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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 20, 1998
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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APPLIED SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 7373 36-4236010
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
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200 APPLIED PARKWAY
UNIVERSITY PARK, IL 60466
(708) 534-5575
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
TIMOTHY J. MCINTYRE
CHIEF FINANCIAL OFFICER
APPLIED SYSTEMS, INC.
200 APPLIED PARKWAY
UNIVERSITY PARK, IL 60466
(708) 534-5575
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
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COPIES TO:
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FREDERICK C. LOWINGER CHRISTOPHER D. LUEKING
SIDLEY & AUSTIN LATHAM & WATKINS
ONE FIRST NATIONAL PLAZA 233 S. WACKER DRIVE, SUITE 5800
CHICAGO, IL 60603 CHICAGO, IL 60606
(312) 853-7000 (312) 876-7700
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
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TITLE OF SECURITIES PROPOSED MAXIMUM AGGREGATE AMOUNT OF
TO BE REGISTERED OFFERING PRICE(1) REGISTRATION FEE
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Common Stock, $.01 par value........... $41,400,000 $12,213
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(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(o) under the Securities Act of 1933, as amended.
-------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY
DETERMINE.
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INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
SUBJECT TO COMPLETION, DATED JULY 20, 1998
PROSPECTUS
SHARES
APPLIED SYSTEMS, INC.
APPLIED SYSTEMS, INC.
COMMON STOCK
Of the shares of Common Stock offered hereby,
are being sold by Applied Systems, Inc. ("Applied Systems"
or the "Company") and are being sold by the Selling
Stockholders. See "Principal and Selling Stockholders." The Company will not
receive any of the proceeds from the sale of shares by the Selling Stockholders.
Prior to this Offering (the "Offering"), there has been no public market
for the Common Stock of the Company. It is currently estimated that the initial
public offering price will be between $ and $ per share. See
"Underwriting" for information relating to the determination of the initial
public offering price. Application has been made for quotation of the Common
Stock on the Nasdaq National Market under the symbol "APPS."
SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SHARES OF COMMON
STOCK OFFERED HEREBY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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PROCEEDS TO
PRICE TO UNDERWRITING PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDERS
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<S> <C> <C> <C> <C>
Per Share............... $ $ $ $
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Total(3)................ $ $ $ $
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(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended. See "Underwriting."
(2) Before deducting expenses payable by the Company estimated at $ .
(3) The Selling Stockholders have granted to the Underwriters a 30-day option to
purchase up to an aggregate of additional shares of Common
Stock solely to cover over-allotments, if any. See "Underwriting." If all
such shares are purchased, the total Price to Public, Underwriting Discount
and Proceeds to Selling Stockholders will be $ , $ and
$ , respectively.
The shares of Common Stock are offered by the several Underwriters when, as
and if delivered to and accepted by them and subject to their right to reject
orders in whole or in part. It is expected that delivery of the certificates for
the shares of Common Stock will be made on or about , 1998.
WILLIAM BLAIR & COMPANY NATIONSBANC MONTGOMERY SECURITIES LLC
THE DATE OF THIS PROSPECTUS IS , 1998
<PAGE> 3
[THE INSIDE FRONT COVER OF THE PROSPECTUS INCLUDES A DIAGRAM DEPICTING THE FLOW
OF INFORMATION AMONG INSURANCE CARRIERS, INSURANCE AGENCIES AND INSURANCE
CUSTOMERS, AS WELL AS TEXT DESCRIBING THE KEY FUNCTIONS OF THE COMPANY'S THE
AGENCY MANAGER AND DIAMOND SYSTEM AUTOMATION PRODUCTS.]
"The Agency Manager" is a registered trademark of the Company. The Diamond
System, TAM-The Vision Series, TAM Advantage, FirstRate and PolicyMiner are
trademarks of the Company. This Prospectus also includes product names and other
trade names, service marks and trademarks of other companies.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN THE
COMMON STOCK AND THE IMPOSITION OF PENALTY BIDS DURING AND AFTER THE OFFERING.
SEE "UNDERWRITING."
2
<PAGE> 4
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements, including the notes thereto, contained
elsewhere in this Prospectus. Unless otherwise indicated, the information in
this Prospectus gives effect, immediately prior to the consummation of the
Offering, to the Reorganization as described in "Reorganization and S
Corporation Distribution." References herein to the "Company" or "Applied
Systems" shall be deemed, unless the context otherwise indicates, to include (i)
with respect to periods following the consummation of the Offering, Applied
Systems, Inc., a Delaware corporation, and its subsidiaries, and (ii) with
respect to periods preceding the consummation of the Offering, ASI, Asktom and
TAM UK, each as defined in "Reorganization and S Corporation Distribution."
Unless otherwise indicated, the information in this Prospectus assumes no
exercise of the Underwriters' over-allotment option. See "Underwriting."
THE COMPANY
Applied Systems is a leading designer, developer and marketer of automation
software for independent insurance agencies. The Company's principal product,
The Agency Manager(R) ("TAM"), significantly improves the productivity and
efficiency of independent property and casualty ("P&C") insurance agencies by
combining client management, policy pricing, electronic data interchange
("EDI"), policy and claims servicing, and accounting and back office
administration into an easy to use, completely integrated, single-entry software
solution. Since the Company's founding in 1980, the Company's products have been
designed to operate on a personal computer platform, and currently support
implementations ranging from single users to large local area and wide area
networks. A significant advantage of TAM over competing products is that it
enables agencies to electronically transmit and receive industry standard
information to and from multiple insurance carriers through EDI. Agencies using
TAM account for over 40% of total industry standard EDI transactions in the P&C
insurance industry. The Company expects to introduce its newest TAM product,
TAM-Vision Series, in the third quarter of 1998. TAM-Vision Series is a Windows
NT, 32-bit, client/server product that is designed to support the next
generation of industry object-based EDI standards. The Company currently serves
over 7,500 agencies, representing over 70,000 concurrent licensed users. Fifteen
percent of the approximately 44,000 independent P&C insurance agencies in the
U.S. are currently customers of Applied Systems.
The Company has begun to leverage its insurance industry expertise through
the introduction of software solutions for P&C insurance carriers. The Company's
Diamond System is a fully integrated Microsoft Windows-based insurance carrier
automation system that offers real-time processing of policies and claims,
automates billing and facilitates the production of regulatory and statistical
reports. The Diamond System provides established EDI connections with the
Company's insurance agency customers, which the Company believes comprise the
largest base of independent agencies on a single EDI-enabled system, as well as
with other insurance agencies operating on industry standard systems. The
Company has sold the Diamond System to 13 insurance carriers to date, and
recently began an active marketing program for the product. There are
approximately 2,400 insurance carriers in the P&C industry in the U.S., most of
which have multiple lines of business in a number of states, representing an
attractive market opportunity for the Diamond System.
Applied Systems also provides its customers with support and maintenance
services, implementation and consulting services, and third-party equipment and
software. In 1997, approximately 35% of the Company's revenue was attributable
to support and maintenance agreements. These agreements entitle customers to
unlimited support as well as product enhancements and new versions of the
Company's products. Product enhancements and new versions are introduced
regularly to offer additional functionality and respond to changes in state
insurance regulations and other insurance industry and technological
developments. As evidence of their high level of satisfaction with the Company's
products and services, approximately 96% of TAM customers since 1996 have
annually renewed their support and maintenance agreements.
A.M. Best Company estimates that approximately $277 billion in total
premiums were written in the P&C insurance industry in the U.S. in 1997. The
Company estimates that agencies and carriers collectively spend a total of
approximately 3 to 4% of such premiums on information technology, including
automation
3
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software and data processing. The Company expects this spending to increase as
competitive pressures on premiums for carriers and on commissions for agencies
continue to necessitate productivity and efficiency improvements. Management
believes insurance agencies are automating to become more efficient across all
areas of their business, allowing them to dedicate more time to providing
customer service, soliciting and developing new clients and retaining and
leveraging existing accounts. Insurance carriers are also focusing on
automation, with many upgrading their systems to more current technologies,
often developed and serviced by third-party vendors, in order to realize
efficiencies and to reduce the size of their in-house technical and data
processing staffs. In addition to efforts to improve automation internally, P&C
insurance carriers are actively promoting automation for the independent
agencies who sell their products. Some insurance carriers provide incentives to
agencies that elect to automate, such as offering financing for or subsidizing
the purchase of an automation system or paying higher commissions to automated
agencies. Automation and EDI allow insurance agencies to efficiently access
policy and pricing data electronically from insurance carriers. Both insurance
agencies and carriers are focusing on EDI because it allows for a higher level
of cost-efficient communication with fewer redundant steps and reduced exposure
to errors and omissions.
Applied Systems, Inc. was incorporated in Delaware in June 1998 and is the
holding company for a business founded in 1980. The Company's principal place of
business is located at 200 Applied Parkway, University Park, IL 60466, and its
telephone number is (708) 534-5575. The Company's Internet site is
http://www.appliedsystems.com.
THE OFFERING
Shares Offered by the Company................. shares
Shares Offered by the Selling Stockholders.... shares
Common Stock Outstanding Immediately After the
Offering...................................... shares(1)
Use of Proceeds............................... General corporate purposes,
including working capital,
product development and
possible acquisitions. See "Use
of Proceeds."
Proposed Nasdaq National Market Symbol........ APPS
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(1) Excludes (i) 1,500,000 shares of Common Stock reserved for issuance under
the Company's Stock Option Plan, including shares of Common Stock
reserved for issuance pursuant to stock options being granted to certain
employees in connection with the Offering at the initial public offering
price, and (ii) 350,000 shares of Common Stock reserved for issuance
pursuant to the Company's Employee Stock Purchase Plan. See
"Management -- Stock Plans."
4
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SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
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THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
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1993 1994 1995 1996 1997 1997 1998
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STATEMENT OF OPERATIONS DATA:
Revenue............................. $48,696 $61,041 $63,234 $64,956 $76,068 $16,816 $22,042
Gross profit........................ 25,009 27,514 29,464 29,828 36,688 7,789 11,184
Non-recurring charge
(credit)(1).................... -- 54 137 6,428 (3,508) 135 --
Operating income (loss)............. 1,762 1,964 2,878 (2,919) 8,713 598 2,136
Net income (loss)(2)................ 1,336 1,577 2,492 (3,288) 8,487 517 2,110
PRO FORMA STATEMENT OF OPERATIONS DATA(3):
Operating income.................... $ 4,753 $ 6,375 $ 1,026 $ 2,341
Income tax provision................ 1,839 2,512 396 937
Net income.......................... 2,877 3,929 620 1,465
Net income per share................ $ $ $ $
Weighted average shares
outstanding(4)...................
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MARCH 31, 1998
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PRO FORMA
ACTUAL AS ADJUSTED(5)
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BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 7,899
Working capital (deficit)................................. (7,898)
Total assets.............................................. 32,707
Total debt................................................ 394
Stockholders' equity...................................... 1,008
</TABLE>
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(1) Represents a non-recurring charge (credit) related to litigation between the
Company and Harbor Software, Inc. ("Harbor"). See Note 12 of Notes to
Combined Financial Statements. See "Risk Factors -- Proprietary Rights; Risk
of Infringement."
(2) Net income (loss) excludes (i) accretion related to the redemption feature
on certain common shares of ASI and (ii) the provision for federal and
certain state income taxes due to ASI's status as an S corporation. ASI's S
corporation status will terminate at the end of the day preceding the
Reorganization. See "Reorganization and S Corporation Distribution."
(3) Pro forma to give effect to (i) the elimination of employee compensation for
Robert R. Eustace and Elsa M. Eustace, who, upon consummation of the
Offering, will no longer be active in the management of the Company or
receive compensation from the Company, which totaled $1,244,000, $1,170,000,
$293,000 and $205,000 for the years ended December 31, 1996 and 1997, and
the three month periods ended March 31, 1997 and March 31, 1998,
respectively, (ii) the elimination of the non-recurring charge (credit)
related to the Harbor litigation, (iii) income tax expense that would have
been recorded based on applicable tax rates had ASI been taxed as a C
corporation during these periods, and (iv) the elimination of accretion
resulting from the elimination of the redemption feature on certain common
shares of ASI.
(4) The number of shares estimated to be outstanding after the Reorganization,
but prior to consummation of the Offering.
(5) Pro forma as adjusted to give effect to (i) payment of an aggregate amount
of $11.0 million to ASI's current stockholders, representing the estimated
undistributed previously taxed S corporation earnings through the date of
the Offering, approximately $6.0 million of which is cash and approximately
$5.0 million of which is represented by the S Corporation Notes (as defined
herein), (ii) the recording of a deferred tax asset that will be recognized
as a result of the termination of ASI's S corporation status, which amount
would have been approximately $2.1 million as of March 31, 1998, and (iii)
the sale of shares of Common Stock offered by the Company
hereby at an assumed initial public offering price of $ , and the
application of the estimated net proceeds therefrom as described in "Use of
Proceeds." See "Reorganization and S Corporation Distribution."
5
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RISK FACTORS
In addition to the other information in this Prospectus, prospective
investors should carefully consider the following factors in evaluating an
investment in the shares of Common Stock offered hereby. This Prospectus
contains forward-looking statements which involve risks and uncertainties. The
Company's actual results may differ significantly from the results discussed in
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed in the following risk factors.
Product Concentration. The Company has derived substantially all of its
revenues from the sale of a limited number of automation products and related
services and third-party products for the P&C insurance industry. Agency system
licenses and related implementation and consulting services and third-party
products incorporated into the Company's TAM product line represented over 60%
of the Company's revenues in each of the three most recent fiscal years. The
Company expects that revenues related to this product line will continue to
account for a majority of the Company's total revenues for the foreseeable
future. The life cycle of the TAM product line is difficult to estimate due to
the potential effect of new products, applications and product enhancements in
the insurance software industry and future competition. Accordingly, the
Company's future operating results will depend, in part, on maintaining and
increasing acceptance of these products and related services. Any factors
adversely affecting the pricing of, or demand for, these products and services
or an increase in competition for such products and services could have a
material adverse effect on the Company's business, operating results and
financial condition. See "Business -- Agency Systems" and "-- Product
Development; Technological Change."
Product Development; Technological Change. The computer software industry
is subject to rapid technological change, changing customer requirements,
frequent new product introductions and evolving industry standards that may
render existing products and services obsolete. As a result, the Company's
position in its existing market or other markets that it may enter could be
altered rapidly by technological advancements not implemented by the Company.
The life cycles of the Company's products are difficult to estimate. The
products must keep pace with technological developments, conform to evolving
industry standards and address increasingly sophisticated customer needs. In
particular, the Company believes that it must continue to respond quickly to
users' needs for broad functionality and multi-platform support and to advances
in hardware and operating systems. Introduction of new products embodying new
technologies and the emergence of new industry standards or migration by
customers to new operating systems could render the Company's products obsolete
and unmarketable. There can be no assurance that the Company will not experience
future difficulties that could delay or prevent the successful development,
introduction and marketing of new products, or that new products and product
enhancements will meet the requirements of the marketplace and achieve market
acceptance. If the Company is unable to develop and introduce products in a
timely manner in response to changing market conditions or customer
requirements, the Company's business, operating results and financial condition
could be materially adversely affected.
Dependence on New Product Acceptance. As part of its product development,
the Company is continually evolving and offering new versions of its products.
The Company has developed TAM-Vision Series ("TAM-Vision"), its new version of
TAM, which is a 32-bit, client/server application. The Company expects to
introduce TAM-Vision in the third quarter of 1998. The Company is also in the
process of actively marketing the Diamond System for insurance carriers. There
can be no assurance that TAM-Vision and the Diamond System will meet the
requirements of the marketplace and achieve market acceptance. Any delay in the
commercial availability or market acceptance of such products could have a
material adverse effect on the Company's business, operating results and
financial condition.
Dependence on Insurance Industry. Since the Company's inception,
substantially all of its revenues have been derived from sales of its automation
products and related services and third-party products to the P&C insurance
industry, and its future growth is critically dependent on increased revenues
from these sources. The success of many of the Company's customers is
intrinsically linked to the health of the P&C insurance industry. The Company
believes that demand for its products and services could be disproportionately
affected by instability or downturns in the P&C insurance industry which may
cause existing and potential customers
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to exit the industry or delay, cancel or reduce any planned expenditures for
insurance automation products and related services.
Fluctuations in Quarterly Operating Results. The Company has experienced,
and expects to continue to experience, significant fluctuations in quarterly
operating results. The Company's future operating results will depend upon a
number of factors, including the demand for the Company's products, the size and
timing of specific sales and product shipments, the delay or deferral of
customer implementations, the level of product and price competition that it
encounters, the length of its sales cycles, the timing of new product
introductions and product enhancements by the Company and its competitors, the
mix of products and services sold, the timing of new hires, general economic
conditions and its ability to develop and market new products and control costs.
Historically, the Company's revenues have been significantly higher in December
and January. The Company's Diamond System product, which is expected to
represent an increasing portion of the Company's revenues, has a significantly
higher unit sales price, longer sales cycle and a potentially longer
implementation period than the Company's other products, all of which could
increase quarterly fluctuations in the Company's operating results. In addition,
a customer's decision to purchase and implement an insurance software system is
usually discretionary, involves a significant commitment of customer resources
and is subject to delays, budget cycles and internal authorization procedures of
the Company's customers. The loss or delay of individual orders could have a
significant impact on the Company's operating results, particularly on a
quarterly basis. As a result of these and other factors, the Company's operating
results for any quarter are subject to significant variation, and the Company
believes that period-to-period comparisons of its operating results are not
necessarily meaningful and should not be relied upon as indications of future
performance. It is likely that the Company's future quarterly operating results
from time to time will not meet the expectations of market analysts or
investors. In such event, the price of the Company's Common Stock would likely
be materially adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Quarterly Results of
Operations" and "-- Absence of a Public Trading Market; Offering Price; Possible
Volatility of Stock Price."
Insurance Industry Consolidation. The Company believes that the P&C
insurance industry is experiencing a period of consolidation resulting in a
decrease in the number of independent agencies, which may affect the demand for
the Company's products and its ability to generate revenues. Although the
Company has not experienced a decrease in the number of TAM users to date, the
acquisition of TAM agencies by agencies using a competitor's product could
result in such a decrease. Any resulting decline in demand for the Company's
products could have a material adverse effect on the business, operating results
and financial condition of the Company.
Competition. The market for the Company's products is highly competitive.
The Company competes on the basis of product features, support and maintenance
programs, and price. A variety of companies currently offer products that
compete with one or more of the Company's product lines. In addition, as the
Company targets new markets and introduces new product lines, it expects to
encounter competition from additional competitors. In the independent insurance
agency market, the Company believes that its most significant competition comes
from systems developed by other insurance software vendors such as AMS and
Delphi. In the P&C insurance carrier market, the Company believes that its most
significant competition comes from policy and claims administration and
information systems developed in-house by insurance carriers. Carriers that
perform in-house administration typically have made a significant investment in
their policy and claims administration systems. In addition, insurance carrier
personnel have a vested interest in maintaining these responsibilities in-house.
The Company also competes with carrier software vendors, including PMSC and
INSpire. Many of the Company's existing competitors, as well as a number of
potential new competitors, have significantly greater financial, technical and
marketing resources than the Company. There can be no assurance that the Company
will be able to compete successfully against current or future competitors or
that competition will not have a material adverse effect on the Company's
business, operating results and financial condition.
Management of Growth, Recruitment and Retention of Technical Personnel. The
growth in the size and complexity of the Company's business and expansion of its
product lines and its customer base have placed, and are expected to continue to
place, a significant strain on the Company's management and operations. The
7
<PAGE> 9
Company's ability to compete effectively and to manage any future growth will
depend on its ability to continue to implement and upgrade insurance software
products on a timely basis and will require it to recruit and hire additional
senior managers, as well as a substantial number of technology, sales and
marketing, and training and support personnel. At various times, the Company has
experienced delays in implementations of its systems due to a shortage of
technical employees and may continue to experience delays in the future.
Competition for technical, marketing, sales and management employees is intense
and the process of locating personnel with the combination of skills and
attributes required to execute the Company's strategy can be difficult,
time-consuming and expensive. There can be no assurance that the Company will be
successful at hiring or retaining such personnel, or that the Company's
personnel, system procedures and controls will be adequate to support the
Company's operations. Any failure to implement and upgrade the Company's
insurance software products or to attract, train, motivate or manage employees
could have a material adverse effect on the Company's business, operating
results and financial condition. See "-- Dependence on Key Personnel," "Business
- -- Employees" and "Management."
Product Liability; Product Defects. The Company's software products are
highly complex and sophisticated and could, from time to time, contain design
defects or software errors that could be difficult to detect and correct.
Despite extensive testing, the Company from time to time has discovered defects
or errors in its products only after its systems have been used by customers. In
addition, the Company or its customers may from time to time experience
difficulties relating to the integration of the Company's products with other
hardware or software in the customer's environment. There can be no assurance
that such defects, errors or difficulties will not cause future delays in
product introductions and shipments, result in increased costs and diversion of
development and support resources, require design modifications or impair
customer satisfaction with the Company's products. Design defects, software
errors, misuse of the Company's products, incorrect data from external sources
or other potential problems within or outside of the Company's control that may
arise from the use of the Company's products could result in financial or other
damages to the Company's customers. The Company does not maintain a separate
product liability insurance policy. Although the Company's license agreements
with its customers typically contain provisions designed to limit the Company's
exposure to potential claims as well as any liabilities arising from such
claims, such provisions may not effectively protect the Company against such
claims and the liability and costs associated therewith. Accordingly, any such
claim could have a material adverse effect on the Company's business, operating
results and financial condition.
Proprietary Rights; Risk of Infringement. The Company's success is heavily
dependent upon its proprietary technology. The Company relies primarily on a
combination of trade secret, copyright and trademark law, confidentiality
agreements and contractual restrictions on copying and disclosure contained in
its customer licenses and nondisclosure agreements with its employees and
contractors to protect proprietary rights in its software. The Company has no
patents or patent applications pending, and existing trade secret and copyright
laws afford only limited protection. Despite the Company's efforts to protect
its proprietary rights, unauthorized parties may attempt to copy aspects of the
Company's products or to obtain and use information that the Company regards as
proprietary. Policing unauthorized use of the Company's products is difficult
and, while the Company is unable to determine the extent to which piracy of its
software products exists, software piracy can be expected to be a persistent
problem, particularly in international markets and as a result of the growing
use of the Internet. In addition, the laws of some foreign countries do not
protect the Company's proprietary rights to the same extent as the laws of the
U.S. There can be no assurance that the steps taken by the Company to protect
its proprietary rights will be adequate or that the Company's competitors will
not independently develop products or technologies that are substantially
equivalent or superior to the Company's products or technologies. See "Business
- -- Intellectual Property Rights and Licenses."
The Company was involved in litigation in which Harbor alleged, and a trial
court found, misappropriation of trade secrets. The litigation with Harbor was
recently settled for $5.0 million. See Note 12 of Notes to Combined Financial
Statements. There can be no assurance that other third parties will not assert
infringement claims against the Company in the future with respect to past,
current or future products. As the number of software products in the industry
increases and the functionality of these products further overlaps,
8
<PAGE> 10
the Company believes that software developers may become increasingly subject to
infringement claims. Any such claims, with or without merit, can be
time-consuming and expensive to defend, cause product shipment delays or require
the Company to alter or abandon its products or enter into royalty or licensing
agreements. Such royalty agreements, if required, may not be available on terms
acceptable to the Company. Successful infringement claims against the Company
could have a material adverse effect on the Company's business, operating
results and financial condition.
Reliance on Microsoft Technologies. The Company's software products are
designed primarily to operate with Microsoft technologies, including Windows NT,
Windows 95, Windows 3.x, Microsoft Office and SQL Server, and the Company
believes it is important that its products and technology continue to be
compatible with new developments in Microsoft technology. A decreasing portion
of the Company's products are also designed to operate with Microsoft DOS.
Although the Company believes that Microsoft technologies are currently widely
utilized by businesses of all sizes, there can be no assurance that businesses
will (i) continue to adopt such technologies as anticipated, (ii) migrate from
older Microsoft technologies (such as DOS or earlier versions of Windows) to
newer Microsoft technologies or (iii) not adopt alternative technologies that
the Company does not support. If businesses do not migrate from older
technologies and adopt the Microsoft technologies with which the Company's
products are compatible or adopt alternative technologies that the Company does
not support, the Company's business, operating results and financial condition
could be materially adversely affected.
Effects of Year 2000. Certain computer software programs will be unable to
process two-digit year-date codes after December 31, 1999 (the "Year 2000
Problem"). Although the Company's insurance carrier software and the current
version of its agency management software are designed to be compatible with the
Year 2000, certain of the Company's agency customers continue to utilize prior
versions of the Company's agency management software that may be affected by the
Year 2000 Problem. Moreover, the compatibility of the Company's software with
the Year 2000 cannot be fully ascertained in advance of the Company's customers
using its products in the Year 2000. There can also be no assurance that
operating systems which support the Company's systems or third-party software
incorporated into the Company's agency management software will be fully
compatible with the Year 2000. The Company also faces risk to the extent that
suppliers of products, services and systems purchased by the Company and others
with whom the Company transacts business may not comply with Year 2000
requirements. To the extent the Year 2000 Problem affects the Company's software
or associated third party software or prevents third parties from timely
delivery of products or services required by the Company, the Company's
business, operating results and financial condition could be materially
adversely affected. Further, as automated insurance agencies explore ways to
mitigate the Year 2000 Problem, the Company may experience a slight increase in
sales of its Year 2000 compatible agency management software that may cause a
one-time increase in revenues to a level that the Company may not be able to
maintain and may, in fact, result in comparatively lower sales of its agency
management software in the periods following such increase. The Company does not
currently have an insurance policy which covers losses arising from the Year
2000 Problem. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Year 2000."
Dependence on Key Personnel. The Company's future success depends, in
significant part, upon the continued services of James P. Kellner, its Chairman
of the Board, President and Chief Executive Officer, as well as other executive
officers and key personnel. The loss of services of Mr. Kellner or one or more
of the Company's other executive officers or key employees could have a material
adverse effect on the Company's business, financial condition and results of
operations, and there can be no assurance that the Company will be able to
retain its executive officers or key personnel. See "Management."
Acquisitions. The Company may, from time to time, pursue acquisitions of
businesses, customer bases, products or technologies that complement or expand
its existing business. The Company evaluates potential acquisition opportunities
from time to time, including those that could be material in size and scope.
Acquisitions involve a number of risks, including the diversion of management's
attention from day-to-day operations to the assimilation of the operations and
personnel of the acquired companies and the incorporation of acquired
operations, customer bases, products or technologies. Such acquisitions could
also have adverse effects on the Company's operating results, and could result
in dilutive issuances of equity securities and
9
<PAGE> 11
dilution of earnings, the incurrence of debt and the loss of key employees. In
addition, many business acquisitions must be accounted for as purchases and,
because most software-related acquisitions involve the purchase of significant
intangible assets, these acquisitions typically result in substantial
amortization charges and charges for acquired research and development projects,
which could have a material adverse effect on the Company's operating results.
There can be no assurance that any such acquisitions will occur or that, if such
acquisitions do occur, the acquired businesses, customer bases, products or
technologies will generate sufficient revenue to offset the associated costs or
effects.
