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 THESECURITIES EXCHANGE
ACT OF 1934 [Fee Required] For the fiscal year ended December 31, 1996.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE
ACT OF 1934 [No Fee Required] For the transition period from ______________ to
_____________.
Commission file Number 0-4186
CONSOLIDATED TECHNOLOGY GROUP LTD.
(Exact name of registrant as specified in its charter)
New York 13-1948169
(State or other jurisdiction (I.R.S. Employer Identification Number)
of incorporation or organization)
160 Broadway, New York, NY 10038
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 233-4500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class Outstanding shares as of April 9, 1997
------------------- --------------------------------------
Common Stock, par value 0.01 per share 45,796,263
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 a 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. [ ]
DOCUMENTS INCORPORATED BY REFERENCE
None
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PART I
Item 1. Business
Introduction
Consolidated Technology Group Ltd. (the "Company" or "Consolidated"), through
its wholly-owned or controlled subsidiaries, is engaged in various businesses
classified into eight business segments. The business consulting services
segment consists of a wholly owned subsidiary of Consolidated. The remaining
segments consists of subsidiaries that are indirectly controlled or owned
through SIS Capital Corp., ("SISC"), a wholly owned subsidiary of Consolidated.
During the years ended December 31, 1996, 1995 and 1994, Consolidated's segments
revenue as a percentage of total was as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Contract Engineering Services 54% 57% 60%
Medical Diagnostics 27% 25% 15%
Electro-Mechanical and Electro-Optical Products Manufacturing 3% 4% 9%
Medical Information Services 7% 7% 7%
Telecommunications 5% 3% 6%
Three Dimensional Products and Services 1% 1% 2%
Audio Products Manufacturing 3% 2% --
Business Consulting Services -- 1% 1%
</TABLE>
Additional financial information regarding the Company's business segments is
presented in the Company's financial statements (see Part IV, 1) including
revenues, operating income or loss and identifiable assets attributable to each
of the Company's business segments. Consolidated provides its subsidiaries with
management, marketing, accounting, administrative support and financing.
Consolidated's revenue and net loss reflect the consolidated revenue and results
of operations of its subsidiaries. Set forth below is a description of
Consolidated's business segments.
CONTRACT ENGINEERING SERVICES
The contract engineering services segment reflects the operations of Trans
Global Services, Inc. ("TGS"). TGS is a Delaware corporation which was
incorporated in January 1995 to hold the stock of its two subsidiaries, Avionics
Research Holdings, Inc. ("Avionics") and Resource Management International, Inc.
("RMI"). Prior to the formation of TGS, Avionics, which was acquired in December
1993, and RMI, which was acquired in November 1994, were directly owned by SISC.
This segment's principal business is technical temporary staffing service. In
performing such services, the segment, through its two wholly-owned
subsidiaries, Avionics and RMI, addresses the current trend of major
corporations in "downsizing" and "outsourcing" by providing engineers, designers
and technical personnel on a temporary contract assignment basis pursuant to
contracts with major corporations. The engagement may relate to a specific
project or may cover an extended period based on the client's requirements. TGS
believes that the market for outsourcing services such as those offered by this
segment results from the trend in employment practices by major corporations in
the aerospace, electronics, energy, engineering and telecommunications
industries to reduce their permanent employee staff and to supplement their
staff with temporary personnel on an as-needed basis. TGS seeks to offer its
clients a cost-effective means of work force flexibility and the elimination of
the inconvenience associated with the employment of temporary personnel, such as
advertising, initial interviewing, fringe benefits and record keeping. The
employees provided by TGS are on temporary contract assignment, and although
they work with the client's permanent employees; however, they receive different
compensation and benefits than permanent employees.
In providing its services, TGS engages the employees, pays the payroll and
related costs, including FICA, worker's compensation and similar Federal and
state mandated insurance and related payments. TGS charges its clients for
services based upon the hourly payroll cost of the personnel. Each temporary
employee submits to TGS a weekly time sheet with work hours approved by the
client. The employee is paid on the basis of such hours, and the client is
billed for those hours at agreed upon billing rates.
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TGS also offers its clients a range of integrated logistical support services
which are performed at TGS's facilities. These services, which are ancillary to
a project, include the management of technical documents involving technical
writing, preparation of engineering reports, parts provisioning documents and
test equipment support documents, establishing maintenance concepts and
procedures, and providing manpower and personnel support. In performing these
services, TGS hires the necessary employees for its own account and may work
with the client in developing and preparing the documentation. Payments would be
made pursuant to a purchase order from the client on a project basis and not as
a percentage of the cost of the employees. To date, the integrated logistics
support business has not generated more than nominal revenue, and no assurance
can be given that TGS will generate any significant revenue or profit from such
services.
TGS's strategy has been directed at increasing its customer base and providing
additional services, such as integrated logistics support, to its existing
customer base. TGS believes that the key to profitability is to provide a range
of services to an increased customer base. In this connection, TGS is increasing
its marketing effort both through its own personnel and in marketing efforts
with other companies that offer complementary services.
Markets and Marketing
The market for TGS's services is comprised of major corporations in such
industries as aerospace, electronics, energy, engineering, computer services and
telecommunications, where "downsizing" and "outsourcing" have become an
increasingly important method of cost reduction. Typically, a client enters into
an agreement with one or a small number of companies to serve as employer of
record for its temporary staff, and its agreements are terminable by the client
without significant notice.
TGS maintains a computerized data base of technical personnel based upon their
qualifications and experience. The data base, which contains more than 100,000
names, is generated through employees previously employed by TGS, referrals and
responses to advertisements placed by TGS in a variety of local media, including
newspapers, yellow pages, magazines and trade publications. Part of its
responsibilities for any engagement is the recruitment and initial interviewing
of potential employees, with the client conducting any final interviews it deems
necessary. The majority of work performed by TGS's employees is performed at the
client's premises and under the client's direction, although TGS is the employer
of record.
TGS markets its services to potential clients through its officers, management
and recruitment personnel who seek to provide potential clients with a program
designed to meet the client's specific requirements. The marketing effort
utilizes referrals from other clients, sales calls, mailings and telemarketing.
TGS also conducts an ongoing program to survey and evaluate the clients' needs
and satisfaction with TGS's services, which it uses as part of its marketing
effort.
Although TGS has eight offices, including its main office in Long Island, New
York, throughout the United States, there is no limited geographic markets for
TGS's services. TGS has in the past established offices in new locations when it
receives a contract in the area and it cannot effectively service such contract
from its existing offices. TGS intends to continue to establish new offices as
necessary to meet the needs of its customers.
A client will utilize contract engineering services such as those provided by
TGS when it requires a person with specific technical knowledge or capabilities
which are not available from the client's permanent staff or to supplement its
permanent staff for a specific project or to meet peak load requirements. When
the client requires personnel, it provides TGS with a detailed job description.
TGS then conducts an electronic search in its computerized resume data base for
candidates matching the job description. In addition, each branch office
maintains a file of active local resumes for candidates available for assignment
in the vicinity of the branch office. The candidates are then contacted by
telephone by TGS's recruiters, who interview interested candidates. If a
candidate is acceptable to TGS and interested in the position, TGS refers the
candidate to the client. An employment agreement is executed with the TGS prior
to the commencement of employment.
TGS serves primarily the aerospace and electronics industries as well as the
telecommunications, banking and computer science industries and public utilities
along with numerous manufacturing companies. TGS is expanding its effort to
address the general trend of "downsizing" and "outsourcing" by major
corporations on a national basis. To meet this goal, TGS has commenced a
national sales campaign addressing a broad spectrum of Fortune 500 companies,
offering a managed staffing service to those companies in the process of
downsizing and outsourcing specific functions. Since a company engaged in
downsizing seeks to focus on its core business needs with its in-house staff,
TGS seeks to identify and address the needs of a specific task or department not
part of the core business for which outsourcing would be an appropriate method
of addressing those needs. In addressing these needs, TGS has conducted
marketing efforts with Manpower International, Inc., TAD Resources International
Inc. and Olsten Corporation. TGS's contracts are generally terminable by the
client on short notice.
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TGS's largest customers for the year ended December 31, 1996 were Boeing,
Lockheed, Northrop Grumman, Gulfstream Aerospace Corp. and Bell Helicopter
Textron, which accounted for approximately $16 million, $13 million, $9 million,
$5 million and $4 million, or 25.6%, 20.8%, 14.4%, 8% and 6.4% of TGS revenue,
respectively. For the year ended December 31, 1995, Northrop Grumman, Lockheed
and Boeing accounted for $19.4 million, $10.2 million and $9.6 million, or
30.7%, 16.1% and 15.2% of TGS revenue, respectively. During the year ended
December 31, 1994, Avionics was the only subsidiary operating in this segment
and Avionics' largest clients for 1994 were Northrop Grumman and Martin Marietta
Corp., which accounted for approximately $14.5 million and $2.0 million,
respectively, which represented approximately 57% and 8% of the segment's
revenue for 1994.
Competition
The business of providing employees on either a permanent or temporary basis is
highly competitive and is typically local in nature. TGS competes with numerous
technical service organizations, a number of which are better capitalized,
better known, have more extensive industry contracts and conduct extensive
advertising campaigns aimed at both employers and job applicants. TGS believes
that the ability to demonstrate a pattern of providing reliable qualified
employees is an important aspect of developing new business and retaining
existing business. Furthermore, the ability of TGS to generate revenues is
dependent not only upon its ability to obtain contracts with clients, but also
to provide its clients with qualified employees. The market for qualified
personnel is highly competitive, and TGS competes with other companies in
attracting employees.
Government Regulations
The technical temporary staffing industry, in which TGS is engaged, does not
require licensing as a personnel or similar agency. However, as a provider of
personnel for other corporations, it is subject to Federal and state regulations
concerning the employment relationship, including those relating to wages and
hours and unemployment compensation. It also maintains 401(k) plans for its
employees and is subject to regulations concerning such plans.
TGS does not have contracts with the government agencies. However, TGS does have
contracts with clients, including major defense contractors, that have contracts
with government agencies. TGS's contracts with its clients are based on hourly
billing rates for each technical discipline. Many of the clients' contracts with
government agencies are subject to renegotiation or cancellation for the
convenience of the government. Since the manpower needs of each of TGS's clients
are based on the client's own requirements and the client's needs are affected
by any modification in requirements, any reduction in staffing by a client
resulting from cancellation or modification of government contracts could
adversely impact the business of TGS.
Potential Business Agreements
TGS has filed an S-1 registration statement with the Securities and Exchange
commission, and if the registration is successful, TGS may enter into joint
ventures, acquisitions or other arrangements, such as joint marketing
arrangements and licensing agreements, which TGS believes would further its
growth and development. In negotiating such agreements or arrangements, TGS
anticipates that such agreements would be based upon the manner in which TGS's
business can be expanded, the extent to which TGS's services can be enhanced or
the market for such services expanded into fields not then being addressed by
TGS. In this connection, TGS may acquire businesses that are related directly or
indirectly to its technical temporary staffing services business. No assurance
can be given that any agreement which TGS enters into will generate any net
income. To the extent that TGS enters into an agreement with an affiliated
party, the terms and conditions of such agreement will be on terms at least as
favorable to TGS as those TGS believes it could achieve in negotiations at arm's
length with an independent third party.
At December 31, 1996, TGS had 963 employees, of which 921 were contract service
employees who performed services on the clients' premises and 42 were executive
and administrative employees. Each of TGS's offices is staffed by recruiters and
sales managers. Each contract service employee enters into a contract with TGS
which sets forth the client for whom and the facility at which the employee's
services are to be performed and the rate of pay. If an employee ceases to be
required by TGS's clients for any reason, TGS has no further obligation to the
employee. Although assignments can be for as short as 90 days, in some cases, it
has been for several years. The average assignment is in the range of six to
nine months. TGS's employees are not represented by a labor union, and TGS
considers its employee relationship to be good.
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MEDICAL DIAGNOSTICS
The medical diagnostics segment reflects the operations of International
Magnetic Imaging, Inc. and its affiliated entities ("IMI"). IMI is a Delaware
corporation, organized on March 8, 1994 to acquire ten Centers which were
managed by International Magnetic Imaging, Inc., a Florida corporation. Such
acquisition was consummated on September 30, 1994. IMI owns and operates ten
medical diagnostic imaging Centers, of which four are multi-modality Centers and
six are exclusively MRI Centers. One of the multi-modality Centers is operated
by a joint venture in which IMI has a 50% interest. IMI also owns MRI Net, Inc.
("MRI Net"), which operates a referral network through which patients are
referred to diagnostic imaging centers throughout the state of Florida,
including IMI's Florida Centers..
Medical diagnostic imaging procedures, such as MRI, are used to diagnose various
diseases and physical injuries. The multi-modality Centers use various imaging
procedures, such as MRI, CT, mammography, X-ray, ultrasound, fluoroscopy and
other technologies while the MRI Centers only offer MRI. MRI systems enhance the
diagnosis of disease and medical disorders, frequently eliminating the need for
exploratory surgery and often reducing the amount and cost of care required to
evaluate and treat a patient. Since the introduction of MRI in the early 1980's,
the use of MRI has experienced rapid growth due to the technology's ability to
provide anatomical images of high contrast and detail. MRI, which does not
utilize x-ray or other radiation based technologies, employs high-strength
magnetic fields, high frequency radio waves and high-speed computers to process
data. In addition, the development of pharmaceutical contrast agents, software
advancements and new hardware peripherals continue to expand the clinical
applications and throughput efficiency of MRI technology.
MRI employs high-strength magnetic fields, high frequency radio waves and
high-speed computers to obtain clear, multi-planar images of the body's internal
tissues without exploratory surgery or biopsy. In addition, MRI is able to
obtain multi-planar slices of the body. These images are then displayed on film
or on the video screen of an MRI system's console in the form of a multi-planar
image of the organ or tissue. This information can be stored on magnetic media
for future access, or "printed" on film for interpretation by a physician and
retention in the patient's files, enabling healthcare professionals to study the
patient's internal conditions in detail. The superiority of MRI image quality
compared to other imaging modalities generally makes possible a more accurate
diagnosis and often reduces the amount and cost of care needed to evaluate and
treat a patient.
The major components of an MRI system are (i) a large, cylindrical magnet, (ii)
radio wave equipment, and (iii) a computer for data storage and image
processing. During an MRI study, a patient lies on a table which is then placed
into the magnet. Although patients have historically spent 30 to 45 minutes
inside the magnet during which time images of multiple planes are acquired, the
newest MRI machines allow patients to spend significantly less time inside the
magnet. Additional time is required for computer processing of the images.
Developments in imaging technology are either hardware or software related. Most
recent developments have been software upgrades which permit greater resolution
and accuracy and greater efficiency of operations. However, there have been
improvements in hardware. IMI seeks to offer the most current and accepted
technologies, and, in this connection, it seeks to upgrade its equipment with
selected software upgrades to the extent financially feasible. IMI also
evaluates new hardware and if it determines that the purchase of the equipment
will be advantageous to IMI and financing is available on acceptable terms, it
may either purchase or lease new equipment. The decision to purchase new MRI
equipment is based on the needs of the market and the advantages of such
equipment over existing equipment.
IMI is not engaged in the practice of medicine, and it does not employ any
physicians. All professional medical services are performed by radiologists who
are independent of IMI and who provide medical services pursuant to agreements
with IMI. Payment for the radiologists' professional services is made to the
radiologists pursuant to agreements with the radiologists. See "Agreements with
Radiologists" below.
Outpatient Services and Patient Base
Each Center is a fixed-site, outpatient facility that is designed, equipped and
staffed to provide physicians and healthcare providers with high quality MRI,
and, with respect to the multi-modality Centers, other medical diagnostic
imaging services that historically were available only at hospitals. IMI
schedules patients, prepares all patient billing and is responsible for the
collection of all charges. IMI is also responsible for related administrative
and record-keeping functions. IMI typically staffs its Centers with technical
and administrative support personnel who assist physicians in obtaining MRI and
other diagnostic scans. The Centers are designed to offer a pleasant environment
where patients are not subjected to the admission complexities and institutional
atmosphere of most hospitals.
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Many physicians and other healthcare providers who have a need for MRI and other
diagnostic imaging procedures do not have the financial ability or desire to own
their own equipment. As a result, such providers use outpatient MRI and
multi-modality facilities such as the Centers for the following reasons, among
others: (i) ability to receive comprehensive MRI and other medical diagnostic
imaging services, including qualified technicians, equipment maintenance,
insurance and equipment upgrades; (ii) desire to obtain quick access to MRI and
other medical diagnostic imaging services; (iii) lack of sufficient patient
volume to justify the capital cost of purchasing an MRI or other medical
diagnostic imaging equipment; (iv) desire to use MRI or other medical diagnostic
imaging equipment to facilitate caring for their patients; (v) lack of financial
ability to purchase MRI or other medical diagnostic imaging equipment, and/or
(vi) inability to obtain required regulatory approval to purchase or operate
such equipment.
In addition, many healthcare providers with sufficient patient utilization and
resources to justify in-house MRI and other medical diagnostic imaging equipment
ownership prefer to use independent facilities such as the Centers in order to:
(i) obtain the use of such equipment without capital investment; (ii) eliminate
the need to recruit, train and manage qualified technicians; (iii) retain the
flexibility to take advantage of all technological developments; (iv) avoid
future uncertainty as to reimbursement policies; (v) provide additional imaging
services when patient demand exceeds in-house capacity, and/or (vi) obtain
radiological and other diagnostic and technical services.
Set forth below is information relating to the Centers.
Date Service
Center Location Commenced
------ -------- ---------
Pine Island Plantation, Florida December 1986
North Miami Beach North Miami Beach, Florida January 1988
Boca Raton(1) Boca Raton, Florida November 1988
Physicians Outpatient Ft. Lauderdale, Florida November 1985
Diagnostic Center(2)
South Dade(3) Miami, Florida December 1989
Oakland Oakland Park, Florida January 1990
San Juan(4) San Juan, Puerto Rico October 1990
Arlington Arlington, Virginia December 1990
Kansas City Overland Park, Kansas October 1991
Orlando(5) Orlando, Florida September 1992
(1) IMI expanded the Boca Raton Center to a multi-modality Center in July 1996.
The Center offers MRI and CT imaging services.
(2) Physicians Outpatient Diagnostic Center ("PODC") has been a multi-modality
Center since prior to IMI's acquisition of the Center. It offers CT,
mammography, X-ray, ultrasound and other modalities.
(3) IMI converted the South Dade Center to a multi-modality Center and upgraded
its MRI equipment in October 1996 at a cost of approximately $2.5 million. As
part of the conversion, the Center was moved to larger facilities, its MRI
equipment was upgraded, and the Center now offers CT, fluoroscopy and ultrasound
services in addition to MRI.
(4) In September 1996, this Center upgraded its MRI equipment.
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(5) The Orlando Center is operated as a joint venture with a non-affiliated
party and is co-managed by IMI and its joint venture partner. The equipment used
in this Center has been provided by IMI's joint venture partner, and IMI's
equipment is used for backup and patient overflow.
IMI has filed an S-1 registration statement with the Securities and Exchange
Commission and if such registration is successful, IMI intends to use the
proceeds for working capital.
Each Center generally has a full-time staff of eight to ten employees, typically
consisting of technicians, file clerks, a marketing representative, a
transcriptionist, one or more receptionists and a center administrator. The
Centers are open at such hours as are appropriate for the local medical
community. Most are open from 7:00 a.m. to 9:00 p.m. each weekday, and many of
the Centers offer extended evening and weekend hours. Each Center is supervised
by a center administrator. IMI is responsible for patient scheduling and billing
the patient (or third party payer) directly. IMI has contracts with independent
board-certified radiologists, some of which have sub-specialty training in
orthopedic and neuroradiology, to interpret IMI's scans and provide the test
results to the referring physician.
IMI is not engaged in the practice of medicine and none of IMI's Centers employs
any physicians to provide medical services. IMI bills patients for both its
services and those of the radiologist who provides professional services. Such a
bill includes both the technical and professional components. Payment for the
radiologists' professional services is paid to the radiologist pursuant to
agreements with the radiologists. Thus, a portion of the IMI's revenue is
payable to the radiologists for their professional services.
IMI markets its services through open houses, lectures, symposia, direct mail
and direct physician marketing. Each Center uses one or more marketing
representatives, the Center's administrator and certain radiologists who
interpret the Company's scans to market its services to the local medical
community, while the Company's national accounts manager focuses on managed care
providers and third party payers. The Company also utilizes the marketing
expertise and abilities of Dr. Schulman, IMI's President and one of three former
owners and founders of IMI.
Almost all of IMI's revenue is derived from third-party payers. For 1996 and
1995, IMI derived approximately 86% and 91% of its revenue from non-government
payers and approximately 14% and 9% from government sponsored healthcare
programs, principally Medicare and Medicaid. IMI's revenue and profitability may
be materially adversely affected by the current trend in the healthcare industry
toward cost containment as government and private third-party payers seek to
impose lower reimbursement and utilization rates and negotiate reduced payment
schedules with service providers. Continuing budgetary constraints at both the
Federal and state level and the rapidly escalating costs of healthcare and
reimbursement programs have led, and may continue to lead, to significant
reductions in government and other third-party reimbursements for certain
medical charges and to the negotiation of reduced contract rates or capitation
or other financial risk-shifting payment systems by third-party payers with
service providers. Both the Federal government and various states are
considering imposing limitations on the amount of funding available for various
healthcare services. IMI cannot predict whether or when any such proposals will
be adopted or, if adopted and implemented, what effect, if any, such proposals
would have on IMI. In addition, rates paid by private third-party payers,
including those that provide Medicare supplemental insurance, are generally
higher than Medicare payment rates. Changes in the mix of IMI's patients among
the non-government payers and government sponsored healthcare programs, and
among different types of non-government payers and government sponsored
healthcare programs, and among different types of non-government payer sources,
could have a material adverse effect on the IMI. Further reductions in payments
to physicians or other changes in reimbursement for healthcare services could
have a material adverse effect on IMI, unless IMI is otherwise able to offset
such payment reductions through cost reductions, increased volume, introduction
of new procedures or otherwise, as to which no assurance can be given. IMI has
consummated and is continuing to negotiate agreements with managed care
organizations pursuant to which the Company provides and will provide MRI and
other services; however, such agreements typically reflect a reduced level of
revenue per scan. Although IMI's average net collection from MRI procedures
increased to $695 for 1996, the net collections per MRI procedure decreased in
prior periods. IMI's average net collection per MRI procedure decreased from
$726 in 1994 to $639 for 1995. The increase for the year ended December 31, 1996
reflected an increase in higher paying procedures as well as a reduction in
lower-paying procedures, principally in the San Juan Center which was not
operational during a portion of the period while the equipment was being
upgraded as well as during the period when San Juan was recovering from the
effects of Hurricane Hortense. No assurance can be given that the average net
collections per MRI Procedure will not decrease in the future. IMI's net
collection per multi-modality procedure was $95 for 1994 and 1995 and $81 for
1996.
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IMI is highly dependent on referrals from physicians who have no contractual or
economic obligation to refer patients to the IMI's facilities. Since the
acquisition of the Centers, the percentage of revenue from the former
physician-partners and other physician-equity owners of the Centers has
decreased in terms of both total revenue and number of scans. The percentage of
revenue derived from referrals from such physicians was 32% for 1994 and 24% for
1995 and 1996.
Commencing in 1995, a portion of IMI's revenue was obtained by physician
referrals which were generated by brokers who negotiated a price with the IMI
for MRI and other scans. To the extent that a third party paid more than IMI
charged for such scans, the broker received a portion of such excess. Effective
October 1, 1996, this practice became illegal in Florida. Such scans accounted
for 9% of IMI's revenue for 1996 and 9% for 1995. Although IMI intends to market
its services directly to physicians and health maintenance organizations, there
may be a decline in revenue from physicians whose scans were obtained through
brokers as a result of the change in the laws.
