10 for information about the ownership of our $0.01 par value common stock by certain persons. This information is incorporated into this Item 12 by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (A) DOCUMENTS FILED AS PART OF THIS REPORT. 1. Financial Statements The following consolidated financial statements and related reports of independent public accountants are included in this report and are incorporated by reference in Part II, Item 8 hereof. See the Index to Financial Statements and Supplemental Schedules on page F-1 hereof. Report of Independent Public Accountants Consolidated Balance Sheets at December 31, 1998 and 1997 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flow for the years ended December 31, 1998, 1997 and 1996 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 InterQuad Services Limited Report of Independent Auditors for PaySys International, Inc. Consolidated Balance Sheets of PaySys at December 31, 1998 and 1997 Consolidated Statements of Operations of PaySys for the three years ended December 31, 1998 Consolidated Statements of Changes in Stockholders' Equity of PaySys for the three years ended December 31, 1998 Consolidated Statements of Cash Flow of PaySys for the three years ended December 31, 1998 Notes to Consolidated Financial Statements of PaySys Report of Independent Auditors for Visibility, Inc. INTELLIGENT SYSTEMS CORPORATION -14- 15 Consolidated Balance Sheets of Visibility at December 31, 1998 and 1997 Consolidated Statements of Operations of Visibility for the three years ended December 31, 1998 Consolidated Statements of Changes in Stockholders' Equity of Visibility for the three years ended December 31, 1998 Consolidated Statements of Cash Flow of Visibility for the three years ended December 31, 1998 Notes to Consolidated Financial Statements of Visibility 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. 2.1 Securities Purchase Agreement between Intelligent Systems Corporation and Advent Global GECC III Limited Partnership dated July 1, 1998. 3(i) Articles of Amendment of Articles of Incorporation dated November 25, 1997. (Incorporated by reference 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 See Exhibits 3(i) and 3(ii) for instruments defining rights of holders of Common Stock and Preferred Stock of Registrant. 4.2 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.) 4.3 Form of Rights Certificate. (Incorporated by reference to Exhibit 4.2 of the Registrant's Report on Form 8-K dated November 25, 1997.) 10.1 Lease Agreement dated March 11, 1985, between a subsidiary of the Registrant and A.R. Weeks. (Incorporated by reference to Exhibit 10.1 to Intelligent Systems Corporation Annual Report on Form 10-K for the fiscal year ended March 31, 1986.) 10.2 Second Amendment to Lease Agreement dated June 19, 1997 between a subsidiary of the Registrant and A.R. Weeks. (Incorporated by reference to Exhibit 10.2 of the Registrant's Form 10-K for the year ended December 31, 1997.) 10.3 Management Compensation Plans and Arrangements: (a) Intelligent Systems Corporation 1991 Stock Incentive Plan, amended June 6, 1997. (b) Intelligent Systems Corporation Change in Control Plan for Officers. (c) Intelligent Systems Corporation Outside Director's Retirement Plan. Item 10.3 (a) is incorporated by reference to Exhibit 4.1 of the Registrant's Form S-8 dated July 25, 1997. Items 10.3 (b) and (c) are incorporated by reference to Exhibit 10.4 to Registrant's Form 10-K for the year ended December 31, 1993. 10.3 Form of Promissory Note of Registrant in favor of sellers of QS, Inc. dated as of July 1, 1997. (Incorporated by reference to Exhibit 10.5 of the Registrant's Form 10-K for the year ended December 31, 1997.)
INTELLIGENT SYSTEMS CORPORATION -15- 16 21.0 List of subsidiaries of Registrant. 23.1 Consent of Arthur Andersen LLP. 23.2 Consent of Morley and Scott. 23.3 Consent of Ernst and Young LLP. 27 Financial Data Schedule (for SEC use only). (B) REPORTS ON FORM 8-K. We did not file any reports on Form 8-K during the quarter ended December 31, 1998. (C) SEE ITEM 14(A)(3) ABOVE. (D) SEE ITEM 14(A)(2) ABOVE. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. INTELLIGENT SYSTEMS CORPORATION Registrant Date: April 21, 1999 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 21, 1999 - --------------------- Chief Executive Officer and Director J. Leland Strange (Principal Executive Officer) /s/ Henry H. Birdsong Chief Financial Officer April 21, 1999 - --------------------- (Principal Accounting and Financial Officer) Henry H. Birdsong /s/ Donald A. McMahon Director April 21, 1999 - ---------------------- Donald A. McMahon /s/ James V. Napier Director April 21, 1999 - -------------------- James V. Napier /s/ John B. Peatman Director April 21, 1999 - -------------------- John B. Peatman /s/ Parker H. Petit Director April 21, 1999 - ------------------- Parker H. Petit
INTELLIGENT SYSTEMS CORPORATION -16- 17 INTELLIGENT SYSTEMS CORPORATION INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULES The following consolidated financial statements and schedules of the Registrant and its subsidiaries are submitted herewith in response to Item 8:
FINANCIAL STATEMENTS: Report of Independent Public Accountants...............................................................F-2 Consolidated Balance Sheets - December 31, 1998 and 1997...............................................F-3 Consolidated Statements of Operations - Years Ended December 31, 1998, 1997 and 1996........................................................F-4 Consolidated Statements of Changes in Stockholders' Equity - Years Ended December 31, 1998, 1997 and 1996........................................................F-5 Consolidated Statements of Cash Flow - Years Ended December 31, 1998, 1997 and 1996........................................................F-6 Notes to Consolidated Financial Statements.............................................................F-7 FINANCIAL STATEMENT SCHEDULES: The following supplemental schedules of the Registrant and its subsidiaries are submitted herewith in response to Item 14(a)(2): Schedule II - Valuation and Qualifying Accounts and Reserves...........................................S-1 Report of Independent Auditors for InterQuad Services Limited..........................................S-2 Report of Independent Auditors for PaySys International, Inc...........................................S-3 Consolidated Balance Sheets of PaySys at December 31, 1998 and 1997.................................S-4 Consolidated Statements of Operations of PaySys for the three years ended December 31, 1998.........S-5 Consolidated Statements of Changes in Shareholders' Equity (Deficit) of PaySys for the three years ended December 31, 1998......................................................S-6 Consolidated Statements of Cash Flow of PaySys for the three years ended December 31, 1998..........S-7 Notes to Consolidated Financial Statements of PaySys................................................S-8 Report of Independent Auditors for Visibility, Inc....................................................S-31 Consolidated Balance Sheets of Visibility at December 31, 1998 and 1997............................S-32 Consolidated Statements of Operations of Visibility for the three years ended December 31, 1998....S-33 Consolidated Statements of Changes in Shareholders' Equity of Visibility for the three years ended December 31, 1998.....................................................S-34 Consolidated Statements of Cash Flow of Visibility for the three years ended December 31, 1998.....S-35 Notes to Consolidated Financial Statements of Visibility...........................................S-36 Schedule II - Valuation and Qualifying Accounts....................................................S-50
INTELLIGENT SYSTEMS CORPORATION F-1 18 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE STOCKHOLDERS OF INTELLIGENT SYSTEMS CORPORATION: We have audited the accompanying consolidated balance sheets of Intelligent Systems Corporation (a Georgia corporation) and its subsidiary companies and operating partnerships as of December 31, 1998 and 1997, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. 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. We did not audit the financial statements of InterQuad Services Limited, a majority-owned subsidiary, which statements reflect total assets and total revenues of 19.5 percent and 37.1 percent, respectively, in 1998 and of 18.9 percent and 31.2 percent, respectively, in 1997 of the consolidated totals. We did not audit the financial statements of PaySys International, Inc., an investment which is reflected in the accompanying financial statements using the equity method of accounting. The investment in PaySys International, Inc. represents 0 percent of total assets in 1998 and 0 percent of total assets in 1997, and the equity in its 1998 net loss and its 1997 net income represents, respectively, 0 percent of consolidated net loss for 1998 and 40 percent of consolidated net loss for 1997. The statements of InterQuad Services Limited and PaySys International, 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 InterQuad Services Limited and PaySys International, Inc., is based solely on the reports of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. 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 audit 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 subsidiary companies and operating partnerships as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. 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, fairly states in all material respects 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 April 20, 1999 INTELLIGENT SYSTEMS CORPORATION F-2 19 INTELLIGENT SYSTEMS CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands except share amounts)
AS OF DECEMBER 31, 1998 1997 - ------------------------------------------------------------------------------------------------------------------------ ASSETS - ------------------------------------------------------------------------------------------------------------------------ Current assets: Cash $ 461 $ 43 Accounts receivable, net 2,165 3,855 Notes and interest receivable 189 330 Inventories 741 611 Other current assets 990 788 - ------------------------------------------------------------------------------------------------------------------------ Total current assets 4,546 5,627 - ------------------------------------------------------------------------------------------------------------------------ Long-term investments 8,593 9,512 Long-term notes receivable 75 133 Property and equipment, at cost less accumulated depreciation and amortization 2,570 2,848 Excess of cost over underlying net assets of businesses acquired, net of accumulated amortization 15 971 Other assets 1,300 -- - ------------------------------------------------------------------------------------------------------------------------ Total assets $ 17,099 $ 19,091 ======================================================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------------------------------------------------------------------------------------------ Current liabilities: Short-term borrowings $ 2,078 $ 1,979 Accounts payable 1,727 1,285 Accrued expenses and other current liabilities 2,568 3,431 - ------------------------------------------------------------------------------------------------------------------------ Total current liabilities 6,373 6,695 - ------------------------------------------------------------------------------------------------------------------------ Long-term debt 900 1,000 - ------------------------------------------------------------------------------------------------------------------------ Minority interest 185 -- - ------------------------------------------------------------------------------------------------------------------------ Stockholders' equity: Common stock, $.01 par value, 20,000,000 authorized, 5,104,467 outstanding at December 31, 1998 and 1997 51 51 Paid-in capital 24,046 24,046 Foreign currency translation adjustment (197) (193) Unrealized gain in available-for-sale securities 633 836 Accumulated deficit (14,892) (13,344) - ------------------------------------------------------------------------------------------------------------------------ Total stockholders' equity 9,641 11,396 - ------------------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $ 17,099 $ 19,091 ========================================================================================================================
The accompanying notes are an integral part of these balance sheets. INTELLIGENT SYSTEMS CORPORATION F-3 20 INTELLIGENT SYSTEMS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands except share amounts)
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------------------- Net sales $ 18,253 $ 21,160 $ 23,678 Expenses: Cost of sales 12,495 13,031 12,838 Marketing 3,561 3,860 4,624 General & administrative 7,346 7,638 7,983 Research & development 1,892 1,485 286 - ---------------------------------------------------------------------------------------------------------------------------------- Loss from operations (7,041) (4,854) (2,053) - ---------------------------------------------------------------------------------------------------------------------------------- Other income: Interest income (expense), net (290) 350 501 Investment income (loss), net 5,776 (2,585) 5,844 Other loss, net (135) (61) (38) - ---------------------------------------------------------------------------------------------------------------------------------- Income (loss) before income tax provision (benefit) and minority interest (1,690) (7,150) 4,254 - ---------------------------------------------------------------------------------------------------------------------------------- Income tax provision (benefit) (152) 16 3 - ---------------------------------------------------------------------------------------------------------------------------------- Income (loss) before minority interest (1,538) (7,166) 4,251 - ---------------------------------------------------------------------------------------------------------------------------------- Minority interest 10 10 12 - ---------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ (1,548) $ (7,176) $ 4,239 ================================================================================================================================== Basic and diluted net income (loss) per share $ (0.30) $ (1.41) $ 0.80 ================================================================================================================================== Basic weighted average shares outstanding 5,104,467 5,087,456 5,278,269 Diluted weighted average shares outstanding 5,104,467 5,087,456 5,309,675 ==================================================================================================================================
The accompanying notes are an integral part of these statements. INTELLIGENT SYSTEMS CORPORATION F-4 21 INTELLIGENT SYSTEMS CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands except share amounts)
YEAR ENDED DECEMBER 31, STOCKHOLDERS' EQUITY 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------ COMMON STOCK, NUMBER OF SHARES, beginning of year 5,104,467 5,126,767 5,312,867 Exercise of options during year -- 25,000 50,000 Purchase and retirement of stock -- (47,300) (236,100) - ------------------------------------------------------------------------------------------------------------------------ End of year 5,104,467 5,104,467 5,126,767 - ------------------------------------------------------------------------------------------------------------------------ COMMON STOCK, AMOUNT, beginning of year $ 51 $ 51 $ 53 Purchase and retirement of stock -- -- (2) - ------------------------------------------------------------------------------------------------------------------------ End of year 51 51 51 - ------------------------------------------------------------------------------------------------------------------------ PAID-IN CAPITAL, beginning of year 24,046 24,139 24,756 Proceeds from options exercised -- 67 -- Purchase and retirement of stock -- (160) (617) - ------------------------------------------------------------------------------------------------------------------------ End of year 24,046 24,046 24,139 - ------------------------------------------------------------------------------------------------------------------------ FOREIGN CURRENCY TRANSLATION ADJUSTMENT, beginning of year (193) (196) (153) Foreign currency translation adjustment during year (4) 3 (43) - ------------------------------------------------------------------------------------------------------------------------ End of year (197) (193) (196) - ------------------------------------------------------------------------------------------------------------------------ UNREALIZED GAIN IN AVAILABLE-FOR-SALE SECURITIES 633 836 3,804 - ------------------------------------------------------------------------------------------------------------------------ ACCUMULATED DEFICIT, beginning of year (13,344) (6,168) (10,407) Net income (loss) (1,548) (7,176) 4,239 - ------------------------------------------------------------------------------------------------------------------------ End of year (14,892) (13,344) (6,168) - ------------------------------------------------------------------------------------------------------------------------ TOTAL STOCKHOLDERS' EQUITY $ 9,641 $ 11,396 $ 21,630 ======================================================================================================================== COMPREHENSIVE INCOME - ------------------------------------------------------------------------------------------------------------------------ Net income (loss) $ (1,548) $ (7,176) $ 4,239 Other comprehensive income (loss): Foreign currency translation adjustments (4) 3 (43) Unrealized gain 633 836 3,804 - ------------------------------------------------------------------------------------------------------------------------ Comprehensive income (loss) $ (919) $ (6,337) $ 8,000 ========================================================================================================================
