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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD ______________ TO ______________
Commission file number: 0-25075
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)
Registrant's telephone number, including area code: (617) 266-5542
Securities registered pursuant to Section 12(b) of the Exchange Act: NONE
Securities registered pursuant to Section 12(g) of the Exchange Act:
COMMON STOCK, $.01 PAR VALUE PER SHARE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
The aggregate market value, based upon the closing sale price of the shares as
reported by the Nasdaq SmallCap Market, of voting stock held by non-affiliates
(without admitting that any person whose shares are not included in such
calculation is an affiliate) on March 19, 1999 was approximately $109,399,245.
As of March 19, 1999, the Registrant had 9,310,574 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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PART I
ITEM 1. BUSINESS.
GENERAL
The Company was incorporated in Delaware in November 1994 as Neurotec
International Corp., a wholly owned subsidiary of Neurotec Hochtechnologie GmbH
("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. from Neurotec GmbH (the "Management
Buyout"). In August 1997, the Company's name was changed to Artificial Life,
Inc.
Artificial Life, Inc. ("Artificial Life" or the "Company") develops, markets and
supports "intelligent" software robots ("bots"). The Company's bots, known as
"SmartBots," are software programs that the Company is developing to automate
and simplify time-consuming and complex business-related Internet functions such
as Web navigation, direct marketing, e-mail automation, user profiling,
knowledge management, sales response and call center automation. The Company is
also developing products for applications in data mining, Web-page analysis,
statistical analysis and customer service to support the functionality of the
SmartBot products. While each Artificial Life SmartBot will function
independently and will be programmed for a particular application, customers
will be able to combine the SmartBots to create what the Company believes will
be the industry's first integrated commercial, robot-based electronic commerce
("e-commerce") solution. In addition, the Company provides software consulting
services to corporations and other entities seeking software solutions,
particularly in the field of "intelligent" software programs.
INDUSTRY BACKGROUND
Computer users and businesses have rapidly adopted the Internet as a means to
gather information, communicate, transact business, interact and be entertained,
making it an important new mass medium. International Data Corporation ("IDC"),
a market research firm, estimates that the number of Internet users exceeded 69
million in 1997, and will grow to over 320 million by 2002. The Internet enables
advertisers to target advertising campaigns utilizing sophisticated databases of
information about the users of various sites and to directly generate revenues
from these users through online transactions. As a result, the Internet has
become a compelling means to advertise and market products and services. IDC
estimates that the total value of goods and services purchased over the Internet
will grow from $12 billion in 1997 to approximately $425 billion per year by the
end of 2002.
Consequently, the amount of information available on the Internet has grown
dramatically. Web sites have proliferated along with the data available on such
sites, making it more difficult and time consuming for users to find the
information they want. Users are spending a substantial portion of their on-line
time searching for the specific information, products or services they desire.
Furthermore, once an Internet user locates a desired site or sites, the user
often finds it difficult to navigate such sites. As Web technology has improved,
many Web sites have become more complex by adding new features, products,
services, chat rooms, games, and other services. It is not uncommon for one Web
site to have dozens of different options and links to other associated sites.
While it is generally true that this increase in information and choices
benefits Web users, more effective tools are needed to find information,
products and services efficiently.
For corporations offering products and services on the Internet, the rapidly
increasing number of Internet users offers benefits but also presents
challenges. For example, a company may place a description of a new product on
its Web site and then find that within a few hours, thousands of Internet users
have sent e-mail messages to learn more about the product. While the volume of
inquiries suggests that the company might ultimately generate significant
revenues from selling its new product online, responding to each of these
inquiries in a timely manner can require an expensive customer service force. A
second problem facing e-commerce companies is the dramatic increase in
competition among e-commerce sites. Numerous e-commerce sites are launched
worldwide on the Internet daily. Accordingly, e-commerce retailers must find
increasingly efficient and cost-effective ways to market their products and
services to new customers and maintain or enhance existing customer
relationships.
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THE ARTIFICIAL LIFE SOLUTION
Artificial Life is developing its ALife suite of SmartBot products to assist in
solving problems relating to information retrieval, Web navigation, sales and
service support and direct marketing on the Internet. These software robots are
designed to communicate in natural language and to respond "intelligently" to
the user's command or inquiry, and in some cases, to act autonomously.
All of the Company's SmartBot products are based on the Company's
ALife-SmartEngine technology. The ALife-SmartEngine is the core component that
gives the Company's products the ability to converse with its users in natural
language, either by text or speech, and also to process and respond to natural
language commands or questions. The ALife-SmartEngine contains several
"intelligent" modules that process and interpret manual input or verbal natural
language. These modules work together to break down the essential components of
human conversation -- detailed knowledge of certain topics, casual talk about
topics of interest ("small talk"), short and long term memory of previously
discussed topics, and some emotional content and intentions that drive the
conversation -- and use these components to "understand" and respond to the user
in a manner that is more human-like and less machine-like than current
"query-based" software. The Company believes that its products will allow people
to interact with computers in a more natural way -- similar to a conversation
with a human being.
Historically, general natural language understanding and processing software
programs (often classified under the category "artificial intelligence") have
focused on understanding the meaning of a sentence in the same way as a human
would, so that the software program can react appropriately to a spoken sentence
or a sentence typed in at the keyboard. These programs have had only limited
success. The ALife-SmartEngine instead attempts to mimic comprehension of a
sentence by using complex pattern matching techniques to determine the actual
goals and intentions of the user. By "understanding" the user's goals and
intentions, ALife-SmartEngine-based products are being designed to possess the
ability to actively drive and maintain a conversation about certain topics, and
not merely react to the user.
The ALife-SmartEngine stores information in "Knowledge Bases," databases which
can be combined or exchanged to give the derived products differing sets of
expertise. Customers can add information to a Knowledge Base using a special
"Knowledge Capture Editor." The ALife-SmartEngine has several linked stages that
read spoken or text-based input and produce spoken or text-based output. When a
user types in text or speaks to the ALife-SmartEngine via standard voice
recognition software packages, the pre-processed speech input is routed to a
parser. The parser then converts the input from a stream of text to a series of
words and phrases. An analysis module draws on the topic information in the
memory section of the ALife-SmartEngine as well as the syntactic structure of
the sentence derived from the Knowledge Base. The major control module of the
ALife-SmartEngine is a meta-control module (the "Meta Controller") that is
essential for switching between the different speech processing modules to
process the input and prepare the appropriate response corresponding to a given
input. The Meta Controller picks a reply appropriate to the perceived intention
of the user by applying a set of rules that define the conversational strategy
of the bot. All modules communicate through the Meta Controller, which also
coordinates and balances the weighting of each of the separate modules as the
bot prepares its composite action.
Most of the Company's SmartBots communicate with the user through a life-like
three-dimensional graphical interface known as an "Avatar." Each product comes
with a standard human-like Avatar. However, the Avatar may be customized by the
customer, including using pre-existing branded icons or displays. For instance,
an e-commerce retailer of computer equipment might customize its Avatar so that
visitors to its Web site converse with a talking computer. The Company believes
that the use of an animated "talking partner" allows people to interact with
computers in a more natural and personal manner, and that the ability of the
Company's customers to customize the Avatars allows them to develop or maintain
brand or name recognition among visitors to a customer's Web site.
PRODUCTS
The Company is currently developing seven basic software robots for use
individually or in various combinations. The Company presently intends to
develop three different product versions of most of its SmartBots: (i) a
"Personal" version intended for use by individual users on their personal Web
pages; (ii) a "Professional" version intended for use by professionals and small
businesses on their Web sites; and (iii) a transaction and client/server based
"Enterprise" version intended for use by large companies, institutions and
government agencies that want to integrate the bots into their existing
computing environment with enhanced and special customizable product features.
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ALIFE-WEBGUIDE: The Company released the Personal version of this SmartBot in
September 1998 and the Professional version in November 1998. It is designed to
reside on a Web site and help users navigate the site by accepting and
processing questions, such as search queries, from users in natural language and
responding to users in natural language. This SmartBot engages the user in a
"conversation" through questions and answers and, upon learning of the user's
interests, is designed to display Web pages that match the content of the
"conversation" or to suggest links to other locations on the Web site. In an
e-commerce application, the ALife-WebGuide can be designed by the Web site host
to function like a human sales associate at a retail store, greeting customers
coming through the door of the virtual store and assisting them with advice and
background information about products and prices. This bot allows the use of a
customizable animated Avatar interface.
ALife-WebGuide runs on both Netscape Navigator or Communicator 3.0 or higher and
Microsoft Internet Explorer 3.0 or higher. The Enterprise version of the
ALife-WebGuide is being designed with a client/server architecture, requiring a
Java virtual machine 1.02 or higher. The Knowledge Capture Tool of the
ALife-WebGuide Enterprise version is being designed to run on Microsoft Windows
95, 98 or NT. The Company released the Personal version 1.0 of the
ALife-WebGuide in September 1998 and the Professional version 1.0 in November
1998. The Company has announced that it intends to release the Enterprise
version 1.0 in April 1999. The Company believes that the potential market for
this product includes Internet Web sites which need or desire a more
user-friendly natural language interface.
ALIFE-SALESREP: The ALife-SalesRep is being designed for e-commerce retailers to
use for one-to-one marketing on the Internet. Retailers will be able to collect
user profile information and to add product information into this SmartBot's
Knowledge Bases to deliver customer-specific targeted sales information on the
Internet via e-mail. For example, the ALife-SalesRep can be configured by a
corporate user to utilize customer profile information to deliver information
about a specific sale or promotion to an existing or potential customer. In this
type of application, the user will typically have the option of downloading the
ALife-SalesRep Avatar to his or her computer. Once the Avatar is resident on the
user's computer, the user can access the e-commerce retailer's Web site simply
by clicking on the Avatar, which will appear as an icon on the user's computer
screen and which in many cases will maintain a link to the host Web site.
The Company is also designing ALife-SalesRep to engage in autonomous action. For
example, a user will download an Avatar, and the Avatar will continue to appear
on the user's start-up screen. Each time the user turns on his computer, the
Avatar, through its link to the host Web site, will automatically download new
information that the program has determined may be of interest to the user,
based upon the information in its Knowledge Bases. For example, the user could
learn from the Avatar resident on the computer that the host company is having a
sale on modems which run at faster speeds than the one the user currently owns.
The host company will have determined which modem the user currently owns
because the user had a "conversation" with the ALife-SalesRep about the user's
computer hardware. Later, the user might be offered discounted tickets by the
Avatar to an upcoming computer industry trade show in the user's hometown at
which the host will be exhibiting its products.
ALife-SalesRep is being designed to run on personal computers with Microsoft
Windows 95, 98 or NT. The Company intends to release the 1.0 Professional and
Enterprise versions of ALife-SalesRep in 1999 and its development is proceeding
on schedule. The initial target market for this product consists of advertising
companies, companies with direct Internet marketing activities and more
generally all companies with extensive Internet sales and marketing strategies
and activities.
ALIFE-MESSENGER: The ALife-Messenger is being designed to serve as a natural
language-based automated e-mail reply and answering service. By customizing the
Knowledge Bases of the ALife-Messenger, a company can automate replies to
incoming e-mail queries and customer requests. The ALife-Messenger is being
designed to work like an off-line ALife-WebGuide by selecting appropriate
answers to input queries in an "intelligent" way. However, instead of displaying
Web pages, the ALife-Messenger is being designed to automatically scan an
incoming e-mail for certain keywords and phrases, prepare a reply e-mail and
attach, as appropriate, additional information that matches what this SmartBot
determines might be useful to the user, such as relevant documents, price-lists,
and links to other Web sites. For an individual who purchases ALife-Messenger
for his Web page, it could be used as a customized e-mail "answering machine" on
the Internet. For a corporate purchaser already using ALife-SalesRep, the
ALife-Messenger could be configured to select the appropriate ALife-SalesRep to
be attached to the reply e-mails, with the goal of improving and supporting the
direct marketing channel.
The ALife-Messenger is being designed to support standard e-mail systems. The
Company has announced that it intends to release the 1.0 version of the
ALife-Messenger in April 1999. The Company intends to market this product to
companies and institutions which need to extensively interact with clients via
e-mail or which have extensive customer/client service programs using the
Internet.
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ALIFE-PORTFOLIO-MANAGER: The ALife-Portfolio-Manager is being developed to
monitor an individual's investment portfolio. The user can specify the desired
characteristics of his or her portfolio, such as particular stocks to own,
specific buy and sell thresholds for individual stocks, and desired ratios of
types of stocks. Once the user's portfolio guidelines are established, the
ALife-Portfolio-Manager will monitor the portfolio 24 hours per day and
autonomously notify the user when the user's price or ratio guidelines are not
being met through one of a variety of predefined media such as e-mail, telephone
or pager. In addition to monitoring existing investment portfolios, the
Alife-Portfolio-Manager is being designed to find other potential investments
fitting the user's specified criteria and notify the investor about any such
investment opportunities once found.
The ALife-Portfolio-Manager is being designed to run on personal computers with
Microsoft Windows 95, 98 or NT. The Company plans to release the 1.0 version of
the ALife-Portfolio-Manager in the third quarter of 1999. At that time, the
ALife-Portfolio-Manager will most likely be released as a component to an
existing project currently under way. The Company anticipates that the
ALife-Portfolio-Manager will first be released for general distribution in the
first quarter of 2000. The Company believes that the market for this product
will consist of individuals and companies in the financial services industry,
including Internet brokers, as well as individual investors.
ALIFE-CALL-CENTER-AGENT: The ALife-Call-Center-Agent is being designed to link
conversations with a Company's WebGuide to a human call center agent. The Alife
Call-Center-Agent adds a module for problem solving to the Alife WebGuide. If
the Alife Call-Center-Agent cannot solve a customer's problem by itself, it
links the customer directly to a human call center agent. A pop-up window
appears on the screen of the human call center agent to link the call center
application directly to the customer.
The ALife-Call-Center-Agent will require an operating platform with a Java
virtual machine. Additional software and hardware enhancements may be necessary
depending on the specific interfaces to call center operating systems. The
Company plans to release the 1.0 version of ALife-Call-Center-Agent by the end
of 1999. The Company intends to market this product directly to customers with
call centers and to call center software vendors.
ALIFE-KNOWLEDGE-MANAGER: This SmartBot is being designed to extract information
contained in a company's Intranet documents, organize it and make it more easily
accessible for retrieval to enable companies to more efficiently and
intelligently manage the large amount of data and documents that companies are
making available on their Intranets. ALife-Knowledge-Manager can be configured
to allow each Intranet user to describe his own profile, background and
interests in addition to other information contained on the Intranet. Once so
configured, users can make natural language search queries about topics of
interest through the ALife-Knowledge-Manager, and the program will respond by
providing relevant information contained on the company's Intranet.
The ALife-Knowledge-Manager is being designed to run on standard OS platforms
and to provide for interfaces to standard databases and third party document
retrieval and management systems. The Company intends to release the first
versions of ALife-Knowledge-Manager in late 1999 or early 2000. The Company
plans to market this product primarily to large corporations with an existing
Intranet infrastructure.
ALIFE-PERSONAL-TUTOR: The Company is developing this SmartBot to address certain
limitations of traditional Computer-based Training ("CBT") and Internet-based
Training ("IBT") products that are currently available. Whereas conventional CBT
and IBT programs follow a pre-defined path of learning, the ALife-Personal-Tutor
is being designed to use student profile information extracted from natural
language conversation between the SmartBot and the student user to automatically
adapt the difficulty and content of the lessons to the skill level of the
student. Using the natural language capabilities of the ALife-SmartEngine,
students will be able to ask numerous questions about any topic at any time in
plain English. In addition, the ALife-Personal-Tutor is being designed to
respond to questions with additional explanatory multimedia data (video and
audio) depending on the context of the ongoing lecture between the student and
the ALife-Personal-Tutor. It will also formulate questions and tests depending
on the flow of the conversation and lesson.
The ALife-Personal-Tutor is being designed in two components and is currently
planned to be sold in two ways: (i) in several application packages with
specific content (such as science, history etc.), called "tutorials" and (ii) as
a generic tool for developing such tutorials. Both modules of the
ALife-Personal-Tutor are being designed to run on Windows 98 and NT (stand alone
versions) or on standard Internet browsers for on-line applications. The Company
intends to release the first tutorials in the second quarter of 1999 and the
generic version by the third quarter of 1999. The Company's target market for
this product is expected to be the CBT and IBT market and the general education
market.
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CONSULTING AND PRODUCT SERVICES
The Company expects to provide consulting, maintenance, technical hotline and
support services for most or all of its products. The Company anticipates that
customers will require support for, and customized versions of, the Company's
SmartBot products or additional developments in order to tailor the product to
the customers' needs. In addition, the Company plans to provide support for the
creation and maintenance of the Knowledge Bases of its bots and customer
specific back-office tools for analyzing client profiles gathered by its bots.
Historically, the Company has derived substantially all of its revenues from
software consulting services provided to a small number of customers. During the
year ended December 31, 1998,substantially all of the Company's revenue was
derived from the completion of its existing obligations for the Company's sole
remaining consulting contract for 1998 and the resulting license sale thereto.
