<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________________ TO _________________
COMMISSION FILE NUMBER 0-25075
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ARTIFICIAL LIFE, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 04-3253298
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
FOUR COPLEY PLACE, SUITE 102
BOSTON, MASSACHUSETTS 02116
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(617) 266-5542
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date:
Common Stock, $0.01 par value per share--
9,808,605 shares as of October 31, 1999
<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
--------------------
ARTIFICIAL LIFE, INC.
(formerly Neurotec International Corp.)
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
------------ ------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 11,687,829 $ 5,705,259
Accounts receivable, trade -- 1,201,692
Due from officer/stockholder and affiliates 162,728 83,052
Prepaid expenses and other current assets 99,958 250,838
------------ ------------
Total current assets 11,950,515 7,240,841
------------ ------------
Property and equipment:
Furniture and fixtures 145,281 356,981
Computer equipment 545,680 1,481,826
Leasehold improvements 45,544 155,087
Office equipment 57,620 182,181
------------ ------------
794,125 2,176,075
Less accumulated depreciation and amortization 160,274 471,750
------------ ------------
633,851 1,704,325
------------ ------------
Other assets:
Capitalized software development costs, net
of accumulated amortization of $122,459 in 1999 215,169 1,157,383
Investments in joint venture -- 565,800
Deposits and other assets 85,185 107,364
------------ ------------
300,354 1,830,547
------------ ------------
$ 12,884,720 $ 10,775,713
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 444,367 $ 506,101
Due to officer/stockholder and affiliates -- 41,012
Note payable - officer/stockholder -- 500,000
Accrued expenses and other current liabilities 171,267 387,418
------------ ------------
Total current liabilities 615,634 1,434,531
------------ ------------
Note payable - officer/stockholder 500,000 --
------------ ------------
Minority interest in consolidated subsidiary -- 42,915
------------ ------------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized, no shares issued and outstanding -- --
Common stock, $.01 par value; 30,000,000 shares authorized,
9,270,574 and 9,808,605 shares issued and outstanding in
1998 and 1999, respectively 92,706 98,086
Additional paid-in capital 13,929,618 15,539,333
Notes receivable from stockholders (79,423) (727,515)
Accumulated deficit (2,147,266) (5,481,433)
Accumulated other comprehensive loss (26,549) (130,204)
------------ ------------
Total stockholders' equity 11,769,086 9,298,267
------------ ------------
$ 12,884,720 $ 10,775,713
============ ============
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
1
<PAGE>
ARTIFICIAL LIFE, INC.
(formerly Neurotec International Corp.)
CONDENSED CONSOLIDATED STATEMENTS OF LOSS
(Unaudited)
<TABLE>
<CAPTION>
Three-month Period Nine-month Period
Ended September 30, Ended September 30,
------------------------------- -------------------------------
1998 1999 1998 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Software license agreements $ -- $ 955,946 $ 116,667 $ 1,307,689
Application services -- 249,193 332,713 1,220,160
Software products -- 6,349 -- 8,190
----------- ----------- ----------- -----------
-- 1,211,488 449,380 2,536,039
----------- ----------- ----------- -----------
Operating expenses:
Selling, general and administrative 480,077 1,677,046 1,076,697 3,719,321
Engineering 59,108 586,292 308,897 1,407,537
Research and development 145,942 205,170 274,045 491,694
Depreciation and amortization 19,784 126,050 73,896 250,335
----------- ----------- ----------- -----------
Total operating expenses 704,911 2,594,558 1,733,535 5,868,887
----------- ----------- ----------- -----------
Loss from operations (704,911) (1,383,070) (1,284,155) (3,332,848)
Other income (expenses):
Foreign exchange loss -- 2,201 -- (42,519)
Equity in loss of joint venture -- (111,169) -- (142,189)
Write-down of investment -- -- -- (45,965)
Interest income -- 99,380 -- 279,936
Interest expense (13,047) (13,873) (19,828) (39,384)
Other, net -- (1,302) -- (1,302)
----------- ----------- ----------- -----------
Loss before provision for
income tax (717,958) (1,407,833) (1,303,983) (3,324,271)
Provision for income tax -- 9,896 -- 9,896
----------- ----------- ----------- -----------
Net loss $ (717,958) $(1,417,729) $(1,303,983) $(3,334,167)
=========== =========== =========== ===========
Basic and diluted net loss per share $ (0.10) $ (0.14) $ (0.19) $ (0.35)
Weighted average shares outstanding
used in per share calculation 7,108,762 9,808,605 7,013,295 9,514,221
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
2
<PAGE>
ARTIFICIAL LIFE, INC.
