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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, 1999
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 on March 17, 2000
was approximately $302,277,450.
As of March 17, 2000, the Registrant had 10,075,915 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, 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 continuing the development of 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 to process and respond to natural language commands or questions. The
ALife-SmartEngine contains several "intelligent" modules that process and
interpret manual input. 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 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." Most products come
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.
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ALIFE-WEBGUIDE: The Company released the Personal Version 1.0 of this SmartBot
in September 1998.; the Professional Version 1.0 in November 1998 and the
Enterprise Version in April 1999. These versions are 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. These SmartBot versions engage the user in a "conversation"
through questions and answers and, upon learning of the user's interests, are
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 versions run 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 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 designed to run on Microsoft Windows 95, 98 or
NT. 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, called BOTME by the Company, 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. In many cases, such as its current use
in the net-tissimo.com web site, it 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 first being designed to run on personal computers with
Microsoft Windows 98 or NT. The Company intends to release the Version of ALife-
SalesRep in 2000. 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 serves 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 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 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. It is intended that,
for a corporate purchaser using ALife-SalesRep, ALife-Messenger could
subsequently 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 supports standard e-mail systems. The Company released the
1.0 Version of the ALife-Messenger in April 1999. The Company markets 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 continuing to be
developed to monitor an individual's investment portfolio. Once the user's
portfolio guidelines are established, the ALife-Portfolio-Manager can 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 continuing to be
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 designed to run on personal computers with
Microsoft Windows 98 or NT. The Company released the 1.0 Version of the
ALife-Portfolio-Manager in November of 1999 on a project application basis only.
The Company anticipates that the ALife-Portfolio-Manager will first be
released for general distribution in March 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 and eCRM solution to a human or live
chat 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 is intended to link the customer directly to a
human call center agent.
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 June of
2000. The Company intends to market this product 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 use the product in its
Web Services to be launched by the Company in 2000.
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 to run on Windows 98 and NT or on
standard Internet browsers for on-line applications. The Company released the
first tutorial in July 1999 as a German language demonstration product focusing
on the life of Albert Einstein called Einstein ALife, and presently the generic
version is planned for release during the second quarter 2000. The Company's
target market for this product is expected to be the CBT and IBT market,
corporate intranets and extranets 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 with the
exception of the year-ended December 31, 1999. During the year ended December
31, 1999, approximately 25% of the Company's revenue was derived from license
sales. 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. 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
In its first year as a publicly traded company, Artificial Life focused on
developing its international presence, its sales and support infrastructure and
completing the development of several products and continuing the development of
others. From its St. Petersburg, Russia development facility, to sales and
support offices in Switzerland, Germany and the United States, the Company feels
it has achieved these primary goals. With these achievements noted and the first
clients in place, the Company will now focus its attention on global sales and
marketing, continued product development and Web Services.
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 intends to
embark on a promotional campaign to increase awareness of the Artificial Life
brand and the ALife family of products in the year 2000. The promotional
campaign is expected to involve traditional media (i.e., radio, television,
print and trade shows) together with an emphasis on Internet channels. The
initial campaign in print, online and television media began in November 1999.
Further, the Company has also begun presenting at targeted industry trade shows
and events.
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 and maintenance, customization and
consulting, licensing fees and potentially in the future, advertising and
subscription 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. In 1999, the Company signed a cooperation agreement
with PriceWaterhouse Coopers GmbH Germany (PwC) for joint sales and development
activities that are intended to leverage the existing client base and consulting
services of PwC to allow for the sale and integration of the Company's products
within the PwC consulting group client base.
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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 wholly owned European subsidiaries in Switzerland and Russia. In
October 1998, the Company formed 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 and act as a holding company for Artificial Life
Solutions AG, the Swiss operating company, and Artificial Life RUS, the Russian
research and development arm of the Company. In November 1998, Artificial Life
Europe AG formed the 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 established its German
subsidiary Artificial Life Deutschland AG ("Artificial Life Deutschland"),
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.
Also in the second quarter 1999, the Company established Artificial Life
Solutions AG. Headquartered in Switzerland, Artificial Life Solutions will focus
on strategic investments, product development, product customization, product-
related marketing and sales activities and general support to Swiss customers.
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
It is the Company's belief that its products will ultimately serve the World
Wide Web in a horizontal capacity but until significant branding is achieved,
targeted vertical markets will be its most effective method in achieving
installation success and product acceptance. The Company plans to sell and
market its products through a variety of methods and channels, including but not
limited to direct sales, distribution and channel agreements, strategic
relationships and third party providers. The Company believes joint ventures and
strategic relationships can be most effective in entering targeted vertical
markets while targeted direct sales can be most effective for large, must-have
clients. It is the Company's belief that this strategy will provide a cost
effective means of achieving maximum exposure for its products and services.
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In the first quarter of 1999, the Company began selling the ALife-WebGuide via
the Company's Web site and through additional distribution partners. Also, 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 is marketing and
selling the Enterprise version of the ALife-WebGuide, and other products as they
are released, and providing consulting services and training in the application
and use of Artifical Life's software products. In September 1999, the Company
signed a German market exclusive cooperation agreement with PriceWaterhouse
Coopers mbH Germany (PwC) for joint sales and development activities. These
efforts are intended to leverage the existing client base and consulting
services of PwC that will allow for the sale and integration of the Company's
products within PwC consulting group client base.
The Company is discussing a strategic relationship with an international entity
already established in the call center market to market and sell the ALife-Call-
Center-Agent. Due to the highly competitive nature of the call-center market,
the Company believes this joint approach has the greater probability of success.
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 enhance its direct marketing efforts by partnering with other selected
vertical market specific entities.
In addition to its prior marketing efforts for the individual products in the
ALife product suite, the Company began, in the second half of 1999 to initiate
marketing campaigns to establish recognition of the Artificial Life brand. These
marketing activities are expected to eventually involve traditional media
together with an emphasis on the Internet channels. The Company will 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. Additionally, the Company will use its own products, ALife-Messenger
and the ALife-WebGuide, to further promote its products and services.
STRATEGIC ALLIANCES AND JOINT VENTURES
In March 1999, the Company agreed to enter into a joint venture with the Bon
Appetit group of Switzerland in which Artificial Life's technology is
being used to offer a software robot based ecommerce solution. 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 licensed its SmartBot products to the
joint venture. Pursuant to a separate development agreement with the joint
venture, the Company will also provide products and software development and
consulting services to the 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 completed a contract for the first phase of a
development and consulting project with a European based global trust. The
project goal was to define and design the trust's future Internet-based
financial services. The successful completion of this phase led to a larger
scale implementation of this development project. As part of the transaction,
the Company is providing, for fees, licensed products and software consulting
services to the trust.
In September 1999 the Company signed a German market joint cooperation agreement
for the development and introduction of new technology for e-business with
PriceWaterhouse Coopers GmbH (Germany). Cooperatively, Pricewaterhouse Coopers
and Artificial Life will invest in the development of both sector-specific and
multifunctional products.
In February and March 2000 the Company signed cooperation agreements with
CyberOffice Communications AG and echtzeit AG, respectively. CyberOffice
Communications AG, a leading supplier of unified communications services intends
to develop new products and services by integrating ALife SmartBot(TM)
functionality into the existing communications and messaging services of the
Indepensis communications portal. The cooperation with echtzeit AG, one of
Europe's leading suppliers of virtual reality, 3D simulation, 3D telecom, and
information technology applications and services, is designed to benefit both
partners with business referrals, innovative Web services, and contract work.
Furthermore, the Company is constantly evaluating strategic alliances with
companies in the United States and Europe for marketing and selling products as
well as for collaborations in product development.
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.
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The Company's development organization is arranged in five 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 product and a research group. The Company
allocates responsibilities among the groups to optimize the time, cost and
quality control issues associated with product development.
As of December 31, 1999, there were 179 employees on the Company's development
staff. The total product development expenses for its ALife-SmartEngine product
suite increased significantly through 1999. The Company expects to allocate
substantial resources to future research and development activities. Through
December 31, 1999, the Company has incurred capitalized software development
costs from its development efforts in the amount of $1,366,093.