Agreements with Radiologists
IMI engages independent radiologists and other specialists to read and interpret
the diagnostic imaging scans performed at the Centers. None of such radiologists
or other specialists are employed by the IMI. In December 1994, IMI entered into
a five-year agreement (the "ERN Agreement") with ERN, a Florida professional
association owned by an independent radiologist, pursuant to which ERN was
engaged by IMI to provide, on an exclusive basis, all radiology services for
five of IMI's Florida Centers through radiologists and other specialists
employed by ERN. ERN receives a fee for its radiology services in an amount
equal to a percentage, ranging from 10% to 20%, of gross revenues received by
the Centers, together with an annual consulting fee of $30,000. Upon the
consummation of this Offering, ERN has the right to receive a five-year warrant
to purchase 100,000 shares of the common stock of Consolidated at an exercise
price equal to the market price of such Common Stock on the day preceding the
date of exercise. IMI has been informed that ERN currently employs five
radiologists and other specialists to perform such radiology services on behalf
of ERN. Prior to December 1996, ERN also provided radiology services to another
of IMI's Florida Centers on a exclusive basis pursuant to an oral agreement.
Since December 1996, an independent radiologist, who had formerly performed such
services as an employee of ERN, has been performing services at such Center
pursuant to an oral agreement with IMI. As of February 1, 1997, IMI entered into
a radiology services agreement with Premier Radiology Group, Inc. and will pay a
fee of 16.5% of net collections from the Center.
In October 1990, IMI entered into a Facilities Use Agreement with an independent
radiologist in Puerto Rico pursuant to which such radiologist performs all
radiology services at the Center in Puerto Rico during the term of such
agreement for which the radiologist receives an annual fee ranging from 10% to
15% of the gross revenues of the Center, subject to increase with respect to
gross revenues of the Center in excess of $2,000,000. In September 1994, in
connection with IMI's acquisition of this Center, the agreement was amended and
Consolidated issued 125,000 shares of its common stock to such radiologist. The
agreement provides for IMI's subsidiary which owns the Center to pay the
radiologist $500,000 as liquidated damages if it terminates the agreement
without cause.
IMI has also entered into agreements with independent radiologists with respect
to the Centers in Virginia and Kansas. The radiologist engaged by the Virginia
Center receives an annual fee of $275,000 plus 15% of the Center's gross
revenues in excess of $2.4 million. The radiologist engaged by the Kansas Center
receives a fee for each study performed ranging from $75 to $150, depending on
the number of studies read.
Certain of the radiologists engaged by IMI, including Dr. Steinberg and other
radiologists employed by ERN, have been granted options to purchase the
Company's Class A Common Stock.
MRI Net
IMI, through MRI-Net, a wholly-owned subsidiary of IMI, operates a referral
network through which patients are referred to 85 diagnostic imaging centers
throughout the state of Florida, including IMI's Florida Centers. IMI markets
MRI Net to HMOs, indemnity plans, workers compensation insurers and other
third-party payers by making available to them at contract rates a range of
imaging services at centers located throughout the state. Pursuant to contracts
with the third-party payers, the participating centers provide diagnostic
imaging services to persons who are covered by the contracting third-party
payers. The Florida Centers are part of such network. During 1996, the centers
participating in the network, including the Florida Centers, serviced a total of
approximately 600 patients per month. These patients were referred to the
centers through MRI Net from approximately 40 different third-party payers. IMI
receives a fee of at least $50 from the center performing the services for each
patient which is referred to it by MRI-Net. Revenues from MRI-Net for 1996 and
1995 constituted less than 2% of IMI's total revenues.
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Government Regulation - Reimbursement
The healthcare industry is highly regulated and is undergoing significant change
as third-party payers, such as Medicare, Medicaid, Blue Cross/Blue Shield plans
and other insurers increase efforts to control the cost, utilization and
delivery of healthcare services. Legislation has been proposed or enacted at
both the Federal and state levels to regulate healthcare delivery in general and
imaging services in particular. In addition, several states, including those in
which IMI operates, have imposed limits on the reimbursement by Medicaid and
Workers Compensation programs for imaging services. These and similar limits may
reduce the income generated by IMI's operations.
In general, Medicare reimburses radiology imaging services under a physician fee
schedule which covers services provided not only in a physician's office, but
also in freestanding imaging centers. IMI believes that reductions in
reimbursement for Medicare services may be implemented from time to time, which
may lead to reductions in reimbursement rates of other third-party payers.
Congress and the Department of Health and Human Services ("HHS") have taken
various actions over the years to reduce reimbursement rates for radiology
services and proposals to reduce rates further are anticipated. IMI is unable to
predict which, if any, proposals will be adopted. Any reductions in Medicare
reimbursement for radiology services could have a material adverse effect on
IMI. In addition, IMI cannot predict the effect healthcare reforms and efforts
to control costs may have on its business, and there can be no assurance that
such reforms or efforts will not have a material adverse effect on IMI's
operations.
Government Regulation - General
IMI's business is subject to extensive Federal and state regulation. Such
regulations cover, among other things, certain reporting requirements,
limitations on ownership and other financial relationships between a provider
and its referral sources, approval by the FDA of the safety and efficacy of
pharmaceuticals and medical devices, the confidentiality of medical records,
antitrust laws, and environmental regulation regarding the use of various
substances, including radioisotopes, and the disposal of medical waste. In
addition, the requirements that IMI must satisfy to conduct its businesses vary
from state to state and many of the state requirements overlap with the Federal
requirements. IMI believes that its operations comply with applicable Federal
and state regulations in all material respects. However, changes in the law or
new interpretations of existing laws can have a material effect on permissible
activities of IMI, the relative costs associated with doing business, and the
amount of reimbursement for IMI's products and services paid by government and
other third-party payers.
IMI believes that in the near future, all outpatient medical diagnostic imaging
centers will be required to be accredited by certain accreditation entities. In
anticipation of these requirements, IMI is currently in the process of having
all of the Centers accredited by an accreditation organization, the requirements
of which IMI believes will satisfy any anticipated future requirements that may
be imposed. There can be no assurance, however, that any such accreditation
requirements will be imposed or, if imposed, what the scope of such requirements
will be or whether IMI will obtain any necessary accreditation.
Mammography
Centers performing mammography services (including screening mammography) must
meet Federal, and in some jurisdictions, state standards for quality as well as
certification requirements. Under interim regulations issued by the Food and
Drug Administration (the "FDA"), all mammography facilities are required to be
accredited, to undergo an annual mammography facility physics survey, to be
inspected annually and pay an annual inspection fee, to meet qualification
standards for physicians, mammography technologists and medical physicists who
interpret mammograms, to meet certification requirements for adequacy, training
and experience of personnel, to meet quality standards for equipment and
practices, and to meet various requirements governing record keeping of patient
files. In addition, the FDA has proposed regulations governing standards for
mammography X-ray equipment, medical physicists standards and minimum quality
standards for mammography facilities including personnel standards and quality
control. Sanctions for violating the Mammography Quality Standards Act of 1992
("MQSA") are varied, ranging from civil monetary penalties, suspension or
revocation of certificates and injunctive relief. Moreover, the MQSA requires
conformity with these standards to obtain payment for Medicare services.
Although the one Center that offers mammography is currently accredited by the
Mammography Accreditation Program of the American College of Radiology, and the
Company anticipates continuing to meet the requirements for accreditation for
such Center as well as any Centers which offer mammography, the withdrawal or
delay of such accreditation could result in the revocation of certification, if
the FDA so determines.
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Permits and Licensure
Certain of IMI's facilities require state licensure and are also subject to
Federal and other state laws and regulations governing imaging facilities and
the staff hired by IMI, such as technicians, to provide services. IMI believes
that it is in compliance with applicable licensure requirements. IMI further
believes that diagnostic testing will continue to be subject to intense
regulation at the Federal and state levels and cannot predict the scope and
effect thereof.
Anti-kickback Laws
IMI is also subject to Federal and state laws prohibiting direct or indirect
payments for patient referrals and regulating reimbursement procedures and
practices under Medicare, Medicaid and state programs as well as in relation to
private payers. The Anti-kickback Statute prohibits the offer, payment,
solicitation or receipt of any remuneration in return for the referral or
arranging for the referral of items or services paid for in whole or in part
under the Medicare and Medicaid programs (the "Anti-kickback Statute"). To date,
courts have interpreted the Anti-kickback Statute to apply to a broad range of
financial relationships between providers and referral sources, such as
physicians and other practitioners. Violations of the statute's provisions may
result in civil and criminal penalties, including fines of up to $25,000 and
exclusion from participation in Medicare and state health programs such as
Medicaid and imprisonment for up to five years.
Since July 1991, the U.S. Department of Health and Human Services has adopted
regulations creating "safe harbors" from Federal criminal and civil penalties
under the Anti-kickback Statute by exempting certain types of ownership
interests and other financial arrangements that do not appear to pose a threat
of Medicare and Medicaid program abuse. Although additional safe harbors have
also been proposed, none of IMI's current activities fit within an applicable
safe harbor that has either been enacted or proposed. Transactions covered by
the Anti-kickback Statute that do not conform to an applicable safe harbor are
not necessarily in violation of the Anti-kickback Statute, but the practice may
be subject to increased regulatory scrutiny and possible prosecution. Several
courts have rendered decisions interpreting the statute. In May 1996, the
District Court of Appeal of Florida, Fourth District held that an arrangement in
which a company marketed the services of a durable medical equipment business to
potential clients and received a percentage of the sales it generated was in
violation of the Anti-kickback Statute. While IMI believes that MRI Net's
operations are different from those in such case, a court could reach a contrary
conclusion. The restrictions of the Anti-kickback Statute may limit the ability
of IMI Company to enter into joint venture or service agreements with
physicians, may restrict its dealings with any physician from whom it has
purchased an interest in a facility and could, if interpreted broadly, preclude
MRI Net from being paid for its services. Although the Company believes that it
is in compliance with the Anti-kickback Statute, there is no assurance that it
will not be found to have engaged in prohibited activities.
Significant prohibitions against physician referrals were enacted by Congress in
the Omnibus Budget Reconciliation Act of 1993. These prohibitions, commonly
known as "Stark II," amended the prior physician self-referral ban known as
"Stark I," by dramatically enlarging the field of physician-owned or
physician-interested entities to which the referral prohibitions apply. Since
January 1, 1995, Stark II has prohibited, subject to certain exemptions, a
physician or a member of his immediate family from referring Medicare patients
to an entity providing "designated health services" (including, among other
things, radiological imaging services, which are the services provided by IMI),
in which the physician has an ownership or investment interest, or with which
the physician has entered into a compensation arrangement. Certain exceptions
are available under Stark II, including the referral of patients to providers
owned by certain qualifying publicly-traded companies in which a referring
physician owns an investment security. At this time, however, the ownership of
investment securities (including common and preferred stock, bonds, debentures,
notes and other debt instruments) in IMI does not qualify for the exemption as
IMI does not have presently shareholder equity of at least $75 million. Other
exceptions exist under the Stark II which may or may not be available to IMI for
arrangements in which IMI may be involved. IMI has been advised by its
healthcare counsel that there are no regulations, administrative pronouncements
or judicial cases interpreting Stark II. While IMI believes that it is in
compliance with the Stark legislation, the statute is broad and ambiguous, and
interpretive regulations have not been issued. Future regulations could require
IMI to modify the form of its relationships with physicians under the Stark II.
Submission of a claim that a provider knows or should know is for services for
which payment is prohibited under the Stark II could result in refunds of any
amounts billed, civil money penalties of not more than $15,000 for each such
service billed (and $100,000 for participation in a "circumvention scheme," and
possible exclusion from the Medicare and Medicaid programs.
There are also Federal (and state) civil and criminal statutes imposing
substantial penalties, including civil fines and/or imprisonment, on health care
providers that fraudulently or wrongfully bill governmental or third-party
payers for health care services. The Federal law prohibiting false billings
allows a private person to bring a civil action in the name of the U.S.
government for violations of its provisions. The potential liability under the
Federal False Claims Act can include treble damages plus a fine of $10,000 per
claim. Courts are currently divided as to whether an Anti-kickback Statute
violation may also be a predicate for false claims liability.
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On August 21, 1996, the Health Insurance Portability and Accountability Act of
1996 (the "1996 Health Act") was signed into law. Title II of the 1996 Health
Act contains significant provisions relating to healthcare fraud and abuse. The
1996 Health Act codifies the long-standing implicit exception in anti-kickback
liability for managed care discounts, if the provider, via the arrangement, is
at "substantial financial risk." In addition, Federal criminal law was revised
to create a new class of criminal healthcare offenses, standards for liability
were clarified and new initiatives were launched to coordinate efforts at the
Federal and state levels to control fraud and abuse. The 1996 Health Act also
increased the penalties under the Federal False Claims Act and permits the
government to reward sources who provide information that results in a recovery
by the government.
Antitrust
Federal and state antitrust laws and regulations may effect the operation of MRI
Net, which is a referral network through which patients are referred to
diagnostic imaging centers in Florida. Because the centers to which patients are
referred are operated by independent entities, they may be deemed competitors
and, therefore, subject to a range of Federal and state antitrust laws and
regulations which prohibit anti-competitive conduct, including price fixing,
division of the market and product tying. Violations of Federal and state
antitrust laws can result in substantial penalties and restrictions on MRI Net's
business activities. Although IMI believes that MRI Net's activities do not
violate the Federal or state anti-trust laws, no assurance can be given that a
court or regulatory agency will not make a contrary determination, which could
have a material adverse effect upon IMI.
State Government Regulation
Many states, including the states in which IMI operates, have adopted statutes
and regulations prohibiting payments for patient referrals and other types of
financial arrangements with healthcare providers, which, while similar in
certain respects to the Federal legislation, vary from state to state. Sanctions
for violation of these state restrictions may include loss of licensure and
civil and criminal penalties. Certain states have also begun requiring
healthcare practitioners to disclose to patients any financial relationship with
a provider, including advising patients of the availability of alternative
providers.
In addition, the laws of many states prohibit business corporations such as IMI
from practicing medicine, employing physicians to practice medicine or sharing
fees with physicians. IMI provides only non-professional services by providing
non-medical (i.e., technical and administrative services), does not exercise
control over the practice of medicine by physicians and does not employ any
physicians for the purpose of providing medical services. All physicians engaged
by IMI are independent contractors. IMI may not dictate the manner in which a
physician interprets a radiological examination or counsels patients. However,
these laws generally have been subjected to limited judicial or regulatory
interpretation, and therefore, there is no assurance that some of IMI's
activities might be found not to be in compliance. If such a claim were
successfully asserted against it, IMI could be subject to civil and criminal
penalties, and could be required to restructure its contractual relationships.
In addition, certain provisions of its contracts, including non-competition
covenants by the contracting professionals, could be ruled unenforceable. Such
results or the inability to successfully restructure contractual arrangements
could have a material adverse effect on IMI's operations.
Many states limit the extent to which providers can engage in risk contracting,
which involves the assumption of a financial risk with respect to providing
services to a patient. In some states, only certain entities, such as insurance
companies, HMOs or independent practice associations are permitted to contract
for the financial risk of patient care. In such states, risk contracting in
certain cases has been deemed to be engaging in the business of insurance. IMI
believes that it is not in violation of any restrictions on risk bearing or
engaging in the business of insurance under applicable state laws. If IMI is
found to be unlawfully engaging in the business of insurance, such a finding
could result in civil or criminal penalties or require a restructuring of IMI's
operations that could have a material adverse impact on IMI's operations.
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Florida
In April 1992, the State of Florida adopted the Patient Self-Referral Act of
1992 which prohibits referrals for certain designated health services by a
healthcare provider to a facility (including a diagnostic imaging center), in
which such provider has an ownership interest. In addition, effective October 1,
1996, the State of Florida enacted legislation which prohibits patient
brokering. The law makes it unlawful for any person, including any healthcare
provider or healthcare facility (including a diagnostic imaging center) to: (a)
offer or pay any commission, bonus, rebate, kickback or bribe, or engage in any
split fee arrangement, in any form whatsoever, to induce the referral of
patients or patronage from a healthcare provider or healthcare facility or (b)
solicit or receive any commission, bonus, rebate, kickback or bribe, or engage
in any split fee arrangement, in any form whatsoever, in return for referring
patients or patronage to a healthcare provider or healthcare facility.
Violations of the law may be punishable by fines and imprisonment. There is an
exception in the 1996 anti-brokering statute related to payments to or by a
health care network entity that has contracted with a health insurer, a health
care purchasing group, or the Medicare or Medicaid program to provide health
goods or services under a health benefit plan when such payments are for goods
or services under the plan. IMI believes that MRI Net is a health care network
entity that falls within the statutory exception. However, there has been no
regulatory or judicial interpretation of the statute clearly applying the
exception to network structures and activities like those of MRI Net, as a
result of which it is not certain that this exception would apply to MRI Net's
activities. If MRI Net's activities are found not to be in compliance with the
statute, it would be subject to fines, imprisonment, and/or a need to
restructure its business. IMI has in the past used the services of "patient
brokers," but discontinued such practice when the anti-brokering statute became
effective. IMI believes that its current procedures otherwise comply with
Florida laws regarding referrals and patient brokering.
Kansas
The State of Kansas prohibits the practice of medicine by non-physicians and the
rebate or division of fees between physicians and non-physicians. IMI believes
that its operations comply with such laws. Currently, the employees of the
Kansas Center provide only technical services relating to the MRI scans.
Professional medical services, such as the reading of the MRI studies and
related diagnosis, are separately provided by licensed physicians pursuant to
bona fide independent contractor agreements. There can be no assurance, however,
that state authorities will not determine that these relationships constitute
the unauthorized practice of medicine by IMI. Such determinations could have a
materially adverse effect upon IMI and would prohibit the Kansas Center from
continuing its current procedures for conducting business. In addition, Kansas
has recently adopted laws similar to the Federal "Anti-Kickback" statutes, which
prohibit the giving or receiving of remuneration's in exchange for the referral
of patients for services for which payment is made by Kansas Medicaid. However,
no Medicaid referrals are accepted by the Kansas Center from persons who receive
any remuneration of any kind from the Kansas Center, and thus the Company
believes it is in compliance with such laws.
Puerto Rico
The Health Facilities Act of Puerto Rico and the Health Facilities Regulations
promulgated thereunder set forth the provisions which regulate the establishment
and operation of health facilities in the Commonwealth of Puerto Rico, including
among others, diagnostic and treatment centers. No person may operate or
maintain a Health Facility in Puerto Rico without a license granted pursuant to
the provisions of the Health Facilities Act and the Health Facilities
Regulations. A license granted under the Health Facilities Act and the Health
Facilities Regulations is valid for two years unless otherwise revoked or
suspended before said term. However, the Office of Regulation and Accreditation
of the Health Department of Puerto Rico currently applies the provisions of the
Health Facilities Act and the Health Facilities Regulations to MRI facilities
which operate in conjunction with, or as part of hospitals. Independent MRI
facilities, such as the one operated by IMI, are not presently regulated under
the Health Facilities Act or Health Facilities Regulations. MRI facilities in
Puerto Rico are subject to certificate of need and convenience ("CON") laws,
which currently may serve to limit the competition for the Company because of
the added time and expense of establishing and operating competing facilities.
No major new health facilities can be constructed without obtaining a CON
granted by the Secretary of Health. In addition, any professional clinical
personnel providing services at IMII's MRI facility must satisfy local license
requirements. The laws and regulations in this area may be subject to material
change. Consequently, there can be no assurance that IMI will be in a position
to comply with future laws and regulations. Moreover, the cost associated with
compliance, including the cost of any additional personnel or contracting with
other qualified organizations to provide certain services, may have a
detrimental effect on the profitability of IMI's operations in Puerto Rico.
Further, even if IMI currently possesses all the licenses and permits necessary
to operate in Puerto Rico, there can be no assurance that IMI will be able to
renew all such licenses and permits. To date, the Commonwealth of Puerto Rico
has not enacted any laws or regulations prohibiting physicians from referring
patients to MRI facilities in which they have an ownership or financial
interest.
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Virginia
Under the Virginia Practitioner Self-Referral Act (the "Virginia Anti-Referral
Law"), unless the practitioner directly provides health services within the
entity and will be personally involved with the provision of care to the
referred patient, a practitioner may not refer a patient for health services to
any entity outside the practitioner's office or group practice if the
practitioner or any of the practitioner's immediate family members is an
investor in such entity. An "investor" is one directly or indirectly possessing
a legal or beneficial ownership interest, including an investment interest,
which is defined as the ownership or holding of an equity or debt security.
Currently, no physician in a position to refer patients to the Virginia Center,
nor any of their immediate family members, is an "investor", as defined in the
Virginia Anti-Referral Law, in IMI or in the entity which owns the Virginia
Center. A referring physician, or an immediate family member of a referring
physician who purchases Common Stock or Warrants in this Offering or otherwise
purchases such Securities in the public market, may be deemed an "investor" as
defined in the Virginia Anti-Referral Law, in that he or she would have an
indirect ownership interest in the entity which owns the Virginia Center,
because such entity is a wholly-owned subsidiary of IMI. Three possible
exceptions to the prohibition exist for such investors. The first exception
permits a practitioner to refer to an entity which is publicly traded and which
meets certain conditions. Even though the practitioner may be deemed an
"investor" in the entity which owns the Virginia Center, it is unclear whether
the exception applies, because the publicly traded entity is IMI, which is the
parent of the owner of the Virginia Center, not the owner of the Virginia Center
itself. Assuming that the exception could apply, IMI, in any event, would be
unlikely to meet all of the conditions set forth in the exception; consequently,
this exception would not be available. The second exception permits the Virginia
Board of Health Professions (the "Board of Health Professions") to grant an
exception if it finds that there is a demonstrated need in the community for the
entity, and several other conditions are met. Once again, there is an issue of
whether the exception applies because the entity in which the investment is made
is IMI, not the owner of the Virginia Center. Assuming the exception could
apply, it is possible for the Company to meet the conditions set forth in this
exception. It is unclear, however, whether the Board of Health Professions would
determine that there is a demonstrated need for the Virginia Center in the
community. If such determination were made by the Board of Health Professions,
assuming that the other conditions are met, this exception could be available to
a physician who purchases, or whose immediate family member purchases, Common
Stock or Warrants in a proposed future public offering or otherwise purchases
such Securities in the public market. Under the regulations adopted pursuant to
the Virginia Anti-Referral Law, any such exception granted by the Board of
Health Professions would be valid only for five years, but would be renewable.
IMI has not yet determined whether to seek qualification under the foregoing
exception. A third, more limited, exception applies if the practitioner refers a
patient who is a member of a health maintenance organization to an entity in
which the practitioner is an investor, if the referral is made pursuant to a
contract with the health maintenance organization. Although the practitioner,
and not the entity to which the referral is made, is the focus of the Virginia
Anti-Referral Law, the law also provides that once a determination of a
violation has been made by the Board of Health Professions, any entity, other
than the practitioner, that presents or causes to be presented a bill for
services that the entity knows or has reason to know is prohibited shall be
subject to a penalty of $20,000 per referral or bill. In addition to the
anti-referral law described above, Virginia law contains a prohibition, similar
to the Federal Anti-kickback Statute, that applies with respect to referrals of
Medicaid patients.
IMI continues to review all aspects of its operations and believes that it
complies in all material respects with the applicable provisions of the
Anti-kickback Statute, Stark II and applicable state laws, although because of
the broad and sometimes vague nature of these laws and regulations, there can be
no assurance that an enforcement action will not be brought against IMI or that
IMI will not be found to be in violation of one or more of these laws or
regulations. IMI intends to monitor developments under Federal and state fraud
and abuse laws, including Stark II. At this time, IMI cannot anticipate what
impact, if any, subsequent administrative or judicial interpretation of these
laws may have on IMI's business, financial condition, cash flow or results of
operations. Further, the laws and regulations in this area are subject to
material change. Consequently, there can be no assurance that IMI will be in a
position to comply with future laws and regulations in this area. Moreover, the
cost associated with compliance, including the cost of any additional personnel
or contracting with other qualified organizations to provide certain services,
may have a material adverse effect on IMI.