(formerly Neurotec International Corp.)
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
<TABLE>
<CAPTION>
Comprehensive Preferred Stock Common Stock
Income ------------------------------ ------------------------------
(Loss) Shares Amount Shares Amount
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1997 -- $ -- 6,967,213 $ 69,672
Net loss $ (1,303,983) -- -- 903,361 9,034
============ ------------ ------------ ------------ ------------
Balance at September 30, 1998 -- $ -- 7,870,574 $ 78,706
============ ============ ============ ============
Balance at December 31, 1998 -- $ -- 9,270,574 $ 92,706
Issuance of common stock -- -- 538,031 5,380
Repayment of notes receivable
from stockholders net of
increases for accrued interest -- -- -- --
Comprehensive income:
Net loss $ (3,334,167) -- -- -- --
Foreign currency translation
adjustment (103,655) -- -- -- --
------------
Total comprehensive loss $ (3,437,822)
============ ------------ ------------ ------------ ------------
Balance at September 30, 1999 -- $ -- 9,808,605 $ 98,086
============ ============ ============ ============
<CAPTION>
Accumulated
Additional Retained Other Total
Paid-in Notes Earnings Comprehensive Stockholders'
Capital Receivable (Deficit) Loss Equity
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1997 $ 426,567 $ -- $ 43,940 $ -- $ 540,179
Net loss 4,302,044 (988,682) (1,303,983) -- 2,018,413
------------ ------------ ------------ ------------ ------------
Balance at September 30, 1998 $ 4,728,611 $ (988,682) $ (1,260,043) $ -- $ 2,558,592
============ ============ ============ ============ ============
Balance at December 31, 1998 $ 13,929,618 $ (79,423) $ (2,147,266) $ (26,549) $ 11,769,086
Issuance of common stock 1,609,715 (674,999) -- -- 940,096
Repayment of notes receivable
from stockholders net of
increases for accrued interest -- 26,907 -- -- 26,907
Comprehensive income:
Net loss -- -- (3,334,167) -- (3,334,167)
Foreign currency translation
adjustment -- -- -- (103,655) (103,655)
Total comprehensive loss
------------ ------------ ------------ ------------ ------------
Balance at September 30, 1999 $ 15,539,333 $ (727,515) $ (5,481,433) $ (130,204) $ 9,298,267
============ ============ ============ ============ ============
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements
3
<PAGE>
ARTIFICIAL LIFE, INC.
(formerly Neurotec International Corp.)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine-month period ended September 30,
-------------------------------------
1998 1999
----------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(1,303,983) $ (3,334,167)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 73,896 372,794
Write-down of investment -- 45,965
Equity in loss of joint venture -- 142,189
Intercompany profit elimination -- 314,281
Interest income accrued on notes receivable from stockholder -- (40,500)
Decrease in due to/from affiliates 243,499 40,000
(Increase) decrease in accounts receivable, trade 273,187 (1,201,692)
Increase in other assets (482) (201,887)
Increase (decrease) in accounts payable and other current liabilities (55,674) 282,240
(Increase) decrease in due to/from officer/stockholder (199,788) 80,730
----------- ------------
Net cash used by operating activities (969,345) (3,500,047)
----------- ------------
Cash flows from investing activities:
Purchases of property and equipment (147,858) (1,398,239)
Expenditures for capitalized software development costs -- (1,007,618)
Net assets acquired in business acquisition -- 21,119
Investment in joint venture -- (1,022,269)
----------- ------------
Net cash used by investing activities (147,858) (3,407,007)
----------- ------------
Cash flows from financing activities:
Proceeds from notes receivable from stockholders -- 67,407
Proceeds from note payable to officer/stockholders 500,000 --
Deferred costs in connection with initial public offering (121,380) --
Proceeds from issuance of common stock 3,322,396 940,096
----------- ------------
Net cash provided by financing activities 3,701,016 1,007,503
----------- ------------
Effect of exchange rate changes on cash -- (83,019)
----------- ------------
Net increase (decrease) in cash and cash equivalents 2,583,813 (5,982,570)
Cash and cash equivalents at beginning of period 22,382 11,687,829
----------- ------------
Cash and cash equivalents at end of period $ 2,606,195 $ 5,705,259
=========== ============
Supplemental disclosure of cash flow information:
Interest paid $ 8,520 $ 39,384
Income taxes paid 2,000 35,000
Note receivable received upon exercise of stock options 93,682 674,999
Note receivable received from issuance of common stock 895,000 --
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
4
<PAGE>
ARTIFICIAL LIFE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
the Company have been prepared in accordance with generally accepted
accounting principles for interim financial information and in accordance
with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and
include the accounts of Artificial Life, Inc. and its wholly-owned
subsidiaries; Artificial Life Europe AG ("ALife Europe") and Artificial
Life Deutschland AG (commenced operations in April 1999), and a 51% owned
subsidiary Artificial Life Ventures, Inc. (acquired in June 1999).