Reliance on Third-Party Software and Hardware. The Company incorporates
into its software products certain application software licensed from third
parties. In addition, in order to offer customers a complete automation system,
occasionally the Company will purchase servers, network software and other
software and hardware products which the Company resells or sublicenses to its
customers and installs together with the Company's products to provide a fully
operational system. If any of these third parties ceases to do business or
abandons or fails to maintain or enhance a particular software or hardware
product line or if the Company is involved in a contractual dispute with one of
its current contractual partners, the Company may need to seek other suppliers.
Any delay in finding alternative suppliers could have a material adverse effect
on the Company's business, operating results and financial condition. In
addition, there can be no assurance that the Company's current suppliers will
not significantly alter their pricing in a manner adverse to the Company. See
"Business -- Products -- Agency Systems -- Third Party Products."
International Operations; Foreign Currency Fluctuations. The Company's
customers outside the U.S. historically have been located principally in Canada
and the U.K. In the future, the Company may decide to conduct business in other
foreign countries. The Company's operations outside the U.S. are subject to
certain risks, including unexpected changes in regulatory requirements, exchange
rates, tariffs and other barriers, political and economic instability,
difficulties in managing distributors or representatives, difficulties in
staffing and managing foreign subsidiary operations, difficulties or delays in
translating products and product documentation into foreign languages, and
potentially adverse tax consequences. There can be no assurance that any of
these factors will not have a material adverse effect on the Company's business,
operating results and financial condition.
Anti-takeover Effects of Charter and Statutory Provisions. Certain
provisions of the Company's Restated Certificate of Incorporation and Restated
By-Laws and certain sections of the Delaware General Corporation Law, including
those which authorize the Company's Board of Directors to issue shares of
preferred stock and to establish the voting rights, preferences and other terms
thereof without further action by stockholders, may be deemed to have
anti-takeover effects and may discourage takeover attempts not first approved by
the Board of Directors (including takeovers which some stockholders may deem to
be in their best interests). These provisions could delay or frustrate the
removal of incumbent directors or the assumption of control by an acquirer, even
if such removal or assumption of control would be beneficial to stockholders.
These provisions also could discourage or make more difficult a merger, tender
offer or proxy contest, even if such events would be beneficial, in the short
term, to the interests of stockholders. Such provisions include, among other
things, (i) a classified Board of Directors serving staggered three-year terms,
(ii) the elimination of stockholder voting by written consent, (iii) that only
the Chairman of the Board or the Board of Directors may call special meetings of
stockholders, (iv) that directors may be removed only for cause and then only by
the holders of at least 75% of the outstanding voting power, (v) permission for
the Board of Directors, when considering a tender offer, merger or other
acquisition proposal, to take into account factors in addition to potential
economic benefits to stockholders and (vi) certain advance notice requirements
for stockholder proposals and nominations for election to the Board of
Directors. The Company is subject to Section 203 of the Delaware General
Corporation Law which, in general, imposes restrictions upon certain acquirers
(including their affiliates and associates) of 15% or more of the Company's
Common Stock.
Ownership by Management and Principal Stockholders. After consummation of
the Offering, Robert R. Eustace, the Company's founder, together with Elsa M.
Eustace, will beneficially own approximately % of the outstanding shares of
Common Stock and, together with officers, directors and relatives of certain
directors, will beneficially own approximately % of the outstanding shares
of Common Stock. By virtue of such holdings, and if and to the extent such
stockholders act in concert (although no agreement or
10
<PAGE> 12
arrangement exists requiring them to do so), such stockholders will have
substantial influence over the election of directors and other matters,
including the outcome of certain fundamental corporate transactions (such as
certain mergers and sales of assets) requiring stockholder approval. The
interests of such stockholders could conflict with the interests of other
stockholders of the Company. See "Principal and Selling Stockholders."
Shares Eligible for Future Sale. Sales of a substantial number of shares of
Common Stock in the public market after the Offering could adversely affect the
market price of the Common Stock. In addition to the shares
of Common Stock offered hereby, substantially all of the remaining shares of the
Common Stock owned by current stockholders of the Company (approximately
shares) have been held for more than one year and, as such, will be
eligible for sale in the public market beginning upon the expiration of the
lock-up agreements described below, subject to certain volume and manner of sale
restrictions imposed by Rule 144 of the Securities Act of 1933, as amended (the
"Securities Act"). Sales of a substantial number of shares of Common Stock in
the public market following the Offering, or the perception that such sales
could occur, could adversely affect the market price of the Common Stock. See
"Shares Eligible for Future Sale."
All existing stockholders of the Company have agreed not to publicly offer,
sell or otherwise dispose of any shares of Common Stock owned by them for 180
days from the date of this Prospectus without the consent of William Blair &
Company, L.L.C. However, William Blair & Company, L.L.C. may, in its sole
discretion and at any time without notice, release all or any portion of the
securities subject to such lock-up agreements. See "Underwriting."
Absence of a Public Trading Market; Offering Price; Possible Volatility of
Stock Price. Prior to the Offering, there has been no public market for the
Common Stock, and there can be no assurance that an active market will develop
upon consummation of the Offering. Consequently, the offering price of the
Common Stock will be determined by negotiations among the Company and
representatives of the Underwriters, and may not be indicative of the market
price of the Common Stock after the Offering. See "Underwriting" for a
description of the factors to be considered in the determination of the initial
public offering price of the Common Stock. The trading price of the Common Stock
also could be subject to significant fluctuations in response to variations in
quarterly operating results, the gain or loss of significant contracts, changes
in management or new products or services offered by the Company or its
competitors, general trends in the industry, changes in analyst estimates and
other events or factors. In addition, the stock market has experienced price and
volume fluctuations which have particularly affected the market price of many
companies in similar industries and which often have been unrelated to the
operating performance of these companies. These market fluctuations may
adversely affect the market price of the Common Stock.
S Corporation Distribution; Prior Tax Periods. In connection with the
distribution of estimated undistributed taxable S corporation earnings by ASI to
the current stockholders of ASI, on or before the day preceding the day of the
Reorganization ASI will make the S Corporation Distribution (as defined herein)
consisting of a cash payment of $6.0 million and the S Corporation Notes (as
defined herein). Amounts due on the S Corporation Notes will be payable only out
of future cash flow from ASI operations and none of the proceeds of the Offering
will be used to repay the S Corporation Notes. Nevertheless, the payment of the
S Corporation Distribution to the current stockholders of ASI will reduce the
amount of cash that would otherwise be available to the Company for other
corporate purposes. The actual amount of the S Corporation Distribution will
depend upon a number of factors, including actual cash receipts and
disbursements of ASI prior to the termination of ASI's S corporation status. Any
increase in the undistributed taxable S corporation earnings over the amount
currently estimated will increase the amount of the distribution to current
stockholders of ASI. See "Reorganization and S Corporation Distribution."
Since January 1987, ASI has elected to be treated for federal income tax
purposes as an "S corporation" under the Internal Revenue Code, of 1986, as
amended (the "Code") and similar treatment has been elected in certain states in
which ASI has conducted business. As an S corporation, ASI's stockholders,
rather than ASI, have been and are required to pay federal and certain state
income taxes based on ASI's taxable earnings, whether or not such earnings have
been distributed to ASI's stockholders. Notwithstanding this
11
<PAGE> 13
election, ASI might be liable for income taxes and other taxes with respect to
taxable periods prior to the day of the Offering. For example, in jurisdictions
in which ASI was not treated as an S corporation, subsequent tax adjustments
upon audit of pre-Offering periods might result in additional tax liability of
ASI. ASI might also be liable, upon audit or otherwise, for additional
non-income taxes (sales, use, payroll and other non-income taxes) in all
jurisdictions (whether or not that jurisdiction treats ASI as an S corporation).
Furthermore, if the Internal Revenue Service (or state taxing authorities) were
to challenge the status of ASI as an S corporation and prevail, then ASI would
be liable for corporate-level federal (and state) income taxes that would have
been imposed on ASI had it filed as a C corporation. The current ASI
stockholders have agreed to provide certain tax indemnities in that regard. See
"Certain Transactions."
Substantial Dilution. Purchasers of the Common Stock in the Offering will
incur an immediate substantial dilution in the net tangible book value per share
of Common Stock. Based on an assumed initial public offering price of
$ per share, as of March 31, 1998 such dilution, on a pro forma basis,
would have been $ per share. See "Dilution."
Significant Unallocated Net Proceeds. A substantial portion of the
anticipated net proceeds of the Offering has not been designated for specific
uses. Therefore, the Company will have broad discretion with respect to the use
of the net proceeds of the Offering. See "Use of Proceeds."
USE OF PROCEEDS
The net proceeds to the Company from the Offering are estimated to be
approximately $ million, assuming an initial public offering price of
$ per share and after deducting the underwriting discount and estimated
offering expenses payable by the Company. The Company will not receive any
proceeds from the sale of shares of Common Stock by the Selling Stockholders.
The principal purposes of the Offering are to obtain funds for general corporate
purposes, including working capital and product development, to facilitate the
Company's access to the public equity markets as a means of attracting and
retaining key employees and to enhance the Company's ability to use its Common
Stock as consideration for possible acquisitions. A portion of the net proceeds
may also be used to acquire or invest in complementary businesses, products or
services; however, there are no commitments or agreements with respect to any
such transaction at the present time. Pending use of the net proceeds for the
above purposes, the Company intends to invest such funds in short-term,
interest-bearing, investment-grade obligations. None of the proceeds of the
Offering will be used to pay the S Corporation Distribution.
DIVIDEND POLICY
The Company does not expect to declare or pay any cash dividends on its
Common Stock in the foreseeable future following the Offering. The Company
intends to retain earnings to finance the growth and development of its
business. The Company's current credit facility prohibits the payment of cash
dividends. Any payment of cash dividends in the future will depend upon the
financial condition, capital requirements and earnings of the Company,
limitations on dividend payments pursuant to the terms of debt agreements and
such other factors as the Board of Directors may deem relevant.
Historically, as an S corporation, ASI has made substantial cash
distributions to its stockholders. As discussed below under "Reorganization and
S Corporation Distribution," on or before the day preceding the day of the
Reorganization, ASI will make the S Corporation Distribution. Purchasers of
Common Stock in the Offering will not receive any portion of such distribution.
REORGANIZATION AND
S CORPORATION DISTRIBUTION
The business of the Company is conducted by three affiliated entities:
Applied Systems, Inc., an Illinois corporation ("ASI"); Asktom, Ltd., an Ontario
corporation ("Asktom"); and The Agency Manager Limited, a United Kingdom
unlimited liability company ("TAM UK"). In contemplation of the Offering,
12
<PAGE> 14
Applied Systems, Inc., a Delaware corporation, was formed in June 1998.
Effective immediately prior to the consummation of the Offering, all of the
equity interests in ASI and Asktom will be contributed by their holders to the
Company in exchange for Common Stock (and cash in lieu of fractional shares of
Common Stock, if any), and the stockholders (each of which is a corporation) of
TAM UK will be merged with and into the Company and those individuals owning the
capital stock of such stockholders will receive Common Stock (and cash in lieu
of fractional shares of Common Stock, if any) in such mergers (such
contributions and mergers, collectively, the "Reorganization.") See "Certain
Transactions."
Since January 1987, ASI has elected to be treated for federal and certain
state income tax purposes as an "S corporation" under the Code. As a result,
ASI's stockholders, rather than ASI, have been and are required to pay federal
and certain state income taxes based on ASI's taxable earnings, whether or not
such earnings have been distributed to ASI's stockholders. ASI will terminate
its S corporation status at the end of the day (the "Termination Date")
preceding the day of the Reorganization. ASI and the current stockholders of ASI
will enter into an agreement which, subject to certain exceptions, will provide
for income taxes attributable to periods (or portions thereof) ending on or
prior to the Termination Date to be borne by the current stockholders of ASI and
for income taxes of ASI attributable to periods (or portions thereof) beginning
after the Termination Date to be borne by ASI. See "Certain Transactions." In
connection with the termination of its S corporation status, on or prior to the
Termination Date, ASI will make one or more distributions of undistributed
previously taxed S corporation earnings to its current stockholders in the
aggregate estimated amount of $11 million (the "S Corporation Distribution"),
consisting of (i) $6.0 million in cash and (ii) $5.0 million aggregate principal
amount of promissory notes bearing interest at a rate of 7.25%, payable on or
before five years from the date of issuance (the "S Corporation Notes"). The
actual amount of such undistributed previously taxed S corporation earnings will
depend upon a number of factors, including actual cash receipts and payments
prior to the Termination Date. Any increase in such undistributed taxable S
corporation earnings will increase the amount of the S Corporation Distribution.
Amounts due on the S Corporation Notes will be payable only out of future cash
flow from ASI operations, and none of the proceeds of the Offering will be used
to repay the S Corporation Notes. ASI, as a subsidiary of the Company, will
become subject to corporate income taxation as a C corporation under the Code
and certain state laws. In accordance with Statement of Financial Accounting
Standards No. 109, ASI will record a net deferred income tax asset at the
Termination Date. If ASI were a C corporation as of March 31, 1998,
approximately $2.1 million of net deferred income tax assets would have been
recorded. The estimated net deferred income tax asset will be revised based upon
the results of operations and financial condition of ASI from March 31, 1998
through the Termination Date and may be significantly larger or smaller than the
foregoing amount. See Note 2 of Notes to Combined Financial Statements.
13
<PAGE> 15
CAPITALIZATION
The following table sets forth at March 31, 1998 (i) the actual total
short-term debt and total capitalization of the Company, (ii) such short-term
debt and capitalization on a pro forma basis to give effect to the S Corporation
Distribution, the reclassification of the deficit to additional paid-in capital
in connection with the termination of the Company's S corporation tax status,
the recording of a deferred tax asset that will be recognized as a result of the
termination of the Company's S corporation tax status, which amount would have
been approximately $2.1 million as of March 31, 1998, and the adoption of the
Restated Certificate of Incorporation and (iii) such pro forma short-term debt
and capitalization as adjusted to reflect the sale of the shares of
Common Stock offered hereby and application of the net proceeds therefrom, after
deducting the underwriting discount and estimated offering expenses. This table
should be read in conjunction with the Company's Combined Financial Statements
and related Notes thereto and other financial information appearing elsewhere in
this Prospectus. See "Use of Proceeds," "Reorganization and S Corporation
Distribution" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."
<TABLE>
<CAPTION>
MARCH 31, 1998
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------- --------- -----------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
Short-term debt:
Current portion of long-term debt........................ $ 359 $ 359
======= ======== ========
Long-term debt:
Long-term debt, less current portion..................... $ 35 $ 35
S Corporation Notes...................................... -- 5,000
------- -------- --------
Total long-term debt, less current portion....... 5,035
------- -------- --------
Stockholders' equity:
Preferred stock, $.01 par value; none authorized, issued
and outstanding, actual; 2,000,000 shares authorized,
none issued and outstanding, pro forma and pro forma
as adjusted...........................................
Common stock, $.01 par value; 100 shares authorized and 1
share issued and outstanding, actual; 45,000,000
shares authorized, shares issued and
outstanding, pro forma; and shares issued and
outstanding, pro forma as adjusted(1)............... 318 318
Additional paid-in capital............................... 2,719 (10,021)
Cumulative translation adjustment........................ 32 32
Retained earnings (deficit).............................. (1,741) 2,100
Treasury stock........................................... (320) (320)
------- -------- --------
Total stockholders' equity............................ 1,008 (7,891)
------- -------- --------
Total capitalization............................. $ 1,043 $ (2,856)
======= ======== ========
</TABLE>
- -------------------------
(1) Excludes (i) 1,500,000 shares of Common Stock reserved for issuance under
the Company's Stock Option Plan, including shares of Common Stock
reserved for issuance pursuant to stock options being granted to certain
employees in connection with the Offering at the initial public offering
price, and (ii) 350,000 shares of Common Stock reserved for issuance
pursuant to the Company's Employee Stock Purchase Plan. See "Management --
Stock Plans."
14
<PAGE> 16
DILUTION
At March 31, 1998, the Company's net tangible book value was $ or
$ per share of Common Stock. Net tangible book value per share
represents the Company's total net tangible assets less total liabilities
divided by the number of shares of Common Stock that will be outstanding
immediately after the Reorganization. Without taking into account any other
changes in net tangible book value after March 31, 1998, other than to give
effect to the receipt of its portion of the estimated net proceeds of the
Offering, at an assumed initial public offering price of $ per share,
the payment of the estimated S Corporation Distribution and the recording of net
deferred tax assets of approximately $2.1 million, the pro forma net tangible
book value of the Company on March 31, 1998 would have been $ or
$ per share. This represents an immediate increase in net tangible book
value to existing stockholders of approximately $ per share and an
immediate dilution to purchasers of Common Stock in the Offering of $
per share, as illustrated by the following:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share.......... $
Net tangible book value per share as of March 31,
1998................................................ $
Net decrease per share attributable to the S
Corporation Distribution and deferred taxes......... $
Increase attributable to new investors................
-------
Pro forma net tangible book value after the Offering..... $
-------
Dilution per share to new investors...................... $
=======
</TABLE>
The following table summarizes at March 31, 1998 on a pro forma basis after
giving effect to the Offering, the difference between existing stockholders and
new investors with respect to the number of shares of Common Stock purchased
from the Company, the total cash consideration paid to the Company, and the
average price per share paid by existing stockholders and by the purchasers of
the shares offered by the Company hereby (at an assumed initial public offering
price of $ per share):
<TABLE>
<CAPTION>
TOTAL
SHARES PURCHASED CONSIDERATION
----------------- ----------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------ ------- ------ ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders(1)(2)...................... % $ % $
New stockholders(2)..............................
--- --- --- ---
Total.................................. 100% $ 100%
=== === === ===
</TABLE>
- -------------------------
(1) The sale of Common Stock by the Selling Stockholders in the Offering will
reduce the number of shares held by existing stockholders to
shares, or approximately % of the total number of shares of Common
Stock to be outstanding after the Offering, and will increase the number of
shares held by the new stockholders to shares, or
approximately % of the total number of shares of Common Stock to be
outstanding after the Offering. See "Principal and Selling Stockholders."
(2) Excludes (i) 1,500,000 shares of Common Stock reserved for issuance under
the Company's Stock Option Plan, including shares of Common Stock
reserved for issuance pursuant to stock options being granted to certain
employees in connection with the Offering at the initial public offering
price, and (ii) 350,000 shares of Common Stock reserved for issuance
pursuant to the Company's Employee Stock Purchase Plan. See
"Management -- Stock Plans."
15
<PAGE> 17
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
the financial statements and the notes thereto included elsewhere herein. The
statement of operations data set forth below with respect to the years ended
December 31, 1995, 1996 and 1997 are derived from, and are qualified by
reference to, the audited financial statements of the Company included elsewhere
in this Prospectus. The statement of operations data set forth below with
respect to the years ended December 31, 1993 and 1994 and the selected financial
data for the quarters ended March 31, 1997 and March 31, 1998 have been derived
from the unaudited financial statements of the Company. The unaudited financial
statements have been prepared on the same basis as the audited financial
statements and, in the opinion of management of the Company, include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the information set forth therein. The results of
operations for the quarter ended March 31, 1998 are not necessarily indicative
of the results that may be expected for the full fiscal year. The selected
financial data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
Combined Financial Statements and Notes thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------------------------- -------------------
1993 1994 1995 1996 1997 1997 1998
---- ---- ---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
License......................... $11,070 $14,878 $13,836 $ 15,435 $20,291 $ 3,967 $ 5,799
Service......................... 16,910 20,474 25,861 29,125 34,793 8,185 10,665
Third-party equipment and
software...................... 20,716 25,689 23,537 20,396 20,984 4,664 5,578
------- ------- ------- -------- ------- -------- -------
Total revenue.............. 48,696 61,041 63,234 64,956 76,068 16,816 22,042
------- ------- ------- -------- ------- -------- -------
Cost of revenue:
License......................... 50 1,164 296 673 1,092 106 511
Service......................... 10,788 15,614 17,778 20,144 22,448 5,424 5,953
Third-party equipment and
software...................... 12,849 16,749 15,696 14,311 15,840 3,497 4,394
------- ------- ------- -------- ------- -------- -------
Total cost of revenue......... 23,687 33,527 33,770 35,128 39,380 9,027 10,858
------- ------- ------- -------- ------- -------- -------
Gross profit...................... 25,009 27,514 29,464 29,828 36,688 7,789 11,184
------- ------- ------- -------- ------- -------- -------
Operating expenses:
Research and development........ 5,520 7,351 7,728 7,876 9,738 2,075 2,749
Sales and marketing............. 6,970 8,893 9,067 8,224 10,182 2,374 2,977
General and administrative...... 10,757 9,252 9,654 10,219 11,563 2,607 3,322
Non-recurring charge
(credit)(1)................... -- 54 137 6,428 (3,508) 135 --
------- ------- ------- -------- ------- -------- -------
Total operating expenses...... 23,247 25,550 26,586 32,747 27,975 7,191 9,048
------- ------- ------- -------- ------- -------- -------
Operating income (loss)........... 1,762 1,964 2,878 (2,919) 8,713 598 2,136
Other income (expense), net....... (384) (299) (160) (38) 66 (10) 61
------- ------- ------- -------- ------- -------- -------
Income (loss) before income
taxes........................... 1,378 1,665 2,718 (2,957) 8,779 588 2,197
Provision for income taxes........ 42 88 226 331 292 71 87
------- ------- ------- -------- ------- -------- -------
Net income (loss)(2).............. $ 1,336 $ 1,577 $ 2,492 $ (3,288) $ 8,487 $ 517 $ 2,110
======= ======= ======= ======== ======= ======== =======
PRO FORMA STATEMENT OF OPERATIONS
DATA (UNAUDITED)(3):
Operating income.................. $ 4,753 $ 6,375 $ 1,026 $ 2,341
Income tax provision.............. 1,839 2,512 396 937
Net income........................ 2,877 3,929 620 1,465
Net income per share.............. $ $ $ $
Weighted average shares
outstanding(4)..................
BALANCE SHEET DATA:
Cash and cash equivalents......... $ 3,829 $ 2,385 $ 2,144 $ 1,780 $ 4,379 $ 3,511 $ 7,899
Working capital (deficit)......... (2,366) (5,377) (5,370) (13,380) (8,248) (13,282) (7,898)
Total assets...................... 16,034 20,871 20,423 20,676 32,577 21,432 32,707
Total debt........................ 4,075 3,617 4,050 1,039 536 884 394
Total stockholders' equity
(deficit)....................... (375) 555 (1,030) (5,880) (47) (5,592) 1,008
</TABLE>
(See
footnotes on following page)
16
<PAGE> 18
(Footnotes from previous page)
______________
(1) Represents a non-recurring charge (credit) related to litigation between the
Company and Harbor. See Note 12 of Notes to Combined Financial Statements
and "Risk Factors -- Proprietary Rights; Risk of Infringement."
(2) Net income (loss) excludes (i) accretion related to the redemption feature
on certain common shares of ASI and (ii) the provision for federal and
certain state income taxes due to ASI's status as an S corporation. If
accretion were reflected as a reduction of net income, net income available
to common stockholders would have been $8,410,000 and $2,059,000 for the
year ended December 31, 1997 and the three months ended March 31, 1998,
respectively. ASI's S corporation status will terminate at the close of the
Termination Date. See "Reorganization and S Corporation Distribution."
(3) Pro forma to give effect to (i) the elimination of employee compensation for
Robert R. Eustace and Elsa M. Eustace, who, upon consummation of the
Offering, will no longer be active in the management of the Company or
receive compensation from the Company, which totaled $1,244,000, $1,170,000,
$293,000 and $205,000 for the years ended December 31, 1996 and 1997, and
the three month periods ended March 31, 1997 and March 31, 1998,
respectively, (ii) income tax expense that would have been recorded based on
applicable tax rates had ASI been taxed as a C corporation during these
periods, (iii) the elimination of the non-recurring charge (credit) related
to the Harbor litigation and (iv) the elimination of accretion resulting
from the elimination of the redemption feature.
(4) The number of shares estimated to be outstanding after the Reorganization,
but prior to the consummation of the Offering.
17
<PAGE> 19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the Company's
financial statements, including the notes thereto, appearing elsewhere in this
Prospectus. Information contained in this Prospectus concerning markets for the
Company's products and trends in the Company's operations or financial results,
as well as other statements including words such as "believe," "estimate," and
"expect" and other similar expressions, constitute forward-looking statements.
These forward-looking statements are subject to business and economic risks,
including, but not limited to those discussed in "Risk Factors," and actual
results may differ materially from historical results and those currently
anticipated.
OVERVIEW
Applied Systems designs, develops and markets comprehensive automation
solutions for independent insurance agencies and P&C insurance carriers. The
Company's revenue consists of fees derived from the licensing of its automation
systems, service revenue from support and maintenance services and
implementation and consulting services, and revenue from the resale of
third-party equipment and software. Since the Company's inception, substantially
all of its revenue has been derived from automation system licenses and related
services and third-party products for the P & C insurance industry. The Company
has developed and recently began an active marketing program for its automation
system for insurance carriers. The Company currently serves over 7,500
independent insurance agencies with its agency automation products and has sold
its carrier system to 13 insurance carriers.
Revenue from the licensing of the Company's agency automation products is
recognized when a product is delivered to the customer. License fees for agency
systems are payable on a cash on delivery basis. For carrier systems, the
Company uses the percentage-of-completion accounting method to recognize license
revenue and related cost of revenue. Carrier system license fees are payable in
installments based on specified events, beginning with contract signing and
ending with a final payment due upon customer acceptance of the completed
system.
Service revenue from support and maintenance services and implementation
and consulting services is driven by the licensing of the Company's automation
systems. Support and maintenance agreements entitle customers to unlimited
technical support as well as product enhancements and new versions of the
Company's products. The majority of these support and maintenance fees are
payable annually in advance. Revenue from support and maintenance services is
recognized ratably over the term of the support agreement. Fees related to
implementation and consulting services are recognized as the services are
performed.
Revenue from the sale of third-party hardware and software products, which
are sold in connection with agency systems, is payable and recognized upon
delivery. Although margins on third-party equipment and software typically are
significantly lower than on licenses of the Company's automation systems, the
Company offers third party equipment and software to customers in need of a
turn-key automation solution.
Cost of license revenue consists primarily of the costs of media, product
manuals, shipping and fulfillment, royalties paid to third parties and personnel
related costs associated with configuration of carrier systems. Cost of service
revenue is comprised primarily of personnel related costs associated with
support and maintenance services and implementation and consulting services.
Cost of third-party equipment and software consists primarily of computer and
peripheral equipment and license fees and royalties for third-party software.
Research and development expenses are comprised primarily of personnel
related costs incurred to enhance the Company's existing products and develop
new products. Sales and marketing expenses consist primarily of personnel
related costs of the Company's sales, marketing and advertising activities.
General and administrative expenses include personnel related costs for
accounting, human resources and executive management, as well as professional
fees and property and sales taxes.
18
<PAGE> 20
The Company has not capitalized any of its software development expenses
because the development costs incurred during the period between achieving
technological feasibility and general release of the product to customers have
not been material.
In connection with the termination of its S corporation status, on or
before the Termination Date, ASI will make the S Corporation Distribution,
consisting of cash and the S Corporation Notes. Amounts due on the S Corporation
Notes will be payable only out of future cash flow from ASI operations and none
of the proceeds of the Offering will be used to repay the S Corporation Notes.
See "Reorganization and S Corporation Distribution."
ASI's pro forma effective tax rate was 39.0% in 1997, 1996 and 1995 and for
each of the three-month periods ended March 31, 1998 and 1997.