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: Ask Jeeves; Autonomy, Inc.;
Big Science Company; Brightware, Inc.; Broadvision, Inc.; Digital Marketing
Concepts, Inc.; eGain, 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 relies 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 endeavored to
cause its employees to execute forms of Confidentiality and Inventions
Agreements which provide that, to the extent permitted by applicable law, all
inventions conceived by an 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>
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, 1999, the Company had 220 full-time employees. Of the
Company's 220 full-time employees, 41 are involved in sales, marketing and
administrative functions and 179 are involved in engineering, 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 15,000
square feet of office space in Saint Petersburg, Russia. The 60 month lease
commenced December 1, 1998 at an annual rental of $35,000. The Company also
leased approximately 2,500 and 9,000 square feet of space in Switzerland and
Germany, at an approximate annual rent of $60,000 and $330,000, respectively,
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 Greater Boston, Massachusetts. Also in July of 1999, the Company began
renting on a short term basis, 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>
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.
HIGH LOW
------ -----
First Quarter $17.50 $ 9.50
Second Quarter 23.00 12.875
Third Quarter 15.00 9.00
Fourth Quarter 19.75 12.875
First Quarter (through March 17, 2000) 38.938 15.875
On March 17, 2000, the last reported sale price of the Common Stock was $30.00
per share. As of March 17, 2000, there were approximately 32 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.
In December 1999, New York Broker, Inc. exercised a portion of its warrant for
140,000 shares, utilizing the net exercise feature of its warrant.
Through December 31, 1999, the Company had temporarily invested excess net
proceeds of the IPO in savings and money market accounts with three major
financial institutions. The Company allocated up to $2,500,000 of such proceeds
to fund certain strategic alliances but used approximately $1,000,000 for such
alliances. The balance of the proceeds were used as general working capital to
fund internal developmental activities and expanded operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation - Liquidity and Capital Resources."
In February 2000, the Company concluded two private placements of Common shares.
Both transactions occurred at purchase prices that were at a premium to the
average closing price for five days prior to the transaction date. The first
transaction netted $2,562,500 to the Company in exchange for 102,500 common
shares; the second transaction netted $1,550,000 to the Company in exchange for
50,000 common shares. Costs related to these transactions were immaterial.
10
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following table presents summary selected historical financial data of the
Company as of and for each of the two years in the period ended December 31,
1996, the periods ended July 3, 1997 and December 31, 1997, and the years ended
December 31, 1998 and 1999 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
------------------- --------------------------------------
YEARS ENDED PERIOD PERIOD
DECEMBER 31, FROM FROM
------------------- JANUARY 1 JULY 4 TO DECEMBER 31,
TO JULY 3, DECEMBER 31, ----------------------
1995 1996 1997 1997 1998 1999
------ ------- ------ ------ ------- ------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Application services $ -- $ 2,790 $ 926 $ 420 $ 333 $ 2,769
Other -- -- 117 117 118 1,140
------ ------- ------ ------ ------- --------
Total revenues 1,217 2,790 1,043 537 451 3,909
------ ------- ------ ------ ------- --------
Operating expenses:
Selling, general and administrative 987 1,193 693 445 1,490 6,039
Engineering and cost of sales 848 702 332 220 640 3,566
Research and development -- -- -- -- 447 666
------ ------- ------ ------ ------- --------
Total operating expenses 1,835 1,895 1,025 665 2,577 10,271
------ ------- ------ ------ ------- --------
Income (loss) from operations (618) 895 18 (128) (2,126) (6,362)
Other income (expenses) (35) (15) -- 179 (65) (376)
------ ------- ------ ------ ------- --------
Income (loss) before tax (653) 880 18 51 (2,191) (6,738)
Provision (benefit) for income taxes (257) 337 5 7 -- 20
------ ------- ------ ------ ------- --------
Net income (loss) $ (396) $ 543 $ 13 $ 44 $(2,191) $ (6,758)
====== ======= ====== ====== ======= ========
Net income (loss) per share(2) $ (.07) $ .08 $ .00 $ .01 $ (.30) $ (.70)
Shares used in computing net
income (loss) per share(2) 5,574 6,967 6,967 6,967 7,289 9,590
<CAPTION>
PREDECESSOR SUCCESSOR
----------------------------------- ----------------------------------
AS OF DECEMBER 31, AS OF JULY 3 AS OF DECEMBER 31,
1995 1996 1997 1997 1998 1999
------ ------- ------ ------ ------- ------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents $ 23 $ 30 $ 38 $ 22 $ 11,688 $ 2,592
Working capital (deficit) (565) 74 132 171 11,335 2,565
Total assets 760 885 1,023 974 12,885 7,988
Long-term debt -- -- -- -- 500 --
Total stockholders' equity $ 82 $ 625 $ 638 $ 540 $ 11,769 $ 5,921
</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) 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>
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, accumulated deficit at December 31, 1999 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 Consolidated 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. Through 1998, the Company's
major source of revenue has been its software consulting services, and it
generated minimal revenue from the sale of its SmartBot software products.
However, in 1999 the Company realized its first significant software license
revenue. The Company continues to expand 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 transition in its primary business
focus from software consulting to product development, marketing and support,
the Company's research and development expenditures, excluding amounts included
in capitalized software development costs, increased from zero in 1997 to
$446,317 in 1998 and $666,046 in 1999. 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 1999, due to
the Company's shift in business focus, the Company had the majority 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>
RESULTS OF OPERATIONS
Fiscal 1999 realized the first significant software license revenues in Company
history. This is consistent with the Company's business strategy as changed to
reflect its focus on product development and license sales.
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. This
change in focus resulted in the Company, in fiscal 1999, realizing its first
significant software license revenue.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Revenues: Revenues for the year ended December 31, 1999 were $3,909,076 as
compared to $450,768 for the year ended December 31, 1998. The increase of
$3,458,308 or 767.20% is primarily due to a contract for licenses and support
entered into with a European trust.
Engineering and Cost of Sales: Engineering expenses generally consist of salary
and payroll tax expenses, training, consulting, subcontracting, and other
expenses incurred to develop and fulfill the engineering design specifications
of the products and service's from which the company derives its revenue.
Engineering expenses for the year ended December 31, 1999 were $3,566,192 as
compared to $640,237 for the year ended December 31, 1998. The increase of
$2,925,955 or 457.01% was due to support activities related to the Company's
product installations and related consulting thereof. The significant increases
in 1999 included salaries and benefits of $1,312,000, consulting expenses of
$515,000, travel of $190,000, recruitment fees of $158,000, amortization of
capitalized software development costs of $250,000 and depreciation expense of
$191,000.
Research & Development Expenses: Research and Development expenses are similar
in nature to engineering expenses with the exception being that they relate to
products in their initial stage and will generate revenue at a later date.
Research and Development expenses for the year ended December 31, 1999 were
$666,046 compared to $446,317 in the year ended December 31, 1998. The increase
of $219,729 or 49.23% is primarily due to costs associated with continued
product research and development related to the Company's product line. As a
result the entire research and development increase related to an increase in
salaries and benefits. The research and development expenses in 1999, like, 1998
are net of capitalized software development costs.
General and Administrative Expenses: General and Administrative Expenses consist
of salary and payroll tax expenses of administrative personnel, rent, and
professional fees and costs associated with employee benefits, supplies,
communications, and travel. General and Administrative expenses for the year
ended December 31, 1999 were $4,055,881 as compared to $1,310,875 for the year
ended December 31, 1998. The increase of $2,745,006 or 209.40% was due to
approximate increases in the following: professional fees, $1,000,000; salaries
and benefits of $840,000; travel, $200,000; with the balance mainly due to costs
associated with the Company's worldwide infrastructure buildup.
Marketing Expenses: Marketing expenses consists of salary, and payroll tax
expenses of marketing personnel, and costs relating to marketing materials,
promotional videos, advertising, trade show related expense, and public relation
activities. Marketing expenses for the year ended December 31, 1999 were
$1,982,694 compared to $179,286 for the year ended December 31, 1998. The
increase of $1,803,403 or 1005.88% was due to approximate increases in the
following: $500,000 for the addition of sales personnel, $200,000 for
promotional material and packaging of products; $800,000 was related to a media
marketing campaign and costs associated with trade shows and $200,000 for the
outside consultants to help market the Company.