During the year ended December 31, 1997, consulting services provided to the
Company's two largest customers, Neurotec Hochtechnologie GmbH (its former
parent company) and Passkey Systems, Inc., accounted for approximately 60% and
40% of the Company's total revenues, respectively. For the year ended December
31, 1996, services provided to Neurotec Hochtechnologie GmbH accounted for
approximately 99% of the Company's total revenues. All revenues derived from
software consulting services to the Company's former parent ceased shortly after
the Management Buyout. Although the Company has shifted its primary business
focus from software consulting to product development, marketing and support,
the Company anticipates that it will continue to derive a portion of its
revenues from software consulting projects. In particular, the Company expects
that it will provide software solutions for companies and other entities seeking
consulting expertise with agent-based software programs. In the near term, the
Company believes that a significant percentage of its revenues may be derived
from software consulting services. See "-- Strategic Alliances and Joint
Ventures".
BUSINESS STRATEGY
The Company's objective is to become a worldwide leader in the development and
implementation of commercial software robot-based solutions to solve various
issues confronting today's Internet use. To achieve this objective, the
Company's strategy includes the following key elements:
BUILD BRAND NAME RECOGNITION. The Company is seeking to achieve rapid and broad
adoption of its products and strong brand recognition. The Company will seek to
achieve this objective by offering "Personal" versions of its products for
non-commercial use free of charge or at a low price. The Company also intends to
embark on an aggressive promotional campaign to increase awareness of the
Artificial Life brand and the ALife family of products. The promotional campaign
is expected to involve all common media (i.e., radio, television, print and
trade shows) with a particular emphasis on Internet channels.
CREATE MULTIPLE REVENUE STREAMS. The Company believes that its growing product
line, corporate customization, product Web sites and its future installed user
base will present a significant opportunity to develop and maintain multiple
revenue streams resulting from product sales, customization and consulting,
licensing fees and potentially in the future, advertising revenues. As these
different revenue streams mature, decisions will be made as to the expansion and
contraction of existing programs based on their success as well as the
introduction of new programs.
ESTABLISH STRATEGIC ALLIANCES. The Company intends to aggressively pursue
strategic alliances to gain access to complementary technologies and
distribution channels. The Company continually evaluates relationships with
companies and other entities that offer technologies complementary to the
Company's SmartBot products (such as speech integration and high-end graphics
providers). The Company intends to use alliances wherever possible to gain
economies of scale and to allow it to focus on its core strengths while using
those of its partners to add the complementary functionality necessary to
increase value to users.
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EXPAND GLOBALLY. The Company believes that significant opportunities exist to
capitalize on the growth of the Internet internationally. Because the Company
was once a subsidiary of a large and well-known German multimedia and Internet
solutions company, it already has significant contacts with a number of European
businesses. The Company believes that its products can be used worldwide, and
accordingly the Company intends to initiate an international program of
partnering and strategic investment to exploit cross-marketing, co-branding and
promotional opportunities. In the fourth quarter of 1998, the Company
established European subsidiaries in Switzerland and Russia. In October 1998,
the Company formed a wholly owned subsidiary Artificial Life Europe AG
("Artificial Life Europe"). Artificial Life Europe, the headquarters of the
Company's European activities will focus on strategic investments in
Switzerland, joint ventures and product related consulting and development
activities in the areas of e-commerce and Internet banking. In November 1998,
Artificial Life Europe AG formed a wholly-owned subsidiary Artificial Life Rus
Ltd ("Artificial Life Rus") which is based in St. Petersburg, Russia. The
primary focus of Artificial Life Rus is product development, quality assurance
and research. In the second quarter of 1999, the Company intends to establish
its German subsidiary Artificial Life Deutschland AG ("Artificial Life
Deutschland"), to be situated in Frankfurt, Germany. Artificial Life Deutschland
will focus on strategic investments, product development, product customization,
product-related marketing and sales activities and general support to German
customers.
LEVERAGE CUSTOMER BASE. The Company intends to cultivate its future installed
user base to gather feedback, test new product releases and create customer
loyalty. The Company plans to collect customer profile data (through the use of
a User Profile Form) for use in development of companion products and services
with the ultimate goal of developing a "community" of loyal users who are
familiar and comfortable with the Company's products. The Company plans to allow
individual users who fill out the User Profile Form to participate in beta
testing of products, information sessions, product and corporate announcements
and product focus chat forums. The Company believes that such communication,
participation and interaction will foster long-term customer loyalty. Several
types of incentives are planned to foster both the sharing of profile
information and the return of value for participation. These may take the form
of reduced user fees, if applicable, free software, contests and other
participatory programs.
EXPAND AND ENHANCE PRODUCT BASE AND TECHNOLOGY. The Company believes that it
must regularly provide new products and technologies and improve existing ones
to be successful. The Company's products utilize proprietary technologies,
including the ALife-SmartEngine. The Company's strategy is to continue to
enhance its existing technologies and develop new technologies that it can
incorporate into future product offerings. Because the Company's product lines
are being centered around core concepts and technology, the Company believes
many complementary products will be able to be developed by leveraging the
Company's existing competencies and experience into new ideas. Furthermore, the
Company believes that its overall strategy will allow it to address issues
regarding products and services in a dynamic, almost real-time basis, thereby
allowing rapid response to market feedback and developments.
MARKETING AND SALES
The Company plans to offer an initial fully-functional "Personal" version of
most of its products to individual, non-commercial users either free of charge
or at a low price. The Company believes that this approach, which has been used
successfully by other Internet companies, will result in more rapid acceptance
and sale of the Company's products to commercial users: a "Professional" version
for professional and small corporate users and/or a transaction and
client/server based "Enterprise" version for networked corporate users. For the
commercial versions of its SmartBot products, the Company intends to charge a
one-time licensing fee and, with respect to the Enterprise version, intends to
also charge a transactional fee based upon the number of users which interact
with its bots. This strategy has been successful in the past for companies such
as Netscape, which distributed free versions of its browser software, and
RealNetworks, Inc., which has brought streaming audio and video to the Internet.
In the first quarter of 1999, the Company began selling the ALife-WebGuide via
the Company's Web site and through additional distribution partners. In March
1999, the Company began distribution of its ALife-WebGuide `intelligent'
software robot for the Benelux market under a non-exclusive distributor
arrangement with MBE Consultants of Belgium. Based in Brussels, MBE Consultants
will market and sell the Enterprise version of the ALife-WebGuide, and other
products as they are released, and provide consulting services and training in
the application and use of Artifical Life's software products in Belgium, the
Netherlands and Luxembourg.
The Company may also decide to license the Professional and/or Enterprise
versions of ALife-WebGuide, the ALife-Messenger and the ALife-SalesRep for a
certain period for free in order to generate market penetration and increase
demand for these commercial versions of the Company's products. For example, in
February 1999, the Company announced that it is donating copies of the
Alife-WebGuide Professional 1.0 to junior and senior high schools across the
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United States. The Alife-WebGuide Professional 1.0 will be used for educational
purposes, giving students the opportunity to learn about artificial life
applications by integrating the Alife-WebGuide Professional 1.0 into their
school Websites and Internet projects.
The Company intends to enter into a strategic relationship with an international
partner already established in the call center market to market and sell the
ALife-Call-Center-Agent. The Company believes this will be necessary because the
call center software market is already highly competitive.
The Company intends to market and sell the ALife-Portfolio-Manager in
cooperation with one or more established companies in the financial services
industry and/or the online banking and trading community.
The ALife-Personal-Tutor and the ALife-Knowledge-Manager target the IBT/CBT
market and the Intranet and corporate market. Accordingly, the Company intends
to distribute and market these products in cooperation with partners with
established experience and sales channels in these growing business segments.
In addition to the marketing efforts for the individual products in the ALife
product suite, the Company intends to initiate marketing campaigns beginning in
the first half of 1999 to establish recognition of the Artificial Life brand.
The Company has recently engaged the services of the Hill & Knowlton public
relations agency to assist in this effort. The marketing activities are expected
to involve all common media (radio, TV, magazines, newspapers, trade shows) with
a particular emphasis on the Internet channels. The Company will use its own
products like the ALife-SalesRep and the ALife-WebGuide to promote its products
and services.
The Company will also generate marketing material using its in-house
capabilities and multi-media know-how to produce video spots and innovative
interactive advertisement techniques for the Internet.
STRATEGIC ALLIANCES AND JOINT VENTURES
In March 1999, the Company agreed to enter into a joint venture with an
international retailer in the field of e-commerce, the terms of which have not
yet been finalized. The main focus of this joint venture is to develop a high
traffic, high volume, low cost e-commerce site on the Internet. The Company
will license its SmartBot products to the joint venture for a royalty. Pursuant
to a development agreement, the Company will also provide products and software
development and consulting services to the joint venture and receive payments
therefor. The joint venture partner will use its purchasing relationships to
obtain certain of the consumer products that will be sold on the joint venture's
e-commerce Website.
In addition, the Company has entered into a contract for the first phase of a
development and consulting project with a European based global trust. The
project goal is to define and design the trust's future Internet-based financial
services. A successful completion of this first phase could lead to a larger
scale implementation 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.
Furthermore, the Company is currently evaluating several strategic alliances
with companies in the United States and Europe for marketing and selling
products as well as for collaborations in product development. For example, the
Company is currently seeking to enter into a collaboration that will provide it
with access to speech recognition software to enable this aspect of its SmartBot
products. The closing of collaboration agreements may influence future product
development, the market direction of certain products and the success of certain
product marketing efforts.
PRODUCT DEVELOPMENT
The Company believes that strong development capabilities are essential to its
future performance and the maintenance of its competitive position. Since its
formation, the Company has primarily developed its technology and products
internally. The Company is exploring the opportunity to extend the functionality
of its ALife-SmartEngine-derived products through the inclusion of third party
software and applications in the development of such products.
7
<PAGE> 9
The Company's development organization is arranged in four groups: the Core
Technology Group, which does research and designs and develops the technologies;
the Production Group, which specifies, produces and maintains product releases;
the Quality Assurance Group, which verifies that products meet their
specifications and the Company's quality standards; and the Competence Group,
which focuses on rapid prototyping of new ideas, consulting and adapting
customer specific versions of the products. The Company allocates
responsibilities among the groups to optimize the time, cost and quality control
issues associated with product development.
As of December 31, 1998, there were 34 employees on the Company's development
staff. The Company estimates that its total product development expenses for its
ALife-SmartEngine product suite will significantly increase through 1999 and
thereafter as it expects to allocate substantial resources to future research
and development. Through December 31, 1998, the Company had incurred capitalized
software development costs from its development efforts in the amount of
$215,169.
To the extent one or more of the Company's competitors introduce products that
more fully address customer requirements, the Company's business could be
materially adversely affected. There can be no assurance that the Company will
be successful in developing and marketing enhancements to its existing products
or new products, incorporating new technology on a timely basis, or that its new
products will adequately address the changing needs of the marketplace. If the
Company is unable to develop and introduce new products or enhancements to
existing products in a timely manner in response to changing market conditions
or customer requirements, the Company's business, prospects, financial condition
and results of operations will be materially adversely affected.
COMPETITION
The market for the Company's products and services is new, evolving and growing
rapidly. Competition can be expected to intensify significantly as the market
matures and the more established software companies, such as Microsoft
Corporation, become increasingly involved. Barriers to entry are relatively
insubstantial. The Company believes that the principal competitive factors for
companies seeking to become involved in the software robot industry are core
technology, delivery methods, brand recognition, ease of use and interfaces.
The Company uses its core technology, the ALife-SmartEngine, in a wide variety
of business areas. Although the Company has not yet identified any competitors
in exactly the same areas in which it is active, there are companies that have
overlapping activities and therefore could be regarded as competition to
Artificial Life. Such firms include, among others: Autonomy, Inc.; Big Science
Company; Brightware, Inc.; Broadvision, Inc.; Digital Marketing Concepts, Inc.;
Extempo, Inc.; General Magic, Inc.; GK Intelligent Systems, Inc.; Haptek, Inc.;
Intellix A/S; Kinetoscope, Inc.; Microsoft Corporation; Netsage Corp.;
Neuromedia, Inc.; Nuance, Inc.; SRA International, Inc. and Virtual
Personalities, Inc. This list may not be complete and may change and
substantially increase over time.
Some of the Company's existing and potential competitors have longer operating
histories, greater name recognition, larger customer bases and significantly
greater financial, technical and marketing resources than the Company. Such
competitors are able to commit operating resources to product development and
enhancement, engage in more thorough marketing campaigns for their products and
services, be more aggressive from a pricing standpoint and make more attractive
offers to potential employees and partners.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company will be relying upon trade secrets, know-how, copyrights and
continuing technological innovations to develop and maintain its competitive
position. The Company seeks to protect such information, in part, by
confidentiality agreements with its corporate partners, collaborators, employees
and consultants. These agreements provide that all confidential information
developed or made known during the course of the individual's or entity's
relationship with the Company is to be kept confidential and not be disclosed to
third parties except in specific circumstances. The Company has caused each of
its employees to execute forms of Confidentiality and Inventions Agreements
which provide that, to the extent permitted by applicable law, all inventions
conceived by the individual during the individual's employment will remain the
exclusive property of the Company. There can be no assurance that these
agreements will not be breached, that the Company would have adequate remedies
for any breach, or that the Company's trade secrets will not otherwise become
known or be independently discovered by competitors. Further, there can be no
assurance that the Company will be able to protect its copyrights, trade secrets
or that others will not independently develop substantially equivalent
proprietary information and techniques.
8
<PAGE> 10
The Company has no patents or patent applications pending, nor does it have any
registered copyrights. There can be no assurance that the existing or future
patents of third parties will not have an adverse effect on the ability of the
Company to continue to commercialize its products. Furthermore, there can be no
assurance that other companies will not independently develop similar products
or duplicate any of the Company's planned products or obtain patents that will
require the Company to alter its products or processes, pay licensing fees or
cease development of its planned products.
EMPLOYEES
As of December 31, 1998, the Company had 45 full-time employees and two
part-time interns. Of the Company's 45 full-time employees, 11 are involved in
sales, marketing and administrative functions and 34 are involved in research
and development. The Company will need to hire additional staff to accomplish
its business development goals. There can be no assurance that the Company will
be able to find, attract or retain such additional staff.
The Company's employees are not represented by any labor unions. The Company
considers its relations with its employees to be good.
SUB-CONTRACTORS AND EXTERNAL HUMAN RESOURCES
To fulfill timely delivery of products, the Company is currently using external
human resources and sub-contractors to develop its products. There can be no
assurance that these external resources and sub-contractors will be available in
the future, or that the current conditions and agreements with these contractors
or resources will remain reasonable.
ITEM 2. PROPERTIES.
The Company rents 7,334 square feet of office space at Four Copley Place, Suite
102, Boston, Massachusetts. The 36 month lease commenced February 1, 1998, at an
annual rental of $205,332. Additionally, the Company leases approximately 2,500
square feet of office space in Saint Petersburg, Russia. The 60 month lease
commenced December 1, 1998 at an annual rental of $24,000. The Company is also
in the process of leasing space in Switzerland and Germany for its European
operations. Due to the planned expansion of the Company, management is currently
negotiating the terms for the lease of additional office space in Boston,
Massachusetts which is to take effect in the second quarter of 1999. Also in the
second quarter of 1999, the Company anticipates leasing additional office space
in New York, New York for the marketing and sale of its products.
ITEM 3. LEGAL PROCEEDINGS.
There are no material legal proceedings pending or, to the Company's knowledge,
threatened against the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
9
<PAGE> 11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock commenced trading on the Nasdaq SmallCap Market on
December 18, 1998 under the symbol "ALIF," and is listed on the Nasdaq SmallCap
Market. Prior to that date, there was no established trading market for the
Common Stock. The following table sets forth for the periods indicated, the
range of the high and low bid quotations for the Company's Common Stock. Such
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commissions and may not represent actual transactions.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
Fourth Quarter (from December 18, 1998) $ 26.75 $ 9.50
First Quarter (through March 19, 1999) 17.50 9.50
</TABLE>
On March 19, 1999, the last reported sale price of the Common Stock was $11.75
per share. As of March 19, 1999, there were approximately 40 holders of record
of the Company's Common Stock. To date, the Company has neither declared nor
paid any cash dividends on shares of its Common Stock and does not anticipate
doing so for the foreseeable future.
A Registration Statement on Form S-1 (File No. 333-64619) registering 1,600,000
shares of the Company's Common Stock, $.01 par value per share, filed in
connection with the Company's initial public offering ("IPO"), was declared
effective by the Securities and Exchange Commission on December 17, 1998. The
primary offering of 1,400,000 shares by the Company and 200,000 shares by the
Selling Stockholder closed on December 22, 1998. On December 23, 1998, the
underwriters exercised an overallotment option to purchase 150,000 shares from
the Selling Stockholder and, on January 19, 1999, exercised an overallotment
option to purchase 50,000 shares from the Selling Stockholder and 40,000 shares
from the Company, exercising a 240,000 share overallotment in full. The
aggregate offering price to the public was $13,600,000 before underwriter
discounts and the costs of the offerings. The underwriters of the IPO were New
York Broker, Inc. and New York Broker Deutschland AG. The following is a summary
of the gross proceeds, underwriter's discounts and expenses, other expenses and
net proceeds in connection with the IPO.
<TABLE>
<CAPTION>
COMPANY SELLING STOCKHOLDER TOTAL
-------------- ------------------- -------------
<S> <C> <C> <C>
Gross proceeds $ 12,240,000 $ 3,400,000 $ 15,640,000
Underwriter discount (979,200) (272,000) (1,251,200)
Underwriter expenses (648,984) (120,216) (769,200)
Other expenses (1,006,443) (119,900) (1,126,343)
-------------- ------------------- -------------
Net proceeds $ 9,605,373 $ 2,887,884 $ 12,493,257
</TABLE>
None of the above expenses was paid either directly or indirectly to directors,
officers, general partners of the Company or its associates, or to persons
owning more than 10% of any class of equity security of the Company or to
affiliates of the Company.