Significant intercompany balances and transactions have been eliminated in
consolidation. Accordingly, they do not include all information and
footnotes required by generally accepted accounting principles for complete
financial statement presentation.
The results of operations for the periods reported are not necessarily
indicative of those that may be expected for a full year. In the opinion of
management, all adjustments (consisting only of normal recurring
adjustments) which are necessary for a fair statement of operating results
for the interim periods presented have been made.
The financial information included in this report has been prepared in
conformity with the accounting policies, reflected in the financial
statements included in the Company's Annual Report on Form 10-K filed with
the Securities and Exchange Commission.
2. NET LOSS PER SHARE
Basic net loss per share is calculated based on the weighted average number
of common shares outstanding for the three and nine month periods ended
September 30, 1998 and 1999. Basic and diluted net loss per share are the
same as the effect of inclusion of all common stock equivalents would be
anti-dilutive.
3. COMMON STOCK
In January 1999, the Company issued 40,000 shares of common stock at $8.50
per share in connection with the underwriter's exercise of its
over-allotment option. Net proceeds to the Company amounted to $302,600.
In May 1999, the Company issued 184,426 shares of common stock in
connection with the exercise of outstanding stock options. The total
proceeds amounted to $674,999 in the form of a note receivable due May 7,
2000 with interest at 15%.
In June 1999, the Company issued 174,179 shares of common stock in
connection with the exercise of outstanding stock options. The total
proceeds amounted to $637,495 and were received in cash.
In June 1999, an officer/stockholder exercised 184,426 stock options using
a net exercise feature, in exchange for 139,426 shares of common stock.
5
<PAGE>
ARTIFICIAL LIFE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
- CONTINUED -
On August 13, 1999, the Company issued 931,300 stock options to officers,
directors, employees and consultants at an option price of $14.50 per
share. The options are exercisable in equal amounts on the first, second
and third anniversary of the option grant.
4. JOINT VENTURE
In April 1999, the Company entered into a joint venture with two
international retailers in the field of e-commerce. The main focus of this
joint venture is to sell consumer goods over the Internet using deep
discounts and high volume, both in terms of transactions and web visits. As
part of the transaction, the Company will license its SmartBot technology
to the joint venture. In addition, the Company will provide products and
software development and consulting services to the joint venture and
receive payments therefor. The partners in the joint venture will be
responsible for using their purchasing relationships to obtain certain
consumer products which will be sold on the joint venture's e-commerce
Website. The Company has allocated up to $2,150,000 of the proceeds from
its IPO to purchase its 50% interest in this joint venture and to meet its
obligations to contribute additional capital to the joint venture. As of
September 30, 1999, $1,022,269 was invested by the Company in the joint
venture. Under the terms of the joint venture agreement, the Company may
market any e-commerce applications it develops to other e-commerce
companies.
5. SEGMENT INFORMATION
The Company, whose operations consist of a single line of business,
develops, markets and supports "intelligent software robots," software
programs that the Company designs to automate and simplify time-consuming
and complex business-related Internet functions.
At September 30, 1999, the Company had operations located outside the
United States in Switzerland, Germany and Russia. The Company's operations
in Europe commenced in late 1998 and generated no revenues as of December
31, 1998.