Net Loss: Net Loss for the year ended December 31, 1999 was $6,758,214 as
compared to $2,191,206 for the year ended December 31, 1998. This increase of
4,567,008 or 208.42% was due to the following. The expansion in Europe,
including the Company's equity and net loss of the joint venture of $509,000,
accounted for approximately one half of this increase. The increased marketing
effort represented approximately another $1,000,000.
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 and Cost of Sales: Engineering expenses generally consist of salary
and payroll tax expenses, training, consulting, subcontracting and other
expenses incurred to develope 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 $640,237 as compared to
$220,091 for the period from July 4, 1997 to December 31, 1997. The increase of
$420,146 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.
General and Administrative Expenses: 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. General and administrative expenses for the year
ended December 31, 1998 were $1,310,875 as compared to $437,216 for the period
from July 4, 1997 to December 31, 1997. The increase of $873,659 was primarily
attributable to the difference in the length of the reporting periods and
increased costs in 1998 including professional fees ($63,568), travel and
entertainment ($43,326), franchise and excise taxes ($43,064), and employment
recruiting ($26,384). In addition general and administrative expenses for the
newly established European operations amounted to $131,042 in 1998.
Marketing Expenses: Marketing expenses consist of salary, and payroll taxes
expenses of marketing personnel, and costs relating to marketing materials such
as promotional videos, advertising, trade show related expenses and public
relation activities. Marketing expenses for the year ended 1998 were $179,286 as
compared to $7,900 in for the period from July 4, 1997 to December 31, 1997. The
increase of $171,386 was mainly due to the addition of a marketing personnel
($62,000) and Public Relations expense of ($110,000).
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>
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 and Cost of Sales: Engineering expenses for the period from July 4,
1997 through December 31, 1997 were $220,091 as compared to $293,104 for the
period from January 1, 1997 through July 3, 1997. The decrease of $73,013 or
24.91% 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.
General and Administrative Expenses:, General and administrative expenses for
the period from July 4, 1997 through December 31, 1997 were $437,216 as compared
to $662,474 for the period from January 1, 1997 through July 3, 1997. The
decrease of $225,258 or 34.00% is attributable to reduced overhead associated
with the Company's reduction in contractual consulting services after the
Management Buyout.
Marketing Expenses: Marketing Expenses for the period for July 4, 1997 through
December 31, 1997 were $7,900 as compared to $30,645 for January 1, 1997 through
July 3, 1997. The decrease of $22,745 or 74.0% is attributable to reduced
overhead 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.
14
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
From inception through July 3, 1997, the Company funded its operations primarily
through initial equity investments in 1994 and 1995 totaling $500,000 and net
income from operations. Subsequent to July 3, 1997, the Company incurred
operating losses in connection with its transition from software consulting to
product development, marketing and sales. These losses are expected to increase
and have been funded to date by a long-term stockholder loan of $500,000, a
private placement of 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. During 1999,
optionholders of the Company exercised options netting the Company approximately
$1,300,000, which was received in 1999 and the first quarter of 2000. In
February 2000, the Company concluded two private placements of Common Stock.
Both transactions occurred at purchase prices that were at a premium to the
average closing price for five days prior to the transaction date. The first
transaction netted $2,562,500 to the Company in exchange for 102,500 common
shares; the second transaction netted $1,550,000 to the Company in exchange for
50,000 common shares. Costs related to either of these transactions were
immaterial. 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 certain office equipment under
various noncancelable leases. Minimum annual lease payments, exclusive of
additional operating costs, for the years ended December 31, 2000, 2001, 2002
and 2003 are approximately $700,000, $450,000, $430,000 and $430,000
respectively.
The Company has an employment agreement its Chief Executive Officer. The
agreement is three years in length and provides for a minimum base salary. The
agreement includes severance payments under certain conditions of approximately
300% of 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 entered 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
licensed its SmartBot technology to the joint venture. In addition, the Company
provided 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 purchasing relationships to obtain certain consumer
products which will be sold on the joint venture's e-commerce Website. The
Company 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 completed a contract for the first phase of a
development and consulting project with a European based global trust. The
project goal was to define and design the trust's future Internet-based
financial services. The successful completion of this phase led to a larger
scale implementation of this development project. As part of the transaction,
the Company is providing licensed products and software consulting services to
the trust.
The Company believes that the net proceeds of the IPO and private placements,
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 January 2001, 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 losses for income tax purposes for fiscal years 1998
and 1999. These losses will be available to carry forward and reduce income
taxes, if any, in future periods.
15
<PAGE>
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. The Company
is not aware of any problems that have arisen from the Year 2000 issue and as a
result does not believe its operations have been affected in any material way.
All costs associated with internal and product specific reviews of Year 2000
compliance that were completed in 1999 were immaterial to the Company's 1999
operating results.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company maintains its cash and cash equivalents in checking, savings, and
money market accounts. Approximately 60% of these deposits are denominated in
U.S. dollars. Approximately 35% of these deposits are denominated in Euros and
the remainder is demoninated in Swiss Franc. 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 cash
denominated in non-U.S. currency units is subject to exchange risks as well as
interest rate risks. The Company believes that a hypothetical 10% increase or
decrease in either interest or exchange rates, however, would not have a
material adverse effect on the Company's financial condition.
16
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Consolidated Financial Statements and supplementary data appear at pages F-1
through F-24 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 December 31, 1998 and
December 31, 1999 (Successor)................................................... F-2
Consolidated Statements of Operations for the periods January 1, 1997 to
July 3, 1997 (Predecessor) and July 4, 1997 to December 31,
1997, and for the years ended December 31, 1998 and 1999
(Successor)...................................................................... F-3
Consolidated Statements of Changes in Stockholders' Equity
for the periods January 1, 1997 to July 3, 1997
(Predecessor) and July 4, 1997 to December 31, 1997 and for the years ended
December 31, 1998 and 1999 (Successor).......................................... F-4
Consolidated Statements of Cash Flows for the periods January 1, 1997 to
July 3, 1997 (Predecessor) and July 4, 1997 to December 31,
1997, and for the years ended December 31, 1998 and 1999 (Successor)............. F-5
Notes to Consolidated Financial Statements........................................... F-6-F-25
</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, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Eberhard Schoneburg............................. 43 President, Chief Executive Officer and Chairman of the Board
Bruno Gabriel................................... 53 Director
Elmar Wohlgensinger............................. 60 Director
Hartmut Bergmann................................ 49 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>
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. In
January 1999 he became Chief Executive Officer of Artificial Life Europe AG.
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. Mr. Bergmann resigned his position in February, 2000.
Felix Widmer was appointed by the Board of Directors in March 2000 to fill the
vacancy created by Mr. Bergmann's resignation in February 2000. He has worked
for Widmer Management, a consulting firm he founded in Switzerland, since 1997.
Prior to that he worked at Guebelin Ltd/Guebelin Inc. of Lucerne, Switzerland
and New York, NY from 1972 to 1996 in a variety of capacities, including
Executive Vice President, Vice President and Director of Finance and
Administration. Previously he worked for the Federal Tax Authority of
Switzerland.
EXECUTIVE OFFICERS. The following table sets forth certain information regarding
the executive officers of the Company as of December 31, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Eberhard Schoneburg............................. 43 President, Chief Executive Officer and Chairman of the Board
Daniel Sapir.................................... 50 Chief Operating Officer
Robert Pantano.................................. 39 Chief Financial Officer
Klaus Kater..................................... 32 Chief Technology Officer
</TABLE>
Daniel Sapir, the Company's Chief Operating Officer, joined the Company in
August 1999. From 1998 until that time, he was CEO of iCentric Solutions, Inc.,
an internet application software company. From 1989 to 1997 he worked at Data
General Corporation as the Vice President of the Enterprise Solutions Business
Unit. From 1987 to 1989 he worked at McDonnell Information Systems as the
Director of Sales for Enterprise Applications and prior to that Mr. Sapir was at
Allerion Corporation as the Director of Channel Sales-Western Operations.