The accompanying notes are an integral part of these statements. INTELLIGENT SYSTEMS CORPORATION F-5 22 INTELLIGENT SYSTEMS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOW (in thousands)
YEAR ENDED DECEMBER 31, CASH PROVIDED BY (USED FOR): 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------- OPERATIONS: Net income (loss) $(1,548) $(7,176) $ 4,239 Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities, net of effects of acquisitions and dispositions: Depreciation and amortization 1,509 2,193 985 Loss (gain) from sale or write-down of assets, net (5,184) 330 (5,804) Equity in net loss (income) of affiliates (592) 2,262 (40) Changes in operating assets and liabilities: Accounts receivable 2,013 453 195 Inventories (130) 37 (203) Other current assets (200) (36) (202) Accounts payable 353 301 (520) Accrued expenses and other current liabilities (1,507) 2,668 885 - ----------------------------------------------------------------------------------------------------------------- Cash provided by (used for) continuing operations (5,286) 1,032 (465) ================================================================================================================= INVESTING ACTIVITIES: Proceeds from sales of investments 5,451 3,667 8,267 Decrease in net assets/liabilities of discontinued operations -- 100 -- Acquisition of company, net of cash acquired 83 (870) -- Increase in ownership of subsidiaries -- (50) (136) Increase in minority interests 10 -- -- Acquisitions of long-term investments (306) (6,329) (1,025) Repayments (advances) under notes receivable, net 232 (1,223) (115) Maturity (purchases) of certificates of deposit -- 1,056 (1,056) Dispositions (purchases) of property and equipment, net 838 (1,162) (1,406) - ----------------------------------------------------------------------------------------------------------------- Cash provided by (used for) investing activities 6,308 (4,811) 4,529 ================================================================================================================= FINANCING ACTIVITIES: Net borrowings (repayments) under short-term borrowing arrangements (600) 1,478 (1,488) Purchase and retirement of stock -- (160) (619) Exercise of stock options -- 67 -- Foreign currency translation adjustment (4) 3 (43) - ----------------------------------------------------------------------------------------------------------------- Cash provided by (used for) financing activities (604) 1,388 (2,150) ================================================================================================================= Net increase (decrease) in cash 418 (2,391) 1,914 Cash at beginning of year 43 2,434 520 - ----------------------------------------------------------------------------------------------------------------- Cash at end of year $ 461 $ 43 $ 2,434 =================================================================================================================
The accompanying notes are an integral part of these statements. INTELLIGENT SYSTEMS CORPORATION F-6 23 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 and us refer to Intelligent Systems Corporation. Nature of Operations - Our business is to create, manage and invest in businesses which we believe have promising growth potential. Consolidated companies (in which we have majority ownership and control) are principally engaged in two industries: technology related products and services and health care services (as defined more specifically in Note 15). Our affiliate companies (in which we have a minority ownership or non-controlling interest) are mainly involved in the technology industry. Use of Estimates - In preparing the financial statements in conformity with generally accepted accounting principles, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions also affect amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Consolidation - The financial statements include the accounts of Intelligent Systems Corporation and its majority owned and controlled U.S. and non-U.S. subsidiary companies after elimination of material accounts and transactions between our subsidiaries. Investments - For entities in which we have 20 to 50 percent ownership interest or where majority ownership is temporary, we account for these investments by the equity method. We account for investments of less than 20 percent in non-marketable equity securities at the lower of cost or market. When calculating gain or loss on the sale of an investment, we use the average cost basis of the securities. Marketable securities are accounted for in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS No. 115). At December 31, 1998, the aggregate fair value of our available-for-sale securities, which consist primarily of 95,449 shares of common stock of Information Advantage, Inc. (successor by merger to IQ Software Corporation (IQ)) totaled $725,000. At December 31, 1997, the aggregate fair value of our available-for-sale securities, which consist primarily of 157,801 shares of IQ common stock, totaled $1,288,000. These amounts include unrealized holding gains of $633,000 and $836,000 as of December 31, 1998 and 1997, respectively. These amounts are reflected as a separate component of stockholders' equity. We classify short-term investments as trading securities under SFAS No. 115. The impact on the December 31, 1998 and 1997 financial statements of applying SFAS No. 115 to the trading securities was immaterial. Our investment in Visibility represents approximately $5.6 million of our long-term investments at December 31, 1998 (see Note 4). If the financial condition of Visibility deteriorates, it could have an adverse effect on our financial condition. 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 year-end exchange rates. We translate income and expense items at average rates of exchange prevailing during the year. Translation adjustments are accumulated as a separate component of stockholders' equity. Earnings include gains and losses that result from foreign currency transactions. Inventories - We state the value of inventories at the lower of cost or market. Cost includes labor, materials and production overhead. Market is defined as net realizable value. Property and Equipment - Property and equipment are carried at cost. For financial reporting purposes, we depreciate these assets using the 150 percent declining balance method over the estimated lives of the assets, as follows:
CLASSIFICATION USEFUL LIFE IN YEARS - -------------- -------------------- Operating equipment 5 Furniture & fixtures 7 Leasehold improvements 1-7 --------------------
Accumulated depreciation and amortization was $2,241,000 and $2,632,000 at December 31, 1998 and 1997, respectively. INTELLIGENT SYSTEMS CORPORATION F-7 24 Intangibles - Intangibles are carried at cost net of related amortization. When we acquire a business, we generally amortize the excess of the cost of the acquisition over underlying net assets of the business acquired over three to five year periods using the straight-line method. Accumulated amortization of intangibles totaled $2.7 million and $1.8 million at December 31, 1998 and 1997, respectively. Our policy is to write off the asset and accumulated amortization for fully amortized intangibles. Periodically we review the values assigned to intangible assets to determine whether they have been permanently impaired. To measure whether goodwill is recoverable, we use an estimate of the undiscounted cash flows of the applicable entity over the remaining life of the goodwill. In 1998, we wrote off $558,000 of goodwill associated with discontinuing certain product lines of the HumanSoft subsidiary (see Note 17). This write-off is reflected in general and administrative expense in the accompanying statements of operations. In 1998, 1997 and 1996, we recorded intangible amortization expense of approximately $957,000, $604,000 and $332,000, respectively. In 1998, we expensed $944,000 of purchased research and development related to the acquisition of JK, Inc. (see Note 2). In 1997, we expensed $953,000 of purchased research and development related to the acquisition of QS, Inc. (see Note 2). These expenses are included in research and development expense on the accompanying statements of operations. Accrued Expenses and Other Current Liabilities - Accrued expenses and other liabilities at December 31, 1998 and 1997 consist of the following:
(in thousands) 1998 1997 ------ ------ Accrued wages and payroll taxes $ 454 $ 574 Deferred revenue 782 1,748 Other accrued expenses 1,329 721 ------ ------
Warranty Costs - We accrue the estimated costs associated with product warranties as an expense in the period the related sales are recognized. Revenue Recognition -Sales of software licenses, technology-related products and services and health care services make up our revenue. We recognize revenue when products are shipped or, in the case of service providers, when the services are rendered. Revenue recognition practices for software are in accordance with Statement of Position 97-2, "Software Revenue Recognition". Generally, we recognize software license revenue upon delivery of the software and related documentation when there are no significant remaining obligations. We accrue the costs of insignificant remaining obligations at the time that we recognize software license revenue. Service fees received from the sale of software maintenance and support contracts provide customers access to technical support and minor upgrades to licensed revenues. These fees are recognized as services are provided over the life of such contracts. We provide for estimated sales returns in the period in which the sales are recorded. Financial Instruments - The carrying value of cash, accounts receivable, accounts payable and other financial instruments included in the accompanying balance sheets approximates their fair value principally due to the short-term maturity of these instruments. Cost of Sales - Cost of sales includes direct material, direct labor and production overhead for product companies and direct cost of services rendered for service companies. Recent Accounting Pronouncements - In June 1997, the Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income". The Statement requires companies to report comprehensive income and its components in its financial statements. Comprehensive income is the total of net income and all other nonowner changes in equity in a period. We adopted the disclosure requirements of this statement in March 1998. In June 1997, the Financial Accounting Standards Board issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information". The Statement requires a management approach to be used when reporting business segments. Reportable segments are based on products and services, geography, legal structure or management structure. We adopted the disclosure requirements of this statement in March 1998. See Note 15. In October 1997, the AICPA issued Statement of Position 97-2, "Software Revenue Recognition". SOP 97-2 clarifies and changes some software recognition practices and supersedes the existing guidance of SOP 91-1. We adopted SOP 97-2 effective January 1, 1998. Adopting SOP 97-2 did not have a material impact on our financial position or results of operations. INTELLIGENT SYSTEMS CORPORATION F-8 25 NOTE 2 ACQUISITIONS QS, Inc. - Effective July 1, 1997, we acquired all of the outstanding common stock of QS, Inc. (QS), a company engaged in providing software products and services to the public health market. We paid $2.0 million in cash and issued a promissory note for $1.5 million due in three equal annual installments beginning July 1, 1998 and bearing interest at 8.5 percent per annum, payable quarterly. The promissory note is guaranteed by an executive officer of the company. The acquisition was accounted for as a purchase. We expensed $953,000 of purchased research and development projects that had not reached technological feasibility and that did not have an alternative future use. Since the acquisition date, we have consolidated the results of operations of QS. JK, Inc. - Effective January 1, 1998, our HumanSoft LLC subsidiary acquired all of the common stock of JK, Inc. (JK), a company that provides software and services to the public health market, in exchange for 1,523 units of limited liability interest in HumanSoft. Immediately afterward, Intelligent Systems acquired 878 of the newly issued HumanSoft units from the sellers of JK for $200,000 cash and a promissory note of $600,000. The note is due in three equal annual installments beginning January 1, 1999 and bears interest of 8.5 percent per annum payable annually. The acquisition was accounted for as a purchase. We expensed $944,000 of purchased research and development projects that had not reached technological feasibility and that did not have an alternative future use. We have consolidated the results of operations of JK since the acquisition. Intelligent Systems has made a claim against the sellers of JK for breach of certain representations and warranties in the acquisition agreements and has asserted the right to offset amounts owed to the sellers under the notes. Although the sellers disagree with our claim, both parties have indicated a willingness to discuss a resolution to the issue. NOTE 3 SALES OF ASSETS Intelligent Enclosures Corporation - Effective April 1, 1998, we sold substantially all the assets and the business operations of our Intelligent Enclosures (IE) subsidiary to Daw Technologies, Inc. in exchange for common stock of Daw. The number of shares of common stock of Daw that we will receive for the assets will be determined at a second closing two years from the date of the sale (or earlier based on certain events). The sales price was fixed at $1.3 million; therefore, the trading price of Daw shares at the second closing will determine the number of Daw shares we will receive. IQ Software Corporation - In 1998, we recorded a gain of $1.0 million and cash proceeds of $1.2 million on the sale of 114,000 shares of common stock of IQ. OrCAD, Inc. - We acquired 208,968 shares of common stock of OrCAD, Inc. in exchange for all of our ownership in a Japanese affiliate in late 1995. On March 1, 1996, OrCAD completed its initial public offering. We sold one-half of our OrCAD common stock (104,484 shares) in the initial public offering and recognized a gain, net of tax, of $337,000 in the first quarter of 1996. We sold our remaining 104,484 shares of common stock of OrCAD in the second quarter of 1997, recognizing a gain of $217,000 on the sale. Paragon Interface, Inc. - Effective April 17, 1998, we sold our minority interest in Paragon Interface, Inc. (a data mapping software company) for $839,000 cash. At the closing, Paragon also repaid a loan of $150,000 from us. We recorded a gain of $457,000 on the sale. PaySys International, Inc. - On March 31, 1997, we sold 252,685 shares (adjusted for a stock split) of common stock of PaySys International, Inc. in a private transaction. We received $2.0 million in cash for the stock and recorded a gain of $1.9 million on the sale. In a second private transaction on July 1, 1998, we sold 437,063 shares of common stock of PaySys. The transaction netted $2.5 million in cash and resulted in a gain of $2.5 million on the sale. At December 31, 1998, we still own 3,606,382 shares of common stock of PaySys. NOTE 4 INVESTMENTS IN AFFILIATES At December 31, 1998, we owned a 42 percent interest (approximately 30% on a diluted basis) in PaySys International, Inc. For some periods during 1997 and 1998, we owned a 58 percent interest. However, since INTELLIGENT SYSTEMS CORPORATION F-9 26 we were majority owner only temporarily and were not the controlling shareholder, our investment in PaySys is classified as an affiliate and accounted for by the equity method of accounting. Our pro rata share of PaySys losses was $7.9 million in 1997. However, in accordance with the equity method of accounting, we only recorded $3.0 million, reducing our investment of $3.0 million to zero on the balance sheet at December 31, 1997 and 1998. During 1998, we did not record any additional losses or income related to PaySys. We have no obligation or intent to provide additional funding to PaySys. No dividends were received from the affiliate during 1998 and 1997. The following table contains the summarized financial information of PaySys.
YEAR ENDED DECEMBER 31, (in thousands) 1998 1997 1996 ------- -------- ------- Current assets $19,028 $ 12,884 $11,700 Current liabilities 23,133 23,207 14,271 Noncurrent assets 3,005 3,604 4,494 Noncurrent liabilities 8,199 4,897 1,761 Net sales $45,905 $ 32,787 $26,924 Operating income (loss) (3,814) (15,063) 592 Net income (loss) (5,163) (15,815)(1) 139 ------- -------- -------
1. Includes non-recurring charges totaling $5.8 million. At December 31, 1998, we owned a 34 percent interest in Visibility, Inc., a software company. The investment is classified as an affiliate and accounted for using the equity method of accounting. No dividends were received from the affiliate in 1998 or 1997. The table below contains the summarized financial information of Visibility.