RESULTS OF OPERATIONS
The following table sets forth certain historical and pro forma statements
of operations data as a percentage of total revenue for the periods indicated
and the percentage change in such data versus the prior comparable period. The
trends illustrated in the following table are not necessarily indicative of
future results.
<TABLE>
<CAPTION>
PERCENTAGE INCREASE
(DECREASE)
THREE MONTHS ---------------------------------
YEARS ENDED ENDED FIRST
DECEMBER 31, MARCH 31, QUARTER
--------------------------- ---------------- 1995 1996 1997 TO
1995 1996 1997 1997 1998 TO 1996 TO 1997 1998
---- ---- ---- ---- ---- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue:
License............................. 21.9% 23.8% 26.7% 23.6% 26.3% 11.6% 31.5% 46.2%
Service............................. 40.9 44.8 45.7 48.7 48.4 12.6 19.5 30.3
Third-party equipment and
software.......................... 37.2 31.4 27.6 27.7 25.3 (13.3) 2.9 19.6
----- ----- ----- ----- -----
Total revenue..................... 100.0 100.0 100.0 100.0 100.0 2.7 17.1 31.1
----- ----- ----- ----- -----
Cost of revenue:
License............................. 0.5 1.0 1.4 0.6 2.3 127.6 62.2 381.3
Service............................. 28.1 31.0 29.5 32.3 27.0 13.3 11.4 9.7
Third-party equipment and
software.......................... 24.8 22.0 20.8 20.8 19.9 (8.8) 10.7 25.7
----- ----- ----- ----- -----
Total cost of revenue............. 53.4 54.0 51.7 53.7 49.2 4.0 12.1 20.3
----- ----- ----- ----- -----
Gross profit.......................... 46.6 46.0 48.3 46.3 50.8 1.2 23.0 43.6
Operating expenses:
Research and development............ 12.2 12.1 12.8 12.3 12.5 1.9 23.6 32.5
Sales and marketing................. 14.3 12.7 13.4 14.1 13.5 (9.3) 23.8 25.4
General and administrative.......... 15.3 15.7 15.2 15.5 15.1 5.8 13.2 27.4
Non-recurring charge (credit)....... 0.2 9.9 (4.6) 0.8 0.0 NM NM NM
----- ----- ----- ----- -----
Total operating expenses.......... 42.0 50.4 36.8 42.7 41.1 23.2 (14.6) 25.8
----- ----- ----- ----- -----
Operating income (loss)............... 4.6 (4.4) 11.5 3.6 9.7 (201.4) NM 257.4
Other income (expense), net........... (0.3) (0.2) 0.1 (0.1) 0.3 76.5 NM NM
----- ----- ----- ----- -----
Income (loss) before income taxes..... 4.3 (4.6) 11.6 3.5 10.0 (208.8) NM 273.6
Provision for income taxes............ 0.4 0.5 0.4 0.4 0.4 46.6 (11.7) 22.2
----- ----- ----- ----- -----
Net income (loss)..................... 3.9% (5.1)% 11.2% 3.1% 9.6% (232.0)% NM 308.0%
===== ===== ===== ===== =====
Pro Forma Data (unaudited):
Operating income.................... -- 7.3% 8.4% 6.1% 10.6% -- 34.1% 128.2%
Income tax provision................ -- 2.8 3.3 2.4 4.2 -- 36.6 136.4
Net income.......................... -- 4.4% 5.2% 3.7% 6.6% -- 36.6% 136.4%
</TABLE>
- ---------------
NM indicates such percentage is not meaningful and has been omitted.
19
<PAGE> 21
THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31, 1997
License Revenue. License revenue for the three month period ended March 31,
1998 increased by 46.2% to $5.8 million from $4.0 million for the comparable
period in 1997 and, as a percentage of total revenue, increased to 26.3% from
23.6% over the same period. The dollar increase in license revenue was primarily
due to growth in agency system license revenue, which grew by 38.0% to $5.1
million for the three months ended March 31, 1998 from $3.7 million for the same
period in 1997. The growth in agency system license revenue was primarily driven
by a 16.9% increase in the number of agency system licenses sold in the U.S. and
a trend toward licensing larger agency systems in the U.S. Carrier system
license revenue increased to $0.7 million for the three months ended March 31,
1998 from $0.3 million for the comparable period in 1997. License revenue as a
percentage of total revenue increased for the three month period ended March 31,
1998 compared to the comparable period in 1997 due to faster growth in license
revenue than service revenue and third-party equipment and software revenue.
Service Revenue. Service revenue increased by 30.3% to $10.7 million for
the three month period ended March 31, 1998 from $8.2 million for the comparable
period in 1997 and, as a percentage of total revenue, decreased to 48.4% from
48.7% over the same period. The dollar increase in service revenue was primarily
due to an increase in support and maintenance revenue caused by fee increases in
January 1997 and January 1998, and growth in the number of users paying support
and maintenance fees as a result of additional agency system licenses sold. The
January 1997 fee increase had a larger positive impact on support and
maintenance revenue for the three months ended March 31, 1998 than the
comparable period in 1997 due to the fact that a large portion of annual support
and maintenance agreements were not subject to the increase until they were
renewed later in 1997. Implementation and consulting services revenue also
increased due to growth in agency system license sales.
Third-Party Equipment and Software Revenue. Third-party equipment and
software revenue for the three month period ended March 31, 1998 increased by
19.6% to $5.6 million from $4.7 million for the comparable period in 1997 and,
as a percentage of total revenue, decreased to 25.3% from 27.7% over the same
period. The dollar increase in third-party equipment and software revenue was
primarily driven by growth in agency system license sales, which are often
accompanied by the sale of third-party equipment and software. The dollar
revenue increase was also due to upgrade sales of newer versions of third-party
equipment and software to existing customers. Third-party equipment and software
as a percentage of total revenue decreased as the Company continued to implement
its strategy of selling these items solely as an accommodation to its agency
system customers and not as a strategic growth opportunity.
Cost of Revenue. Cost of license revenue increased to $0.5 million for the
three month period ended March 31, 1998 from $0.1 million for the comparable
period in 1997 and, as a percentage of license revenue, increased to 8.8% from
2.7% over the same period. Cost of license revenue increased primarily due to
growth in carrier system license revenue, because carrier systems entail
additional configuration costs. Cost of service revenue for the three month
period ended March 31, 1998 increased by 9.7% to $6.0 million from $5.4 million
for the comparable period in 1997 and, as a percentage of service revenue,
decreased to 55.8% from 66.3% over the same period. This decrease was primarily
attributable to improved productivity of the Company's service organization
which allowed for slower growth in service personnel related costs than the
growth experienced in service revenue. Cost of third-party equipment and
software revenue for the three month period ended March 31, 1998 increased by
25.7% to $4.4 million from $3.5 million for the comparable period in 1997 and,
as a percentage of third-party equipment and software revenue, increased to
78.8% from 75.0% over the same period. This increase in the cost as a percentage
of related revenue was due to an increase in costs for these products without a
commensurate increase in price to customers, as a result of increasingly
competitive market conditions for these products.
Research and Development Expenses. Research and development expenses for
the three month period ended March 31, 1998 increased by 32.5% to $2.7 million
from $2.1 million for the comparable period in 1997 and, as a percentage of
total revenue, increased to 12.5% from 12.3% over the same period. The increase
in research and development expenses was primarily due to increased costs
related to development of the TAM-Vision and Diamond System products.
20
<PAGE> 22
Sales and Marketing Expenses. Sales and marketing expenses increased by
25.4% to $3.0 million for the three month period ended March 31, 1998 from $2.4
million for the comparable period in 1997 and, as a percentage of total revenue,
decreased to 13.5% from 14.1% over the same period. The dollar increase in sales
and marketing expenses was due to a $0.3 million write-off of a bad debt
associated with a carrier system and increased personnel related costs necessary
to support the Company's sales growth.
General and Administrative Expenses. General and administrative expenses
increased by 27.4% to $3.3 million for the three month period ended March 31,
1998 from $2.6 million for the comparable period in 1997 and, as a percentage of
total revenue, decreased to 15.1% from 15.5% over the same period. The dollar
increase in general and administrative expenses was primarily due to an increase
in personnel related expenses and professional fees necessary to manage and
support the expansion of the Company's operations.
Non-Recurring Charge (Credit). For the three month period ended March 31,
1998 there was no non-recurring charge or credit. For the comparable period in
1997, there was a $0.1 million charge incurred in connection with litigation
between the Company and Harbor.
Other Income (Expense), Net. Other income (expense), net was $70,349 more
favorable for the three-month period ended March 31, 1998 than the comparable
period in 1997 due to a $60,818 increase in interest income arising from
increased cash and cash equivalent balances and a $9,531 reduction in interest
expense.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
License Revenue. License revenue increased by 31.5% to $20.3 million in
1997 from $15.4 million in 1996 and, as a percentage of total revenue, increased
to 26.7% in 1997 from 23.8% in 1996. The increase in license revenue was mainly
attributable to growth in agency system license revenue, which increased by
27.7% to $18.4 million in 1997 from $14.4 million in 1996. The growth in agency
system license revenue was mainly driven by an 11.4% increase in the number of
agency systems licenses sold in the U.S. and a trend towards licensing larger
agency systems in the U.S. Carrier system license revenue increased to $1.9
million in 1997 from $1.0 million in 1996.
Service Revenue. Service revenue increased by 19.5% to $34.8 million in
1997 from $29.1 million in 1996 and, as a percentage of total revenue, increased
to 45.7% in 1997 from 44.8% in 1996. The increase in service revenue was
primarily due to an increase in support and maintenance revenue caused by a fee
increase in January 1997, and growth in the number of users paying support and
maintenance fees resulting from additional agency system licenses sold.
Implementation and consulting services revenue also increased in 1997 compared
to 1996 due to growth in agency system licenses sold.
Third-Party Equipment and Software Revenue. Third-party equipment and
software revenue increased by 2.9% to $21.0 million in 1997 from $20.4 million
in 1996 and, as a percentage of total revenue, decreased to 27.6% in 1997 from
31.4% in 1996. The dollar increase in third-party equipment and software revenue
was primarily driven by growth in agency system license sales which are often
accompanied by the sale of third-party equipment and software, and due to
upgrade sales of newer versions of third-party equipment and software to
existing customers. Third-party equipment and software revenue as a percentage
of total revenue decreased in 1997 compared to 1996 as the market for these
products became increasingly competitive, and as the Company continued to
implement its strategy of selling these items only as an accommodation to its
agency system customers and not as a strategic growth opportunity.
Cost of Revenue. Cost of license revenue increased by $0.4 million to $1.1
million in 1997 from $0.7 million in 1996 and, as a percentage of license
revenue, increased to 5.4% in 1997 from 4.4% in 1996. Cost of license revenue
increased primarily due to growth in carrier system license revenue, because
carrier systems entail additional configuration costs. Cost of service revenue
increased by 11.4% to $22.4 million in 1997 from $20.1 million in 1996 and, as a
percentage of service revenue, decreased to 64.5% in 1997 from 69.2% in 1996 as
service personnel related costs grew more slowly than service revenue due to
improved productivity of the Company's service organization. Cost of third-party
equipment and software revenue increased by 10.7% to $15.8 million in 1997 from
$14.3 million in 1996 and, as a percentage of third-party equipment and software
revenue, increased to 75.5% in 1997 from 70.2% in 1996. The increase in this
cost as a percentage of related
21
<PAGE> 23
revenue was due to an increasingly competitive market for these products and the
Company's decision to address these market conditions by decreasing selling
prices and gross margins on these products.
Research and Development Expenses. Research and development expenses
increased by 23.6% to $9.7 million in 1997 from $7.9 million in 1996 and, as a
percentage of total revenue, increased to 12.8% in 1997 from 12.1% in 1996. The
increase in research and development expenses was mainly due to the development
of TAM-Vision, the Diamond System and the Year 2000-compliant version of TAM.
Sales and Marketing Expenses. Sales and marketing expenses increased by
23.8% to $10.2 million in 1997 from $8.2 million in 1996. As a percentage of
total revenue, sales and marketing expenses increased to 13.4% in 1997 from
12.7% in 1996. The dollar increase in sales and marketing expenses was due to
increased personnel related costs necessary to support the Company's sales
growth. The increase in sales and marketing expenses as a percentage of total
revenue was due to disproportionate growth in license revenue, which carries
higher sales commissions than the Company's other types of revenue.
General and Administrative Expenses. General and administrative expenses
increased by 13.2% to $11.6 million in 1997 from $10.2 million in 1996. As a
percentage of total revenue, general and administrative expenses decreased to
15.2% in 1997 from 15.7% in 1996. The dollar increase in general and
administrative expenses was primarily due to an increase in personnel related
expenses and professional fees necessary to manage and support the expansion of
the Company's operations.
Non-Recurring Charge (Credit). In 1997 and 1996 there was a non-recurring
credit of $3.5 million resulting from an insurance recovery in connection with
litigation between the Company and Harbor. In 1996 there was a non-recurring
charge of $6.4 million related to the same litigation.
Other Income (Expense), Net. Other income (expense), net was $103,765 more
favorable in 1997 than 1996 due to a $91,759 reduction in interest expense and a
$12,006 increase in interest income.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
License Revenue. License revenue increased by 11.6% to $15.4 million in
1996 from $13.8 million in 1995 and, as a percentage of total revenue, increased
to 23.8% in 1996 from 21.9% in 1995. The increase in license revenue was mainly
attributable to an increase in carrier system license revenue, which grew to
$1.1 million in 1996 from $0.1 million in 1995. Agency system license revenue
increased 4.4% to $14.4 million in 1996 from $13.8 million in 1995, primarily
due to a 4.1% increase in the number of agency system licenses sold in the U.S.
License revenue as a percentage of total revenue grew in 1996 compared to 1995
primarily due to a decline in third-party equipment and software revenue, as
discussed below.
Service Revenue. Service revenue increased by 12.6% to $29.1 million in
1996 from $25.9 million in 1995 and, as a percentage of total revenue, increased
to 44.8% in 1996 from 40.9% in 1995. The increase in service revenue was
attributable to an increase in support and maintenance revenue, driven by a
January 1995 fee increase that was not fully reflected in annual contracts until
1996, and growth in the number of users paying support and maintenance fees
resulting from additional agency system licenses sold. This increase was
partially offset by a slight decline in implementation and consulting services
revenue in 1996 compared to 1995, due to longer lead times in some agency system
implementations and relatively modest growth in agency system license sales.
Service revenue as a percentage of total revenue increased in 1996 compared to
1995 primarily due to a decline in sales of third-party equipment and software,
as discussed below.
Third-Party Equipment and Software Revenue. Third-party equipment and
software revenue decreased by 13.3% to $20.4 million in 1996 from $23.5 million
in 1995. As a percentage of total revenue, third-party equipment and software
decreased to 31.4% in 1996 from 37.2% in 1995. The decline in third-party
equipment and software revenue was due to the Company's decision during 1996 to
attempt to stabilize selling prices and gross margins for these products in the
face of increasingly competitive pricing conditions.
Cost of Revenue. Cost of license revenue increased to $0.7 million in 1996
from $0.3 million in 1995 and, as a percentage of license revenue, increased to
4.4% in 1996 from 2.1% in 1995. Cost of license revenue increased primarily due
to growth in carrier system license revenue, because carrier systems entail
additional
22
<PAGE> 24
configuration costs. Cost of service revenue grew by 13.3% to $20.1 million in
1996 from $17.8 million in 1995 and, as a percentage of service revenue,
increased to 69.2% in 1996 from 68.7% in 1995. Cost of third-party equipment and
software revenue decreased by 8.8% to $14.3 million in 1996 from $15.7 million
in 1995 and, as a percentage of third-party equipment and software revenue,
increased to 70.2% in 1996 from 66.7% in 1995. The dollar decrease in cost of
third-party equipment and software revenue was mainly due to a decline in
related revenue. The increase in this cost of revenue as a percentage of related
revenue was due to increasingly competitive conditions in the marketplace for
these products, partly offset by the Company's effort to stabilize selling
prices and gross margins for these products.
Research and Development Expenses. Research and development expenses
increased by 1.9% to $7.9 million in 1996 from $7.7 million in 1995 and, as a
percentage of total revenue, decreased to 12.1% in 1996 from 12.2% in 1995.
Research and development expenses were relatively stable in 1996 compared to
1995 as the Company's pace of enhancing and developing systems remained steady
year-to-year.
Sales and Marketing Expenses. Sales and marketing expenses decreased by
9.3% to $8.2 million in 1996 from $9.1 million in 1995 and, as a percentage of
total revenue, decreased to 12.7% in 1996 from 14.3% in 1995. The decrease in
sales and marketing expenses was due to a decrease in sales commissions and
personnel related costs in 1996 compared to 1995 due to the elimination of
certain sales management positions and incentive programs, which also resulted
in a reduction in the Company's sales force.
General and Administrative Expenses. General and administrative expenses
increased by 5.8% to $10.2 million in 1996 from $9.7 million in 1995 and, as a
percentage of total revenue, general and administrative expenses increased to
15.7% in 1996 from 15.3% in 1995. The increase in general and administrative
expenses was mainly due to higher rent expenses associated with the Company's
new corporate headquarters.
Non-Recurring Charge (Credit). In 1996 and 1995, non-recurring charge of
$6.4 million and $0.1 million, respectively, were incurred in connection with
litigation between the Company and Harbor.
Other Income (Expense), Net. Other income (expense), net was $122,609 more
favorable in 1996 than 1995 due to a $120,117 decrease in interest expense and
$2,492 increase in interest income.
23
<PAGE> 25
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth, for the five quarters beginning January 1,
1997 and ending March 31, 1998 (i) certain historical and pro forma statement of
operations data and (ii) certain historical and pro forma statement of
operations data expressed as a percentage of total revenue. In management's
opinion, the unaudited quarterly statement of operations data have been prepared
on the same basis as the audited financial statements and include all
adjustments, consisting of normal recurring adjustments, necessary for a fair
presentation of the information for the quarters presented, when read in
conjunction with the Company's Combined Financial Statements and related Notes
included elsewhere in this Prospectus. The Company believes that
quarter-to-quarter comparisons of its operating results are not necessarily
meaningful and should not be relied upon as an indication of future performance.
<TABLE>
<CAPTION>
THREE MONTH PERIODS ENDED
-----------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31,
1997 1997 1997 1997 1998
--------- -------- --------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
License.................................................. $ 3,967 $ 4,793 $ 4,982 $ 6,549 $ 5,799
Service.................................................. 8,185 8,429 8,990 9,189 10,665
Third-party equipment and software....................... 4,664 4,860 4,862 6,598 5,578
------- ------- ------- ------- -------
Total revenue........................................ 16,816 18,082 18,834 22,336 22,042
------- ------- ------- ------- -------
Cost of revenue:
License.................................................... 106 467 114 405 511
Service.................................................... 5,424 5,537 5,650 5,837 5,953
Third-party equipment and software......................... 3,497 3,667 3,686 4,990 4,394
------- ------- ------- ------- -------
Total cost of revenue................................ 9,027 9,671 9,450 11,232 10,858
------- ------- ------- ------- -------
Gross profit................................................ 7,789 8,411 9,384 11,104 11,184
------- ------- ------- ------- -------
Operating expenses:
Research and development................................... 2,075 2,340 2,594 2,729 2,749
Sales and marketing........................................ 2,374 2,439 2,595 2,774 2,977
General and administrative................................. 2,607 2,864 3,047 3,045 3,322
Non-recurring charge (credit).............................. 135 117 245 (4,005) --
------- ------- ------- ------- -------
Total operating expenses............................. 7,191 7,760 8,481 4,543 9,048
------- ------- ------- ------- -------
Operating income............................................ 598 651 903 6,561 2,136
Other income (expense), net................................. (10) 2 27 47 61
------- ------- ------- ------- -------
Income before income taxes.................................. 588 653 930 6,608 2,197
Provision for income taxes.................................. 71 83 83 55 87
------- ------- ------- ------- -------
Net income.................................................. $ 517 $ 570 $ 847 $ 6,553 $ 2,110
======= ======= ======= ======= =======
PRO FORMA STATEMENT OF OPERATIONS DATA:
Operating income........................................... $ 1,026 $ 1,061 $ 1,440 $ 2,848 $ 2,341
Income tax provision....................................... 396 415 572 1,129 937
Net income................................................. 620 648 895 1,766 1,465
</TABLE>
<TABLE>
<CAPTION>
AS A PERCENTAGE OF TOTAL REVENUE
-------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
License.................................................. 23.6% 26.5% 26.5% 29.3% 26.3%
Service.................................................. 48.7 46.6 47.7 41.2 48.4
Third-party equipment and software....................... 27.7 26.9 25.8 29.5 25.3
----- ----- ----- ----- -----
Total revenue........................................ 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- -----
Cost of revenue:
License.................................................... 0.6 2.6 0.6 1.8 2.3
Service.................................................... 32.3 30.6 30.0 26.2 27.0
Third-party equipment and software......................... 20.8 20.3 19.6 22.3 19.9
----- ----- ----- ----- -----
Total cost of revenue................................ 53.7 53.5 50.2 50.3 49.2
----- ----- ----- ----- -----
Gross profit................................................ 46.3 46.5 49.8 49.7 50.8
----- ----- ----- ----- -----
Operating expenses:
Research and development................................... 12.4 12.9 13.8 12.2 12.5
Sales and marketing........................................ 14.1 13.5 13.8 12.4 13.5
General and administrative................................. 15.5 15.8 16.1 13.6 15.1
Non-recurring charge (credit).............................. 0.8 0.7 1.3 (17.9) 0.0
----- ----- ----- ----- -----
Total operating expenses............................. 42.8 42.9 45.0 20.3 41.1
----- ----- ----- ----- -----
Operating income............................................ 3.5 3.6 4.8 29.4 9.7
Other income (expense), net................................. (0.0) 0.0 0.1 0.2 0.3
----- ----- ----- ----- -----
Income before income taxes.................................. 3.5 3.6 4.9 29.6 10.0
Provision for income taxes.................................. 0.4 0.5 0.4 0.3 0.4
----- ----- ----- ----- -----
Net income.................................................. 3.1% 3.1% 4.5% 29.3% 9.6%
===== ===== ===== ===== =====
PRO FORMA STATEMENT OF OPERATIONS DATA:
Operating income........................................... 6.1% 5.9% 7.6% 12.8% 10.6%
Income tax provision....................................... 2.4 2.3 3.0 5.1 4.3
Net income................................................. 3.7% 3.6% 4.8% 7.9% 6.6%
</TABLE>
The Company has experienced significant fluctuations in quarterly operating
results primarily due to the seasonality of its sales. Historically, the
Company's revenue has been significantly higher in December and
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<PAGE> 26
January than other months due to the Company's sales force incentive programs,
as well as year-end performance incentives earned by agencies from carriers that
can provide agencies with additional funds for a new system purchases. December
sales, which are typically higher than January sales, also benefit from the
accelerated tax benefits agencies receive by making such purchases before the
end of the year.
Operating results also fluctuate due to variations in costs of revenue.
Cost of license revenue has fluctuated significantly due to variations in
license revenue for lower margin carrier systems. Cost of service revenue as a
percentage of service revenue declined during 1997 primarily as a result of a
support and maintenance fee increase in January 1997 and increased productivity
of the Company's service organization.
The Company incurred non-recurring charges and credits during the periods
shown related to litigation between the Company and Harbor, which caused
significant fluctuations in operating income.
The Company expects that it will continue to experience significant
fluctuations in quarterly operating results. The Company's future operating
results will depend upon a number of factors including the demand for its
products, the size and timing of specific sales and product shipments, the delay
or deferral of customer implementations, the level of product and price
competition encountered, the length of its sales cycles, the timing of new
product introductions and enhancements by the Company and its competitors, the
mix of products and services sold, the timing of new hires, general economic
conditions and its ability to develop and market new products and control costs.
In addition, if carrier system license revenue represents a larger percentage of
total revenue, the Company could experience greater fluctuations in operating
results due to the higher price and related cost of these systems which may
shift between quarters.
As a result of these and other factors, the Company's operating results for
any quarter are subject to significant variation, and the Company believes that
period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied upon as indications of future performance.
It is likely that the Company's future quarterly operating results from time to
time will not meet the expectations of market analysts or investors. In such
event, the price of the Company's Common Stock would likely be materially and
adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily from cash flow from
operations. At March 31, 1998, the Company had cash and cash equivalents of $7.9
million.
For 1997 and the three month period ended March 31, 1998, net cash provided
by operating activities was $6.6 million and $5.7 million, respectively. For
both periods, net cash provided by operating activities consisted primarily of
net income before depreciation, amortization and non-cash, non-recurring charges
and credits. Accounts receivable increased by $5.2 million during 1997, due to
sales growth during 1997 and a greater seasonal increase in sales in the last
quarter compared to the comparable period in 1996. Accounts receivable balances
decreased by $1.8 million during the three month period ended March 31, 1998,
due to a seasonal slowdown in sales activity. Unearned support and services,
which consists of cash received for support and maintenance services and
implementation and consulting services not yet performed, increased by $4.5
million primarily due to sales growth during 1997 and greater seasonality in
sales in the last quarter compared to the comparable period in 1996. Sharp
increases in sales can often lead to an increased backlog of unperformed
implementation and consulting services, as was the case in late 1997. Accounts
payable and accrued expenses fluctuated during 1997 and the three month period
ended March 31, 1998, primarily due to varying sales levels which entail changes
in purchases of third-party equipment and software.
Net cash used in investing activities for 1997 and the three month period
ended March 31, 1998 was $0.9 million and $1.0 million, respectively. In 1997,
net cash used in investing activities consisted mainly of purchases of property
and equipment related to the Company's new corporate headquarters, which were
first occupied in late 1996, partly offset by the proceeds from the sale and
lease-back of certain office equipment. For the three month period ended March
31, 1998, net cash used in investing activities consisted primarily of purchases
of property and equipment related to the Company's corporate headquarters and a
net increase in a receivable from Applied Properties (as defined herein). See
"Certain Transactions."
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<PAGE> 27
Net cash used in financing activities for 1997 and the three month period
ended March 31, 1998 was $3.0 million and $1.1 million, respectively, consisting
mainly of distributions to stockholders. The Company has historically
distributed a significant portion of its earnings as S corporation dividends.
See "Reorganization and S Corporation Distribution."
ASI has a $7,000,000 line of credit with First Midwest Bank which expires
on July 1, 1999. Borrowings under this line of credit bear interest at the
prevailing prime rate of interest, 8.5% at March 31, 1998, are secured by all of
ASI's assets, including accounts receivable, inventories, equipment and
buildings, and are personally guaranteed by certain stockholders. Further, any
borrowings under the line of credit are payable on demand. As of June 30, 1998,
ASI has no borrowings under this line of credit. Available borrowings are
reduced by letters of credit. As of June 30, 1998, ASI had a letter of credit
outstanding in connection with the litigation with Harbor in the amount of $2.5
million. The Company expects this letter of credit to be canceled based on the
recent settlement agreement between the Company and Harbor. The majority
stockholder of ASI has assigned his $5,000,000 life insurance policy to First
Midwest Bank. The Company anticipates that on or before the consummation of the
Offering, the personal guarantees and assignment will be released.
In connection with its conversion to C corporation status, to be effected
immediately prior to the Offering, the Company expects to make the S Corporation
Distribution. Approximately $6.0 million of the S Corporation Distribution will
be paid in cash, and approximately $5.0 million will be paid by issuance of the
S Corporation Notes. ASI expects to repay the S Corporation Notes from future
cash flows from operations, and none of the proceeds from the Offering will be
used to pay any part of the S Corporation Distribution.