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.S. in Accountancy 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>
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 1999 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, 1999 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
$100,000 in the fiscal year ended December 31, 1999.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG TERM COMPENSATION
-----------------------------------------------------
OTHER ANNUAL SECURITIES
NAME AND PRINCIPAL POSITION(1) YEAR SALARY($) COMPENSATION UNDERLYING OPTIONS
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Eberhard Schoneburg 1999 $263,538 300,000
President and Chief 1998 $240,414 $ 0 0
Executive Officer(2)........... 1997 54,254 22,500(3) 0
Bruno Gabriel(5)
Chief Executive Officer-
Artificial Life Europe AG...... 1999 $216,496 $ 0 200,000
Robert Pantano 1999 $121,923 61,388
Chief Financial Officer........ 1998 $100,080 $ 0 41,442
1997 70,079 0 0
Klaus Kater 1999 $121,923 61,388
Chief Technical Officer........ 1998 $ 57,692 41,442
</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.
(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.
(4) Daniel Sapir became the Company's Chief Operating Officer in August 1999,
but did not have a total compensation which exceeded $100,000 in the
fiscal year ended December 31, 1999. However, Mr. Sapir currently has an
annual base salary of $130,000.
(5) In 1998 Bruno Gabriel provided services to the Company as an independent
consultant. Total compensation in 1998 amounted to $173,537; In addition,
on June 30, 1998, he was granted options to purchase 184,426 shares of
Common Stock at an exercise price of $3.66 per share, exercisable
immediately.
OPTION GRANTS. The following table sets forth certain information regarding
options granted during the fiscal year ended December 31, 1999 by the Company to
the Named Executive Officers.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANT
--------------------------------------------------------- POTENTIAL REALIZABLE VALUE
NUMBER OF PERCENT OF AT ASSUMED ANNUAL RATES OF
SECURITIES TOTAL OPTIONS EXERCISE STOCK PRICE APPRECIATION FOR
UNDERLYING GRANTED TO OR BASE OPTION TERM
OPTIONS EMPLOYEES IN PRICE EXPIRATION ----------------------------
NAME AND PRINCIPAL POSITION GRANTED (#) FISCAL YEAR (%) ($/SHARE) DATE 5% ($) 10% ($)
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Eberhard Schoneburg 300,000 20.1% $ 14.50 8/31/02 $685,669 $1,439,850
Robert Pantano 60,000 4.0% $ 14.50 4/1/02 137,400 288,000
1,388 0.1% $ 17.94 11/15/01 2,554 5,233
Klaus Kater 60,000 4.0% $ 14.50 4/1/02 137,400 288,000
1,388 0.1% $ 17.94 11/15/01 2,554 5,233
Daniel Sapir 25,000 1.7% $ 13.00 8/13/03 70,000 150,750
Bruno Gabriel 200,000 13.4% $ 14.50 8/13/02 458,000 960,000
</TABLE>
<PAGE>
OPTION EXERCISES.
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 ($)
ACQUIRED ON VALUE -------------------------- --------------------------
NAME EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ------------ ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Eberhard Schoneburg.......... 0 0 0 300,000 0 1,012,500
Robert Pantano............... 0 0 62,830 40,000 585,508 135,000
Klaus Kater.................. 0 0 62,830 40,000 585,508 135,000
Daniel Sapir................. 0 0 0 25,000 0 121,875
Bruno Gabriel(1)............. 139,426 2,091,387 0 200,000 0 675,000
</TABLE>
- --------------------
(1) Bruno Gabriel exercised an option to purchase 184,426 shares of Common
Stock, utilizing a net exercise feature, resulting in the issuance of
139,426 shares of Common Stock.
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.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. Messrs.
Wohlgeninger and Bergmann, both non-employee directors, constitute the Company's
Compensation Committee. Subsequent to Year-End, Mr. Bergmann resigned as a
director. Mr. Widner was selected by the remaining directors to succeed him as a
director and on this 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 17, 2000 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>
<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 55.3%
Robert Pantano (4).............................................................................. 62,830 0.6%
Klaus Kater (4)................................................................................. 62,830 0.6%
Bruno Gabriel .................................................................................. 729,426 7.2%
Elmar Wohlgensinger ............................................................................ 227,934 2.3%
Hartmut Bergmann................................................................................ 0 *
Felix Widmer.................................................................................... 6,000 *
All current directors and executive officers as a group (6 persons)............................. 6,956,397 68.2%
</TABLE>
* Less than 1%
(1) Shares of Common Stock that an individual or group has the right to
acquire within 60 days of March 17, 2000, 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 shares of Common Stock outstanding as
of March 17, 2000.
(4) Consists solely of shares subject to stock options which are currently
exercisable.
(5) Includes 125,660 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."
22
<PAGE>
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, was originally due and payable on January 1, 2000.
Subsequent to year end the due date of the note was extended to April 30, 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. During the period from September 26, 1998 to December 31,
1999, the Company advanced Mr. Shoneburg approximately $547,525 for living and
personal expenses. Mr. Shoneburg repaid or applied against amounts owed him a
total of $626,893. The balance due the Company as of December 31, 1999 was
$43,479.
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 June 1999, the Company acquired 51% of the outstanding stock of Cybermind
Ventures, Inc. ("Cybermind") for $75,000 from two of the Company's stockholders,
Eberhard Schoneburg and Cybermind Interactive AG. Cybermind was inactive with a
net loss in 1999 through the date of acquisition of $5,520. At the time of the
acquisition, Cybermind's name was changed to Artificial Life Ventures, Inc. In
November 1999, the Company acquired the remaining 49% of the outstanding stock
of Artificial Life Ventures, Inc. from Cybermind Interactive AG. The Company
acquired this stock for $75,000 cash and the issuance of 5,000 stock options at
an exercise price of $14.50 per share. The options are valued at $25,000 and
have a three year life and vest in equal amounts on the first, second and third
anniversary of the grant date. Goodwill recognized in connection with this
acquisition amounted to approximately $86,000, and is being amortized over five
years.
<PAGE>
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.
EXHIBIT NO. DESCRIPTION
- ----------- -----------
*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.
24
<PAGE>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
*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.
10.12 Lease Agreement dated March 30, 1999 between the company
(Artificial Life Deutschland A.G.) and Internationales
Immobilien.
10.13 Lease Agreement dated December 31, 1999 between the company
(Artificial Life Rus) and the Association of Concert
Performers in the Russian Federation (ARENDODATEL).
10.14 Lease Agreement dated October 1, 1999 between the company
(Artificial Life Solutions) and Vierwaldstatter Bereiligungen
AG.
10.15 Lease Agreement dated July 1, 1999 between the company
(Artificial Life Solutions) and Vierwaldstatter Bereiligungen
AG.
25
<PAGE>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.16 Lease Agreement dated August 1, 1999 between the company
(Artificial Life Solutions) and Charles Barrier Immobilien.
10.17 A June 1999 Stock Purchase Agreement between the Company and
Eberhard Schoneburg for the Purchase of 490,000 Shares of
Cybermind Ventures, Inc.
10.18 A June 1999 Stock Purchase Agreement between the Company and
Cybermind Interactive AG for the Purchase of 20,000 Shares of
Cybermind Ventures, Inc.
10.19 A Member 1999 Stock Purchase Agreement between the Company and
Cybermind Interactive AG for the Purchase of 490,000 Shares of
Cybermind Ventures, Inc.
21 Subsidiaries of the Company
27.1 Financial Data Schedule
99.1 Important Factors Regarding Forward-Looking Statements
*Previously filed.
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, 2000.