Through December 31, 1998, the Company had temporarily invested the entire net
proceeds of the IPO in savings and money market accounts with three major
financial institutions. However, the Company has allocated up to $2,500,000 of
such proceeds to fund certain strategic alliances. See "Management's Discussion
and Analysis of Financial Condition and Results of Operation - Liquidity and
Capital Resources."
10
<PAGE> 12
ITEM 6. SELECTED FINANCIAL DATA
The following table presents summary selected historical financial data of the
Company as of and for each of the three years in the period ended December 31,
1996, the periods ended July 3, 1997 and December 31, 1997, and the year ended
December 31, 1998 and should be read in conjunction with "Management's
Discussion and Analyses of Financial Conditions and Results of Operations" and
the Financial Statements and the notes thereto included in this Form 10-K.
SELECTED FINANCIAL DATA(1)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
-------------------------------------------------- ---------------------------
PERIOD
FROM PERIOD FROM
YEARS ENDED DECEMBER 31, JANUARY 1 JULY 4 TO YEAR ENDED
------------------------ TO JULY 3, DECEMBER 31, DECEMBER 31,
1994(2) 1995 1996 1997 1997 1998
-------- --------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Application services $ -- $ 1,217 $ 2,790 $ 926 $ 420 $ 333
Other -- -- -- 117 117 118
-------- --------- -------- -------- -------- --------
Total revenues -- 1,217 2,790 1,043 537 451
-------- --------- -------- -------- -------- --------
Operating expenses:
Selling, general and administrative 22 967 1,101 634 415 1430
Engineering -- 828 656 307 205 590
Research and development -- -- -- -- -- 447
Depreciation and amortization -- 40 138 84 45 110
-------- --------- -------- -------- -------- --------
Total operating expenses 22 1,835 1,895 1,025 665 2,577
-------- --------- -------- -------- -------- --------
Income (loss) from operations (22) (618) 895 18 (128) (2,126)
Other income (expenses) -- (35) (15) -- 179 (65)
-------- --------- -------- -------- -------- --------
Income (loss) before tax (22) (653) 880 18 51 (2,191)
Provision (benefit) for income taxes -- (257) 337 5 7 --
-------- -------- --------- -------- -------- -------
Net income (loss) $ (22) $ (396) $ 543 $ 13 $ 44 $(2,191)
======== ========= ======== ======== ======== =======
Net income (loss) per share(3) $ (.02) $ (.07) $ .08 $ .00 $ .01 $ (.30)
Shares used in computing net
income (loss) per share(3) 1,393 5,574 6,967 6,967 6,967 7,289
<CAPTION>
PREDECESSOR SUCCESSOR
------------------------------------------------ -----------------------------------
AS OF DECEMBER 31, AS OF JULY 3, AS OF DECEMBER 31, AS OF DECEMBER 31,
------------------------------ ------------- ------------------ ------------------
1994(2) 1995 1996 1997 1997 1998
------- ------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents $ 43 $ 23 $ 30 $ 38 $ 22 $ 11,688
Working capital (deficit) 28 (565) 74 132 171 11,335
Total assets 43 760 885 1,023 974 12,885
Long-term debt -- -- -- -- -- 500
Total stockholders' equity $ 28 $ 82 $ 625 $ 638 $ 540 $ 11,769
</TABLE>
(1) In connection with the Management Buyout on July 4, 1997, the Company
has presented its assets at fair value as of such date of the change in
control and has presented separately operations prior to the Management
Buyout (Predecessor) and subsequent to the Management Buyout
(Successor). See Note 1 of Notes to Financial Statements.
(2) Initial period of operations from November 15, 1994 to December 31,
1994.
(3) Net income (loss) per share is determined by dividing the net income
(loss) attributable to common stockholders by the weighted average
number of Common Stock and Common Stock equivalents outstanding during
the period. See Note 2 of Notes to Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
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.
11
<PAGE> 13
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"). The results of
operations for the Company for 1997 have been separately presented to reflect
the results of operations prior to the Management Buyout, as Predecessor
operations, and for the period subsequent to the Management Buyout, as Successor
operations. 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.
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 December 31, 1998 reflects the
results of operations of the Company only from the date of the Management
Buyout.
The only difference in accounting policies utilized in the presentation of the
Successor and Predecessor financial statements is the estimated useful lives
utilized in the depreciation of property and equipment, as described in Note 2
of Notes to Financial Statements.
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. To date, the Company's major
source of revenue has been derived from its software consulting services, and it
has generated minimal revenue from the sale of its SmartBot software products.
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. 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.
12
<PAGE> 14
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.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO PERIOD FROM JULY 4, 1997 TO DECEMBER
31, 1997
Note: The December 31, 1997 period only includes activity from July 4, 1997,
approximately 6 months, as a result of the Management Buyout (see above).
Revenues: Revenues for the year ended December 31, 1998 were $450,768 as
compared to $537,008 for the period from July 4, 1997 to December 31, 1997. The
decrease of $86,240 or 16.1% is primarily attributable to the Company's decision
to shift its revenue focus from consulting to product based sales.
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 year ended December 31, 1998 were $590,192 as compared to $205,069 for the
period from July 4, 1997 to December 31, 1997. The increase of $385,123 is
primarily attributable to the difference in the length of the reporting periods
and the increased activity with the Company's primary domestic client in 1998.
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 year ended December
31, 1998 were $446,317 as compared to $0 for the period from July 4, 1997 to
December 31, 1997. This increase is directly related to the substantial increase
in research and development activity by the Company in 1998. All research and
development expenses for periods prior to 1998 were related to contractual
software consulting services for which the Company was reimbursed and were
included in engineering expenses. The research and development expenses in 1998
are net of costs capitalized for software development.
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 year ended December 31, 1998 were
$1,430,109 as compared to $415,072 for the period from July 4, 1997 to December
31, 1997. The increase of $1,015,037 was primarily attributable to the
difference in the length of the reporting periods and increased costs in 1998
including professional fees ($63,568), public relations ($61,475), travel and
entertainment ($43,326), franchise and excise taxes ($43,064), and employment
recruiting ($26,384). In addition, selling, general and administrative expenses
for the newly established European operations amounted to $131,042 in 1998.
Net Loss: Net loss for the year ended December 31, 1998 was $2,191,206 as
compared to net income of $43,940 for the period from July 4, 1997 to December
31, 1997. This increase of $2,235,146 was directly related to the decrease in
software consulting revenues related to the Company's transition of its primary
business focus to product development, marketing and support.
13
<PAGE> 15
PERIOD FROM JULY 4, 1997 THROUGH DECEMBER 31, 1997 COMPARED TO PERIOD FROM
JANUARY 1, 1997 THROUGH JULY 3, 1997
Revenues: Revenues for the period from July 4, 1997 through December 31, 1997
were $537,008 as compared to $1,043,414 for the period from January 1, 1997
through July 3, 1997. The decrease of $506,406 or 48.5% is directly attributable
to the Company's discontinuing software consulting work for its former parent
after the Management Buyout.
Engineering Expenses: Engineering expenses for the period from July 4, 1997
through December 31, 1997 were $205,069 as compared to $307,198 for the period
from January 1, 1997 through July 3, 1997. The decrease of $102,129 or 33.2%
resulted primarily from the Company's discontinuing software consulting work for
its former parent after the Management Buyout.
Research and Development Expenses: Research and development expenses for the
period from July 4, 1997 through December 31, 1997 and the period from January
1, 1997 through July 3, 1997 were related to contractual software consulting
services for which the Company was reimbursed and were included in engineering
expenses.
Selling, General and Administrative Expenses: Selling, general and
administrative expenses for the period from July 4, 1997 through December 31,
1997 were $415,072 as compared to $633,825 for the period from January 1, 1997
through July 3, 1997. The decrease of $218,753 or 34.5% is attributable to
reduced overhead associated with the Company's reduction in contractual
consulting services after the Management Buyout.
Net Income: Net income for the period ended December 31, 1997 was $43,940 as
compared to $12,669 for the period from January 1, 1997 through July 3, 1997.
The increase of $31,271 or 246.8% is attributable to the settlement income
received from the former parent and a reduction in depreciation expense as a
result of reflecting long-term assets at fair value subsequent to the Management
Buyout, offset by the reduction in consulting services revenue from the former
parent.
PERIOD FROM JANUARY 1, 1997 THROUGH JULY 3, 1997 COMPARED TO YEAR ENDED DECEMBER
31, 1996
Note: The 1997 period includes the activity from January 1, 1997 through July 3,
1997 only, approximately 6 months, as a result of the Management Buyout (see
above).
Revenues: Revenues for the period from January 1, 1997 through July 3, 1997 were
$1,043,414 as compared to $2,789,878 for the year ended December 31, 1996. The
decrease of $1,746,464 or 62.6% is attributable to the shortened period
resulting from the Management Buyout and a reduction in consulting service
contracts with the former parent partially offset by an increase in revenues
from its major domestic customer.
Engineering Expenses: Engineering expenses for the period from January 1, 1997
through July 3, 1997 were $307,198 as compared to $656,086 for the year ended
December 31, 1996. The decrease of $348,888 or 53.2% is directly attributable to
the shortened period resulting from the Management Buyout and a reduction in
consulting service contracts with the former parent.
Research and Development Expenses: Research and development expenses for the
period from January 1, 1997 through July 3, 1997 and the year ended December 31,
1996 were related to contractual software consulting services for which the
Company was reimbursed and were included in engineering expenses.
Selling, General and Administrative Expenses: Selling, general and
administrative expenses for the period from January 1, 1997 through July 3, 1997
were $633,825 as compared to $1,101,109 for the year ended December 31, 1996.
The decrease of $467,284 or 42.4% is primarily attributable to the shortened
period resulting from the Management Buyout.
Net Income: Net income for the period from January 1, 1997 through July 3, 1997
was $12,669 as compared to $543,344 for the year ended December 31, 1996. The
decrease of $530,675 or 97.7% is attributable to the reduction in consulting
service contracts with the former parent.
14
<PAGE> 16
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 Non-Voting 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 IPO. 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 various office equipment under
various noncancelable leases. Minimum annual lease payments, exclusive of
additional operating costs, for the years ended December 31, 1998, 1999, 2000
and 2001 are $223,372, $251,640, $251,267 and $43,811, respectively.
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 agreed to enter into a joint venture with an international
retailer 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 partner in the joint
venture will be responsible for using its purchsasing 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.
In addition, the Company has entered into a contract for the first phase of a
development and consulting project with a Europe-based global trust. The project
goal is to define and design the trust's future Internet-based financial
services and to use these services to broaden the trust's market potential. A
successful completion of this first phase could lead to a larger scale
implementation 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 at least 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. This
loss will be available to carry forward and reduce income taxes, if any, in
future periods.
15
<PAGE> 17
IMPACT OF THE 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 is in the process of 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 are not deemed
material, includes its existing and planned computer software and hardware. The
Company believes that these systems are Year 2000 compliant and has made an
initial determination 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. At this time, however, the
Company is developing a specific plan for assessing third party vendor systems,
assessing the readiness of significant suppliers and customers, and taking
remedial action, if necessary. The Company does not know the amount or material
nature of expenditures that it may incur in connection with this assessment, but
continues to believe that the costs associated with the Year 2000 compliance
will not have a material impact on the Company's future operating results. The
Company expects its detailed review and compliance program to be completed by
May 31, 1999. The Company, however, will continue to monitor the Year 2000
readiness of these systems and will take additional review or remedial action if
it deems it necessary to do so. During the remainder of 1999, but not later than
September 30, 1999, the Company will evaluate its need to complete a final
review, which may include soliciting and obtaining certification of Year 2000
compliance from certain third party software vendors and determining the
readiness of its significant suppliers and customers. Nevertheless, 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.
In addition, the Company's products 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 at this time is determining specific plans for
certifying the Year 2000 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 in the second quarter of 1999, the Company plans
to develop appropriate contingency plans to address situations in which various
systems of the Company, or of third-parties with which the Company does
business, are not Year 2000 compliant. Some risks of the Year 2000 issue,
however, are beyond the control of the Company and its suppliers and customers.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company maintains its cash and cash equivalents in checking, savings, and
money market accounts. These deposits are denominated primarily in U.S. dollars.
Deposits in both fixed rate and floating rate interest accounts carry a degree
of interest rate risks. Fixed rate deposits may be adversely impacted due to a
rise in interest rates, while floating rate deposits may produce less income
than expected if interest rates fall. Due in part to these factors, the
Company's future interest income may fall short of expectations due to changes
in interest rates. The Company believes that a hypothetical 10% increase or
decrease in interest rates, however, would not have a material adverse effect on
the Company's financial condition.
16
<PAGE> 18
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Consolidated Financial Statements and supplementary data appear at pages F-1
through F-17 of this report on Form 10-K.
<TABLE>
<CAPTION>
Index to Consolidated Financial Statements:
<S> <C>
Independent Auditors' Report-------------------------------------------------------- F-1
Consolidated Financial Statements:
Consolidated Balance Sheets as of July 3, 1997 (Predecessor),
December 31, 1997 and December 31, 1998 (Successor).------------------------ F-2
Consolidated Statements of Operations for the year ended
December 31, 1996, for the periods January 1, 1997 to
July 3, 1997 (Predecessor) and July 4, 1997 to December 31,
1997, and for the year ended December 31, 1998
(Successor).---------------------------------------------------------------- F-3
Consolidated Statements of Changes in Stockholders' Equity for
the year ended December 31, 1996, for the periods January 1,
1997 to July 3, 1997 (Predecessor) and July 4, 1997 to
December 31, 1997 and for the year ended December 31,
1998 (Successor).----------------------------------------------------------- F-4
Consolidated Statements of Cash Flows for the year ended
December 31, 1996, for the periods January 1, 1997 to
July 3, 1997 (Predecessor) and July 4, 1997 to December 31,
1997, and for the year ended December 31, 1998 (Successor).----------------- F-5
Notes to Consolidated Financial Statements.----------------------------------------- F-6-F-17
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS. The following table sets forth certain information regarding the
directors of the Company as of December 31, 1998:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Eberhard Schoneburg............................. 42 President, Chief Executive Officer and
Chairman of the Board
Bruno Gabriel................................... 52 Director
Elmar Wohlgensinger............................. 59 Director
Hartmut Bergmann................................ 48 Director
</TABLE>
Eberhard Schoneburg has been President and a member of the Board of Directors of
the Company since November 1994. He was Chief Executive Officer from November
1994 to May 1996 and from October 1997 to the present. Mr. Schoneburg has been
the Chairman of the Board of Directors of the Company since the founding of the
Company. The Company was founded in November 1994 as Neurotec International
Corp., a wholly owned subsidiary of Neurotec GmbH, a German multimedia and
Internet solutions company owned by Mr. Schoneburg and two corporate investors:
a major
17
<PAGE> 19
German retailer and an industrial conglomerate. Neurotec GmbH was part of the
Neurotec Group, a group of high tech companies founded in Germany by Mr.
Schoneburg in 1993. In 1997 he sold all of his shares in Neurotec GmbH to the
remaining stockholders and contemporaneously purchased 100% of the shares of the
Company from Neurotec GmbH. From 1989 to 1994 Mr. Schoneburg was a professor for
industrial applications of artificial intelligence at Fachhochschule Furtwangen,
Germany. From 1988 to 1993, he was the Chairman of the BIT Group, a group of
five German high tech companies which he founded in 1988.
Mr. Schoneburg was awarded the First Prize of the Berlin Innovation Award
in 1990 for the development of the First European Neural Compiler and again in
1992 for the development of an expert system for detecting chemical hazards for
Procter and Gamble. He has published five course books on a wide variety of
topics such as computer viruses, neural networks, evolution strategies and
genetic programming and over 60 research papers on related topics. He is also a
member of the jury of the Golden Award of Montreux.
Bruno Gabriel joined the Company's Board of Directors in September 1998. Since
1989, Mr. Gabriel has been a management consultant to several European
companies. From 1984 to 1989, he was the Chief Executive Officer and President
of the ALSO Group, a European distributor of personal computers and computer
equipment which he founded in 1984. From 1978 to 1984, Mr. Gabriel was the Chief
Executive Officer of ADV/ORGA Switzerland, a software and consulting company.
From 1976 until 1978, he was manager for new media at Tagesanzeiger Zurich, a
Swiss newspaper company. Mr. Gabriel began his career in 1971 as a manager for
software development at Telekurs AG, a Swiss telecommunications company.
Elmar Wohlgensinger joined the Company's Board of Directors in September 1998.
He has worked for the IHA Institute, a Swiss market research company, since 1961
where he has been a member of the board since 1970 and President since 1980. Mr.
Wohlgensinger is a Vice President of ATAG Holding, an accounting firm, and has
been a member of ATAG Ernst & Young management, an accounting firm, since 1991.
Mr. Wohlgensinger also serves on the boards of German GFK, EKN Bank Nidwalden,
Schweizerische Gesellschaft Fuer Marketing and the Chamber of Commerce of
Central Switzerland.