In July 1998, the Company settled its lawsuit with Harbor which will result
in a $2.4 million cash payment by the Company, net of an insurance
reimbursement.
The Company does not expect to have significant capital expenditures in
either 1998 or 1999.
The Company believes that the net proceeds from the Offering, together with
existing sources of liquidity and anticipated cash flow from operations, will
satisfy the Company's anticipated working capital and capital expenditure
requirements through at least 1999. However, depending on its rate of growth and
profitability, the Company may require additional equity or debt financing to
meet its working capital requirements or capital expenditure needs in the
future. There can be no assurance that additional financing will be available
when required or, if available, on terms satisfactory to the Company.
YEAR 2000
Certain computer software programs will be unable to process two-digit
year-date codes after December 31, 1999 (the "Year 2000 Problem"). As a result,
computer systems and software used by many companies in a very wide variety of
applications will experience operating difficulties unless they are modified or
upgraded to adequately process information involving, related to or dependent
upon the century change. The Company conducted a review of its internal systems
and has developed a plan to modify or replace programs as necessary. The total
cost of implementing this Year 2000 plan is not expected to be significant to
the Company's financial results. The Company is also assessing the potential
overall impact of the Year 2000 Problem on the Company's products. Based on the
Company's assessment to date, while the Company believes its current versions of
its software products and services are substantially compatible with the Year
2000, this compatibility cannot be fully ascertained in advance of the Company's
customers using its products in the Year 2000. Also, some of the Company's
customers are currently running earlier versions of the Company's software
products that are not compatible with the Year 2000, and the Company has been
encouraging such customers to migrate to current product versions. The costs of
resolving the Year 2000 Problem may have a material adverse effect on the
Company's business, operating results and financial condition.
The Company may in the future be subject to claims based on the Year 2000
Problem in third-party products or arising from the integration of multiple
products within a customer's overall system. Although the
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<PAGE> 28
Company has not been a party to any litigation or arbitration proceeding to date
involving such claims, there can be no assurance that the Company will not in
the future be required to defend itself or negotiate resolutions based on such
claims. The costs of defending and resolving Year 2000-related claims, and any
liability of the Company for Year 2000-related damages, including consequential
damages, could have a material adverse effect on the Company's business,
operating results and financial condition.
The Company faces risk to the extent that suppliers of products, services
and systems purchased by the Company and others with whom the Company transacts
business do not comply with Year 2000 requirements. In the event any such third
parties cannot timely provide the company with products, services or systems
that meet the Year 2000 requirements on a timely basis, or in the event the Year
2000 Problem prevents such third parties from timely delivery of products or
services required by the Company, the Company's operating results could be
materially adversely affected. To the extent the Year 2000 Problem causes
significant delays in, or cancellation of, decisions to purchase the Company's
products or services, the Company's business, operating results and financial
condition could be materially adversely affected. See "Risk Factors -- Effects
of the Year 2000."
INFLATION
The Company believes that inflation generally has not had a material effect
on the results of its operations.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement No.
131, "Disclosures about Segments of an Enterprise and Related Information." This
statement introduces an approach to defining the Company's segments for
financial reporting purposes on a basis consistent with how the Company's
management evaluates the operations of the business. This statement is effective
for the Company's year ended December 31, 1998. All periods presented must
comply with the required disclosures. The Company does not believe that this
standard will have any impact on its financial statement disclosures.
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<PAGE> 29
BUSINESS
Applied Systems is a leading designer, developer and marketer of automation
software for independent insurance agencies. The Company's principal product,
The Agency Manager(R) ("TAM"), significantly improves the productivity and
efficiency of independent P&C insurance agencies by combining client management,
policy pricing, EDI, policy and claims servicing, and accounting and back office
administration into an easy to use, completely integrated, single-entry software
solution. The Company currently serves over 7,500 agencies, representing over
70,000 concurrent licensed users. Fifteen percent of the approximately 44,000
independent P&C insurance agencies in the U.S. are currently customers of
Applied Systems. The Company has begun to leverage its insurance industry
expertise through the introduction of software solutions for P&C insurance
carriers. The Company's Diamond System is a fully integrated Microsoft
Windows-based P&C insurance carrier automation system that offers real-time
processing of policies and claims, automates billing and facilitates the
production of regulatory and statistical reports. The Company has sold the
Diamond System to 13 insurance carriers to date and recently began an active
marketing program for the product. Applied Systems also provides its customers
with support and maintenance services and implementation and consulting services
as well as third-party equipment and software. In 1997, approximately 35% of the
Company's revenue was attributable to support and maintenance agreements.
INDUSTRY BACKGROUND
The insurance industry is composed of several markets including P&C
insurance, life insurance, medical insurance and disability insurance. P&C
insurance provides financial protection for individuals, businesses and others
against losses of property or losses by third parties for which the insured is
liable. P&C insurers underwrite policies that cover various types of risk, which
can generally be categorized as commercial lines covering businesses, and
personal lines covering individuals. Commercial lines, which represent
approximately 44% of annual P&C insurance premiums, cover property, general
liability, workers' compensation, vehicles and equipment, directors' and
officers' liability, theft, medical malpractice as well as other commercial
risks. Personal lines, which represent approximately 49% of annual P&C insurance
premiums, include coverages such as automobile (physical damage and liability)
and homeowners' insurance. Reinsurance premiums account for the remaining 7% of
annual P&C insurance premiums. Approximately 75% of commercial policies are
written through independent agencies while 60% of personal policies are sold
through captive agents.
P&C insurance policies in the U.S. are underwritten by insurance carriers
and sold either by agents and brokers or directly to the consumer. An
"independent" agent or broker is one who sells the policies of a number of
different insurance carriers, while a "captive" agent offers and sells the
policies of a single insurance carrier. Certain carriers sell policies directly
to the consumer through direct response channels upon the initiative of the
consumer via telephone and, more recently, the Internet. The Company believes
there are approximately 44,000 independent insurance agencies serving the P&C
insurance industry in the U.S. and approximately 2,400 insurance carriers
writing P&C insurance.
The P&C insurance industry is subject to supervision and regulation on a
state-by-state basis. State insurance regulators closely regulate the product
offerings, claims processes and premium structure of insurance carriers. These
state regulations are continually changing, requiring standard industry forms to
be continually updated.
The P&C insurance industry has experienced significant changes during the
last two decades, driven primarily by downward pressure on premiums for carriers
and on commissions for agencies, consolidation of independent agencies and, most
recently, increased utilization of direct response channels in personal lines.
Extensive price competition in the form of lower premiums has resulted from high
investment returns for carriers on invested premiums and the entry of new
competitors in the market. Lower insurance premiums have reduced agencies'
commissions. As a result, both agencies and carriers are focusing on writing
higher volumes of insurance, achieving higher renewal and retention rates,
reducing operating costs and producing efficiencies in order to remain
competitive. Automation has been a principal means by which to achieve these
objectives.
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According to A.M. Best Company, approximately $277 billion in total P&C
premiums were written in the U.S. in 1997. The Company estimates that agencies
and carriers spend a total of approximately 3 to 4% of such premiums on
information technology, including automation software and data processing. The
Company expects the market for third-party automation software to grow for the
reasons described below.
The functions performed by independent insurance agencies are highly data
intensive. These tasks include gathering information from prospective customers,
generating proposals, preparing customer applications, communicating with
carriers, servicing policies and billing customers. Independent insurance
agencies must perform these functions efficiently to be competitive and
profitable. As a result, agencies are increasingly automating activities that
were previously performed manually or handled inefficiently by outdated systems
that were not easy to use, lacked broad functionality and scalability, and were
not fully integrated.
In addition, consolidation among agencies is increasing the demand for
automation. As competition has increased and P&C insurance carriers have
demanded higher premium volumes from agencies, many agencies have found it
necessary to merge with other agencies resulting in fewer, larger agencies.
Consolidation of independent agencies primarily affects smaller agencies that
are unable to automate cost-effectively. As a result of such consolidation,
certain agencies are becoming candidates for automation, or are combining with
automated agencies and adding licensed users to those automated systems.
Similarly, insurance carriers need to process larger amounts of information
efficiently to be competitive. Communicating with agencies, processing policies,
handling claims, billing customers and producing regulatory and statistical
reports are all tasks that can be performed more efficiently through automation.
Insurance carriers historically have utilized customized, platform-specific
legacy software developed internally or licensed from third-party suppliers.
Carrier legacy applications generally require large MIS and data processing
departments, are expensive to implement and support, are difficult and expensive
to scale with growth and have limited interoperability with the variety of
information resources and systems available today. Insurance carriers are
increasingly upgrading their automation systems to more current technologies to
become more efficient, and often rely on third-party providers rather than
in-house alternatives for these improvements.
In addition to efforts to improve automation internally, insurance carriers
are actively promoting automation for independent agencies. Some insurance
carriers provide incentives to agencies that elect to automate, such as offering
financing for or subsidizing the purchase of an automation system or paying
higher commissions to automated agencies. Both insurance carriers and agencies
are focusing on EDI because it allows a higher level of cost-efficient
communication with fewer redundant steps and reduced exposure to errors and
omissions. Replacing paper-based information and data flows with computer
networks has led to decreased costs for all industry participants, including
insurance carriers, independent agencies and insureds. The use of EDI for the
exchange of data, including the upload of application information from agencies
to carriers and the download of policies and forms from carriers to agencies, is
increasing. The Agency-Company Organization for Research and Development
("ACORD"), an independent insurance association which develops electronic data
standards, has also been instrumental in promoting EDI.
THE APPLIED SYSTEMS SOLUTION
Complete Automation Solution for Insurance Agencies. TAM is an easy to use,
completely integrated, single-entry application that significantly improves the
productivity and efficiency of independent agencies by combining client
management, policy pricing, EDI, policy and claims servicing, and accounting and
back office administration into a single software solution. The Company believes
TAM enables agencies to become more efficient across all areas of their
business, allowing them to dedicate more time to providing customer service,
soliciting and developing new clients and retaining and leveraging existing
accounts. This software is designed to operate on a personal computer platform
and supports implementations ranging from single users to large local area and
wide area networks, allowing the system to be easily and cost-effectively scaled
to meet the changing needs of independent agencies. In addition, the Company's
ability to download an agency's entire database of customer information from its
various carriers allows for an efficient transition from an older legacy system.
The Company expects to introduce TAM-Vision, its newest version of TAM, in the
third
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<PAGE> 31
quarter of 1998. TAM-Vision is a 32-bit, client/server application that features
increased functionality and speed.
Support and Maintenance Program. The Company provides comprehensive support
and maintenance services to its customers who participate in the Company's
support and maintenance program. This program entitles customers to unlimited
support as well as product enhancements and new versions of the Company's
products. Product enhancements and new versions are introduced regularly to
offer additional functionality and respond to changes in state insurance
regulations and other insurance industry and technological developments.
Management believes that its comprehensive support services reduce its
customers' need for internal MIS and regulatory support personnel. The Company
does not provide extensive customization to its agencies and carriers, which
minimizes the costs associated with providing support and maintenance.
Improvements in features and functionality, including those requested by
customers through the Company's user group, are incorporated into the Company's
base product through upgrades. In addition, the Company is committed to
providing the highest level of customer service through its toll-free support
system staffed by approximately 220 employees. The Company also provides a
rigorous training program that the Company believes enhances customer
satisfaction and reduces costs related to customer support. The Company
continues to expand its customer service resources and offerings and integrate
new technologies as a means to further differentiate itself from its
competitors. As evidence of their high level of satisfaction with the Company's
products and services, approximately 96% of TAM customers since 1996 have
renewed their support and maintenance agreements.
Interface Between Insurance Agencies and Insurance Carriers. The Company's
TAM product fully integrates internal EDI functionality, allowing agencies to
perform industry standard uploads and downloads without relying on third-party
software. TAM features a superior single-entry, multiple carrier capability that
supports more agency/carrier interfacing pairs than any competing product. EDI
transactions between insurance carriers and TAM agencies account for over 40% of
total P&C industry electronic downloads and over 60% of total electronic
uploads. Due to the Company's accomplishments in the area of EDI, it has been
awarded ACORD's Download Vendor of the Year and Upload Vendor of the Year each
year for the past four years. The Company believes its award-winning
capabilities in EDI have enabled agencies and carriers to lower costs, improve
productivity and reduce errors and omissions.
Automated Policy and Claims Processing, Billing, and Regulatory and
Statistical Reporting for Insurance Carriers. The Company's Diamond System is a
fully integrated Microsoft Windows-based system that offers real-time processing
of policies and claims, automates billing and facilitates the production of
regulatory and statistical reports. Unlike many competing systems, the Diamond
System operates in a local area network environment and has a scalable open
architecture. The Company has maintained a common code base across its Diamond
System customers allowing the Company to cost-effectively implement enhancements
and upgrades to those customers. This standardization also minimizes the time
needed for installation. The Diamond System provides carriers with established
EDI connections with the Company's agency customers, which the Company believes
comprise the largest base of independent agencies on a single EDI-enabled
system, as well as with other insurance agencies operating on industry standard
systems.
STRATEGY
The Company is committed to maintaining and enhancing its position as a
leading provider of automation software for independent insurance agencies and
becoming a leading provider of systems to insurance carriers in the P&C market.
The Company believes that the following factors are important to achieving these
goals.
Continue to Focus on Independent Agencies. Since its inception, the Company
has targeted independent insurance agencies in the P&C industry. This focus has
enabled the Company to understand the needs of its agency customers and to use
that knowledge to develop its products and services to meet the specific
requirements of the insurance agency market. The Company plans to continue to
leverage its experience and reputation in the insurance agency market to enhance
its competitive position. The Company currently serves over 7,500 agencies,
representing over 70,000 concurrent licensed users. Fifteen percent of the
approximately 44,000 independent P&C insurance agencies in the U.S. are
currently customers of Applied Systems. The
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<PAGE> 32
Company intends to continue to target the remaining 85% that are operating on
competing systems or are not yet automated.
Further Penetrate Market for Insurance Carrier Systems. The Company plans
to aggressively market its Diamond System to P&C insurance carriers. The Company
currently has low penetration among the approximately 2,400 insurance carriers
in the P&C industry in the U.S., most of which have multiple lines of business
in a number of states, representing an attractive market opportunity for the
Diamond System. The Company is currently focusing the marketing of the Diamond
System on personal lines of insurance, which is a high transaction and low
premium sector of the insurance market characterized by intense price
competition and a focus on cost reduction. The Company believes that the Diamond
System will enable carriers to achieve the operating efficiencies necessary to
compete successfully in this sector of the insurance market and allow them to
enter new markets more efficiently.
Advance Position as Industry Innovator in Interface Technology. The Company
is committed to maintaining and enhancing its position as the leading innovator
of EDI technology in the P&C insurance automation software market. By working
closely with agencies and carriers to develop new EDI functionality for its
products, the Company has been successful in creating a number of EDI
innovations. The Company was the first to deliver a complete automation solution
for agencies capable of single-entry, multiple company interface utilizing ACORD
standards. The Company also performed the industry's first exchange of industry
standard data between an agency and a carrier over the Internet and continues to
facilitate information downloads from carriers to agencies using low-cost
Internet connections. The Company intends to continue to enhance its EDI
capabilities in order to differentiate its products and further penetrate both
the agency and carrier markets.
Maintain Technological Leadership. The Company commits substantial time and
resources to technological development, which it believes is key to the
successful sale and implementation of its products. The Company intends to
maintain its technology leadership position in the insurance software industry
by anticipating and responding to evolving industry needs and by adopting
technological advances in software and hardware to address those needs. The
latest version of TAM operates on a 32-bit platform, the most advanced platform
currently offered in the P&C insurance agency software market. The Company also
developed the Diamond System to respond to the needs of insurance carriers for
complete policy, billing and claims automation and interface capability. The
Company continues to develop new interface solutions and is currently designing
its products to support ACORD's object-based technology, ACORD Objx.
Leverage Relationships in Insurance Agency and Insurance Carrier Customer
Bases. The Company provides complementary systems to both P&C insurance agencies
and carriers, which generate significant opportunities for the Company to
leverage its customer base. Through TAM, the Company has established a broad
base of EDI-enabled insurance agency customers capable of effecting
state-of-the-art information transfers. In marketing the Diamond System, the
Company intends to emphasize the potential benefits of immediate access to this
customer base. In addition, the Company believes that as carriers increasingly
target TAM agencies due to the increased efficiencies that result from the TAM
system, more agencies will demand the TAM product.
PRODUCTS
The Company offers a complete automated management system for independent
agencies and offers policy, billing and claims administration software to meet
the needs of insurance carriers. The Company develops, markets, installs and
offers support and maintenance, and implementation and consulting services for
all of its products.
Agency Systems
The Agency Manager. The Agency Manager is a fully integrated management
system primarily designed for independent P&C agencies. The Company believes
that TAM has the broadest range of features offered in a single product for
agencies in the P&C insurance software industry. TAM is designed to operate on a
personal computer platform and can support implementations ranging from single
users to large local area and
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<PAGE> 33
wide area networks. TAM provides efficient integration of customer/policy
databases, accounting, policy rating, ACORD forms, automated marketing,
transactional filing, digital imaging, network faxing, motor vehicle reports and
integration with Microsoft Office and Mail. In addition, TAM offers advanced
features such as carrier, agency and state-specific forms and custom reports.
TAM fully integrates internal EDI functionality allowing agencies to perform
industry standard uploads and downloads without relying on third party software.
In developing its software products, the Company works closely with the
Applied Systems Client Network ("ASCnet"), the TAM user group that compiles
suggestions for product enhancements from its members and communicates them to
the Company. ASCnet has played a valuable role in the evolution of TAM.
The Company has continually added new features and functionality to
successive versions of TAM, successfully integrating each of these new features
into the base TAM product. The Company believes that these new features increase
an agency's productivity and efficiency. Approximately 15% of all independent
P&C agencies in the U.S. are currently utilizing TAM and over 40% of all P&C
industry downloads and 60% of all uploads are effected between insurance
carriers and TAM agencies. Further establishing its role as a technological
leader, the Company expects to introduce the newest TAM product, TAM-Vision, in
the third quarter of 1998. TAM-Vision is a Windows NT, 32-bit, client/server
product that is designed to support ACORD's Objx standards. License fees for TAM
vary depending on the number of users and sites being licensed.
TAM Advantage.(TM) TAM Advantage is the Company's competitively priced
solution specifically designed for smaller agencies that require a simpler
version of TAM. TAM Advantage offers the same technology as TAM, but is tailored
to meet the needs of these agencies.
FirstRate.(TM) FirstRate is a comparative pricing/rating system for
personal and commercial lines of insurance that fully integrates with TAM or may
be operated on a stand-alone basis. FirstRate equips independent insurance
agencies with a fast and accurate comparative rating system. The Company has
licensed approximately 2,100 FirstRate systems.
Third-Party Products. The Company offers insurance agencies complete
third-party computer hardware systems such as servers, workstations and
printers, and computer software such as Windows NT, Microsoft Office, SQL Server
and the Microsoft BackOffice line. The Company offers these third-party products
as part of its commitment to providing its agency customers with a complete
automation solution.
Insurance Carrier Systems
The Diamond System. The Diamond System provides an automation solution for
regional and national P&C insurance carriers. The Company's Diamond System is a
fully integrated Microsoft Windows-based system that offers real-time processing
of policies and claims, automates billing and facilitates the production of
regulatory and statistical reports. The Diamond System offers established EDI
connections with the Company's insurance agency customers, which the Company
believes comprise the largest base of independent agencies on a single
EDI-enabled system, as well as other insurance agencies operating on industry
standard systems. The Company has sold the Diamond System to 13 insurance
carriers to date and recently began an active marketing program for the product.
The Diamond System is designed to operate on local area and wide area
networks, and does not require a proprietary, single-purpose hardware platform.
Traditionally, insurance carrier processing has been served by main frame-based
systems which require an overnight batch cycle in order to process each day's
transactions. Any errors in data input or processing using a batch system are
not identified and corrected until the next day. The Company believes that
on-line, real-time processing for insurance carrier transactions can lead to a
significant reduction in transaction processing expenses.
In developing the Diamond System, the Company incorporated insurance
functions, business rules and database structures common to all insurance
companies into its "Diamond Base." The Company configures
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the Diamond Base for each insurance carrier by incorporating carrier-specific
rate formulas, underwriting rules, third-party data access, billing plans and
policy forms.
PolicyMiner(TM) and Policy-Rollover.(TM) PolicyMiner is a tool designed to
assist P&C insurance carriers and agencies in electronically analyzing policies
currently in effect and maintained on TAM systems to determine whether or not to
recommend a change in carrier for a given policy. If a change in carrier is
decided upon, PolicyMiner electronically transfers that policy upon renewal to
the new carrier via EDI. PolicyMiner eliminates the need for individual analysis
of the high volume of policies managed by an agency. PolicyMiner and
Policy-Rollover are products that identify "blocks" of policies within an
existing agency system that are to be "rolled," or transferred to a carrier,
based on a number of user-selected attributes such as type of policy, location
and policy effective period. PolicyMiner-Plus is a product that contains the
same features as PolicyMiner and Policy-Rollover, but adds a carrier-specific
pricing and underwriting feature for premium and commission comparison between
each existing policy version and a proposed new policy version. This allows the
carrier and agency to "mine" the agency's database utilizing premium and
commission comparisons.
SERVICES
Support and Maintenance. All of the Company's agency customers receive one
year of support and maintenance service with the initial system purchase.
Customers may enter into support and maintenance agreements thereafter that
entitle them to continued support as well as product enhancements and new
versions of the Company's products. Technological system advances, including
those requested by customers through the Company's user group, ASCnet, are
incorporated into the Company's base product through product enhancements and
new versions. Upgrades of the Company's products are introduced regularly to
respond to changes in state insurance regulations and other insurance industry
and technological developments. The Company employs approximately 20 individuals
dedicated to incorporating each state's regulations into its products. By
providing upgrades to all of its agency customers participating in the Company's
support and maintenance program, the Company is able to minimize the cost of
supporting multiple versions of its products.
Implementation and Consulting Services. The Company offers full
implementation services, including installation, data conversion, training and
consulting services. The Company's training services provide customers with a
formalized program to ensure that applications will be utilized in an efficient
and cost-effective manner. The Company offers extensive training at its
facilities in University Park, Illinois and its regional training centers in
California, Florida, Massachusetts, Minnesota, New Jersey, Texas, Washington and
Ontario, Canada. The Company's consulting services are performed on site and are
designed to assist customers with agency-specific workflows and enhance system
utilization.
PRODUCT DEVELOPMENT
Applied Systems has a history of introducing innovations and adopting
leading edge technology in its products. The market for the Company's products
is characterized by rapidly changing technology, the need to comply with varied
and continuously changing state insurance regulations and frequent introductions
of new products and enhancements. The Company's future success depends in part
on its ability to enhance its existing products and services and develop new
products and services to meet changing customer requirements. To this end, the
Company relies in part on input from its licensed user group, ASCnet, to improve
the functionality and ease of use of its agency systems. The Company offers
upgrades to all of its customers who participate in the Company's support and
maintenance program. The Internet has facilitated updates on a more regular
basis. The Company's product development efforts are focused on enhancement of
existing products and services, expansion of operating system compatibility and
development of new applications for the insurance software market. The latest
example of the Company's product development efforts is TAM-Vision, which is a
Windows NT-based, 32-bit, client/server version of TAM expected to be introduced
in the third quarter of 1998.
Since inception, the Company has made substantial investments in enhancing
and developing its products and services. The Company spent approximately $7.7
million, $7.9 million and $9.7 million in 1995, 1996 and
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<PAGE> 35
1997, respectively, on research and development and the Company intends to
devote substantial resources to product development in the future. The Company
has approximately 235 employees who specialize in product development and
participate in the initial installations of new products.
SALES AND MARKETING
The Company markets and sells its products through its direct sales force
which consists of approximately 75 employees located primarily in North America.
Approximately 70 of these salespeople are responsible for selling agency
products and services. The Company's U.S. agency sales force is divided into
four regional sales units and one national accounts unit. The regional sales
units are supervised by regional managers and are responsible for sales to
small- and medium-sized independent insurance agencies. The national accounts
unit sells to larger agencies.
The Company dedicates approximately 75% of its agency sales force to new
customer sales. Sales prospects originate primarily from the Company's
advertising and marketing, current customer referrals and industry trade shows.
Any inquiries from potential customers as a result of these marketing efforts
are channeled through the Company's central headquarters to the appropriate
regional or national accounts salesperson. Sales presentations are conducted at
the prospective agency and include a full demonstration of the product. The
balance of the agency sales force focuses on generating revenue from the
Company's current customer base through sales of additional user licenses and
third-party hardware and software. These employees also maintain and strengthen
customer relationships by disseminating information regarding product
enhancements and technical specifications for software compatibility.
The Company's carrier system salespeople are based at the Company's
headquarters. The Company intends to add sales resources to this group as it
begins to more aggressively market the Diamond System. The Company currently
provides incentives to a portion of its existing agency sales force to generate
leads for Diamond System sales.
A substantial portion of sales force compensation is based on commissions,
with additional incentives offered for new user sales. The Company believes that
its commission based compensation system optimizes sales productivity.
The Company markets its products through participation in trade shows,
target marketing and advertising in trade publications. The Company maintains
control over the content and timing of its advertising and promotional materials
by producing substantially all of its marketing materials in-house, thus
reducing costs and ensuring timely development and delivery.
CUSTOMERS
The Company has a diverse customer base. During 1997, no single customer
accounted for more than 2% of total sales. The quality of the Company's support
and maintenance has been a key factor in its 96% customer retention rate since
1996 for support and maintenance agreements and the development of a strong
relationship with its user group. Customers for the Company's agency products
range from small- to medium-sized independent insurance agencies to large
national agencies. The Company currently serves over 7,500 independent insurance
agencies. Customers for the Company's insurance carrier products are regional
and national insurance carriers. The Company has sold its Diamond System to 13
insurance carriers to date.
INTELLECTUAL PROPERTY RIGHTS AND LICENSES
The Company provides its products to customers on a "right-to-use" basis
under exclusive and non-exclusive licenses containing confidentiality and
nondisclosure provisions. The Company seeks to protect its software and other
intellectual property through a combination of trade secret, copyright and
trademark law. In addition, the Company relies on confidentiality agreements and
contractual restrictions on copying and disclosure contained in its licenses and
nondisclosure agreements with its employees and contractors.
Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or to
obtain and use information that the Company regards as proprietary.
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<PAGE> 36
Policing unauthorized use of the Company's products is difficult and, while the
Company is unable to determine the extent to which piracy of its software
products exists, software piracy can be expected to be a persistent problem. In
addition, the laws of some foreign countries do not protect the Company's
proprietary rights to the same extent as do the laws of the U.S. There can be no
assurance that the steps taken by the Company to protect its proprietary rights
will be adequate or that the Company's competitors will not independently
develop technologies that are substantially equivalent or superior to the
Company's products and technologies. In addition, certain technology used in the
Company's products is licensed from third parties. See "Risk Factors -- Reliance
on Microsoft Technologies."