Other financial data for the nine months ended September 30, 1999 is as
follows:
<TABLE>
<CAPTION>
United States Europe Eliminations Total
------------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
Revenue from external
customers $ 2,178,350 $ 357,689 $ -- $ 2,536,039
Intersegment revenue 322,050 1,218,401 (1,540,451) --
Loss from operations (1,855,081) (1,163,503) (315,583) (3,334,167)
Identifiable assets 12,355,336 2,810,554 (4,390,177) 10,775,713
</TABLE>
6
<PAGE>
ARTIFICIAL LIFE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
- CONCLUDED -
6. ACQUISITIONS
In June 1999, the Company acquired 51% of the outstanding stock of
Cybermind Ventures, Inc. ("Cybermind") for $75,000 from two of the
Company's stockholders. Cybermind was inactive with a net loss in 1999
through the date of acquisition of $5,520. At the time of the acquisition,
Cybermind's name was changed to Artificial Life Ventures, Inc. In November
1999, the Company acquired the remaining 49% of the outstanding stock of
Artificial Life Ventures, Inc. from a stockholder of the Company. The
Company acquired this stock for $75,000 in cash and the issuance of 5,000
stock options at an exercise price of $14.50 per share. The options have a
three year life and vest in equal amounts on the first, second and third
anniversary of the grant date.
In October 1999, ALife Europe acquired all the outstanding common stock of
IT Partners AG ("IT") for 120,000 Swiss Francs (approximately $80,000). IT
is a Swiss company organized in June 1999 as a dealer of computer and other
equipment and to provide related consulting services. IT was inactive
through the date of acquisition.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q may contain forward-looking statements as
that term is defined in the Private Securities Litigation Reform Act of 1995.
The words "believe", "expect", "anticipate" and similar expressions identify
forward-looking statements. Such statements are based on management's current
assumptions and expectations and are subject to a number of factors and
uncertainties which could cause actual results or business conditions to differ
materially from those anticipated in the forward-looking statements. There can
be no assurance that actual results will not differ materially from those
described in such statements because of various factors, including, but not
limited to: the recent change in the Company's strategy; limited revenues
generated by the Company; the Company's dependence on the growth in demand for
agent-based software products, such as the Company's suite of SmartBot products;
competition with more established software companies; market acceptance of the
Company's software robot products; the Company's ability to minimize design
defects, software errors, misuse of the Company's products, incorrect data from
external sources and other potential problems which may be out of the Company's
control; the Company's ability to remain competitive by enhancing existing
products, developing new products and technologies that address the increasingly
sophisticated and varied needs of its customers and by responding to
technological advances and emerging industry standards and practices on a cost-
effective and timely basis; the ability of the Company to retain its key
employees; the Company's dependence on third party contractors to complete
portions of its development work; certain risks associated with sales in foreign
markets, including political and economic instability, restrictive trade
policies of foreign governments, local economic conditions in foreign markets,
potentially adverse tax consequences and the burdens on customers of complying
with a variety of applicable laws; the Company's dependence on continued growth
of the Internet and online commerce; the Company's ability to protect its
intellectual property and other proprietary rights; the Company's ability to
raise additional financing, as necessary; the Company's ability to establish and
maintain brand identity; the management of the Company's foreign operations; the
success by the Company in identifying and licensing third party voice
recognition software which will be compatible with its products; the impact of
government regulations; the failure by the Company, its clients or suppliers to
be year 2000 compliant; and, general economic conditions.
OVERVIEW
The Company was incorporated in Delaware in November 1994 as Neurotec
International Corp., a wholly-owned subsidiary of Neurotec GmbH, a German
multimedia and Internet solutions company owned by Eberhard Schoneburg,
Artificial Life's President, Chief Executive Officer and Chairman, and two
corporate investors: a major German retailer and an industrial conglomerate. In
July 1997, Mr. Schoneburg sold all of his shares of Neurotec GmbH to the two
remaining stockholders and contemporaneously purchased 100% of the shares of
Neurotec International Corp. (the "Management Buyout"). In August 1997, the
Company changed its name to Artificial Life, Inc.
As a result of a change in control of the Company in connection with the
Management Buyout, the Company has presented its assets and liabilities
subsequent to July 3, 1997 to reflect the purchase price paid for the stock of
the Company. This treatment is consistent with "push down" accounting as
promulgated by the Securities and Exchange Commission ("SEC"). In Management's
opinion, the purchase price of the Company's stock in the Management Buyout
reflected the fair value of the Company at such time.
8
<PAGE>
The difference between the Company's net book value at July 4, 1997 and the fair
value has been recorded as a reduction of the Company's net deferred tax asset
and long-term assets, resulting in a new depreciation basis for financial
statement purposes for such assets. As of July 4, 1997, the stockholder's equity
section reflects cumulative earnings prior to the Management Buyout as paid-in
capital. As a result, retained earnings at September 30, 1999 reflects the
results of operations of the Company only from the date of the Management
Buyout.