YEAR ENDED DECEMBER 31, (in thousands) 1998 1997 ------- ------- Current assets $10,236 $ 6,755 Current liabilities 14,402 11,894 Noncurrent assets 1,337 1,452 Noncurrent liabilities 2,029 1,855 Net sales $30,193 $21,850 Operating income (loss) 1,040 (2,892 Net income (loss) 679 (3,360 ------- -------
NOTE 5 ACCOUNTS AND NOTES RECEIVABLE AND OTHER COMMITMENTS At December 31, 1998 and 1997, our allowance for doubtful accounts and sales returns amounted to $1,188,000 and $207,000, respectively. Provisions for doubtful accounts and sales returns were $240,000, $46,000 and $312,000 for the years ended December 31, 1998, 1997 and 1996, respectively. As of December 31, 1998, we hold a minority ownership position in Risk Laboratories, LLC (risk management software). We own approximately 30 percent of Risk and account for this investment by the equity method. We have also made loans to Risk with terms expiring in 1999 and bearing interest at 3.5 percent over prime. These loans amounted to $133,000 and $218,000 at December 31, 1998 and 1997, respectively. Our pro rata share of Risk losses was $106,000 in 1998. However, in accordance with the equity method of accounting, we only recorded $80,000, reducing our investment of $200,000 to zero on the balance sheet at December 31, 1998. We have no commitment for additional funding under the terms of the existing agreements. In April 1995, we entered into a Pledge Agreement with IQ Software Corporation (IQ) under which we pledged 240,163 shares of IQ stock held by the company as collateral for a loan of $1.8 million from IQ to DayStar Digital Inc. In 1996, IQ released 85,259 shares of stock held as collateral that we then sold in the public market. In 1997, we repaid the $1.8 million debt of DayStar to IQ and IQ released the balance of 154,904 shares to us. Subsequently, we wrote off $3.0 million related to uncollectability of the note from DayStar when DayStar ceased operations in October 1997. NOTE 6 BORROWINGS Terms and borrowings under our credit facilities are summarized as follows: INTELLIGENT SYSTEMS CORPORATION F-10 27
(in thousands) 1998 1997 ------ ------ Maximum outstanding (month-end) $2,477 $1,172 Outstanding at year end $ 750 $ 700 Average interest rate at year end 8.5% 8.5% Average borrowings during the year $1,127 $1,040 Average interest rate 10.4% 8.7% ------ ------
Interest paid on debt during 1998, 1997 and 1996 amounted to $118,000, $103,000 and $61,000, respectively. NOTE 7 LONG-TERM DEBT Our long-term debt consists of the promissory notes payable to the sellers of QS and JK, as more fully described in Note 2. Maturities of long-term debt are as follows:
YEAR ENDED DECEMBER 31, (in thousands) 2000 $700 2001 200 ---- Total long-term debt payments $900 ====
NOTE 8 INCOME TAXES The income tax provision (benefit) related to operations consists of the following:
YEAR ENDED DECEMBER 31, (in thousands) 1998 1997 1996 ----- ---- ---- Current: Foreign $ -- $ -- $ -- Domestic (152) 16 3 ----- ---- ---- $(152) $ 16 $ 3 ===== ==== ====
We do not show a reconciliation between our effective tax rate and the U.S. statutory rate since only state income and foreign taxes are provided. At December 31, 1998, our domestic subsidiaries had net operating loss carryforwards totaling $23.0 million. The net operating loss carryforwards, if unused as offsets to future taxable income, will expire beginning in 2005 and continuing through 2018. We may not be able to use these carryforwards because, in some cases, they are limited to taxable income of a particular subsidiary or may be subject to annual limitation under the Internal Revenue Code if there is a greater than 50 percent change in ownership as defined under Section 382. We account for income taxes using Statement of Financial Accounting Standard 109, "Accounting for Income Taxes". We have a deferred tax benefit of approximately $10.0 million at December 31, 1998 and 1997. Since our ability to realize the deferred tax asset is uncertain, the amount is offset in both 1998 and 1997 by a valuation allowance of an equal amount. The deferred tax benefit at December 31, 1998 and 1997 relates primarily to net operating loss carryforwards. Income taxes paid (or refunds received) during 1998, 1997 and 1996 amounted to $(152,000), $16,000 and $3,000, respectively. NOTE 9 COMMITMENTS AND CONTINGENCIES Leases - We have noncancellable operating leases expiring at various dates through 2004. Future minimum lease payments are as follows:
YEAR ENDED DECEMBER 31, (in thousands) 1999 $1,189 2000 1,086 2001 963 2002 891 2003 184 Thereafter 31 ------ Total minimum lease payments $4,344 ======
Rental expense for leased facilities and equipment related to operations amounted to $1.2 million, $1.2 million and $1.0 million, for the years ended December 31, 1998, 1997 and 1996, respectively. INTELLIGENT SYSTEMS CORPORATION F-11 28 Legal Matters - Our HumanSoft subsidiary has filed for relief under Chapter 11 of the federal bankruptcy code. While we believe we have taken adequate reserves for this situation, there can be no assurance that unanticipated claims or expenses related to this proceeding will not arise. We are party to a small number of other legal matters arising in the ordinary course of business. It is management's opinion that none of these matters will have a material adverse impact on our consolidated financial position or results of operations. NOTE 10 POST-RETIREMENT BENEFITS Effective January 1, 1992, we adopted the Outside Directors' Retirement Plan which provides that each nonemployee director, upon resignation from the Board after reaching the age of 65, will receive a lump sum cash payment equal to $5,000 for each full year of service as a director of the company (and its predecessors and successors) up to $50,000. We have accrued $80,000 to date for anticipated future payments under the plan. NOTE 11 STOCKHOLDERS' EQUITY We have authorized 20,000,000 shares of Common Stock, $.01 par value per share, and 2,000,000 shares of Series A Preferred Stock, $.10 par value per share. No shares of Preferred Stock have been issued; however, we adopted a Rights Agreement on November 25, 1997, which provides that, under certain circumstances, shareholders may redeem the Rights to purchase shares of Preferred Stock. The Rights have certain anti-takeover effects. The Board of Directors has authorized stock repurchases at various times in the past. We repurchased and retired 47,300 shares of common stock in the year ended December 31, 1997 but made no repurchases during 1998. NOTE 12 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 provides shares of common stock that may be sold to officers and key employees. Stock options are granted at fair market value on the date of grant. As of December 31, 1998, 660,000 options are fully vested and exercisable at a weighted average price per share of $1.75. Of the unvested options, 5,000 vest in 1999. All options expire ten years from their respective dates of grant. At December 31, 1998, the weighted average remaining contractual life of the outstanding options is 5.76 years. There are 660,000 options exercisable with option prices ranging from $0.875 to $2.94 and with a weighted average price per share of $1.75. Stock option transactions during the three years ended December 31, 1998 were as follows:
1998 1997 1996 --------- ---------- ----------- Options outstanding at Jan. 1 665,000 690,000 640,000 Options granted -- -- 410,000 Options exercised -- 25,000 50,000 Options canceled -- -- 310,000 Options outstanding at Dec. 31 665,000 665,000 690,000 Options available for grant at Dec. 31 185,000 185,000 -- Option price ranges per share: Granted -- -- $2.25-2.94 Exercised -- $2.25-2.94 0.875 Canceled -- -- 2.07 Weighted average option price per share: Granted -- -- $ 2.42 Exercised -- $ 2.67 0.875 Canceled -- -- 2.07 Outstanding at Dec. 31 $ $1.75 $ 1.75 $ 1.79 -------- ---------- -----------
INTELLIGENT SYSTEMS CORPORATION F-12 29 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 1996 has been estimated as of the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: - - risk free interest rate of 6.3 percent - - expected life of the option of 6 years - - expected dividend yield rate of 0 percent - - expected volatility of 63 percent Under these assumptions, the weighted average fair value of options granted in 1996 was $1.54. There were no awards under the Plan in 1997 and 1998. The fair value of the grants would be amortized over the vesting period for the options. Accordingly, our pro forma net income (loss) and net income (loss) per common share assuming compensation cost as determined under SFAS No. 123 would have been the following:
YEAR ENDED DECEMBER 31, (in thousands except per share data) 1998 1997 1996 ------- ------- ------- Net income (loss) $(1,548) $(7,176) $4,205 Net income (loss) per common share basic and diluted $ (0.30) $ (1.53) $ 0.80 ------- ------- ------
Because SFAS No. 123 method of accounting has not been applied to grants and awards prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that expected in future years. NOTE 13 FOREIGN SALES AND OPERATIONS Aggregate export and foreign sales from continuing operations were $7.0 million, $7.0 million and $5.9 million for the years ended December 31, 1998, 1997 and 1996, respectively. Export and foreign sales were made principally in the United Kingdom and the Far East. Sales in these geographic areas are as follows:
YEAR ENDED DECEMBER 31, (in thousands) 1998 1997 1996 ------ ------ ------ United Kingdom $7,011 $6,813 $5,934 Far East 49 210 -- ------ ------ ------
For the years ended December 31, 1998, 1997 and 1996, income (loss) before provision for income taxes derived from foreign subsidiaries approximated $(1,092,000), $(930,000) and $43,000, respectively. As of December 31, 1998 and 1997, foreign subsidiaries had assets of $3.3 million and $3.6 million, respectively, and total liabilities of $3.4 million and $4.0 million, respectively. Foreign subsidiaries are located in England and there are no currency exchange restrictions 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 14 EARNINGS PER SHARE For the years ended December 31, 1998 and 1997, basic and diluted weighted average shares outstanding are the same because all of our common stock equivalents (stock options) are non-dilutive since we reported a loss for each period. For the year ended December 31, 1996, our diluted weighted average shares outstanding include the assumed conversion of stock options resulting in an increase of 31,406 shares outstanding.
YEAR ENDED DECEMBER 31, (in thousands) 1998 1997 1996 ------- ------- ------ Net income (loss) $(1,548) $(7,176) $4,239 Basic earnings (loss) per share $ (0.30) $ (0.27) $ 0.80 Basic weighted average shares 5,104 5,087 5,278 Diluted earnings (loss) per share $ (0.30) $ (0.41) $ 0.80 Diluted weighted average shares 5,104 5,087 5,310
INTELLIGENT SYSTEMS CORPORATION F-13 30 NOTE 15 INDUSTRY SEGMENTS Our operating divisions are principally involved in two industry segments: health care services and technology related products and services. Operations in health care services involve mental health and substance abuse treatment programs and, through August 1996, locum tenens service (placement of physicians in temporary positions). We derived 10.6 percent, 13.5 percent and 37 percent of our consolidated revenue in 1998, 1997 and 1996, respectively, from a national chain of hospitals in which our PsyCare subsidiary conducts some of its treatment programs. Beginning in late 1996 and continuing in 1997, most of the programs located in the chain's hospitals were closed. Operations in technology related products and services include design, development and marketing of microcomputer software; educational training programs for PC users; design, manufacture and sales of mini-environments for semiconductor manufacturing (through April 1998); and manufacture and sales of bio-remediating parts washers. Total revenue by industry includes sales to unaffiliated customers. Sales between the two industry segments are not material. Operating profit is total revenue less operating expenses. None of the general corporate overhead expense has been allocated to the individual industry segments. Identifiable assets by industry are those assets that are used in our operations in each industry. Corporate assets are principally cash, marketable securities, notes receivable and investments. The table following contains segment information for the years ended December 31, 1998, 1997 and 1996.
YEAR ENDED DECEMBER 31, 1998 Health (in thousands) Tech. Care Consol. ------- ------- ------- Net sales $14,124 $4,129 $18,253 R&D 1,892 -- 1,892 Depreciation 814 97 911 Operating income (loss) (5,848) 77 (5,771) General corp. expenses 1,270 ------- ------- ------- Consolidated operating loss (7,041) Interest expense (290) Investment income 5,776 Other loss, net (135) ------- ------- ------- Loss from continuing operations before income tax provision and minority interest (1,690) Income tax provision 152 ------- ------- ------- Loss before minority interest (1,538) Minority interest 10 ------- ------- ------- Net loss from continuing operations $(1,548) ======= ======= ======= Capital expenditures $ 896 $ 9 $ 905 ======= ======= ======= Identifiable assets $ 6,954 $ 960 $ 7,914 Corporate assets 9,185 ------- ------- ------- Total assets at year end $17,099 ======= ======= ======= Year ended December 31, 1997 Health (in thousands) Tech. Care Consol. ------- -------- ------- Net sales $14,957 $6,203 $21,160 R&D 1,485 -- 1,485 Depreciation 964 147 1,111 Operating loss (2,290) (912) (3,202) General corp. expenses 1,652 ------- -------- ------- Consolidated operating loss (4,854) Interest income 350 Investment loss (2,585) Other loss, net (61) ------- -------- ------- Loss from continuing operations before income tax provision and minority interest (7,150) Income tax provision 16 ------- -------- ------- Loss before minority interest (7,166) Minority interest 10 ------- -------- ------- Net loss from continuing operations $(7,176) ======= ======== ======= Capital expenditures $ 1,973 $ 7 $ 1,980 ======= ======== ======== Identifiable assets $ 7,762 $ 1,059 $ 8,821 Corporate assets 10,270 ------- -------- ------- Total assets at year end $19,091 ======= ======== =======
INTELLIGENT SYSTEMS CORPORATION F-14 31
YEAR ENDED DECEMBER 31, 1996 Health (in thousands) Tech. Care Consol. ------- ------- ------- Net sales $10,698 $12,980 $23,678 R&D 286 -- 286 Depreciation 550 140 690 Operating profit (loss) (1,135) 433 (702) General corp. expenses 1,351 ------- ------- ------- Consolidated operating loss (2,053) Interest income 501 Investment income 5,844 Other loss, net (38) ------- ------- ------- Income from continuing operations before income tax provision and minority interest 4,254 Income tax provision 3 ------- ------- ------- Income before minority interest 4,251 Minority interest 12 ------- ------- ------- Net income from continuing operations $ 4,239 ======= ======= ======= Capital expenditures $ 1,275 $ 262 $ 1,537 ======= ======= ======= Identifiable assets $ 4,859 $ 2,671 $ 7,536 Corporate assets 17,391 ------- ------- ------- Total assets at year end $24,927 ======= ======= =======
NOTE 16 QUARTERLY FINANCIAL DATA (unaudited) The table below contains a summary of selected quarterly data for the years ended December 31, 1998 and 1997.
FOR QUARTERS ENDED (in thousands except MARCH JUNE SEPT. DEC. per share data) 31 30 30 31 ------- ------ ------- ------- 1998 Net sales $ 4,804 $5,322 $ 4,409 $ 3,718 Operating loss (3,389) (813) (2,093) (746) Net income (loss) (2,608)(a) 690(b) 282(c) 88(d) Basic income (loss) per share (0.51) 0.14 0.06 0.02 Diluted income (loss) per share (0.51) 0.13 0.05 0.02 1997 Net sales $ 5,108 $5,320 $ 5,248 $ 5,484 Operating loss (684) (531) (2,605) (1,034) Net income (loss) 584(e) (869)(f)(6,984)(g) 92(h) Basic and diluted income (loss) per share 0.11 (0.17) (1.37) 0.02
a. Includes charge of $944,000 for in-process R&D, $191,000 charge for restructuring and gain of $947,000 on investment. b. Includes gains of $1.7 million on investments. c. Includes charge of $955,000 to discontinue product lines and gain of $2.5 million on investment. d. Includes $829,000 income in equity of affiliates. e. Includes gain of $1.9 million on investment. f. Includes gain of $217,000 on investment and $721,000 loss in equity of affiliate. g. Includes charge of $953,000 for in-process R&D, write-off of $3.0 million note and $1.25 million loss in equity of affiliate. h. Includes gain of $469,000 on investment and $707,000 income in equity of affiliate. NOTE 17 HUMANSOFT SUBSIDIARY PETITION FOR RELIEF UNDER CHAPTER 11 On November 17, 1998, our HumanSoft subsidiary filed a petition for relief under Chapter 11 of the federal bankruptcy laws in the United States Bankruptcy Court for the Northern District of Georgia in response to an involuntary filing under Chapter 7 by three creditors. In late August 1998, HumanSoft announced that it was curtailing operations related to two of its three software product lines. Under Chapter 11, certain claims against HumanSoft in existence prior to the filing date are stayed. HumanSoft's QS Technologies subsidiary continues to operate its software business located in Greenville, SC. In the quarter ended September 30, 1998, we recorded a write-off related to the discontinued product lines and management believes that adequate reserves have been established for potential claims against HumanSoft. Intelligent Systems holds a first priority secured claim on all assets of HumanSoft. HumanSoft has filed a Plan of Reorganization and a Disclosure Statement with the court and is awaiting approval of the Disclosure Statement and its Plan of Reorganization for a vote by interested parties. While we believe that the plan proposed by HumanSoft is reasonable and in the best interests of creditors and customers under the circumstances, we cannot guarantee that the plan will be accepted or confirmed, that costs and expenses related to the action will not exceed current estimates, or that unforeseen claims or liabilities will not arise. INTELLIGENT SYSTEMS CORPORATION F-15 32 NOTE 18 SUBSEQUENT EVENTS InterQuad Services - Effective February 1, 1999, we sold our ownership in the InterQuad Services (Services) subsidiary. Services provides technical and software training in England. We sold our interest in return for a 19 percent interest in a privately held U.K. company whose principal asset is a 49 percent ownership in InterQuad Group. InterQuad Group is a privately held U.K. based company that provides computer hardware, software, training and consulting services to businesses. Effective as of the date of the sale, we will no longer consolidate the results of Services and will record our minority investment in accordance with our policy described in Note 1. Our cost basis is zero. Sale of Information Advantage Stock - In January 1999, we sold our remaining 95,449 shares of common stock of Information Advantage (formerly IQ Software). The gain on the sale, which resulted in cash proceeds of $902,000, will be reported in our results for the first quarter of 1999. INTELLIGENT SYSTEMS CORPORATION F-16 33 SCHEDULE II INTELLIGENT SYSTEMS CORPORATION VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
BALANCE AT CHARGED TO BEGINNING COSTS AND BALANCE AT DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS(a.) RECLASSIFICATION(c.) END OF PERIOD - ----------------------------------- ------------ ------------ --------------- --------------------- -------------- ALLOWANCE FOR DOUBTFUL ACCOUNTS(b.) Year Ended December 31, 1996 318,101 311,887 258,283 -- 371,705 Year Ended December 31, 1997 371,705 46,963 211,760 -- 206,908 Year Ended December 31, 1998 206,908 239,734 126,537 867,463 1,187,568
a. Write-offs of accounts receivable against allowance accounts. b. This includes the combination of the Allowance for Sales Returns with the Allowance for Doubtful Accounts. c. Reclassification of unearned revenue to Allowance for Doubtful Accounts. INTELLIGENT SYSTEMS CORPORATION S-1 34 INTERQUAD SERVICES LIMITED AUDITORS' REPORT TO THE STOCKHOLDERS AND DIRECTORS OF INTERQUAD SERVICES LIMITED We have audited the balance sheet at 31 December 1998 and the profit and loss account for the year then ended of Interquad Services Limited which have been prepared under the historical cost convention and the company's accounting policies. RESPECTIVE RESPONSIBILITIES OF THE DIRECTORS AND AUDITORS The company's directors are responsible for the preparation of financial statements. It is our responsibility to form an independent opinion, based on our audit, on those statements and to report our opinion to you. BASIS OF OPINION We conducted our audit in accordance with Auditing Standards issued by the Auditing Practices Board. The results of our audit would not have been materially different had the audit been conducted in accordance with U.S. generally accepted auditing standards. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the company's circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements. OPINION In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Interquad Services Limited as at 31 December 1998 and the results of its operations for the year then ended. The financial statements conform with UK generally accepted accounting principles. In our opinion, the financial statements would not be materially different if prepared under U.S. generally accepted accounting principles. Morley & Scott Chartered Accountants REGISTERED AUDITOR London 31 March 1999 INTELLIGENT SYSTEMS CORPORATION S-2 35 Report of Independent Auditors Board of Directors PaySys International, Inc. We have audited the accompanying consolidated balance sheets of PaySys International, Inc. and subsidiaries as of December 31, 1997 and 1998, 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, 1998. 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 generally accepted auditing standards. 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, 1997 and 1998 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, in 1997 (effective October 1, 1997) the Company adopted Statement of Position 97-2, "Software Revenue Recognition", changing its method of recognizing revenue on software transactions. Ernst & Young LLP February 25, 1999 Atlanta, Georgia INTELLIGENT SYSTEMS CORPORATION S-3 36 PaySys International, Inc. and Subsidiaries Consolidated Balance Sheets
DECEMBER 31 1997 1998 -------- -------- (In thousands, except share data) ASSETS Current assets: Cash and cash equivalents $ 1,074 $ 1,846 Accounts receivable, less allowance for bad debts of $431 and $1,078 at December 31, 1997 and 1998, respectively 6,288 8,338 Unbilled receivables 5,238 8,558 Prepaid expenses and other current assets 284 286 -------- -------- Total current assets 12,884 19,028 Furniture and equipment, net 2,765 2,511 Computer software costs, net of accumulated amortization of $391 and $770 at December 31, 1997 and December 31, 1998, respectively 692 301 Deposits and other assets 147 193 -------- -------- $ 16,488 $ 22,033 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable $ 3,055 $ 1,734 Accrued employee compensation 2,483 2,000 Deferred revenues 11,614 13,762 Current portion of long-term debt and capital lease obligations 408 3,629 Accrued royalties 3,398 926 Other current liabilities 2,249 1,082 -------- -------- Total current liabilities 23,207 23,133 Long-term debt and capital lease obligations, less current portion 4,069 7,679 Deferred rent expense 828 520 -------- -------- 28,104 31,332 Shareholders' equity (deficit): Preferred stock, $.01 par value; 10,000,000 shares authorized; 2,779,689 shares issued and outstanding; liquidation preference of $15,900 at December 31, 1998 -- 28 Common stock, $.01 par value; 30,000,000 shares authorized; 7,131,825 and 5,797,534 shares issued and outstanding at December 31, 1997 and December 31, 1998, respectively 71 58 Additional paid-in capital 5,705 13,236 Deferred stock compensation (67) (41) Accumulated deficit (17,254) (22,417) Cumulative translation adjustments (71) (163) -------- -------- (11,616) (9,299) -------- -------- $ 16,488 $ 22,033 ======== ========