The Company was involved in litigation in which Harbor alleged, and a trial
court found, misappropriation of trade secrets. The litigation with Harbor was
settled in July 1998 for $5.0 million. There can be no assurance that other
third parties will not assert infringement claims against the Company in the
future with respect to past, current or future products. See "Risk
Factors -- Proprietary Rights; Risk of Infringement," and Note 12 of Notes to
Combined Financial Statements. As the number of software products in the
industry increases and the functionality of these products further overlap, the
Company believes that software developers may become increasingly subject to
infringement claims. Any such claims, with or without merit, can be
time-consuming and expensive to defend, cause product shipment delays or require
the Company to enter into royalty or licensing agreements.
COMPETITION
The market for the Company's products is highly competitive. A variety of
companies currently offer products that compete with one or more of the
Company's product lines. In addition, as the Company targets new markets and
introduces new product lines, it expects to encounter competition from
additional software vendors. The Company competes on the basis of product
features and functionality, price and maintenance and support programs. The
Company believes that its products generally compete effectively with respect to
these factors.
In the independent insurance agency market, the Company believes that its
most significant competition comes from systems developed by other insurance
software vendors such as AMS and Delphi. In the P&C insurance carrier market,
the Company believes that its most significant competition comes from policy and
claims administration and information systems developed in-house by insurance
carriers. Carriers that perform in-house administration typically have made a
significant investment in their policy and claims administration systems. In
addition, insurance carrier personnel have a vested interest in maintaining
these responsibilities in-house. The Company also competes with outside software
vendors including PMSC and INSpire. Many of the Company's existing competitors,
as well as a number of potential new competitors, have significantly greater
financial, technical and marketing resources than the Company.
FACILITIES
The Company's corporate headquarters, its principal administrative, product
development, sales and marketing operations and its principal customer training
center are located in University Park, Illinois in a building with approximately
160,000 square feet of office space. The Company leases the property from an
entity controlled by the founder and principal stockholder of the Company and
the current Chairman, Chief Executive Officer and President of the Company. See
"Certain Transactions." The lease expires in September 2006 and currently
provides for an annual base rent of $1.6 million with annual increases of the
greater of the national consumer price index or 2%. The Company is currently
negotiating a new lease for this property which it expects to enter into in the
third quarter of 1998. The Company owns an office building in Canada which is
approximately 13,000 square feet and is used for the Company's Canadian
operations. In addition, the Company leases office space in eleven locations in
the U.S. for sales and training facilities and in one location in the U.K. The
U.S. properties are located throughout the country and range in size from
approximately 1,000 square feet to 18,000 square feet. The leases generally have
terms expiring between late 1998 and 2001. The Company also owns two office
buildings in Illinois, one of which is 33,000 square feet, the other of which is
38,000 square feet, is not currently being used by the Company and which the
Company intends to sell. The
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Company believes that its existing facilities are suitable and adequate for its
present needs and that suitable additional space will be available as needed to
accommodate any expansion of operations.
EMPLOYEES
As of June 30, 1998, the Company had approximately 1,100 employees, of
which approximately 235 employees perform software and product development, 570
perform customer services, 135 are engaged in sales and marketing activities,
135 perform corporate functions and 25 perform configuration and evaluation of
hardware. Of the Company's employees, 970 are located within the U.S. and 130
are located outside the U.S. None of the Company's employees is represented by a
collective bargaining unit. The Company considers its relations with its
employees to be good.
LEGAL PROCEEDINGS
The Company is party to various claims, legal actions and complaints
arising in the ordinary course of business. Management does not believe that any
such matters individually or in the aggregate could have a material adverse
effect on the Company's financial condition or results of operation.
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<PAGE> 38
MANAGEMENT
The following table sets forth certain information concerning each of the
Company's executive officers and directors.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
James P. Kellner................ 40 Chairman of the Board, President and Chief Executive Officer
Timothy J. McIntyre............. 40 Executive Vice President and Chief Financial Officer
Thomas H. Carruth............... 37 Executive Vice President-Software Services
John J. Higginson............... 30 Executive Vice President-Technology
Patrick J. Kellner.............. 37 Executive Vice President-Sales
Patricia E. Ruisz............... 42 Executive Vice President-Operations
Glen R. Eustace................. 28 Vice President-Financial Management and Director
William A. Huff................. 52 Director
</TABLE>
EXECUTIVE OFFICERS AND DIRECTORS
James P. Kellner was appointed President of the Company in 1991, Chief
Executive Officer in April 1997 and Chairman of the Board of Directors in June
1998. He joined the Company in 1985 as a programmer/analyst. In 1988, he was
selected to head the Company's newly formed Large Systems Division and was
responsible for marketing automation systems to large independent insurance
agencies. Mr. Kellner received his B.A. from Augustana College. James P. Kellner
and Patrick J. Kellner are brothers.
Timothy J. McIntyre began his employment with the Company in May 1998.
Prior to joining the Company, he was General Manager of Investor Relations and
Financial Management from 1996 to May 1998 and Manager of Financial Planning
from 1993 to 1996 at Ryerson Tull, a materials distribution company. Mr.
McIntyre has an accounting degree from the University of Notre Dame, an M.B.A.
from the University of Chicago and is a C.P.A. and a C.C.M. (Certified Cash
Manager).
Thomas H. Carruth joined the Company in 1991 as Vice President/General
Manager for the Indianapolis (Liberty) operation. In 1993 he assumed the
additional responsibilities of the Marietta support operation and, in 1994, he
began managing the Company's rating operation located in Minneapolis. Mr.
Carruth was appointed Executive Vice President-Software Services in 1995. Mr.
Carruth received his B.A. from Miami University, Oxford, Ohio.
John J. Higginson joined the Company in 1990 as a Customer Support
Engineer. In 1995, Mr. Higginson was promoted to Vice President-Software
Services with responsibility for the operation of the Company's U.S. customer
support center. In 1997, Mr. Higginson was promoted to his current position of
Executive Vice President-Technology. Mr. Higginson received his B.A. from
Northern Illinois University and is a Certified Netware Engineer and a Microsoft
Certified Systems Engineer.
Patrick J. Kellner joined the Company in 1987 as a regional sales
specialist in Wisconsin. In 1991, Mr. Kellner was promoted to Vice President,
National Sales Manager and in 1996 was promoted to the new position of Vice
President-Sales for the Company Systems Division. In 1997, Mr. Kellner was named
Executive Vice President-Sales and is responsible for the Sales and Marketing of
all the Company's products in the U.S. Mr. Kellner received his B.A. from
Augustana College.
Patricia E. Ruisz joined the Company in 1984. In 1985, she became the
manager of the Company's Customer Order Processing Department. Between 1988 and
1989, Ms. Ruisz was primarily responsible for overseeing the commencement of the
Company's operations in Canada. In 1989, she was promoted to the position of
Chief Operating Officer and in July 1998 such title was changed to Executive
Vice President-Operations.
Glen R. Eustace began his career at the Company in 1994 as Director,
Financial Planning. In late 1995, he was promoted to Executive Vice
President-Business Development and in 1998 became Vice President --
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<PAGE> 39
Financial Management. For the three year period prior to joining Applied
Systems, he was a financial analyst with Baxter Healthcare Corporation where his
duties included financial planning, international treasury functions and general
accounting. Mr. Eustace has a B.S. in Finance from the University of Illinois.
Glen R. Eustace is the son of Robert R. and Elsa M. Eustace, the founders and
principal stockholders of the Company.
William A. Huff has served as a director of the Company since its
incorporation on April 1, 1986. He also serves as a member of the board of
directors of GreatBank, N.A. in Evanston, Illinois and First National Bank in
Chicago Heights, Illinois. Mr. Huff received his B.S. from Indiana University
and his J.D. from the University of Illinois. Mr. Huff has been engaged in the
private practice of law since 1979 and provides legal services to the Company
from time to time. See "Certain Transactions."
BOARD OF DIRECTORS
The business of the Company is managed under the direction of the Company's
Board of Directors. The Board of Directors is currently composed of three
directors, including two executive officers of the Company. Following the
Offering, the directors will be divided into three classes. Upon the expiration
of the term of each class of directors, directors comprising that class will be
elected for a three-year term at the next succeeding annual meeting of
stockholders. Each director holds office until that director's successor has
been duly elected and qualified. The Company intends to expand the Board of
Directors prior to the consummation of the Offering to include two individuals
who are not officers or employees of the Company. One director will be in Class
I and will stand for election at the annual meeting of stockholders to be held
in 1999. The other additional director and Mr. Huff will be in Class II and will
stand for election at the annual meeting of stockholders to be held in 2000. Mr.
Kellner and Mr. Eustace will be in Class III and will stand for election at the
annual meeting of stockholders to be held in 2001. Officers of the Company are
elected at each annual meeting of the Board of Directors and serve at the
discretion of the Board.
BOARD COMMITTEES
The Company's Board of Directors has established an Audit Committee and a
Compensation Committee. The directors who will comprise such committees after
the consummation of the Offering have not yet been determined. The Audit
Committee recommends the firm to be appointed as independent accountants to
audit financial statements and to perform services related to the audit, reviews
the scope and results of the audit with the independent accountants, reviews
with management and the independent accountants the Company's year-end operating
results and considers the adequacy of the internal accounting procedures. The
Compensation Committee reviews and recommends the compensation arrangements for
all officers, approves such arrangements for other senior level employees and
administers and takes such other action as may be required in connection with
certain compensation and incentive plans of the Company (including the grant of
stock options).
COMPENSATION OF DIRECTORS
Directors who are officers or employees of the Company do not receive
compensation for serving as directors. Non-employee directors receive a $12,000
annual retainer and an additional fee of $500 per meeting of the Board of
Directors or a committee thereof. All directors are reimbursed for out-of-pocket
expenses incurred in connection with attendance at meetings of the Board of
Directors and meetings of committees of the Board of Directors.
In connection with the Offering, the Company has adopted the Stock Option
Plan. See "Management -- Stock Plans." Pursuant to this plan, on the
consummation of the Offering (or, if later, on the date on which a person is
first elected or begins to serve as a non-employee director) each non-employee
director will be granted a nonqualified option to purchase 5,000 shares of
Common Stock which will vest one-half each on the first and second anniversaries
thereof and, on the last day of each calendar quarter of the year, each person
who is a non-employee director will be granted a nonqualified option to purchase
500 shares of Common Stock which will vest on the day prior to the first
anniversary of the date of grant. The per share exercise price of such options
will be equal to the fair market value of the Common Stock on the date of grant
of such option.
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<PAGE> 40
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to this Offering, all executive officer compensation decisions have
been made by the entire Board of Directors of the Company, including James P.
Kellner and Glen R. Eustace. Following the Offering, all executive officer
compensation decisions will be made by the Compensation Committee.
EXECUTIVE COMPENSATION
Summary Compensation. The following table sets forth compensation awarded
to, earned by or paid for services rendered to the Company in all capacities
during the fiscal year ended December 31, 1997 by the Company's Chief Executive
Officer and each of the Company's other five most highly compensated executive
officers who were serving as such at the close of fiscal 1997 (collectively, the
"Named Executives").
SUMMARY COMPENSATION TABLE(1)
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
----------------------
NAME AND CAPACITY SERVED SALARY BONUS
------------------------ ------ -----
<S> <C> <C>
James P. Kellner............................................ $202,000 $260,521(2)
Chairman, Chief Executive Officer and President
Robert R. Eustace(3)........................................ 709,362 --
Former Chairman and Chief Executive Officer
Elsa M. Eustace(4).......................................... 460,560 --
Corporate Secretary
Patrick J. Kellner.......................................... 136,000 95,350
Executive Vice President -- Sales
Thomas H. Carruth........................................... 125,000 50,350
Executive Vice President -- Software Services
Dawn M. Eustace(5).......................................... 150,000 23,750
Executive Vice President -- Hardware
Glen R. Eustace(6).......................................... 150,000 23,600
Executive Vice President -- Business Development
</TABLE>
- -------------------------
(1) Other compensation in the form of perquisites and other personal benefits
has been omitted, because the aggregate amount of such perquisites and other
personal benefits was the lesser of either $50,000 or 10% of the total
annual salary and bonus of the Named Executive for such year.
(2) Includes shares of Common Stock of the Company valued as of the date of
grant at approximately $35,000.
(3) Robert R. Eustace resigned as Chief Executive Officer in April 1997 and as
Chairman of the Board of Directors in June 1998 and, upon consummation of
the Offering, will cease employment with the Company.
(4) Effective upon the consummation of the Offering, Elsa M. Eustace will resign
as Corporate Secretary and cease employment with the Company.
(5) Effective upon the consummation of the Offering, Dawn M. Eustace will cease
employment with the Company.
(6) In July 1998, Glen R. Eustace became Vice President -- Financial Management.
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<PAGE> 41
EMPLOYMENT AGREEMENT
The Company entered into an employment agreement with Mr. McIntyre in May
1998 that has an initial term of two years and provides for automatic renewal
periods of one year each unless either party receives timely notice of
non-renewal. Pursuant to such employment agreement, Mr. McIntyre receives an
annual base salary of $135,000 and is eligible for an annual discretionary bonus
and participation in other compensatory plans of the Company from time to time.
If Mr. McIntyre's employment is terminated by the Company without cause or by
Mr. McIntyre with cause, he will receive a severance allowance equal to six
months of base salary on the date of termination and continued health insurance
benefits at the Company's expense. If Mr. McIntyre's employment is terminated by
the Company with cause or by Mr. McIntyre without cause, no severance benefits
will be provided. The employment agreement further provides that Mr. McIntyre
may not consult, control or be employed by any direct competitor of the Company
for a period of two years following his employment with the Company.
STOCK PLANS
Stock Option Plan
In connection with this Offering, the Board of Directors of the Company
adopted and the Company's stockholders approved the Company's Stock Option Plan.
Up to an aggregate of 1,500,000 shares of Common Stock may be issued upon the
exercise of stock options granted under the Stock Option Plan. These stock
options may be either incentive stock options ("ISOs") within the meaning of
Section 422 of the Code, or nonqualified stock options. No stock options may be
issued under the Stock Option Plan later than ten years after the effective date
of such Plan.
The purposes of the Stock Option Plan are to align the interests of the
Company's stockholders and the recipients of options under the Stock Option Plan
by increasing the proprietary interest of such recipients in the Company's
growth and success and to advance the interests of the Company by attracting and
retaining officers and other key employees and well-qualified independent
directors.
The Stock Option Plan is administered by the Compensation Committee.
Subject to the terms of the Stock Option Plan, the Compensation Committee is
authorized to select eligible officers and other key employees for participation
in the Stock Option Plan and to determine the number of shares of Common Stock
subject to each option granted thereunder, the exercise price of such option,
the time and conditions of exercise of such option and all other terms and
conditions of such option.
The Compensation Committee may delegate some or all of its power and
authority under the Stock Option Plan to the Chief Executive Officer or other
executive officer of the Company as it deems appropriate. However, the
Compensation Committee generally may not delegate its power and authority with
regard to the selection for participation in the Stock Option Plan of an officer
or other person who is a "covered employee" within the meaning of Section 162(m)
of the Code or who, in the Compensation Committee's judgment, is likely to be a
covered employee at any time during the period in which an option to such
employee would be outstanding or who is subject to Section 16 of the Exchange
Act or decisions concerning the time, pricing or amount of an option grant to
such an officer or other person.
The purchase price of shares of Common Stock subject to an option granted
under the Stock Option Plan is determined by the Compensation Committee at the
time of grant, but, in the case of an incentive stock option, may not be less
than 100% of the fair market value of such shares of Common Stock on the date of
grant. The aggregate fair market value (determined as of the date the option is
granted) of the stock with respect to which ISOs are exercisable for the first
time by the optionee in any calendar year (under the Stock Option Plan and any
other incentive stock option plan of the Company) may not exceed $100,000.
Options granted under the Stock Option Plan may not be exercised after ten years
from the date of grant. In the case of any eligible employee who owns or is
deemed to own stock representing more than 10% of the total combined voting
power of all classes of stock of the Company, the exercise price of any ISOs
granted under the Stock Option Plan may not be less then 110% of the fair market
value of the Common Stock on the date of grant, and the exercise period may not
exceed five years from the date of grant.
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<PAGE> 42
Options granted under the Stock Option Plan are not transferable by the
optionee other than by will or under the laws of descent and distribution.
Unless otherwise provided for in the option agreement relating to an option,
each option terminates on the earlier of the date of the expiration of the
option or three months after the date the optionee terminates employment with
the Company for any reason other than termination for cause or the retirement on
or after age 65 after a minimum of five years employment with the Company or the
death or disability of the optionee. Unless otherwise provided for in the option
agreement relating to an option, during such post-employment period, the
optionee may exercise the option in respect of the number of shares that were
exercisable on the date of termination of employment. Unless otherwise provided
for in the option agreement relating to an option, in the event of retirement of
an optionee on or after age 65 after a minimum of five years of employment with
the Company or the death or disability of an optionee before the date of
expiration of the option, the option terminates on the earlier of the date of
expiration or one year following the date of termination of employment, during
which period the option may be exercised in respect of the number of shares
remaining subject to the option on the date of termination of employment. If an
optionee's employment is terminated for cause, all options held by such optionee
will terminate automatically on the effective date of such optionee's
termination of employment.
The Stock Option Plan provides that an option agreement may permit an
optionee to tender previously owned shares of Common Stock in partial or full
payment for shares to be purchased on exercising an option. Unless sooner
terminated by action of the Board of Directors, the Stock Option Plan will
terminate in ten years. Subject to certain exceptions, it may be amended,
altered or discontinued by the Board of Directors without stockholder approval.
In the event of a Change in Control of the Company (as defined in the Stock
Option Plan), each outstanding stock option will become exercisable in full.
The Compensation Committee will make grants under the Stock Option Plan,
subject to completion of this Offering, of options to purchase Common Stock as
follows: , and received non-qualified stock options to
purchase and shares of Common Stock, respectively. Each such
stock option has a per share exercise price equal to the initial public offering
price and will expire ten years after the date of grant. Such options will
become exercisable in equal portions in annual installments over five years
subsequent to the date of grant. Additional grants of non-qualified options
covering an aggregate of shares of Common Stock with a per share
exercise price equal to the initial public offering price will be made, subject
to completion of this Offering, to other employees of the Company.
Employee Stock Purchase Plan
In connection with the Offering, the Board of Directors of the Company
adopted and the Company's stockholders approved the Company's Employee Stock
Purchase Plan (the "Purchase Plan"). A total of 350,000 shares of Common Stock
have been reserved for issuance under the Purchase Plan, none of which has been
issued. The Purchase Plan provides eligible employees with an opportunity to
purchase Common Stock at a discount through automatic payroll deductions. The
Purchase Plan is intended to qualify as an employee stock purchase plan within
the meaning of Section 423 of the Code.
Employees eligible to participate in the Purchase Plan include each
employee of the Company who has been an employee for at least twelve consecutive
months on a given enrollment date, except that employees who own stock
representing 5% or more of the total voting power of the Common Stock are not
eligible to participate in the Purchase Plan.
Eligible employees acquire Common Stock under the Purchase Plan by electing
to have an amount up to 8% of their earnings withheld pursuant to the Purchase
Plan (subject to the maximum limitation described in the next paragraph). The
amount withheld is then used to purchase shares of Common Stock on one or more
specified purchase dates during any six-month period ("Offering Period").
Offering Periods commence on each June 1 and December 1; the initial Offering
Period will commence December 1, 1998 and expire on May 31, 1999. No interest
will be paid on amounts withheld pursuant to the Purchase Plan from a
participating employee's compensation. On the last day of the Offering Period,
the entire account balance of a participating employee is applied to purchase
the maximum number of shares of Common Stock. The shares
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<PAGE> 43
are purchased at a price equal to 85% of the lesser of (i) the fair market value
of the Common Stock on the date of purchase (the last business day of the
Offering Period) or (ii) the fair market value of the Common Stock on the first
day of the Offering Period.
At any time prior to the expiration of any Offering Period, an employee may
cancel his or her participation in such Offering Period, and participation ends
automatically on termination of employment with the Company. Under the Purchase
Plan, rights of any employee to purchase Common Stock may not accrue at a rate
that exceeds $25,000 in fair market value per calender year.
401(k) Profit Share Plan
The Company sponsors a voluntary contribution plan qualified under Section
401(k) of the Code (the "401(k) Plan"). The 401(k) Plan allows eligible
employees to make contributions up to 15% of their compensation. Under the
401(k) Plan, the Company may contribute to the 401(k) Plan an amount of matching
contributions which is determined at its discretion.
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CERTAIN TRANSACTIONS
The business of Applied Systems is currently conducted by three affiliated
entities: ASI, Asktom and TAM UK (together, the "Reorganized Entities"). The
Company and the stockholders of each of the Reorganized Entities will enter into
a Contribution and Merger Agreement which provides for all of the equity
interests in ASI and Asktom to be contributed to the Company and for the
stockholders of TAM UK (each of which is a corporation) to be merged with and
into the Company, in all cases immediately prior to the consummation of this
Offering. In exchange for such transfers, Robert R. Eustace, the founder and
majority stockholder of the Reorganized Entities, will receive, together with
his spouse, Elsa M. Eustace, shares of Common Stock of the Company, James
P. Kellner, Chairman, Chief Executive Officer and President of the Company, will
receive shares of Common Stock, Glen R. Eustace, an officer and
director of the Company, will receive shares of Common Stock and Dawn
M. Eustace, an executive officer of ASI, will receive shares of Common
Stock. Following the Reorganization, the Company will be a holding company with
ASI, Asktom and TAM UK as its wholly-owned subsidiaries.
ASI currently leases its principal facility, which consists of
approximately 160,000 square feet of office and training space, from Applied
Properties L.L.C. ("Applied Properties"). Robert R. Eustace and James P. Kellner
together hold substantially all of the ownership interests in Applied
Properties. The lease payments (net of utilities, insurance and taxes) in fiscal
years 1995, 1996 and 1997 were approximately $18,000, $436,544 and $1,607,024,
respectively. The current lease payments are approximately $1.6 million per
year. The Company will enter into a new lease agreement prior to the
consummation of the Offering including payments which the Company believes will
be no higher than those which would be charged by an unrelated third-party under
similar circumstances. See "Business -- Facilities."
In October 1995, Applied Properties secured a one-year construction loan
allowing for maximum borrowings of $9,600,000. The loan was collateralized by
ASI's principal facility and two other buildings owned by ASI. As of December
31, 1997, the construction loan had been converted to a mortgage note. The
mortgage note bears interest at 8.0% and is similarly secured. The mortgage note
is guaranteed by ASI and Robert R. and Elsa M. Eustace. As of March 31, 1998,
the mortgage note balance was $9,600,000. The mortgage is payable in monthly
installments of $116,474, and a balloon payment is due in December 2002.
In connection with the construction of the Company's principal facility,
ASI loaned funds to Applied Properties. These loans resulted in amounts due to
ASI of $2,083,528 and $1,825,542 as of December 31, 1996 and December 31, 1997,
respectively. The aggregate amount outstanding under these loans is currently
approximately $5.0 million. The loans are expected to be repaid in full when ASI
and Applied Properties enter into a new lease for the principal facility, which
is expected to be in the third quarter of 1998.
ASI leases a property in Florida from Applied Properties on a
month-to-month basis. This property is used for business meetings and to house
ASI employees. Monthly rental expense is determined by the management of Applied
Properties and is approximately $6,000. Upon consummation of the Offering, the
lease agreement will be terminated.
ASI and the current ASI stockholders will enter into a Tax Indemnification
Agreement relating to their respective income tax liabilities for periods (or
portions thereof) ending on or prior to the close of, and beginning after, the
Termination Date. The Tax Indemnification Agreement generally provides that,
subject to certain exceptions, the current ASI stockholders will be responsible
for any federal and state income taxes imposed upon ASI for all taxable periods
(or portions thereof) ending on or prior to the Termination Date (the
"Pre-Termination Period") (other than state income taxes in states where ASI has
not elected S corporation status or S corporation status is not respected) and
ASI will be responsible for all federal and state income taxes of ASI for
taxable periods (or portions thereof) beginning after the Termination Date (the
"Post-Termination Period"). Because ASI will be fully subject to corporate
income taxation after the Termination Date, the reallocation of income and
deductions between the Pre-Termination Period and the Post-Termination Period
may increase the taxable income of one party while decreasing that of another
party. Accordingly, subject to certain limitations, the Tax Indemnification
Agreement generally provides that the current ASI stockholders will be
indemnified by ASI with respect to federal and state income taxes shifted from a
Post-Termination Period to a Pre-Termination Period, and ASI will be indemnified
by the current ASI
43
<PAGE> 45
stockholders with respect to federal and state income taxes shifted from a
Pre-Termination Period to a Post-Termination Period. See "Reorganization and S
Corporation Distribution."
Mr. Huff, a director of the Company, and the law firm of Huff & Kennedy, of
which Mr. Huff is a partner, have performed legal services on behalf of the
Company. The legal fees paid to Huff & Kennedy did not exceed 5% of Huff &
Kennedy's gross revenues during the firm's last full fiscal year. The Company
expects such services to continue in the future.
In January 1992, ASI entered into a Stock Purchase Agreement with the
Estate of Thomas A. Eustace, Robert R. Eustace's brother, pursuant to which ASI
agreed to purchase for an aggregate purchase price of $3,200,000, in the form of
$500,000 in cash and a five year note in the amount of $2,700,000, an aggregate
of 200 shares of common stock of ASI and 200 shares of common stock of Asktom,
each of which represented 20% of the outstanding shares of common stock of each
corporation at such time. Erica Eustace, Robert K. Eustace's niece, and Victoria
Eustace, Robert R. Eustace's sister-in-law received aggregate payments pursuant
to the Stock Purchase Agreement of $337,500, $337,500, and $28,125 for the years
ended December 31, 1995, December 31, 1996 and December 31, 1997, respectively.
There are no further amounts payable under this agreement.
ASI's bank line of credit is personally guaranteed by Robert R. and Elsa M.
Eustace. See "Management's Discussion and Analysis of Financial Condition and
Results of Operation -- Liquidity and Capital Resources."
Any future transactions between the Company and its executive officers,
directors and affiliates will be on terms no less favorable to the Company than
can be obtained from unaffiliated third parties, and any material transactions
with any such persons will be approved by a majority of the members of the
Company's Board of Directors and by a majority of the disinterested members of
the Company's Board of Directors.
44
<PAGE> 46
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of June 30, 1998, before and after
giving effect to the sale of the shares of Common Stock offered hereby and after
giving effect to the Reorganization, by (i) each person who is known by the
Company to own beneficially more than 5% of the outstanding shares of Common
Stock, (ii) each director of the Company, (iii) each of the Named Executives,
(iv) each Selling Stockholder and (v) all directors and executive officers of
the Company as a group.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
OF COMMON STOCK NUMBER OF OF COMMON STOCK
PRIOR TO THE OFFERING SHARES AFTER THE OFFERING
--------------------- BEING ---------------------
NAME OF BENEFICIAL OWNER(1) NUMBER PERCENT OFFERED NUMBER PERCENT
--------------------------- ------ ------- --------- ------ -------
<S> <C> <C> <C> <C> <C>
Robert R. Eustace(2)................... % %
Glen R. Eustace(3).....................
Dawn M. Eustace(4).....................
James P. Kellner.......................
Steven A. Dye(5).......................
Michael T. Eustace(5)..................
Nicholas E. Eustace(5).................
All executive officers and directors as
a group (8 persons).................. % %
</TABLE>
- -------------------------
* Less than 1%.
(1) The mailing address of each of these individuals is c/o the Company, 200
Applied Parkway, University Park, IL 60466.
(2) Consists of shares owned by Robert R. Eustace and Elsa M. Eustace, his wife,
as joint tenants with right of survivorship.