Following the Management Buyout, the Company's management made the strategic
decision to shift the Company's primary business focus from providing software
consulting services to the development, marketing and support of its ALife suite
of SmartBot software products. Management's decision to shift the primary
business focus of the Company has had and will likely continue to have an
adverse effect on the Company's results of operations in the near term. The
Company expects that an increasing percentage of its future revenues will be
derived from sales and services associated with its SmartBot software products
and that revenues from its consulting business, as a percentage of gross
revenues, will significantly decrease over time. For the first two quarters of
1999, the Company's major source of revenue was derived from its software
consulting services, and it generated minimal revenue from the sale of its
SmartBot software products. However, the third quarter of 1999 showed product
license revenues exceeding application service revenues for the first time in
Company history. The Company is currently expanding its research and
development, production and marketing capabilities associated with the
anticipated sale of its SmartBot products, and as a result, operating expenses
are expected to increase significantly going forward. The Company expects to
continue to incur increasing losses and generate negative cash flow from
operations until at least the year 2000. To the extent that the Company's
product development, marketing and sales efforts do not result in commercially
successful products that generate significant net revenues, the Company will be
materially adversely affected. There can be no assurance that the Company will
ever generate sufficient revenues from the sale of the Company's products or
associated services to achieve or maintain profitability.
In addition, as a result of the Company's recent transition in its primary
business focus from software consulting to product development, marketing and
support, the Company's research and development expenditures increased to
$446,317 for the year ended December 31, 1998 from zero in 1997 and $491,694 for
the nine months ended September 30, 1999 compared to $274,045 for the nine
months ended September 30, 1998. This increase is due to the fact that, prior to
1998, all research and development expenditures were related to consulting
services for which the Company was reimbursed by its customers and thus, such
expenditures are included in engineering expenses in the Company's financial
statements through December 31, 1997. Conversely, during 1998, due to the
Company's shift in business focus, the Company had most of its employees engaged
in the research and development of its SmartBot products.
Because the Company has shifted its primary business focus from software
consulting to product development, marketing and support, results of operations
to date are not reflective of the Company's business prospects going forward.
Moreover, the Company expects to experience significant fluctuations in its
future operating results due to a variety of factors. Factors that may affect
the Company's operating results include the success of product development, the
amount of software consulting undertaken in the future, market acceptance of the
Company's products, frequency and timeliness of new product releases, success of
strategic alliances, the mix of product and service sales, the Company's
response to competitive pressure and its ability to attract and retain qualified
personnel. Gross profit margins will vary from product to product and between
products and services and although the Company may have some ability to affect
its products and services mix, the Company's sales mix may vary from period to
period and its gross margins will fluctuate accordingly.
9
<PAGE>
RESULTS OF OPERATIONS
The Company's principal source of revenue from inception through May 1998 was
from the provision of software consulting services. From inception through July
3, 1997, the preponderance of those revenues were generated by subcontracts
issued from Artificial Life's former parent company and affiliates thereof, all
of which revenues ceased shortly after the Management Buyout. Of the non-related
party revenues, most were derived from the Company's long-term consulting
contract with its major domestic client. This consulting contract started in
late 1996 and concluded in May 1998.
During the fourth quarter of 1997, the Company began evaluating the addition of
software product development to its core business of providing software
consulting services. The Company commenced software development plans while it
continued to provide software consulting services under its existing contracts
and to seek new consulting contracts. In the first quarter of 1998, the Company
began software development activities while continuing to service its one
existing consulting contract. During this time the Company limited its efforts
in seeking new consulting contracts as it began to shift its primary business
focus to software development. During the second quarter of 1998, when the
Company's major domestic consulting contract ended, the Company focused a
substantial portion of its available resources on product development.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1998
REVENUES: Revenues for the nine months ended September 30, 1999 were $2,536,039
as compared to $449,380 for the nine months ended September 30, 1998. The
increase of $2,086,659 or 464.34% is primarily attributable to the Company
entering into a consulting agreement with a European Trust which generated
application services and license revenue of $1,877,217 and license revenues
related to the Company's joint venture of $357,689. Revenue for the nine months
ended September 30, 1998 was from application services and software license
agreements.
ENGINEERING EXPENSES: Engineering expenses generally consist of salary and
payroll tax expenses, training, consulting, subcontracting and other expenses
incurred to develop and fulfill the engineering requirements of the products and
services from which the Company derives its revenues. Engineering expenses for
the nine months ended September 30, 1999 were $1,407,537 as compared to
$308,897 for the nine months ended September 30, 1998. The increase of
$1,098,640 or 355.67% is primarily attributable to costs incurred in connection
with the European Trust consulting agreement entered into in 1999 and the need
for additional personnel with the growth in business.