See accompanying notes. S-4 37 PaySys International, Inc. and Subsidiaries Consolidated Statements of Operations
YEAR ENDED DECEMBER 31 1996 1997 1998 -------- -------- -------- (In thousands) Revenues: License fees $ 13,366 $ 13,088 $ 18,385 Services 13,558 19,699 27,520 -------- -------- -------- Total revenues 26,924 32,787 45,905 Cost of revenues: License fees 2,935 4,223 1,934 Services 8,956 15,683 20,608 -------- -------- -------- Total cost of revenues 11,891 19,906 22,542 Gross margin 15,033 12,881 23,363 Operating expenses: Sales and marketing 3,270 4,865 6,240 Research and development 6,944 10,641 11,804 General and administrative 4,227 6,900 4,793 Royalty termination settlement - - 4,340 Non-cash compensation - 3,722 - Write-off of capitalized software - 949 - Cost of abandoned stock offering - 867 - -------- -------- -------- Total operating expenses 14,441 27,944 27,177 Income (loss) from operations 592 (15,063) (3,814) Interest income (expense): Interest income 83 95 118 Interest expense (233) (442) (1,279) -------- -------- -------- (150) (347) (1,161) -------- -------- -------- Income (loss) before income taxes 442 (15,410) (4,975) Income tax expense 303 405 188 -------- -------- -------- Net income (loss) $ 139 $(15,815) $ (5,163) ======== ======== ========
See accompanying notes. S-5 38 PaySys International, Inc. and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity (Deficit)
PREFERRED STOCK COMMON STOCK TREASURY STOCK ---------------------- --------------------------------------------- ADDITIONAL NUMBER NUMBER NUMBER PAID-IN OF SHARES AMOUNT OF SHARES AMOUNT OF SHARES AMOUNT CAPITAL ---------------------------------------------------------------------------------- (In thousands, except share data) Balance at December 31, 1995 - $ - 6,822,520 $ 68 159,050 $(491) $ 2,074 Comprehensive income: Net income - - - - - - - Foreign currency translation - adjustments - - - - - - Comprehensive income Exercise of employee stock options - - 4,000 - - - - Issuance of stock purchase warrants - - - - - - 5 ---------------------------------------------------------------------------------- Balance at December 31, 1996 - - 6,826,520 68 159,050 (491) 2,079 Comprehensive loss: Net loss - - - - - - - Foreign currency translation adjustment - - - - - - - Comprehensive loss Noncash compensation from stock purchase warrants and stock options - - - - - - 3,793 Issuance of warrants - - - - - - 307 Exercise of stock purchase warrants - - and stock options 464,355 5 - - 15 Retirement of treasury stock - - (159,050) (2) (159,050) 491 (489) ---------------------------------------------------------------------------------- Balance at December 31, 1997 - - 7,131,825 71 - - 5,705 Comprehensive loss: Net loss - - - - - - - Foreign currency translation adjustment - - - - - - - Comprehensive loss Noncash compensation from stock purchase warrants and stock options - - - - - - - Issuance of warrants - - - - - - 147 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 - $ - $13,236 ==================================================================================
DEFERRED CUMULATIVE STOCK ACCUMULATED TRANSLATION COMPENSATION DEFICIT ADJUSTMENTS TOTAL ---------------------------------------------------------- Balance at December 31, 1995 $ - $ (1,578) $ (61) $ 12 Comprehensive income: Net income - 139 - 139 Foreign currency translation 6 adjustments - - 6 ---------- Comprehensive income 145 Exercise of employee stock options - - - - Issuance of stock purchase warrants - - - 5 ---------------------------------------------------------- Balance at December 31, 1996 - (1,439) (55) 162 Comprehensive loss: Net loss - (15,815) - (15,815) Foreign currency translation adjustment - - (16) (16) ---------- Comprehensive loss (15,831) Noncash compensation from stock purchase warrants and stock options (67) - - 3,726 Issuance of warrants - - - 307 Exercise of stock purchase warrants and stock options - - - 20 Retirement of treasury stock - - - - ---------------------------------------------------------- Balance at December 31, 1997 (67) (17,254) (71) (11,616) 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 Issuance of warrants - - - 147 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) $ (9,299) ==========================================================
See accompanying notes. S-6 39 PaySys International, Inc. and Subsidiaries Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31 1996 1997 1998 ------- -------- -------- (In thousands) OPERATING ACTIVITIES Net income (loss) $ 139 $(15,815) $ (5,163) Add (deduct) adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation 624 1,052 1,480 Amortization of computer software 1,383 2,257 391 Amortization of discounts on debt 45 15 118 Provision for doubtful accounts 24 288 647 Accrued rent expense (233) (294) (308) Deferred income taxes 228 277 - Noncash compensation 5 3,726 26 Changes in operating assets and liabilities: Accounts receivable and unbilled receivables (3,289) (2,664) (6,017) Other assets (113) (138) (48) Accounts payable (75) 1,195 (1,321) Income taxes payable (6) - - Deferred revenues 3,541 3,240 2,148 Accrued employee compensation 96 1,164 (483) Other liabilities 1,098 4,163 (3,639) ------- -------- -------- Net cash provided by (used in) operating activities 3,467 (1,534) (12,169) INVESTING ACTIVITIES Purchases of furniture and equipment (665) (2,112) (1,224) Computer software development (1,132) (216) - ------- -------- -------- Net cash used in investing activities (1,797) (2,328) (1,224) FINANCING ACTIVITIES Proceeds from issuance of preferred stock - - 7,373 Exercise of options and warrants - 20 173 Proceeds from borrowings 23 4,491 9,735 Principal payments on long-term debt, capital lease obligations, and line of credit (884) (1,596) (3,023) ------- -------- -------- Net cash provided by (used in) financing activities (861) 2,915 14,258 ------- -------- -------- Effect of foreign currency translation on cash and cash equivalents 6 (16) (93) ------- -------- -------- Increase (decrease) in cash and cash equivalents 815 (963) 772 Cash and cash equivalents at beginning of period 1,222 2,037 1,074 ------- -------- -------- Cash and cash equivalents at end of period $ 2,037 $ 1,074 $ 1,846 ======= ======== ========
See accompanying notes. S-7 40 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 1998 1. SIGNIFICANT ACCOUNTING POLICIES BUSINESS PaySys International, Inc. (the Company) develops, licenses and supports computer software for use by financial institutions, retailers and third party processors to process credit card transactions. 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. 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. NEW ACCOUNTING STANDARD In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" which established standards for the reporting and display of comprehensive income and its components in a full set of comparative general-purpose financial statements. The Statement became effective for the Company in 1998. Comprehensive income is defined in this Statement as net income plus other comprehensive income, which, under existing accounting standards includes foreign currency items, minimum pension liability adjustments and unrealized gains and losses on certain investments in debt and equity securities. Comprehensive income is reported by the Company in the consolidated statements of changes in stockholders' equity. The adoption of SFAS 130 resulted in revised and additional disclosures but had no effect on the financial position, results of operations, or liquidity of the Company. REVENUE RECOGNITION Revenues are derived from sales of software licenses and related services. S-8 41 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) REVENUE RECOGNITION (CONTINUED) Through September 30, 1997, the Company's revenue recognition policies were in accordance with Statement of Position (SOP) 91-1, "Software Revenue Recognition". Under the provisions of SOP 91-1, the Company generally recognized software license revenue upon delivery of the software and related documentation when there were no significant remaining obligations and collectibility was assessed as probable. 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. Adoption of the new revenue recognition policies of SOP 97-2, "Software Revenue Recognition", is required for all transactions beginning January 1, 1998, but earlier adoption is encouraged for periods not previously reported. Prior periods reported under SOP 91-1 may not be restated. The Company elected to adopt the provisions of SOP 97-2 effective October 1, 1997. The most significant impact of adopting SOP 97-2 on the Company's revenue recognition policies is later recognition of revenue on certain contracts than under past practices. Under SOP 97-2, license and professional service fee revenues from contracts which 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 collectibility is assessed as probable; professional services revenue as the services are performed; and postcontract 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. S-9 42 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, Australia, New Zealand, 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 $133,000, $680,000 and $240,000 during the years ended 1996, 1997 and 1998, respectively. In 1998 no individual customer exceeded 10% of revenues. During 1997 one customer accounted for 19% of revenues, and during 1996 a different customer accounted for 11% 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 which bear minimal risk. 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. S-10 43 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) COMPUTER SOFTWARE 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 reached. Costs of maintaining existing software and research and development are expensed as incurred. The Company capitalized software development costs of $1,132,000, $210,000 and $0 during the years ended 1996, 1997, and 1998, respectively. The Company records amortization of software development costs capitalized in an amount equal to the greater of the amount computed using i) the ratio that current gross revenues for a product bear to the total of current and anticipated revenues for that product or ii) the straight-line method over the estimated useful life of the released product (currently three years). Amortization of internally-developed software costs totaled $1,168,000, $2,257,000 and $357,000 for the years ended December 31, 1996, 1997 and 1998, respectively. The higher amortization of capitalized software costs for 1997 is due to the write-off of $949,000, of capitalized software costs for projects deemed to have no net realizable value. 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-11 44 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) STOCK-BASED COMPENSATION In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation", which 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. As permitted by SFAS No. 123, the Company continues to account for stock option grants in accordance with APB 25 and has elected the pro forma disclosure alternative of the effect of SFAS No. 123. Accordingly, adoption of the standard in 1996 did not affect the Companies' results of operations. ABANDONED STOCK OFFERING In December 1997, the Company abandoned a planned public offering of its common stock. Costs associated with the abandoned offering were expensed during 1997. RECLASSIFICATION Certain amounts reported in the 1996 and 1997 financial statements have been reclassified to conform to the 1998 financial statement presentation. S-12 45 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. FURNITURE AND EQUIPMENT Furniture and equipment consists of the following:
DECEMBER 31 1997 1998 ---------------------------- (In thousands) Furniture and equipment: Office furniture and equipment $ 937 $ 1,011 Computer equipment 2,461 2,551 Computer equipment under capital lease 1,389 1,960 --------------------------- 4,787 5,522 Less allowances for depreciation and amortization (2,022) (3,011) --------------------------- $ 2,765 $ 2,511 ===========================
3. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company considers its cash and cash equivalents, accounts receivable, line of credit and long-term debt and capital lease obligations to be its only significant financial instruments and believes that the carrying amounts of these instruments approximates 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 the short-term nature of these instruments. S-13 46 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. LONG-TERM DEBT AND LEASES Long-term debt and capital lease obligations consist of the following:
DECEMBER 31 1997 1998 ----------------------- (In thousands) 13.5% Note payable due March 31, 2001 (1) $ 4,000 $ 4,000 Less discount 292 314 ----------------------- 3,708 3,686 12% Note payable due in quarterly installments through April 30, 2001 (2) -- 4,444 Unsecured note payable due in quarterly installments through April 30, 2001, interest at 8% -- 535 Unsecured obligation due in monthly installments through December 15, 1999, interest at 8.5% -- 1,374 Loan from product development joint venture due August 31, 2002 (3) -- 536 Other debt 11 52 Capital lease obligations, various imputed interest rates and monthly payments 758 681 ----------------------- 4,477 11,308 Less current portion (408) (3,629) ----------------------- $ 4,069 $ 7,679 =======================
S-14 47 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 first lien on equipment, accounts receivable and software and related material. In addition, this note requires periodic issuance of warrants to purchase shares of the Company's common stock (see Note 7). (2) This note is secured by a lien junior to the $4,000,000, 13.5% note payable due March 31, 2001, on equipment, accounts receivable and software and related material. The lender has also been granted a contingent warrant to purchase 962,055 shares of the Company's common stock, exercisable at $.01 per share only upon an event of default as defined in the loan agreement. (3) The Company entered into a software development joint venture agreement for a specific project, whereby the Company may borrow from co-developer fifty percent of the associated development cost, up to $600,000. The loan is non-interest bearing and repayment is due by the earlier of August 31, 2002 or as future revenue is recognized from the sales of the jointly developed product. The Company expects to repay this loan in 1999 and accordingly the balance is included in the current portion of long term debt. The Company's notes payable and long-term debt agreements contain restrictive covenants restricting additional borrowings, the incurrence of liens on assets, the acquisition and disposition of assets, capital expenditures and distributions to shareholders. 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 $86,000, $145,000 and $310,000 for 1996, 1997 and 1998, respectively. Total rental expense was $1,108,000, $2,209,000 and $ 2,784,000 and for 1996, 1997, and 1998, respectively. S-15 48 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. LONG-TERM DEBT AND LEASES (CONTINUED) Required payments by year for long-term debt, capital leases and noncancelable operating leases with initial or remaining terms in excess of one year at December 31, 1997, were as follows:
LONG-TERM CAPITAL OPERATING YEAR ENDING DECEMBER 31, DEBT LEASES LEASES ------------------------------------------------------------------------ (In thousands) 1999 $ 3,212 $470 $2,032 2000 1,250 124 2,005 2001 6,479 105 1,880 2002 -- 59 1,880 2003 -- -- 1,806 ---------------------------------- 10,941 758 9,603 Less amount representing interest -- (77) (34) ---------------------------------- $10,941 $681 $9,569 ==================================
5. COMMITMENTS AND CONTINGENCIES ROYALTY AGREEMENT In 1998, the Company entered into 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 which totaled less than $1,000,000 and 15% of any sale, license or other grant of right to use product which 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. S-16 49 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 5. COMMITMENTS AND CONTINGENCIES (CONTINUED) LEGAL MATTERS In August 1997, the Company settled a copyright infringement lawsuit for $550,000. The Company has paid $350,000 as of December 31, 1998 and is paying the remaining $200,000 in equal quarterly installments of $50,000. The Company accrued an estimated reserve of $325,000 for this lawsuit at December 31, 1996 and accrued an additional $225,000 in 1997 when additional information regarding the total settlement of $550,000 became available. 6. INCOME TAXES The provisions for income taxes for 1996, 1997 and 1998 are as follows:
YEAR ENDED DECEMBER 31 1996 1997 1998 ------------------------- (In thousands) Current tax expense: Federal $ 21 $ -- $ -- Foreign 54 128 188 State -- -- -- ------------------------- Total current 75 128 188 Deferred tax expense (benefit): Federal 181 248 -- Foreign -- -- -- State 47 29 -- ------------------------- Total deferred 228 277 -- ------------------------- $303 $405 $188 =========================
S-17 50 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. INCOME TAXES (CONTINUED) Income tax expense for the year ended December 31, 1998 relates to current foreign withholding taxes payable. No additional income tax expense has been recorded for the year ended December 31, 1998 due to the Company's loss for the period and the related net operating loss carryforward position. A reconciliation of the statutory U.S. income tax rate to the effective income tax rate is as follows:
YEAR ENDED DECEMBER 31 1996 1997 1998 ----------------------------------- (In thousands) Tax (benefit) at statutory federal rate $ 150 $(5,239) $(1,692) State taxes net of federal benefit 31 -- -- Research and development credit (490) -- -- Foreign tax credits (205) -- (224) Foreign withholding taxes 1 128 188 Foreign operations not subject to U.S. tax 58 349 (14) Meals and entertainment 34 34 74 Other-net (16) (305) (306) Change in valuation allowance 740 5,438 2,162 ------------------------------------ Total income tax expense $ 303 $ 405 $ 188 ====================================
S-18 51 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 1996 1997 1998 ------------------------------------- (In thousands) Deferred tax assets: Net operating loss carryforwards $ 1,349 $ 4,126 $ 5,591 Accruals not deductible for tax purposes 445 2,424 2,629 General business credit carryforwards 1,771 1,280 1,567 Foreign tax credit carryforwards 69 407 316 Minimum tax credit carryforwards 207 185 213 Property and equipment, principally due to depreciation -- -- 9 ------------------------------------- Total gross deferred tax assets 3,841 8,422 10,325 Deferred tax liability: Property and equipment, principally due to depreciation (40) (109) -- Amortization of intangibles (912) (263) (113) ------------------------------------- Total gross deferred tax liabilities (952) (372) (113) Less valuation allowance (2,612) (8,050) (10,212) ------------------------------------- Net deferred tax asset $ 277 $ -- $ -- =====================================
At December 31, 1998, the Company had general business and foreign tax carryforwards which expire in 1999 through 2013 and AMT credit carryforwards available to offset future federal income tax liabilities totaling approximately $2,100,000. The Company has net loss carryforwards of $7,900,000 generated through December 31, 1997 and net operating loss of $3,400,000 generated in the year ended December 31, 1998 for federal income tax purposes which may be carried forward through 2012 and 2018, respectively. S-19 52 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 $3,500,000 at December 31, 1998. 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 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 COMMON STOCK In October 1997 the Company's Board of Directors approved a five-for-one stock split effected as a stock dividend. Accordingly, all the share data has been retroactively adjusted to reflect these changes. WARRANTS Pursuant to a 1992 loan agreement between the Company and Sirrom Capital, L.P. (Sirrom), Sirrom obtained a warrant to purchase 150,000 shares of the Company's common stock at an exercise price of $.002 per share. The warrant was exercised in August 1997. Pursuant to a loan agreement dated January 24, 1994 between the Company and ISC, ISC received a warrant to purchase 277,605 shares of the Company's common stock at $.002 per share in consideration for making the loan. The warrant was exercised in August 1997. S-20 53 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 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 $300,000. If the debt remains outstanding for certain periods during the term of the financing arrangement the Company is required to issue warrants to purchase additional shares. During 1998, the Company issued warrants to purchase 47,500 additional shares exercisable at $.002 per share and valued these additional warrants at approximately $147,000. 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. Warrants issued under this agreement expire March 31, 2001. In connection with the June 17, 1998 Series A-1 preferred stock issuances and Sirrom's required consent to the issuances pursuant to the terms of the Sirrom financing agreement, the Company granted Sirrom contingent warrants to purchase up to 58,262 shares of common stock, exercisable at $.01, but only immediately prior to the event of a distribution of assets or funds of the Company to Series A-1 preferred stockholders. 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-21 54 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. SHAREHOLDERS' EQUITY (CONTINUED) STOCK-BASED AWARDS TO EMPLOYEES (CONTINUED) Proforma 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 1996, 1997 and 1998: risk-free interest rate of 6% for 1996 and 1997 and 5.5% for 1998; dividend yields of 0%; and a weighted-average expected life of the awards of 8 years, 8 years and 7 years, respectively. The weighted average fair value of awards during 1996, 1997 and 1998 was $.26, $.66 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 proforma 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 1996 1997 1998 --------------------------------------------- (In thousands) Net income (loss) $ 89 $(17,032) $(5,255)
Because SFAS No. 123 is applicable only to awards subsequent to December 31, 1994, its pro forma effect will not be fully reflected until 1999. S-22 55 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. SHAREHOLDERS' EQUITY (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 allows for the granting of options for up to 411,250 shares of common stock to employees, non-employee directors, consultants and other vendors. S-23 56 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 1996, 1997 and 1998 under the Company's stock option plans.