Insurance
IMI or its subsidiaries are defendants in legal actions arising out of the
performance of its imaging services. Damages assessed in connection with, and
the cost of defending, any such actions could be substantial. MI obtained and
currently maintains liability insurance which it believes is adequate for its
present operations. There can be no assurance that IMI will be able to continue
or, if necessary, increase such coverage or to do so at an acceptable cost, or
that IMI will have other resources sufficient to satisfy any liability or
litigation expense that may result from any uninsured or underinsured claims.
IMI also requires all of its radiologists to maintain malpractice and other
liability coverage.
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Potential Acquisitions
IMI may, in the future, seek to purchase additional medical diagnostic imaging
centers, including MRI and multi-modality centers. However, IMI has no
agreements or understandings and is not engaged in negotiations with respect to
the acquisition of any such additional centers. No assurance can be given that
it can or will be able to acquire any additional centers on reasonable terms or
that any centers which it may acquire will operate profitably. Medical
diagnostic imaging centers may be acquired from (i) radiologists who own and
operate such centers (ii) physicians who may be required by law to divest
themselves of such centers, and (iii) owners, including investment partnerships
and limited liability companies formed to operate such centers, that are seeking
to leave the imaging business. IMI may also enter into joint ventures with
hospitals or other entities which desire access to medical diagnostic imaging
technologies but lack the financial or management resources to establish a
separate imaging center. In evaluating the desirability of acquiring any such
centers, IMI will consider a number of factors, including the net income and
cash flow of the center, third-party reimbursement patterns, the condition and
age of the medical diagnostic imaging equipment, the relationships with managed
care organizations and physicians and hospitals in the area, competition, the
demography of the region, the reputation of the center, the nature of the
revenue base and available financing.
Competition
The health care industry, including the market for medical diagnostic imaging
services in general and MRI services in particular is highly fragmented. Such
services are performed by both hospitals and imaging centers, such as the
Centers, which are not affiliated with any hospital. Competition varies by
market and is generally higher in larger metropolitan areas where there are
likely to be more facilities and more managed care organizations putting pricing
pressure on the market. IMI competes with both hospitals and independent medical
diagnostic imaging centers. Furthermore, to the extent that another center
offers imaging services in addition to MRI, IMI may be in a competitive
disadvantage in marketing to managed care organizations, physicians and
patients. To a lesser extent, IMI competes with mobile MRI service providers.
Because of the cost of equipping and staffing an MRI or multi-modality center,
MRI and other medical diagnostic imaging modalities are rarely offered by a sole
practitioner or by a small group practice or by a large group practice that does
not have a substantial demand for such services. Competition often focuses on
physician referrals at the local market level as well as participation in
managed care organizations. Successful competition for referrals is a result of
many factors, including participation in health care plans, quality and
timeliness of test results, type and quality of equipment, the location of the
center, convenience of scheduling and availability of patient appointment times.
Many competitors are larger and are better known than IMI in the market in which
the Centers are located. IMI believes that hospitals are its most significant
competitors and have certain competitive advantages, including their established
community position, physician loyalty and convenience for physicians making
rounds at the hospitals. IMI believes that its services are competitive with
those offered by others in the areas serviced by its Centers. Furthermore, to
the extent that IMI seeks to expand through the acquisition of other centers,
IMI may compete with other, better capitalized companies seeking to make
acquisitions. There can be no assurance that IMI will be able to compete
effectively in the future. In addition, the establishment or transfer of
ownership in some jurisdictions may be subject to CON laws. In some states, such
laws may hinder IMI's ability to expand, while in others such laws may affect
the ability of potential competitors to enter the market. Except for Puerto
Rico, none of the states in which the Centers are located have CON laws which
affect independent free-standing diagnostic imaging centers. Any change in CON
laws which reduce the restrictions on potential competitors, such as hospitals,
may have a materially adverse effect upon IMI's business and operations.
Employees
As of December 31, 1996, IMI had 189 employees, 128 of whom were involved in
Center operations, nine of whom were involved in sales and marketing, 22 of whom
were executive and management employees and 30 of whom were involved in billing
and other administrative activities. None of IMI's employees are represented by
a labor organization, and IMI believes that its employee relations are good.
ELECTRO-MECHANICAL AND ELECTRO-OPTICAL PRODUCTS MANUFACTURING
The electro-mechanical and electro-optical products manufacturing segment
reflects the operations of Sequential Electronic Systems, Inc., ("SES"), S-Tech,
Inc., ("S-Tech"), Televend, Inc., ("Televend") and FMX Corporation, ("FMX"), all
of which are wholly owned subsidiaries of SES Holdings, Inc., ("SESH") with the
exception of FMX which is 51% owned by SESH. SESH is a Delaware corporation that
was organized in July 1992. On December 20, 1996, SISC sold all of its ownership
in SESH to Lafayette Industries, Inc., ("Lafayette"), in exchange for a
controlling interest in Lafayette.
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Sequential Electronic Systems, Inc.
SES is a Delaware corporation organized in 1985. The principal products
manufactured by SES are optical encoders, encoded motors and limit programmers.
Products Manufactured
Optical encoders, like those that are produced by SES, are utilized in almost
every manufacturing process where position is required as a part of the
manufacturing process. Encoders are used as position sensors on CNC machines,
packaging machinery, etc., in industries such as food packaging, manufacture of
paper products, and as measurement devices on medical equipment. Additionally,
SES furnishes encoders to the military for such applications as position
transducers for the Multi-Launch Rocket System and for the Patriot Missile
Defense System. Both of these systems were extensively used in the Gulf War. SES
encoders are also used in the latest state-of-the-art NEXRAD weather system. SES
high resolution encoders provide azimuth and elevation data on the National
Aeronautics and Space Administration's telemetry tracking antennas located
around the world.
Encoded motors are used as capstan drives in weather map recorders and
state-of-the-art instrumentation tape recorders. These recorders are used by the
government in antisubmarine warfare detection systems in seismic measurement
recording systems.
Limit programmers are primarily designed in industry to control the sequence of
events required during the manufacturing process. SES limit programmers are
found in machinery to manufacture tires, toilet tissue, disposable diapers, as
well as machinery used to package bread, cake, coffee, soap and other consumer
purchased products. SES limit programmers provide direct digital position
output, allowing for the direct transfer of digital position information to
microcomputer based control systems.
Markets, Marketing and Competition
Revenues for SES has decreased from the prior periods amounting to $1,363,000,
$2,556,000 and $3,035,000 for 1996, 1995 and 1994 respectively. Revenues from
two U.S. government agencies amounted to $893,000 and $563,000 for 1995 and
1994, respectively, which comprised 20% and 15% , respectively, of total
revenues for 1995 and 1994. No revenues were earned from these government
agencies in 1996. SES believes that the high resolution encoder market is
becoming a significant market to the U.S. government again after a no-budget
year for 1996. Primary areas of sales for high resolution encoders are the
missile test ranges under the heading of Missile Range Instrumentation. U.S.
government facilities that are anticipated to be covered are Air Force bases
that are tied into respective weapons test centers. In order to take advantage
of fiscal 1997 U.S. government budgets and new programs, an effort is being made
to determine the level of upcoming new procurements and upgrading of existing
range instrumentation. Photo-Sonics, a Burbank, California company is a major
supplier of missile range instrumentation devices to the U.S. government and a
significant portion of Photo Sonics devices use encoders manufactured by SES. In
order for SES to reestablish itself as a leader in the military type hardware,
it will require visits and presentations to weapons test centers and the
utilization of the Photo-Sonics sales force.
Related to non-military applications, SES presently completed an order for
prototype units for ABB Daimen Benz for encoders. These units are currently in
evaluation for use as part of the speed control system for rail cars.
The future growth of SES will require a restructuring of existing product lines
as the current product lines may not be sufficient to sustain the growth of SES.
The future spending of the U.S. government on military related projects has been
and will continue to be volatile due to unpredictability of amounts budgeted for
military spending. As such, no assurances can be given that SES will be able to
produce sales volumes that will sustain its planned growth.
Government Regulation
As a manufacturer of products that are used in devices purchased by the Defense
Department or its contractors, SES is subject to the provisions of the
procurements regulations of the Defense Department. These regulations generally
provide the government with the right to terminate the contract for the
convenience of the Defense Department, and, in certain cases may include
provisions for renegotiation. The Department of Defense also has regulations
pursuant to which the Defense Department may inspect a contractor's or
sub-contractor's manufacturing facilities. Such inspectors frequent SES's
facilities on a regular basis.
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Employees
As of December 31, 1996, SES had 21 employees. None of SES's employees are
represented by a labor organization, and SES believes that its employee
relations are good.
S-Tech, Inc.
S-Tech is a Delaware corporation that was organized in June 1992. S-Tech is a
design and manufacturing facility which has several unique and specialized
product lines which consist of specialized vending machines, avionics equipment
and industrial lighting.
Markets, Marketing and Competition
Specialized vending is used to describe a vending product which includes
sophisticated electronic circuitry and or computer software. The vending
products presently being manufactured under contract include prepaid telephone
debit card machines, automated payment centers, information kiosks and stamp
machines. S-Tech has entered into contracts with such major companies as
ConEdison, NYNEK and Kinkos. Previously, S-Tech manufactured in excess of 11,000
stamp machines for the United States Postal Service and designed and
manufactured the token vending machines for the New York City Transist
Authority.
The avionics equipment manufactured by S-Tech consists primarily of various
cockpit instruments and oil pressure transmitters. The majority of these
products require a qualified product list designation ("QPL"). The QPL list
consists of qualified products, with a limited number of approved sources, which
are purchased by the Department of Defense, contractors and subcontractors. In
many instances this QPL designation places the company in a highly advantageous
competitive position as it pertains to government contracts by limiting the
number of qualified bidders. In addition, S-Tech responds to "build-to-print"
solicitations which are subject to competitive bidding. These products are
manufactured in accordance with drawings and data packages provided by the
Department of Defense or other procuring agencies.
S-Tech's revenues for 1996, 1995 and 1994 was $1,015,000, $2,556,000 and
$619,000, respectively.
Telephone Debit Card Vending
The specialized vending product line offers the maximum opportunity for
long-term growth and profitability. The specific products that S-Tech is
currently targeting are the prepaid telephone calling card machines and the
automated bill payment centers. The prepaid telephone calling card machines
require that S-Tech be able to provide its customers with a card that is
dispensed from the machine. In response to a recent industry demand, S-Tech has
designed a prepaid telephone calling card machine for the purpose of dispensing
calling cards. Pre-paid calling cards are already used worldwide as the most
convenient and affordable means of making long-distance telephone calls made
away from home. The telephone debit card vending machines are used in a variety
of locations such as bus stations, airports, cruise lines, rental car locations,
hotel lobbies, gift shops, nursing homes, train stations and gas stations.
Automated Payment Centers
S-Tech's experience in the USPS programs and in specialty vending products
permitted the company to expand their product base into a number of new areas.
The most important of these is the Automated Bill Payment Center. S-Tech is
presently under contract to design, develop and manufacture a customer operated
Bill Payment Center for a major utility company and is being considered by two
(2) other public service companies for a similar unit. The unit is simple in
operation, aids the user with visual prompts, accepts currency, prints a
transaction report, and provides change to the customer. Customer interface with
the system begins with a touch screen selection button, Start Transaction or
English/Spanish selection. The system responds with the first help screen
showing an animated version of the bill form. The screen will then show how the
bill is to be inserted into the bar code scanner on the payment machine.
Software identifies when the bill form is in place, and will automatically begin
the scan. Three attempts will be programmed, after which, the system will flag
the second help screen. The second help screen will show in animated form the
proper method for reading and manually punching in the account number as it
appears on the bill form. The animation shows where the account number appears,
the number of characters, and how to use the touch screen keypad.
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Once the account number has been entered the system uses the existing public
service company's software to interface with their main-frame system. This
interface retrieves the customer name, address, and all other pertinent billing
facts such as usage, current balance due, and account status (i.e. the same
information that is available to the current clerk operated system). When the
system asks for a confirmation, the touch screen will again be enabled for a
response. Upon a positive response the system provides a help screen to aid in
the selection of the account payment. An animated screen will demonstrate a
complete or partial payment, enable the currency validator and display how bills
are to be inserted. The system will also instruct the customer to insert large
bills first so that an undesired change situation will be avoided. Once payment
is received and validated, the account is credited and the account transaction
is forwarded to the main frame where it is registered. Change is always given in
the largest denomination available. The payment centers use intelligent routines
which will prevent the input of currency in an undesirable manner and in turn
prevent situations where a larger than normal amount of change must be
dispensed. The program will be used to dispense change in the most efficient
manner to assure that the system will remain in operation for as long as
possible. For the average $6.50 of change dispensed, the unit will be able to
service several hundred clients in terms of change in $5 and $1 bills, quarters,
nickels and pennies.
The final step in the transaction sequence is the printing of a receipt and
recording of the transaction. The machine will automatically switch to the
display mode in English until a customer initiates the transactions or bilingual
mode. A telephone line is provided on the payment center to permit the customer
to speak with a representative of the public service company if clarification is
required or verification is needed such as "reinstalling a disconnect notice".
The system automatically requests service when any of the utility functions
approach a level which can cause an "out of service" condition within several
transactions. If service is not accomplished a threshold is established upon
which the system disables. Items such as a low currency dispenser, low coin
hopper, printer paper low, floppy disc near full condition, or the bill
validator is full will generate an alert signal to be sent to the appropriate
monitor. Special software monitors bill volume so that a stacker full signal is
avoided (which will remove the unit from operation). This condition must be
avoided because it could occur in the middle of a transaction where it will lead
to an unacceptable level of customer stress and inconvenience.
The following options can also be provided:
Single frame video of customer(s).
Audio (interactive) or message upon initial customer contact with touch screen.
Special signage.
Credit/Debit card payments.
Permit payment for other public service companies
Bilingual graphics.
Vending of standard Prepaid Telephone Calling Cards
Alarm system (security)
The most significant of these options is the ability to support other public
service companies by providing an interactive communications network that will
permit interfacing with different devices, external networks and proprietary
hosts on the same network as well as easily add on new devices with a minimum of
change and in a relative short period of time. This system will permit the
Payment Center to facilitate collections for other public service companies,
payment by credit card and payment by bank debit card thus expanding the centers
capability and sharing of the systems cost. This proposed system would ensure
that an internationally standards-oriented baseline technology architecture is
implemented to facilitate connection to a much broader variety of host-based and
network-based technologies and expand the potential products and services
offered by the system within the context of its current strategies as well as
beyond.
S-Tech believes this system represents the best possible combination of
architecture, technology, support and experience available. The proposed network
system enables access to all types of shared cash dispensing networks. The
system will control and manage all aspects of bill payment authorization on
behalf of the host system, with features such as:
Authorization Processing
Network Interface
Host System Interface
Message Management
Security Processing
Failure Monitoring
Reporting/MIS
Bill Payment Device Handling
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The market potential is significant since over 30% of the customer base do not
have checking accounts or credit cards. Most public service companies prefer
their customers to pay by mail. However, a considerable number of customers
continue to use the service company's payment centers which operate like
mini-banks or use various retail stores such as pharmacies, card shops and check
cashing facilities for the payment of bills. These methods cost the service
company a commission or fee. The service company's payment centers are generally
busy during lunch hour, on Fridays (pay day), at the end of the month or before
and after normal working hours resulting in a large waiting lines to pay their
bills thus adding to their frustration. The Customer Operated Bill Paying
Machine provides a means for the customer to pay, either in full or in part,
their bill, reconcile accounts, and to do so with 24 hour availability and
independent of any clerical assistance unless required by the customer.
Information Kiosks
The automated payment center paves the way into another market. The kiosk
provides access to forms for municipalities and the federal government, Internet
accessibility, "how to get-to" information centers, postal information centers,
court house directories, and for college registration and student services.
Expanding capabilities in this field leads to other similar kiosk related
products. S-Tech negotiated for a contract to design and develop the hardware
for a Municipality Forms Kiosk that will permit individuals to obtain computer
generated forms used by the various agencies of a municipality at one central
location. At present, 21 units are on order with the potential sales of over 100
units. These new products have broad base applications for public service
companies, municipalities governments and postal services for both domestic and
on an international basis. S-Tech is presently negotiating to design and
fabricate a cash payment machine that can be utilized as a customer interactive
customer selection and payment machine in fast food locations. This concept will
also be applicable to customer interactive machines for checkout and payment in
supermarkets. Special signage and kiosk designs are also included to provide
other revenue sources and unique vending designs will be incorporated in these
designs for money handling and MIS data transmission.
Stamp Vending Products
S-Tech manufactures automatic postage stamp booklet vending machines, automatic
postage stamp vending machines and currency to coin change machines. S-Tech's
postage stamp booklet vending machines dispense one or two different stamp
booklet denominations booklets and are programmable for price. S-Tech's
programmable stamp booklet vending machines contain an electronic control board
of electronic components, integrated circuits and micro-switches, which allow
for channel and price selection instead of requiring replacement of the entire
coin changer. In addition, this design permits adaptation of the machine to
foreign currencies. The units have a self- testing capability, cold temperature
compensation and anti-tampering devices. The coin changer has slug and bent coin
protection and is adjustable in $.05 increments up through $12.75 with change
being returned in nickels and quarters. The units are usually "through the
wall" mounted, allowing for servicing from the rear.
The automatic postage stamp vending units operate in a similar manner to the
automatic postage stamp booklet vending units and also contain multi-channels
for the dispensing of various denominations of stamps. For example, if so
selected, one channel may dispense four 32 cent stamps, a second channel may
dispense one 32 cent stamp and a third channel may dispense three 32 cent
stamps. In the event that the post office changes the stamp price, the machine
has the capability of returning penny stamps and/or change to the customer. For
example, if the stamp price is 32 cents and the customer inserts four dimes into
the machine, he would receive one 32 cent stamp, three penny stamps and one
nickel change. The bulk of S-Tech sales of postal products to date have been to
the United States Postal Service. However, over the past two years the company
has developed commercial applications and is presently marketing in the
commercial area. These locations include hospitals, colleges and universities,
office supply stores and a number of other specialty stores. Sales to Kinkos, an
office supply store, over the past two years were approximately 250 stamp
machines with bill validators.
Token Vending
Several years ago the S-Tech management team designed and manufactured the token
vending machines for the New York City Transit Authority. The contract provided
for the design, manufacture and the installation and maintenance of 59 machines
that are located in the NYC transit system. The system is fully operational
today and has never experienced a break-in. S-Tech's marketing will be expanded
for this product line. The United States Postal Service has recently embarked
upon a program called "the Future Electronic Marketplace" in order to improve
their image as a public communications facilitator and regain revenues lost to
other carriers through the use of computers and fax machines. This program
consists of three revenue sources: vending machines for their prepaid telephone
calling card in association with American Express; a customer interactive system
linked to 200 million home TV's, 40 million PC's and 15,000 kiosks which will
provide information on government forms, payment of fees, retail catalog sales
and postal services. S-Tech is meeting with the United States Postal Service in
an attempt to participate in this program.
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Avionics Products
The S-Tech avionics product line consists of both new and spare (replacement)
items to maintain existing aircraft in an operational status. The products
consists of a variety of approximately 20 synchro repeater instruments and 2 oil
pressure transmitters. This product line had been relatively flat in sales with
a range of $1 to $3 million dollars annually. The last few years have been seen
a significant reduction in sales due to a reduction in Department of Defense
(DOD) expenditures. Although there is no guarantee of an upswing in the late
90's, it must be anticipated that inventories are low and spares will be
required. Projected annual sales for this product area is anticipated to
increase slightly because of the low inventory levels coupled with S-Tech's
strategy to expand the instrument product line. In the event that the DOD 5 year
forecast indicate future procurement of these items, S-Tech will be requalifying
nine (9) indicators and one transmitter in anticipation of future procurements.
In addition to the DOD sales, a limited number of sales are made in the
galvanometer type indicator area to commercial accounts. Approximately 95% of
S-Tech's business in this product line is defense related.
The total market is in the billions of dollars. Selection of biddable items will
include only those products which are within our capability and when competition
has not forced the price down to a level which does not meet our ROI objectives.
Competition is fairly aggressive and solicitations may have as few as 2 or 3
bidders or as many as 15 to 20 bidders. It is reasonable to expect an award
percentage, based upon previous experience, of approximately 4% for build to
print programs.
The majority of S-Tech sales are obtained through the bidding process for the
military items that are identified by CBD announcements, filing of 129 Forms at
cognizant agencies and by repeat bid requests as a prior manufacturer. S-Tech
carefully reviews the CBD publications and seeks out those instruments that
align themselves with the QPL and desired technology.
As part of its marketing strategy, S-Tech actively identifies other avionics
products that will be:
Separated as small business set-aside.
Competition Advocacy break-outs.
SBIR requirements.
Major OEM subcontract requirements.
Catalogs, advertising and visits to major avionics centers and aircraft
manufacturers is essential to maintain this product line growth. Attendance at
major avionics related shows and membership in key national organizations such
as SAE, Air Force Association and the Navy League is essential. Financing will
provide the assets to accomplish these tasks.
Recent solicitations for oil pressure transmitters similar to ones currently
manufactured by S-Tech were bid and are presently pending. These units if
awarded to S-Tech will require design modifications to our existing design.
However one contract in this family of units will permit us a better competitive
opportunity to bid on the other items in this family of units since the
differences are only the operating pressure range.
The requirements for night vision compatible instruments (green illumination
instead of white or red) is becoming an increasing requirement for low level
support aircraft and helicopters. This is a requirement to avoid blooming (pilot
blindness) when using night vision image intensified goggles. S-Tech presently
has a proposal submitted to Lockheed to modify two QPL instruments for this type
of application.
S-Tech intends initially to: (1) bid on items that are repeat items or similar
to repeat items to minimize our risk(s); (2) bid on items to reduce inventory
excess levels; and (3) select items that are well within our capability (low
risks). In the long term, S-Tech will expand its QPL instruments and
transmitters to allow for increased sales.
Government Regulation
As a manufacturer of products purchased by the Department of Defense or its
contractors, S-Tech is subject to the provisions of the procurement regulations
of the Department of Defense. These regulations generally provide the government
with the right to terminate the contract for the convenience of the Department
of Defense, and, in certain cases may include provisions for renegotiating. The
Department of Defense also has regulations pursuant to which the Department may
inspect a contractor's or subcontractor's manufacturing facilities. Such an
inspector is present at S-Tech's facility on a regular basis.
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Employees
As of December 31, 1996, S-Tech had 11 employees. None of S-Tech's employees are
represented by a labor organization, and S-Tech believes that its employee
relations are good.
Televend, Inc.
Televend is a Delaware corporation that was organized in December 1995. Televend
has developed and markets a line of telephone cards for general use. Televend
intends to ultimately sell the telephone cards using S-Tech's telephone calling
card vending machines and is currently selling the cards through an independent
network of sales representatives.
Markets, Marketing and Competition
Prepaid phone cards were first issued in Italy nearly 20 years ago. They are now
used in over 200 countries and enable the holder to place a call from a public
telephone without the use of a coin or token. These prepaid phone cards are
"smart cards" with the value stored in the card itself utilizing optical,
magnetic strip or chip technology. These types of cards were issued by the
country's PTT (Public Telephone & Telegraph) and require telephones specially
designed for their acceptance. European sales are estimated at $5 billion per
year, Japanese sales alone are approximately $4 billion.