RESEARCH AND DEVELOPMENT EXPENSES: Research and development expenses consist of
expenses similar in nature to engineering expenses except that such expenses
typically relate to new products and activities that will generate revenue at
some future date. Research and development expenses for the nine months ended
September 30, 1999 were $491,694 as compared to $274,045 for the nine months
ended September 30, 1998. The increase of $217,649 or 79.42% is attributable to
the Company's increased product development activities. Significant increases
include professional affiliation costs of approximately $60,000, travel expenses
of $36,000 and amortization of capitalized software costs of $122,000.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Selling expenses consist of salary
and payroll tax expenses of marketing personnel and costs relating to marketing
materials, promotional videos, advertising and public relations activities.
General and administrative expenses consist of salary
10
<PAGE>
and payroll tax expenses of administrative personnel, rent, legal and accounting
fees and costs associated with employee benefits, supplies, communications and
travel. Selling, general and administrative expenses for the nine months ended
September 30, 1999 were $3,719,321 as compared to $1,076,697 for the nine months
ended September 30, 1998. The increase of $2,642,624 or 245.44% is primarily
attributable to the establishment of our U.S. and international sales and
administrative infrastructure. Significant increases include payroll costs of
approximately $914,000, professional fees of $623,000, marketing and promotion
expenses of $458,000 and travel and entertainment expenses of $308,000.
NET LOSS: Net loss for the nine months ended September 30, 1999 was $3,334,167
as compared to a net loss of $1,303,983 for the nine months ended September 30,
1998. This increase of $2,030,184 or 155.69% was primarily attributable to the
Company's international expansion of its sales, marketing and developmental
infrastructure.
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1998
REVENUES: Revenues for the quarter ended September 30, 1999 were $1,211,488 as
compared to $0(zero) for the quarter ended September 30, 1998. The increase is
primarily attributable to the Company entering into a consulting agreement with
a European Trust that generated application service and license revenue of
$920,000.
ENGINEERING EXPENSES: Engineering expenses generally consist of salary and
payroll tax expenses, training, consulting, subcontracting and other expenses
incurred to develop and fulfill the engineering requirements of the products and
services from which the Company derives its revenues. Engineering expenses for
the quarter ended September 30, 1999 were $586,292 as compared to $59,108 for
the quarter ended September 30, 1998. The increase of $527,184 or 891.90% is
primarily attributable to costs incurred in connection with the European Trust
consulting agreement entered into in 1999 and the need for additional employees
as a result of the growth in the Company's business.
RESEARCH AND DEVELOPMENT EXPENSES: Research and development expenses consist of
expenses similar in nature to engineering expenses except that such expenses
typically relate to new products and activities that will generate revenue at
some future date. Research and development expenses for the quarter ended
September 30, 1999 were $205,170 as compared to $145,942 for the quarter ended
September 30, 1998. The increase of $59,228 or 40.58% is primarily attributable
to an increase of payroll costs of $55,000 associated with increased product
development activities.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Selling expenses consist of salary
and payroll tax expenses of marketing personnel and costs relating to marketing
materials, promotional videos, advertising and public relations activities.
General and administrative expenses consist of salary and payroll tax expenses
of administrative personnel, rent, legal and accounting fees and costs
associated with employee benefits, supplies, communications and travel. Selling,
general and administrative expenses for the quarter ended September 30, 1999
were $1,677,046 as compared to $480,077 for the quarter ended September 30,
1998. The increase of $1,196,969 or 249.33% is primarily attributable to the
establishment of our U.S. and international sales and administrative
infrastructure. Significant increases include payroll costs of approximately
$491,000, professional fees of $129,900, marketing and promotion expenses of
$229,074 and travel and entertainment expenses of $63,000.
NET LOSS: Net loss for the quarter ended September 30, 1999 was $1,417,729 as
compared to a net loss of $717,958 for the quarter ended September 30, 1998.
This increase of $699,771 or 97.47% was primarily due to the Company's
international expansion.