WEIGHTED EXERCISE PRICE AVERAGE SHARES RANGE EXERCISE PRICE ----------------------------------------------- Outstanding at January 1, 1996 415,830 $ 0 - $0.80 $ 0.79 Granted 504,670 0.80 - 3.10 1.20 Exercised (4,000) 0 0 ------------------------------------------- Outstanding at December 31, 1996 916,500 0 - 3.10 1.02 Granted 297,075 3.10 3.10 Expired (153,740) 3.10 3.10 Exercised (1,750) 0 0 ------------------------------------------- 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 $1.30 =========================================== Exercisable at December 31, 1996 315,160 $ 0 - $3.10 $0.80 Exercisable at December 31, 1997 583,845 $0.80 - $3.10 $1.04 Exercisable at December 31, 1998 796,581 $0.80 - $3.10 $1.24
S-24 57 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. SHAREHOLDERS' EQUITY (CONTINUED) STOCK-BASED AWARDS TO EMPLOYEES (CONTINUED) Options outstanding at $.80 per share totaled 827,250 of which 643,643 were exercisable at December 31, 1998. The weighted average remaining contractual life of options exercisable at $.80 per share was 7.0 years at December 31, 1998. Options outstanding at $3.10 per share totaled 476,000 of which 152,938 were exercisable at December 31, 1998. The weighted average remaining contractual life of options exercisable at $3.10 per share was 9.0 years at December 31, 1998. 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. Additionally, during 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. In addition, the amendment added provisions (i) restricting transfer of any shares obtained from exercise of the warrants until the earlier of achievement of certain milestones or February 2003 and (ii) withholding certain registration rights until achievement of the milestones. 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. S-25 58 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. SHAREHOLDERS' EQUITY (CONTINUED) STOCK-BASED AWARDS TO EMPLOYEES (CONTINUED) At December 31, 1998, a total of 6,895,311 shares of the Company's common stock were reserved for the exercise of outstanding stock warrants and options and conversion of convertible preferred stock. 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 which 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 who have completed three months of service are eligible to participate in the Plan and are fully vested. 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. Contribution expense related to the Plan during 1996, 1997, and 1998 was $100,000, $200,000 and $194,000, respectively. S-26 59 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 9. FOREIGN OPERATIONS Export sales were $8.8 million, $20.7 million and $27.6 million in 1996, 1997, and 1998, respectively. Such revenues were derived principally from Australia, New Zealand, Canada, West Indies, South Africa and South America. Accounts receivable (billed and unbilled) arising from foreign revenues total $8 million and $12.1 million as of December 31, 1997 and 1998, respectively. Information about the Company's operations by geographic area is as follows:
1996 1997 1998 ---------------------------------- (In thousands) UNITED STATES Revenues $ 26,445 $ 32,543 $ 41,828 Income (loss) from continuing operations 301 (14,662) (4,826) Long-lived assets 4,482 3,425 2,571 Identifiable Assets 16,086 16,148 21,324 EUROPE/FAR EAST Revenues $ 479 $ 244 $ 4,077 Income (loss) from continuing operations (162) (1,153) (149) Long-lived assets 12 179 434 Identifiable Assets 108 340 709
S-27 60 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 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 1996 1997 1998 ---------------------------- (In thousands) Furniture and equipment acquired under capital lease obligations $933 $358 $ 382 ============================ Cash paid for interest $204 $277 $1,303 ============================ Cash paid for income taxes $ 65 $128 $ 188 ============================
11. YEAR 2000 DATE CONVERSION (UNAUDITED) The Company develops software products which are date sensitive and affected by the Year 2000 issue. The Company believes that it has taken all steps necessary to ensure that all currently supported mainframe products, with the exception of CardPac(TM) and VISION21(TM) products, are Year 2000 ready. The Company anticipates completing testing and reprogramming procedures to ensure Year 2000 readiness for currently supported non-mainframe products by the third quarter of 1999. The Company has taken steps to inform users of CardPac and VISION21 products that such products are not Year 2000 ready and that the Company does not plan to modify such products to ensure Year 2000 readiness. Accordingly, the Company would not be responsible for Year 2000 problems related to CardPac or VISION21 products. In early 1999, internal use software programs not already upgraded, will be upgraded to provide for Year 2000 compliance. The Company is communicating with vendors and other third party service providers regarding the status of their Year 2000 readiness. The Company's operations may be affected by Year 2000 issues affecting third parties with whom it has relationships (e.g., utilities and banks). A Year 2000 problem affecting those third parties that the Company relies upon, may have a material adverse effect on its business, financial condition and S-28 61 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. YEAR 2000 DATE CONVERSION (UNAUDITED) (CONTINUED) results of operations. The Company is not aware of any third parties on which the Company's operations materially rely, that will not be Year 2000 ready, but can not fully assess the potential exposure of third parties. Many hardware, operating systems and application products developed by third parties interact or operate with the Company's software products. In addition, customers or others may modify the Company's software products after they have been installed. The Company can not assess the Year 2000 readiness of these third parties' hardware and software products, operating systems or modified software products. If these third party products are not Year 2000 ready, it could adversely affect the performance and functionality of the Company's products that work with these products. Although the Company would not be responsible for these Year 2000 problems, it is unable to assess the effect they may have on the Company's business, financial condition and results of operations. The Company has incurred significant costs to make its products and internal systems Year 2000 ready, consisting primarily of internal labor costs. The Company does not expect the cost of future Year 2000 readiness to be material to its financial statements. A contingency plan for business continuation will be developed in the event that any vendor-supplied software does not meet the Company's Year 2000 readiness deadlines, or in the event of a systems failure due to the Year 2000. There can be no assurance that assessments to date will prove to be accurate. Serious deficiencies which are not currently identified or fully understood may arise in the future and may have a material adverse impact on the Company's business, financial conditions and results of operations. S-29 62 PaySys International, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 12. SUBSEQUENT EVENTS (UNAUDITED) On April 15, 1999, the Company entered into a Senior Subordinated Note and Warrant Purchase Agreement ("the Agreement") pursuant to which the Company issued a $15,000,000 Senior Subordinated Note ("Note"). The proceeds were applied to retirement of the 13.5% $4,000,000 note payable due March 31, 2001 and of the remaining $4,193,840 principal amount of the 12% note payable due April 30, 2001. The balance of the proceeds will be used for general corporate purposes. The Note is payable on April 15, 2006, and bears interest at 12.5% annually, to be paid quarterly in arrears beginning in June 1999. 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 in the Agreement. The Agreement contains covenants restricting additional borrowings, the incurrence of liens on assets, the acquisition and disposition of assets, capital expenditures and distributions to shareholders. The Company issued a common stock purchase Warrant covering 999,563 shares at an exercise price of $0.01 per share in conjunction with the issuance of the Note. The Warrant is exercisable between April 15, 1999 and April 15, 2006. In the event of a change in control or an event of default, as defined in the Agreement, or within one year of the redemption of all outstanding shares of Series A-1 Preferred Stock, the holder or holders of the Warrant have the right to put the Warrant to the Company at the then current fair market value of the shares underlying the Warrant. Warrantholders 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. S-30 63 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Visibility Inc.: We have audited the accompanying consolidated balance sheets of Visibility Inc. (a Delaware corporation) and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, redeemable convertible preferred stock and stockholders' deficit and cash flows for each of the three years in the period ended December 31, 1998. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Visibility Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule of Visibility Inc. and subsidiaries listed 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 consolidated financial statements. The schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. Arthur Andersen LLP Boston, Massachusetts April 20, 1999 S-31 64 VISIBILITY INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997
ASSETS 1998 1997 CURRENT ASSETS: Cash and cash equivalents $ 1,162,605 $ 2,629,725 Accounts receivable, net of allowance for doubtful accounts of $424,000 and $484,000 in 1998 and 1997, respectively 8,563,901 3,820,103 Prepaid expenses and other current assets 509,604 304,997 ------------ ------------ Total current assets 10,236,110 6,754,825 PROPERTY AND EQUIPMENT, NET 1,112,122 1,308,133 OTHER ASSETS 225,348 144,090 ------------ ------------ Total assets $ 11,573,580 $ 8,207,048 ============ ============ LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES: Short-term bank loans $ 1,500,000 $ 1,500,000 Current portion of capital lease obligations 188,068 285,997 Accounts payable 3,220,513 2,156,923 Accrued expenses 3,507,122 3,234,427 Deferred revenue 5,986,378 4,716,824 ------------ ------------ Total current liabilities 14,402,081 11,894,171 NOTES PAYABLE TO SHAREHOLDERS 1,602,378 1,525,453 CAPITAL LEASE OBLIGATIONS 192,706 122,441 DEFERRED RENT 118,811 92,409 DEFERRED INCOME TAXES 115,000 115,000 ------------ ------------ Total liabilities 16,430,976 13,749,474 ------------ ------------ COMMITMENTS AND CONTINGENCIES (Note 10) REDEEMABLE CONVERTIBLE PREFERRED STOCK Series A redeemable convertible preferred stock, $.001 par value- Authorized, issued and outstanding--1,881,721 shares, at redemption value (liquidation preference of $5,250,000) 5,250,000 5,250,000 Series B redeemable convertible preferred stock, $.001 par value- Authorized, issued and outstanding--1,628,700 shares, at redemption value (liquidation preference of $879,500) 879,500 879,500 Series C redeemable convertible preferred stock, $.001 par value- Authorized, issued and outstanding--337,331 shares, at redemption value 2,250,000 2,250,000 (liquidation preference of $2,250,000) ------------ ------------ Total redeemable convertible preferred stock 8,379,500 8,379,500 STOCKHOLDERS' DEFICIT Common stock, $.001 par value- Authorized--15,000,000 shares Issued and outstanding--1,189,669 shares 1,190 1,190 Additional paid-in capital 452,397 452,397 Accumulated deficit (13,692,297) (14,371,273) Accumulated other comprehensive income (loss) 1,814 (4,240) ------------ ------------ Total stockholders' deficit (13,236,896) (13,921,926) ------------ ------------ Total liabilities, redeemable convertible preferred stock and stockholders' deficit $ 11,573,580 $ 8,207,048 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. S-32 65 VISIBILITY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 REVENUES: Software licenses $ 10,580,620 $ 7,468,984 $ 4,981,589 Maintenance and support services 15,648,548 11,866,985 11,214,147 Hardware equipment sales 3,963,723 2,513,204 3,786,319 ------------ ------------ ------------ 30,192,891 21,849,173 19,982,055 ------------ ------------ ------------ COST OF REVENUES: Software licenses 2,140,600 1,382,908 1,212,307 Maintenance and support services 8,874,150 7,825,208 7,722,279 Hardware equipment sales 3,208,613 1,997,848 3,296,766 ------------ ------------ ------------ 14,223,363 11,205,964 12,231,352 ------------ ------------ ------------ Gross profit 15,969,528 10,643,209 7,750,703 OPERATING EXPENSES: Selling and marketing 5,928,999 5,231,012 6,347,771 Research and development 6,628,824 5,370,082 3,931,914 General and administrative 2,372,088 2,934,459 3,230,043 ------------ ------------ ------------ 14,929,911 13,535,553 13,509,728 ------------ ------------ ------------ Income (loss) from operations 1,039,617 (2,892,344) (5,759,025) INTEREST EXPENSE, NET 315,392 448,801 252,996 OTHER (INCOME) EXPENSE, NET (19,751) 19,169 25,695 ------------ ------------ ------------ Income (loss) before provision for income taxes 743,976 (3,360,314) (6,037,716) PROVISION FOR INCOME TAXES 65,000 -- 10,440 ------------ ------------ ------------ Net income (loss) $ 678,976 $ (3,360,314) $ (6,048,156) ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements. S-33 66 VISIBILITY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
-------------------------REDEEMABLE CONVERTIBLE PREFERRED STOCK--------------------------- REDEEMABLE CONVERTIBLE REDEEMABLE CONVERTIBLE REDEEMABLE CONVERTIBLE PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK SERIES A SERIES B SERIES C SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT BALANCE, DECEMBER 31, 1995 -- $ -- -- $ -- -- $ -- COMPREHENSIVE LOSS: Net loss -- -- -- -- -- -- Comprehensive loss -- -- -- -- -- -- ----------- ------------ ----------- ------------ ----------- ---------- BALANCE, DECEMBER 31, 1996 -- -- -- -- -- -- Issuance of Series A preferred stock 1,881,721 5,250,000 -- -- -- -- Conversion of common stock to preferred stock -- -- 1,628,700 879,500 337,331 2,250,000 COMPREHENSIVE LOSS: Net loss -- -- -- -- -- -- Foreign currency translation adjustment -- -- -- -- -- -- Comprehensive loss -- -- -- -- -- -- ----------- ------------ ----------- ------------ ----------- ---------- BALANCE, DECEMBER 31, 1997 1,881,721 5,250,000 1,628,700 879,500 337,331 2,250,000 COMPREHENSIVE INCOME: Net income -- -- -- -- -- -- Foreign currency translation adjustment -- -- -- -- -- -- Comprehensive income -- -- -- -- -- -- ----------- ------------ ----------- ------------ ----------- ---------- BALANCE, DECEMBER 31, 1998 1,881,721 $ 5,250,000 1,628,700 $ 879,500 337,331 $ 2,250,000 =========== ============ =========== ============ =========== =========== ---------------------------------------STOCKHOLDERS' DEFICIT---------------------------- COMMON STOCK ADDITIONAL COMPREHENSIVE ACCUMULATED ACCUMULATED SHARES AMOUNT PAID-IN INCOME (LOSS) OTHER DEFICIT CAPITAL COMPREHENSIVE INCOME (LOSS) BALANCE, DECEMBER 31, 1995 3,155,700 $ 3,156 $ 3,579,931 $ -- $ (4,962,803) COMPREHENSIVE LOSS: Net loss -- -- -- $ (6,048,156) -- (6,048,156) ------------ Comprehensive loss -- -- -- $ (6,048,156) -- -- ---------- ---------- ----------- ============ ------------- ------------ BALANCE, DECEMBER 31, 1996 3,155,700 3,156 3,579,931 -- (11,010,959) Issuance of Series A preferred stock -- -- -- -- -- Conversion of common stock to preferred stock (1,966,031) (1,966) (3,127,534) -- -- COMPREHENSIVE LOSS: Net loss -- -- -- $ (3,360,314) -- (3,360,314) Foreign currency translation adjustment -- -- -- (4,240) (4,240) -- ------------ Comprehensive loss -- -- -- $ (3,364,554) -- -- ---------- ----------- ----------- ============ ------------- ------------ BALANCE, DECEMBER 31, 1997 1,189,669 1,190 452,397 (4,240) (14,371,273) COMPREHENSIVE INCOME: Net income -- -- -- $ 678,976 -- 678,976 Foreign currency translation -- -- -- 6,054 6,054 -- adjustment ------------ Comprehensive income -- -- -- $ 685,030 -- -- ---------- ----------- ----------- ============= ------------- ------------ BALANCE, DECEMBER 31, 1998 1,189,669 $ 1,190 $ 452,397 $ 1,814 $(13,692,297) ========== =========== =========== ============= ============ -------------- TOTAL STOCKHOLDERS' DEFICIT BALANCE, DECEMBER 31, 1995 $ (1,379,716) COMPREHENSIVE LOSS: Net loss (6,048,156) Comprehensive loss -- ------------ BALANCE, DECEMBER 31, 1996 (7,427,872) Issuance of Series A preferred stock -- Conversion of common stock to preferred stock (3,129,500) COMPREHENSIVE LOSS: Net loss (3,360,314) Foreign currency translation adjustment (4,240) Comprehensive loss -- ------------ BALANCE, DECEMBER 31, 1997 (13,921,926) COMPREHENSIVE INCOME: Net income 678,976 Foreign currency translation adjustment 6,054 Comprehensive income -- ------------ BALANCE, DECEMBER 31, 1998 $(13,236,896) ============