Hartmut Bergmann joined the Board of Directors in December 1998, upon completion
of the Company's IPO, pursuant to an agreement between the Company and the
underwriters New York Broker, Inc. and New York Broker Deutschland AG. Mr.
Bergmann has been Chairman of the Management Board of New York Broker
Deutschland AG since 1990. From 1976 until he joined New York Broker Deutschland
AG, he was with Hornblower Fischer AG, a regional German brokerage firm where he
was a Member of the Management Board from 1976 through 1989. Previously he was a
financial consultant with Merrill Lynch in Germany.
EXECUTIVE OFFICERS. The following table sets forth certain information regarding
the executive officers of the Company as of December 31, 1998:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Eberhard Schoneburg............................. 42 President, Chief Executive Officer and
Chairman of the Board
Robert Pantano.................................. 38 Chief Financial Officer
Klaus Kater..................................... 31 Chief Technology Officer
</TABLE>
Robert Pantano, the Company's Chief Financial Officer, joined the Company in
April 1995 as an accountant, was appointed Controller and Director of Human
Resources in 1996 and was promoted to his present position in September 1997.
From 1993 until joining the Company, Mr. Pantano worked as the Controller and
General Manager of Intertech International Corp., an international engineering
firm. From 1990 to 1993, he was a Principal with Global Vision International, an
international export trade consulting firm specializing in central and eastern
Europe. Mr. Pantano holds a B.A. in accounting from Bentley College.
Klaus Kater joined the Company as Chief Technology Officer in May 1998. From
December 1997 through April 1998, Mr. Kater provided consulting services to the
Company. Prior to that time, from June 1997 to December 1997, he was Managing
Director for the mediaCenter Research Institute GmbH, a German multimedia
research center and a subsidiary of Neurotec GmbH. From March 1996 to July 1997,
Mr. Kater worked as a freelance consultant, coordinating the activities of the
Wirtschaftsforderungsgesellschaft Business Development Institute in the context
of multimedia initiatives, and concurrently from 1993 to 1996, he worked for
Neurotec GmbH, where he served as project manager for chemical expert
18
<PAGE> 20
systems. From 1992 to 1993, Mr. Kater was a project manager at Expert Informatik
GmbH, where he managed a team that developed an expert system for Procter &
Gamble. From 1990 to 1992, he ran his own company Kater & Stirm
Softwareentwicklung GbR which produced and sold software for the hotel
management market. Mr. Kater holds a degree in computer science and artificial
intelligence from Fachhochschule of Furtwangen in Germany.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE. The Company's executive
officers and directors are required under Section 16(a) of the Exchange Act to
file reports of ownership of Company securities and changes in ownership with
the Securities and Exchange Commission. Copies of those reports must also be
furnished to the Company. Based solely on a review of the copies of reports
furnished to the Company and written representations that no other reports were
required, the Company believes that during 1998 the executive officers and
directors of the Company complied with all applicable Section 16(a) filing
requirements.
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION. The following tables set forth certain information with
respect to compensation paid or accrued for services rendered to the Company in
all capacities for the fiscal year ended December 31, 1998 by its Chief
Executive Officers and the one other most highly compensated executive officer
of the Company whose salary and bonus exceeded $100,000 (the "Named Executive
Officers"). No other executive officer of the Company earned greater than
$100,000 in the fiscal year ended December 31, 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG TERM COMPENSATION
------------------------------------ ----------------------
OTHER ANNUAL SECURITIES
NAME AND PRINCIPAL POSITION(1) YEAR SALARY($) COMPENSATION UNDERLYING OPTIONS
- ----------------------------- ------ ----------- -------------- ----------------------
<S> <C> <C> <C> <C>
Eberhard Schoneburg 1998 $ 240,414 $ 0 0
President and Chief 1997 54,254 22,500(3) 0
Executive Officer(2)...... 1996 200,439 0 0
Robert Pantano 1998 $ 100,080 $ 0 41,442
Chief Financial Officer... 1997 70,079 0 0
1996 56,253 0 0
</TABLE>
(1) Klaus Kater became the Company's Chief Technology Officer in September
1997, but did not have a total compensation which exceeded $100,000 in the
fiscal years ended December 31, 1997 and 1998. However, pursuant to an
Employment Agreement dated as of May 1, 1998, Mr. Kater currently has an
annual base salary of $100,000.
(2) Mr. Schoneburg assumed the position of Chief Executive Officer in October
1997.
(3) Consists of rent paid by the Company for an apartment occupied by Mr.
Schoneburg.
OPTION GRANTS. The following table sets forth certain information regarding
options granted during the fiscal year ended December 31, 1998 by the Company to
the Named Executive Officers.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANT
--------------------------------------------------------- POTENTIAL REALIZABLE VALUE
NUMBER OF PERCENT OF AT ASSUMED ANNUAL RATES OF
SECURITIES TOTAL OPTIONS EXERCISE STOCK PRICE APPRECIATION FOR
UNDERLYING GRANTED TO OR BASE OPTION TERM
OPTIONS EMPLOYEES IN PRICE EXPIRATION --------------------------
NAME AND PRINCIPAL POSITION GRANTED (#) FISCAL YEAR (%) ($/SHARE) DATE 5% ($) 10% ($)
- --------------------------- ----------- --------------- --------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Eberhard Schoneburg.......... -- -- -- -- -- --
Robert Pantano............... 16,442 2.1% $ 3.66 5/1/00 $ 6,168.00 $ 12,637.00
25,000 3.2% 6.50 10/1/00 16,656.00 34,125.00
</TABLE>
19
<PAGE> 21
OPTION EXERCISES. The Named Executive Officers did not exercise any options
during the fiscal year ended December 31, 1998.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS
SHARES FISCAL YEAR-END (#) AT FISCAL YEAR-END ($)
ACQUIRED ON VALUE --------------------------- -----------------------------
NAME AND PRINCIPAL POSITION EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- --------------------------- ------------ ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Eberhard Schoneburg.......... 0 0 0 0 0 0
Robert Pantano............... 0 0 41,442 0 347,150 0
</TABLE>
DIRECTOR COMPENSATION. Directors who are not employees of the Company receive
$3,000 for each meeting of the board of directors attended and reimbursed for
reasonable out-of-pocket expenses incurred in attending such meetings.
Non-employee directors are also eligible for participation in the Company's 1998
Equity Incentive Plan, and the Company may, in the future grant non-qualified
stock options to non-employee directors as an incentive to join or remain on the
Board of Directors.
EMPLOYMENT AGREEMENTS. Under an Executive Employment Agreement dated July 1,
1998, and amended and restated as of September 1, 1998, the Company has agreed
to employ Eberhard Schoneburg as President, Chief Executive Officer and Chairman
of the Board of Directors for a period of three years at an initial annual base
salary of $240,000 plus an incentive bonus equal to 3% of the Company's income
from operations. The Agreement also provides that the annual base salary will
increase as determined by the Board but at not less than 10% per year. If Mr.
Schoneburg is terminated without cause (including a failure to renew the
agreement) or if he terminates his employment for "good reason" (as defined in
the agreement), he will be entitled to receive a lump sum payment of one to
three times (depending upon whether such termination occurs before or after a
change of control of the Company) the sum of (i) his base salary plus (ii) the
greater of the average of his two most recent annual bonuses or his annual bonus
payable in the year of termination. The agreement also contains a non-compete
and non-solicitation provision which covers the longer of the term of his
employment or any time period during which he serves as a director of the
Company, plus a period of one year thereafter.
Pursuant to an Employment Agreement dated May 1, 1998, the Company has agreed to
employ Robert Pantano as Chief Financial Officer and Klaus Kater as Chief
Technology Officer (each an "Officer" and collectively, the "Officers") for at
least eighteen months at initial annual base salaries of $100,000. The
agreements also provides that the Officers are entitled to participate in any
bonus and incentive programs that may be in effect for employees of the Company
and that the Officers' base salaries will be reviewed at least annually by the
Company's Chief Executive Officer and may be adjusted upward at such time at the
sole discretion of the Chief Executive Officer. On May 1, 1999, the Officers
will each be entitled to receive stock options with a fair market value of
$25,000. If either Officer is terminated by the Company without "cause" (as
defined in the agreement) or if he terminates his employment for "good reason"
(as defined in the agreement) he is entitled to severance pay, at the rate in
effect on the termination date, for a period of six months. The agreements also
contain non-compete and non-solicitation provisions which cover the term of the
Officers' employment plus any additional time during which the Officer is
receiving any severance benefits from the Company, as well as confidentiality
and assignment of invention and intellectual property provisions.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. Messrs.
Wohlgeninger and Bergmann, both non-employee directors, constitute the Company's
Compensation Committee.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of March 19, 1999 by (i) each person
known by the Company to own beneficially 5% or more of the Common Stock; (ii)
each Named Executive Officer; (iii) each director of the Company and (iv) all
current directors and executive officers of the Company as a group:
20
<PAGE> 22
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK
BENEFICIALLY OWNED (1)
--------------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER (2) SHARES PERCENT (3)
- ---------------------------------------- ------------ -------------
<S> <C> <C>
Eberhard Schoneburg.................................................................. 5,567,377 59.8%
Robert Pantano (4)................................................................... 41,442 *
Klaus Kater (4)...................................................................... 41,442 *
Bruno Gabriel (5).................................................................... 774,426 8.3%
Elmar Wohlgensinger (6).............................................................. 243,934 2.6%
Hartmut Bergmann .................................................................... 0 *
All current directors and executive officers as a group (6 persons) (7).............. 6,668,621 71.6%
</TABLE>
* Less than 1%
(1) Shares of Common Stock that an individual or group has the right to
acquire within 60 days of March 19, 1999, pursuant to the exercise of
options or warrants are deemed to be outstanding for the purposes of
computing the percentage ownership of such individual or group, but are
not deemed to be outstanding for the purpose of computing the percentage
ownership of any other person shown in the table. Except as indicated in
footnotes to this table, the Company believes that the beneficial owners
named in this table have sole voting and investment power with respect to
all shares of Common Stock shown to be beneficially owned by them based on
information provided to the Company by such beneficial owners.
(2) The address of all persons who are executive officers or directors of the
Company is: c/o Artificial Life, Inc., Four Copley Place, Suite 102,
Boston, Massachusetts, 02116.
(3) Percentage of ownership is based on 9,310,574 shares of Common Stock
outstanding as of March 19, 1999.
(4) Consists solely of shares subject to stock options which are currently
exercisable.
(5) Includes 184,426 shares subject to stock options which are currently
exercisable.
(6) Includes 163,934 shares subject to stock options which are currently
exercisable.
(7) Includes 431,244 shares subject to stock options which are currently
exercisable.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Company was founded 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 remaining two
stockholders for approximately $1,027,000 and contemporaneously purchased 100%
of the shares of the Company (Neurotec International Corp.) from Neurotec GmbH
for approximately $500,000. See "Note 1 of Notes to Financial Statements."
On June 29, 1998, Mr. Schoneburg loaned the company $500,000 at an
annual interest rate of 10%. The full amount of the loan, including principal
and all accumulated interest thereon, is due and payable on January 1, 2000.
Prior to the date of the Management Buyout, Mr. Schoneburg received
fixed compensation payments of $5,000 each month with additional compensation,
if any, determined by the former parent based on the level of activities
dedicated by Mr. Schoneburg to the Company versus other subsidiaries of the
former parent.
Beginning January 1, 1998, Mr. Schoneburg's salary was deferred. During
the time that his salary was deferred, the Company made net advances to Mr.
Schoneburg of approximately $273,000 for living and personal expenses. On
September 25, 1998 the Company paid Mr. Schoneburg a total of $175,385
representing 38 weeks of deferred salary. Mr. Schoneburg used the after tax
proceeds of this payment to repay a portion of the advances made to him during
the deferral period.
Prior to the time that they became directors of the Company in
September 1998, Bruno Gabriel and Elmar Wohlgensinger provided consulting
services to the Company. During that time, Messrs. Gabriel and Wohlgensinger
advised the Company on strategic and logistical issues regarding the
establishment of business opportunities outside the United States. In
consideration for such services, in 1998, Mr. Gabriel was paid or had accrued an
aggregate of $173,537 by the Company and on June 30, 1998, Messrs. Gabriel and
Wohlgensinger were granted options to purchase 184,426 and 163,934 shares of
Common Stock, respectively. These options are exercisable immediately for a
period of one year at an exercise price of $3.66 per share.
In September 1998, the Company raised gross proceeds of $4,120,000 by
completing a private placement of 824,000 shares of Common Stock with 23
investors at a price of $5.00 per share. Mr. Wohlgensinger purchased 80,000
shares of the Common Stock in this private placement offering for an aggregate
purchase price of $400,000.
21
<PAGE> 23
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
a. Documents filed as part of this Report:
1. Financial Statements
See "Index to Financial Statements" at Item 8 to this Annual
Report on Form 10-K.
2. Financial Statement Schedules
b. Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1998.
c. Exhibits
The following is a list of exhibits filed as part of this Annual Report
on Form 10-K.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
*3.1 Amended and Restated Certificate of Incorporation of the
Company. Filed as Exhibit 3.1 to the Company's Registration
Statement on Form S-1 (File No. 333-64619) and incorporated
herein by reference.
*3.2 Restated Bylaws of the Company. Filed as Exhibit 3.2 to the
Company's Registration Statement on Form S-1 (File No.
333-64619) and incorporated herein by reference.
*4.1 Specimen Common Stock Certificate for share of Common Stock of
the Company. Filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-1 (File No. 333-64619) and
incorporated herein by reference.
*4.2 Form of Representatives' Warrant issued by the Company to
underwriters New York Broker, Inc. and New York Broker
Deutschland AG. upon consummation of the Company's IPO. Filed
as Exhibit 4.2 to the Company's Registration Statement on Form
S-1 (File No. 333-64619) and incorporated herein by reference.
*10.1 Form of the Company's Employee Confidentiality and Inventions
Agreement. Filed as Exhibit 10.1 to the Company's Registration
Statement on Form S-1 (File No. 333-64619) and incorporated
herein by reference.
*10.2 Form of Company's Advisory Board Confidentiality and
Inventions Agreement. Filed as Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (File No. 333-64619) and
incorporated herein by reference.
*10.3 Amended and Restated Executive Employment Agreement between
the Company and Eberhard Schoneburg, dated as of September 1,
1998. Filed as Exhibit 10.3.1 to the Company's Registration
Statement on Form S-1 (File No. 333-64619) and incorporated
herein by reference.
*10.4 Employment Agreement between the Company and Robert Pantano,
dated as of May 1, 1998. Filed as Exhibit 10.4 to the
Company's Registration Statement on Form S-1 (File No.
333-64619) and incorporated herein by reference.
</TABLE>
22
<PAGE> 24
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
*10.5 Employment Agreement between the Company and Klaus Kater,
dated as of May 1, 1998. Filed as Exhibit 10.5 to the
Company's Registration Statement on Form S-1 (File No.
333-64619) and incorporated herein by reference.
*10.6 Lease Agreement, dated February 6, 1995, between the Company
and Copley Place Associates Nominee Corporation. Filed as
Exhibit 10.6 to the Company's Registration Statement on Form
S-1 (File No. 333-64619) and incorporated herein by reference.
*10.7 Lease Amendment No. 1, dated July 27, 1995, between the
Company and Copley Place Associates Nominee Corporation. Filed
as Exhibit 10.7 to the Company's Registration Statement on
Form S-1 (File No. 333-64619) and incorporated herein by
reference.
*10.8 Lease Amendment No. 2, dated February 27, 1997, between the
Company and Copley Place Associates Nominee Corporation. Filed
as Exhibit 10.8 to the Company's Registration Statement on
Form S-1 (File No. 333-64619) and incorporated herein by
reference.
*10.9 Consortium Agreement, dated October 10, 1995, between the
Company and Massachusetts Institute of Technology. Filed as
Exhibit 10.9 to the Company's Registration Statement on Form
S-1 (File No. 333-64619) and incorporated herein by reference.
*10.10 1998 Equity Incentive Plan. Filed as Exhibit 10.10 to the
Company's Registration Statement on Form S-1 (File No.
333-64619) and incorporated herein by reference.
*10.11 Form of Subscription Agreement, dated June 1998, between the
Company, Eberhard Schoneburg and the purchaser of 1,000,000
shares of Common Stock and the purchasers of an aggregate of
130,000 shares of Non-Voting Common Stock. Filed as Exhibit
10.11 to the Company's Registration Statement on Form S-1
(File No. 333-64619) and incorporated herein by reference.
*10.12 Form of Subscription Agreement dated September 23, 1998
between the Company and the purchasers of 824,000 shares of
Common Stock. Filed as Exhibit 10.12 to the Company's
Registration Statement on Form S-1 (File No. 333-64619) and
incorporated herein by reference.
*10.13 Form of Amendment and Confidential Offering Supplement, dated
September 23, 1998. Filed as Exhibit 10.13 to the Company's
Registration Statement on Form S-1 (File No. 333-64619) and
incorporated herein by reference.
27.1 Financial Data Schedule
99.1 Important Factors Regarding Forward-Looking Statements
</TABLE>
*Previously filed.
23
<PAGE> 25
SIGNATURES
Pursuant to the requirements of Section 31 or 15(d) of the Securities
Exchange Act of 1934, the Registrant certifies that it has duly caused this
Annual Report on Form 10-K to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Boston, Commonwealth of Massachusetts,
on March 29, 1999.
ARTIFICIAL LIFE, INC.