(3) Son of Robert R. Eustace and Elsa M. Eustace.
(4) Daughter of Robert R. Eustace and Elsa M. Eustace.
(5) Nephew of Robert R. Eustace and Elsa M. Eustace, cousin of Glen R. Eustace
and Dawn M. Eustace and an employee of the Company whose employment will
cease upon consummation of the Offering.
45
<PAGE> 47
DESCRIPTION OF CAPITAL STOCK
The Restated Certificate of Incorporation (the "Charter") to be adopted by
the Company provides that the authorized capital stock of the Company consists
of 45,000,000 shares of Common Stock, par value $.01 per share, and 2,000,000
shares of preferred stock, $.01 par value per share (the "Preferred Stock").
COMMON STOCK
Holders of Common Stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Accordingly, holders of a majority of the shares of Common Stock
entitled to vote in any election of directors may elect all of the directors
standing for election. Holders of Common Stock are entitled to receive ratably
such dividends, if any, as may be declared by the Board of Directors out of
funds legally available therefor, subject to any preferential dividend rights of
outstanding Preferred Stock. Upon the liquidation, dissolution or winding up of
the Company, the holders of Common Stock are entitled to receive ratably the net
assets of the Company available after the payment of all debts and other
liabilities and subject to the prior rights of holders of any outstanding
Preferred Stock. Holders of Common Stock have no preemptive, subscription,
redemption or conversion rights. The outstanding shares of Common Stock are, and
the shares offered by the Company in the Offering will be, when issued and paid
for, fully paid and nonassessable.
PREFERRED STOCK
The Charter provides that the Board of Directors is authorized, subject to
certain limitations, without further stockholder approval, to issue from time to
time up to an aggregate of 2,000,000 shares of Preferred Stock in one or more
series and to fix or alter the designations, preferences, rights and any
qualifications, limitations or restrictions of the shares of each such series
thereof, including the dividend rights, dividend rates, conversion rights,
voting rights, terms of redemption (including sinking fund provisions),
redemption price or prices, liquidation preferences and the number of shares
constituting any series or designations of such series. The issuance of
Preferred Stock may have the effect of delaying, deferring or preventing a
change of control of the Company. The rights, preferences and privileges of
holders of Common Stock are subject to, and may be adversely affected by, the
rights of the holders of shares of any series of Preferred Stock which the
Company may designate and issue in the future. The Company has no current plans
to issue any shares of Preferred Stock.
DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law (the "DGCL"). Subject to certain exceptions, Section 203
prohibits a publicly held Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years after
the date of the transaction in which the person became an interested
stockholder, unless the interested stockholder attained such status with the
approval of the Board of Directors or unless the business combination is
approved in a prescribed manner. However, such restriction does not apply if the
business combination is with an interested stockholder who became an interested
stockholder at a time when the restrictions contained in Section 203 did not
apply. The restrictions contained in Section 203 did not apply when Robert R.
Eustace became an interested stockholder because the voting stock of the Company
was not listed on a national securities exchange or authorized for quotation on
The Nasdaq National Market or held of record by more than 2,000 stockholders. A
"business combination" includes mergers, asset sales and other transactions
resulting in a financial benefit to the interested stockholder which is not
shared pro rata with the other stockholders of the Company. Subject to certain
exceptions, an "interested stockholder" is a person who, together with
affiliates and associates, owns, or within the past three years did own, 15% or
more of the corporation's voting stock.
The Charter provides for the division of the Board of Directors into three
classes as nearly equal in size as possible with staggered three-year terms. See
"Management -- Board of Directors." Any director may be removed only with cause
and then only by the vote of at least 75% of the outstanding voting power.
46
<PAGE> 48
The Charter empowers the Board of Directors, when considering a tender
offer or merger or acquisition proposal, to take into account factors in
addition to potential economic benefits to stockholders. Such factors may
include (i) the comparison of the proposed consideration to be received by
stockholders in relation to the then current market price of the Company's
capital stock, the estimated current value of the Company in a freely negotiated
transaction and the estimated future value of the Company as an independent
entity, (ii) the impact of such a transaction on the employees, suppliers and
customers of the Company and its effect on the communities in which the Company
operates and (iii) the ability of the Company to fulfill its objectives under
applicable statutes and regulations.
The Charter provides that any action required or permitted to be taken by
the stockholders of the Company may be taken only at a duly called annual or
special meeting of the stockholders. The Company's Charter provides that special
meetings may be called only by the Chairman of the Board or a majority of the
Board of Directors of the Company. These provisions could have the effect of
delaying until the next annual stockholders meeting stockholder actions which
are favored by the holders of the outstanding voting securities of the Company.
These provisions may also discourage another person or entity from making a
tender offer for the Company's Common Stock, because such person or entity, even
if it acquired all or a majority of the outstanding voting securities of the
Company, would be able to take action as a stockholder (such as electing new
directors or approving a merger) only at a duly called stockholders meeting, and
not by written consent.
The DGCL provides generally that the affirmative vote of a majority of the
shares entitled to vote on any matter is required to amend a corporation's
certificate of incorporation or by-laws, unless a corporation's certificate of
incorporation or by-laws, as the case may be, requires a greater percentage. The
Charter does not require a greater percentage. The By-Laws may also be amended
or repealed by a majority vote of the Board of Directors.
The By-Laws provide that for nominations for the Board of Directors or for
other business to be properly brought by a stockholder before an annual meeting
of stockholders, the stockholder must first have given timely notice thereof in
writing to the Secretary of the Company. To be timely, a stockholder's notice
generally must be delivered not later than 90 days in advance of the anniversary
date of the release of the Company's proxy statement to stockholders in
connection with the prior year's annual meeting of stockholders. The notice must
contain, among other things, certain information about the stockholder
delivering the notice and, as applicable, background information about each
nominee or a description of the proposed business to be brought before the
meeting. Business transacted at a special meeting is limited to the purposes for
which the meeting is called.
The foregoing provisions could have the effect of making it more difficult
for a third party to acquire, or discouraging a third party from attempting to
acquire, control of the Company.
The Charter contains certain provisions permitted under the DGCL relating
to the liability of directors. These provisions eliminate a director's liability
for monetary damages for a breach of fiduciary duty, except in certain
circumstances involving certain wrongful acts, such as the breach of a
director's duty of loyalty or acts or omissions which involve intentional
misconduct or a knowing violation of law. The Charter and By-Laws also contain
provisions indemnifying the directors and officers of the Company to the fullest
extent permitted by the DGCL. The Company believes that these provisions will
assist the Company in attracting and retaining qualified individuals to serve as
directors.
The Company will also enter into indemnity agreements with each of its
directors that require the Company to advance expenses to each such director in
the event that a claim is brought against such director with respect to an
action for which the Company is obligated to provide indemnification under the
Company's Charter and By-Laws.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock will be
.
47
<PAGE> 49
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, the Company will have shares
of Common Stock outstanding. Of these shares, the shares sold in the Offering
will be freely tradeable without restriction or further registration under the
Securities Act, except that any shares purchased by "affiliates" of the Company,
as that term is defined in Rule 144 ("Rule 144") under the Securities Act
("Affiliates"), generally may be sold only in compliance with the limitations of
Rule 144 described below.
The remaining shares of Common Stock are deemed
"Restricted Shares" under Rule 144 because they were originally issued by the
Company in a private transaction in reliance upon an exemption from the
Securities Act. Under Rule 144, substantially all of these remaining Restricted
Shares will become eligible for resale 90 days after the date the Company
becomes subject to the reporting requirements of the Securities Exchange Act of
1934, as amended (the "Exchange Act") (i.e., 90 days after the consummation of
the Offering), and may be resold in the public market prior to such date only in
compliance with the registration requirements of the Securities Act or pursuant
to a valid exemption therefrom; and approximately of such
shares are subject to Lock-up Agreements.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including an Affiliate, who has beneficially owned
Restricted Shares for at least one year is entitled to sell within any
three-month period a number of such shares that does not exceed the greater of
(i) one percent of the then outstanding shares of Common Stock (approximately
shares immediately after the Offering) or (ii) the average weekly
trading volume in the Common Stock in the over-the-counter market during the
four calendar weeks preceding the date on which notice of such sale is filed. In
addition, under Rule 144(k), a person who is not an Affiliate and has not been
an Affiliate for at least three months prior to the sale and who has
beneficially owned Restricted Shares for at least two years may resell such
shares without compliance with the foregoing requirements. In meeting the one
and two-year holding periods described above, a holder of Restricted Shares can
include the holding periods of a prior owner who was not an Affiliate.
LOCK-UP AGREEMENTS
All existing stockholders of the Company, who after the Offering will hold
in the aggregate approximately shares of Common Stock and options to
purchase shares of Common Stock, have agreed, pursuant to
Lock-up Agreements, that they will not, without the prior written consent of
William Blair & Company, L.L.C. of the Underwriters, offer, sell, contract to
sell or otherwise dispose of any shares of Common Stock beneficially owned by
them for a period of 180 days after the date of this Prospectus, except pursuant
to bona fide gifts to persons who agree in writing to be bound by the provisions
of the Lock-up Agreements.
STOCK OPTIONS
In connection with the Offering, the Company will grant certain employees
options to acquire up to an aggregate shares of Common Stock
at the initial public offering price. An additional shares
of Common Stock are available for future grants under the Company's Stock Option
Plan. See "Management -- Stock Plans".
The Company intends to file one or more registration statements on Form S-8
under the Act to register all shares of Common Stock issuable pursuant to the
Company's Stock Option Plan and Purchase Plan. The Company expects to file these
registration statements prior to the expiration of the Lock-up Agreements and
such registration statements are expected to become effective upon filing.
Shares covered by these registration statements will thereupon be eligible for
sale in the public markets, subject to the Lock-up Agreements, to the extent
applicable.
48
<PAGE> 50
UNDERWRITING
The several Underwriters named below (the "Underwriters"), for which
William Blair & Company, L.L.C. and NationsBanc Montgomery Securities LLC are
acting as representatives (the "Representatives"), have severally agreed,
subject to the terms and conditions set forth in the Underwriting Agreement by
and among the Company, the Selling Stockholders and the Underwriters (the
"Underwriting Agreement"), to purchase from the Company and the Selling
Stockholders, and the Company and the Selling Stockholders have agreed to sell
to each of the Underwriters, the respective number of shares of Common Stock set
forth opposite each Underwriter's name in the table below.
<TABLE>
<CAPTION>
NUMBER
UNDERWRITERS OF SHARES
------------ ---------
<S> <C>
William Blair & Company, L.L.C. ............................
NationsBanc Montgomery Securities LLC.......................
--------
Total
========
</TABLE>
In the Underwriting Agreement, the Underwriters have agreed, subject to the
terms and conditions set forth therein, to purchase all of the Common Stock
being sold pursuant to the Underwriting Agreement if any of the Common Stock
being sold pursuant to the Underwriting Agreement (excluding shares covered by
the over-allotment option granted therein) is purchased. In the event of a
default by any Underwriter, the Underwriting Agreement provides that, in certain
circumstances, the purchase commitments of the non-defaulting Underwriters shall
be increased or the Underwriting Agreement may be terminated.
The Representatives have advised the Company that the Underwriters propose
to offer the Common Stock to the public initially at the public offering price
set forth on the cover page of this Prospectus and to selected dealers at such
price less a concession of not more than $ per share. The Underwriters may
allow, and such dealers may re-allow, a concession not in excess of $ per
share to certain other dealers. After commencement of the initial public
offering, the public offering price, and other selling terms may be changed by
the Representatives.
The Selling Stockholders have granted to the Underwriters an option,
exercisable within 30 days after the date of this Prospectus, to purchase up to
an aggregate of additional shares of Common Stock to cover
over-allotments, at the same price per share to be paid by the Underwriters for
the other shares offered hereby. If the Underwriters purchase any such
additional shares pursuant to this option, each of the Underwriters will be
committed to purchase such additional shares in approximately the same
proportion as set forth in the table above. If less than all of such additional
shares are purchased, the Underwriters will purchase such shares from the
Selling Stockholders pro rata. The Underwriters may exercise the option only for
the purpose of covering over-allotments, if any, made in connection with the
distribution of the shares of Common Stock offered hereby.
All existing stockholders of the Company who hold in the aggregate
shares of Common Stock and the Company, have agreed, for a
period of 180 days after the date of this Prospectus, without the prior written
consent of William Blair & Company, L.L.C., they will not, directly or
indirectly, offer, sell, contract to sell, grant any option to purchase, or
otherwise dispose of or transfer any Common Stock or securities convertible or
exchangeable into, or exercisable for, Common Stock. In considering a request
for its consent to a sale or transfer within the 180-day period, William Blair &
Company, L.L.C. will take into account various factors, including, but not
limited to, the number of shares requested to be sold, the anticipated manner
and timing of sale, the potential impact of the sale on the market for the
Common Stock, and market conditions generally. The Company may grant options and
issue Common Stock under the Stock Option Plan and issue unregistered shares in
connection with any acquisition during the lock-up period.
The Company and the Selling Stockholders have agreed to indemnify the
Underwriters and their controlling persons against certain liabilities,
including liabilities under the Securities Act, or to contribute to payments the
Underwriters may be required to make in respect thereof.
49
<PAGE> 51
At the request of the Company, approximately of Common
Stock offered hereby are being reserved for sale to certain persons, including
the Company's employees and others who have a business relationship with the
Company.
The Representatives have informed the Company that the Underwriters will
not confirm, without client authorization, sales to their client accounts as to
which they have discretionary authority.
Prior to this offering, there was no public market for the Common Stock of
the Company. Consequently, the initial public offering price for the Common
Stock will be determined by negotiations among the Company and the
Representatives. Among the factors which will be considered in such negotiations
are the prevailing market conditions, the results of the operations of the
Company in recent periods, the market capitalizations and stages of development,
and recent market prices of securities of other companies which the Company and
the Representatives believe to be comparable to the Company, estimates of the
business potential of the Company, the present state of the Company's
development, the general condition of the securities markets at the time of the
Offering, and other factors which are deemed relevant. There can be no assurance
that an active trading market will develop for the Common Stock or that the
Common Stock will trade in the public market subsequent to the Offering at or
above the initial public offering price.
During and after the Offering, the Underwriters may purchase and sell the
Common Stock in the open market in order to facilitate the Offering.
Specifically, the Underwriters may over-allot or otherwise create a short
position in the Common Stock for their own account by selling more shares of
Common Stock than have been sold to them by the Company and the Selling
Stockholders pursuant to the Underwriting Agreement. The Underwriters may elect
to cover any such short position by purchasing shares of Common Stock in the
open market or by exercising the over-allotment option granted to them by the
Company and the Selling Stockholders. The Underwriters also may impose a penalty
bid, whereby selling concessions allowed to syndicate members or other
broker-dealers in respect of shares of Common Stock sold in this offering for
their account may be reclaimed by the syndicate if such shares are repurchased
by the syndicate in stabilizing or covering transactions.
The activities described above may stabilize, maintain, or otherwise affect
the market price of the Common Stock and make such price higher than it might
otherwise be in the open market. The imposition of a penalty bid may also affect
the price of the Common Stock to the extent that it discourages resales thereof.
These activities, if commenced, may be discontinued at any time without notice
and may be effected on The Nasdaq National Market or otherwise. Neither the
Company nor any of the Underwriters makes any representation or prediction as to
whether the Underwriters will engage in such transactions or choose to
discontinue any transactions engaged in or the direction or magnitude of any
effect that such transactions may have on the price of the Common Stock.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Sidley & Austin, Chicago, Illinois. Certain legal
matters in connection with the Offering will be passed upon for the Underwriters
by Latham & Watkins, Chicago, Illinois.
EXPERTS
The combined financial statements of the Company as of December 31, 1996
and 1997 and the financial statements of Applied Systems, Inc. as of June 30,
1998 and for the period from June 25, 1998 (date of inception) through June 30,
1998 and for each of the three years in the period ended December 31, 1997,
appearing in this Prospectus and in the Registration Statement have been audited
by Arthur Andersen LLP, independent public accountants, as indicated in their
reports with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in giving said reports.
50
<PAGE> 52
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-1 (including all amendments
thereto, the "Registration Statement") under the Securities Act with respect to
the Common Stock offered hereby. As permitted by the rules and regulations of
the Commission, this Prospectus omits certain information contained in the
Registration Statement. For further information with respect to the Company and
the Common Stock offered hereby, reference is hereby made to the Registration
Statement and to the exhibits and schedules filed therewith. Statements
contained in this Prospectus regarding the contents of any agreement or other
document filed as an exhibit to the Registration Statement are not necessarily
complete, and in each instance reference is made to the copy of such agreement
filed as an exhibit to the Registration Statement, each such statement being
qualified in all respects by such reference. The Registration Statement,
including the exhibits and schedules thereto, may be inspected at the public
reference facilities maintained by the Commission at Room 204, Judiciary Plaza,
450 Fifth Street, N.W., Washington, DC 20549; Citicorp Center, 500 West Madison
Street, Chicago, Illinois 60661; and Seven World Trade Center, New York, New
York 10048; and copies of all or any part thereof may be obtained from such
office upon payment of the prescribed fees. The Commission maintains a Web site
(http://www.sec.gov) that contains reports, proxy and information statements and
other information regarding registrants, such as the Company, that file
electronically with the Commission.
Upon completion of the Offering, the Company will be subject to the
information requirements of the Exchange Act of 1934, and, in accordance
therewith, will file reports, proxy statements and other information with the
Commission. Such reports, proxy material and other information concerning the
Company will be available for inspection and copying at prescribed rates at the
public reference facilities maintained by the Commission at the addresses set
forth above and will be available on the Commission's Web site
(http://www.sec.gov).
51
<PAGE> 53
APPLIED SYSTEMS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants of Applied Systems
Group..................................................... F-2
Combined Balance Sheets of Applied Systems Group as of
December 31, 1996 and 1997 and March 31, 1998 (unaudited)
and March 31, 1998 (unaudited pro forma).................. F-3
Combined Statements of Operations of Applied Systems Group
for the years ended December 31, 1995, 1996 and 1997 and
for the three months ended March 31, 1997 (unaudited) and
1998 (unaudited).......................................... F-4
Combined Statements of Stockholders' Equity (Deficit) of
Applied Systems Group for the years ended December 31,
1995, 1996 and 1997 and for the three months ended March
31, 1998 (unaudited)...................................... F-5
Combined Statements of Cash Flows of Applied Systems Group
for the years ended December 31, 1995, 1996 and 1997 and
for the three months ended March 31, 1997 (unaudited) and
1998 (unaudited).......................................... F-6
Notes to Financial Statements of Applied Systems Group...... F-7
Report of Independent Public Accountants of Applied Systems,
Inc. ..................................................... F-20
Balance Sheet of Applied Systems, Inc. as of June 30,
1998...................................................... F-21
Statement of Operations of Applied Systems, Inc. for the
Period from June 25, 1998 (Date of Inception) through June
30, 1998.................................................. F-22
Statement of Stockholder's Equity of Applied Systems, Inc.
for the Period from June 25, 1998 (Date of Inception)
through June 30, 1998..................................... F-23
Statement of Cash Flows of Applied Systems, Inc. for the
Period from June 25, 1998 (Date of Inception) through June
30, 1998.................................................. F-24
Notes to Financial Statements of Applied Systems, Inc. ..... F-25
</TABLE>
F-1
<PAGE> 54
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Applied Systems Group:
We have audited the accompanying combined balance sheets of APPLIED SYSTEMS
GROUP as of December 31, 1996 and 1997, and the related combined statements of
operations, stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1997. 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 Applied Systems Group as of
December 31, 1996 and 1997, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
July 17, 1998
F-2
<PAGE> 55
APPLIED SYSTEMS GROUP
COMBINED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, PRO FORMA
------------------------- MAR. 31, MAR. 31, 1998
1996 1997 1998 (NOTE 2)
----------- ----------- ----------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................................. $ 1,779,915 $ 4,379,041 $7,899,060 $ 1,899,060
Accounts receivable --
Customers, net of allowance for doubtful accounts of
$301,079, $307,671 and $614,156 (unaudited) in 1996,
1997 and 1998, respectively........................... 6,563,688 11,678,685 9,857,182 9,857,182
Stockholders............................................ 99,395 184,074 180,869 180,869
Employees............................................... 171,025 134,446 87,546 87,546
Harbor Software, Inc. and related items................. -- 4,275,261 2,775,261 2,775,261
Costs on contracts in progress............................ 567,242 545,984 352,952 352,952
Inventory................................................. 1,910,980 2,164,541 1,715,789 1,715,789
Prepaid expenses and other assets......................... 979,906 887,425 764,072 764,072
Assets held for sale...................................... 612,363 -- -- --
Deferred tax asset........................................ -- -- -- 2,100,000
----------- ----------- ----------- -----------
Total current assets................................ 12,684,514 24,249,457 23,632,731 19,732,731
----------- ----------- ----------- -----------
PROPERTY, PLANT AND EQUIPMENT:
Land...................................................... 154,679 228,382 228,382 228,382
Building and improvements................................. 2,931,447 2,919,141 2,909,187 2,909,187
Computer and office equipment............................. 3,394,364 4,246,806 4,582,206 4,582,206
Transportation equipment.................................. 694,769 785,664 780,006 780,006
Furniture and fixtures.................................... 1,903,681 2,301,737 2,423,630 2,423,630
----------- ----------- ----------- -----------
9,078,940 10,481,730 10,923,411 10,923,411
Less -- Accumulated depreciation and amortization......... (4,595,687) (5,354,411) (5,611,188) (5,611,188)
----------- ----------- ----------- -----------
Property, plant and equipment, net.................. 4,483,253 5,127,319 5,312,223 5,312,223
----------- ----------- ----------- -----------
RELATED-PARTY RECEIVABLE.................................... 2,083,528 1,825,542 2,399,870 2,399,870
----------- ----------- ----------- -----------
ASSETS HELD FOR SALE........................................ 1,424,613 1,374,992 1,362,588 1,362,588
----------- ----------- ----------- -----------
Total assets........................................ $20,675,908 $32,577,310 $32,707,412 $28,807,412
=========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Current maturities of long-term debt...................... $ 548,285 $ 491,390 $ 359,002 $ 359,002
Accounts payable.......................................... 3,067,516 4,270,271 2,800,702 2,800,702
Accrued expenses --
Harbor Software, Inc. and related items................. 5,589,000 5,589,000 5,589,000 5,589,000
Other................................................... 3,653,920 4,226,196 4,227,762 4,227,762
Customer deposits......................................... 1,565,149 1,666,920 1,995,383 1,995,383
Unearned support and services............................. 11,640,792 16,153,228 16,459,130 16,459,130
----------- ----------- ----------- -----------
Total current liabilities........................... 26,064,662 32,497,005 31,530,979 31,530,979
----------- ----------- ----------- -----------
NOTE PAYABLE TO STOCKHOLDERS................................ -- -- -- 5,000,000
----------- ----------- ----------- -----------
LONG-TERM DEBT, less current maturities..................... 490,875 44,754 34,921 34,921
----------- ----------- ----------- -----------
COMMITMENTS AND CONTINGENCIES
REDEEMABLE COMMON STOCK..................................... -- 82,479 133,268 133,268
----------- ----------- ----------- -----------
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock.............................................. 415,517 317,892 317,892 317,892
Additional paid-in capital................................ 2,626,935 2,719,560 2,719,560 (10,021,398)
Cumulative translation adjustment......................... 118,673 65,032 31,750 31,750
Retained earnings (deficit) and members' equity........... (8,720,754) (2,829,412) (1,740,958) 2,100,000
Less -- Treasury stock.................................... (320,000) (320,000) (320,000) (320,000)
----------- ----------- ----------- -----------
Total stockholders' equity (deficit)................ (5,879,629) (46,928) 1,008,244 (7,891,756)
----------- ----------- ----------- -----------
Total liabilities and stockholders' equity.......... $20,675,908 $32,577,310 $32,707,412 $28,807,412
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-3
<PAGE> 56
APPLIED SYSTEMS GROUP
COMBINED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
--------------------------------------- -------------------------
1995 1996 1997 1997 1998
----------- ----------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUE:
License................................ $13,835,675 $15,434,757 $20,290,811 $ 3,966,762 $ 5,798,692
Service................................ 25,860,663 29,125,072 34,793,617 8,184,859 10,665,443
Third-party equipment and software..... 23,537,580 20,396,000 20,983,992 4,664,196 5,577,965
----------- ----------- ----------- ----------- -----------
Total revenue.................. 63,233,918 64,955,829 76,068,420 16,815,817 22,042,100
----------- ----------- ----------- ----------- -----------
COST OF REVENUE:
License................................ 295,903 673,582 1,092,372 106,103 510,641
Service................................ 17,777,487 20,143,612 22,447,695 5,424,197 5,952,984
Third-party equipment and software..... 15,696,270 14,310,844 15,839,634 3,497,063 4,394,827
----------- ----------- ----------- ----------- -----------
Total cost of revenue.......... 33,769,660 35,128,038 39,379,701 9,027,363 10,858,452
----------- ----------- ----------- ----------- -----------
Gross profit................... 29,464,258 29,827,791 36,688,719 7,788,454 11,183,648
----------- ----------- ----------- ----------- -----------
OPERATING EXPENSES:
Research and development............... 7,727,950 7,875,594 9,737,922 2,075,002 2,748,432
Sales and marketing.................... 9,066,647 8,224,424 10,181,878 2,374,042 2,977,318
General and administrative............. 9,654,468 10,218,508 11,563,423 2,606,676 3,321,791
Nonrecurring charge (credit) (see Note
12)................................. 137,000 6,428,000 (3,508,000) 135,000 --
----------- ----------- ----------- ----------- -----------
Total operating expenses....... 26,586,065 32,746,526 27,975,223 7,190,720 9,047,541
----------- ----------- ----------- ----------- -----------
OPERATING INCOME (LOSS).................. 2,878,193 (2,918,735) 8,713,496 597,734 2,136,107
----------- ----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest income........................ 120,806 123,298 135,304 12,948 73,766
Interest expense....................... (281,079) (160,962) (69,203) (22,679) (13,148)
----------- ----------- ----------- ----------- -----------
Total other income (expense)... (160,273) (37,664) 66,101 (9,731) 60,618
----------- ----------- ----------- ----------- -----------
Income (loss) before income
taxes........................ 2,717,920 (2,956,399) 8,779,597 588,003 2,196,725
PROVISION FOR INCOME TAXES............... 226,269 331,651 292,701 70,792 86,519
----------- ----------- ----------- ----------- -----------
NET INCOME (LOSS)........................ 2,491,651 (3,288,050) 8,486,896 517,211 $ 2,110,206
ACCRETION TO REDEMPTION VALUE OF COMMON
STOCK.................................. -- -- 77,479 -- 50,789
----------- ----------- ----------- ----------- -----------
Net income (loss) available to
common stockholders.......... $ 2,491,651 $(3,288,050) $ 8,409,417 $ 517,211 $ 2,059,417
=========== =========== =========== =========== ===========
PRO FORMA BASIC AND DILUTED NET INCOME
PER SHARE (UNAUDITED):
Pro forma income data --
Net income (loss) available to
common stockholders............... $ 2,491,651 $(3,288,050) $ 8,409,417 $ 517,211 $ 2,059,417
Elimination of accretion resulting
from the elimination of redemption
feature........................... -- -- (77,479) -- (50,789)
Pro forma adjustment to recognize C
corporation provision for income
taxes............................. 833,720 (1,484,647) 3,131,342 158,529 770,204
----------- ----------- ----------- ----------- -----------
Pro forma net income (loss)......... $ 1,657,931 $(1,803,403) $ 5,355,554 $ 358,682 $ 1,340,002
=========== =========== =========== =========== ===========
Pro forma basic and diluted net income
per share........................... $ .41 $ .03 $ .10
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE> 57
APPLIED SYSTEMS GROUP
COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
RETAINED
EARNINGS
(DEFICIT)
ADDITIONAL AND CUMULATIVE
COMMON PAID-IN MEMBERS' TRANSLATION TREASURY
STOCK CAPITAL EQUITY ADJUSTMENT STOCK TOTAL
-------- ---------- ----------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, January 1, 1995............ $415,517 $2,626,935 $(2,231,289) $ 72,848 $(320,000) $ 564,011
Net income........................ -- -- 2,491,651 -- -- 2,491,651
Foreign currency translation
adjustment..................... -- -- -- 12,263 -- 12,263
Write-off of receivable from
affiliate...................... -- -- (261,645) -- -- (261,645)
Distributions to stockholders..... -- -- (3,836,656) -- -- (3,836,656)
-------- ---------- ----------- -------- --------- -----------
BALANCE, December 31, 1995.......... 415,517 2,626,935 (3,837,939) 85,111 (320,000) (1,030,376)
Net loss.......................... -- -- (3,288,050) -- -- (3,288,050)
Foreign currency translation
adjustment..................... -- -- -- 33,562 -- 33,562
Capital contribution.............. -- -- 169,331 -- -- 169,331
Distributions to stockholders..... -- -- (1,764,096) -- -- (1,764,096)
-------- ---------- ----------- -------- --------- -----------
BALANCE, December 31, 1996.......... 415,517 2,626,935 (8,720,754) 118,673 (320,000) (5,879,629)
Net income........................ -- -- 8,486,896 -- -- 8,486,896
Foreign currency translation
adjustment..................... -- -- -- (53,641) -- (53,641)
Change in par value............... (97,500) 97,500 -- -- -- --
Accretion to redemption value of
common stock................... (125) (4,875) (77,479) -- -- (82,479)
Capital contribution.............. -- -- 772,500 -- -- 772,500
Distributions to stockholders..... -- -- (3,290,575) -- -- (3,290,575)
-------- ---------- ----------- -------- --------- -----------
BALANCE, December 31, 1997.......... 317,892 2,719,560 (2,829,412) 65,032 (320,000) (46,928)
Net income (unaudited)............ -- -- 2,110,206 -- -- 2,110,206
Foreign currency translation
adjustment (unaudited)......... -- -- -- (33,282) -- (33,282)
Accretion to redemption value of
common stock (unaudited)....... -- -- (50,789) -- -- (50,789)
Distributions to stockholders
(unaudited).................... -- -- (1,187,195) -- -- (1,187,195)
Capital contribution
(unaudited).................... -- -- 216,232 -- -- 216,232
-------- ---------- ----------- -------- --------- -----------
BALANCE, March 31, 1998
(unaudited)....................... $317,892 $2,719,560 $(1,740,958) $ 31,750 $(320,000) $ 1,008,244
======== ========== =========== ======== ========= ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE> 58
APPLIED SYSTEMS GROUP
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
--------------------------------------- ------------------------
1995 1996 1997 1997 1998
----------- ----------- ----------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................................. $ 2,491,651 $(3,288,050) $ 8,486,896 $ 517,211 $ 2,110,206
Adjustments to reconcile net income (loss) to net
cash provided by operating activities --
Depreciation and amortization.................... 1,053,184 1,138,320 1,303,182 168,780 269,181
(Gain) loss on sale of fixed assets.............. 142,051 112,660 (83,616) -- --
Changes in assets and liabilities --
Accounts receivable, net....................... (21,479) (914,888) (5,199,735) 43,585 1,841,608
Costs on contracts in progress................. (341,262) (108,034) 21,258 (128,000) 193,032
Inventory...................................... (141,502) 1,022,907 (253,561) 10,604 448,752
Prepaid expenses and other assets.............. 188,427 (130,754) 92,481 469,243 123,353
Accounts payable and accrued expenses.......... (938,669) 436,076 1,875,031 (327,437) (1,468,003)
Nonrecurring charge (credit)................... -- 5,589,000 (4,275,261) -- 1,500,000
Customer deposits.............................. 456,415 327,744 101,771 39,527 328,463
Unearned support and services.................. 1,193,408 1,751,390 4,512,436 912,297 305,902
----------- ----------- ----------- ---------- -----------
Net cash provided by operating activities... 4,082,224 5,936,371 6,580,882 1,705,810 5,652,494
----------- ----------- ----------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net........... (1,534,932) (1,468,288) (2,021,302) (301,670) (441,681)
Proceeds (purchase) of asset held for sale......... -- (612,363) 612,363 612,363 --
Proceeds from sale of fixed assets................. 295,000 -- 207,291 -- --
Change in related-party receivable................. (2,422,461) 375,189 257,986 88,473 (574,328)
----------- ----------- ----------- ---------- -----------
Net cash (used in) provided by investing
activities................................ (3,662,393) (1,705,462) (943,662) 399,166 (1,016,009)
----------- ----------- ----------- ---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings (repayments) on bank line of credit,
net.............................................. 1,571,809 (1,994,809) -- -- --
Principal repayments on long-term debt............. (1,137,163) (897,801) (556,016) (155,469) (142,221)
Proceeds from issuance of long-term debt........... -- 60,000 53,000 -- --
Distributions to stockholders...................... (1,097,318) (1,764,096) (3,290,575) (421,693) (1,187,195)
Capital contribution............................... -- -- 772,500 207,500 216,232
----------- ----------- ----------- ---------- -----------
Net cash used in financing activities....... (662,672) (4,596,706) (3,021,091) (369,662) (1,113,184)
----------- ----------- ----------- ---------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH.............. 2,088 1,470 (17,003) (4,680) (3,282)
----------- ----------- ----------- ---------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS........................................ (240,753) (364,327) 2,599,126 1,730,634 3,520,019
CASH AND CASH EQUIVALENTS, beginning of year......... 2,384,995 2,144,242 1,779,915 1,779,915 4,379,041
----------- ----------- ----------- ---------- -----------
CASH AND CASH EQUIVALENTS, end of year............... $ 2,144,242 $ 1,779,915 $ 4,379,041 $3,510,549 $ 7,899,060
=========== =========== =========== ========== ===========
SUPPLEMENTAL INFORMATION:
Interest paid...................................... $ 222,136 $ 65,291 $ 135,580 $ 19,664 $ 187,375
Income taxes paid.................................. 95,701 343,186 416,888 10,388 78,224
NONCASH INVESTING AND FINANCING ACTIVITIES:
Conversion of related party note payable to
members' equity.................................. -- 169,331 -- -- --
Property distributed to stockholders............... 2,739,338 -- -- -- --
Write-off of receivable from affiliate through
equity........................................... 261,645 -- -- -- --
</TABLE>
F-6
<PAGE> 59
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(INFORMATION RELATED TO THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998, IS UNAUDITED.)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Applied Systems, Inc. ("ASI"), an Illinois S corporation, markets
internally developed software and third party personal computer hardware and
software to independent insurance agents, insurance brokers and insurance
companies operating in the property and casualty insurance industry, and
provides customer support and maintenance services, as well as other
implementation and consulting services such as training, data conversion and
installation. Asktom, Ltd. ("Asktom"), an Ontario corporation, and The Agency
Manager Limited ("TAM UK"), a United Kingdom unlimited liability company, have
operations similar to ASI. All entities are under common ownership and control
and are collectively referred to as the "Company" or "Applied Systems Group."