The accompanying notes are an integral part of these consolidated financial statements. S-34 67 VISIBILITY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 678,976 $(3,360,314) $(6,048,156) Adjustments to reconcile net income (loss) to net cash used in operating activities- Depreciation and amortization 734,440 911,003 1,140,699 Interest expense capitalized to debt 76,925 57,016 -- Changes in assets and liabilities, net of assets acquired- Accounts receivable, net (4,743,798) (377,113) 987,236 Prepaid expenses and other current assets (204,607) (128,544) 163,168 Accounts payable 1,063,590 (167,529) 670,570 Accrued expenses 272,695 201,367 380,577 Deferred revenue 1,269,554 557,387 1,760,649 Deferred rent 26,402 26,403 26,402 ----------- ----------- ----------- Net cash used in operating activities (825,823) (2,280,324) (918,855) ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition, net of cash acquired (126,000) (23,346) -- Purchases of fixed assets (206,878) (372,292) (1,026,353) Other assets (3,078) 15,626 3,858 ----------- ----------- ----------- Net cash used in investing activities (335,956) (380,012) (1,022,495) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of Series A preferred stock -- 3,500,000 -- Proceeds from issuance of notes payable -- 2,200,000 800,000 Repayment of notes payable -- (250,000) (172,817) Payment of capital lease obligation (311,395) (358,092) (352,771) Payments of short-term bank loans, net -- (600,000) 2,100,000 ----------- ----------- ----------- Net cash provided by (used in) financing activities (311,395) 4,491,908 2,374,412 ----------- ----------- ----------- FOREIGN EXCHANGE IMPACT ON CASH 6,054 (4,240) -- ----------- ----------- ----------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1,467,120) 1,827,332 433,062 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 2,629,725 802,393 369,331 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,162,605 $ 2,629,725 $ 802,393 =========== =========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for- Interest $ 242,771 $ 236,980 $ 183,487 =========== =========== =========== Income taxes $ -- $ -- $ -- =========== =========== =========== SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES: Acquisition of equipment under capital lease $ 283,731 $ -- $ 32,768 =========== =========== =========== Conversion of notes payable into 627,240 shares of Series A Redeemable Convertible Preferred Stock $ -- $ 1,750,000 $ -- =========== =========== =========== Acquisition of certain assets of the former European distributor- Fair value of assets acquired- Equipment $ -- $ 109,135 $ -- Goodwill and other intangible assets 126,000 140,865 -- ----------- ----------- ----------- 126,000 250,000 -- Forgiveness of Visibility debt, net -- (226,654) -- ----------- ----------- ----------- Cash payment for acquisition $ 126,000 $ 23,346 $ -- =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. S-36 68 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 (1) NATURE OF THE BUSINESS Visibility Inc., a Delaware corporation, and subsidiaries (the Company), develops, markets, sells and supports an integrated line of business application software for manufacturers. The Company is subject to a number of risks similar to those of other companies in a similar stage of development. Principal among these risks are the ability to obtain adequate financing, dependence on key individuals, successful development and marketing of services and products, and competition from other companies. Management believes that its current cash reserves and available borrowings under the Company's bank line of credit will provide sufficient working capital to finance the Company through December 31, 1999. The Company may attempt to raise additional capital during 1999 in order to fund operations, product marketing and development, and working capital requirements. There can be no assurance that additional financing will be available or on terms favorable to the Company. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A summary of the Company's significant accounting policies follows: Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain prior-year balances have been reclassified in order to conform with current year presentation. Principles of Consolidation The accompanying financial statements include the accounts of the Company and its wholly owned subsidiaries after elimination of intercompany accounts and transactions. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. The Company invests in a money market account and believes the investment is subject to minimal credit and market risk. The carrying amounts of cash and cash equivalents approximate their fair value due to the short-term maturities of these investments. S-36 69 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 Foreign Currency Translation The functional currency for the Company's United Kingdom subsidiary is the British pound sterling. Gains (losses) from foreign currency translations of the United Kingdom subsidiary are credited or charged to accumulated other comprehensive income (loss), which is included as a component of stockholders' equity in the accompanying consolidated balance sheets. The functional currency of the Company's other foreign operations is the U.S. dollar. Gains and losses resulting from the remeasurement of foreign currencies into U.S. dollars for these subsidiaries are included in the results of operations and the amounts are insignificant. Fair Value of Financial Instruments The Company's financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable and long-term debt. The carrying amounts of the Company's cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to their short-term nature. See Note 6 for fair value information pertaining to the Company's long-term debt. Revenue Recognition In October 1997, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 97-2, Software Revenue Recognition. SOP 97-2 was adopted by the Company effective January 1, 1998 and has not had a material effect on revenue recognition. In accordance with the provisions of SOP 97-2, the Company recognizes revenue from noncancelable software licenses upon product shipment, provided collection is probable and no significant vendor and postcontract customer obligations remain at the time of shipment. Sales of the Company's products do not require significant production, modification or customization of software. Installation of the software is routine, requires insignificant effort and is not essential to the functionality of the system or software. The Company accounts for insignificant vendor obligations by deferring a portion of the revenue and recognizing it when the related services are performed. Postcontract support (maintenance) service fees are typically billed separately and are recognized on a straight-line basis over the life of the applicable agreement. The Company recognizes service revenues from consulting and implementation services, including training, provided by both its own personnel and by third parties, upon performance of the services. Long-term service and development contracts are recognized using the percentage of completion method. Revenue from equipment sales is recognized upon shipment of the equipment. Impairment of Long-Lived Assets In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This statement addresses the accounting for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. S-37 70 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 This statement requires that long-lived assets, including intangibles, be reviewed for impairment whenever events or changes in circumstances, such as a change in market value, indicates that the asset's carrying amounts may not be recoverable. Impairment losses are to be measured and recorded based on the fair value of the asset. Capitalized Software Development Costs The Company capitalizes certain software development costs after technological feasibility of the product has been established. Costs incurred prior to the establishment of technological feasibility are charged to research and development expense. The Company capitalized no software developments costs during 1998, 1997 and 1996, as the costs incurred after technological feasibility was established were deemed to be immaterial. Capitalized software costs are amortized ratably over the useful life of the product, generally two years, and are charged to cost of revenues. There was no amortization expense for the years ended December 31, 1998 and 1997 relating to capitalized software. Amortization expense for the year ended December 31, 1996 was $312,000, including $111,000 of previously capitalized software costs expensed to cost of revenues because their future realization was uncertain. Income Taxes The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences, utilizing current tax rates, of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Recent Accounting Pronouncements In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS 133 will be effective for the Company's year ending December 31, 2000. Management believes that this statement will not have a significant impact on the Company. In March 1998, the AICPA issued Statement of Position (SOP) 98-4, which amends certain provisions of SOP 97-2. The Company believes it is in compliance with the provisions of SOP 97-2 as amended by SOP 98-4. However, detailed implementation guidelines for this standard have not been issued. Once issued, such guidance could lead to unanticipated changes in the Company's current revenue recognition practices, and such changes could be material to the Company's results of operations. In December 1998, the AICPA issued Statement of Position 98-9, which amends certain provisions of SOP 97-2 and extends the deferral of the application of certain passages of SOP 97-2 provided by SOP 98-4 until 2000. The Company is currently evaluating the impact of SOP 98-9 on its financial statements and related disclosures. S-38 71 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 In March 1998, the AICPA issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. This standard requires companies to capitalize qualifying computer software costs which are incurred during the application development stage and amortize them over the software's estimated useful life. The Company is required to adopt this standard in 1999 and is currently evaluating the impact that its adoption will have on the consolidated financial position and results of operations of the Company. (3) ACQUISITION On May 15, 1997, the Company established a wholly owned UK subsidiary, Visibility Europe Ltd. (the Subsidiary), which acquired certain equipment and intangible assets of the Company's then European distributor, whose parent company was formerly also a minority stockholder of the Company, for $250,000. The purchase price was allocated $109,135 to equipment and $140,865 to goodwill and other intangibles, which are being amortized on a straight line basis over three years. This acquisition was accounted for as a purchase. Additional purchase price is contingent on the Subsidiary achieving certain profitability levels for 1997 and 1998, which the Company did not meet in 1997. The Company achieved the 1998 targeted profitability, resulting in an additional $126,000 of contingent consideration. This contingent payment has been accounted for as an addition to goodwill. Pro forma information for this acquisition has not been presented as the impact was not material. (4) PROPERTY AND EQUIPMENT Property, plant and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Maintenance and repair costs are charged to expense as incurred. Fixed assets consist of the following at December 31, 1998 and 1997:
ESTIMATED USEFUL LIVES 1998 1997 Furniture and fixtures 5 years $ 528,255 $ 591,253 Equipment 1-3 years 3,192,787 2,717,463 Computer software 3 years 541,847 463,482 Leasehold improvements 2-10 years 350,411 350,493 ---------- ---------- 4,613,300 4,122,691 Less--Accumulated depreciation and amortization 3,501,178 2,814,558 ---------- ---------- $1,112,122 $1,308,133 ========== ==========
Included above is equipment held under capital leases with a cost of $943,950 and $1,683,114, and accumulated amortization of $531,633 and $1,358,397 at December 31, 1998 and 1997, respectively. S-39 72 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 (5) LINE OF CREDIT The Company has a line of credit with a bank which allows for borrowings of up to $2,500,000. Borrowings are limited to the lesser of a borrowing base calculation based on certain percentages of accounts receivable, as defined, or $2,500,000. The borrowing base at December 31, 1998 was $2,500,000. Interest accrues at the bank's prime lending rate (7.75% at December 31, 1998) plus 2%. Borrowings are secured by substantially all assets of the Company. At December 31, 1998, the Company had borrowed $1,500,000 under the line of credit. In connection with the November 1997 amendment of this agreement, the Company issued the bank a warrant to purchase 71,685 shares of common stock at an exercise prices of $2.79 per share. The fair value of this warrant was immaterial. In connection with the April 1998 amendment of this agreement, the bank will be issued a warrant to purchase 10,526 shares of common stock at an exercise price of $4.75 per share in the event the Company defaults under this agreement, as defined. To date, no warrants have been issued as the Company has been in compliance. The agreement also requires the Company to achieve minimum levels of profitability and quick ratio, as defined. The bank also requires the Company to cause outstanding borrowings to not exceed $1,500,000 for at least five consecutive days per quarter, among other restrictions. The Company was in compliance with these covenants as of December 31, 1998. Subsequent to year end, the bank agreed to renew the line of credit agreement through April 4, 2000 and lower the interest rate to prime plus 1.5%. Additionally, the requirement to cause outstanding borrowings to not exceed $1,500,000 for at least five consecutive days per quarter was increased to $1,750,000. The renewed agreement will also require the Company to achieve a minimum debt service coverage ratio, as defined. (6) LONG-TERM DEBT The Company has $327,000 of notes outstanding to a stockholder as of December 31, 1998 and December 31, 1997. The notes accrue interest at the prime rate (7.75% at December 31, 1998) plus 3% per annum. During 1997, the maturity date was extended to March 31, 1999. Subsequent to year end, the maturity date was further extended to January 1, 2000 and, accordingly, the outstanding borrowings and accrued interest of $473,000 are reflected as noncurrent in the accompanying balance sheet. The borrowings are secured by the Company's accounts receivable. During November 1996, the Company entered into several stockholder note agreements, totaling $800,000. During 1997, the Company entered into several additional stockholder note agreements, totaling $1,200,000, of which $250,000 was repaid during 1997. All of these notes were due upon demand, carried a rate of 10% per annum and were unsecured. All of the outstanding notes were converted into Series A Preferred Stock in 1997 (see Note 12). The Company has $1,000,000 of borrowings under a senior subordinated note agreement due to a shareholder, the parent company of its former European distributor. The note plus accrued interest is reflected as a long-term note payable in the accompanying balance sheets and is due on May 15, 2000. The note is subject to acceleration provisions upon the closing of an initial public offering, sale or other disposition, as defined. The note accrues interest at 8% per annum, payable upon maturity, and is S-40 73 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 unsecured. As part of the financing, the Company also issued a warrant for the purchase of up to 50,000 shares of common stock at $6.67 per share. The fair value of the warrant was not material. The warrant expires upon repayment of the senior subordinated note. Interest expense for 1998 and 1997 on these notes payable to stockholders totaled $120,000 and $110,000, respectively. The fair value of the Company's debt approximates its carrying value based on the current rate offered to the Company for obligations of the same remaining maturities. (7) RELATED PARTY TRANSACTIONS During 1996 and the beginning of 1997, the Company had a distribution agreement that provided a stockholder with exclusive distribution rights in certain European markets in exchange for royalties which management believes represented fair value as negotiated on an arms-length basis. Royalty income received during the years ended December 31, 1997 and 1996 amounted to approximately $0 and $592,000, respectively. Maintenance and service revenue from this stockholder for the years ended December 31, 1998, 1997 and 1996 was approximately $28,000, $48,000 and $44,000, respectively. The Company reimbursed this stockholder approximately $7,000, $188,000 and $323,000 in 1998, 1997 and 1996, respectively, for expenses incurred by the Company but paid by this stockholder. At December 31, 1998, accounts receivable included approximately $13,000 related to this stockholder. (8) BENEFIT PLAN The Company has a defined contribution plan, which is qualified under Section 401(k) of the Internal Revenue Code. The plan covers substantially all employees who meet minimum age and service requirements and allows participants to defer a portion of their salary. After one year of employment, the Company contributes 25% of the employee's contribution, up to a maximum of 6% of the employee's salary. Employer contributions may be suspended at the option of the Board of Directors. The Company's contributions to the plan for the years ended December 31, 1998, 1997 and 1996 were approximately $100,000, $86,000 and $21,000, respectively. (9) INCOME TAXES Income (loss) before income taxes for domestic and foreign operations are as follows:
1998 1997 1996 Domestic $ 1,649,938 $(2,235,762) $(5,161,809) Foreign (905,962) (1,124,552) (875,907) ----------- ----------- ----------- $ 743,976 $(3,360,314) $(6,037,716) =========== =========== ===========
S-41 74 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 The provision for income taxes consists of the following for 1998, 1997 and 1996:
1998 1997 1996 Current tax expense- Federal $38,000 $ -- $ -- State 27,000 -- 10,440 Foreign -- -- -- ------- ------- ------- $65,000 $ -- $10,440 ======= ======= =======
The 1998 federal tax expense represents alternative minimum taxes payable and the 1998 state provision represents minimum and other non-income measured taxes. The Company utilized approximately $1,550,000 of federal and state net operating loss carryforwards in 1998 and reduced the valuation allowance accordingly. A reconciliation of the federal statutory rate to the Company's effective tax rate is as follows:
1998 1997 1996 Income tax provision (benefit) at statutory rate 34% (34)% (34)% State tax provision (benefit) 10 (4) (4) Impact of foreign tax rates 9 3 4 (Decrease) increase in valuation allowance (59) 29 35 Other 15 6 (1) --- --- --- 9% --% --% === === ===
The Company has $5,850,000 of U.S. federal net operating loss carryforwards available to reduce future taxable income, if any. These net operating loss carryforwards expire in varying amounts through 2012 and are subject to the review and possible adjustment by the Internal Revenue Service. The Company has $3,622,000 of foreign net operating loss carryforwards available to reduce future taxable income in the foreign jurisdictions, if any. Section 382 of the Internal Revenue Code and the tax laws of certain foreign jurisdictions also contain provisions that could place annual limitations on the utilization of these net operating loss carryforwards in the event of a change in ownership, as defined. S-42 75 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 Significant components of deferred income taxes are as follows:
1998 1997 Deferred tax liabilities- Depreciation and other $ 115,000 115,000 ----------- ----------- Total deferred tax liabilities $ 115,000 $ 115,000 =========== =========== Deferred tax assets- Net operating loss carryforwards $ 2,822,000 $ 3,266,000 Allowance for doubtful accounts 153,275 178,196 Deferred rent 48,713 37,887 Accrued benefits 188,430 195,330 Tax credits 402,023 362,023 Other 59,054 102,736 ----------- ----------- 3,673,495 4,142,172 Valuation allowance (3,673,495) (4,142,172) ----------- ----------- Total deferred tax assets $ -- $ -- =========== ===========
The valuation allowance at December 31, 1998 and 1997 relates to the uncertainty of realizing the tax benefits of the deferred tax assets. (10) COMMITMENTS AND CONTINGENCIES The Company leases facilities under various operating leases. The Company also leases certain equipment under noncancelable capital and operating leases. Future minimum lease commitments under all noncancelable operating and capital leases at December 31, 1998 are as follows:
OPERATING CAPITAL LEASES LEASES 1999 $ 320,057 $235,905 2000 302,699 108,442 2001 300,102 123,891 2002 305,197 -- 2003 301,234 -- Thereafter 233,182 -- ---------- -------- Total minimum lease payments $1,762,471 468,238 ========== Less--Amount representing interest 87,464 -------- Present value of minimum lease payments (including current portion of $188,068) $380,774 ========
S-43 76 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 Total rent expense under noncancelable operating leases was approximately $464,000, $491,000 and $389,000 for the years ended December 31, 1998, 1997 and 1996, respectively. (11) CONCENTRATIONS OF CREDIT RISK Financial instruments that potentially expose the Company to concentrations of credit risk include trade accounts receivable. To minimize this risk, ongoing credit evaluations of customers' financial condition are performed, although collateral is not required. The Company maintains reserves for potential credit losses. No one customer accounted for 10% or more of gross accounts receivable or total revenues in 1998, 1997 or 1996. (12) STOCKHOLDERS' EQUITY (a) Preferred Stock On October 6, 1997, the Company amended and restated its Certification of Incorporation, whereby the Company's authorized shares of $.001 par value common stock was increased to 15,000,000. The Company also authorized the issuance of 3,847,752 shares of $.001 par value preferred stock, of which 1,881,721 shares are designated as Series A Preferred Stock, 1,628,700 shares are designated as Series B Preferred Stock and 337,331 shares are designated as Series C Preferred Stock. The Company issued 1,881,721 shares of Series A Redeemable Convertible Preferred Stock in exchange for $3,500,000 of cash plus the conversion of the $1,750,000 notes payable issued in 1997 and 1996. The Company also allowed common stockholders to convert 1,966,031 shares of common stock into 1,628,700 shares of Series B Redeemable Convertible Preferred Stock and 337,331 shares of Series C Redeemable Convertible Preferred Stock. The Series A, Series B and Series C Redeemable Convertible Preferred Stock have the following rights and preferences: VOTING Preferred stockholders are entitled to vote on an as-converted basis together with common stockholders as one class. DIVIDENDS The preferred stockholders are entitled to receive dividends or other distributions equal to the dividend or distribution that would be received had the preferred stockholders converted their shares into common stock. S-44 77 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 LIQUIDATION In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company, the holders of Series A, B and C Redeemable Convertible Preferred Stock are entitled to receive a $2.79, $.54 and $6.67 per share liquidation preference, respectively, plus accrued or unpaid dividends. If the assets available for distribution are insufficient to permit payment of the liquidation preference amount, then the holders of the preferred stock shall share ratably in any distribution, as defined. After distribution to the preferred stockholders of the full liquidation preference amount, any remaining assets available for distribution are distributed both to holders of common stock and preferred stock on a pro rata basis, 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, but rather all preferred stock will be converted into common stock and share in the proceeds on a pro rata basis. CONVERSION Each share of preferred stock is convertible, at the option of the holder, into one share of common stock, adjusted for certain dilutive events, as defined. In the event of an initial public offering with a per share price of less than $15.00, each holder of the preferred stock will receive a cash payment equal to the liquidation preference (the IPO Preference Amount) and all shares shall convert automatically into common stock. The shares automatically convert upon the occurrence of a qualified offering with a per share price greater than or equal to $15.00 without any IPO Preference Amount. REDEMPTION As of March 31, 2003, the holders of the preferred stock may require the Company, with 30 days' written notice, to redeem outstanding preferred stock. The redemption price equals the liquidation preference plus all accrued but unpaid dividends. OTHER RESTRICTIONS The Corporation is restricted, without the approval of 51% of the holders of preferred stock, from issuing additional shares of preferred stock, common stock or convertible debt, altering the terms of outstanding preferred stock, amending its articles of incorporation, selling or otherwise disposing of all or substantially all of its assets or voluntary dissolving or otherwise liquidating the Company. S-46 78 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 (b) Stock Option Plans In 1994, the Company adopted the Visibility Inc. and Subsidiaries Stock Option Plan (the 1994 Plan), which is administered by the Board of Directors. The 1994 Plan provides for the issuance to key employees and directors of the Company options to purchase shares of common stock. The maximum number of shares of common stock that may be issued under the 1994 Plan is 202,500 shares. Options are granted under the 1994 Plan at exercise prices not less than the fair value of the stock on the date of grant. The options are exercisable over periods determined by the Board of Directors and expire after 10 years from the date of grant. On February 2, 1996, the Company adopted the Visibility Inc. and Subsidiaries 1996 Stock Plan (the Plan), which is administered by the Board of Directors. The Plan provides for the issuance of incentive and nonqualified options to purchase shares of common stock to key employees and directors of the Company. The maximum number of shares of common stock that may be issued under the Plan is 1,050,000 shares. Incentive stock options may be granted under the Plan at exercise prices not less than the fair value of the stock on the date of grant. The options are exercisable over periods determined by the Board of Directors and expire 10 years from the date of grant. The following summarizes the stock option activity under the Company's stock option plans:
WEIGHTED AVERAGE OUTSTANDING EXERCISE OPTIONS PRICE Balance, December 31, 1995 202,500 $0.67 Granted 758,400 1.38 Exercised -- -- Canceled (232,500) 1.60 ---------- ----- Balance, December 31, 1996 728,400 1.11 Granted 1,098,850 0.20 Exercised -- -- Canceled (674,700) 0.63 ---------- ----- Balance, December 31, 1997 1,152,550 0.40 Granted 196,300 0.40 Exercised -- -- Canceled (162,499) 0.25 ---------- ----- Balance, December 31, 1998 1,186,351 $0.42 ========== =====
S-46 79 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 At December 31, 1998, 1997 and 1996, options to purchase 549,162, 364,600 and 256,200 shares were exercisable, respectively. The options exercisable at December 31, 1998, 1997 and 1996 had a weighted average exercise price of $0.49, $0.55 and $0.73, respectively. Options generally vest over three to four years. At December 31, 1998, 66,149 shares were available for future option grants. During 1995, the Financial Accounting Standards Board issued SFAS No. 123, Accounting for Stock-Based Compensation, which defines a fair value-based method of accounting for employee stock options or similar equity instruments and encourages all entities to adopt that method of accounting for all their employee stock compensation plans. However, it also allows an entity to continue to measure compensation costs for those plans using the intrinsic method of accounting prescribed by APB Opinion 25. Entities electing to remain with the accounting in APB Opinion 25 must make pro forma disclosures of net income as if the fair-value-based method of accounting defined in SFAS No. 123 has been applied. The Company has elected to account for its stock-based compensation plans under APB Opinion 25. Had compensation costs for the stock option plan been determined using the fair value-based method as prescribed by SFAS No. 123, the Company's 1998 net income and 1997 and 1996 net losses would have been decreased and increased, respectively, to the following pro forma amounts:
1998 1997 1996 Net income (loss)- As reported 678,976 (3,360,314) (6,048,156) Pro forma 665,174 (3,373,765) (6,062,922)
Consistent with SFAS No. 123, pro forma compensation cost has not been calculated for options granted prior to January 1, 1995. Pro forma compensation cost may not be representative of that to be expected in future years. The weighted average per share fair values of options granted during 1998, 1997 and 1996 using the minimum value method were $0.09, $0.05 and $0.33, respectively. The values were estimated on the date of grant using the following weighted average assumptions for grants in 1998, 1997 and 1996: risk-free interest rate of 5.17%, 6.15% and 5.99%, respectively, expected life of five years, expected dividend yield of 0% and volatility factor of 0%. The weighted average remaining contractual life of outstanding options was 7.98 years and the range of exercise prices was $0.20 to $1.67 at December 31, 1998. S-47 80 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 (13) FOREIGN OPERATIONS The following table summarizes the Company's operations by geographic area:
1998 1997 1996 Revenues- North America $ 24,022,301 $ 19,592,990 $ 19,869,482 Europe 6,170,590 2,256,183 112,573 ------------ ------------ ------------ Consolidated total $ 30,192,891 $ 21,849,173 $ 19,982,055 ============ ============ ============ Income (loss) from operations- North America $ 1,964,561 $ (1,767,792) $ (4,883,118) Europe (924,944) (1,124,552) (875,907) ------------ ------------ ------------ Consolidated total $ 1,039,617 $ (2,892,344) $ (5,759,025) ============ ============ ============ Identifiable assets- North America $ 7,872,620 $ 6,204,875 $ 6,500,699 Europe 3,700,960 2,002,173 66,039 ------------ ------------ ------------ Consolidated total $ 11,573,580 $ 8,207,048 $ 6,566,738 ============ ============ ============
Export sales were not material in 1998, 1997 or 1996. S-48 81 SCHEDULE II VISIBILITY INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NET BALANCE AT PROVISION DEDUCTIONS BALANCE AT BEGINNING OF CHARGED TO FROM END OF PERIOD OPERATIONS FROM ALLOWANCE(1) PERIOD Year Ended December 31, 1998 $ 484 $ 40 $ (100) $ 424 Year Ended December 31, 1997 518 99 (133) 484 Year Ended December 31, 1996 325 223 (30) 518
(1) Accounts deemed uncollectable, net of recoveries. S-49 EX-2.1 2 SECURITIES PURCHASE AGREEMENT 1 EXHIBIT 2.1 COMMON STOCK SECURITIES PURCHASE AGREEMENT This agreement (this "Agreement") is made effective as of July l, 1998, between Advent Global GECC III Limited Partnership, a Delaware limited partnership (the "Purchaser"), and the Seller set forth on the signature page attached hereto (the "Seller"). WHEREAS, the Purchaser desires to purchase and the Seller desires to sell that number of shares of Common Stock (the "Common Stock"), par value $.01 per share, of PaySys International, Inc., a Florida corporation (the "Company"), listed next to the Seller on Schedule A (the "Shares"), in exchange for cash, on the terms and subject to the conditions stated herein; and WHEREAS, the Purchaser and the Company are parties to that certain Securities Purchase Agreement made effective as of June 17, 1998 (the "Series A-l Agreement"), wherein the Purchaser is acquiring Series A-l Convertible Participating Preferred Stock par value $.01 per share, of the Company, in exchange for the Shares. NOW, THEREFORE, in consideration of the mutual promises and covenants set forth herein, the parties hereto agree as follows: SECTION l AUTHORIZATION AND SALE OF THE SECURITIES 1. 1 Sale of the Securities. Subject to the terms and conditions hereof, at the Closing (as defined below), the Seller shall sell to the Purchaser, and the Purchaser shall purchase from the Seller that number of Shares specified opposite the Seller's name on the Schedule A in exchange for cash, as set forth, as to the Seller, as set forth on Schedule A. SECTION 2 CLOSING DATE: DELIVERY 2.1 Closing. The closing of the purchase and sale of the Shares (the "Closing") shall take place at the location and time set forth below on July 1, 1998, or at such other place and time upon which the Seller and the Purchaser shall agree. The date of the Closing is referred to as the "Closing Date". 2.2 Location of Closing. The Closing shall take place at the offices of Finn Dixon & Herling LLP at One Landmark Square, Stamford, Connecticut, at 10:00 a.m. on the Closing Date. 2.3 Delivery. At the Closing, the Seller shall deliver to the Purchaser the appropriate 1 2 certificate(s) representing the Shares purchased by the Purchaser at the Closing, duly executed with appropriate stock powers, signatures guaranteed, which shall be delivered against payment of the consideration therefor in the amount specified an Schedule A, by certified check or wire transfer of same day funds (or any combination thereof). SECTION 3 REPRESENTATIONS AND WARRANTIES OF THE SELLER The Seller hereby represents and warrants to the Purchaser with respect to the sale of the Shares as follows: 3.1 Title to Shares. The Seller is the record and beneficial owner of the Shares set forth opposite the Seller's name on Schedule A, free and clear of any Security Interest, and has full power and authority to convey such Shares, free and clear of any Security Interest, and, upon delivery of and payment for such Shares as herein provided, the Purchaser will acquire good, marketable and valid title thereto, free and clear of any Security Interest. 3.2 Authority Relative to this Agreement. The Seller has the full legal right and power and all authority and approval required to enter into, execute and deliver this Agreement and to perform fully the Seller's obligations hereunder and thereunder. This Agreement has been duly executed and delivered by the Seller and constitutes the legal, valid and binding obligation of the Seller enforceable against the Seller in accordance with its terms. 3.3 Absence of Conflicts. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby and the performance by the Seller of this Agreement in accordance with its terms and conditions will not: (i) require any notice to, filing or registration with, or permit, license, variance, waiver, exemption, franchise, order, consent, authorization or approval of, any other person; (ii) violate, conflict with or result in a breach of any provision of or constitute a default (or an event which, with notice or lapse of time or both, would constitute a breach or default) under, or result in the termination of, or accelerate the performance required by, or result in the creation of any Security Interest on the Shares held by the Seller or upon the assets, properties or businesses of the Seller under any of the terms, conditions or provisions of any contract or other agreement (written or oral) to which the Seller is a party or by or to which the Seller or the Shares held by the Seller are bound or subject; or (iii) violate any Law or any judgment ruling, order, writ, injunction or award of any Governmental Authority which is applicable to the Seller or to the Shares held by the Seller. 3.4 Brokers or Finders. Neither the Purchaser nor the Seller has incurred or will incur, directly or indirectly, as a result of any action take by the Seller, any liability for brokerage or finders' fees or agents' commissions or any similar charges in connection with this Agreement or any transaction contemplated hereby. 2 3 SECTION 4 REPRESENTATIONS AND WARRANTIES OF THE PURCHASER The Purchaser hereby represents and warrants to the Seller with respect to the purchase of the Shares as follows: 4. 