The vast majority of cards issued in the United States are "remote memory" cards
with all information stored in a network-based central computer. These cards are
used from any touchtone phone by dialing a toll-free 800 number and entering the
PIN number unique to the card and then dialing any domestic or international
call. Many cards are "rechargeable" which enable the holder to add additional
time to the card after the initial amount purchased runs out. The market for
prepaid cards in the United States is estimated at $10 billion per year. To
date, U.S. market penetration is estimated to be less than 4%.
The prepaid phone cards have a promotional value. Several national promotional
programs have already been implemented by companies such as American Express,
Ryder, NBC, Mienekie, Dollar Rent-A-Car, and Monroe Mufflers. Over the next few
years, public awareness will increase dramatically as consumers are inundated
with millions of cards to be given away or sold by corporate and retail giants
such as Coca-Cola, Pepsi, Philip Morris, RJR, Nabisco, APT, Kodak, K Mart and
Walmart, Sears and major car rental companies.
The market for telephone cards in the United States is arguably the largest in
the world at between $5.0 billion to $15.0 billion. A survey of the market for
prepaid phone cards in the United States has shown that it has developed into
five primary segments. These markets are: utility, promotional, corporate,
affinity and collector. The utility component of the market is based upon sales
to consumers through retail establishments such as convenience stores, travel
agents, newsstands, check cashing stores and supermarkets. The consumer is
typically charged rates ranging from $.29 to $.60 per minute for domestic long
distance calling time. The promotional premium segment is based upon cards that
are given away to reward customer loyalty or promote specific products. Prepaid
phone cards have been given away with purchases of frozen dinners, baby food,
dog food, sneakers, soft drinks and clothing just to name a few. This has proven
to be a particularly effective marketing tool since long distance calls have
nearly universal appeal. The corporate segment of the market is based upon the
use of prepaid cards by corporations for use by their employees for calls made
outside the office. Not only does this achieve a cost savings for the business,
but additionally allows for effective budgeting. The affinity component of the
market is based upon a group or organization distributing prepaid cards to its
members. Affinity groups such as motor clubs religious organizations, alumni
groups, unions, etc., receive commissions and residuals for the use of
group-issued cards by their members. The collector portion of the market is
based upon the card itself (the image, its desirability and its availability) as
well as the underlying economics. Many collectors expect the value of their
cards to increase which also brings into consideration soundness as a financial
investment.
The market for prepaid phone cards in the United States has developed slowly.
Although prepaid cards have been issued for several years, current estimates of
annual sales of approximately $150 million indicate a market penetration of less
than 4 percent, with rapid growth predicted. The U.S. has been the last major
market to develop due to the general lack of public awareness about the use and
benefits of prepaid calling. Public awareness will increase dramatically with
the development and implementation of promotional and premium programs currently
being planned by many Fortune 500 companies. Consumers will be inundated with
millions of cards which will be given away by such corporate and retail giants.
Additionally, companies currently issuing membership and charge cards to their
customer base (e.g. AAA, Exxon, Sunoco, Fingerhut and Blockbuster) are planing
to market and distribute telephone cards to their existing data base.
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Once there is a widespread recognition of prepaid phone cards and their use,
distribution of cards to the utility segment will increase dramatically. Since a
typical call (3 to 5 minutes in duration) with a prepaid card is substantially
less expensive and does not have the attendant fraud problems associated with
conventional credit cards. It can be assumed that a large part of that market
will convert to the use of a prepaid card. Given the fact that Nippon Telephone
& Telegraph sells over $4.0 billion of cards through more than 140,000 points of
distribution (retail stores and vending machines) with a customer base of
approximately 125 million, the utility market in the United States can be
conservatively projected to a similar level.
As the market expands, consumers will become sensitive to items such as the cost
per minute and the availability of network-based enhanced features such as voice
mail, store and forward of voice and data, audio text and other interactive
services. These features, combined with the rechargeable feature of the cards
will also lead to a dramatic increase in the corporate and affinity segments of
the market. Numerous corporations and organizations will custom tailor a
telephone card program for their employees and members.
Another factor affecting the market is regulation by various federal and state
agencies, including the Federal Communications Commission, as well as state
Public Utility and Tax Commissions.
Although competition is high for this product area, Televend intends to capture
its share of the market by innovative design, improved reliability, customized
features for large quantity purchases, special signage, and use of state of the
art components. The United States Postal Service is presently in a pilot program
with American Express and MCI (telephone carrier) to sell prepaid telephone
calling cards over the counter.
Televend has generated revenues of $387,000 and $357,000 in 1996 and 1995,
respectively, and has incurred net losses of $268,000 and $134,000 for 1996 and
1995. No assurances can be given that Televend will be able to generate revenues
significant enough to penetrate the competitive environment of selling telephone
calling cards as Televend is competing with competitors that have a current
market share, a more competitive pricing arrangement and significantly greater
capital resources.
Employees
As of December 31, 1996, Televend had one employees. None of Televend's
employees are represented by a labor organization, and Televend believes that
its employee relations are good.
FMX Corp.
FMX is a Delaware corporation that was organized in 1995. FMX is a development
stage company which designs, develops and integrates all of the critical
building blocks of a Fingerprint ID System ("FIDS"). In conjunction, FMX has
completed development of a proprietary unique optical fingerprint scanner,
VLS-10, which has a live-scan ten print touch/roll and single print touch/roll
capability. Presently in development is the VLS-IFP, which is of the same genre
as the VLS-10. This unit is significantly smaller and is designed to be
integrated with SmartCard technology. Presently, there are no comparable units
available to OEM system integrators. FMX expects that its FIDS can be
implemented into a super high reliability product because of the tight control
of the individual building blocks and the connecting interfaces. This is a cost
effective package which will be offered to OEMs in the security, entitlement,
and law enforcement markets as well as positioning FMX to be able to participate
and directly compete in the "low end" access control market.
FMX considers that one of the major impediments to general acceptance of
fingerprint as opposed to retinal and hand geometry biometric constructs has
been the inability of all fingerprint scanners to satisfactorily scan and/or
reliably image the broad spectrum of fingerprint quality evidenced in any user
population of the representative randomly chosen subjects. FMX expects that its
scanners will allow a much increased spectrum of user acceptance, which in this
crucial area, will be on a par with the very much less accurate systems based on
retinal patterns or hand geometry.
FMX anticipates an immediate market for the sale of the VLS-10 to OEMs who
currently buy fingerprint scanners from only one source. FMX's penetration of
this market is based upon the superior performance and ergonomic comfort of the
VLS-10. There are at least 10 OEMs using fingerprint identification systems and
significantly more using only the scanner.
The VLS-IFP is structured to appeal to the credit card companies, who are
interested in integration of fingerprint scanners into smart cards, and
periodically attempt to tantalize television audiences with the predicted
technical advancements.
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A patent application on the unique electro-optical mechanization of VLS-10 and
VLS-IFP is in progress but has not been completed to date.
FMX has not generated any revenues and no assurances can be given that the
future revenues generated by FMX, if any, will be substantial. Additionally, a
lack of sufficient funding will delay the development of the prototypes and
could result in the competitor companies developing a product of similar
capability prior to FMX's prototype completion. Further development and
perfection of other biometric devices may effect the marketability of FMX's
product. During 1996, FMX has incurred $144,000 in research development
expenses. The research and development and all substantial engineering is
performed by the 49% minority interest owner of the company. Administrative
support is provided by Consolidated.
MEDICAL INFORMATION SERVICES
The medical information services segment reflects the activity of Netsmart
Technologies, Inc., ("Netsmart"). Netsmart is a Delaware corporation, organized
in September 1992 under the name Medical Services Corp., a holding company,
whose operations were conducted by its wholly owned subsidiary, Carte Medical
Corp. In October 1993, Medical Services Corp. merged its subsidiary into itself
and changed its name to Carte Medical Corporation. In June 1995, Carte Medical
Corporation's name was changed to CSMC Corporation, and in February 1996, the
Company's name was changed to Netsmart Technologies, Inc. Substantially all of
Netsmart's revenue during 1995 and 1994 was generated by its health information
systems and related services which are marketed by its subsidiary Creative Socio
Medics, Corp. ("CSM") which was acquired by Carte Medical Holdings, Inc., a
wholly owned subsidiary of SISC. In September of 1995 the stock of CSM was
transferred by Carte Medical Holdings, Inc. to Netsmart.
Netsmart develops, markets and supports computer software designed to enable
organizations to provide a range of services in a network computing environment.
A network computing environment is a computer system that provides multiple
users with access to a common database and functions. A network system can be a
local system, such as a local area network, known as a LAN, which operates
within an office or facility, or a distributed system which provides
simultaneous access to a common data base to many users at multiple locations.
There are typically three parties in Netsmart's network system - the sponsor
(the party that maintains the data base, and may be a managed care organization,
a university or a financial institution), the users (the users are the
individuals who use the system, and may be the subscribers of a managed care
organization, the students at a university or the bank care or credit card
holders of a financial network) and the service providers (the service providers
are those who provide goods or services to the users, and may be physicians,
pharmacies, banks and merchants who provide goods, services or funds to bank
card or credit card holders).
Netsmart has developed proprietary network technology utilizing smart cards
which it markets in the health care, financial and education fields as the
CarteSmart System.
A smart card is a plastic card about the size of a standard credit card which
contains a single embedded microprocessor chip with both data storage and
computing capabilities. The smart card software provides access to the
information stored in the chip, the ability to update stored information and
includes security elements to restrict unauthorized access to or modification of
certain information stored on the card utilizing a smart card reader system. The
smart card reader system and the software provides the ability to include
information on both the smart card and the organization's computer system.
Netsmart also supplies network applications which use telecommunications rather
that than smart cards to obtain access to and manage data.
Health Information Systems and Services
Since the acquisition of CSM, Netsmart has offered its customers a range of
products and services principally based upon the health information systems
which were developed and marketed by CSM prior to the acquisition. Users
typically purchase one of the health information systems, in the form of a
perpetual license to use the system, as well as contract services, maintenance
and third party hardware and software which Netsmart offers pursuant to
arrangements with the hardware and software vendors. The contract services
include project management, training, consulting and software development
services, which are provided either on a time and material basis or pursuant to
a fixed-price contract. The software development services may require CSM to
adapt one of its health information systems to meet the specific requirements of
the customer.
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Although the health information systems constituted the basis of CSM's business,
revenue from the license of such systems has not represented a major component
of its revenues. The typical price for a license for CSM's health information
systems ranges from $10,000 to $30,000. During 1996, 1995 and 1994, CSM
installed health information systems licensing of such systems represented
approximately $329,000, $162,000 and $375,000, for 1996, 1995 and 1994,
respectively, accounting for approximately 3.9%, 2.2% and 7.4% of revenue for
such periods.
Netsmart offers software systems developed by CSM which are designed to meet the
requirements of providers of long-tern specialty care treatment. Certain of its
systems were developed to meet the requirements of Federally funded target
cities projects and is installed in Baltimore, Los Angeles, Atlanta and Cuyahoga
County (Cleveland), Ohio
A customer's purchase order may also include third party hardware or software.
For 1996, 1995 and 1994, revenue from hardware and third party software
accounted for approximately $1.1 million, $2.1 million and $900,000,
representing 13%, 29.1% and 18.1%, respectively, of revenues in such periods.
In addition to its health information systems and related services, CSM offers
specialty care facilities a data center, at which its personnel perform data
entry and data processing and produce operations reports. These services are
typically provided to smaller substance-abuse clinics. During 1996, 1995 and
1994, CSM's service bureau operation generated revenue of approximately $2.2
million, $1.7 million and $1.6 million, respectively, representing approximately
25.8%, 23.6% and 32.5% of CSM's revenues for such periods. The largest user of
the service bureau is the State of New York Office of Alcohol and Substance
Abuse Services, which uses CSM's service bureau to maintain its statewide
database of methadone users, however, such customer accounted for less than 4%
of CSM's revenues 1996, 1995 and 1994. Netsmart intends to augment the marketing
effort for the service bureaus, although no assurance can be given that such
operations will continue to be profitable.
Maintenance services have generated increasing revenue and are becoming a more
significant portion of CSM's business. Since purchasers of health information
system licenses typically purchase maintenance service. Maintenance revenue
increases as new customers obtain licenses for its health information services.
Under its maintenance contracts, which are executed on an annual basis, CSM
maintains its software and provides certain upgrades. Its obligations under the
maintenance contract may require CSM to make any modifications necessary to meet
new Federal reporting requirements. CSM does not maintain the hardware and third
party software sold to its customers.
The CarteSmart System
Netsmart's CarteSmart System software was designed to operate on
industry-standard computer networks and smart cards. A smart card is a plastic
card the size of a standard credit card which contains an embedded
microprocessor chip. The card has data storage and computing capabilities and
the smart card software includes security elements to restrict unauthorized
access to or modification of certain information contained on the card. A smart
card may also include a magnetic stripe to allow it to be used in networks that
do not include smart card functionality. The smart cards are designed to be
issued only by the sponsor organization, such as a managed care organization,
specialty care facility, administrator of an entitlement program or other
similar organization, a university or a bank or credit card organization.
The CarteSmart software consists of components which allow Netsmart to develop
network applications for sponsors with less effort that would be required if
those network applications were developed from scratch. The CarteSmart software
consists of an Application Program Interface ("API") and an API Generator which
shows fast customization of the API for specific network applications. The API
is a set of software modules that provide the common functions required to
support a computer network using smart cards. By using the API, Netsmart or a
sponsor may develop network systems more quickly than if all of the software
necessary to Implement the network were custom written for a particular network
application. The API Generator is a tool developed by Netsmart that it designed
to allow Netsmart or a network sponsor to develop a custom API for a particular
network and reduce the effort required to build network systems.
The CarteSmart System is designed to operate on file servers and personal
computers which utilize the DOS, Windows 3.1, Windows 95, Windows MT or UNIX
operating systems, depending upon the application. The software used in the
smart card can be used or adapted for use in most commercially available smart
CarteSmart cards generally meet international standards and are considered
commodity products, although each manufacturer has its own software to interface
with a computer. Accordingly, Netsmart believes that a manufacturer would
provide any necessary assistance in order to market its cards.
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Although Netsmart's CarteSmart System software has general applications, its
experience with each of its four CarteSmart clients reflects a need to customize
the software to meet the specific need of the client. Although the customization
need not be significant, each user has its unique requirements that must be met.
These requirements may include the need to enable the CarteSmart System to
interface with the client's existing systems to the development of a range of
software products to meet needs which are not presently being served.
Netsmart's initial applications were designed to meet the needs of managed care
organizations and entitlement programs and Netsmart developed a smart card
interface to its health management systems. Each time a patient visits a
participating health care provider, the health care provider adds to the
patient's data base information concerning the visit, including the date,
procedures performed and diagnosis. At the time of the first visit to a
participating physician, the physician enters information relating to the
diagnosis and treatment given on that visit together with such information
relating to chronic conditions, such as allergies and medication, as the
physician deems important. Netsmart does not anticipate that the health care
provider will be expected to include information relating to earlier diagnosis
or treatment; however, the organization which provides the smart card may
require additional information to be input at the initial visit. This
information is input into the patient's smart card and may also be transmitted
to the managed care organization's central data base, where, unless
dissemination of such information has been restricted by the patient other
health care providers will have access to the information. The health care
provider can read information from, and write information onto the smart card
through a card interface device, which is standard computer peripheral equipment
readily available from composer outlets and can be easily connected to a
personal computer. The information transferred to the smart card is first input
by the health care provider on a computer and includes the date of service,
diagnosis, treatment including any prescribed medication, and any other
information which the health care provider determines.
At the time of the visit, the health care provider inputs the standard codes for
use diagnosis and procedures performed. Errors in inputting the diagnosis and
the procedure code delay payment or affect the amount of payment. The SmartCard
System can be integrated with the health care provider's existing practice
management system, without incurring any additional personnel. The CarteSmart
System software has integrated within it an easy to use diagnosis and procedure
code look-up capability, as well as error checking and other safeguards which
assist the health care provider in inputting the proper codes based upon normal
medical terminology.
The smart card stores only a limited amount of information, and is intended to
reflect current medical conditions and not a record of medical treatment from
birth. When the storage capacity of the card, which is equivalent to
approximately ten typed pages, is reached, items are deleted on a chronological
basis, with the earliest items being deleted first, although there is an
override procedure by which certain crucial medical information, such as
allergies and chronic conditions, can be retained, regardless of the date when
the patient was diagnosed or treated for the condition. The card also includes
information on each prescription which the patient is taking. A smart card is
different from a magnetic stripe card, such as is used at Virginia Commonwealth
University ("VCU"), in that it has an updatable data storage capacity, which a
magnetic stripe card does not.
To date, Netsmart has licensed its CarteSmart software in conjunction with pilot
projects for San Diego County and the Albert Einstein School of Medicine, which
involved the issuance of smart cards to approximately 1,200 mental health
patients participating in the California Medical Managed Care Initiative.
Netsmart is presently negotiating for an expansion of the program to include
substance abuse and acute care as well as mental health for the county's total
health care population. Netsmart is also marketing its CarteSmart System to
other entitlement programs and managed care organizations; however, except for
the pilot project in San Diego County, Netsmart has not entered into any
agreements with any such organizations, and no assurance can be given that
Netsmart will enter into any such agreements.
In November 1995, Netsmart entered into an agreement with the Albert Einstein
School of Medicine to add the CarteSmart System to its existing system to
provide smart card network capabilities for use in its clinics and out-patient
facilities. Netsmart is presently customizing the CarteSmart health care
application software to meet the requirements of the Albert Einstein School of
Medicine, including the ability to interface with its present computer systems
in addition to the health information system licensed from Netsmart.
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During 1995, Netsmart commenced marketing its CarteSmart based products to
markets other than the health care field. In July 1995, Netsmart entered into an
agreement pursuant to which it installed a magnetic stripe identification system
which uses CarteSmart technology to provide for the centralized issuance of a
single card to all persons allowed access to the facility and its services. The
card contains the individual's name, photo, signature and unique card
identification number, which defines the holder's entitlement to food service
and library services. Approximately 20,000 students are using the system.
Netsmart is negotiating with respect to an agreement to expand the program to
support additional services, however, no assurance can be given that the program
will be expanded. A magnetic card differs from a smart card since it does not
have an independent updatable data storage capability. Netsmart believes that a
major market for its smart card technology is the financial services industry,
including banks and credit card issuers. Commencing in May 1995, Netsmart
entered into a series of letter agreements with IBN for services and CarteSmart
software licenses for the implementation of a satellite based distributed
network of automatic teller machines and off-line point of sale terminals using
smart cards for the former Soviet Union. Netsmart is negotiating a definitive
agreement to develop the system and license the system to IBN. IBN is a New
York-based company which has rights to install such systems in the former Soviet
Union. Netsmart's agreement with IBM is not contingent upon the success of IBN's
installations in the former Soviet Union, although the extent of its revenues
from royalties will be based on the number of cards issued and may be adversely
affected by political developments in the former Soviet Union. The system being
delivered to IBN includes Oasis Technologies IST/Share Financial Transaction
System software and other third party software which Netsmart is integrating
with its CarteSmart software to complete the IBN system.
In developing the CarteSmart System for the financial services industry,
Netsmart is using networking technologies that use telecommunications networks
as well as smart cards. In addition, Netsmart, through a subsidiary, purchased
the SATC Software, which processes retail plastic card transactions and merchant
transactions. The purchase price is $650,000, of which $325,000 was paid by
Netsmart and the remaining $325,000 was paid by Oasis. The SATC Software is
designed to perform functions required by credit card issuers, including
applications processing and tracking credit evaluations, credit authorization
and the printing of statements. Netsmart has an agreement with Oasis pursuant to
which the subsidiary will become a joint venture corporation owned 50% by
Netsmart and 50% by Oasis and/or its principals.
Markets and Marketing
Although the market for smart card systems includes numerous applications where
a secure distributed data base processing system in important, CSM's initial
marketing efforts were directed to the health and human services market,
including managed care organizations and entitlement programs. In the United
States alone, CSM believes that there are presently more than 75 million persons
who participate in managed care programs, which are sponsored by almost 600
organizations or health insurers. Because of the relationship between the
organization and the participating medical care providers and patients, the
organization can institute a smart card system without the need for CSM to
conduct a separate marketing effort directed at the medical care providers.
Although independent health insurers which do not operate a managed care
organization may, in the future, be a market for a smart card system, because
the relationship between the insurer and the medical care provider is different
from that of the managed care organization and its participating medical care
providers, CSM is not treating independent insurance companies as a market for
the CarteSmart System, an no assurance can be given that it will ever become a
market for the system.
The market for CSM's health information systems and related services is
comprised of various providers of specialty care involving long-term treatment
of a repetitive nature rather than short-term critical care, such as medical and
surgical hospitals or clinics. CSM believes that there are approximately 15,000
providers of such treatment programs in the United States, including public and
private hospitals, private and community-based residential facilities and
Federal, state and local governmental agencies. Of these facilities,
approximately 200 are customers of CSM.
Netsmart believes that the acquisition of the CSM business and assets
complements its CarteSmart business and personnel. Following the acquisition,
Netsmart developed the graphical and smart card interface tot he CSM health
information system and commenced a marketing effort directed to the Netsmart's
customer base. The two smart card agreements, San Diego County and the Albert
Einstein School of Medicine, represent amendments to existing contracts to
include smart card services.
Netsmart's health information systems are marketed principally to specialized
care facilities, many of which are operated by government entities and include
entitlement programs. During 1996, 1995 and 1994, approximately 31%, 54% and
47%, respectively, of CSM's revenues was generated from contracts with
government agencies. Contracts with government agencies generally include
provisions which permit the contracting agency to cancel the contract at its
convenience.
For one customer accounted for more than 10% of Netsmart's revenue. IBN
Limited generated revenue of approximately $1.9 million representing 22% of
Netsmart's revenue.
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For 1995, one customer accounted for more than 10% of Netsmart's revenue. The
State of Colorado generated revenue of approximately $1.4 million, representing
18.5% of revenue for the year. CSM's largest customer for 1994 was Cuyahoga
County (Cleveland) Ohio, from which CSM recognized revenue of $250,000, or 7.0%
of revenue.
Netsmart believes that the CarteSmart software has applications beyond the
health and human services market and is seeking to market the software to
educational institutions and in the financial services industry. In April, 1995,
Netsmart entered into a joint marketing agreement with Oasis, pursuant to which
each company markets the software of the other company. Oasis, an independent
software developer, has developed and markets a transaction processing system,
known as IST/Share, designed for high volume users in the financial services
industry. Mr. Storm R. Morgan, a director of and consultant to Netsmart, is an
office of, and has an equity interest in Oasis. Netsmart believes that its
agreement with Oasis will enhance its ability to market and introduce its
product to the financial services industry where Oasis has an existing client
base.
Netsmart may enter into negotiations with other companies which have business,
product lines or products which are compatible with Netsmart's business
objectives. However, no assurance can be given as to the ability of Netsmart to
enter into any agreement with such a company or that any agreement will result
in licenses of the CarteSmart System.
At December 31, 1996, Netsmart had a backlog of orders, including ongoing
maintenance and data center contracts, in the aggregate amount of $3.7 million,
substantially all of which are expected to be filled during 1997. Such orders
and contracts relate substantially to health information sales and services.
Netsmart's sales force is comprised of three full-time sales representatives, as
well as Mr. Leonard M. Luttinger, chief operating officer, John F. Phillips,
president of CSM, and SMI, a consultant to Netsmart. Mr. Storm R. Morgan's
services include activities relating to the marketing of the CarteSmart System
to industries outside of the medical field. His present efforts are devoted
principally to the financial services industry. In addition Mr. Luttinger and
other members of Netsmart's technical staff are available to assist in market
support, especially for proposals which contemplate the use of smart card
transaction processing networks.