By: /s/ Eberhard Schoneburg
---------------------------------------
Eberhard Schoneburg
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Annual Report on Form 10-K has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Eberhard Schoneburg President, Chief Executive Officer and
- --------------------------- Director (Principal executive officer) March 29, 1999
Eberhard Schoneburg
/s/ Robert Pantano Chief Financial Officer (Principal
- --------------------------- financial and accounting officer) March 29, 1999
Robert Pantano
/s/ Bruno Gabriel
- ---------------------------
Bruno Gabriel Director March 29, 1999
/s/ Elmar Wohlgensinger
- ---------------------------
Elmar Wohlgensinger Director March 29, 1999
- ---------------------------
Hartmut Bergmann Director
</TABLE>
24
<PAGE> 26
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Artificial Life, Inc.
Boston, Massachusetts
We have audited the accompanying consolidated balance sheets of Artificial Life,
Inc. (formerly Neurotec International Corp.) as of July 3, 1997 (Predecessor)
and December 31, 1997 and 1998 (Successor), and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for the
year ended December 31, 1996, the periods ended July 3, 1997 (Predecessor) and
December 31, 1997 and the year ended December 31, 1998 (Successor). These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our 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 consolidated 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 consolidated
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 consolidated financial position of Artificial Life,
Inc. as of July 3, 1997 and December 31, 1997 and 1998, and the consolidated
results of its operations and its cash flows for the year ended December 31,
1996, for the periods ended July 3, 1997 and December 31, 1997, and the year
ended December 31, 1998, in conformity with generally accepted accounting
principles.
Wolf & Company, P.C.
Boston, Massachusetts
March 14, 1999
F-1
<PAGE> 27
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
| SUCCESSOR
PREDECESSOR | ---------------------------------
-------------- | DECEMBER 31,
JULY 3, | ---------------------------------
1997 | 1997 1998
-------------- | ------------- ----------------
<S> <C> | <C> <C>
Current assets: |
Cash and cash equivalents $ 37,936 | $ 22,382 $ 11,687,829
Accounts receivable, trade 206,673 | 273,187 -
Due from officer/stockholder 3,802 | - 122,728
Due from former parent and affiliates 191,377 | 243,499 -
Notes receivable affiliate - | - 40,000
Refundable income taxes 13,333 | 6,336 -
Prepaid expenses and other current assets 63,403 | 59,442 99,958
-------------- | ------------- ----------------
Total current assets 516,524 | 604,846 11,950,515
-------------- | ------------- ----------------
|
Property and equipment: |
Furniture and fixtures 176,128 | 80,276 145,281
Computer equipment 272,458 | 178,975 545,680
Leasehold improvements 159,334 | 33,406 45,544
Office equipment 58,785 | 27,443 57,620
-------------- | ------------- ----------------
666,705 | 320,100 794,125
Less accumulated depreciation and amortization 257,316 | 45,066 160,274
-------------- | ------------- ----------------
409,389 | 275,034 633,851
-------------- | ------------- ----------------
Other assets: |
Net deferred tax asset 51,591 | - -
Capitalized software development costs - | - 215,169
Deposits and other assets 45,529 | 94,392 85,185
-------------- | ------------- ----------------
97,120 | 94,392 300,354
-------------- | ------------- ----------------
|
$ 1,023,033 | $ 974,272 $ 12,884,720
============== | ============= ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities: |
Note payable to former parent $ 68,844 | $ - $ -
Accounts payable 209,459 | 195,159 444,367
Due to officer/stockholder - | 27,015 -
Deferred revenue - | 116,667 -
Accrued expenses 97,367 | 95,252 171,267
Net deferred tax liability 9,279 | - -
-------------- | ------------- ----------------
Total current liabilities 384,949 | 434,093 615,634
-------------- | ------------- ----------------
Note payable - officer/stockholder - | - 500,000
-------------- | ------------- ----------------
Commitments and contingencies |
|
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, 6,967,213 shares issued and outstanding |
in 1997 and 9,270,574 issued and outstanding in 1998 69,672 | 69,672 92,706
Additional paid-in capital 430,328 | 426,567 13,929,618
Notes receivable from stockholders - | - (79,423)
Retained earnings (deficit) 138,084 | 43,940 (2,147,266)
Accumulated other comprehensive loss - | - (26,549)
-------------- | ------------- ----------------
Total stockholders' equity 638,084 | 540,179 11,769,086
-------------- | ------------- ----------------
|
$ 1,023,033 | $ 974,272 $ 12,884,720
============== | ============= ================
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE> 28
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PREDECESSOR | SUCCESSOR
---------------------------------- | ----------------------------------
PERIOD FROM | PERIOD FROM
YEAR ENDED JANUARY 1 TO | JULY 4 TO YEAR ENDED
DECEMBER 31, JULY 3, | DECEMBER 31, DECEMBER 31,
1996 1997 | 1997 1998
--------------- -------------- | -------------- ---------------
<S> <C> <C> | <C> <C>
Revenues: |
Former Parent and Affiliates: |
Application services $ 2,757,253 $ 666,229 | $ 197,948 $ -
--------------- -------------- | -------------- ---------------
Trade: |
Software license agreements - 116,667 | 116,667 116,667
Application services 32,625 260,518 | 222,393 332,713
Software products - - | - 1,388
--------------- -------------- | -------------- ---------------
32,625 377,185 | 339,060 450,768
--------------- -------------- | -------------- ---------------
Total revenues 2,789,878 1,043,414 | 537,008 450,768
--------------- -------------- | -------------- ---------------
|
Operating expenses: |
Selling, general and administrative 1,101,109 633,825 | 415,072 1,430,109
Engineering - former parent 49,349 39,168 | - -
Engineering - other 606,737 268,030 | 205,069 590,192
Research and development - - | - 446,317
Depreciation and amortization 137,300 84,368 | 45,066 110,097
--------------- -------------- | -------------- ---------------
Total operating expenses 1,894,495 1,025,391 | 665,207 2,576,715
--------------- -------------- | -------------- ---------------
Income (loss) from operations 895,383 18,023 | (128,199) (2,125,947)
Other income (expenses): |
Cancellation fee income - - | 189,938 -
Foreign exchange gain (loss) 10,319 3,579 | (9,285) (985)
Writedown of equity investment - - | - (49,637)
Interest income - - | - 18,620
Interest expense (24,996) (3,399) | (1,848) (33,257)
--------------- -------------- | -------------- ---------------
Income (loss) before provision |
for income taxes 880,706 18,203 | 50,606 (2,191,206)
|
Provision for income taxes 337,362 5,534 | 6,666 -
--------------- -------------- | -------------- ---------------
Net income (loss) $ 543,344 $ 12,669 | $ 43,940 $ (2,191,206)
=============== ============== | ============== ===============
Basic and diluted net income (loss) per share $ 0.08 $ - | $ 0.01 $ (0.30)
|
Weighted average shares outstanding |
used in per share calculation 6,967,213 6,967,213 | 6,967,213 7,289,385
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 29
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMPREHENSIVE PREFERRED STOCK COMMON STOCK ADDITIONAL
INCOME ------------------------- -------------------------- PAID-IN
(LOSS) SHARES AMOUNT SHARES AMOUNT CAPITAL
------------- -------- ----------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Predecessor
Balance at December 31, 1995 - $ - 6,967,213 $ 69,672 $ 430,328
Net income $ 543,344 - - - - -
============= -------- ----------- ----------- ----------- -------------
Balance at December 31, 1996 - - 6,967,213 69,672 430,328
Net income $ 12,669 - - - - -
============= -------- ----------- ----------- ----------- -------------
Balance at July 3, 1997 - - 6,967,213 69,672 430,328
Successor
Fair value adjustments related to the
Management Buyout and change
in control - - - - (3,761)
Net income $ 43,940 - - - - -
============= -------- ----------- ----------- ----------- -------------
Balance at December 31, 1997 - - 6,967,213 69,672 426,567
Issuance of common stock - - 2,303,361 23,034 13,503,051
Comprehensive income:
Net loss $ (2,191,206) - - - - -
Foreign currency translation
adjustment (26,549) - - - - -
-------------
Total comprehensive loss $ (2,217,755)
============= -------- ----------- ----------- ----------- -------------
Balance at December 31, 1998 - $ - 9,270,574 $ 92,706 $ 13,929,618
======== =========== =========== =========== =============
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED
RETAINED OTHER TOTAL
NOTES EARNINGS COMPREHENSIVE STOCKHOLDERS'
RECEIVABLE (DEFICIT) LOSS EQUITY
--------- ------------ ------------- -------------
<S> <C> <C> <C> <C>
Predecessor
Balance at December 31, 1995 $ - $ (417,929) $ - $ 82,071
Net income - 543,344 - 543,344
--------- ------------ ------------- -------------
Balance at December 31, 1996 - 125,415 - 625,415
Net income - 12,669 - 12,669
--------- ------------ ------------- -------------
Balance at July 3, 1997 - 138,084 - 638,084
Successor
Fair value adjustments related to the
Management Buyout and change
in control - (138,084) - (141,845)
Net income - 43,940 - 43,940
--------- ------------ ------------- -------------
Balance at December 31, 1997 - 43,940 - 540,179
Issuance of common stock (79,423) - - 13,446,662
Comprehensive income:
Net loss - (2,191,206) - (2,191,206)
Foreign currency translation
adjustment - - (26,549) (26,549)
Total comprehensive loss
--------- ------------ ------------- -------------
Balance at December 31, 1998 $ (79,423) $ (2,147,266) $ (26,549) $ 11,769,086
========= ============ ============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 30
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PREDECESSOR
------------------------------------
PERIOD FROM
YEAR ENDED JANUARY 1
DECEMBER 31, TO JULY 3,
1996 1997
---------------- ----------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 543,344 $ 12,669
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation and amortization 137,300 84,368
Unrealized foreign exchange gain (5,790) (9,078)
Deferred income taxes 214,560 -
Writedown of equity investment - -
(Increase) decrease in deposits and other assets (5,345) (1,800)
(Increase) decrease in due from former parent and affiliates (223,234) 60,125
(Increase) decrease in accounts receivable, trade - (206,673)
Decrease in refundable income taxes 11,390 5,535
(Increase) decrease in prepaid expenses and other current assets (763) (30,262)
Increase (decrease) in accounts payable and accrued expenses (421,910) 134,111
Increase (decrease) in deferred revenue - -
Increase (decrease) in due to/from officer/stockholder - (3,802)
---------------- ----------------
Net cash provided (used) by operating activities 249,552 45,193
---------------- ----------------
Cash flows from investing activities:
Purchases of property and equipment (242,476) (37,396)
Purchase of equity investment - -
Expenditures for capitalized software development costs - -
Increase in notes receivable affiliate - -
---------------- ----------------
Net cash used by investing activities (242,476) (37,396)
---------------- ----------------
Cash flows from financing activities:
Repayment of note payable to former parent - -
Proceeds from note payable - officer/stockholder - -
Proceeds from issuance of common stock - -
---------------- ----------------
Net cash provided (used) by financing activity - -
---------------- ----------------
Effect of exchange rate changes on cash - -
---------------- ----------------
Net increase (decrease) in cash and cash equivalents 7,076 7,797
Cash and cash equivalents at beginning of period 23,063 30,139
---------------- ----------------
Cash and cash equivalents at end of period $ 30,139 $ 37,936
================ ================
Supplemental disclosure of cash flow information:
Income taxes paid $ 131,440 $ -
Interest paid 24,996 3,399
<CAPTION>
SUCCESSOR
-------------------------------------
PERIOD FROM
JULY 4 TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1997 1998
---------------- ----------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 43,940 $ (2,191,206)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation and amortization 45,066 110,097
Unrealized foreign exchange gain - -
Deferred income taxes - -
Writedown of equity investment - 49,637
(Increase) decrease in deposits and other assets (53,571) 58,158
(Increase) decrease in due from former parent and affiliates (52,122) 243,499
(Increase) decrease in accounts receivable, trade (66,514) 273,187
Decrease in refundable income taxes 6,997 6,336
(Increase) decrease in prepaid expenses and other current assets 3,961 (40,516)
Increase (decrease) in accounts payable and accrued expenses (16,415) 325,538
Increase (decrease) in deferred revenue 116,667 (116,667)
Increase (decrease) in due to/from officer/stockholder 30,817 (149,740)
---------------- ----------------
Net cash provided (used) by operating activities 58,826 (1,431,677)
---------------- ----------------
Cash flows from investing activities:
Purchases of property and equipment (5,536) (474,025)
Purchase of equity investment - (99,274)
Expenditures for capitalized software development costs - (210,058)
Increase in notes receivable affiliate - (40,000)
---------------- ----------------
Net cash used by investing activities (5,536) (823,357)
---------------- ----------------
Cash flows from financing activities:
Repayment of note payable to former parent (68,844) -
Proceeds from note payable - officer/stockholder - 500,000
Proceeds from issuance of common stock - 13,446,662
---------------- ----------------
Net cash provided (used) by financing activity (68,844) 13,946,662
---------------- ----------------
Effect of exchange rate changes on cash - (26,181)
---------------- ----------------
Net increase (decrease) in cash and cash equivalents (15,554) 11,665,447
Cash and cash equivalents at beginning of period 37,936 22,382
---------------- ----------------
Cash and cash equivalents at end of period $ 22,382 $ 11,687,829
================ ================
Supplemental disclosure of cash flow information:
Income taxes paid $ - $ 2,000
Interest paid 1,848 8,257
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 31
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1996, THE PERIODS JANUARY 1, 1997 TO JULY 3, 1997
AND JULY 4, 1997 TO DECEMBER 31, 1997 AND THE YEAR ENDED DECEMBER 31, 1998
1. ORGANIZATION, RISKS AND UNCERTAINTIES
NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Artificial Life, Inc. ("Artificial Life" or the "Company") develops,
markets and supports "intelligent" software robots ("bots"). The Company's bots,
known as "SmartBots," are software programs that the Company designs to automate
and simplify time-consuming and complex business-related Internet functions such
as Web navigation, direct marketing, user profiling, information gathering,
messaging, knowledge management, sales response and call center automation. The
Company recently changed its primary business focus from software consulting to
the development, marketing and support of it's ALife suite of SmartBot software
products. As a consequence of the Company's recent change in its primary
business focus, the Company expects that an increasing percentage of its future
revenues will be derived from sales and services associated with its software
robot products and that revenues from its consulting business will, as a percent
of gross revenues, significantly decrease over time.
In addition, because the Company's emerging online agent-based software
products business will require significant infusions of additional capital,
results of operations to date are not reflective of the Company's future results
of operations. The Company's decision to become a provider of software robot
products is predicated on the assumption that the demand for such products will
be large enough to permit the Company to operate profitably. There can be no
assurance that the Company's assumption will be correct or that the Company will
be able to successfully compete as a provider of such products. If the Company's
assumption is not accurate, or if the Company is unable to compete as a provider
of online agent-based software products, the Company's business, prospects,
financial condition and results of operations will be materially adversely
affected.
The Company's management has recently obtained funds to support its
operations through a combination of sources including a long-term loan from a
stockholder, private placements of Common Stock and an initial public offering.
In 1996, the Company was a wholly-owned subsidiary of Neurotec
Hochtechnologie GmbH, a German corporation. Neurotec Hochtechnologie GmbH has
two other wholly-owned subsidiaries other than the Company and conducts
operations in Germany. In 1996, approximately 99% of the Company's revenues was
derived from the Company's then parent company.
On July 4, 1997, Eberhard Schoneburg, the Company's President, Chief
Executive Officer and Chairman and a minority stockholder of the Company's
former parent company, entered into an agreement with the former parent company,
to sell his 10% interest in the former parent company for DM 1,800,000,
approximately $1,027,000, in cash to the two remaining equal stockholders and
contemporaneously purchase all of the outstanding shares of Neurotec
International Corp. for DM 850,000, approximately $485,000, in cash (the
"Management Buyout").
The Company was founded in November 1994, by the former parent company
with a total capital investment of $500,000 in cash. Net book value of the
Company at the date of the Management Buyout, including cumulative earnings
since inception of $138,084, amounted to $638,084.
F-6
<PAGE> 32
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 SEC.
The results of operations for the Company for 1997 have been separately
presented to reflect the results of operations prior to the Management Buyout,
as Predecessor operations, and for the period subsequent to the Management
Buyout, as Successor operations. In Management's opinion, the purchase price of
the Company's stock in the Management Buyout reflected the fair value of the
Company at that time.
The difference between the Company's net book value at July 4,1997 and
the purchase price 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 December
31, 1997 and 1998 reflect the results of operations of the Company only from the
date of the Management Buyout.
The only difference in accounting policies utilized in the presentation
of the Successor and Predecessor financial statements is the estimated useful
lives utilized in the depreciation of property and equipment, as described in
Note 2.
In connection with the Management Buyout, the Company agreed not to
compete in any manner with the former parent company in Europe through the
period ended December 31, 1998. Subsequent to the Management Buyout, the Company
changed its name to Artificial Life, Inc.
During the periods January 1, 1997 to July 3, 1997 and July 4, 1997 to
December 31, 1997, approximately 64% and 37%, respectively, of the Company's
revenue was derived from various contracts with the Company's former parent
company and its affiliates. As a result of the Management Buyout and the
Company's changing its primary business focus from software consulting to the
development, marketing and sale of its ALife suite of SmartBot software
products, the Company is not anticipating any future revenue to be derived from
its former parent.