1 Experience. The Purchaser has substantial experience in evaluating and investing in private placement transactions of securities in companies similar to the Company so that the Purchaser is capable of evaluating the merits and risks of the Purchaser's investment in the Company and has the capacity to protect the Purchaser's own interests. The Purchaser represents and warrants to the Seller that it is aware that the purchase of Shares involves substantial risk and that its financial condition and investments are such that it is in a financial position to hold the Shares for an indefinite period of time and to bear the economic risk of and withstand a complete loss of such investment. 4.2 Investment. The Purchaser is acquiring the Shares for investment for the Purchaser's own account, not as a nominee or agent, and, except as contemplated by the Series A-l Agreement, not with the view to, or for resale in connection with, any distribution thereof. The Purchaser understands that the Shares have not been, and will not be, registered under the Securities Act of 1933, as amended (the "Securities Act"), or the securities laws of any state by reason of exemptions from the registration provisions of the Securities Act and such laws which depend upon, among other things, the bona fide nature of the investment intent and the accuracy of the Purchaser's representations as expressed herein. 4.3 Rule 144. The Purchaser acknowledges that the Shares must be held indefinitely unless subsequently registered under the Securities Act or an exemption from such registration is available. The Purchaser is aware of the provisions of Rule l44 promulgated under the Securities Act which permit the limited resale of shares purchased in a private placement subject to the satisfaction of certain conditions, including, among other things, (i) the existence of a public market for the Shares, (ii) the availability of certain current public information about the Company, (iii) the resale occurring not less than one year after a party (who is not an "affiliate") has purchased and fully paid for the shares to be sold, (iv) the sale being effected through a "broker's transaction" or in transactions directly with a "market maker" (as provided by Rule l44(f)) and (v) the number of shares being sold during any three-month period not exceeding specified limitations. 4.4 No Public Market. The Purchaser understands that no public market now exists for the Shares and that there is no assurance that a public market will ever exist for the Shares. 4.5 Access to Data. The Purchaser has had an opportunity to discuss the Company's business, management, and financial affairs with the Company's management and the opportunity to review the Company's facilities and business plan. The Purchaser has also had an opportunity to ask questions of officers of the Company, which questions were answered to its satisfaction. The Purchaser acknowledges that it has had an opportunity to conduct its own independent due diligence investigation of the Company. 3 4 4.6 Authorization. This Agreement, when executed and delivered by the Purchaser, will constitute the valid and legally binding obligation of the Purchaser, enforceable in accordance with its respective terms, subject to (i) laws of general application relating to bankruptcy, insolvency, and the relief of debtors, and (ii) rules of law governing specific performance, injunctive relief, or other equitable remedies. The Purchaser has full partnership, power and authority to enter into and to perform its obligations under this Agreement in accordance with its respective terms. The Purchaser represents that it has not been organized, reorganized or recapitalized specifically for the purpose of investing in the Company. 4.7 Brokers or Finders. Neither the Purchaser nor the Seller has incurred, or will incur, directly or indirectly, as a result of any action taken by the Purchaser, any liability for brokerage or finders' fees or agents' commissions or any similar charges in connection with this Agreement or any transaction contemplated hereby. 4.8 Accredited Investor. The Purchaser (i) has adequate means of providing for his current needs, (ii) has no need for liquidity in his investment in the Shares, and (iii) is able to bear the economic risk of losing its entire investment in the Shares. The Purchaser has its principal office in the state set forth in Section 7.5 hereto. The Purchaser is an accredited investor, as such term is defined in Rule 501(a) of Regulation D promulgated under the Securities Act. SECTION 5 CONDITIONS TO THE OBLIGATIONS OF THE PURCHASER Thc obligations of the Purchaser to purchase the Shares at the Closing is, at the option of the Purchaser, subject to the fulfillment on or prior to the Closing Date of the following conditions: 5.1 Representations and Warranties. The representations and warranties made by the Seller in Section 3 of this Agreement shall have been true and correct when made, and shall be true and correct in all material respects as of the Closing Date. 5.2 Consents. The Seller shall have obtained, or shall obtain within the time periods required by applicable law, all necessary blue sky law permits and qualifications, or secured exemptions therefrom, required by any state for the sale of the Shares at the Closing and shall have obtained all other consents, permits and waivers necessary to consummate and the transactions contemplated by this Agreement, and any consents required under any agreements, licenses, leases or commitments of the Seller. 5.3 Proceedings and Documents. All corporate and other proceedings in connection with the transactions contemplated hereby and all documents and instruments incident to such transactions shall be reasonably satisfactory in substance and form to counsel for the Purchaser and they shall have received all such counterpart originals or certified or other copies of such documents as they may reasonably request. 4 5 5.4 Opinions of Counsel. The Purchaser shall have received from counsel for the Seller (who shall by reasonably acceptable to the Purchaser) an opinion, dated the Closing Date, satisfactory in form and substance to the Purchaser and their special counsel, and which shall be substantially in the form of Exhibit 1 attached hereto. 5.5 No Litigation. No action, suit or other proceeding shall be pending or threatened before any court, tribunal, or governmental authority seeking or threatening to restrain or prohibit the consummation of the transactions contemplated hereby, or seeking to obtain substantial damages in respect thereof or which would otherwise materially and adversely affect the Company, its subsidiaries, or their respective business, assets, prospects or financial condition. 5.6 Compliance with Laws. The offer and purchase and sale of the Shares to the Purchaser shall be legally permitted by all laws and regulations to which the Sellers or the Purchaser are subject. 5.7 Simultaneous Transactions. The sale and purchase at all Shares listed on Schedule A is conditioned upon the simultaneous (i) closing of the purchase by Purchaser of additional shares of Common Stock from selling stockholders in an amount that, when added to the Shares purchased hereunder, shall total not less than 699,301 shares of Common Stock and (ii) Second Closing (as such term is defined in the Series A-1 Agreement). SECTION 6 CONDITIONS TO THE OBLIGATIONS OF THE SELLER The Seller's obligation to sell the Shares at the Closing is, at the option of the Seller, subject to the fulfillment on or prior to the Closing Date of the following conditions: 6.1 Representations and Warranties. The representations and warranties made by the Purchaser in Section 4 of this Agreement shall have been true and correct when made, and shall be true and correct in all material respects as of the Closing Date. 6.2 Blue Sky Law. The Seller shall have obtained all necessary blue sky law permits and qualifications, or secured exemptions therefrom, required by any state for the offer and sale of the Shares at the Closing. 6.3 No Litigation. No action, suit or other proceeding shall be pending or threatened before any court, tribunal or governmental authority seeking or threatening to restrain or prohibit the consummation of the transactions contemplated hereby, or seeking to obtain substantial damages in respect thereof or which would otherwise materially and adversely affect the Company, its business, assets, prospects or financial condition. 5 6 SECTION 7 GENERAL PROVISIONS 7.1 Governing Law. All or part of this Agreement and the legal relations between the parties hereto has been negotiated in the State of Georgia and will be enforced under the laws of the State of Georgia without regard to its conflicts of laws provisions. 7.2 Successors and Assigns: Third Party Beneficiaries. Except as otherwise expressly limited herein, the provisions hereof shall inure to the benefit of, and be binding upon, the successors (including successor trustees, in the case of a trustee), assigns, heirs, executors. and administrators of the parties hereto. Nothing in this Agreement, expressed or implied, is intended to confer upon any party other than the parties hereto and their respective successors and assigns any rights, remedies, obligations, or liabilities under or by reason of this Agreement. 7.3 Entire Agreement: Amendment and Waiver. This Agreement constitutes the full and entire understanding and agreement between the parties with regard to the subject matter hereof and thereof and supersede all prior agreements among the parties. All prior negotiations and agreements shall be merged into this Agreement. Any term of this Agreement may be amended, and the observance of any term hereof may be waived (either generally or in a particular instance) only with the written consent of the Purchaser and the Seller. Any amendment or waiver effected in accordance with this Section 7.3 shall bc binding upon each of the parties hereto. 7.4 Survival. The representations, warranties, covenants, and agreements made herein shall survive any investigation made by the Purchaser and the closing of the transactions contemplated hereby for two years from the Closing. 7.5 Notices, etc. All notices and other communications required or permitted hereunder shall be in writing and shall be (i) mailed by registered or certified mail, postage prepaid, (ii) delivered by reliable overnight courier service, or (iii) otherwise delivered by hand, by messenger or by fax, addressed (A) if to the Purchaser, c/o Advent International Corporation, 10l Federal Street, Boston, MA 02110, Attention: Marcia Hooper, telecopier no. (617) 951-0566, or at such other address as the Purchaser shall have furnished to the Sellers in writing, with a copy to Finn Dixon & Herling LLP, One Landmark Square, Stamford, Connecticut 06901, Attention: Michael J. Herling, telecopier no. (203) 348-5777, or (B) if to the Seller, to such Seller's address set forth on Schedule A or at such other address as such Seller shall have furnished to the Purchaser in writing. 7.6 Delays or Omissions. No delay or omission to exercise any right, power, or remedy accruing to either party upon any breach or default under this Agreement, shall be deemed a waiver of any other breach or default theretofore or thereafter occurring. Any waiver, permit, consent, or approval of any kind or character on the part of either party of any breach or default under this Agreement, or any waiver on the part of any party of any provisions or conditions of this Agreement, must be in writing and shall be effective only to the extent specifically set forth in such writing. All remedies, either under this Agreement or by law or otherwise afforded to 6 7 any of the parties, shall be cumulative and not alternative. 7.7 References. Unless the context otherwise requires, any reference to a "Section" refers to a section of this Agreement. Any reference to "this Section" refers to the whole number section in which such reference is contained. 7.8 Severability. If any provision of this Agreement is held to be unenforceable under applicable law, then such provision shall be excluded from this Agreement and the balance of this Agreement shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. The court in its discretion may substitute for the excluded provision an enforceable provision which in economic substance reasonably approximates the excluded provision. 7.9 Dispute Resolution. Any claim or controversy arising out of or relating to this Agreement shall be settled by non-binding arbitration in accordance with the CPR Institute for Dispute Resolution's Rules for Non-Administered Arbitration of Business Disputes by three arbitrators, of whom each party shall appoint one. Any Arbitrator not appointed by a party shall be selected from the CPR Institute for Dispute Resolution Panels of Distinguished Neutrals. The arbitration shall be governed by re United States Arbitration Act, 9 U.S.C. 1-16. The place of arbitration shall be Atlanta, Georgia, or such other places as the parties shall mutually agree. The Arbitrators are not empowered to award damages in excess of actual damages or to award punitive damages. All applicable statutes of limitation shall be tolled while the procedures specified in this Section 7.9 are pending so long as both parries are diligently pursuing the arbitration. If one party is not diligently pursuing the arbitration, then the party diligently pursuing the arbitration may notify the other that such tolling shall cease. The parties will take such action, if any, required to effectuate such tolling. 7.10 Pronouns. All pronouns and any variation thereof refer to the masculine, feminine or neuter, singular or plural, as the identity of the person or persons may require. 7.11 Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original and enforceable against the parties actually executing such counterpart, and all of which, when taken together, shall constitute one instrument. 7.12 Remedies. The parties to this Agreement acknowledge and agree that a breach of any of the covenants of the Seller or the Purchaser set forth in this Agreement may not be compensable by payment of money damages and, therefore, that the covenants of the foregoing parties set forth in this Agreement may be enforced in equity by a decree requiring specific performance. 7.13 Certain Definitions. As used in this Agreement, the following terms shall have the following meanings unless the context otherwise requires. (i) "Governmental Authority" means any federal, state, municipal or other governmental or quasi-governmental department, commission, board, bureau, agency or instrumentality, or 7 8 any court of the United States of America or any political subdivision thereof, or of any other country. (ii) "Law" means any foreign, federal, state or local constitution, statute, regulation, rule, ordinance, code, plan, injunction, order, decree, ruling, charge or treaty. (iii) "Security Interest" means any adverse claim, mortgage, pledge, lien, encumbrance, opinion, restriction on transfer, easement, right of way, matter of survey, charge, or other security interest. Executed effective as of the date first set forth above.
THE PURCHASER: ADVENT GLOBAL GECC III LIMITED PARTNERSHIP By: Advent Global Management Limited Partnership, General Partner By: Advent International Limited Partnership, General Partner By: Advent International Corporation, General Partner By: ------------------------------------------------------- Marcia Hooper Vice President THE SELLER: INTELLIGENT SYSTEMS CORPORATION By: ------------------------------------------------------- Name: Bonnie L. Herron Title: Vice President
8 9 SCHEDULE A
- ---------------------------------------------------------------------------------------- Seller's Name and Address No. of Shares Cash Consideration - ---------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------- Intelligent Systems Corporation 437,063 $2,500,000.00 - ----------------------------------------------------------------------------------------
9 EX-21.0 3 LIST OF SUBSIDIARIES OF REGISTRANT 1 EXHIBIT 21.0 INTELLIGENT SYSTEMS CORPORATION LIST OF PRINCIPAL SUBSIDIARY COMPANIES AS OF MARCH 1, 1999
SUBSIDIARY NAME STATE OF ORGANIZATION --------------- --------------------- ChemFree Corporation Georgia HumanSoft LLC Georgia JK, Inc. Wyoming PsyCare America, LLC dba Rapha or Rapha Treatment Centers Georgia QS Technologies, Inc. Georgia Quadram Corporation Georgia
EX-23.1 4 CONSENT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K for the fiscal year ended December 31, 1998 into Intelligent Systems Corporation's previously filed Registration Statements on Form S-8 (File No. 33-99432 and No. 333-32157). Arthur Andersen LLP Atlanta, Georgia April 20, 1999 EX-23.2 5 CONSENT OF MORLEY AND SCOTT 1 EXHIBIT 23.2 19 April 1999 The Directors Intelligent Systems Corporation 4355 Shackleford Road Norcross GA 30093 U.S.A. Dear Sirs INTERQUAD SERVICES LIMITED As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K for the fiscal year ended December 31, 1998 into Intelligent Systems Corporation's previously filed Registration Statements on Form S-8 (File No. 33-99432 and No. 333-32157). Yours faithfully MORLEY & SCOTT EX-23.3 6 CONSENT OF ERNST AND YOUNG LLP 1 EXHIBIT 23.3 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-99432 and No. 333-32157) of Intelligent Systems Corporation of our report dated February 25, 1999, with respect to the consolidated financial statements of PaySys International, Inc. and Subsidiaries as of December 31, 1997 and 1998 and for the three years in the period ended December 31, 1998 included in Intelligent Systems Corporation's Form 10-K for the year ended December 31, 1998. Ernst & Young LLP April 16, 1999 Atlanta, Georgia EX-27 7 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF THE INTELLIGENT SYSTEMS CORPORATION FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 U.S. DOLLARS YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 1 461 0 2,165 0 741 4,546 2,570 0 17,099 6,372 0 0 0 51 9,591 17,099 18,253 0 12,495 25,294 0 0 290 (1,690) (152) (1,548) 0 0 0 (1,548) (.30) (.30)
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