Product Development
During 1995 and 1994 Netsmart developed and enhanced the CarteSmart System, and
six of its employees were engaged in such activities. For 1995 and 1994,
research and development expenses were $699,000 and $367,000, respectively,
representing a 90.4% increase. The increase reflects research and development
for smart card and related products and the graphical interface for Netsmart's
health information systems. During 1996 the Company did not incur any research
and development expenses, since the personnel who had been engaged in such
activities were reassigned to work on the IBN contract and the development of
Smart Card products. As a result, their salaries and related expenses were
included as costs of revenue with respect to their work on the Smart Card
product. As a result of such product development the Company incurred $279,000
in capitalized software costs. In 1997 Netsmart intends to expand its
development activities. Netsmart intends to develop a product based on both the
SATC Software and its own technologies including the CarteSmart System, and to
develop a network support tool for the financial services industry. The proposed
enhancements include an increased language capability so that it can be
multilingual, an interface with the CarteSmart System and an interface with
Oasis' IST/Share, which is a transaction processing system for high volume users
in the financial services industry.
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Competition
Netsmart is in the business of licensing software to entitlement programs and
managed care organizations, specialty care institutions and other major computer
users who have a need for access to a distributed data network and marketing
health information systems software to specialty care organizations. The
software industry in general is highly competitive, in addition, with
technological developments in the communications industry, it is possible that
communications as well as computer and software companies may offer similar or
compatible services. Although Netsmart believes that it can provide a health
care facility or managed care organization with software to enable it to perform
its services more effectively, other companies, including major computer and
communications companies have the staff and resources to develop competitive
systems, and users, such as insurance companies, have the ability to develop
software systems in house. Because of the large subscriber base participating in
the major managed care organizations, the inability of Netsmart to license any
such organizations could have a materially adverse effect upon its business.
Furthermore, various companies have offered smart card programs, by which a
person can have his medical records stored and software vendors and insurance
companies have developed software to enable a physician or other medical care
provider to have direct access to the insurer's computer and other software
designed to maintain patient health and/or medication records. The market is
very cost sensitive. In marketing systems such as the CarteSmart System,
Netsmart must be able to demonstrate the ability of the network sponsor to
provide enhanced services at lower effective cost. Major systems and consulting
vendors, such as Unisys, AT&T Corp. and Andersen Worldwide may offer packages
which include smart cards and other network services. No assurance can be given
that Netsmart will be able to compete successfully with such competitors.
Netsmart believes the health insurance industry is developing switching software
to be used in transmitting claims from health care providers to the insurers,
and insurers or managed care organizations may also develop or license or
purchase from others the software to process such claims, which would compete
with certain functions of the CarteSmart System. The health information systems
business is highly competitive, and is serviced by a number of major companies
and a larger number of smaller companies, many of which are better capitalized,
better known and have better marketing staffs than Netsmart, and no assurance
can be given that Netsmart will be able to compete effectively with such
companies. Major vendors of health information systems include Shared Medical
Systems Corp. And HBO Corp. Netsmart believes that price competition is a
significant factor in its ability to market its health information systems and
services.
Netsmart also faces intense competition as it seeks to enter the education and
financial services markets. Competition for the education market includes not
only major and minor software developers, but credit card issuers and
telecommunications companies. In marketing its CarteSmart-based products to
educational institutions, Netsmart can focus on the benefits to the university
of providing an all-purpose card to ease administration and reduce costs.
Major credit card issuers and communications companies, such as American
Express, AT&T and MCI, can offer similar services by permitting the university
to link their cards with the university's services. Such organizations can also
use these marketing efforts so a part of their overall corporate marketing
strategy to familiarize the students with their particular cards and services in
hopes of attracting the students with their particular cards and services in
hopes of attracting the students as a long-term user of their cards and
services. As part of a marketing plan, rather than a profit center, such card
issuers may be able to offer the universities services similar to Netsmart, but
at a lower cost to the university. In this context, it is possible that, unless
Netsmart can enter into a marketing arrangement with a major card issuer or
telecommunications company, Netsmart may not be able to compete successfully in
marketing its CarteSmart products to educational institutions.
The financial services industry is served by numerous software vendors. In
addition, major banks, credit card issuers and other financial services
companies have the resources to develop networking software in house. At
present, most financial institutions use magnetic stripe cards rather than smart
cards. Netsmart believes that its CarteSmart System together with the SATC
Software and its joint marketing agreement with Oasis, which presently serves
the financial services industry, will assist Netsmart in selling and licensing
its products and services in the financial services industry. However, to the
extent that smart cards become more important in the financial services
industry, more companies in the financial services industry, as well as the
major computer and software companies, all of whom are better known and
substantially better capitalized than Netsmart, and numerous smaller software
developers, are expected to play an increasingly active role in developing and
marketing smart card based products. No assurance can be given as to the ability
of Netsmart to compete in this industry.
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Government Regulations
The Federal and State governments have adopted numerous regulations relating to
the health care industry, including regulations relating to the payments to
health care providers for various services. The adoption of new regulations can
have a significant effect upon the operations of health care providers and
insurance companies. Although Netsmart's business is aimed at meeting certain of
the problems resulting from government regulations and from efforts to reduce
the cost of health care, the effect of future regulations by governments and
payment practices by government agencies or health insurers, including
reductions in the funding for or scope of entitlement programs, cannot be
predicted. Any change in, the structure of health care in the United States can
have a material effect on companies providing services, including those
providing software. Although Netsmart believes that one likely direction which
may result from the current study of the health care industry would be an
increased trend to managed care programs, which is the market to which Netsmart
is seeking to license its CarteSmart System. No assurance can be given that
Netsmart's business will benefit from any changes in the industry structure.
Even if the industry does evolve toward more health care being provided by
managed care organizations, it is possible that there will be substantial
concentration in a few very large organizations, which may seek to develop their
own software or obtain software from other sources. To the extent that the
health care industry evolves with greater government sponsored programs and less
privately run organizations, Netsmart's business may be adversely affected.
Furthermore, to the extant that each state changes its own regulations in the
health care field, it may be necessary for Netsmart to modify its health
information systems to meet any new record-keeping or other requirements imposed
by changes in regulations, an no assurance can be given that Netsmart will be
able to generate revenues sufficient to cover the costs of developing the
modifications.
A substantial percentage of CSM's business has been with government agencies,
including specialized care facilities operated by, or under contract with,
government agencies. The decision on the part of a government agency to enter
into a contract is dependent upon a number of factors, including economic and
budgetary problems affecting the local area, and government procurement
regulations, which may include the need for approval by more than one agency
before a contract is signed. In addition, contracts with government agencies
generally include provisions which permit the contracting agency to cancel the
contract at its convenience.
Intellectual Property Rights
The CarteSmart System is a proprietary system developed by CSM. Netsmart has no
patent rights for the CarteSmart System or health information system software,
but it relies upon non-disclosure and secrecy agreements with its employees and
third parties to whom Netsmart discloses information. No assurance can be given
that Netsmart will be able to protect its proprietary rights to its system or
that any third party will not claim rights in the system. Disclosure of the
codes used in the CarteSmart System or in any proprietary product, whether or
not in violation of a non-disclosure agreement, could have a materially adverse
affect upon Netsmart, even if Netsmart is successful in obtaining injunctive
relief. Furthermore, Netsmart may not be able to enforce its rights in the
CarteSmart System in certain foreign countries.
Source of Supply
Since Netsmart does not provide any of the hardware or the smart cards it is the
responsibility of the licensee to obtain the hardware smart cards and other
supplies. Netsmart's software operates on computer hardware and smart cards
manufactured by a number of suppliers.
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Potential Business Agreements
Netsmart may enter into joint ventures, acquisitions or other arrangements, such
as joint marketing arrangements and licensing agreements, which Netsmart
believes would further Netsmart's growth and development. In negotiating such
agreements or arrangements, Netsmart anticipates that such agreements would be
based upon the manner in which Netsmart's business can be expanded, the extent
to which either Netsmart's technology can be introduced or developed in fields
not then being addressed by Netsmart or the extent to which additional channels
can be developed for Netsmart's products and technology. Netsmart is a
participant in a joint marketing vehicle by which Netsmart's products can be
marketed by other parties to the marketing arrangement, including IBM, and
Netsmart would have access to customers of the marketing partners. Netsmart's
proposed joint agreement with Oasis to purchase the SATC Software and its joint
marketing agreement with Oasis are other examples of such agreements. Although
Netsmart is engaged in negotiations and performing its due diligence
investigations, with respect to a potential acquisition, Netsmart has not
entered into any letters of intent or agreements with respect to any such
arrangements or transactions. Furthermore, no assurance can be given that any
agreement which Netsmart enters into will generate any revenue to Netsmart. To
the extent that Netsmart enters into an agreement with an affiliated party, the
terms and conditions of such agreement will be on terms at least as favorable to
Netsmart as those Netsmart could achieve in negotiations at arm's length with an
independent third party. If any such agreement is with an affiliated party,
Netsmart will seek the approval of a majority of the directors who have no
affiliation with the other party.
Employees
As of December 31, 1996, Netsmart had 71 employees, including five executive,
five marketing and marketing support, 54 technical and seven clerical and
administrative employees. The chief executive officer and the president of
Netsmart devote only a portion of their time to the business of Netsmart.
TELECOMMUNICATIONS
The telecommunications segment reflects the operations of ARC Networks, Inc.,
("ARC"). ARC is a Delaware corporation organized on January 15, 1997 to acquire
all of the issued and outstanding stock of A.R.C. Networks, Inc., a New York
corporation ("Arc-NY"), which commenced operations in January 1994. The
acquisition of Arc-NY is referred to as the "Arc Reorganization." Pursuant to an
agreement and plan of reorganization dated January 17, 1997, the Company issued,
in exchange for all of the issued and outstanding shares of capital stock of
Arc-NY, an aggregate of 3,000,000 shares of Common Stock and 1,000 shares of
Series A Convertible Preferred Stock. From 1993 until the organization of Arc-NY
in 1994, the business of the Company was conducted as a division of Avionics
Research Corporation, a New York corporation ("Avionics") which is a
wholly-owned subsidiary of Trans Global Services, Inc., a publicly-held
subsidiary of Consolidated. References to ARC include ARC, Arc-NY and the
operations as a division of Avionics, unless the content indicates otherwise.
ARC offers local and long-distance telephone services to, and provides data
cable installation services for computer systems for, commercial customers. ARC
also sells prepaid telephone debit cards. The market for the telecommunication
services offered by ARC results from a combination of the trends toward
competition and deregulation together with technological developments which
enable telecommunications service providers to offer a range of services to
commercial and, to a lesser extent, residential users. Prior to the 1980s, there
was little competition with respect to either local or long-distance telephone
service. Pursuant to the AT&T Divestiture Order in 1984, AT&T transferred the
business and assets of its 22 BOCs to seven regional telephone holding companies
known as the Baby Bells. The AT&T Divestiture Order also created approximately
200 local access and transport areas ("LATAs"). As a result of this decree,
separate markets developed for local and for long-distance service, and the BOCs
offered local telephone service and AT&T offered long-distance telephone
service. Service between LATAs within a state (inter-LATA service) and, in some
states within a LATA (intra-LATA service) may be provided by both the local
telephone operating company and long-distance carriers.
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Prior to the AT&T divestiture, the BOCs as well as telephone operating companies
not affiliated with the Bell System, for the most part operated
government-regulated monopolies for most local telephone service. While the
divestiture encouraged competition in the markets for long-distance telephone
service and terminal equipment, the BOCs retained monopoly control over the
market for local telephone service. Since 1984, competition for long-distance
service has dramatically increased, and long-distance providers other than AT&T
presently carry a significant portion of domestic long-distance calls. While the
AT&T Divestiture Order did not directly provide for competition for local
telephone service, a number of factors served to promote competition for such
service. These factors included (i) the desire of major commercial customers for
an alternative to the local telephone operating company for local telephone
service, (ii) technological advances in the transmission of data and video
requiring a greater capacity and reliability than was available over the
then-predominant copper-based local telephone networks, (iii) the development of
fiber optic and digital electronic technology, (iv) the monopoly position of the
local telephone operating company whose rate-of-return based pricing structure
provided little incentive to upgrade networks or seek to meet specialized
customer needs, and (v) the significant access charges which long-distance
carriers were required to pay the local telephone operating company to originate
and terminate long-distance calls on the local telephone operating company's
telephone networks.
While long-distance telephone service has become highly competitive, with MCI,
Sprint and a number of smaller companies, such as Frontier, offering
long-distance service in competition with AT&T, local telephone service has been
dominated by the local telephone operating companies, including the BOCs. In
1993, despite FCC attempts to encourage local service competition for switched
and special access services, local competition had not developed as quickly as
long-distance, in part because of both the dominance of the local telephone
company as well as state regulatory restrictions. However, in major metropolitan
areas, a number of carriers offered limited local exchange telephone service in
competition with the local telephone operating company.
In providing telephone service, CLECs have their own telephone switching
equipment, and some CLECs, such as TCG, have their own telephone lines, which
are generally fiber optic lines. These lines run from the CLECs switching
equipment to the end users. CLECs also lease lines from ILEC. Because of the
cost of installing telephone lines throughout a major city or metropolitan area,
CLECs have generally marketed their services, at least initially, to commercial
users in business districts, such as the financial and mid-town business
districts in New York City.
Telephone Services
Local Telephone Service
Local telephone services, which are provided by the ILECs and CLECs include (i)
local telephone exchange service, by which local telephone services, such as
dial tone and local phone calls, are provided to end users, (ii) dedicated
telephone service, which includes private lines and special access services,
(iii) switched access services, which consist of charges received by the local
exchange carriers from long-distance carriers, and (iv) toll services, which
include intra-LATA long-distance calls. All of these services, other than
switched-access service [?] are resold by the Company as a switchless reseller.
As such, the Company does not maintain any telephone lines or switching
equipment, but, rather, uses the lines and switches of the underlying carriers.
CLECs initially entered the local telephone service market by providing only
dedicated services to customers directly connected to the CLECs' networks. As a
result of Federal and state regulatory decisions beginning in 1989, CLECs were
being permitted to interconnect their networks with those of the local telephone
operating company. These decisions gave the CLECs the ability to access
customers either by leasing facilities from the local telephone operating
company or installing extensions to the CLECs own network and also resulted in
the creation of CLECs which offered a full range of service. As a result of
certain recent Federal and state regulatory actions and the 1996 Act, in
particular by the requirement that ILECs make available for resale most services
they offer end user customers, the range of local telephone services which can
be offered by CLECs has increased.
ARC offers local and long-distance, including international, telephone services,
principally to commercial users in New York City and, since November 1996, in
Chicago and South Florida. The local telephone services offered by ARC includes
all of the local telephone service which are offered by the CLECs from which ARC
purchases services and all services offered by Nynex. In New York, Chicago and
South Florida, ARC resells telephone service provided by TCG. In New York City,
the Company also offers service provided by three other CLECs and Nynex. ARC is
engaged in negotiations with the local telephone operating companies covering
Chicago and South Florida to resell their services, however, no assurance can be
given that ARC will be successful in obtaining such a contract
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ARC purchases local telephone services from CLECs and, in New York City, Nynex,
and it resells such service to its customers. The principal supplier of local
telephone service to ARC is TCG, from which ARC has purchased local telephone
service since 1993. ARC has a ten-year agreement with TCG, pursuant to which ARC
may resell TCG's local telephone service in New York City, Chicago, South
Florida and each other metropolitan area in which TCG offers such service. Since
February 1997, the Company has purchased Nynex local telephone service for
resale pursuant to Nynex' tariffs. ARC's agreements with CLECs provide it with
the ability to offer services in certain regions of the United States which are
not served by TCG. See "Business -- Agreements with Telephone Carriers."
ARC's contracts with the CLECs from which it purchases telephone services
requires ARC to commit to purchase a specified dollar volume of service each
month. Except for its agreement with TCG, which has been in effect since
1993,ARC's purchase commitments do not become effective until the contract has
been in effect for a specified period. Based on the contracts in effect in March
1997, the minimum monthly commitments as of April 1998 will be approximately
$86,000 with respect to local telephone service. ARC's purchases from TCG are
presently in excess of its minimum requirements. See "Business -- Agreements
with Telephone Carriers."
ARC's rates for local, long-distance and international telephone service are set
forth in its tariffs, which are filed with the FCC and state public service
commission in each state in which it offers such service. The tariff sets forth
the charges for each service provided by ARC. ARC has two rate structures for
local telephone service -- one for service obtained by ARC from TCG or other
CLECs and the other for services provided by an ILEC, which, in New York City,
is Nynex. ARC does not have agreements with other ILECs. Although it is engaged
in negotiations with ILECs in Chicago and South Florida, no assurance can be
given that ARC will be successful in obtaining such agreements.
ARC has no minimum usage obligations with Nynex. However, the prices paid to
Nynex are higher than they would be if there were a provision for guaranteed
usage. Although the rates paid by ARC under its agreement with Nynex are
typically higher than the rates paid to the CLECs, ARC believes that its ability
to offer Nynex service is important to ARC's customers. The rates paid by ARC to
Nynex for local telephone service are set forth in Nynex's tariffs, which are
subject to change with notice. Nynex is required to file tariff changes with the
New York Public Service Commission, and such filings which are monitored by ARC.
ARC can change its pricing with respect to Nynex service in response to changes
by Nynex. Although ARC must file new tariffs any time it changes its rates or
rate structure, it is not subject to public hearings and the waiting period
prior to the effectiveness of new tariffs is considerably shorter for ARC than
for Nynex. ARC's agreements with the CLECs require the CLECs to provide ARC with
15 to 30 days notice prior to any note change, during which period ARC can
change its pricing.
The use of ARC's services rather than those of the underlying carrier are
transparent to the user. The lines used by the customer are the same lines that
are provided by the CLECs or ILECs to their own customers. The only difference
is that the rate paid to ARC may be lower than that which would be charged
directly by the ILEC to the customer and any servicing of the telephone lines is
performed by ARC. ARC bills the customer and provides any service which may be
required.
The local carrier for ARC's customers is generally selected by the customer or
by ARC with the consent of the customer. ARC may provide its customers with two
carriers for local service, and, in New York City, may include both Nynex and a
CLEC. By offering a choice of carriers, ARC can offer telephone redundancy to
major commercial users to provide them with telecommunications capability even
if the principal carrier is experiencing problems in providing service.
In addition to offering local telephone service to its customers, ARC offers a
range of telecommunications services which are customized to meet the particular
needs of its clients. These services include the development of custom billing
records and management reports, bundled billing and customer service on a
24-hours a day, seven days a week basis. Bundled billing separately identifies
service provided through the ILEC, service provided through CLECs, long-distance
services, the amount which would have been paid under the tariffs of the
customer's prior carriers and the amount of savings. ARC also offers data
communications users a number of products for the installation and maintenance
of LAN lines, such as concentrators and bridges and design services relating to
ARC's data transmission and distribution requirements.
In addition to providing local telephone service, ARC designs and installs a
wide area network ("WAN"). A WAN is used to connect telephone users in more than
one location, which may be in the same or different geographical areas. Since
WAN service requires a telephone link between two locations, ARC uses the
services of an underlying carrier to provide such services. ARC presently uses
TCG and Nynex for such services. Because of the lack of installation and support
staff outside of the New York City metropolitan area, ARC generally limits these
services to customers in the New York City area. To the extent that such service
is required outside of the New York City metropolitan area, ARC will subcontract
such service.
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long-distance and International Telephone Services
ARC also offers long-distance and international telephone service, which it
purchases from Frontier, a national long-distance carrier which is a subsidiary
of Rochester Telephone Company Interstates, including New York, Illinois and
Florida, and it has applied for authorization to offer such services in other
states. Although the long-distance telephone market is dominated by AT&T, MCI
and Sprint, many long-distance companies such as Frontier offer such service on
a regional or national basis. Frontier offers such service on a national basis,
and ARC may resell such from any location in the United States. Frontier also
provides ARC's international long-distance service for calls made outside of the
New York City metropolitan area.
ARC provides switched access long distance service, which means that the
customer can obtain access to the long-distance service by dialing the number 1,
plus the area code and number ("1+ " service). ARC charges its customers at
rates which it believes are generally lower than the rates offered by the three
major long-distance providers, although no assurance can be given that ARC's
rates are or will be lower than or competitive with the rates charged by its
competitors. Long-distance telephone service provided by ARC is processed
through Frontier's switching equipment, but ARC bills the customers and has the
obligation to provide any required service.
International long-distance telephone services for telephone debit cards and
calls originating in the New York City metropolitan area are provided by a
number of international long-distance carriers, other than Frontier. ARC also
offers its customers a dedicated international line, and it presently provides
such service to two customers -- a major accounting firm and a major mail-order
clothing company.
The Company generally bills its long-distance service at a flat per minute rate,
which is not dependent upon the time of day that such calls are made.
Telephone Credit and Debit Cards
A telephone credit card is a card on which telephone calls can be charged. ARC
offers calling cards to users of its local and long-distance telephone service.
Users of ARC's telephone credit cards dial a toll-free number and place the
call. In order to place the call, the caller must input a personal
identification number ("PIN"). ARC bears the credit risk with respect to calls
charged to its cards, since it must pay the long-distance carrier and bill the
customer. ARC bills its customers monthly, generally within 25 days after the
end or a monthly billing cycle. If payment is not received within 25 days of the
billing date, ARC charges its customers a finance charge. ARC pays its
international carriers on a bi-monthly or monthly basis and it bills its
customers monthly, with the result that ARC must finance its telephone costs.
The calling cards can be used for local, long-distance and international
service. The user of the calling card must dial a local or toll-free number to
place the call. So-called "0+" service is not available for ARC's calling cards.
0+ service enables a telephone credit card holder to place a call by dialing "0"
and the telephone number and provide the card number after a prompt which asks
for the card number. A user of the calling card cannot designate the underlying
carrier, which is determined by ARC, based on a least cost routing program.
Domestic long-distance service for the telephone debit and credit cards is
provided by Citizens Telecommunications Company ("Citizens").
While telephone credit cards have been available from telephone companies since
the 1960s, the issuance and use of telephone debit cards developed during the
1980s. Telephone debit cards are debit cards which provide telephone users with
a preset dollar value of long-distance, including international long-distance,
telephone calls. The face value of the cards, which represents the dollar value
of the telephone service to be provided and the price paid by the user, ranges
from a few dollars, which may entitle the holder to one or two calls, to $20,
$50 or more.
ARC's telephone debit cards entitle the holder to a set number of units,
depending on the price of the card. The number of units charged for any call is
a function of the number of minutes and the destination. All calls within the
continental United States cost the same number of units per minute. Calls to
Europe have a higher cost per minute than domestic calls and calls to Asia have
a higher cost per minute than calls to Europe. The amount ARC charges per unit
is based upon the cost to the Company of the call.
The long-distance and international telephone service providers for ARC's
telephone debit card are different from those used by the Company for its 1+
service. Domestic long-distance service for ARC's telephone debit cards is
provided by Citizens. International service is provided by a number of
companies.
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ARC owns a debit card platform in New York City which it uses for processing
calls for users of its prepaid telephone debit cards as well as its credit
cards. A debt card platform is a computer system designed to perform various
functions for a provider of telephone debit and credit cards, including call
processing, voice prompts, pricing tables, management reports and certain
routing procedures.
Cabling and Wiring Services
ARC also offers data cable installation services for computer systems for
commercial users. This service is not related to any telephone service provided
by ARC and consists of cable installation for local area networks and related
wiring services. With the increase of ARC's local telephone service and the
addition of domestic and international long-distance service and telephone debit
cards in 1996, the cable and wiring services are becoming a less important part
of ARC's business.
Markets and Marketing
ARC markets its products and services through a staff of ten persons, including
the vice president -- sales. ARC directs its marketing efforts toward medium to
large businesses that have significant telecommunications requirements. In
addition, ARC's long-distance service and telephone debit cards are sold through
its independent commission sales staff. In general, ARC's employees market its
local and long-distance service to commercial users, principally medium to large
telephone users, and the commission sales personnel market ARC's long-distance
and telephone debit card services to a broader range of telephone users. The
commission sales personnel are not employees of ARC, and their compensation
consists solely of commissions based on revenues generated.