In October 1998, the Company formed Artificial Life Europe AG
("Artificial Life Europe") as a wholly-owned subsidiary. Artificial Life Europe
is located in Luzern, Switzerland and was established as the Company's European
headquarters.
In November 1998, Artificial Life Europe formed Artificial Life Rus
Limited ("Artificial Life Rus") as a wholly owned subsidiary. Artificial Life
Rus is located in St. Petersburg, Russian Federation and was formed to perform
software development.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to a
concentration of credit risk principally consist of cash and cash equivalents
and accounts receivable.
The Company maintains its cash and cash equivalents in checking,
savings and money market accounts. The majority of the Company's cash and cash
equivalents were on deposit in one major financial institution in 1997 and three
major financial institutions in 1998.
During the periods January 1, 1997 to July 3, 1997 and July 4, 1997 to
December 31, 1997, the Company recognized revenue from one customer amounting to
approximately $377,000 and $333,000, respectively, representing 36% and 62%,
respectively, of its total revenues. During the year ended December 31, 1998,
the substantial majority of the Company's revenue was derived from this same
customer. Accounts receivable, trade were due entirely from this customer at
July 3, 1997 and December 31, 1997.
F-7
<PAGE> 33
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MANAGEMENT ESTIMATES
The process of preparing 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 assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. These
estimates and assumptions involve the areas of collection of receivables,
contract costs, depreciation and amortization and certain accruals, among
others. Actual results could differ from those estimates.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of
Artificial Life, Inc., Artificial Life Europe, AG and Artificial Life Rus
Limited. All significant intercompany balances and transactions have been
eliminated.
All assets and liabilities of Artificial Life Europe which has the
Swiss Franc as its functional currency and Artificial Life Rus which has the
Russian Rouble as its functional currency, are translated at the year end
exchange rate. The operations of Artificial Life Europe and Artificial Life Rus
included in the consolidated statement of operations are translated using the
weighted average exchange rate during the period. Translation gains and losses
are not included in determining net income but are accumulated as a separate
component of stockholder's equity. Foreign currency transaction gains and losses
are included in determining net income.
CASH EQUIVALENTS
Cash equivalents consist of short-term investments with original
maturities of three months or less when purchased.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation and amortization
of property and equipment is calculated using the straight-line method over the
following useful lives.
<TABLE>
<CAPTION>
ESTIMATED USEFUL LIVES
------------------------------------------
CLASSIFICATION PREDECESSOR SUCCESSOR
-------------- ----------- ---------
<S> <C> <C>
Furniture and fixtures 7 years 5 years
Computer equipment 3-5 years 3 years
Leasehold improvements Lease term Lease term
Office equipment 5 years 4 years
</TABLE>
Expenditures for maintenance, repairs and minor renewals are charged to
expense as incurred. Betterments and major renewals are capitalized.
COMPUTER SOFTWARE COSTS
Costs of developing software which are incurred beyond the point of
demonstrated technological feasibility are capitalized and, after the product is
available for general release to customers, such costs are amortized based on
the greater of the charge resulting from the straight-line method over a
three-year period or the proportion of current sales to estimated future
revenues of the product.
F-8
<PAGE> 34
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
REVENUE RECOGNITION
The Company recognizes revenue from marketing computer software
programs as follows:
Revenues from the sale of initial "software license
agreements" for computer programs and related services are
recognized upon the delivery of the software.
Development and application services contract revenues and
related costs are recognized upon the completion of the
contract or certain phases as defined in each agreement.
Revenues from the sale of software products are recognized
upon delivery of the software.
There are no significant future costs associated with any of the
Company's revenue transactions. Development costs which are not required to be
capitalized, marketing and installation costs are charged to earnings as
incurred.
COMPREHENSIVE INCOME
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income," as of January 1, 1998.
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as foreign currency translation adjustments, are reported as a
separate component of the equity section of the balance sheet, such items, along
with net income, are components of comprehensive income. The adoption of SFAS
No. 130 had no effect on the Company's net income or stockholders' equity.
COMPUTATION OF NET INCOME (LOSS) PER SHARE
The Company adopted SFAS No. 128, "Computation of Earnings Per Share,"
during 1997. The provision and disclosure requirements for SFAS No. 128 were
required to be adopted for interim and annual periods ending after December 15,
1997, with restatement of earnings per share for prior periods. In accordance
with SFAS No. 128, basic earnings per share is computed using the weighted
average number of common shares outstanding during the period. Diluted earnings
per share is computed using the weighted average number of common shares
outstanding during the period and the weighted average dilutive common
equivalent shares outstanding during the period. Common equivalent shares
consist of the incremental common shares issuable upon the exercise of stock
options and warrants (using the Treasury Stock method); common equivalent shares
are excluded from the calculation if their effect is anti-dilutive. All common
equivalent shares of the Company are not dilutive . Therefore, diluted earnings
per share is the same as basic earnings per share. Pursuant to SEC Staff
Accounting Bulletin No. 98, common stock issued for nominal consideration, prior
to the anticipated effective date of an IPO, are required to be included in the
calculation of basic and diluted net loss per share, as if they are outstanding
for all periods presented. To date, the Company has not had any stock issuances
for nominal consideration.
STOCK-BASED COMPENSATION
The Company has adopted the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." As allowed under the provisions of
SFAS No. 123, the Company applies Accounting Principles Board Opinion No. 25 and
related interpretations in accounting for its employee stock options plans.
There are no effects on reported net income (loss) and earnings per share based
on the fair value of options and shares as prescribed by SFAS No. 123.
F-9
<PAGE> 35
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STOCK DIVIDEND, REVERSE STOCK SPLIT AND CHANGES IN AUTHORIZED STOCK
On June 10, 1998, the Company declared a dividend of 339 shares of
common stock for each share of common stock held to stockholders of record on
June 10, 1998. On September 22, the Company effected a 1-for-2.44 reverse stock
split and amended the total authorized shares of Voting Common Stock to
19,000,000 shares and Non-Voting Common Stock to 1,000,000 shares. Effective
with the consummation of the IPO on December 17, 1998, the Company amended its
articles of organization to amend the total authorized shares of common stock to
30,000,000 shares, all voting, and to authorize 5,000,000 shares of preferred
stock. All references in the financial statements to shares, share prices, per
share amounts, stock options and authorized shares have been retroactively
adjusted for the stock dividend, reverse stock split and change in authorized
stock.
INCOME TAXES
Deferred tax assets and liabilities are recorded for temporary
differences between the financial statement and tax basis of assets and
liabilities. Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the period in which the deferred tax
assets or liabilities are expected to be realized or settled. A deferred tax
asset is recorded for any net operating loss, capital loss and tax credit
carryforward for income tax purposes, to the extent their realization is more
likely than not. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities will be adjusted through the provision for income taxes.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Carrying amounts of certain of the Company's financial instruments,
including cash and cash equivalents, accounts receivable, accounts payable,
accrued expenses and other liabilities approximate fair value due to their short
maturities. Based upon rates currently available for loans with similar terms,
the carrying value of notes receivable approximates fair value.
3. RELATED PARTY TRANSACTIONS
The Company had transactions with its former parent company and
wholly-owned subsidiaries of the former parent company, MediaCenter GmbH
("MediaCenter") and IST Intelligent Safety Technologies GmbH ("IST"), and a
stockholder of the former parent company as follows:
a) The Company provided contract services to the former parent
company, IST and to a stockholder of the former parent company
on which it recorded revenue of $2,757,253, $666,229 and
$197,948 for the year ended December 31, 1996 and the periods
January 1, 1997 to July 3, 1997 and July 4, 1997 to December
31, 1997, respectively. Certain contracts for services are
denominated in Deutsche Marks ("DM").
b) The Company received advances from the former parent company
in the amount of DM120,000. The advances were due on September
30, 1997 with interest at 8.5%. The note payable of $68,844
recorded on the balance sheet at July 3, 1997 is based on the
exchange rate on that date. Interest expense on these advances
amount to $7,271, $3,399 and $1,848 for the year ended
December 31, 1996 and the periods from January 1, 1997 to July
3, 1997 and July 4, 1997 to December 31, 1997, respectively.
The advances were repaid in 1997 (see below).
c) The former parent charged the Company for engineering services
rendered. These costs amounted to $49,349 and $39,168 for the
year ended December 31, 1996 and the period from January 1,
1997 to July 3, 1997, respectively. No services were rendered
by the former parent after the Management Buyout.
d) Through July 3,1997, the former parent company charged the
Company for various expenses paid on the Company's behalf and
the Company charged the former parent company and MediaCenter
for various expenses paid by the Company on their behalf as
follows:
F-10
<PAGE> 36
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
PREDECESSOR
---------------------------------------------
PERIOD FROM
YEAR ENDED JANUARY 1,
DECEMBER 31, 1996 TO JULY 3, 1997
----------------- ---------------
<S> <C> <C>
Expenses paid by former parent on
Company's behalf:
Travel and Promotion.................................. $ 6,915 $ --
=========== =============
Expenses paid by the Company on behalf of the former parent:
Consortium Agreement.................................. $ 62,500 $ 46,875
Engineering costs..................................... 22,447 8,873
Travel and promotion.................................. 20,506 1,497
----------- -------------
$ 105,453 $ 57,245
=========== =============
Expenses paid by the Company on behalf of the MediaCenter:
Legal fees............................................ $ 22,303 $ --
Travel and promotion.................................. 15,789 --
Equipment............................................. 7,600 --
----------- -------------
$ 45,692 $ --
=========== =============
</TABLE>
The Company was charged interest on overdue amounts of $17,016 in 1996.
No interest was charged in 1997.
In 1997, subsequent to the Management Buyout, and as a result of
unresolved disputes between the Company and its former parent in connection with
existing contractual obligations of the former parent, the Company discontinued
performing services for its former parent company and its affiliates. At that
time, the Company had in process several contracts for services to be provided
to the former parent company and outstanding accounts receivable from the former
parent of $160,000. In addition, the Company owed the former parent $119,938 in
notes payable, accounts payable and accrued expenses. In December of 1997, the
Company and the former parent negotiated a settlement agreement whereby the
former parent agreed to forgive all outstanding liabilities owed by the Company
and make a cash payment of $230,000 in full settlement of all outstanding
accounts receivable and all of its contractual obligations to the Company. The
transaction resulted in the recognition of cancellation fee income of $189,938
in 1997. The $230,000 payment was received in full in January 1998.
Compensation paid to Company's President, Chief Executive Officer and
Chairman amounted to $200,439, $54,254 and $22,500 for the year ended December
31, 1996 and the periods January 1, 1997 to July 3, 1997 and July 4, 1997 to
December 31, 1997, respectively. In 1998, the Company's President, Chief
Executive Officer and Chairman entered into an employment agreement with the
Company at an annual salary of $240,000.
Net amounts due from the former parent company and affiliates at July
3, 1997 and December 31, 1997 consist of the following:
<TABLE>
<CAPTION>
PREDECESSOR | SUCCESSOR
------------------------ | -----------------------
JULY 3, 1997 | DECEMBER 31, 1997
------------------------ | -----------------------
SHAREHOLDER | SHAREHOLDER
FORMER OF FORMER | FORMER OF FORMER
PARENT PARENT | PARENT PARENT
-------- -------- | -------- --------
<S> <C> <C> | <C> <C>
Settlement Agreement ... $ -- $ -- | $230,000 $ --
Contract Services ...... -- 155,718 | -- 13,499
Reimbursements |
receivables .......... 55,151 -- | -- --
Reimbursements |
payable .............. (19,492) -- | -- --
-------- -------- | -------- --------
Total .................. $ 35,659 $155,718 | $230,000 $ 13,499
======== ======== | ======== ========
</TABLE>
F-11
<PAGE> 37
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
There were no amounts due to or from the former parent company and
affiliates at December 31, 1998.
On June 29, 1998, the Company issued a note payable to an
officer/stockholder in the amount of $500,000. The note is unsecured and bears
interest at 10%. Payment of principal and accrued interest is due on January 1,
2000. Interest accrued during the years ended December 31, 1998 amounted to
$25,000 on the note payable.
In 1998, the Company made advances totaling $40,000 to a company owned
by a stockholder and an officer/stockholder of the Company. The advances are
unsecured, bear interest at 10% and are due on December 31, 1999.
The Company pays expenses on behalf of and provides cash advances to
officer/stockholders from time to time. Amounts outstanding are non-interest
bearing and due on demand.
4. INCOME TAXES
The income tax provision (benefit) consists of:
<TABLE>
<CAPTION>
PREDECESSOR | SUCCESSOR
-------------------------------------- | -----------------------------------------
PERIOD FROM | PERIOD FROM
YEAR ENDED JANUARY 1 TO | JULY 4, TO YEAR ENDED
DECEMBER 31, 1996 JULY 3, 1997 | DECEMBER 31, 1997 DECEMBER 31, 1998
---------------- -------------- | ---------------- ----------------
<S> <C> <C> | <C> <C>
Current: |
Federal.............. $ 75,124 $ 3,039 | $ 3,661 $ (1,710)
State................ 47,678 2,495 | 3,005 --
---------------- -------------- | ---------------- ----------------
122,802 5,534 | 6,666 (1,710)
---------------- -------------- | ---------------- ----------------
Deferred: |
Federal.............. 201,107 -- | -- 1,710
State................ 13,453 -- | -- --
---------------- -------------- | ---------------- ----------------
214,560 -- | -- 1,710
---------------- -------------- | ---------------- ----------------
$ 337,362 $ 5,534 | $ 6,666 $ --
================ ============== | ================ ================
</TABLE>
The difference between actual income tax expense and expected income
tax expense computed by applying the U.S. federal income tax rate of 34% to
income (loss) before income taxes is explained as follows:
<TABLE>
<CAPTION>
PREDECESSOR | SUCCESSOR
--------------------------------- | -----------------------------------------
PERIOD FROM | PERIOD FROM
YEAR ENDED JANUARY 1 TO | JULY 4 TO YEAR ENDED
DECEMBER 31, 1996 JULY 3, 1997 | DECEMBER 31, 1997 DECEMBER 31, 1998
----------------- ------------- | ------------------ --------------------
<S> <C> <C> | <C> <C>
Expected income tax provision (benefit) $ 299,440 $ 6,189 | $ 17,206 $ (745,010)
State taxes, net of federal income |
tax benefit......................... 40,346 1,647 | 1,983 (137,389)
Surtax exemption...................... -- (3,458) | (2,295) --
Change in valuation reserve on |
deferred tax assets................. -- -- | (12,532) 826,618
Other................................. (2,424) 1,156 | 2,304 55,781
------------- ----------- | ------------ ------------
Provision for income taxes....... $ 337,362 $ 5,534 | $ 6,666 $ --
============= =========== | ============ ============
</TABLE>
F-12
<PAGE> 38
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effects of temporary differences that give rise to the deferred
tax assets and deferred tax liabilities at July 3, 1997 and December 31, 1997
and 1998, are presented below:
<TABLE>
<CAPTION>
PREDECESSOR | SUCCESSOR
----------- | -----------------------------
JULY 3, | DECEMBER 31, DECEMBER 31,
1997 | 1997 1998
----------- | ----------- ----------
<S> <C> | <C> <C>
Deferred tax assets: |
Federal net operating loss carryforward .................... $ -- | $ -- $ 687,839
State net operating loss carryforward....................... -- | -- 190,476
Start-up costs capitalized for income tax purposes.......... 69,205 | 46,499 23,793
Vacation accrual not deductible for income tax purposes..... 3,114 | 4,182 4,182
Property and equipment...................................... -- | 27,292 --
----------- | ----------- ----------
72,319 | 77,973 906,290
Valuation allowance on deferred tax asset -- | (69,862) (896,480)
----------- | ----------- ----------
72,319 | 8,111 9,810
----------- | ----------- ----------
Deferred tax liabilities: |
Property and equipment...................................... 17,614 | -- 1,699
Prepaid rent deducted for income tax purposes............... 8,422 | 8,111 8,111
Unrealized foreign exchange gains........................... 3,971 | -- --
----------- | ----------- ----------
30,007 | 8,111 9,810
----------- | ----------- ----------
Net deferred tax asset $ 42,312 | $ -- $ --
=========== | =========== ==========
</TABLE>
There was no change in the valuation allowance on deferred tax assets
for the year ended December 31, 1996 and the period January 1, 1997 to July 3,
1997. The changes in the valuation allowance on deferred tax assets for the
period July 4, 1997 to December 31, 1997 and the year ended December 31, 1998
are as follows:
<TABLE>
<CAPTION>
PERIOD FROM JULY 4 TO YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998
--------------------- -----------------
<S> <C> <C>
Balance at beginning of period................................ $ -- $ 69,862
Increase in valuation allowance on existing deferred tax
assets due to Management Buyout ............................ 42,312 --
Increase in valuation allowance on deferred tax assets arising
from revaluation of assets due to Management Buyout......... 40,082 --
Increase (decrease) in valuation allowance due to change in
deferred tax assets during the period....................... (12,532) 826,618
----------- -------------
$ 69,862 $ 896,480
=========== =============
</TABLE>
At December 31, 1998, the Company has approximately $2,000,000 of
federal and state net operating loss carryforwards expiring in 2018 and 2003,
respectively. The net operating loss carryforwards may be subject to annual
limitations based on ownership changes in the Company's common stock as provided
in Section 382 of the Internal Revenue Code.