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Basis of Presentation
The accompanying combined financial statements include the accounts of ASI,
Asktom and TAM UK, which are all under common ownership and control. All
intercompany balances and transactions have been eliminated in the combination.
b. Interim Financial Information
The unaudited combined balance sheet as of March 31, 1998, the unaudited
combined statement of stockholders' equity for the three months ended March 31,
1998, and the unaudited combined statements of operations and cash flows for the
three months ended March 31, 1997 and 1998, include, in the opinion of
management, all adjustments (consisting of normal and recurring adjustments)
necessary to present fairly the Company's financial position, results of
operations and cash flows. Operating results for the three months ended March
31, 1998, are not necessarily indicative of the results which may be expected
for the year ending December 31, 1998. The information included in these notes
to financial statements relating to the three months ended March 31, 1997 and
1998, is unaudited.
c. Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid investments (with
original maturities of three months or less), principally U.S. Government
securities, which are stated at cost, and approximate fair value.
F-7
<PAGE> 60
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
d. Customer Accounts Receivable
The following summarizes the trade accounts receivable allowance activity
for the years ending 1995, 1996 and 1997 and the three-month period ended March
31, 1998:
<TABLE>
<S> <C>
December 31, 1994....................................... $ 172,986
Increase to operating expense......................... 45,829
Charge to allowance................................... (156,929)
---------
December 31, 1995....................................... 61,886
Increase to operating expense......................... 302,514
Charge to allowance................................... (63,321)
---------
December 31, 1996....................................... 301,079
Increase to operating expense......................... 177,514
Charge to allowance................................... (170,922)
---------
December 31, 1997....................................... 307,671
Increase to operating expense......................... 309,750
Charge to allowance................................... (3,265)
---------
March 31, 1998 (unaudited).............................. $ 614,156
=========
</TABLE>
The sales return allowance is $740,643, $1,079,538 and $1,117,001
(unaudited) at December 31, 1996 and 1997, and March 31, 1998, respectively.
e. Inventories
Inventories, which consist of personal computers and component parts, are
stated at the lower of cost or market. Cost is determined using the average cost
method.
f. Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is computed
using the straight-line and double-declining balance methods at rates adequate
to depreciate the cost of applicable assets over their expected useful lives.
Repairs and maintenance are charged to expense as incurred. Gains or losses
resulting from sales or retirements are recorded as incurred, at which time
related costs and accumulated depreciation are removed from the accounts. The
estimated useful lives are as follows:
<TABLE>
<CAPTION>
ASSET DESCRIPTION LIFE
- ----------------- ----
<S> <C>
Building and improvements.............................. 15-39 years
Computer and office equipment.......................... 5-7 years
Transportation equipment............................... 5 years
Furniture and fixtures................................. 7 years
</TABLE>
g. Software Development Costs
The Company does not capitalize software development costs since the
development costs incurred during the period between achieving technological
feasibility and general release of the product to customers have not been
material.
h. Research and Development Expenditures
Expenditures for research and development are charged to expense as
incurred.
F-8
<PAGE> 61
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
i. Assets Held for Sale
At December 31, 1996 and 1997, and March 31, 1998, ASI had an unoccupied
building in Matteson, Illinois that was held for sale. The book value of such
building was $1,304,613, $1,254,992 and $1,242,588 (unaudited) at December 31,
1996 and 1997, and March 31, 1998, respectively. This asset has been classified
as assets held for sale in the accompanying combined financial statements. No
impairment loss has been recorded on this asset held for sale as, in
management's opinion, the fair value less cost to sell is in excess of book
value.
At December 31, 1996, ASI had approximately $600,000 of furniture and
fixtures which were subsequently sold and leased back from an unrelated entity.
As such, these assets were classified as current and reflected as assets held
for sale in the accompanying combined financial statements at December 31, 1996.
No gain or loss was recorded for this transaction.
j. Deferred Offering Costs
As of March 31, 1998, the Company had incurred approximately $40,000
(unaudited) in costs related to the Company's proposed Offering. These costs
have been capitalized and are included in prepaid expenses and other assets in
the accompanying unaudited combined balance sheet at March 31, 1998. Upon
completion of the Company's proposed Offering, the deferred Offering costs will
be reclassified to common stock as a reduction of the proceeds from the
Offering.
k. 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 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.
l. Financial Instruments and Vulnerability Due to Certain Concentrations
The carrying value for current assets and current liabilities reasonably
approximates fair value due to the short maturity of these items. Since the
Company's long-term debt is not publicly quoted, fair value estimates are based
on each obligation's characteristics, including remaining maturities, interest
rate, credit rating, collateral, amortization schedule and liquidity. The
carrying amount for long-term debt approximates fair value.
Financial instruments that potentially subject the Company to concentration
of credit risk consist principally of cash investments and trade receivables.
The Company has cash investment policies that limit cash investments to
short-term low-risk investments. The Company has a customer base, consisting
primarily of insurance agents and insurance companies, which potentially
subjects it to a concentration of credit risk. However, this risk exposure is
limited due to the large number of customers comprising the Company's customer
base and its dispersion across many different geographic areas. Accounts
receivable from sales and services provided to customers are unsecured.
Additionally, the Company establishes accounts receivable allowances based upon
factors relating to the credit risk of specific customers, historical trends and
other information.
The Company's software products are designed primarily to operate with
Microsoft technologies, and the Company's strategy requires that its products
and technology be compatible with new developments in Microsoft technology. If
businesses do not use Microsoft technologies or migrate from older technologies
or do not adopt the Microsoft technologies with which the Company's products are
compatible, the Company's business, operating results and financial condition
could be materially and adversely affected.
F-9
<PAGE> 62
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
m. Foreign Currency Translation
The balance sheets of Asktom and TAM UK have been translated at the
exchange rates in effect as of December 31, 1996 and 1997, and March 31, 1998.
Income and expense accounts have been translated at the average rate in effect
during the periods. Gains and losses resulting from the translation are deferred
and classified as a separate component of stockholders' equity.
Certain sales to affiliated companies have been denominated in foreign
currencies. Foreign currency transactions gains and losses are recognized based
on the difference between the foreign exchange rates on the sales date and on
the payment date. The net foreign exchange gain and loss is reflected in the
accompanying combined statements of operations.
n. Distributions
The Company makes periodic distributions of income to its stockholders,
which are reflected in the accompanying combined statement of stockholders'
equity.
o. Revenue Recognition
The Company recognizes license fees from The Agency Manager ("TAM"), TAM
Advantage and FirstRate products upon delivery. Revenue from the Company's
Diamond product is recognized using the percentage-of-completion method of
accounting based on modules (states and lines of business) completed as a
percentage of total modules. Anticipated losses are recognized when they become
known. Revisions in estimated profits are made in the month in which the
circumstances requiring the revision become known. Training, data conversion and
installation services are recognized as revenue when the services are performed.
Revenue for maintenance and support service is recognized over the term of the
support agreement. Revenue from third-party equipment and software is derived
from the resale and licensing of third-party hardware and software products in
connection with sales of TAM licenses and is generally recognized upon delivery
together with the TAM license revenue. Unearned support and services includes
training and other services which are recognized as revenues when the related
services are performed.
p. Income Taxes
ASI has elected to be treated as an S corporation for income tax purposes.
Accordingly, ASI has not recorded a tax provision for federal income taxes.
Income tax expense in the accompanying combined statements of operations
primarily represents applicable state income taxes of those states that do not
recognize Subchapter S corporations or states which impose taxes on S
corporation income and Canadian income taxes. Earnings and losses of ASI are
reported on the personal income tax returns of the stockholders. Asktom and TAM
UK account for income taxes in accordance with their respective foreign taxing
authority.
TAM UK is treated as an unlimited liability company for UK tax purposes and
a partnership for U.S. income tax purposes. TAM UK has experienced losses to
date. As such, no UK taxes were incurred. For U.S. income tax purposes, the
losses are reported on the personal income tax returns of the TAM UK
stockholders subject to certain limitations.
Generally, undistributed earnings of foreign subsidiaries will not be
subject to U.S. tax until distributed as dividends. Since the earnings have been
or are intended to be indefinitely reinvested in foreign operations, no
provision has been made for any U.S. taxes on Asktom's portion of undistributed
earnings. Furthermore, any taxes paid to foreign governments on those earnings
may be used, in whole or in part, as credits against the U.S. tax on any
dividends distributed from such earnings. As of March 31, 1998, there were
approximately $560,000 (unaudited) of undistributed earnings from Asktom and no
undistributed earnings from TAM UK.
F-10
<PAGE> 63
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Upon termination of the S corporation status, net deferred income tax
assets and an income tax benefit will be recorded for taxable temporary
differences existing at the time of change in tax status. If the termination of
the S corporation status had been March 31, 1998, net deferred income tax assets
and an income tax benefit of approximately $2,100,000 (unaudited) would have
been recorded. The estimated net deferred income tax asset will be revised based
upon the results of operations and financial condition of ASI between March 31,
1998, and the date the S corporation status is terminated. Deferred income taxes
will be recorded under the asset and liability method of accounting for income
taxes which requires the recognition of deferred income taxes based upon the tax
consequences of "temporary differences" by applying enacted statutory tax rates
applicable to future years to differences between the financial statements
carrying amounts and the tax basis of existing assets and liabilities. As of
March 31, 1998, net deferred income tax assets would have consisted of the
following (unaudited):
<TABLE>
<S> <C>
Harbor Software, Inc. and related items.................. $1,139,000
Allowances for trade accounts receivable................. 493,000
Accrued expenses and other reserves...................... 468,000
----------
Total net deferred income tax assets........... $2,100,000
==========
</TABLE>
Additional paid-in capital and retained earnings will be adjusted to
reflect the capitalization of retained earnings to additional paid-in capital
upon the conversion of ASI to a C corporation.
ASI and the current ASI stockholders have entered into a Tax
Indemnification Agreement relating to their respective income tax liabilities
for periods (or portions thereof) ending on or prior to the close of, and
beginning after, the date that ASI terminates its S corporation status
("Termination Date"). The Tax Indemnification Agreement generally provides that,
subject to certain exceptions, the current stockholders will be responsible for
any federal and state income taxes imposed upon ASI for all taxable periods (or
portions thereof) ending on or prior to the Termination Date (other than state
income taxes in states where the Company has not elected S corporation status or
S Corporation status is not respected) and ASI will be responsible for all
federal and state income taxes of ASI for taxable periods (or portions thereof)
beginning after the Termination Date. Because ASI will be fully subject to
corporate income taxation on and after the Termination Date, the reallocation of
income and deductions between the period during which ASI was treated as an S
corporation (the "Pre-Termination Period") and the period during which ASI will
be subject to corporate income taxation (the "Post-Termination Period") may
increase the taxable income of one party while decreasing that of another party.
Accordingly, subject to certain limitations, the Tax Indemnification Agreement
generally provides that the current ASI stockholders will be indemnified by ASI
with respect to federal and state income taxes shifted from a Post-Termination
Period to a Pre-Termination Period, and ASI will be indemnified by the current
stockholders with respect to federal and state income taxes shifted from a
Pre-Termination Period to a Post-Termination Period.
q. Pro Forma Net Income (Loss) Per Share
Pro forma net income (loss) per share is computed based upon the pro forma
net income (loss) as described below and the estimated number of shares that
will be outstanding effective upon the completion of the Reorganization (see
Note 14).
r. Pro Forma Balance Sheet and Statements of Operations
The pro forma net income and net income per share includes a provision for
federal and state income taxes as if ASI had been a C corporation. The effective
income tax rate of 39% reflects the combined federal and state income taxes.
Further, pro forma net income has been adjusted to eliminate the effect of
accretion
F-11
<PAGE> 64
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
since management anticipates the stockholder agreements will be terminated upon
consummation of the Offering (see Note 8).
ASI will convert to a C corporation in connection with the completion of
the Offering resulting in the recording of approximately $2,100,000 (unaudited)
in net deferred income tax assets, as discussed in Note 2p. On or before the day
preceding the day of the Offering, ASI intends to declare a distribution to its
existing stockholders of ASI's undistributed S corporation earnings (tax basis)
through the closing of the Offering (the "Distribution"). ASI currently
estimates the Distribution will be $11,000,000. Retained earnings of ASI, after
recording the distribution, will be reclassified to additional paid-in capital
in connection with the termination of ASI's S corporation election. The
unaudited pro forma combined balance sheet gives effect to these items. No other
contemplated transactions in connection with the Offering are included in the
unaudited pro forma combined balance sheet information.
s. New Accounting Pronouncement
In June, 1997, the Financial Accounting Standards Board issued Statement
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
This statement introduces an approach to defining the Company's segments for
financial reporting purposes on a basis consistent with how the Company's
management evaluates the operations of the business. This statement is effective
for the Company's year ended December 31, 1998. All periods presented must
comply with the required disclosures. The Company does not believe that this
standard will have any impact on its financial statement disclosures.
3. SEASONALITY
The Company has experienced, and expects to continue to experience,
significant fluctuations in quarterly operating results. The Company's future
operating results will depend upon a number of factors including the demand for
the Company's products, the size and timing of specific sales and product
shipments, the delay or deferral of customer implementations, the level of
product and price competition that it encounters, the length of its sales
cycles, the timing of new product introductions and product enhancements by the
Company and its competitors, the mix of products and services sold, the timing
of new hires, its ability to develop and market new products and control costs
and general economic conditions. Historically, the Company's revenues have been
significantly higher in December and January than in other months.
4. BANK LINE OF CREDIT
As of December 31, 1996 and 1997, and March 31, 1998, ASI had a $7,000,000
bank line of credit which expires on July 1, 1999. Borrowings under the line of
credit bear interest at the prevailing prime rate of interest (8.25% and 8.5% at
December 31, 1996 and 1997, respectively, and 8.5% March 31, 1998), are secured
by all of ASI's assets (including accounts receivable, inventories, equipment
and buildings) and are personally guaranteed by certain stockholders. Further,
any borrowings are payable on demand. ASI had no borrowings under this agreement
at December 31, 1996 and 1997, and March 31, 1998. Available borrowings are
reduced by letters of credit (see Note 10). The bank has an assignment of a
$5,000,000 life insurance policy on the majority stockholder of the Company.
The line-of-credit agreement contains various financial and nonfinancial
covenants. The financial covenants include, among other things, a minimum
retained earnings balance and a minimum debt service ratio. At December 31,
1997, ASI was in compliance with or had obtained waivers for all such covenants.
At March 31, 1998, ASI was in compliance with all such covenants.
F-12
<PAGE> 65
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
5. LONG-TERM DEBT
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- MAR. 31,
1996 1997 1998
--------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Mortgage note, secured by the related property,
bearing interest at 8.15% at December 31, 1996,
and 7.94% at December 31, 1997, and March 31,
1998, principal and interest payable in monthly
installments of $18,835 through October 1,
1998............................................ $ 383,684 $ 181,467 $ 128,277
Mortgage note, secured by the related property,
bearing interest at 8.15% at December 31, 1996,
and 7.94% at December 31, 1997, and March 31,
1998, principal and interest payable in monthly
installments of $28,295 through October 1,
1998............................................ 576,404 272,615 192,710
Notes payable for purchase of treasury shares,
payable in monthly installments of $28,125 plus
accrued interest at the prime rate through
January 1, 1997................................. 28,125 -- --
Other obligations................................. 50,947 82,062 72,936
--------- --------- ---------
1,039,160 536,144 393,923
Less -- Current maturities........................ (548,285) (491,390) (359,002)
--------- --------- ---------
$ 490,875 $ 44,754 $ 34,921
========= ========= =========
</TABLE>
Maturities of long-term debt at December 31, 1997, are as follows:
<TABLE>
<S> <C>
1998...................................................... $491,390
1999...................................................... 28,822
2001...................................................... 15,932
--------
$536,144
========
</TABLE>
Certain stockholders of the Company personally guarantee the mortgage notes
payable.
6. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) plan (the "Plan") covering all qualified employees
of ASI. Under terms of the Plan, ASI will match up to 25% of the first $2,000
contributed to the Plan by eligible employees. Matching contributions aggregated
$138,000, $145,000, $158,000, $38,000 (unaudited) and $41,000 (unaudited) for
the years ended December 31, 1995, 1996 and 1997, and the three months ended
March 31, 1997 and 1998, respectively.
A Voluntary Employees' Beneficiary Association ("VEBA") is maintained to
fund employee health benefits for ASI. During the years ended 1995, 1996 and
1997, and the three months ended March 31, 1997 and 1998, the Company
contributed approximately $743,000, $717,000, $680,000, $35,000 (unaudited) and
$165,000 (unaudited), respectively, to this VEBA.
F-13
<PAGE> 66
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
7. STOCKHOLDERS' EQUITY
During 1997, the par value of ASI's common stock was changed from no par
value to par value of $.01 per share.
During 1996, a stockholder of TAM UK converted his stockholder loan to
members' equity.
During 1995, ASI completed a 250-for-1 stock split increasing the number of
authorized, issued and outstanding shares from 1,000 shares to 250,000 shares.
Asktom has 1,000 shares of no par value common stock authorized with 800 shares
issued and outstanding. During 1995, TAM UK was reorganized from a limited
liability company to an unlimited liability company. As a result, TAM UK is
treated similar to a partnership and has no common stock. TAM UK's members'
equity is included with retained earnings on the accompanying combined financial
statements.
Stockholders' equity is composed of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------- MAR. 31,
1996 1997 1998
----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C>
Common stock --
ASI......................................... $ 100,000 $ 2,375 $ 2,375
Asktom...................................... 315,517 315,517 315,517
TAM UK...................................... -- -- --
Additional paid-in capital --
ASI......................................... 2,626,935 2,719,650 2,719,650
Asktom...................................... -- -- --
TAM UK...................................... -- -- --
Retained earnings (deficit) --
ASI......................................... (7,352,342) (1,154,835) (194,852)
Asktom...................................... 407,367 557,546 566,346
TAM UK...................................... (1,775,779) (2,232,123) (2,112,452)
Treasury stock --
ASI......................................... -- -- --
Asktom...................................... (320,000) (320,000) (320,000)
TAM UK...................................... -- -- --
Cumulative translation adjustment --
ASI......................................... -- -- --
Asktom...................................... 107,578 45,981 41,900
TAM UK...................................... 11,095 19,051 (10,150)
=========== =========== ===========
</TABLE>
During 1995, ASI distributed certain property and related improvements to
the stockholders of the Company. The value of this distribution approximated the
cost of the property and was $2,739,338. The stockholders then contributed this
property to Applied Properties LLC (see Note 11).
8. REDEEMABLE COMMON STOCK
ASI is a party to stockholder agreements with certain stockholders
(covering 18,750 shares). These agreements stipulate that, in the event of the
death of the stockholder, the stockholder's estate is required to sell and ASI
is required to purchase the stock at book value (as defined). Further, in the
event that the stockholder wishes to sell his stock, he must first offer it to
ASI and ASI has the option to purchase the stock at book value. Should ASI
decide not to exercise its option to purchase the stock, the stockholder \must
then offer it to other stockholders. ASI is the beneficiary of an $8,500,000
life insurance policy on one stockholder.
F-14
<PAGE> 67
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Upon consummation of the Offering, management anticipates these stockholder
agreements will be terminated.
9. GEOGRAPHIC INFORMATION
Transactions between geographic segments are accounted for at transfer
prices determined by management. Transfers between segments include eliminations
of intercompany sales between geographic regions. Segment operating profit
(loss) includes all costs and expenses directly related to the segment involved
and no allocation of expenses.