In marketing its services directly to commercial customers, ARC seeks to develop
a program for the prospective client that may include local, long-distance
and/or international telephone services. To the extent that a client only
requires local, long-distance or international telecommunications, the package
offered by ARC is structured to the specific requirements of the client. One
element of ARC's marketing strategy is to offer redundant capabilities to
provide the client with continuous service even when the main telephone provider
is having service difficulties. ARC's ability to offer the services of Nynex as
well as service provided by CLECs provides it with the capability of offering
the services of more than one provider of local service. Furthermore, ARC
believes that its ability to offer Nynex local telephone service at a rate which
may be lower than the client could receive directly from Nynex can be important
in its marketing program towards clients who want Nynex, as the ILEC, to provide
the underlying service. ARC also offers a dedicated international line to one or
more countries to clients who have significant international telecommunications
requirements.
ARC's long-distance service is offered both as part of a package with local
service and calling cards and as a separate service independent of local
service. ARC generally markets it telephone credit cards as an ancillary service
for clients who use ARC's local telephone service. ARC does not market such
cards to the public generally.
The end-user market for telephone debit cards consists principally of low income
households with little or no credit, including immigrant populations, who use
the cards for substantially all of their long-distance and international
telephone calls, middle income households who use the cards for travel and
away-from-home calls, students and military personnel. A significant portion of
the international telephone debit card use is generated by the immigrant
population, and ARC's international telephone debit card service is marketed by
ARC's distributors to this segment of the population.
Most of ARC's debit cards are sold to distributors, who pay ARC a price
reflecting a discount from the face amount of the card. The face amount of the
card represents the price paid by the end user and the value of telephone
service provided. The agreements with distributors are generally short term. The
distributor must pay for all cards taken by the distributor before the cards are
activated, regardless of whether the cards are ultimately sold by the
distributors. ARC does not sell its telephone debit cards on a consignment
basis. The distributors may manufacture their own cards, but the cards cannot be
used until electronically activated by ARC. During 1996, two distributors of
telephone debit cards accounted for more than 5% of ARC's revenue. No purchaser
of telephone debit cards accounted for 10% of total revenue for 1996.
ARC also markets its telephone debit cards for use as a promotion or premium in
connection with the services being offered by ARC. Under such programs, the
customer would provide its clients with a telephone debit card with a modest
face value, which the customer would use as part of its own marketing or
promotion program. These promotions could be one time promotions or an ongoing
part of the customer's marketing plan. Through February 28, 1997, ARC has sold
telephone debit cards to two customers for promotions. One of such customers, a
major toy chain, used the cards for a short-term promotion. The other customer,
a wire transfer company, has been purchasing the cards from ARC as part of an
ongoing promotion since September 1996.
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In 1997, ARC commenced a marketing effort for the sale of telephone debit cards
through vending machines. ARC has agreements for the placement of such vending
machines in a hospital in Newark, New Jersey and in one casino-hotel in each of
Atlantic City, New Jersey and Las Vegas, Nevada. The initial unit is scheduled
for installation in late March 1997. ARC owns the vending machines and pays the
hospital and holds a commission on all cards sold through the machine.
The market for ARC's data cabling installation services is primarily
institutional customers, including hospitals and government agencies. ARC's
largest customer for such services in 1996 was Mitel, from which ARC provided
such services for the New York City Board of Education. Revenue from Mitel was
approximately $869,000 (15.6% of revenue), $629,000 (19.4%) and $768,000 (33.9%)
in 1996, 1995 and 1994, respectively. During 1996, 1995 and 1994, the only other
customers for data cabling installation services that accounted for more than
10% of total revenue were Newark Beth Israel Hospital, which accounted for
revenue of approximately $542,000 (16.7%) in 1995 and $283,000 (12.7%) in 1994,
and University School of Medicine and Dentistry of New Jersey, which accounted
for revenue of approximately $503,000 (22.7%) in 1994. The nature of data cable
installation services is such that once the installation project is completed,
there is no further revenue from the customer unless the customer separately
purchases other services from ARC.
ARC is also an authorized vender for data cable installation services for New
York State. Pursuant to a contract, New York State agencies are authorized to
purchase such services from ARC. Since the contract was signed in January 1997,
ARC has not generated any revenue pursuant to such contract.
With the expansion of its local telephone service and the addition of
long-distance and international telephone service and telephone debit cards in
1996, ARC believes that data cabling and wiring services will become an
increasingly less important portion of its business.
At March 15, 1997, the Company had a backlog of firm orders for data cabling and
wiring services of approximately $600,000, all of which is expected to be
completed during 1997. There is no backlog for telephone service
Agreements with Telephone Carriers
ARC has an agreement dated March 18, 1993, with TCG, pursuant to which ARC can
resell TCG's local telephone services. The agreement has a term of ten years
which continues on a year-to-year basis thereafter unless terminated by either
party. The agreement provides for minimum usage requirements, based on the
number of minutes of telephone service purchased. The estimated minimum dollar
volume of service is approximately $50,000 per month. If ARC fails to meet the
minimum requirements, it will be billed for a surcharge. ARC does not have any
funds on deposit with TCG, and TCG provides the Company with an open line of
credit.
ARC has an agreement with Frontier, pursuant to which ARC may offer Frontier's
domestic and international long-distance telephone service. The agreement has a
term of three years, commencing in February 1997, and continues on a
year-to-year basis unless terminated by either party. ARC has provided Frontier
with a $50,000 letter of credit as a deposit. The agreement has minimum monthly
requirements which start at $10,000 for the fourth month and increase to
$500,000 for the thirteenth month and thereafter. If the minimum is not met, ARC
can either pay the amount of the shortfall or pay a surcharge on the service
actually used. ARC is not prohibited from offering long-distance services from
other carriers. ARC is conducting negotiations with other long-distance
telephone companies who offer such service on a regional or national basis,
although no assurance can be given that ARC will be successful in these
negotiations. In order to obtain long-distance service from additional carriers,
ARC may be required to post substantial deposits or letters of credit.
ARC has an agreement with Citizens pursuant to which it purchases domestic
long-distance telephone service for its debit card service. The agreement has a
two-year term, commencing in August 1996. The agreement provides for a monthly
commitment of $50,000, commencing January 1997. If the minimum is not met for
any month, ARC pays a surcharge equal to 25% of the deficiency.
ARC has met its minimum requirements for February 1997.
In November 1996, ARC entered into an agreement with Brooks Fiber Properties,
Inc. ("Brooks") pursuant to which the ARC may resell Brooks' local telephone
service in certain metropolitan areas for a three-year period beginning in March
1997. The agreement provides for minimum usage starting at $6,000 in April 1997
and increasing to $18,000 in October 1997. Thereafter the agreement requires an
annual minimum of $300,000. If a minimum is not attained in any month, ARC pays
the shortfall and, during the following year, may use the unused telephone usage
in a subsequent month after the minimum has been met. No deposit is required
pursuant to this agreement.
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Although ARC does not have a formal agreement with Nynex, it purchases for
resale Nynex' local telephone service based on Nynex' tariffs for the sale of
such services to resellers. ARC has no minimum obligations under the Nynex
tariffs and it has a $4,375 deposit with Nynex.
Service and Maintenance
ARC is required to provide customer service for all of its telephone customers.
Regardless of which carrier provides the underlying service that is resold by
ARC, the bills sent by ARC to its telephone customers list a local Company
telephone number to be called for any service problems. ARC refers any service
problem to the appropriate carrier.
With respect to its data cable installation service, ARC provides the customer
with a warranty with respect to its workmanship of one to five years, depending
on the nature of the work. ARC obtains from its supplier of cable and related
equipment used in providing data cable wiring services a 15-year warranty, which
is issued after the project is completed and certified by ARC. As of March 15,
1997, the Company had not incurred any costs in connection with its warranties.
Competition
The telecommunications industry in general is highly competitive. Major industry
participants such as AT&T, MCI, Sprint and the BOCs have far more resources and
experience than ARC in providing local, long-distance and prepaid telephone
debit card services. Moreover, foreign carriers are entering the United States
market through alliances with larger domestic telecommunication carriers. No
assurance can be given that ARC can successfully compete against these larger
industry participants.
Local telephone service
The market for local telephone service highly competitive and is becoming
increasingly competitive. Since the AT&T Divestiture Order, local telephone
service has been provided solely or dominated by either one of the regional
BOCs, such as Nynex in New York City, or other independent operating companies,
including subsidiaries of GTE and Sprint. The ILECs have significant customer
bases and provide local telephone service to a vast majority of the commercial
and residential telephone users in their respective service areas. These
companies have significantly greater assets and revenue and are better known
than ARC. No assurance can be given that ARC can or will successfully compete
against the ILECs.
ARC anticipates that competition with respect to local telephone service will
increase and that other major companies, including other BOCs and other
telephone operating companies and long-distance telephone providers, will offer
local telephone services in major markets. For example, AT&T and MCI have
reportedly begun offering local service in some major markets. Such competition
could result in price competition and erosion of gross margins, which could have
a materially adverse affect upon ARC's ability to compete. Furthermore, CLECs,
such as TCG, whose telephone service is resold by ARC, compete with ARC in
offering telephone service to commercial users, which is ARC's targeted customer
base.
Competition for providing local telephone service to commercial users is based
on price, reliability and quality of service. The ability of ARC compete
successfully is dependent upon its ability to demonstrate to commercial
customers that the price, reliability and service which it offers compares
favorably with the price, reliability and service offered by its competitors, as
to which no assurance can be given. Furthermore, as a result of the 1996 Act,
local telephone operating companies may have more flexibility in their pricing
structure, which could result in lower rates to major telephone users, which
constitute the market targeted by ARC. Since the 1996 Act is designed to
encourage competition in the local telephone market, there can be no assurance
that ARC will not be adversely affected by the implementation of the 1996 Act.
Long distance service
The market for long-distance telephone service is highly competitive.
Long-distance telephone service is dominated by AT&T, MCI and Sprint, which
offer long-distance telephone service on a national basis. In addition, a number
of major national and international telecommunications companies, such as
Frontier, as well as regional telephone operating companies, offer long-distance
telephone service on a regional or national basis. Such corporations have
significantly greater assets and revenue and are better known than ARC. No
assurance can be given that ARC can or will successfully compete with such
companies in the long-distance telephone market.
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Telephone debit cards
The market for prepaid telephone calling cards is a relatively new
telecommunications service. The market for prepaid telephone calling cards is
highly competitive. In addition to the major long-distance telephone companies,
which offer or have announced the intention of offering prepaid telephone cards,
a large number of smaller companies offer such cards. Competition for such cards
is based largely on price. To the extent that the major telecommunications
aggressively market such cards at relatively low prices, they may quickly
dominate the market. No assurance can be given as to the ability of ARC to
operate this business profitably.
A key factor in the prepaid telephone card business is the price and
distribution structure of the company offering the cards. In establishing a
pricing structure, the issuer of telephone debit cards must consider the cost of
service, the amount charged for various types of calls and the discount given to
the distributor. A large number of companies offer and have offered prepaid
telephone debit cards. However, in recent years, many have such companies have
discontinued their business.
Data cable installation services
Competition in the cable and wiring service business is highly competitive. In
providing these services, ARC competes with major computer and
telecommunications companies, such as AT&T, as well as a large number of
independent companies that offer such services. Because of the fragmented nature
of this business, no single company or group of companies dominates the field.
Competition is based on price and service, and ARC believes that its charges and
services compare favorably with other companies offering such services in the
New York City metropolitan area.
Government Regulations
The telecommunications industry is subject to regulation at the Federal level by
the FCC and at the state level by state public utility and public service
commissions. Changes in regulation have resulted in reduced rates for telephone
services where demand is great, such as long-distance service between major
metropolitan areas, and additional competition. While the changes in regulation
may have made rate changes easier for CLECs, ILECs are presently subject in many
states to regulations which do not permit them to offer significant discounts to
major users of local telephone services. To the extent that ILECs are able to
offer more favored rates to business customers, which represents the principal
market for ARC's services, ARC's ability to compete could be adversely affected.
Although the effects of the AT&T Divestiture Order which resulted in the
divestiture by AT&T of the BOCs, as well as recent changes in Federal law have
reduced regulations in a manner which encourages competition for local and
long-distance telephone service. ARC is and will continue to be subject to
certain regulations by the FCC and state public utility and public service
commissions. At the Federal level, as a common carrier, ARC may not unjustly
discriminate, must offer service upon reasonable request and charge just and
reasonable rates, pursuant to publicly filed tariffs. At the state level, ARC
must be certified prior to providing local, long-distance or prepaid debit card
service, maintain tariffs with current rates, terms and conditions and file
reports as required by the individual public service commissions. Changes in
government regulations may have an adverse effect upon ARC's business and
prospects, particularly as ARC seeks to enter new markets. There can be no
assurance that ARC will receive all state authorizations required for ARC to
enter new markets or that ARC will be able to comply with ongoing federal and
state regulatory requirements. ARC intends to offer local telephone service in
California following completion of this Offering. ARC has applied for, but has
not received, authorization to offer such service, and no assurance can be given
that such authorization will be obtained.
ARC is subject to state regulation, including tariff and other filings in each
state in which it offers telephone services. ARC's rates for local,
long-distance and international telephone service are set forth in its tariffs,
which are filed with the FCC and state public service commissions. The tariffs
sets forth the charges for each service provided by ARC. In New York City, ARC
has two rate structures for local telephone service -- one for service obtained
by ARC from TCG or other CLECs and the other for services provided by Nynex. ARC
must file new tariffs any time it changes its rates or rate structure; however,
it is not subject to public hearings and the waiting period prior to the
effectiveness of new tariffs is typically shorter for ARC than for ILECs.
During the late 1970s and early 1980s, many companies offered discount
long-distance service. Of those companies only MCI and Sprint and a small number
of companies, including Frontier, have been able to penetrate the long-distance
market to any significant extent and each of those companies incurred very
significant costs in both marketing and capital expenditures in order to attain
their present market position. No assurance can be given that the same or
similar factors will not also affect the local telephone market or that ARC will
be able to survive the anticipated industry consolidation.
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As a result of the 1996 Act, the BOCs may offer long-distance telephone service
and other services not previously permitted to the BOCs; however, their ability
to offer such services is conditioned upon the meeting of certain requirements
that are expected to lead to additional competition in the local telephone
market. These requirements include making their local services available for
resale, providing competitors access to their network facilities, implementing
number portability and dialing parity. Additional competition for local exchange
service may have the effect of reducing the rates charged by, and improving the
services provided by, the ILECs, which could have a downward effect on rates to
major commercial telephone users. Such a development could reduce the margin
between the price at which ARC can sell service and the price paid by ARC for
such service, which could have a material adverse effect upon ARC.
Product Development
ARC does not engage in product development and enhancement or research and
development. ARC does, however, consider new products and services which it
believes are consistent with its business. ARC does not anticipate that, in the
near future, it will develop any proprietary telephone products, however, it may
seek to acquire such products or to obtain marketing rights to such products. No
assurance can be given that ARC can or will obtain any such products or rights
to any such products or that any products which are obtained by ARC can or will
be profitably developed.
Potential Business Agreements
ARC may enter into joint ventures, acquisitions or other arrangements, such as
joint marketing arrangements and licensing agreements, which ARC believes would
further its growth and development. In negotiating such agreements or
arrangements, ARC anticipates that such agreements would be based upon the
manner in which ARC's business can be expanded, the extent to which ARC's
services can be enhanced or the market for such services expanded. In this
connection, ARC may acquire businesses that are related directly or indirectly
to its telephone service business. No assurance can be given that any agreement
which ARC enters into will generate any net income. To the extent that ARC
enters into an agreement with an affiliated party, the terms and conditions of
such agreement will be on terms at least as favorable to ARC as those ARC
believes it could achieve in negotiations at arm's length with an independent
third party.
Employees
At December 31, 1996, the Company had 21 employees, of which nine were executive
and administrative, nine were sales and marketing, including the vice president
- -- sales and three were technical service and support. ARC's employees are not
represented by a labor union, and ARC considers its employee relationship to be
good.
THREE DIMENSIONAL PRODUCTS AND SERVICES
The three-dimensional products and services reflect the consolidated operations
of 3D Holdings International, Inc., ('"3D"), a Delaware corporation. The
consolidated operation of 3D includes the operating activity of 3D Technology,
Inc., 3D Imaging International, Inc. and Vero International, Inc., all of which
are directly or indirectly controlled by 3D.
3D is engaged in the development and marketing of products based on
three-dimensional imaging and digitizing technology. Three-dimensional
digitizing is the process of constructing a digital image of an object.
Three-dimensional digitizing products are used in various phases of the
development and manufacture of a product, including rapid prototyping,
manufacturing of components and quality control. 3D's scanning products can
generate digitized images which can be input into Computer Assisted Design or
Computer Assisted Manufacturing ("CAD/CAM') software systems.
3D was founded to develop solutions using three-dimensional imaging technology
in response to a perceived need by the manufacturing and metrology industries
for products to enable them to develop and introduce new products and to improve
the quality control and maintenance operations. As a result of developments in
laser and other imaging technologies, it became possible in many instances for a
manufacturer to design products more efficiently using three-dimensional imaging
technology either by itself or combined with CAD/CAM systems. It also became
easier to duplicate products for which the manufacturer did not have drawings of
the molds. Similarly in metrology, which is the science of measuring, it became
possible to determine rapidly whether a product or part meets the specifications
and tolerances, either at the manufacturing facility at the time of production
or in the field as part of continued maintenance.
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CAD/CAM systems are software systems used to design products and to generate the
necessary computerized instructions for the manufacture of an object in
accordance with the computerized design. The resulting computer instructions can
be translated into instructions for Computerized Numeric Control ("CNC") or
Computerized Measuring Machines ("CMM") or stored as a database for future
reference. CNC is manufacturing equipment, which is programmed to manufacture a
part, or component based on computerized instructions. The computerized
instructions can be generated by either CAD/CAM systems or directly from
scanning equipment. CMM equipment is used in quality control to ascertain
whether the product conforms to the specification.
Rapid prototyping is the generation of a physical model of a product. The model
can be either designed on a CAD system or produced from digital information
generated by a scan of the object. Scanning equipment, such as 3D's OpticaTM
laser scanner, can generate a digitized image of an object in a form, which can
be input into a CAD program and modified in the CAD system to meet the design
requirements of the manufacturer. The use of rapid prototyping systems is
intended to reduce the development time of a product. Rapid prototyping systems
are used in industries such as the automotive, aviation and medical fields,
which reduce substantial time and resource to product design.
In the manufacturing process, a laser scanner can be mounted directly onto
manufacturing equipment, principally CNC, which uses the digitized information
to generate an object having the same outside dimensions as the scanned object.
In addition, in the same manner as rapid prototyping, the scanned image can be
used as the basis for the further development of a product, and the data
generated can be used either to make the product or to make the molds and dies
used in the manufacture of the product. 3D's optical laser scanner is designed
to enable a manufacturer to perform these functions.
Since the scanning operations generate a computer file setting forth the
dimensions and other measurements of an object, this information can be used in
quality control and maintenance to determine whether the object being scanned
meets the required specifications and tolerances. 3D's Lazer TracerTM is
designed to be used by quality control and maintenance personnel to determine
whether the finished product complies with the specifications.
Vero International, Inc., one of the 3D subsidiaries, distributes VISI-CAD and
VISI-CAM software pursuant to an exclusive distribution agreement with Vero
International Software Srl, an Italian corporation. VISI-CAD is a PC-based
surface and solids modeling and designs package which is used to create
three-dimensional designs. VISI-CAM is a PC based multi-axis, multi-surface,
milling and turning and EDM CAM package which can use information generated by
Surfacing software packages or VISI-CAD to complete the manufacturing of a
product.
In addition to the hardware and software products which 3D markets, 3D
Technology, Inc., one of the subsidiary, offers scanning and digitizing services
for customers who do not require a scanning system but can use a folio which can
be used in the customer's CAD/CAM systems.
3D has completed the development of a foot digitizer, which is used to develop
shoes and shoe-lasts for a person based upon the digitized image of his foot. 3D
has an informal agreement with a manufacturer of non-laser scanners, to develop
an initial prototype of a foot digitizer. 3D is discussing with four major shoe
companies, the potential of marketing the foot digitizer system for custom shoe
and orthopedic shoe applications.
During 1996, the European Community Counsel ("EEC") awarded one of their BRITE
contracts to a consortium of partners headed by BIBA, a highly reputable
computer science institute in Germany and 3D Imaging International, Inc., for
the development of a software for industrial applications in the field of Rapid
Prototyping via CAD and CAM. The project titled " An Engineering Workbench for
Industrial Application of Rapid Prototyping Techniques" is being jointly
developed by the consortium members and sub contracted to Vero International
Software Srl of Italy. The EEC provided the funding for the development and upon
completion, 3D will market and sell this product through world wide distribution
network of Vero International Software, Srl.
Optical Laser Scanner and Lazer Tracer
3D has developed a number of laser scanning sensors and integrated systems - its
Optica laser scanner which can be mounted on CNC or CMM equipment and digitized
data from this scanner can be transferred to CAD/CAM systems. Replica series
products are stand alone digitizing systems, which come in different sizes, and
its Lazer Tracer, which is a hand-held contour-measuring system, designed to use
for quality control. The computerized instructions can be either generated by
CAD/CAM equipment or directly from scanning equipment. The Lazer Tracer is based
on certain patents ("GE patent rights") being acquired by 3D from General
Electric Company ("GE") pursuant to a January 1994 agreement. Pursuant to the
agreement with GE, 3D acquired four uncompleted prototypes for the Lazer Tracer
and is required to complete the development of the prototypes and to deliver
them to GE.
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3D's Optica laser scanner takes a three-dimensional picture of a solid object by
recording the reflection of a beam of light that is "reflected" off the solid
object and is recorded by a special camera that converts the light emitted by
the laser and projected onto the object's surface into electrical impulses and
digitizes the input. It enables a user to reconstruct a physical object by
converting the image generated by the sensor into a three-dimensional
replication by identifying the points on the surface of the object into a series
of mathematical x, y and z coordinates, These coordinates represent the height,
width and depth of each point on a three-dimensional grid. The proposed laser
scanner is designed to interface with most standard CNC controllers and can be
mounted directly onto a CNC machine. The digitizing software incorporated into
the laser scanner can generate data in formats which are accepted by standard
CAD/CAM software. Once the data is input into a CAD/CAM system, it can be
modified to meet the manufacturers specific needs. The Optica laser scanners are
manufactured by a nonaffiliated company, which is using its own base technology
to meet 3D's specific needs. However, 3D does not have any long-term commitments
with the supplier.
The principal uses for 3D's Optica laser scanner include rapid prototyping and
reverse engineering; duplication of parts or components for which there is no
CAD design. The software in the scanner enables the user to see a virtual image
of the product on a computer screen in addition to producing a physical model of
the product. By being able to visualize and feel a model of a product, a
manufacturer can save substantial time and effort and introduce the product to
market earlier than would otherwise be the case. In cases where the manufacturer
has a part, but not a computer design, the scanner can be used to produce a
virtual image that is needed to create a CAD model from which a die or mold can
be produced. Using this method, a manufacturer can make an exact duplicate of
almost any item ranging from antique furniture to plastic bottles and containers
to automobile and aircraft parts.