5. COMMITMENTS
CONSORTIUM AGREEMENT
Effective October 10, 1995, the Company entered into a consortium
agreement with the Massachusetts Institute of Technology ("MIT"). Under the
agreement, MIT will conduct research projects for the "Things That Think
Consortium." The Consortium is an international association of corporate members
who have joined "to address the future of computation as it is increasingly
imbedded in things other than computers." The term of the agreement is for five
years through October 9, 2000. The agreement 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 agreement. The
Company was sharing 50% of this cost with its former parent through June 1997.
F-13
<PAGE> 39
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On August 6, 1997, the Company obtained a suspension of the contract
until February 5, 1998, at which time the contract resumed under its original
terms. The Company will be solely responsible for the $125,000 annual cost
through October 9, 2000. Total costs incurred by the Company in connection with
the agreement amounted to $62,500, and $32,598 for the year ended December 31,
1996 and the period January 1, 1997 to July 3, 1997, respectively, and $125,000
for the year ended December 31, 1998.
LEASES
The Company leases office and other space and various office equipment
under various noncancellable leases. Future minimum annual lease payments,
exclusive of additional operating costs, are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1999.................................... $ 251,640
2000.................................... 251,267
2001.................................... 43,811
2002.................................... 24,951
2003.................................... 22,872
------------
$ 594,541
============
</TABLE>
Rent expense for the year ended December 31, 1996, the periods January
1, 1997 to July 3, 1997 and July 4, 1997 to December 31, 1997 and the year ended
December 31, 1998 amounted to approximately $231,300, $135,900, $92,400, and
$253,300, respectively. The 1998 rent expense is net of approximately $20,400
which was recorded as part of capitalized software development costs.
EMPLOYMENT CONTRACTS
The Company has employment agreements with all of its executive
officers. The agreements are generally one to three years in length and provide
for minimum salary levels. These agreements include severance payments under
certain conditions of approximately one half to three times each officer's
annual compensation. In addition the chief executive officer of the Company is
entitled to receive an annual incentive bonus of 3% of the Company's profits
from operations.
6. PROFIT SHARING PLAN
Effective October 1, 1995, the Company implemented a 401(k) profit
sharing plan for the benefit of all employees. Employees are eligible to
participate after twelve months of service and may contribute up to 15% of their
compensation subject to statutory limitations. The Company matches 50% of
employee contributions up to 1 1/2% of the employee's compensation.
Profit sharing expense for the year ended December 31, 1996, the
periods January 1, 1997 to July 3, 1997 and July 4, 1997 to December 31, 1997
and the year ended December 31, 1998 amounted to approximately $7,000, $4,800,
$3,700, and $10,500, respectively.
7. STOCKHOLDERS' EQUITY
PUBLIC OFFERING
In August 1998, the Company executed a letter of intent to proceed with
a proposed initial public offering of the Company's stock (the "IPO"). The IPO
was consummated on December 17, 1998. Expenses incurred in connection with the
IPO amounted to $2,597,227, resulting in net proceeds of $9,302,773 to the
Company. Upon consummation of the IPO, under the terms of the letter of intent,
the underwriters managing the offering will have the right to appoint one member
of the Board of Directors. The right to have a representative on the Company's
board extends for the term of the
F-14
<PAGE> 40
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Warrant (defined below). The Company has delivered a warrant (the "Warrant") to
the underwriters at the closing of the IPO equal to ten percent of the total
number of shares sold pursuant to the IPO, 184,000 shares. The Warrant is
exercisable any time after one year from the date of closing for a period of
four years at a price equal to 120% of the offering price per share, or $10.20
per share.
COMMON STOCK
In June 1998, the Company sold 53,278 shares of non-voting common stock
and the majority stockholder of the Company sold 409,836 shares of voting common
stock through private placements to foreign investors overseas based on
arms-length negotiations with unrelated parties. The shares were sold for $3.66
per share. Expenses incurred in connection with the private placements amounted
to $13,633. As a result, the Company received net proceeds of $181,367. This
stock was unregistered and was subject to restrictions on resale in the United
States pursuant to Regulation S promulgated under the Securities Act of 1933, as
amended. Upon the closing of the IPO, non-voting common stock was converted into
voting common stock.
Subsequent to the sale of stock by the majority stockholder, the
Company received a loan of $500,000 from the stockholder.
On September 23, 1998, the Company sold 824,000 shares of voting common
stock for $5.00 per share through private placements to foreign investors.
Expenses incurred in connection with the private placements amounted to $173,519
resulting in net proceeds of $3,946,481 being received by the Company. The stock
was unregistered and was subject to restrictions on resale in the United States
pursuant to Regulation S promulgated under the Securities Act of 1933, as
amended. Upon the closing of the IPO, the Company registered 164,800 of these
shares for inclusion in the public offering.
STOCK OPTIONS
On April 1, 1998, the Company adopted the 1998 Equity Incentive Plan
(the "Plan") which provides for the issuance of both non-statutory and incentive
stock options to employees, officers, directors and consultants of the Company.
At the time the Company reserved 409,811 shares of common stock to be issued
under the Plan. Incentive stock options for 69,525 shares of common stock were
granted on May 1, 1998 with an initial exercise price of $3.66 per share, the
estimated fair market value on that date. The exercise price increases by $3.66
per share per quarter until the second anniversary of the date of grant at which
time the options are to expire.
On September 25, 1998, the Plan was amended to increase the shares
reserved for issuance under the Plan to a total of 1,200,000 shares; 761,476
shares of voting common stock and 438,524 shares of non-voting common stock. All
options issued prior to June 30, 1998 were for voting common stock. Effective
with the amendment, the Company granted non-statutory stock options for 184,426
shares of voting common stock and 362,701 shares of non-voting common stock with
an exercise price of $3.66 per share expiring on July 1, 1999. On June 30, 1998,
the Company also amended the terms of the incentive stock options issued to two
individuals on May 1, 1998 for a total of 32,884 shares of common stock to
provide that the exercise price for such options is to remain at $3.66 per share
over the life of the option.
On October 1, 1998, the Company granted incentive stock options for
65,000 shares of common stock at an exercise price of $6.50 per share expiring
on September 30, 2000.
On November 10, 1998, the Company granted non-statutory stock options
for 100,000 shares of common stock at an exercise price of $6.50 per share
expiring on November 9, 2000.
With the amendment of the authorized common stock at the time of the
IPO, all no-voting common stock options were converted to voting common stock
options.
F-15
<PAGE> 41
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
All options presently granted under the Plan were immediately
exercisable on the grant date. The vesting of future option grants will be
established by the Company's Board of Directors or a duly authorized committee
thereof.
A summary of the status of the Company's stock options as of December
31, 1998 and the changes during the year then ended is presented below.
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
---------------- ------------------------
<S> <C> <C>
Outstanding at beginning of period...................... -- $ --
Granted - price equals fair value....................... 781,652 4.60
Exercised............................................... (26,083) 3.66
Canceled -- --
-----------
Outstanding at end of period............................ 755,569 $ 4.38
===========
Options exercisable at end of period.................... 755,569
===========
Options available for future grants..................... 418,348
===========
</TABLE>
The following table summarizes information about stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING AND EXERCISABLE
----------------------------------------------------------------------------------------------------------------
RANGE OF NUMBER WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICE OUTSTANDING REMAINING CONTRACTUAL LIFE EXERCISE PRICE
------------------ ---------------- ------------------------------- ----------------------
<S> <C> <C> <C>
$3.66-$10.98 755,569 .83 years $4.38
</TABLE>
The Company applies Accounting Principles Board Opinion No. 25 and
related interpretations in accounting for its Plan.
Pro forma information regarding net loss and net loss per share is
required by SFAS No. 123, which also requires that the information be determined
as if the Company had accounted for its employee stock options under the fair
value method. In 1998, prior to the completion of the initial public offering of
common stock, the fair value of each option grant was estimated using the
minimum value method. The minimum value method differs from other methods of
valuing options, such as the Black-Scholes option pricing model, because it does
not consider the effect of expected volatility. All of the Company's stock
options were granted in 1998 prior to the IPO. The fair value of options was
estimated at the date of grant using the following weighted average assumptions:
<TABLE>
<S> <C>
Risk Free interest rate................................. 5.4%
Dividend yield.......................................... None
Expected life of options in years....................... .75
</TABLE>
Option valuation models require the input of highly subjective
assumptions including the expected life of the options. Because the Company's
employee stock options have characteristics significantly different from those
of traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options. The Company's pro forma information for 1998 is as
follows:
<TABLE>
<S> <C>
Pro forma net loss...................................... ($2,321,637)
Pro forma net loss per share............................ ($0.32)
</TABLE>
The pro forma net loss per share above is calculated using the weighted
average number of shares of common stock outstanding as described in Note 2. The
weighted average fair value of options granted during the year ended December
31, 1998 was $0.17
F-16
<PAGE> 42
ARTIFICIAL LIFE, INC.
(FORMERLY NEUROTEC INTERNATIONAL CORP.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. NOTES RECEIVABLE FROM STOCKHOLDERS
In connection with the exercise of stock options on July 31, 1998, the
Company received notes receivable in the amount of $93,682. The notes are due in
biweekly installments through July 31, 2000 with interest at 9%.
9. ACCRUED EXPENSES
Accrued expenses at July 3, 1997 and December 31, 1997 and 1998 consist
of the following:
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
----------- -----------------------------------
DECEMBER 31, DECEMBER 31,
JULY 3, 1997 1997 1998
--------------- -------------- -------------
<S> <C> <C> <C>
Accrued salaries..................................... $ 62,629 $ 3,657 $ 25,282
Accrued vacations.................................... 25,211 13,089 28,292
Accrued and withheld payroll taxes................... 6,474 56,082 12,063
Accrued professional fees............................ -- 15,000 40,099
Accrued state excise tax............................. -- -- 21,103
Accrued interest on note payable to officer/stockholder -- -- 25,000
Other accrued expenses............................... 3,053 7,424 19,428
----------- ----------- ----------
Total accrued expenses............................ $ 97,367 $ 95,252 $ 171,267
=========== =========== ==========
</TABLE>
10. SUBSEQUENT EVENTS
In December 1998 and January 1999, the Underwriter exercised its entire
over-allotment option. Under the option, the Underwriter purchased 40,000
additional shares from the Company and 200,000 additional shares from the
Company's major stockholder. The shares were purchased at the public offering
price of $8.50 per share less the underwriting discounts, commissions and
expenses. Net proceeds received by the Company for its portion of the
overallotment exercised in January amounted to $302,600, net of expenses of
$37,400.
In March 1999, the Company agreed to enter into a joint venture with
an international retailer in the field of e-commerce. Terms of the joint
venture are to be finalized in the near future. The main focus of this venture
is to develop a high traffic, high volume, low cost e-commerce site on the
Internet using the Company's SmartBot based products. The Company anticipates
its investment in a 50% interest in this joint venture will not exceed
$2,150,000.
11. 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 December 31, 1998, the Company has operations located outside the
United States in Switzerland and Russia. The Company's operations in Europe
commenced late in 1998 and generated no revenues as of December 31, 1998.
Other financial data for the year ended December 31, 1998 is as
follows:
<TABLE>
<CAPTION>
UNITED
STATES EUROPE ELIMINATIONS TOTAL
------------- ---------- ------------- ------------
<S> <C> <C> <C> <C>
Loss from operations $ (1,991,042) $(200,164) $ -- $(2,191,206)
Identifiable Assets 13,089,011 525,430 (729,721) 12,884,720
</TABLE>
The Company's entire operations were located in the United States
during the year's ended December 31, 1996 and 1997.
F-17
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted
from Artificial Life, Inc. and subsidiary's annual financial statements
for the year ended December 31, 1998 and is qualified in its entirety
by reference to such financial statements contained in Form 10-K.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> US DOLLAR
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 11,687,829
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 11,950,515
<PP&E> 794,125
<DEPRECIATION> 160,274
<TOTAL-ASSETS> 12,884,720
<CURRENT-LIABILITIES> 615,634
<BONDS> 0
0
0
<COMMON> 92,706
<OTHER-SE> 11,676,380
<TOTAL-LIABILITY-AND-EQUITY> 12,884,720
<SALES> 1,388
<TOTAL-REVENUES> 450,768
<CGS> 0
<TOTAL-COSTS> 2,576,715
<OTHER-EXPENSES> 32,002
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 33,257
<INCOME-PRETAX> (2,191,206)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,191,206)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,191,206)
<EPS-PRIMARY> (0.30)
<EPS-DILUTED> (0.30)
</TABLE>
<PAGE> 1
Exhibit 99.1
IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS
From time to time, Artificial Life, Inc. (the "Company"), through its
management, may make forward-looking statements, such as statements concerning
the expected future revenues or earnings or concerning projected plans,
performance, conduct, product development and commercialization, as well as
estimates relating to future operations. There are certain risk factors that
could cause future results to differ materially from those anticipated by
management including, but not limited to, the following:
RECENT CHANGE IN STRATEGY. The Company was incorporated in Delaware in November
1994 as Neurotec International Corp., a wholly owned subsidiary of Neurotec
Hochtechnologie GmbH ("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. from Neurotec GmbH (the "Management Buyout"). In August
1997, the Company's name was changed to Artificial Life, Inc. Moreover, the
Company has recently changed its primary business focus from software consulting
to the development, marketing and support of its ALife product suite of
"intelligent" software robots (also known as software agents). Accordingly, the
Company is in the initial phase of rolling out its software products and is
subject to certain risks inherent in launching new products. To address these
risks, the Company must, among other things, complete development of its
software robot products, enter into strategic relationships, marketing and
distribution arrangements, respond to competitive developments, and attract,
retain and motivate qualified personnel. In addition, because the Company has
adopted this new business strategy, results of operations to date are not
reflective of the Company's future results of operations. The Company's decision
to develop, market and support software robot products is predicated on the
assumption that the demand for such products will be large enough to permit the
Company to operate profitably. There can be no assurance that the Company's
assumption will be correct or that the Company will be able to successfully
compete as a provider of such products. If the Company's assumption is not
accurate, or if the Company is unable to compete as a provider of agent-based
software products, the Company's business, prospects, financial condition and
results of operations will be materially adversely affected.
MINIMAL REVENUES AND RECENT LOSSES; PERIOD TO PERIOD COMPARISONS; LIMITED
OPERATING HISTORY; ANTICIPATION OF CONTINUED LOSSES. Since its incorporation in
November 1994, the Company has been engaged primarily in the provision of
software consulting services and to date has generated limited revenues. Through
July 3, 1997, the Company had recorded cumulative net income in predecessor
operations of $138,084 primarily through its software consulting business, a
significant majority of which business was with the Company's former parent
company and affiliates thereof and ceased shortly after the Management Buyout on
July 4, 1997. As a consequence of the Company's recent change in its primary
business focus from software consulting to the development, marketing and
support of its ALife suite of SmartBot software products, the Company expects
that an increasing percentage of its future revenues will be derived from sales
and services associated with its software robot products and that revenues from
its consulting business, as a percentage of gross revenues, will significantly
decrease over time. Accordingly, past financial results do not reflect the
results of the Company's current business activities. In the year ended December
31, 1998, the Company incurred a net loss of $2,191,206. Furthermore, its
limited operating history leads the Company to believe that period-to-period
comparisons of its operating results are not meaningful and that the results for
any period should not be relied upon as an indication of future performance. The
Company faces the risks and problems associated with pursuing a new business
strategy and has a limited operating history on which to evaluate its future
prospects. Such prospects should be considered in light of the risks, expenses
and difficulties frequently encountered in launching new products in a new and
emerging industry characterized by rapid technological change, a number of
potential market entrants and intense competition. The Company expects to incur
significant losses until at least the year 2000. There can be no assurance that
the
<PAGE> 2
Company will achieve or sustain significant revenues or become cash flow
positive or profitable in the near future or ever.
DEPENDENCE ON EMERGING MARKETS; ACCEPTANCE OF THE COMPANY'S PRODUCTS. The
Company's future financial performance will depend in large part on the growth
in demand for agent-based software products, such as the Company's suite of
SmartBot products. This market is new and emerging, is rapidly evolving, is
characterized by an increasing number of market entrants and will be subject to
frequent and continuing changes in customer preferences and technology. As is
typical in new and evolving markets, demand and market acceptance for the
Company's technologies is subject to a high level of uncertainty. Because the
market for the Company's products is evolving, it is difficult to assess or
predict with any assurance the size or growth rate, if any, of this market.
There can be no assurance that a significant market for the Company's products
will develop, or that it will develop at an acceptable rate or that new
competitors will not enter the market. In addition, even if a significant market
develops for such products, there can be no assurance that the Company's
products will be successful in such market. If a significant market fails to
develop, develops more slowly than expected or attracts new competitors, or if
the Company's products do not achieve market acceptance, the Company's business,
prospects, financial condition and results of operations will be materially
adversely affected.
COMPETITION. The market for the Company's products and services is new, evolving
and growing rapidly. Competition can be expected to intensify significantly as
the market matures and the more established software companies become
increasingly involved. Barriers to entry are relatively insubstantial. Although
the Company has not yet identified any competitors in exactly the same areas in
which it is active, there are companies that have overlapping activities and
therefore could be regarded as competition to Artificial Life. The Company
believes that the principal competitive factors affecting the market for the
Company's products include core technology, delivery methods, brand recognition,
ease of use and interfaces. The relative importance of each of these factors
depends upon the specific customer involved. There can be no assurance that the
Company will be able to compete effectively with respect to any of these
factors.