11
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
From inception through July 3, 1997, the Company funded its operations primarily
through initial equity investments in 1994 and 1995 totaling $500,000 and net
income from operations. Subsequent to July 3, 1997, the Company incurred
operating losses in connection with its transition from software consulting to
product development, marketing and sales. These losses are expected to increase
and have been funded to date by a long-term stockholder loan of $500,000, a
private placement of Common Stock of $181,367, the net proceeds of which the
Company received in June 1998 and a private placement of 824,000 shares of
Common Stock which raised $3,946,481 in net proceeds. In December 1998, the
Company received $9,302,773 net proceeds from its Initial Public Offering in
which 1,400,000 shares of common stock were sold. In January 1999, the Company
issued 40,000 shares of common stock at $8.50 per share in connection with the
underwriter's exercise of its over-allotment option. Net proceeds to the
Company amounted to $302,600. In May 1999, the Company issued 184,426 shares of
common stock in connection with the exercise of outstanding stock options. The
total proceeds amounted to $674,999 in the form of a note receivable due May 7,
2000 with interest at 15%. In June 1999, the Company issued 174,179 shares of
common stock in connection with the exercise of outstanding stock options. The
total proceeds amounted to $637,495 and were received in cash. In June 1999, an
officer/stockholder exercised 184,426 stock options using a net exercise
feature, in exchange for 139,426 shares of common stock. The Company's
requirements for additional capital will depend on many factors, including but
not limited to the progress and costs associated with its research and
development activities, production costs and sales, marketing and promotional
programs, establishment of foreign operations and the levels of revenues
achieved through the sale of its SmartBot suite of products. The Company has
currently placed excess funds in interest bearing vehicles such as money market
accounts and savings accounts.
Effective October 10, 1995, the Company entered into a consortium agreement (the
"MIT Agreement") with the Massachusetts Institute of Technology ("MIT"). Under
the MIT Agreement, MIT will conduct research projects for the "Things That Think
Consortium." The term of the agreement is for five years through October 9, 2000
but provides for early termination, with one year written notice, as well as
renewal options. The Company is obligated to pay an annual membership fee of
$125,000 under the MIT Agreement.
The Company leases office and other space and office equipment under various
noncancelable leases. Minimum annual lease payments, exclusive of additional
operating costs, for the years ended December 31, 1999, 2000, 2001, 2002, 2003
and thereafter are $384,502, $625,261, $417,805, $49,188, $49,188 and $172,158,
respectively. In addition, a new lease agreement is anticipated to be signed
during the fourth-quarter of 1999 for space requirements for the New York
office.
The Company has employment agreements with certain corporate officers. The
agreements are generally one to three years in length and provide for minimum
base salaries. These agreements include severance payments under certain
conditions of approximately 50% to 300% of each officer's annual compensation.
In addition the President, Chief Executive Officer and Chairman of the Company
is entitled to receive an annual incentive bonus of 3% of the Company's profits
from operations.
The Company has entered into a joint venture with two international retailers in
the field of e-commerce. The main focus of this joint venture is to sell
consumer goods over the Internet using deep discounts and high volume, both in
terms of transactions and web visits. As part of the transaction, the Company
will license its SmartBot technology to the joint venture. In addition, the
Company will provide products and software development and consulting services
to the joint venture and receive payments therefor. The partners in the joint
venture will be responsible for using their purchasing relationships to obtain
certain consumer products which will be sold on the joint venture's e-commerce
Website. The Company has allocated up to $2,150,000 of the proceeds from its
IPO to purchase its 50% interest in this joint venture and to meet its
obligations to contribute additional capital to the joint venture. As of
September 30, 1999,
12
<PAGE>
the Company has invested $1,022,269 in this joint venture. License revenue
recorded in the second quarter of 1999 amounting to $351,743 was derived from
this relationship.
In addition, the Company has concluded its development and consulting project
with a Europe-based global trust and has submitted its findings to the client.
The project goal was to define and design the trust's future Internet-based
financial services and to use these services to broaden the trust's market
potential. The Company is currently involved in the implementation phase of
this development project. As part of the transaction, the Company would provide
products and software consulting services to the trust and receive payments
therefor.
The Company believes that the net proceeds of the IPO, together with its current
cash and cash equivalents, and other cash generated from operations will enable
the Company to maintain its current and planned operations through July 2000,
although there can be no assurance that the Company will not have additional
capital needs prior to such time. If cash generated from operations is
insufficient to satisfy the Company's liquidity requirements after that time,
the Company may seek to sell additional equity or debt securities or obtain a
credit facility. The sale of additional equity or convertible debt securities
could result in additional dilution to the Company's stockholders. There can be
no assurance that financing will be available in amounts or on terms acceptable
to the Company, if at all.