3D's Lazer Tracer, which is based on a GE patent, is designed for the metrology
industry and uses laser technology to measure geometric features such as radii,
angles and curves. Unlike the Optica laser scanner, which can also perform
measuring tasks, the Lazer Tracer is hand held and is designed for use on the
assembly lines and in maintenance operations where the continued performance of
a part is important. The Lazer Tracer is designed to measure the various
parameters against stored information as to the specifications and permissible
tolerances. The unit is intended to be used in any environment and will provide
quick indications whether the product meets the specifications. The quality
control functions can be used in any facility where it is important to know
rapidly whether the product complies with the specifications, especially when it
is difficult for another measuring device to determine whether the product
conforms to specifications. One such application is aircraft maintenance where
another measuring device may have difficulty in determining whether the blade of
a jet engine continues to meet specifications. The patents cover hand-scanning
devices which can be used in the metrology industry. 3D commenced marketing both
the Optica and Replica scanners in 1996, and have received a number of orders
from Jewelry, Automotive and aerospace industries. Two service bureaus, one in
Ohio and other in Massachusetts have purchased these equipment and start using
the equipment for their customers.
Management believes that this trend will continue during 1997.
VISI-CAD and VISI-CAM
VISI-CAD is a state-of-the-art PC-based surface and solids modeling software and
design package used to create three-dimensional models using both MS-Windows 95
and MS-Windows NT software environments. The different VISI-CAD modules allow a
designer to elaborate on models by using a flexible and intelligent sketcher
without the need for concentration on choosing detailed geometry commands. For
example, in constructing a line that connects two other elements, VISI-CAD
presents all tangency and separation possibilities according to the position of
the cursor line without recourse to the menus.
VISI-CAM is a state-of-the-art PC-based multi-axis, multi-surface milling,
turning and EDM CAM software package which uses information generated by
Surfacing software packages or VISI-CAD, or other CAD system to complete the
manufacturing of a product. VISI-CAM offers surfacing, milling and editing
modules. VISI-CAM is an easy to use series of software packages featuring
pop-down menus and dialogue boxes and powerful commands, all available by
clicking a mouse. It also offers a range of CNC applications and an integrated
geometry generation and machine tool simulation package.
Digitizing and Design Services
3D has recently begun to offer imaging, digitizing and product development
services at its Connecticut facility. These services involve the digitizing of
an object provided by the client, the use of the Surfacing software to generate
an image with the desired surface and the delivery of a computer file, which can
be used in any CAD/CAM system. 3D offers these services both as an independent
source of revenue and as a part of its marketing program for its products and
services.
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Foot Digitizer
3D has an informal agreement with a nonaffiliated West German manufacturer of
nonlaser based three-dimensional scanning equipment pursuant to which such
manufacturer has developed for 3D a prototype of the Foot Digitizer. The Foot
Digitizer is a three dimensional scanner which rapidly scans a human foot. The
resulting scan is designed to be used to develop shoe lasts which are custom
designed for the scanned foot. The Foot Digitizer is expected to be marketed to
manufacturers of orthopedic shoes and custom made footwear. The ability of 3D to
market the Foot Digitizer will be dependent upon 3D's ability to demonstrate to
custom shoe manufacturers that the Foot Digitizer represents a method of
increasing revenues and gross profit, as to which no assurance can be given.
This system has gone through clinical testing at the Norway Orthopedic Center
for European FDA approval. 3D, through its offices in Belgium, filed an EEC
project during March 1995, with other industrial market leaders from Europe, to
make a total system that will be utilized to produce foot casts automatically
from a digitized foot. Upon approval, the EEC may fund this project on an
installment basis. 3D would manage the project and upon proper funding,
establish worldwide marketing and distribution channels.
Other Products
In addition to its products and software, 3D has marketing rights with respect
to CAD/CAM software and hardware. As a result, 3D is able to market an
integrated system to meet the specific needs of its clients. Such a system could
include an Optica scanner or Lazer Tracer, the Surfacer software, CAD/CAM
software and hardware.
Markets and Marketing
The market for three-dimensional scanning equipment and the Surfacer software
includes a range of manufacturing and industrial companies in industries as
varied as the automotive and aircraft, manufacturers of molds and dies for
plastic containers, toys and any industry or application where the creation of a
product requires the development of an accurate three-dimensional scanning and
the metrology market, where precise measurements are required to determine
whether a product meets the specifications. With the recent market introduction
of the Optica and Replica laser scanners and the Lazer Tracer, 3D has commenced
marketing its products both directly to end users, including customers who would
purchase the products on an OEM or VAR basis, and it is seeking to establish a
network of representatives.
Competition
3D competes with other laser scanning products as well as products which scan
objects using technologies which are not laser based. Competition is based on
the cost and safety or perceived safety of the equipment, the specific
requirements of the user and the compatibility of the scanning equipment with
the user's CAD/CAM and manufacturing equipment. 3D's competitors include a
number of small and medium sized companies that offer products that are designed
for certain specific applications. No assurance can be given that 3D will be
able to compete successfully with such competitors.
Intellectual Property Rights
In January 1994, 3D entered in to an agreement with GE pursuant to which it
agreed to purchase from GE a patent and patent application relating to the
technology used in the Lazer Tracer. The agreement requires 3D to pay the
purchase price of $175,000 as follows: $25,000 on signing the contract, which
payment has been made, and three payments of $50,000 due at various times after
3D has delivered the fourth Lazer Tracer units. The agreement also grants 3D a
license to use certain GE technology relating to the Lazer Tracer. The agreement
also gives GE a non-exclusive irrevocable right to sell the GE patent rights,
subject to any licenses previously granted by GE. GE has agreed to give 3D
notice prior to granting any such licenses, which will enable 3D to take title
to the GE patent rights prior to the grant of any license by GE. No assurance
can be given that the GE patent rights will be effective in limiting the
development of competing products by others who could design around the patents.
Except for the GE patent rights, 3D has no other patent or copyrights on its
products. Although 3D has signed non-disclosure agreements with its employees
and others to whom it discloses proprietary information, no assurance can be
given that such protection will be sufficient. The unauthorized use or
disclosure of 3D's proprietary software and other proprietary information may
have a materially adverse effect upon its business.
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Government Regulations
The Lazer tracer sensors and other laser-based products are subject to
regulation by the Federal Bureau of Radiation Health ("BRH") of the Occupational
Safety and Health Administration, which requires that all such products meet
certain standards. 3D has filed with the BRH applications with respect to its
laser products, and 3DT may sell the products in the United States. Other
countries, including Canada, also may subject laser products to regulation. 3D
intends to make application under applicable laws to market its products in
Canada.
Employees
As of December 31, 1996 3D had approximately 10 employees None of 3D's employees
are represented by a labor organization, and 3D believes that its employee
relations are good.
AUDIO PRODUCTS MANUFACTURING
The Audio Products Manufacturing segment reflects the operations of WWR
Technology, Inc., ("WWR"), which is a wholly owned subsidiary of SESH. WWR was
incorporated in 1992 for the purpose of acquiring the professional products
business segment of the KlipschTM loudspeaker line from Klipsch and Associates,
Inc. ("KA"). WWR acquired the inventory, tooling, equipment and certain licenses
from KA as part of such purchase. The predecessor to KA was founded in the mid
1940's by Paul W. Klipsch and has established itself as a leader in loudspeaker
design and innovation. KA's primary market traditionally has been the home high
fidelity loudspeaker business. Concurrently, it has developed a reputation as a
manufacturer of rugged, well designed loudspeakers for the professional,
commercial and theater sound markets. The acquisition of the Klipschtm
Professional product line gives WWR one of the most long-established and, WWR
believes, recognizable brand names in the industry. After WWR's acquisition of
the Klipschtm professional loudspeaker line from KA, KA continued to manufacture
products and provide other related services to WWR pursuant to a manufacturing
agreement between WWR and KA. In August 1994, WWR entered into a lease for a
manufacturing facility in Hope, Arkansas and between August and October 1994
moved all of its manufacturing and related services into the newly leased
facility. In connection with the completion of this move, the manufacturing
agreement with KA was terminated.
The nature of WWR's business is to market and sell loudspeakers and related
products to the professional audio market. The professional audio market is
defined as any application for loudspeakers other than those used for home and
automotive entertainment purposes. Generally, this is a definition of the
difference between "home entertainment" and commercial sound reproduction. As
part of the future development of commercial sound reproduction, WWR believes
that the application of digitally controlled and processed signals to control
and enhance the performance of professional loudspeakers will become a
significant factor in the marketplace. WWR believes it has access to the
resources needed, on an as-needed contractual basis with original equipment
manufacturers, to successfully develop these products although there can be no
assurance that it will be able to do so.
Markets and Marketing
Products are sold through a network of domestic and international independent
manufacturers' representatives who are compensated on a commission basis to
retailers, distributors, sound contractors installers and occasionally to end
users. WWR assumed the responsibility for international sales from KA in the
spring of 1993, and such sales currently constitute a significant portion of
WWR's total sales. During 1996, 1995 and 1994 international sales constituted
approximately 20%, 20% and 23% of total sales, respectively. International sales
are made to appointed distributors in individual countries and the distributors
resell and service the products within their respective countries.
The Markets for the products include, but are not limited to: contractor
installation of sound systems, paging systems, musical instrument sound
re-enforcement, public address, concert sound, fixed installation, touring
sound, theater and sound re-enforcement. End users of the products include:
churches, synagogues, stadiums, concert halls, restaurants, schools, musical
performers, movie theaters and all other applications where information and/or
entertainment is presented to the public in a commercial venue.
The contractor installation market is comprised of customers of WWR. These
customers bid on installation of audio systems based on specifications provided
by acoustical consultants in the process of designing or renovating commercial
properties, restaurants, nightclubs, churches, concert halls, stadiums and other
similar buildings. The requirements for each project vary according to the need
and purpose of the facility and the sound systems and the types of loudspeakers
range from small speakers for simple paging systems to very large speakers for
concert halls, theaters or stadiums. WWR sees this market as having significant
growth potential for its products and has developed and continues to develop
products targeted to the various needs of this market.
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The musical instrument market include retail sale of products to professional
and amateur musicians. Loudspeakers in this market have two general purposes:
(1) the reproduction of amplified or electronic instruments, and (2) the
re-enforcement of voice and acoustic instruments. A portion of WWR's product
line is targeted specifically to this product and the product line for this
market has been expanded by WWR with new loudspeakers introduced in 1994 and
plans to continue to introduce additional new products in 1995.
The motion picture theater market has improved over the past few years as a
result of the increase in the number of motion pictures including digital film
sound tracks. Digital based sound reproduction systems were subsequently
introduced in motion picture theaters and while there has been little new
construction of movie theaters, the current trend is to upgrade the sound
reproduction systems in current theaters. WWR is upgrading its motion picture
product line to meet the needs of this market. The concert and touring sound
market is comprised of two segments: (1) the tours of the "big" name
entertainers handled by major international touring sound companies, and (2) the
smaller regional or national sound companies that provide services to lesser
known performers and events. While there are significant sales in the major
international touring sound companies market as a whole, the loudspeaker portion
is dominated by the proprietary enclosure (cabinet) designs of the large touring
sound companies using the raw frame components made by original equipment
manufacturers ("OEMs"), including WWR. WWR has a number of raw frame component
drivers that have significant potential in this market. Success in this portion
of the market must be viewed as a marketing tool; by having its products
selected for use on major tours, WWR has the opportunity to be associated with
the success of the tour and/or the artist. The smaller regional touring
companies represent a greater opportunity for WWR as these customers are not as
likely to be building their own enclosures and, therefore, purchase whole
speaker systems.
New Products
WWR is engaged in market research to determine the specific needs of the end
user so as to develop new market oriented products. Two new trapezoidal shaped
loudspeakers have been introduced for use in various commercial applications.
Currently under development are the following: a new line of loudspeakers
designed for the musical instrument market, two new medium format (size) horns
for use in fixed installations and updating of the motion picture product line
utilizing newly developed components. A line of loudspeakers designed for the
musical instrument market were put into production and became available for
purchase in October 1994 and it is expected that the new construction techniques
and materials for this line of loudspeakers will enable WWR to achieve higher
gross profit margins.
Competition
The industry is comprised of a large number of competing manufacturers, the
majority of which are of little overall impact in the market. Generally, the
smaller firms specialize in selected portions of the market as opposed to
offering a wide array of products. However, there are two dominant competitors
in the overall professional loudspeaker industry - Harmon International
Industries, Inc. (Harmon) which owns a number of product lines including JBL and
Mark IV industries, Inc. which owns Electro Voice (EV), Altec Lansing (Altec)
and University Sound (University). Other competitors include, but are not
limited to, Bose Corporation, Peavey Electronics, Inc., Apogee Sound, Inc.,
Meyer Sound Laboratories, Inc. and Eastern Acoustic Works, Inc. WWR provides
high quality products for all segments of the market but, due to the relatively
smaller size of the product line offered by WWR, it is not able to compete with
JBL and EV on a model by model basis. It is the plan of WWR to continue niche
marketing, while expanding is product offerings as business conditions allow.
WWR's general pricing policy and distribution is to offer its high quality
products at competitive prices and to limit the distribution of KlipschTM
Professional products to a selected group of retail and contractor customers. By
doing so, WWR is able to position KlipschTM Professional as a "limited
distribution" product line offering the contractor and retailer the opportunity
to differentiate themselves in the range of products they offer and to further
enhance their profit margins by offering products that are not as easily
"shopped for price".
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Licenses
As part of the purchase of substantially all of the assets of the KlipschTM)
Professional loudspeaker business from KA, WWR received a non-exclusive
trademark license for the use of KA's trademark "KlipschTM" in conjunction with
various professional loudspeaker products ("Licensed Products") provided that
the trademark is used only in combination with the terms "Professional
Loudspeakers," "Professional Products," "Pro Loudspeakers," Pro Products" or a
similar designation pre-approved by KA. WWR also has agreed to indicate that
"KlipschTM" is a registered trademark of KA. The licenses are world-wide and
royalty free, and KA has agreed not to grant licenses and/or otherwise permit
others to use in the professional market the trademarks and certain design
patents licensed to WWR. However, the licenses are terminable if WWR defaults in
certain of their respective obligations to KA, becomes bankrupt or insolvent or
reorganizes or ceases to use the "KlipschTM" trademark for 18 or more
consecutive months. The loss of these licenses would effectively eliminate the
ability of WWR to continue to sell under the KlipschTM Professional brand,
however it would not prohibit WWR from seeking other professional loudspeaker
products to distribute through its distribution network. WWR believes that WWR's
relationship with KA is good, there can be no assurance that there will be no
future developments which will cause a termination of the licenses.
Employees
As of December 31, 1996 WWR had 42 employees None of WWR's employees are
represented by a labor organization, and WWR believes that its employee
relations are good.
BUSINESS CONSULTING SERVICES
The business consulting services segment reflects the activity of The Trinity
Group, Inc., ("Trinity"). Trinity is a Delaware corporation that was organized
in May 1989. Trinity provides management and related services both to
Consolidated's subsidiaries as well as nonaffiliated entities. Trinity's
management services include management, finance, accounting, operations,
marketing and other services, which are typically rendered pursuant to a
consulting agreement. In the early stages of the subsidiaries' development,
Trinity's officers, may serve as senior executive officers of the subsidiaries.
In addition, Consolidated, either through Trinity or one of the other
subsidiaries, may provide or arrange financing for the subsidiaries. To the
extent that the subsidiaries are not generating an operating profit, Trinity may
defer the receipt of payment until the subsidiary has the resources to pay the
fee. Transactions between Trinity and the subsidiaries are eliminated in
consolidation.
In addition to performing services for its subsidiaries, Trinity provides
similar management services for other companies which are not affiliated with
Consolidated. Services for both the subsidiaries and non-affiliated companies
are performed principally by the president and chief executive officer of
Consolidated. Other services may be performed by other officers of Trinity or
Consolidated or by independent consultants who are engaged on an ad hoc basis.
The fee structure, which is set prior to the engagement, may be paid in cash or
securities. Trinity does not conduct any advertising or any active marketing
program. Typically, Trinity is engaged as a result of personal contacts by
Consolidated's president and chief executive officer.
Trinity competes with numerous consulting firms, including major international
firms, consulting divisions of major accounting firms, consulting divisions of
equipment manufacturers and numerous independent firms, some of which may have
ongoing relationships with the potential clients, including relationships
resulting from a prior employment or other affiliation. Trinity's ability to
compete successfully in providing consulting services is presently dependent
upon the personal contacts of Mr. Lewis S. Schiller, and no assurance can be
given that Trinity can or will be able to perform services for nonaffiliated
entities. To the extent that Trinity's resources are required for the
management, operation and funding of Consolidated's subsidiaries, Trinity's
ability to perform services for nonaffiliated parties is now significantly
limited.
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HOLDING COMPANIES
The activity of the holding companies reflects the operations of Consolidated
Technology Group Ltd., the Registrant, and SISC, a wholly owned subsidiary of
the Registrant.
Consolidated Technology Group, Ltd.
Consolidated Technology Group, Ltd., ("Consolidated" or "the Company"),
(formerly Sequential Information Systems, Inc.) is a New York corporation
organized on August 2, 1961. Consolidated does not generate revenues but does
incur expenses including executive and administrative salaries and related
payroll taxes and benefits, consulting fees, legal and accounting fees, public
relations fees and other general and administrative fees. Consolidated charges
the underlying subsidiaries for specifically identified expenses incurred on
behalf of the subsidiaries. Transactions between Consolidated and its
subsidiaries are eliminated in consolidation. As of December 31, 1996,
Consolidated had four employees, including the chief executive officer, that
provide management and administrative services for Consolidated, SIS Capital
Corp. and The Trinity Group.
SIS Capital Corp.
SIS Capital Corp., ("SISC"), was organized by Consolidated for the purposes of
making investments in or advancing funds to companies in which Consolidated has
or proposes to obtain an equity position. SISC or one of SISC's subsidiaries
holds the Company's equity and debt position in all of the operating
subsidiaries. SISC also invests in companies in which it does not intend to
obtain an equity position for the purpose of generating investment income.
During 1996, 1995 and 1994, SISC advanced funds to a related company that is
accounted for under the equity method and is not a consolidated subsidiary.
Item 2. Property
Contract Engineering Services
TGS leases an aggregate of approximately 12,800 square feet of office facilities
at two locations in Long Island, New York, where it maintains its executive
offices. It also rents modest office space in Houston, Texas, Phoenix, Arizona,
Arlington, Texas, Los Angeles, California, Seattle, Washington, Orlando, Florida
and Wichita, Kansas. The aggregate annual rent payable by TGS is approximately
$160,000, which is subject to annual increases. TGS believes that its present
office space is adequate for its present needs and that additional office space
is readily available on commercially reasonable terms.
Medical Diagnostics
IMI's executive and administrative facilities are located in approximately 8,000
square feet of space at 2424 North Federal Highway, Boca Raton, Florida, which
are leased from a nonaffiliated landlord for a term expiring in February 2000,
at an annual rental of approximately $200,000. The Pine Island, Boca Raton, San
Juan and Kansas City Centers are located in facilities owned by IMI. The
remaining Centers occupy premises which are leased by IMI from nonaffiliated
landlords at an annual aggregate rental of approximately $750,000, inclusive of
the rent for IMI's executive and administrative facilities. The leases provide
for annual escalation's and expire during the period from 1997 to 2000. IMI
believes that its present facilities are adequate. To the extent that IMI moves
its MRI or other imaging equipment, IMI may incur significant expenses in both
moving the equipment and adapting the facility for MRI use.
Electro-Mechanical and Electro-Optical Products Manufacturing
SES leases on a month to month basis approximately 15,000 square feet of office
and manufacturing space in Elmsford, New York at an annual rental of
approximately $141,000 S-Tech leases approximately 6,500 square feet of
manufacturing and office space in West Babylon, New York at an annual rental of
approximately $28,000 under a lease expiring in 1997. Televend leases 500 square
feet of office space in New York City, which it rents on a month-to-month basis
from SISC at an annual rental of approximately $7,500 which represents the cost
of such space to SISC. The companies operating in the electro-mechanical and
electro-optical products manufacturing segment believe that their space is
adequate for their immediate needs and that, if additional space is required, it
would be readily available at commercially reasonable rates.
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Medical Information Services
Netsmart's executive offices and facilities are located in approximately 18,000
square feet of space at 146 Nassau Avenue, Islip, New York, pursuant to a lease
which terminates on February 28, 1999, at a minimum annual rental of $248,000.
This lease provides for fixed annual increases ranging from 4% to 5%. Netsmart
believes that such space is adequate for its immediate needs. Netsmart also
leases approximately 1,800 square feet of office space at 7590 Fay Avenue, La
Jolla, California, pursuant to a lease which terminates on March 31, 1999, at a
minimum annual rental of $31,000. This lease provides for fixed annual increases
of 4%. Netsmart occupies, on a month to month basis, approximately 1,500 square
feet of office space in Wethersfield, Connecticut, at a monthly rental of
$2,000. Netsmart believes that its space is adequate for its immediate needs and
that, if additional space is required, it would be readily available on
commercially reasonable rates.
Telecommunications
ARC occupies approximately 1,600 square feet of office space in Hauppauge, New
York which it rents from TGS at an annual rent of approximately $12,000 and
1,000 square feet of office space in New York City, which it rents on a
month-to-month basis from SISC at an annual rental of approximately $24,000. The
rent paid by ARC reflects the cost of such space to TGS and SISC. ARC's debit
card platform is located in office space in New York City, pursuant to a
month-to-month lease, for which ARC pays an annual rental of approximately
$3,600. ARC's offices in Chicago and Ft. Lauderdale, Florida are located in
office space rented on a month-to-month basis for an aggregate of $300 per
month. ARC believes that additional office space would be readily available as
and where required.
Three Dimensional Products and Services
The companies operating in the three dimensional products and services segment
lease approximately, 3,000 square feet of office space in Trumbull, Connecticut
for an annual rental of approximately $44,000 and approximately,2,800 square
feet of office space in Hartford, Connecticut for an annual rental of
approximately $35,000.
Audio Products Manufacturing
WWR Technology occupies approximately 70,000 square feet of usable
manufacturing, office and storage space located in Hope, Arkansas at an annual
rental of approximately $76,000.
Business Consulting and Holding Companies
Consolidated, SISC and Trinity lease approximately 7,000 square feet of office
space at 160 Broadway, New York, NY, at an annual rental of approximately
$100,000. Approximately 1,500 square feet of such space is used by subsidiaries
for which they are charged approximately $32,000 on an annual basis.
Additionally, approximately 1,000 square feet of such space is occupied by a
related company that is accounted for under the equity method and is not a
consolidated subsidiary, for which the related company is charged approximately
$16,500 on an annual basis.
45
<PAGE>
Item 3. Legal Proceedings
Holding Company
Consolidated has been named as a defendant in a lawsuit filed by a company it
was contemplating acquiring in January 1995 for alleged unauthorized use of
proprietary information specific to that line of business. Outside counsel
handling this case has advised the Consolidated that it has meritorious defenses
to obtain a dismissal of the lawsuit.
Contract Engineering Services
The DOL has filed a complaint against Job Shop and its principal stockholder for
civil violations of ERISA resulting from the failure of Job Shop to deposit
employee contributions to Job Shop's 401(k) retirement plan. A similar complaint
was filed by former employees of Job Shop against Job Shop, its principal
stockholder and others. At November 22, 1994, the amount due to the Job Shop
401(k) plan was approximately $3.0 million, which amount may have increased
since such date as a result of interest and penalties. Neither TGS nor RMI, the
subsidiary which acquired assets and assumed certain obligations of Job Shop in
November 1994, has been named as a defendant in either of such actions. The DOL
has raised with TGS the possibility that RMI may by liable with respect to Job
Shop's ERISA liability as a successor corporation or purchaser of plan assets,
even though RMI did not assume such obligations and paid value for the Job Shop
assets which it did purchase. Although TGS believes that RMI is not a successor
corporation to Job Shop and is not responsible for Job Shop's ERISA violations,
the DOL may take a contrary position. If the DOL takes such a position and
prevails, it would have a material adverse effect upon the operations of RMI and
possibly TGS as a whole. Although TGS is engaged in discussions with the DOL, no
assurance can be given that such discussions will result in any settlement
acceptable to TGS. During 1996, TGS established a $300,000 reserve with respect
to the DOL's claim, however, no assurance can be given that such reserve will be
adequate.