<TABLE>
<CAPTION>
TRANSFERS
UNITED UNITED BETWEEN
STATES CANADA KINGDOM SEGMENTS TOTAL
----------- ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
December 31, 1995 --
Net sales..................... $56,842,636 $8,349,237 $ 817,471 $(2,775,426) $63,233,918
Depreciation and
amortization............... 916,058 79,890 57,236 -- 1,053,184
Research and development...... 7,368,045 262,113 97,792 -- 7,727,950
Operating profit (loss)....... 2,528,953 1,042,555 (675,894) (17,421) 2,878,193
Capital expenditures.......... 1,325,821 124,836 84,275 -- 1,534,932
Identifiable assets........... 19,845,533 3,038,034 169,555 (2,630,231) 20,422,891
Identifiable liabilities...... 19,861,612 2,813,343 1,347,099 (2,568,786) 21,453,268
December 31, 1996 --
Net sales..................... 57,243,881 8,585,664 1,035,821 (1,909,537) 64,955,829
Depreciation and
amortization............... 987,913 93,124 57,283 -- 1,138,320
Research and development...... 7,410,832 328,870 135,892 -- 7,875,594
Operating profit (loss)....... (3,440,176) 1,219,457 (684,464) (13,552) (2,918,735)
Capital expenditures.......... 1,278,569 114,225 75,494 -- 1,468,288
Identifiable assets........... 20,144,883 3,143,184 409,984 (3,022,143) 20,675,908
Identifiable liabilities...... 24,770,332 2,632,723 2,271,818 (3,119,336) 26,555,537
December 31, 1997 --
Net sales..................... 68,638,817 7,803,741 818,901 (1,193,039) 76,068,420
Depreciation and
amortization............... 1,161,823 95,901 45,458 -- 1,303,182
Research and development...... 9,164,528 387,660 185,734 -- 9,737,922
Operating profit (loss)....... 8,936,533 745,995 (957,730) (11,302) 8,713,496
Capital expenditures.......... 1,843,442 137,042 40,818 -- 2,021,302
Identifiable assets........... 31,951,633 3,636,442 485,910 (3,496,676) 32,577,309
Identifiable liabilities...... 30,384,591 3,002,262 2,676,076 (3,438,691) 32,624,238
March 31, 1997 (unaudited) --
Net sales..................... 14,975,000 2,080,000 151,000 (390,000) 16,816,000
Depreciation and
amortization............... 139,000 19,000 11,000 -- 169,000
Research and development...... 1,975,000 64,000 36,000 -- 2,075,000
Operating profit (loss)....... 549,000 267,000 (214,000) (4,000) 598,000
Capital expenditures.......... 293,000 4,000 5,000 -- 302,000
Identifiable assets........... 21,268,000 2,978,000 372,000 (3,187,000) 21,431,000
Identifiable liabilities...... 25,635,000 2,260,000 2,395,000 (3,266,000) (27,024,000)
</TABLE>
F-15
<PAGE> 68
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
TRANSFERS
UNITED UNITED BETWEEN
STATES CANADA KINGDOM SEGMENTS TOTAL
----------- ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
March 31, 1998 (unaudited) --
Net sales..................... $19,709,000 $2,635,000 $ 35,000 $ (337,000) $22,042,000
Depreciation and
amortization............... 191,000 61,000 17,000 -- 269,000
Research and development...... 2,553,000 129,000 66,000 -- 2,748,000
Operating profit (loss)....... 2,332,000 13,000 (204,000) (5,000) 2,136,000
Capital expenditures.......... 351,000 85,000 6,000 -- 442,000
Identifiable assets........... 32,300,000 3,890,000 538,000 (4,021,000) 32,707,000
Identifiable liabilities...... 29,700,000 3,322,000 2,787,000 (4,110,000) 31,699,000
</TABLE>
10. COMMITMENTS AND CONTINGENCIES
The Company leases certain office space and equipment under noncancelable
operating leases that expire at various dates through 2006. Rent expense under
such leases totaled approximately $1,480,000, $2,131,000, $3,556,000, $842,000
(unaudited) and $808,000 (unaudited) for the years ended December 31, 1995, 1996
and 1997, and the three months ended March 31, 1997 and 1998, respectively.
Minimum annual rental commitments under noncancelable operating leases
(excluding related-party leases) for periods subsequent to December 31, 1997,
are as follows:
<TABLE>
<S> <C>
1998..................................................... $1,755,618
1999..................................................... 1,212,349
2000..................................................... 110,212
2001..................................................... 2,271
2002..................................................... --
----------
$3,080,450
==========
</TABLE>
Minimum annual rental commitments under noncancelable related-party
operating leases for the periods subsequent to December 31, 1997, are as
follows:
<TABLE>
<S> <C>
1998.................................................... $ 1,565,724
1999.................................................... 1,597,037
2000.................................................... 1,628,979
2001.................................................... 1,661,559
2002.................................................... 1,694,790
2003 and thereafter..................................... 6,659,496
-----------
$14,807,585
===========
</TABLE>
Letters of credit outstanding, which reduce ASI's available borrowings on
the line of credit, totaled $4,767,508, $4,737,508 and $4,737,508 (unaudited) at
December 31, 1996 and 1997, and at March 31, 1998, respectively. Accordingly,
available borrowings under the line-of-credit agreement are $2,232,492,
$2,262,492 and $2,262,492 (unaudited) at December 31, 1996 and 1997, and at
March 31, 1998, respectively.
The Company is obligated to pay software royalties on certain product sales
at rates ranging from .24% to 3%.
ASI is self-insured for certain health benefits up to $50,000 per
occurrence per individual with an aggregate maximum self-insurance exposure of
approximately $1,200,000 per year. Employees of Asktom and
F-16
<PAGE> 69
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
TAM UK are covered under the national health care plan of their respective
country and a supplemental policy with a private insurance company.
The Company does not maintain a separate product liability insurance
policy. Although the Company's license agreements with its customers typically
contain provisions designed to limit the Company's exposure to potential claims
as well as any liabilities arising from such claims, such provisions may not
effectively protect the Company against such claims and the liability and costs
associated therewith.
11. RELATED-PARTY TRANSACTIONS
In October, 1996, ASI moved into a building owned by Applied Properties
LLC, a company owned by certain stockholders of the Company. ASI made lease
payments to Applied Properties LLC in the amount of $18,000, $436,544,
$1,607,024, $400,927 (unaudited) and $408,564 (unaudited) for the years ended
December 31, 1995, 1996 and 1997, and the three months ended March 31, 1997 and
1998, respectively. Management of Applied Properties LLC determines the lease
payment. ASI is responsible for all property taxes and maintenance on the
building.
In October, 1995, Applied Properties LLC secured a one-year construction
loan agreement allowing for maximum borrowings of $9,600,000, bearing interest
at prime. The maturity date was extended for six months, to April 16, 1997. The
loan was guaranteed by ASI and two stockholders. It was collateralized by the
principal facility and two other buildings owned by ASI. Applied Properties LLC
had borrowings under this construction loan agreement of $6,094,400 and $0 as of
December 31, 1996 and 1997, respectively. As of December 31, 1997, the
construction loan had been converted to a mortgage note in the principal amount
of $9,600,000. The mortgage note bears interest at 8.0% and is secured by the
principal facility and two buildings owned by ASI. The mortgage note is
guaranteed by ASI and two stockholders. As of December 31, 1997, and March 31,
1998, the mortgage note balance was $9,600,000 and $9,441,525 (unaudited),
respectively. The mortgage is payable in monthly installments of $116,474
(including interest), and a balloon payment is due in December, 2002.
In connection with the construction of the Company's principal facility,
ASI loaned funds to Applied Properties. These loans resulted in amounts due to
ASI of $2,083,528, $1,825,542 and 2,399,870 (unaudited) as of December 31, 1996
and 1997, and March 31, 1998, respectively.
ASI leased a property in Florida from Applied Properties on a
month-to-month basis. This property is used for business meetings and to house
ASI employees. Monthly rent expense is approximately $6,000. Upon consummation
of the Offering, management anticipates the lease agreement will be terminated.
Management of Applied Properties determines the lease payment.
While ASI performs certain administrative services for Applied Properties
LLC, no management fee is charged to Applied Properties LLC.
The Company incurred approximately $990, $3,520, $4,437, $0 (unaudited) and
$3,740 (unaudited) for the years ended December 31, 1995, 1996 and 1997 and for
the three months ended March 31, 1997 and 1998, respectively, in fees to a law
firm having a partner who is a director of the Company.
12. LITIGATION
In November, 1992, Harbor Software, Inc. ("Harbor" or "Plaintiff") filed a
suit against ASI claiming copyright infringement, fraud, Lanham Act violations,
misappropriation of trade secrets, unfair competition and unjust enrichment.
Before or during trial, the fraud, Lanham Act, unfair competition and unjust
enrichment claims were withdrawn or dismissed. Following a jury trial, on
October 3, 1996, a jury returned a verdict in favor of ASI on the copyright
claim, but in favor of Harbor on the trade secret claim, awarding Plaintiff
$4,000,000 in compensatory damages and $1,000,000 in punitive damages. Following
post-trial
F-17
<PAGE> 70
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
motions by both parties, the court awarded Plaintiff an additional $339,000 in
attorney fees, while rejecting Plaintiff's request for injunctive and other
relief. ASI filed a timely appeal of the final judgment on February 15, 1997, to
the United States Court of Appeals, Second Circuit. A letter of credit in the
amount of $2,500,000, as well as a personal guaranty by ASI's principal
stockholders, Robert and Elsa Eustace (also in the amount of $2,500,000) was
issued and accepted by Plaintiff to secure the judgment pending appeal. In
addition, the judgment is secured by a lien on the assets of ASI. Oral arguments
were held on March 5, 1998, and ASI is awaiting the decision of the U.S. Court
of Appeals.
In a related matter, ASI reached a settlement with one of its insurance
companies for recovery of defense costs and indemnity of the judgment. In
January, 1998, ASI entered into a Settlement Agreement and Partial Release with
this insurance company. This agreement specified the following: (i) the
insurance company would reimburse ASI for its legal fees, expert fees and other
costs and fees incurred in defense of the Harbor suit, for services and expenses
incurred from April 6, 1994, through the completion of the current appellate
proceedings, (ii) upon mutual agreement between the insurance company and ASI as
it relates to the payment of any judgment or settlement, any payment will be
shared equally by the insurance company and ASI, (iii) to the extent that any
payment is received by ASI from a second insurance company with whom ASI is
seeking coverage for defense and indemnification arising out of the Harbor suit,
any amounts received relating to legal fees and other defense costs will be
remitted to the first insurance company on a dollar-for-dollar basis, and any
amounts received relating to indemnity will be shared equally by the first
insurance company and ASI and, (iv) if upon completion of the appellate
proceedings, the case continues in the trial court, both the first insurance
company and ASI may contest whether the first insurance company has a duty to
defend ASI or pay any future settlement or judgment. With respect to the second
insurance company, ASI has appealed an adverse decision related to coverage of
the claim.
ASI recorded the $5,339,000 judgment and an additional $250,000 of expense
during the year ended December 31, 1996. ASI recorded the receivable and related
impact of the settlement agreement with the first insurance company during the
year ended December 31, 1997. ASI recorded the legal fees and other costs
associated with the Harbor suit in the period the related services were
performed. The original judgment, settlement agreement with the first insurance
company and legal fees and other costs are reflected in the caption
"Nonrecurring charge (credit)" in the accompanying combined statements of
operations. Subsequent to year-end, ASI received a $1,500,000 payment from the
first insurance company.
In July, 1998, the Harbor suit was settled for $5,000,000. On July 17,
1998, ASI paid the $5,000,000 settlement and also received payment of $2,500,000
from its insurance company. This settlement will result in a change in
accounting estimate of approximately $310,000 which will be recorded as a
reduction of operating expenses in ASI's quarter ending September 30, 1998.
In March, 1996, Newberg/Perini filed a suit against ASI and Applied
Properties LLC for enforcement of a mechanic's lien. The action sought
$2,187,500. ASI and Applied Properties LLC filed a counterclaim of approximately
$700,000 for damages related to breach of warranty and poor workmanship. A
letter of credit in the amount of $2,187,500 was issued to the TICOR Title
Insurance Company and was canceled in July, 1998. In June, 1998, ASI, Applied
Properties LLC and Newberg/Perini entered into a Settlement Agreement and
Release which resulted in a settlement requiring ASI and Applied Properties LLC
to pay Newberg/Perini $909,500. ASI paid the settlement and recorded a
corresponding receivable from Applied Properties LLC.
The Company is a party to various claims, legal actions and complaints
arising in the ordinary course of business activities. For the years ended
December 31, 1995, 1996 and 1997, and for the three months ended March 31, 1997
and 1998, various actions were settled totaling $535,000, $19,000, $7,000, $0
(unaudited) and $165,000 (unaudited), respectively. Management believes that the
ultimate liability, if any, resulting from them will not materially affect the
Company's financial position.
13. COMPREHENSIVE INCOME
During the first quarter of 1998, the Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
No. 130"), which requires companies to report all
F-18
<PAGE> 71
APPLIED SYSTEMS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
changes in equity during a period, except those resulting from investment by
owners and distributions to owners, in a financial statement for the period in
which they are recognized. The Company has chosen to disclose comprehensive
income, which encompasses net income and foreign currency translation
adjustments, in the notes to financial statements for interim periods.
The components of comprehensive income for the periods presented are as
follows:
<TABLE>
<CAPTION>
MARCH 31,
---------------------
1998 1997
---------- --------
(UNAUDITED)
<S> <C> <C>
Net income.................................................. $2,110,206 $517,211
Cumulative translation adjustment........................... (33,282) (17,084)
Accretion to redemption value of common stock............... (50,789) --
---------- --------
Comprehensive income...................................... $2,026,135 $500,127
========== ========
</TABLE>
14. SUBSEQUENT EVENTS
ASI will convert to a C corporation at the close of the day prior to the
day of the Reorganization (as defined below) resulting in the recording of
approximately $2,100,000 (unaudited) in net deferred income tax assets as
discussed in Note 2p. The estimated net deferred income tax asset will be
revised based upon the results of operations and financial condition of ASI
between March 31, 1998, and the date the S corporation status is terminated. On
or before the day preceding the day of the Reorganization (as defined below),
ASI intends to declare a distribution to its existing stockholders of ASI's
undistributed S corporation tax earnings through the close of the day prior to
the day of the Reorganization. This estimated distribution of approximately
$11,000,000 will consist of $6,000,000 in cash and $5,000,000 in promissory
notes payable on or before five years from the date of issuance and bearing
interest at a rate of 7.25%.
Applied Systems, Inc., a newly formed Delaware corporation, and the
stockholders of ASI, Asktom and TAM UK will enter into a Contribution and Merger
Agreement which provides for all of the equity interests in ASI and Asktom to be
contributed to Applied Systems, Inc., the newly formed Delaware company, and for
the merger of the stockholders (each of which is a corporation) of TAM UK into
the new corporation immediately prior to the consummation of the Offering. In
exchange for such transfers, the stockholders of these companies will receive
shares of common stock of Applied Systems, Inc., the newly formed Delaware
company (the "Reorganization"). Following the Reorganization, Applied Systems,
Inc., the newly formed Delaware company, will be a holding company with ASI,
Asktom and TAM UK as its wholly owned subsidiaries.
In July, 1998, the Company established the Stock Option Plan. One million
five hundred thousand shares of common stock are reserved for issuance under the
Stock Option Plan. Options will be issued to certain employees in connection
with the Offering with an exercise price equal to the Offering price. The Stock
Option Plan provides for the grant of incentive stock options and nonqualified
stock options.
In connection with the Offering, the Board of Directors adopted an Employee
Stock Purchase Plan (the "Purchase Plan"). A total of 350,000 common shares have
been reserved for issuance under the Purchase Plan. The Purchase Plan permits
eligible employees to purchase stock at a discount through automatic payroll
deductions. Eligible employees acquire stock under the Purchase Plan by electing
to have an amount up to 8% of their earnings withheld. The amount withheld is
used to purchase shares on one or more specified purchase dates during any
six-month period ("Offering Period"). Offering Periods commence on each June 1
and December 1; the initial Offering Period will commence December 1, 1998, and
expire on May 31, 1999. The shares are purchased at a price equal to 85% of the
lesser of (a) the fair market value of the stock on the date of purchase or (b)
the fair market value of the stock on the first date of the Offering Period.
F-19
<PAGE> 72
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholder of
Applied Systems, Inc.:
We have audited the accompanying balance sheet of APPLIED SYSTEMS, INC. (a
Delaware corporation) as of June 30, 1998, and the related statements of
operations, stockholder's equity and cash flows for the period from June 25,
1998 (date of inception) through June 30, 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Applied Systems, Inc. as of
June 30, 1998, and the results of its operations and its cash flows for the
period from June 25, 1998 (date of inception), to June 30, 1998, in conformity
with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
July 17, 1998
F-20
<PAGE> 73
APPLIED SYSTEMS, INC.
BALANCE SHEET
JUNE 30, 1998
ASSETS
<TABLE>
<S> <C>
Total assets...................................... $ --
=======
STOCKHOLDER'S EQUITY
STOCKHOLDER'S EQUITY:
Common stock, $.01 par value, 100 shares authorized,
1 share issued and outstanding......................... $ --
Additional paid-in capital................................ 1,000
Deficit................................................... (1,000)
-------
Total stockholder's equity........................ $ --
=======
</TABLE>
The accompanying notes are an integral part of this balance sheet.
F-21
<PAGE> 74
APPLIED SYSTEMS, INC.
STATEMENT OF OPERATIONS
FOR THE PERIOD FROM JUNE 25, 1998 (DATE OF INCEPTION)
THROUGH JUNE 30, 1998
<TABLE>
<S> <C>
OPERATING EXPENSES -- general and administrative............ $ 1,000
-------
OPERATING LOSS.............................................. (1,000)
-------
NET LOSS.................................................... $(1,000)
=======
</TABLE>
The accompanying notes are an integral part of this statement.
F-22
<PAGE> 75
APPLIED SYSTEMS, INC.
STATEMENT OF STOCKHOLDER'S EQUITY
FOR THE PERIOD FROM JUNE 25, 1998 (DATE OF INCEPTION)
THROUGH JUNE 30, 1998
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
--------------- PAID-IN STOCKHOLDER'S
SHARES AMOUNT CAPITAL DEFICIT EQUITY
------ ------ ---------- ------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE, June 25, 1998....................... -- $-- $ -- $ -- $ --
Stock issued............................... 1 -- 1,000 -- 1,000
Net loss................................... -- -- -- (1,000) (1,000)
-- -- ------ ------- -------
BALANCE, June 30, 1998....................... 1 $-- $1,000 $(1,000) $ --
== === ====== ======= =======
</TABLE>
The accompanying notes are an integral part of this statement.
F-23
<PAGE> 76
APPLIED SYSTEMS, INC.
STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM JUNE 25, 1998 (DATE OF INCEPTION)
THROUGH JUNE 30, 1998
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss for the period................................... $(1,000)
Noncash compensation expense........................... 1,000
-------
Net cash provided by operating activities......... --
NET INCREASE IN CASH........................................ --
CASH, beginning of period................................... --
-------
CASH, end of period......................................... $ --
=======
NONCASH FINANCING ACTIVITY -- issuance of common stock in
exchange for services rendered............................ $ 1,000
=======
</TABLE>
The accompanying notes are an integral part of this statement.
F-24
<PAGE> 77
APPLIED SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Applied Systems, Inc. ("the Company"), a Delaware corporation, is a holding
company that was formed on June 25, 1998. Immediately prior to the consummation
of the initial public offering (the "Offering"), the Company and the
stockholders of Applied Systems, Inc. ("ASI"), an Illinois S corporation,
Asktom, Ltd. ("Asktom"), an Ontario corporation, and The Agency Manager Limited
("TAM UK"), a United Kingdom unlimited liability company, will enter into a
Contribution and Merger Agreement which provides for all of the equity interests
in ASI and Asktom to be contributed to the Company and for the stockholders of
TAM UK to be merged with and into the Company. In exchange for such transfers,
the stockholders of these companies will receive shares of common stock of the
Company.
2. OFFERING REGISTRATION
In July, 1998, the sole stockholder of the Company authorized management of
the Company to file a registration statement with the Securities and Exchange
Commission permitting the Company to sell common stock to the public.
3. COMMON STOCK
In exchange for administrative services performed, the Company issued 1,000
shares of common stock to Robert Eustace which the Company valued at $1,000.
F-25
<PAGE> 78
[THE INSIDE BACK COVER INCLUDES PICTURES OF
REPRESENTATIVE COMPUTER SCREENS DEPICTING THE AGENCY MANAGER,
AS WELL AS PICTURES AND DIAGRAMS OF INSURANCE INDUSTRY DOCUMENTS
AND INFORMATION THAT CAN BE PRODUCED FROM THE SYSTEM, SUCH AS
AN INSURANCE POLICY AND AN AUTOMOBILE IDENTIFICATION CARD.]
<PAGE> 79
- ------------------------------------------------------
- ------------------------------------------------------
NO DEALER, SALES REPRESENTATIVE OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE
ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THE OFFERING
OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR A SOLICITATION OF ANY OFFER TO BUY COMMON STOCK BY ANYONE IN ANY
JURISDICTION IN WHICH SUCH AN OFFER OR SOLICITATION IS NOT AUTHORIZED, OR IN
WHICH THE PERSON MAKING SUCH AN OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO,
OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN
IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE OF THIS PROSPECTUS.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 6
Use of Proceeds....................... 12
Dividend Policy....................... 12
Reorganization and S Corporation
Distribution........................ 12
Capitalization........................ 14
Dilution.............................. 15
Selected Financial Data............... 16
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 18
Business.............................. 28
Management............................ 37
Certain Transactions.................. 43
Principal and Selling Stockholders.... 45
Description of Capital Stock.......... 46
Shares Eligible for Future Sale....... 48
Underwriting.......................... 49
Legal Matters......................... 50
Experts............................... 50
Additional Information................ 51
Index to Financial Statements......... F-1
</TABLE>
------------------
UNTIL , 1998 (25 DAYS FROM THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN
ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
SHARES
APPLIED SYSTEMS, INC.
APPLIED SYSTEMS, INC.
COMMON STOCK
------------------------
PROSPECTUS
, 1998
------------------------
WILLIAM BLAIR & COMPANY
NATIONSBANC MONTGOMERY SECURITIES LLC
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 80
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The expenses (other than underwriting discount and expenses) payable by the
Company in connection with the sale of the Common Stock offered hereby
(including the Common Stock which may be issued pursuant to an over-allotment
option) are as follows:
<TABLE>
<CAPTION>
AMOUNT
-------
<S> <C>
SEC registration fee........................................ $12,213
NASD filing fee............................................. 4,640
Nasdaq National Market fee.................................. *
Printing and engraving expenses............................. *
Legal fees and expenses..................................... *
Accounting fees and expenses................................ *
Blue Sky fees and expenses (including legal fees and
expenses)................................................. *
Transfer agent and registrar fees and expenses.............. *
Miscellaneous............................................... *
-------
Total.................................................. $ *
=======
</TABLE>
- -------------------------
* To be filed by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Delaware General Corporation Law and the Company's Restated Certificate
of Incorporation ("Charter") and By-Laws provide for indemnification of the
Company's directors and officers for liabilities and expenses that they may
incur in such capacities. In general, directors and officers are indemnified
with respect to actions taken in good faith in a manner reasonably believed to
be in, or not opposed to, the best interests of the Company, and with respect to
any criminal action or proceeding, actions that the indemnitee had no reasonable
cause to believe were unlawful. Reference is made to the Company's Charter and
By-Laws filed as Exhibits 3.1 and 3.2 hereto, respectively.
The Company will enter into indemnity agreements with each of its directors
that will require the Company to advance expenses to each such director in the
event that a claim brought against such director with respect to an action for
which the Company is obligated to provide indemnification under the Company's
Charter and By-Laws.
The Underwriting Agreement provides that the Underwriters are obligated,
under certain circumstances, to indemnify directors, officers and controlling
persons of the Company against certain liabilities, including liabilities under
the Securities Act of 1933, as amended (the "Securities Act"). Reference is made
to the form of Underwriting Agreement filed as Exhibit 1 hereto.
The Company is purchasing directors' and officers' liability insurance,
which would provide coverage against certain liabilities, including liabilities
under the Securities Act.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
As compensation for services, the Company issued to James P. Kellner 1,250
shares of its common stock on each of January 1, 1995, January 1, 1996 and
January 1, 1997, representing an aggregate of 1.5% of the outstanding shares of
ASI at the time of grant.
II-1
<PAGE> 81
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C> <C>
1.1* -- Form of Underwriting Agreement
2.1* -- Contribution and Merger Agreement
3.1* -- Form of Restated Certificate of Incorporation of the Company
3.2* -- Form of Restated By-Laws of the Company
5.1* -- Opinion of Sidley & Austin
10.1* -- Stock Option Plan
10.2* -- Employee Stock Purchase Plan
10.3* -- Lease between the Company and Applied Properties, L.L.C.
relating to the Company's corporate headquarters
10.4* -- Employment Agreement between the Company and Timothy J.
McIntyre
10.6* -- Tax Indemnification Agreement
10.7* -- Form of Indemnification Agreement between the Company and
each of its directors
11* -- Statement re: computation of per share earnings
23.1 -- Consent of Arthur Andersen LLP
23.2* -- Consent of Sidley & Austin (included in Exhibit 5.1)
24.1* -- Powers of Attorney (included on signature page)
</TABLE>
- -------------------------
* To be filed by amendment.
(b) Financial Statement Schedules:
None of the schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are required
under the related instructions or are inapplicable, and therefore have been
omitted.
ITEM 17. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to provisions described in Item 14 above, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes (1) to provide to the
underwriters at the closing specified in the underwriting agreement certificates
in such denominations and registered in such names as required by the
underwriters to permit prompt delivery to each purchaser; (2) that for purposes
of determining any liability under the Securities Act, the information omitted
from the form of prospectus filed as part of a registration statement in
reliance upon Rule 430A and contained in the form of prospectus filed by the
registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act
shall be deemed to be part of this registration statement as of the time it was
declared effective; and (3) that for the purpose of determining any liability
under the Securities Act, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
II-2
<PAGE> 82
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in Chicago, Illinois on July 20, 1998.
APPLIED SYSTEMS, INC.
By: /s/ JAMES P. KELLNER
------------------------------------
James P. Kellner
President and Chief Executive
Officer
POWER OF ATTORNEY AND SIGNATURES
We, the undersigned officers and directors of Applied Systems, Inc, hereby
severally constitute and appoint James P. Kellner and Timothy J. McIntyre, and
each of them singly, our true and lawful attorneys, with full power to them and
each of them singly, to sign for us in our names in the capacities indicated
below, all pre-effective and post-effective amendments to this registration
statement, including any filings pursuant to Rule 462(b) under the Securities
Act of 1933, as amended, and generally to do all things in our names and on our
behalf in such capacities to enable Applied Systems, Inc. to comply with the
provisions of the Securities Act of 1933, as amended, and all requirements of
the Securities and Exchange Commission.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed on July 20, 1998 by the following persons
in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLES(S)
--------- ---------
<C> <S>
/s/ JAMES P. KELLNER Chairman of the Board, President and Chief
- --------------------------------------------------- Executive Officer
James P. Kellner
/s/ TIMOTHY J. MCINTYRE Executive Vice President and Chief Financial
- --------------------------------------------------- Officer (Principal Financial and Accounting
Timothy J. McIntyre Officer)
/s/ GLEN R. EUSTACE Executive Vice President -- Business
- --------------------------------------------------- Development and Director
Glen R. Eustace
/s/ WILLIAM A. HUFF Director
- ---------------------------------------------------
William A. Huff
</TABLE>
II-3
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
reports dated July 17, 1998 (and to all references to our Firm) included in or
made a part of this Registration Statement.
ARTHUR ANDERSEN LLP
Chicago, Illinois
July 20, 1998