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 March 29, 2000
Eberhard Schoneburg executive officer)
/s/ Robert Pantano Chief Financial Officer (Principal
- ------------------------ financial and accounting officer) March 29, 2000
Robert Pantano
/s/ Bruno Gabriel
- ------------------------
Bruno Gabriel Director March 29, 2000
/s/ Elmar Wohlgensinger
- ------------------------
Elmar Wohlgensinger Director March 29, 2000
</TABLE>
- ------------------------
Felix Widmer Director [ ]
26
<PAGE>
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 December 31, 1998 and
1999 (Successor), and the related consolidated statements of operations, changes
in stockholders' equity and cash flows for the periods ended July 3, 1997
(Predecessor) and December 31, 1997 and the years ended December 31, 1998 and
1999 (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 December 31, 1998 and 1999, and the consolidated results of its
operations and its cash flows for the periods ended July 3, 1997 and December
31, 1997, and the years ended December 31, 1998 and 1999, in conformity with
generally accepted accounting principles.
WOLF & COMPANY, P.C.
Boston, Massachusetts
March 14, 2000
F-1
<PAGE>
ARTIFICIAL LIFE, INC.
(formerly Neurotec International Corp.)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
Successor
------------------------------
December 31,
1998 1999
------------ ------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 11,687,829 $ 2,592,388
Accounts receivable, trade - 1,094,430
Accounts receivable, affiliate - 346,172
Due from officer/stockholders 122,728 51,708
Notes receivable affiliate 40,000 -
Deposits - 227,858
Refundable foreign taxes - 121,444
Prepaid expenses and other current assets 99,958 198,640
------------ ------------
Total current assets 11,950,515 4,632,640
------------ ------------
Property and equipment:
Computer equipment 545,680 1,743,792
Furniture and fixtures 145,281 499,211
Leasehold improvements 45,544 95,381
Office equipment 57,620 166,087
------------ ------------
794,125 2,504,471
Less accumulated depreciation and amortization 160,274 638,749
------------ ------------
633,851 1,865,722
------------ ------------
Other assets:
Costs in excess of fair value of net assets acquired,
net of accumulated amortization of $5,306 - 99,520
Capitalized software development costs, net of
accumulated amortization of $246,737 in 1999 215,169 1,119,356
Investment in unconsolidated subsidiary 48,951 186,186
Deposits and other assets 36,234 84,887
------------ ------------
300,354 1,489,949
------------ ------------
$ 12,884,720 $ 7,988,311
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 444,367 $ 980,979
Note payable - officer/stockholder - 500,000
Accrued expenses 171,267 586,283
------------ ------------
Total current liabilities 615,634 2,067,262
------------ ------------
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,
9,270,574 shares issued and outstanding in 1998
and 9,863,415 shares issued and outstanding in 1999 92,706 98,634
Additional paid-in capital 13,929,618 15,563,784
Notes receivable from stockholders (79,423) (749,981)
Accumulated deficit (2,147,266) (8,905,480)
Accumulated other comprehensive loss (26,549) (85,908)
------------ ------------
Total stockholders' equity 11,769,086 5,921,049
------------ ------------
$ 12,884,720 $ 7,988,311
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
ARTIFICIAL LIFE, INC.
(formerly Neurotec International Corp.)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Predecessor | Successor
------------- | ----------------------------------------------
Period from | Period from
January 1 | July 4 to Year Ended Year Ended
to July 3, | December 31, December 31, December 31,
1997 | 1997 1998 1999
------------- | ----------- ------------ ------------
<S> <C> | <C> <C> <C>
Revenues: |
Trade: |
Software license agreements $ 116,667 | $ 116,667 $ 116,667 $ 1,127,500
Application services 260,518 | 222,393 332,713 2,087,560
Software products - | - 1,388 12,243
------------- | ----------- ------------ ------------
377,185 | 339,060 450,768 3,227,303
|
Former Parent and Affiliates 666,229 | 197,948 - 681,773
------------- | ----------- ------------ ------------
|
Total revenues 1,043,414 | 537,008 450,768 3,909,076
------------- | ----------- ------------ ------------
|
Operating expenses: |
General and administrative 662,474 | 437,216 1,310,875 4,055,881
Engineering - former parent 39,168 | - - -
Engineering and cost of sales 293,104 | 220,091 640,237 3,566,192
Research and development - | - 446,317 666,046
Sales and marketing 30,645 | 7,900 179,286 1,982,694
------------- | ----------- ------------ ------------
Total operating expenses 1,025,391 | 665,207 2,576,715 10,270,813
------------- | ----------- ------------ ------------
|
Income (loss) from operations 18,023 | (128,199) (2,125,947) (6,361,737)
|
Other income (expenses): |
Cancellation fee income - | 189,938 - -
Foreign exchange gain (loss) 3,579 | (9,285) (985) (112,180)
Equity in loss of unconsolidated subsidiary - | - - (508,884)
Writedown of investment in unconsolidated |
subsidiary - | - (49,637) (45,965)
Interest income - | - 18,620 344,038
Interest expense (3,399) | (1,848) (33,257) (53,984)
------------- | ----------- ------------ ------------
Income (loss) before provision |
for income taxes 18,203 | 50,606 (2,191,206) (6,738,712)
|
Provision for income taxes 5,534 | 6,666 - 19,502
------------- | ----------- ------------ ------------
|
Net income (loss) $ 12,669 | $ 43,940 $ (2,191,206) $ (6,758,214)
============= | =========== ============ ============
|
Basic and diluted net income (loss) per share $ - | $ 0.01 $ (0.30) $ (0.70)
|
Weighted average shares outstanding |
used in per share calculation 6,967,213 | 6,967,213 7,289,385 9,590,074
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
ARTIFICIAL LIFE, INC.
(formerly Neurotec International Corp.)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Comprehensive
Income Preferred Stock Common Stock
----------------------------- -------------------------
(Loss) Shares Amount Shares Amount
------------- ------------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
PREDECESSOR
Balance at December 31, 1996 - $ - 6,967,213 $69,672
Net income $ 12,669 - - - -
============= ------------- ---------- --------- ----------
Balance at July 3, 1997 - - 6,967,213 69,672
SUCCESSOR
Fair value adjustments related
to the Management Buyout and
change in control - - - -
Net income $ 43,940 - - - -
============= ------------- ---------- --------- ----------
Balance at December 31, 1997 - - 6,967,213 69,672
Issuance of common stock - - 2,303,361 23,034
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
Issuance of common stock - - 592,841 5,928
Issuance of stock options in connection
with acquisition - - - -
Repayment of notes receivable from
stockholders net of increases for
accrued interest - - - -
Comprehensive income:
Net loss $ (6,758,214) - - - -
Foreign currency translation
adjustment (59,359) - - - -
-------------
Total comprehensive
loss $ (6,817,573)
============= ------------- ---------- --------- ----------
Balance at December 31, 1999 - $ - 9,863,415 $98,634
============= ========== ========= ==========
<CAPTION>
Accumulated
Additional Retained Other Total
Paid-in Notes Earnings Comprehensive Stockholders'
Capital Receivable (Deficit) Loss Equity
-------------- ------------- --------------- --------------- --------------
<S> <C> <C> <C> <C> <C>
PREDECESSOR
Balance at December 31, 1996 $ 430,328 $ - $ 125,415 $ - $ 625,415
Net income - - 12,669 - 12,669
-------------- ------------- --------------- --------------- --------------
Balance at July 3, 1997 430,328 - 138,084 - 638,084
SUCCESSOR
Fair value adjustments related to the
Management Buyout and change
in control (3,761) - (138,084) - (141,845)
Net income - - 43,940 - 43,940
-------------- ------------- --------------- --------------- --------------
Balance at December 31, 1997 426,567 - 43,940 - 540,179
Issuance of common stock 13,503,051 (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 13,929,618 (79,423) (2,147,266) (26,549) 11,769,086
Issuance of common stock 1,609,166 (674,999) - - 940,095
Issuance of stock options in
connection with acquisition 25,000 - - - 25,000
Repayment of notes receivable from
stockholders net of increases for
accrued interest - 4,441 - - 4,441
Comprehensive income:
Net loss - - (6,758,214) - (6,758,214)
Foreign currency translation
adjustment - - - (59,359) (59,359)
Total comprehensive
loss
-------------- ------------- --------------- --------------- --------------
Balance at December 31, 1999 $ 15,563,784 $ (749,981) $(8,905,480) $(85,908) $ 5,921,049
============== ============= =============== =============== ==============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
ARTIFICIAL LIFE, INC.