The Company's present or future competitors may be able to develop products
comparable or superior to those offered by the Company or adapt more quickly
than the Company to new technologies or evolving customer requirements. In order
to be successful in the future, the Company must respond to technological
change, customer requirements and competitors' current products and innovations.
In particular, while the Company is currently developing products and product
enhancements that it believes address customer requirements, there can be no
assurance that the Company will successfully complete the development or
introduction of these products and product enhancements on a timely basis or
that these products and product enhancements will achieve market acceptance.
Accordingly, there can be no assurance that the Company will be able to compete
effectively in its market, that competition will not intensify or that future
competition will not have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.
PRODUCT CONCENTRATION. The Company expects to derive an increasing percentage of
its revenues from sales of its SmartBot software robot products and associated
services. Broad market acceptance of these products is critical to the Company's
future success. As a result, failure to achieve broad market acceptance, or, if
achieved, future declines in demand of these products as a result of
competition, technological change, ease of use or otherwise would have a
material adverse effect on the Company's business, prospects, financial
condition and results of operations. In addition, the Company's future financial
performance may depend in part on the successful development, introduction and
customer acceptance of future versions of the Company's software robot products,
and there can be no assurance that any such future products will achieve market
acceptance.
<PAGE> 3
PRODUCT DEFECTS AND PRODUCT LIABILITY. The Company's software robot products are
complex and could from time to time contain design defects or software errors
that could be difficult to detect and correct. There can be no assurance that,
despite testing by the Company, errors will not be found in the Company's
products which could result in delay in or inability to achieve market
acceptance and thus could have a material adverse effect upon the Company's
business, prospects, financial condition and results of operations.
Because the Company's software robot products can be used by its clients to
perform mission critical functions, design defects, software errors, misuse of
the Company's products, incorrect data from external sources or other potential
problems within or out 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 clients. The Company maintains only limited product liability
insurance, and such insurance may likely not be adequate to effectively protect
the Company against product liability claims and the costs and expenses
associated therewith. The Company anticipates that its sales and licensing
agreements with its clients will typically contain provisions designed to limit
the Company's exposure to potential claims. Such provisions, however, 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 upon the Company's business, prospects, financial condition and results
of operations.
RAPID TECHNOLOGICAL CHANGE. To remain competitive, the Company must continue to
enhance and improve the ease of use, responsiveness, functionality and features
of its family of SmartBot software robot products. The industry in which the
Company operates is characterized by rapid technological change, changes in user
and customer requirements and preferences, frequent new products and service
introductions embodying new technologies and the emergence of new industry
standards and practices that could render the Company's existing products and
proprietary technology and software obsolete. The Company's success will depend,
in part, on its ability to enhance its existing products, develop new products
and technologies that address the increasingly sophisticated and varied needs of
its customers, and respond to technological advances and emerging industry
standards and practices on a cost-effective and timely basis. There can be no
assurance that the Company will successfully develop, license or acquire and
implement new technologies or adapt its proprietary technology and products to
customer requirements or emerging industry standards. If the Company is unable,
for technical, legal, financial or other reasons, to adapt in a timely manner in
response to changing market conditions or customer requirements, the Company's
business, prospects, financial condition and results of operations would be
materially adversely affected.
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL. The Company's
performance is substantially dependent on the continued services and performance
of its senior management and other key personnel, particularly Eberhard
Schoneburg, the Company's President, Chief Executive Officer and Chairman. The
Company has entered into an employment agreement with Mr. Schoneburg, as well as
with Robert Pantano, its Chief Financial Officer, and Klaus Kater, its Chief
Technology Officer. The Company does not maintain key man life insurance on any
of its senior management or key personnel. The Company's performance also
depends upon the Company's ability to retain and motivate its other officers and
key employees. The loss of the services of, and the failure to promptly replace,
any of its executive officers or other key employees could have a material
adverse effect on the Company's business, prospects, financial condition and
results of operations. The Company's future success also depends on its ability
to identify, attract, hire, train, retain and motivate other highly skilled
software engineers and managerial and marketing personnel. There is currently a
shortage of qualified software engineers and programmers. Competition for such
personnel is intense, and there can be no assurance that the Company will be
able to successfully attract, integrate or retain sufficiently qualified
personnel. The failure to attract and retain the necessary personnel could have
a material adverse effect on the Company's business, prospects, financial
condition and results of operations.
<PAGE> 4
DEPENDENCE ON THIRD PARTY CONTRACTORS. The Company intends to use consultants to
complete portions of the development work on its ALife suite of SmartBot
software products and to assist customers in the installation and support of the
Company's SmartBot software products. Competition for such personnel is intense.
There can be no assurance that the Company will be successful in attracting or
retaining such consultants. In addition, the Company's ability to provide its
software consulting services and introduce its products is dependent, in part,
on the ability of these independent consultants to complete their engagements in
a timely and cost-effective manner. In particular, consulting resources will be
required to install, support and customize the Company's software products,
including creating the content of the Knowledge Bases (databases which can be
combined or exchanged to give the derived products differing sets of expertise).
Therefore, the availability of such resources will directly impact sales of such
products. Some of these consultants will be employees of other companies who
will only be able to work on the Company's products on a part-time basis. If the
Company is not successful in attracting the necessary consultants or if such
consultants cannot complete the necessary tasks in a timely and cost-effective
manner, the Company's business, prospects, financial condition and results of
operations could be materially adversely affected.
RISKS ASSOCIATED WITH INTERNATIONAL SALES. A key component of the Company's
strategy is to expand its sales in foreign markets, especially in Europe. The
Company anticipates that it will expend significant financial and management
resources to develop programs of partnering and strategic investments
internationally. If the revenues generated by these marketing programs are
insufficient to offset the expense of establishing and maintaining such
programs, the Company's business, prospects, financial condition and results of
operations could be materially adversely affected. There can be no assurance
that the Company will be able to expand its sales in foreign markets.
The Company's international sales are subject to certain risks not inherent in
its domestic sales, including political and economic instability in foreign
markets, 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. All of such
factors may suppress demand for the Company's services and products. The impact
of such factors on the Company's business is inherently unpredictable. There can
be no assurance that such factors will not have a material adverse effect upon
the Company's revenues from international sales and, consequently, the Company's
business, prospects, financial condition and results of operations.
DEPENDENCE ON CONTINUED GROWTH OF INTERNET AND ONLINE COMMERCE. The Company's
future revenues and any future profits are in a large part dependent upon the
willingness of consumers to accept the Internet as an effective medium of
commerce and for obtaining information. The Company is especially dependent upon
the long-term acceptance and growth of online commerce. Rapid growth in the use
of and interest in online services is a recent phenomenon, and there can be no
assurance that such acceptance and use will continue to develop or that a
sufficiently broad base of consumers will adopt and continue to use the Internet
and other online services as a medium of commerce. Demand and market acceptance
for recently introduced services and products over the Internet are subject to a
high level of uncertainty. For the Company to be successful, consumers must
accept and utilize this novel way of conducting business and obtaining
information.
The Internet may not be accepted by consumers as a viable commercial marketplace
for a number of reasons, including potentially inadequate development of the
necessary network infrastructure or delayed development of enabling technologies
and performance improvements. To the extent that online services continue to
experience significant growth in the number of users, their frequency of use or
an increase in their bandwidth requirements, there can be no assurance that the
infrastructure of the Internet and other online services will be able to support
the demands placed upon them. In addition, Internet services could lose their
viability due to delays in the development or adoption of new standards and
protocols required to handle increased levels of online activity or due to
increased government regulation. Changes in or insufficient availability of
<PAGE> 5
telecommunications services to support Internet services also could result in
slower response times and adversely affect usage of the Internet and other
online services generally. If use of the Internet and other online services does
not continue to grow or grows more slowly than expected, if the infrastructure
for Internet services does not effectively support the growth that may occur, or
if the Internet does not become a viable commercial marketplace, the Company's
business, prospects, financial condition and results of operations would be
materially adversely affected.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS. The Company will be relying
upon trade secrets, know-how, copyrights and continuing technological
innovations to develop and maintain its competitive position. The Company seeks
to protect such information, in part, by confidentiality agreements with its
corporate partners, collaborators, employees and consultants. These agreements
provide that all confidential information developed or made known during the
course of the individual's or entity's relationship with the Company is to be
kept confidential and not be disclosed to third parties except in specific
circumstances. The Company has caused each of its employees to execute forms of
Confidentiality and Inventions Agreements which provide that, to the extent
permitted by applicable law, all inventions conceived by the individual during
the individual's employment are the exclusive property of the Company. There can
be no assurance that these agreements will not be breached, that the Company
would have adequate remedies for any breach, or that the Company's trade secrets
will not otherwise become known or be independently discovered by competitors.
Further, there can be no assurance that the Company will be able to protect its
trade secrets and copyrights, or that others will not independently develop
substantially equivalent proprietary information and techniques.
The Company has no patents or patent applications pending, nor does it have any
registered copyrights. There can be no assurance that the existing or future
patents of third parties will not have an adverse effect on the ability of the
Company to continue to commercialize its products. Furthermore, there can be no
assurance that other companies will not independently develop similar products
or duplicate any of the Company's planned products or obtain patents that will
require the Company to alter its products or processes, pay licensing fees or
cease development of its planned products. The occurrence of any such event may
have a material adverse effect on the Company's business, prospects, financial
condition and results of operations.
NEED FOR ADDITIONAL CAPITAL. The Company currently believes the net proceeds
from its initial public offering, together with the Company's existing cash,
cash equivalents, short-term investments and other cash generated from
operations, will enable the Company to maintain its current and planned
operations at least through July 2000, although there can be no assurance that
the Company will not have additional capital needs prior to such time. Delays in
the completion of software development programs are common in the industry. If
the Company experiences delays in the scheduled development of its initial
SmartBot software robot products, it may require substantial additional funds
until such time as products are completed and cash generated from sales of
products and services is sufficient to fund continued growth of the business. In
the event that such additional financing is necessary, the Company may seek to
raise such funds through public or private equity or debt financing or other
means. No assurance can be given that additional financing will be available
when needed, or that, if available, such financing will be obtained on terms
acceptable to the Company. To the extent that the Company raises additional
capital by issuing equity securities, ownership dilution will result to existing
stockholders. In the event that adequate funds are not available, the Company's
business, prospects, financial condition and results of operations may be
materially adversely affected.
RISKS ASSOCIATED WITH BRAND DEVELOPMENT. The Company believes that establishing
and maintaining brand identity is a critical aspect of its strategy.
Furthermore, the Company believes that brand recognition will become
increasingly important as low barriers to entry encourage competition in the
software robot industry. In order to attract and retain customers and strategic
partners, and in response to competitive pressures, the Company intends to
substantially increase its financial commitment to the creation and maintenance
of brand development. The Company plans to accomplish this, although not
exclusively, through
<PAGE> 6
advertising campaigns in several forms of media, including radio, television,
print and trade shows, with a particular emphasis on the Internet channels. If
the Company does not generate a corresponding increase in revenue as a result of
its branding efforts or otherwise fails to promote its brand successfully, or if
the Company incurs excessive expenses in an attempt to promote and maintain its
brand, the Company's business, prospects, financial condition and results of
operations would be materially adversely affected.
RISKS OF DOING BUSINESS ABROAD. The Company anticipates that some of the
consultants it may hire to complete portions of the development work on its
products may be located in foreign countries. In addition, the Company intends
to organize additional subsidiaries in foreign countries. As a result, the
Company may be subject to a number of risks, including, among other things,
difficulties relating to administering its business globally, managing foreign
operations, currency fluctuations, restrictions against the repatriation of
earnings, export requirements and restrictions, and multiple and possibly
overlapping tax structures. The realization of any of the foregoing could have a
material adverse effect on the Company's business, prospects, financial
condition and results of operations.
During 2002, all European Union countries are expected to be operating with the
euro as their single currency. Uncertainty exists as to the effect the euro will
have on the marketplace. Additionally, all of the final rules and regulations
have not yet been defined and finalized by the European Commission with regard
to the euro currency. The Company cannot yet predict the anticipated impact of
the euro conversion on the Company.
DEPENDENCE ON THIRD PARTY LICENSES. The Company is designing its SmartBot
software products to recognize voice input as well as text-based input. The
voice recognition capabilities of these products will depend to a large extent
on the availability of highly accurate voice recognition software packages,
which the Company intends to license from third parties rather than develop
itself. The Company believes that the success of its products will depend to a
large extent on its ability to allow users to interact in a natural
conversational manner. There can be no assurance that the Company will be
successful in identifying third party voice recognition software which will
successfully interact with its products or that the Company will be able to
license such software products on commercially reasonable terms, or at all.
Failure by the Company to successfully identify viable voice recognition
software or enter into license agreements could have a material adverse effect
on the Company's business, prospects, financial condition and results of
operations.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES. The Company believes that it is
not currently subject to direct regulation by any domestic or foreign
governmental agency, other than regulations applicable to businesses generally.
However, due to the increasing popularity and use of the Internet, a number of
domestic and foreign laws and regulations covering issues such as user privacy,
pricing, content, copyrights, distribution and characteristics and quality of
products and services are being considered and may be enacted. The European
Community has already adopted a directive restricting the use of personal data.
The adoption of such laws or regulations may decrease the growth in use of the
Internet, which would, in turn, decrease the demand for the Company's products
and services and increase the Company's cost of doing business. Moreover, the
applicability to online services of existing domestic and foreign laws in
various jurisdictions governing issues such as intellectual property ownership,
sales and other taxes, libel and personal privacy is uncertain and may take
years to resolve. Any such new legislation or regulation, the application of
laws and regulations from jurisdictions whose laws do not currently apply to the
Company's business, or the application of existing laws and regulations to
online services could have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.
Tax authorities in a number of states are currently reviewing the appropriate
tax treatment of companies engaged in Internet commerce. New state tax
regulations may subject the Company to additional state sales and income taxes.
As some of the Company's products will be available over the Internet in
multiple states and foreign countries, such jurisdictions may claim that the
Company is required to qualify to do business as a foreign corporation in each
such state and foreign country. The failure by the Company to qualify as a
foreign
<PAGE> 7
corporation in a jurisdiction where it is required to do so could subject the
Company to taxes and penalties for the failure to do so. It is possible that the
governments of other states and foreign countries also might attempt to regulate
the Company's transmissions of content on its Web sites or prosecute the Company
for violations of their laws. There can be no assurance that violations of local
laws will not be alleged or charged by state or foreign governments, that the
Company might not unintentionally violate such law or that such laws will not be
modified, or new laws enacted, in the future.
In addition, several telecommunications carriers are petitioning to have
telecommunications over the Internet regulated by the Federal Communications
Commission (the "FCC") in the same manner as other telecommunications services.
In addition, because the growing popularity and use of the Internet has burdened
the existing telecommunications infrastructure and many areas with high Internet
use have begun to experience interruptions in phone service, local telephone
carriers, such as Pacific Bell, have petitioned the FCC to regulate Internet
service providers ("ISPs") and online service providers ("OSPs") in a manner
similar to long distance telephone carriers and to impose access fees on the
ISPs and OSPs. If either of these petitions is granted, or the relief sought
therein is otherwise obtained, the costs of communicating on the Internet could
increase substantially, potentially slowing the growth in use of the Internet.
Any such new legislation or regulation or application or interpretation of
existing laws could have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.
INTERNET COMMERCE SECURITY RISKS. A significant barrier to electronic commerce
and communications is the secure transmission of confidential information over
public networks. The Company relies on encryption and authentication technology
licensed from third parties to provide the security and authentication necessary
to effect secure transmission of confidential information. There can be no
assurance that advances in computer capabilities, new discoveries in the field
of cryptography or other events or developments will not result in a compromise
or breach of the algorithms used by the Company to protect data. If any such
compromise of the Company's security were to occur it could have a material
adverse effect on the Company's business, prospects, financial condition and
results of operations. The Company may be required to expend significant capital
and other resources to protect against the threat of such security breaches or
to alleviate problems caused by such breaches. Concerns over the security of
Internet transactions and the privacy of users may also inhibit the growth of
the Internet generally, and the Web in particular, especially as a means of
conducting commercial transactions. To the extent that activities of the Company
or third party contractors involve the storage and transmission of proprietary
information, security breaches could expose the Company to a risk of loss or
litigation and possible liability. There can be no assurance that the Company's
security measures will prevent security breaches or that failure to prevent such
security breaches would not have a material adverse effect on the Company's
business, prospects, financial condition and results of operations.
YEAR 2000 COMPLIANCE. The Company uses a significant number of computer software
programs and operating systems in its internal operations. The use of computer
programs that rely on two-digit date programs to perform computations and
decision-making functions may cause computer systems to malfunction in the Year
2000 and lead to significant business delays and disruptions. The Company has
analyzed the software applications that it uses or has developed and believes
that they are Year 2000 compliant. However, until the Year 2000 arrives, the
Company cannot be absolutely certain that its analysis is correct. The costs of
any Year 2000 remedial modifications must be expensed in the year incurred, and
thus will impact the Company's earnings. The Company is currently unable to
predict the extent to which it would be vulnerable to any failure by its clients
or suppliers to remediate any Year 2000 issues on a timely basis. The failure of
a client or supplier subject to the Year 2000 to convert its systems on a timely
basis or a conversion that is incompatible with the Company's systems could have
a material adverse effect on the Company's business, prospects, financial
condition and results of operations. In addition, the Company's products 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.