The Company has incurred a loss for income tax purposes for fiscal 1998 and the
first three quarters of 1999. This loss will be available to carry forward and
reduce income taxes, if any, in future periods.
YEAR 2000 ISSUE
The Year 2000 issue is the result of computer programs using a two-digit format,
as opposed to four digits, to indicate the year. Any of the Company's computer
programs or other information systems that have time-sensitive software or
embedded microcontrollers may recognize a date using "00" as the year 1900
rather than the Year 2000. This could result in a system failure or
miscalculations causing disruptions of operations.
The Company has completed a detailed review of its information and non-
information technology systems as they pertain to both internal operations and
product development. This review, the costs of which were not material, included
its existing and planned computer software and hardware. The Company believes
that these systems are Year 2000 compliant and that the costs and/or
consequences associated with the Year 2000 issue are not expected to have a
material adverse effect on its business operations or future financial
condition. The detailed review which was completed during the second quarter of
1999 revealed no material issues regarding network hardware and software. In
addition, certain other internal systems and third party development tools were
evaluated with a final assessment completed during the third quarter of 1999. In
the course of its review, the Company also solicited and obtained certification
of Year 2000 compliance from certain third party software vendors and determined
the readiness of its significant suppliers and customers. The Company does not
currently expect to experience Year 2000 problems as its computer hardware is
generally no more than two years old and it has the latest version of computer
software programs. The Company, however, will continue to monitor the Year 2000
readiness of its systems and will take additional review or remedial action if
it deems it necessary to do so.
The Company's products, however, are designed to operate with third party
software and data. The operation of the Company's existing and proposed products
will be adversely affected if such third party software and data are not Year
2000 compliant or if such third parties have not used compatible technology in
achieving compliance. The Company is in the process of certifying the Year 2000
13
<PAGE>
readiness of third party software and data as they relate to and interact with
the Company's software products and consulting activities.
To the extent that the Company's assessment is completed without identifying any
non-compliant systems operated by the Company or by third parties, the Year 2000
issue could have a material effect on the operations of the Company. The
Company could experience delays in the development of its products. Once its
products are developed and offered for commercial sale, the Company could
experience delays in delivering such products or could deliver products that do
not operate correctly, which could cause the Company to lose business and even
customers and could subject the Company to claims for damages. Problems with
the Year 2000 issue could also result in delays in the Company invoicing its
customers or in the Company receiving payments from them. The severity of these
possible problems would depend on the nature of the problem and how quickly it
could be corrected or an alternative implemented, which is unknown at this time.
After completing its assessment, the Company is developing appropriate
contingency plans to address situations in which various systems of the Company,
or of third-parties with which the Company does business, do not prove to be
Year 2000 compliant. Some risks of the Year 2000 issue, however, are beyond the
control of the Company and its suppliers and customers.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
---------------------------------------------------------
During the nine months ended September 30, 1999, the Company increased the
amounts of cash denominated in foreign currencies in connection with its
European operations. The Company believes these amounts, $1,656,944 at
September 30, 1999, are necessary to meet the operating requirements of its
European subsidiaries.
14
<PAGE>
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
-----------------
None.
ITEM 2. CHANGE IN SECURITIES
--------------------
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDER
--------------------------------------------------
The Company held its Annual Meeting of Shareholders on August 13, 1999 and the
following matters were voted at that meeting:
1. The election of Elmar Wohlgensinger as Class III Director, to serve
for a three year term of office expiring in 2002 or until his
successor is elected. The following chart shows the number of votes
cast for or against Mr. Wohlgensinger, as well as the number of
abstentions and broker nonvotes:
For Against Abstain Broker Nonvotes
--- ------- ------- ---------------
7,688,039 2,705 N/A N/A
2. The proposal to increase by 1,500,000 shares the aggregate number of
shares for which stock options and stock awards may be granted under
the Company's 1998 Equity Incentive Plan. The following chart shows
the number of votes cast for or against the proposal, as well as the
number of abstentions and broker nonvotes:
For Against Abstain Broker Nonvotes
--- ------- ------- ---------------
7,047,783 29,504 1,125 655,532
ITEM 5. OTHER INFORMATION
-----------------
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits:
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K:
No Reports on Form 8-K were filed by the Company during the three
months ended September 30, 1999.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
ARTIFICIAL LIFE, INC.
---------------------
(registrant)
By: /s/ Eberhard Schoneburg
----------------------
Eberhard Schoneburg
Chairman, President &
Chief Executive Officer
(Principal Executive Officer)
Dated: November 15, 1999
16
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