(formerly Neurotec International Corp.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Predecessor Successor
------------------ | ---------------------------------------------
Period from | Period from
January 1 | July 4 to Year Ended Year Ended
to July 3, | December 31, December 31, December 31,
1997 | 1997 1998 1999
------------------ | ----------------- ------------ -------------
<S> <C> | <C> <C> <C>
Cash flows from operating activities: |
Net income (loss) $ 12,669 | $ 43,940 $(2,191,206) $(6,758,214)
Adjustments to reconcile net income (loss) to net cash |
provided (used) by operating activities: |
Depreciation and amortization 84,368 | 45,066 110,097 698,403
Unrealized foreign exchange gain (9,078) | - - -
Writedown of investment in unconsolidated subsidiary - | - 49,637 45,965
Equity in loss of unconsolidated subsidiary - | - - 508,884
Intercompany profit elimination - | - - 327,200
Interest income accrued on note receivable from
stockholder - | - - (66,375)
(Increase) decrease in due from former parent and |
affiliates 60,125 | (52,122) 243,499 (368,547)
(Increase) decrease in accounts receivable, trade (206,673) | (66,514) 273,187 (1,102,426)
(Increase) decrease in other assets (26,527) | (42,613) 23,978 (510,279)
Increase (decrease) in accounts payable and accrued |
expenses 134,111 | (16,415) 325,538 984,244
Increase (decrease) in deferred revenue - | 116,667 (116,667) -
Increase (decrease) in due to/from |
officer/shareholders (3,802) | 30,817 (149,740) 74,261
--------- | -------- ------------- -----------
Net cash provided (used) by operating activities 45,193 | 58,826 (1,431,677) (6,166,884)
--------- | -------- ------------- -----------
|
Cash flows from investing activities: |
Purchases of property and equipment (37,396) | (5,536) (474,025) (1,820,027)
Investments in unconsolidated subsidiary and joint venture - | - (99,274) (1,022,269)
Expenditures for capitalized software development costs - | - (210,058) (1,100,592)
Expenditures for business acquisitions - | - - (229,937)
Net assets acquired in business acquisitions - | - - 147,890
Decrease (increase) in notes receivable affiliate - | - (40,000) 40,000
--------- | -------- ------------- -----------
Net cash used by investing activities (37,396) | (5,536) (823,357) (3,984,935)
--------- | -------- ------------- -----------
|
Cash flows from financing activities: |
Repayment of note payable to former parent - | (68,844) - -
Repayment of notes receivable from stockholders - | - - 70,816
Proceeds from note payable - officer/stockholder - | - 500,000 -
Proceeds from issuance of common stock - | - 13,446,662 940,095
--------- | -------- ------------- -----------
Net cash provided (used) by financing activities - | (68,844) 13,946,662 1,010,911
--------- | -------- ------------- -----------
|
Effect of exchange rate changes on cash - | - (26,181) 45,467
--------- | -------- ------------- -----------
|
Net increase (decrease) in cash and cash equivalents 7,797 | (15,554) 11,665,447 (9,095,441)
|
Cash and cash equivalents at beginning of period 30,139 | 37,936 22,382 11,687,829
--------- | -------- ------------- -----------
|
Cash and cash equivalents at end of period $ 37,936 | $ 22,382 $11,687,829 $ 2,592,388
========= | ======== ============= ===========
|
Supplemental disclosure of cash flow information: |
Income taxes paid $ - | $ - $ 2,000 $ 19,502
Interest paid 3,399 | 1,848 8,257 78,984
Note receivable received upon exercise of stock options - | - - 674,999
Stock options issued in business acquisition - | - - 25,000
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Periods January 1, 1997 to July 3, 1997
and July 4, 1997 to December 31, 1997 and the Years Ended
December 31, 1998 and 1999
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. In
1998, the Company 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 1997, 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.
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.
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.
F-6
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
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 subsequently, 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
Stansstad, 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.
In March 1999, the Company formed a wholly-owned subsidiary Artificial Life
Deutschland AG, ("Artificial Life Germany") located in Frankfurt, Germany. The
subsidiary was formed to serve European markets and combine the Company's
European sales and marketing initiatives. The subsidiary commenced operations in
June 1999 and concentrates on the development of Internet applications for banks
and financial service organizations.
In June, 1999, Artificial Life Europe formed a wholly-owned subsidiary
Artificial Life Solutions, AG located in Stansstad, Switzerland. The subsidiary
was formed principally to provide software development and product support for
customers in the Switzerland area.
Also in, June 1999, the Company acquired 51% of the outstanding stock of
Cybermind Ventures, Inc. ("Cybermind") for $75,000 from two of the Company's
stockholders. Cybermind was inactive with a net loss in 1999 through the date of
acquisition of $5,520. At the time of the acquisition, Cybermind's name was
changed to Artificial Life Ventures, Inc. ("Artificial Life Ventures"). In
November 1999, the Company acquired the remaining 49% of the outstanding stock
of Artificial Life Ventures from a stockholder of the Company. The Company
acquired this stock for $75,000 in cash and the issuance of 5,000 stock options
at an exercise price of $14.50 per share. The options are valued at $25,000,
have a three year life and vest in equal amounts on the first, second and third
anniversary of the grant date. Goodwill recognized in connection with this
acquisition amounted to approximately $86,000, and is being amortized over five
years.
F-7
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
In October 1999, Artificial Life Europe acquired all the outstanding common
stock of IT Partners AG ("IT") for 120,000 Swiss Francs (approximately $80,000).
IT is a Swiss company organized in June 1999 as a dealer of computer and other
equipment and to provide related consulting services. IT was inactive through
the date of acquisition. Goodwill recognized in connection with this acquisition
amounted to approximately $19,000, and is being amortized over five years.
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 three major financial institutions in 1998 and
two major financial institutions in 1999.
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.
In 1999, the Company recognized revenues from one customer in the amount of
$2,483,467, representing 63.5% of its total revenues. At December 31, 1999, 83%
of accounts receivable, trade was due from this customer. Also in 1999, the
Company recognized revenues, after elimination of unrealized intercompany
profit, from license and application services sales to a joint venture of the
Company in the amount of $681,773, representing 17.4% of its total revenues. At
December 31, 1999 the entire accounts receivable, affiliate was due from the
joint venture.
F-8
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
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, Artificial Life Rus, Artificial Life
Solutions, Artificial Life Germany, Artificial Life Ventures and IT. All
significant intercompany balances and transactions have been eliminated.
All assets and liabilities of Artificial Life Europe, including its
subsidiaries Artifical Life Solutions and IT, which has the Swiss Franc as its
functional currency, Artificial Life Rus which has the Russian Rouble as its
functional currency, and Artificial Life Germany, which has the Euro as its
functional currency, are translated at the year end exchange rate. The
operations of these companies 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.
Estimated Useful Lives
------------------------
Classification Predecessor Successor
-------------- ------------ ----------
Computer equipment....................... 3-5 years 3 years
Furniture and fixtures................... 7 years 5 years
Leasehold improvements................... Lease term Lease term
Office equipment......................... 5 years 4 years
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
two-year period or the proportion of current sales to estimated future revenues
of the product.
F-9
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
Revenue Recognition
The Company recognizes revenues 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.
Advertising Expense
Advertising costs are charged to expense when incurred. Advertising costs
amounted to $660,090 in 1999. There were no advertising costs prior to 1999.
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-10
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
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, 1998 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.
Reclassification
Certain items previously reported in specific financial statement captions
have been reclassified to conform with the 1999 presentation.
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 applications revenue of $666,229 and $197,948 for 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 DM 120,000. The advances were due on September 30, 1997 with
interest at 8.5%. Interest expense on these advances amount to $3,399 and
$1,848 for 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 $39,168 for the period from January 1,
F-11
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997 to
December 31, 1997 and the Years Ended December 31, 1998 and 1999
1997 to July 3, 1997. No services were rendered by the former parent after the
Management Buyout.
(d) Through July 3, 1997, the Company charged the former parent company
for various expenses paid by the Company on its behalf as follows:
<TABLE>
<CAPTION>
Predecessor
---------------
Period From
January 1,
to July 3, 1997
---------------
<S> <C>
Expenses paid by the Company on behalf of the
former parent:
Consortium Agreement ...................... $46,875
Engineering costs ......................... 8,873
Travel and promotion ...................... 1,497
-------
$57,245
=======
</TABLE>
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 the Company's President, Chief Executive Officer and
Chairman amounted to $54,254 and $22,500 for 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 in 1998
and $264,000 in 1999.
F-12
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997
and July 4, 1997 to December 31, 1997
and the Years Ended December 31, 1998 and 1999
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 and 1999
amounted to $25,000 and $50,000, respectively, on the note payable. Subsequent
to year-end, the note was extended to April 30, 2000.
In 1998, the Company made advances totaling $40,000 to Artificial Life
Ventures, a company originally owned by a stockholder and an officer/stockholder
of the Company. The advances are unsecured, bear interest at 10% and were due on
December 31, 1999. In 1999, the Company purchased all of the outstanding stock
of this affiliate.
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.
See also Notes 1 and 9.
F-13
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
4. Income Taxes
The income tax provision (benefit) consists of:
<TABLE>
<CAPTION>
Predecessor Successor
----------------- -----------------------------------------------------------------
Period from Period from
January 1 July 4 to Year Ended Year Ended
to July 3, December 31, December 31, December 31,
1997 1997 1998 1999
----------------- --------------------- --------------------- ---------------
<S> <C> <C> <C> <C>
Current:
Federal $ 3,039 $ 3,661 $ (1,710) $ -
State 2,495 3,005 - -
Foreign - - - 19,502
----------------- --------------------- --------------------- --------------
5,534 6,666 (1,710) 19,502
----------------- --------------------- --------------------- --------------
Deferred (prepaid):
Federal - - 1,710 -
State - - - -
Foreign - - - -
----------------- --------------------- --------------------- --------------
- - 1,710 -
----------------- --------------------- --------------------- --------------
$ 5,534 $ 6,666 $ - $ 19,502
================= ===================== ===================== ==============
</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
January 1 July 4 to Year Ended Year Ended
to July 3, December 31, December 31, December 31,
1997 1997 1998 1999
----------------- --------------------- --------------------- ---------------
<S> <C> <C> <C> <C>
Expected income tax expense (benefit) $ 6,189 $ 17,206 $ (745,010) $(2,291,162)
State taxes, net of federal income tax
benefit 1,647 1,983 (137,389) (238,022)
Surtax exemption (3,458) (2,295) - -
Foreign tax rate differences - - - 233,453
Change in valuation reserve on deferred
tax asset - (12,532) 826,618 2,452,142
Other 1,156 2,304 55,781 (136,909)
----------------- --------------------- --------------------- ---------------
Provision (benefit) for income
taxes $ 5,534 $ 6,666 $ - $ 19,502
================= ===================== ===================== ===============
</TABLE>
F-14
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities at December 31, 1998 and 1999 are presented
below:
Successor
--------------------------
December 31,
1998 1999
------------ ------------
Deferred tax assets:
Federal net operating loss carryforward $ 687,839 $ 1,999,003
State net operating loss carryforward 190,476 554,361
Foreign net operating loss carryforward - 593,172
Equity in loss of unconsolidated subsidiary - 204,928
Start-up costs capitalized for income tax purposes 23,793 1,087
Other 4,182 4,182
------------ ------------
906,290 3,356,733
Valuation allowance on deferred tax asset (896,480) (3,348,622)
------------ ------------
9,810 8,111
------------ ------------
Deferred tax liabilities:
Prepaid rent deducted for income tax purposes 8,111 8,111
Other 1,699 -
------------ ------------
9,810 8,111
------------ ------------
Net deferred tax asset $ - $ -
============ ============
The change in the valuation allowance on deferred tax assets is as follows:
<TABLE>
<CAPTION>
Predecessor Successor
------------- --------------------------------------------
Period from Period from
January 1 July 4 to Year Ended Year Ended
to July 3, December 31, December 31, December 31,
1997 1997 1998 1999
------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Balance at beginning of period $ - $ - $ 69,862 $ 896,480
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 2,452,142
------------- ------------ ------------ ------------
Balance at end of period $ - $ 69,862 $ 896,480 $ 3,348,622
============= ============ ============ ============
</TABLE>
F-15
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
At December 31, 1999, the Company has approximately $6,000,000 of federal
and state net operating loss carryforwards expiring in 2019 and 2004,
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. In addition, the Company's German
subsidiary has available approximately $1,000,000 of net operating loss
carryforwards that can be used to reduce the subsidiaries future taxable income.
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.
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 $32,598 for the period January 1, 1997 to July 3, 1997,
and $125,000 for each of the years ended December 31, 1998 and 1999.
F-16
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997
and July 4, 1997 to December 31, 1997
and the Years Ended December 31, 1998 and 1999
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>
2000.......................................... $ 700,000
2001.......................................... 450,000
2002.......................................... 430,000
2003.......................................... 430,000
2004.......................................... 200,000
Thereafter.................................... 150,000
------------
$ 2,360,000
============
</TABLE>
Rent expense for the periods January 1, 1997 to July 3, 1997 and July 4,
1997 to December 31, 1997 and the years ended December 31, 1998 and 1999
amounted to approximately $135,900, $92,400, $253,300, and $377,300,
respectively. The 1998 and 1999 rent expense is net of approximately $20,400
and $86,000, respectively, which was recorded as part of capitalized software
development costs.
Employment Contract
The Company has an employment agreement with its chief executive officer.
The agreement is three years in length and provides for a minimum salary level.
The agreement includes severance payments under certain conditions of
approximately three times the 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 its United States 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 periods January 1, 1997 to July 3, 1997 and
July 4, 1997 to December 31, 1997 and the years ended December 31, 1998 and
1999 amounted to approximately $4,800, $3,700, $10,500, and $21,100,
respectively.
F-17
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
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 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,
160,000 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. In December 1999, the underwriters
exercised 140,000 shares of the Warrant using a net exercise feature
resulting in the issuance of 54,810 shares of common stock.
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.
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 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.
F-18
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
Stock Option Plan
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.
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. With the amendment
of the authorized common stock at the time of the IPO, all non-voting common
stock options were converted to voting common stock options.
On July 1, 1999, the Plan was amended to increase the shares reserved for
issuance under the Plan to a total of 2,700,000.
F-19
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
A summary of the status of the Company's stock options under the Plan as of
December 31, 1998 and 1999 and the changes during the years then ended is
presented below:
<TABLE>
<CAPTION>
1998 1999
------------------------- --------------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
------------ --------- ------------- ---------
<S> <C> <C> <C> <C>
Outstanding at beginning of year - $ - 755,569 $ 4.38
Granted - price equals fair value 781,652 4.60 1,489,476 14.60
Exercised (26,083) 3.66 (543,031) 3.66
Canceled - - (123,086) 13.61
------------ -------------
Outstanding at end of period 755,569 $ 4.38 1,578,928 $ 13.56
============ =============
Options exercisable at end of year 755,569 215,228
============ =============
Options available for future grants 418,348 551,958
============ =============
</TABLE>
In 1999, options for 184,426 shares were exercised using a net exercise feature
resulting in the issuance of 139,426 shares.
The following table summarizes information about stock options outstanding under
the Plan at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------- ---------------------------------------
Weighted Weighted
Average Weighted- Average Weighted-
Range of Remaining Average Remaining Average
Exercise Number Contractual Exercise Number Contractual Exercise
Price Outstanding Life Price Outstanding Life Price
-------- ----------- ----------- --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
$3.66 - $6.50 197,884 0.74 $ 6.02 197,884 0.74 $ 6.02
$14.50 - $17.94 1,376,476 2.62 $ 14.61 12,776 1.81 $ 15.25
$21.96 4,568 0.33 $ 21.96 4,568 0.33 $ 21.96
</TABLE>
F-20
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
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. In 1999, the Company estimated
the fair value of options granted using the Black-Scholes option pricing model.
The fair value of options was estimated at the date of grant using the following
weighted average assumptions:
1998 1999
---- ----
Risk Free interest rate................... 5.4% 6.0%
Dividend yield............................ None None
Expected life of options in years......... .75 1.50
Expected volatility....................... None 60.0%
Option valuation models require the input of highly subjective assumptions
including the expected life of the options and their expected volatility.
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 and 1999 is as follows:
1998 1999
---- ----
Pro forma net loss................ $(2,321,637) $(7,221,251)
Pro forma net loss per share...... $ (0.32) $ (0.75)
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 and 1999 was $0.17 and $2.75, respectively.
Other Stock Options
- -------------------
In November 1999, the Company issued stock options for 5,000 shares of
common stock at an exercise price of $14.50 per share in connection with its
acquisition of the remaining 49% of the outstanding stock of Artificial Life
Ventures. The options have a three year life and vest in equal amounts on
the first, second and third anniversary of the grant date. The fair value of the
options, determined using the Black-Scholes option pricing model, was $25,000.
F-21
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
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%. At December 31,
1998 and 1999, the outstanding balance of these notes receivable amounted to
$79,423 and $8,607, respectively.
In connection with the exercise of options on May 7, 1999, the Company
received a note receivable in the amount of $674,999. The note is due on May 7,
2000 with interest at 15%. The outstanding balance of this note was $741,374,
including accrued interest of $66,375, at December 31, 1999.
9. Accrued Expenses
Accrued expenses at December 31, 1998 and 1999 consist of the following:
Successor
------------------------------
December 31, December 31,
1998 1999
------------ ------------
Accrued salaries......................... $ 25,282 $ 81,401
Accrued vacations........................ 28,292 144,495
Accrued and withheld payroll taxes....... 12,063 81,803
Accrued professional fees................ 40,099 214,833
Accrued state excise tax................. 21,103 --
Accrued interest on note payable to
officer/stockholder.................... 25,000 --
Other liabilities........................ 19,428 63,751
---------- ----------
Total accrued expenses......... $ 171,267 $ 586,283
========== ==========
F-22
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
10. JOINT VENTURE
In April 1999, the Company entered into a joint venture with two
international retailers in the field of e-commerce. The main focus of this
joint venture is to sell consumer goods over the Internet using deep
discounts and high volume, both in terms of transactions and web visits. As
part of the transaction, the Company will license its SmartBot technology
to the joint venture. In addition, the Company will provide products and
software development and consulting services to the joint venture and
receive payments therefor. The partners in the joint venture will be
responsible for using their purchasing relationships to obtain certain
consumer products which will be sold on the joint venture's e-commerce
Website. The Company has allocated up to $2,150,000 of the proceeds from
its IPO to purchase its 50% interest in this joint venture and to meet its
obligations to contribute additional capital to the joint venture. As of
December 31, 1999, $1,022,269 was invested by the Company in the joint
venture. In March, 2000 the Company agreed to invest an additional $938,550
in the joint venture. Under the terms of the joint venture agreement, the
Company may market any e-commerce applications it develops to other
e-commerce companies.
The Company accounts for its investment in the joint venture on the equity
method. The summarized unaudited financial information of the joint venture
since its inception is as follows:
Unaudited
-----------
Earnings data:
Revenues $ 31,513
Operating loss (1,003,357)
Net loss (1,017,768)
Company's equity in net loss (508,884)
Balance sheet data:
Current assets 455,317
Non-current assets 2,187,530
Current liabilities 1,061,783
Non-current liabilities 677,988
Net assets 903,076
Company's equity in net assets 451,538
The Company's investment in unconsolidated subsidiary at December 31, 1999
is reduced by the elimination of unrealized intercompany profits as of
December 31, 1999 in the amount of $327,200.
F-23
<PAGE>
ARTIFICIAL LIFE, INC.
(Formerly Neurotec International Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Concluded)
Periods January 1, 1997 to July 3, 1997 and July 4, 1997
to December 31, 1997 and the Years Ended December 31, 1998 and 1999
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 had 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. In 1999, the
Company commenced operations in Germany.
Other financial data for the years ended December 31, 1998 and 1999 is as
follows:
<TABLE>
<CAPTION>
United
1998 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
1999
- ----
Revenues from external
customers............................ $ 3,072,781 $1,163,495 $ (327,200) $ 3,909,076
Intersegment revenue.................... 343,136 1,103,101 (1,446,237) --
Interest income......................... 437,765 17,047 (110,774) 344,038
Interest expense........................ 52,039 115,151 (113,206) 53,984
Depreciation and amortization
expense.............................. 374,924 318,173 5,306 698,403
Equity in loss of unconsolidated
subsidiary........................... -- 508,884 -- 508,884
Income tax expense...................... -- 19,502 -- 19,502
Net loss................................ (3,808,578) (2,628,322) (321,314) (6,758,214)
Investment in unconsolidated
subsidiary........................... 186,186 -- -- 186,186
Expenditures for property
and equipment........................ 397,219 1,422,808 -- 1,820,027
Identifiable Assets..................... 10,247,094 1,095,256 (3,354,039) 7,988,311
</TABLE>
The Company's entire operations were located in the United States during the
year ended December 31, 1997.
12. SUBSEQUENT EVENTS
In February 2000, the Company sold 152,500 shares of common stock through
private placements with two foreign investors at prices which approximated
quoted market prices on the dates of the sales. Total proceeds to the Company
amounted to $4,112,500.
F-24
<PAGE>
Exhibit No.
- -----------
21 List of Subsidiaries of Company
Name Jurisdiction of Incorporation
---- -----------------------------
Artificial Life Europe, AG Switzerland
Artificial Life Rus Limited Russia
Artificial Life
Deutschland Akriengesellschaf Germany
Artificial Life Solutions, AG Switzerland
Artificial Life Ventures, Inc. Delaware
IT Partners, AG Switzerland
<TABLE> <S> <C>
<PAGE>
<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, 1999 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-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<EXCHANGE-RATE> 1
<CASH> 2,592,388
<SECURITIES> 0
<RECEIVABLES> 1,094,430
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 4,632,640
<PP&E> 2,504,471
<DEPRECIATION> 638,749
<TOTAL-ASSETS> 7,988,311
<CURRENT-LIABILITIES> 2,067,262
<BONDS> 0
0
0
<COMMON> 98,634
<OTHER-SE> 5,822,415
<TOTAL-LIABILITY-AND-EQUITY> 7,988,311
<SALES> 12,243
<TOTAL-REVENUES> 3,909,076
<CGS> 0
<TOTAL-COSTS> 10,270,813
<OTHER-EXPENSES> 322,991
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 53,984
<INCOME-PRETAX> (6,738,712)
<INCOME-TAX> 19,502
<INCOME-CONTINUING> (6,758,214)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,758,214)
<EPS-BASIC> (.70)
<EPS-DILUTED> (.70)
</TABLE>
<PAGE>
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 years ended
December 31, 1998, and December 31, 1999 the Company incurred a net loss of
$2,191,206, respectively. 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>
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. Such firms
include, among others: Ask Jeeves; Autonomy, Inc.; Big Science Company;
Brightware, Inc.; Broadvision, Inc.; Digital Marketing Concepts, Inc.; eGain,
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. 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>
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. 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 continue 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 continue
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 continue 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>
DEPENDENCE ON THIRD PARTY CONTRACTORS. The Company intends to utilize
consultants to perform portions of the 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 continue to 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 could 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
could 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 continuing to
attract 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 continue to 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>
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 endeavored to cause 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, and recent private placement 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 until at least through January 2001, 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 is becoming
increasingly important as low barriers to entry encourage competition in the
software robot industry. In order to continue to attract and retain customers
and strategic partners, and in response to competitive pressures, the Company is
attempting to increase its financial commitment to the creation and maintenance
of brand development. The Company plans to accomplish this, although not
exclusively, through
<PAGE>
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
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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.