In May 1991, prior to the acquisition of Avionics by TGS, the Government
Printing Office wrote TGS asking for reimbursement of approximately $300,000 for
allegedly unauthorized work on two programs. TGS believes that these claims are
without merit and intends to contest these claims vigorously if reasserted. TGS
believes that the ultimate disposition of this matter will not have a material
adverse affect on TGS's consolidated financial position.
Medical Diagnostics
In May 1996, IMI commenced an arbitration proceeding before the American
Arbitration Association in Los Angeles, California against Radman, Inc.
("Radman"), a manufacturer of teleradiology systems and equipment, entitled
International Magnetic Imaging, Inc. v. Radman, Inc., alleging fraud and breach
of contract and seeking rescission of a purchase agreement between IMI and
Radman for a teleradiology system as well as an award of money damages in an
amount not less than $485,000, together with interest, attorneys' fees and
costs. Radman has asserted certain counterclaims against IMI in such proceeding
seeking an award of money damages in the sum of at least $236,000, together with
interest, 'exemplary and punitive damages, reasonable attorneys' fees and other
costs of the action. This matter is presently pending. IMI believes that it has
meritorious defenses to Radman's counterclaims.
In December 1994, IMI placed a purchase order with Advanced NMR Systems, Inc.
("ANMR"), for Instascan MRI equipment upgrade systems for an aggregate of $1.5
million. Three of the systems have been installed at the Centers and the
remaining two have not yet been installed at IMI's facilities. By letter dated
February 25, 1996, IMI notified ANMR that it was terminating and rescinding the
purchase agreements for such equipment as well as certain other related
agreements between the parties and seeking the return of the approximate
$723,000 previously paid to ANMR as well as money damages as a result of certain
material deficiencies in such equipment. By letter dated March 22, 1996, ANMR's
counsel denied such claimed deficiencies, disputed IMI's right to terminate such
agreements and claimed that IMI is in breach thereof for, among other things,
failing to pay the approximate $752,000 balance of the purchase price for such
equipment. ANMR also threatened to commence an action against IMI to assert its
rights under such agreements. In October 1996, IMI commenced a state court
action against ANMR in Florida.
In January 1996, Drs. Ashley Kaye and James Sternberg, two of the former
stockholder-directors of IMI-Florida, and Dr. Sternberg's wife, threatened to
commence an action against two subsidiaries of IMI, Consolidated and Mr. Lewis
S. Schiller, chairman of the board of Consolidated and IMI, for alleged
violations of securities and common law in connection with the execution in 1994
of an asset purchase agreement between MD Corp. and a subsidiary of IMI and
non-payment of the $3,375,000 Subordinated Notes of two subsidiaries of the
Company issued to MD Corp. in connection therewith. Although IMI reflects the
principal and interest on such Subordinated Notes as liabilities on its
consolidated balance sheet and no notice of default has been given, no assurance
can be given that an adverse decision in any action based on such claims will
not have a material adverse effect upon IMI.
46
<PAGE>
Vanguard, on its own behalf or on behalf of other persons who may be affiliated
with Vanguard, based on a purported agreement relating to the introduction of
Consolidated and the Company to IMI-Florida and assistance in the negotiation of
the acquisition of the Centers, has asserted a claim against the Company and/or
SISC that it has the right, among other things, to a 10% interest in the Common
Stock of the Company, on a fully-diluted basis, prior to this Offering and prior
to the issuance of certain warrants to DVI, for no cash consideration. In
addition, Vanguard has claimed that it is entitled to a $200,000 fee due at the
time of the acquisition of the Centers, consulting fees of $240,000 per year for
five years, reimbursement of nonaccountable expenses and a 5% interest in any
future medical acquisition by the Company. No assurance can be given that any
litigation which may ensue would not seek damages exceeding the claim described
above and, if decided unfavorably to the Company, would not have a material
adverse affect on the Company. If Vanguard commences an action against the
Company and prevails, it would have a material adverse effect upon the Company,
and, furthermore, if it prevails with respect to its claim for Common Stock, the
issuance of such Common Stock could result in a non-cash charge to earnings for
the value of such Common Stock, dilution to the stockholders, including the
stockholders who purchased stock in this Offering, and a reduction in the net
tangible book value per share. In addition, the Company may not be able to use
Consolidated's net loss or tax loss carryforward to reduce its tax liability if
a sufficient number of shares of Common Stock were issued to Vanguard.
Electro-Mechanical and Electro-Optical Products Manufacturing
Lafayette Industries, Inc., a subsidiary acquired during 1996 via a reverse
merger, whose business prior to the reverse merger was the manufacturer and sale
of store fixtures, was discontinued in 1996. The manufacturing facilities for
these operations were located in Mexico and were seized by the landlord.
Although Lafayette is contesting the seizure, no assurances can be given that
Lafayette will be able to realize any future benefit from these assets and has
placed a reserve on the full amount of such assets. Lafayette and its
subsidiaries, including SES Holdings and its subsidiaries, are contingently
liable individually and jointly with others as guarantors of long-term debt and
obligations principally relating to various debt agreements, leased equipment
and facilities. In connection with those transactions, Lafayette has been
notified that it is party to various litigation with individual claims ranging
to approximately $1,600,000. Although management has made what it feels is its
best estimate of the liability, the nature of the liability is subject to
substantial uncertainty. The amount of potential additional liability above
that accrued can not be reasonably estimated. Due to the uncertainty of the
pending litigation, substantial doubt about Lafayette's ability to continue as a
going concern, and certain scope limitations, Lafayette and its subsidiaries
received a disclaimer of opinion from its independent auditors who are the same
as Consolidated's independent auditors. Lafayette and its subsidiaries
represents 5.2% of Consolidated's consolidated revenue and 6.8% of
Consolidated's consolidated assets.
Medical Informations Services
On or about September 29, 1995, an action was commenced against Netsmart by the
filing of a summons with notice in the Supreme Court of the State of New York,
County of New York. The action was commenced by Jacque W. Pate, Jr., Melvin
Pierce, Herbert A. Meisler, John Gavin, Elaine Zanfini, individually and
derivatively as shareholders of Onecard Health Systems Corporation and Onecard
Corporation, which corporations are collectively referred to as "Onecard". The
named defendants include, in addition to the subsidiary, officers and directors
of the subsidiary and the Company. A complaint was filed on November 15, 1995.
The complaint makes broad claims respecting alleged misappropriation of
Onecard's trade secrets, corporate assets and corporate opportunities, breach of
fiduciary relationship, unfair competition, fraud, breach of trust and other
similar allegations, apparently arising at the time of, or in connection with
the organization of the subsidiary in September 1992. The complaint seeks
injunctive relief and damages, including punitive damages of $130,000,000.
Management believes that the action is without merit, and it will vigorously
defend the action. Nevertheless, due to uncertainties in the legal process, it
is at least reasonably possible that management's view of the outcome will
change in the near term and there exists the possibility that there could be a
material adverse impact on the operations of Netsmart.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to security holders for a vote during the year ended
December 31, 1996.
47
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Consolidated's common stock is traded on the Nasdaq SmallCap Market under the
symbol COTG. Set forth below is the reported high and low bid prices of the
common stock for the quarters listed.
Quarter Ending High Bid Low Bid
March 31, 1995 $1.28 $0.63
June 30, 1995 $1.19 $0.88
September 30, 1995 $0.94 $.050
December 31, 1995 $0.63 $0.25
March 31, 1996 $0.41 $0.16
June 30, 1996 $0.63 $0.22
September 30, 1996 $0.31 $0.13
December 31, 1996 $0.30 $0.06
As of December 31, 1996, there were approximately 19,175 holders of record of
the Company's common stock.
No cash dividends have been paid to the holders of the Common Stock during the
years ended December 31, 1996, 1995 and 1994.
Item 6. Selected Financial Data
<TABLE>
<CAPTION>
Year Ended December 31, Year Ended July 31,
----------------------- -------------------
1996 1995 1994 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Selected Statements of
Operations Data
Revenues $114,924,000 $110,097,000 $41,578,000 $15,742,000 $3,839,000
============ ============ =========== =========== ==========
Loss from Operations ($ 9,338,000) ($11,112,000) ($10,464,000) ($10,566,000) ($1,403,000
========== ========== ========== ========== =========
Income (Loss) before
Extraordinary Item ($ 9,570,000) ($11,360,000) ($11,428,000) ($10,772,000) $594,000
Extraordinary Item - Net of Tax -- -- -- -- 146,000
----------- ---------- ---------- ---------- -------
Net Income (Loss) ($ 9,570,000) ($11,360,000) ($11,428,000) ($10,772,000) $740,000
=========== ========== ========== ========== =======
Net Income (Loss) per Common
Share ($0.23) ($0.51) ($0.80) ($1.35) $0.18
==== ==== ==== ==== ====
Selected Balance Sheet Data
Total Assets $71,814,000 $66,312,000 $68,089,000 $7,381,000 $4,775,000
========== ========== ========== ========= =========
Long-term Obligations:
Debt and Capital Lease $19,448,000 $8,408,000 $11,183,000 -- --
Obligations
Convertible Debentures 700,000 -- -- -- --
Deferred Interest 568,000 -- -- -- --
Subordinated Debt 312,000 5,003,000 17,926,000 -- --
----------- ----------- ----------
Total Long-term Obligations $21,028,000 $13,411,000 $29,109,000
========== ========== ==========
Dividends Declared per
Common Share -- -- -- -- --
</TABLE>
The following factors make the above selected financial data non comparable for
the following indicated periods and reasons:
(1) The fiscal year ended July 31, 1993 includes other income of $1,523,000 from
the reacquisition of a subsidiary.
48
<PAGE>
(2) The fiscal year ended July 31, 1994 includes expense of $7,140,000 from the
issuance of stock options to consultants.
(3) The year ended December 31, 1994 includes expense of $4,140,000 from the
issuance of stock options to consultants.
(4) The year ended December 31, 1995 includes expense of $3,869,000 from the
issuance of stock options to consultants.
(5) In December 1993, the Company acquired ARC Acquisition Group, Inc. and ARC
Networks, Inc. and in June 1994, the Company acquired Creative Socio-Medics,
Inc. Such acquisitions resulted in: (i) an increase in assets of approximately
$13,000,000 as of July 31, 1994; (ii) an increase in revenues of approximately
$11,000,000 for the fiscal year ended July 31, 1994 and $14,400,000 for the year
ended December 31, 1994; and (iii) a net increase in net loss of approximately
$173,000 for the fiscal year ended July 31, 1994 and $1,600,000 for the year
ended December 31, 1994.
(6) In September 1994 the Company acquired International Magnetic Imaging, Inc.
and in November 1994, the Company acquired Job Shop Technical Services and
Computer Engineering Services. Such acquisitions resulted in: (i) an increase in
assets of approximately $47,200,000 as of December 31, 1994; (ii) an increase in
revenues of approximately $11,500,000 for the year ended December 31, 1994; and
(iii) a net decrease in net loss of approximately $270,000 for the year ended
December 31, 1994.
(7) In May 1995 the Company acquired Concept Technologies resulting in: (i) an
increase in assets of approximately $1,780,000 as of December 31, 1995; (ii) an
increase in revenues of approximately $2,149,000 for the year ended December 31,
1995; and (iii) an increase in net loss of approximately $553,000 for the year
ended December 31, 1995.
(8) In December 1996, the Company acquired Lafayette Industries, Inc. resulting
in an increase of assets of approximately $2,100,000, an increase in long-term
obligations of approximately $700,000.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Financial Condition - Liquidity and Capital Resources
At December 31, 1995, it was determined that the ability of the Company to
continue as a going concern was dependent upon the success of the Company's
subsidiary's marketing efforts and their efforts to obtain sufficient debt and
equity to enable them to continue operations. As of the second quarter of 1996,
the Company had a significant reduction in losses for five of the segments
compared to the second quarter ended June 30, 1995 and also had a significant
reduction in corporate and other expenses. However, during the third and fourth
quarters, losses increased in such that only two of the segments ended up with
significant yearly reduced losses. During the third and fourth quarters, the
Contract Engineering Services and Medical Information Services segments incurred
significant single item expenses that are not expected to be of a recurring
nature, including $300,000 for a contingency settlement and $3,493,000 of
noncash expense related to stock issuance's. Furthermore, the Medical
Diagnostics segment reported a fourth quarter loss which is the first quarterly
loss of this particular segment since it was acquired. As a result of the above,
the ability of the Company to continue as a going concern as of December 31,
1996 will depend primarily on the ability of the Company to efficiently utilize
the funding it received for certain subsidiaries during 1996. Such funding
consisted of the following via various sources as follows:
Debt Refinancing
In January and September 1996, the Company refinanced a significant portion of
the current subordinated debt that was to be paid by the Medical Diagnostics
segment in 1996. Such financing consisted of term loans of $6,000,000, an
accounts receivable revolving loan of $6,000,00. As a result of the financing,
approximately $12,400,000 of debt that was currently due was replaced by
long-term debt.
49
<PAGE>
Equity Offerings
During August 1996, NetSmart, a subsidiary of the Company operating in the
Medical Information Services segment, completed an initial public offering
issuing common shares representing approximately 22% of the outstanding shares
and received net proceeds of approximately $3,800,000 and additionally, received
approximately $1,600,000 upon the exercise of 800,000 stock purchase warrants.
In July 1996 a subsidiary operating in the contract engineering services segment
(which is already publicly held), raised $2,000,000 from the sale of common
stock via a Regulation S offering. This subsidiary has filed a S-1 registration
with respect to the sale of additional equity shares, however, no assurances can
be given that such offering will be completed.
A subsidiary of the Company, operating in the Medical Diagnostics segment, filed
an S-1 Registration statement with the Securities and Exchange Commission with
respect to an initial public offering. No assurances can given that the public
offering will be completed.
Working Capital Condition
As of December 31, 1995, the Company had a working capital deficit of
$13,359,000. As of December 31, 1996, the Company has negative working capital
of $6,729,000 representing a decrease in the working capital deficit of
$6,630,000. Due in large part to the aforementioned debt refinancing in the
medical diagnostics segment. The Company's continued ability to reduce the
working capital deficit relies primarily on the success of continuing efforts to
increase the profitability of the underlying subsidiaries. As further explained
in the following "Sources of Cash" discussion, restrictions exist with regards
to the Company's use of the Medical Diagnostics segment's cash.
Sources of Cash
The Company's principal working capital consists of cash and cash equivalents.
Cash and cash equivalents were $3,866,000 at December 31, 1996 compared to
$1,636,000 at December 31, 1995. During 1996, International Magnetic Imaging,
("IMI") generated approximately $6,887,000 in cash from operations while the
remaining segments used approximately $7,009,000 of cash for operations.
Pursuant to an IMI financing agreement with a creditor, restrictions exist on
the distributions of IMI funds whereby IMI may not make payments out of the
ordinary course of IMI operations and specifically, not to the parent company,
(Consolidated), or any subsidiary or affiliate. The other segments are thereby
required to operate on their own cash flows and as of December 31, 1996 the most
significant impact from these restrictions is on the Three Dimensional Products
and Services segment and the Electro-Mechanical Electro-Optical Products
Manufacturing segments which are currently unable to operate without cash
infusions from the parent company, (Consolidated). It is imperative that these
segments obtain alternative sources of funding. (i.e. equity offerings, debt
financing) or increased volume at higher operating margins, in order to continue
as operating segments and no assurance can be given that these segments will be
able to continue as operating entities. The remaining segments are less affected
by the restrictions on IMI's cash since they operated substantially with their
own cash flows during 1996. Sources of cash other than from operations includes
proceeds from the issuance of long-term debt of $19,468,000, proceeds from the
issuance of stock and the exercise of options and warrants of $10,047,000,
collections on repayments of notes receivable of $3,449,000, cash of an acquired
company of $1,020,000, and proceeds from the sale of marketable securities of
$1,244,000.
Uses of Cash
Uses of cash includes the repayment of long-term and subordinated debt of
$19,954,000, capital expenditures of $4,920,000, payments on capital leases of
$1,565,000, payments for loans made of $3,523,000, purchases of investments of
$385,000 and expenditures of $279,000 for software development, $589,000 for
deferred offering costs, and $1,369,000 for costs of issuing stock in the
medical information services segment.. Other net uses of cash amounted to
$292,000.
Changes in Other Working Capital Assets and Liabilities
Significant changes in working capital, other than cash, includes an increase in
accounts receivable of $1,918,000 (primarily from an increase in volume
primarily from the Contract Engineering Services segment) and an increase in
accounts payable and accrued expenses and accrued payroll and related expenses
of approximately $1,692,000 (primarily from an increase in payroll and payroll
related obligations of the contract engineering services segment and a $400,000
contingency reserve that was recorded by the same segment).
50
<PAGE>
Effect of Loan Defaults
The Company is in technical default on loans approximating $7,227,000 as of
December 31, 1996 of which $6,300,000 relates to the Medical Diagnostics
segment, $325,000 relates to the Audio Products Manufacturing segment, $467,000
relates to the Electro-Mechanical Electro-Optical Products Manufacturing segment
and $135,000 relates to the Three Dimensional Products and Services segment.
Such default has not had, and is not expected to have a significant impact on
the operations of the related segment. The creditors have not called such loans
and all amounts are classified as current liabilities in the Company's December
31, 1996 balance sheet.
Results of Operations
Consolidated operating losses for 1996 were $1,774,000 less than in 1995 and
were $1,126,000 less than in 1994. The operating loss for 1996 includes
certain noncash expenses as follows:
Year Ended
December 31,
1996
----
Medical Information Services segment - stock
options and stock purchase warrants $3,722,000
Medical Information Services segment - issuance
of stock in lieu of cash for services rendered 1,747,000
Contract Engineering Services segment- issuance
of stock in lieu of cash for services rendered 80,000
Corporate and Other - consulting expense
from exercise of stock options 45,000
------
Total noncash Expenses $5,594,000
=========
For the year ended December 31, 1996, excluding the above noncash expenses, an
improvement in operating results was achieved by an increase in overall gross
margins of $1,241,000 while operating expenses, other than the $5,594,000 of
nonrecurring expenses shown above, decreased by $6,127,000. Additionally, during
the same time period, revenues increased $4,827,000. On an overall basis, the
consolidated net loss when comparing 1996 to 1995 decreased by $1,790,000 or 16%
The percentage of relative contribution to revenues, gross profit, and selling
general and administrative expenses by industry segment is shown in the
following tables. Changes within the individual industry segments themselves is
discussed further within the respective industry segment discussions.
<TABLE>
<CAPTION>
Percentage of Total
Year Ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Revenues
Contract Engineering Services 54% 57% 60%
Medical Diagnostics 27% 25% 16%
Audio Manufacturing and Services 3% 2% --
Electro-Mechanical and Electro- Optical Products Manufacturing 3% 4% 9%
Medical Information Services 7% 7% 7%
Telecommunications 5% 3% 6%
Three Dimensional Products and Services 1% 2% 2%
Business Consulting Services * * *
Gross Profit (Loss)
Contract Engineering Services 23% 20% 26%
Medical Diagnostics 65% 59% 44%
Audio Manufacturing and Services 2% 1% --
Electro-Mechanical and Electro- Optical Products Manufacturing (1%) 5% 3%
Medical Information Services 6% 9% 9%
Telecommunications 2% 3% 10%
Three Dimensional Products and Services 3% 3% 5%
Business Consulting Services * * 3%
</TABLE>
51
<PAGE>
<TABLE>
<CAPTION>
Percentage of Total
Year Ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Selling, General and Administrative Expense
Contract Engineering Services 15% 24% 11%
Medical Diagnostics 32% 21% 10%
Audio Manufacturing and Services 4% 2% --
Electro-Mechanical and Electro- Optical Products Manufacturing 5% 6% 9%
Medical Information Services 23% 13% 13%
Telecommunications 5% 4% 5%
Three Dimensional Products and Services 7% 10% 11%
Business Consulting Services * * 4%
Corporate and Other 9% 20% 37%
</TABLE>
* - Less than one percent.
Discussion of Operations by Segment
Contract Engineering Services
The contract engineering services segment reflects the operations of Trans
Global Services, Inc. ("TGS") and its two subsidiaries, Avionics Research
Holdings, Inc. ("Avionics") and Resource Management International, Inc. ("RMI")
from January 1995 through December 31, 1996. During 1995, Avionics and RMI were
merged with TGS via a reverse acquisition and references to operations prior to
January 1995, relate to the operations of Avionics and RMI as subsidiaries of
SISC.
Revenue from technical temporary staffing services is based on the hourly cost
of payroll plus a percentage. The success of TGS's business is dependent upon
its ability to generate sufficient revenues to enable it to cover its fixed
costs and other operating expenses, and to reduce its variable costs, primarily
interest. Under its agreements with its clients, TGS is required to pay its
employees and pay all applicable Federal and state withholding and payroll taxes
prior to receipt of payment from the clients. Furthermore, TGS's payments from
its clients are based upon the hourly rate paid to the employee, without regard
to when payroll taxes are payable with respect to the employee. Accordingly,
TGS's cost of services are greater during the first part of the year, when
Federal Social Security taxes and state unemployment and related taxes, which
are based on a specific level of compensation, are due. Thus, until TGS
satisfies its payroll tax obligations, it will have a lower gross margin than
after such obligations are satisfied. Furthermore, to the extent that TGS
experiences turnover in employees, its gross margin will be adversely affected.
For example, in 1996, Social Security taxes are payable on the first $62,700 of
compensation. Once that level of compensation is paid with respect to any
employee, there is no further requirement for TGS to pay Social Security tax for
such employee. Since most of TGS's employees receive compensation in excess of
that amount, TGS's costs with respect to any employee are significantly higher
during the period when it is required to pay Social Security taxes than it is
after such taxes have been paid.
For 1996, TGS had revenues of $62.6 million, reflecting a 1% decrease from the
revenue of $63.2 million during 1995. This decrease is attributed to the loss of
a contract on January 1, 1996, from one of TGS's larger customers in the
aerospace industry. By December 31, 1996, TGS had increased its revenue base so
that, at such date, the annual rate of revenue was greater than it was prior to
the loss of the customer. During 1996, approximately 61% of TGS's revenue was
derived from its three largest clients and 75% of such revenue was derived from
its five largest clients. TGS's gross margin for 1996 was 8.2%, as compared to
6.3% for 1995. The increase reflects a higher gross margin on the new contracts
entered into by the Company as compared with the lower gross margin on the
contract that was lost. For 1995, the Company had revenues of $63.2 million,
reflecting a 150% increase in revenue from the revenue of $25.3 million during
1994. During 1994, operations consisted of Avionics for the entire year and RMI
from November 22, 1994, the date of acquisition. The increase in revenue in 1995
reflected the inclusion of the operations of RMI for the entire year, as well as
an increase in revenue from Avionics' clients resulting from its increased
marketing effort. The increase in costs of sales from $23.7 million for 1994 to
$59.2 million for 1995 also reflects the inclusion of the operations of RMI. The
gross margin was 6.3% for both 1995 and 1994.
Selling, general and administrative expenses decreased by $2 million, or 31%,
from 1995 to 1996 and increased by $5.4 million, or 538%, from 1994 to 1995. The
significant fluctuation in operating expenses reflects a number of factors,
including the following:
Consulting Fees - During 1995, TGS incurred $2.3 million of noncash
expense from the issuance of securities for consulting services and no
such expenses were incurred in either 1996 or 1994.
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<PAGE>
Payroll Tax Penalties - During 1996 and 1995 penalties for late
withholding taxes were $635,000 and $1 million, respectively, and
during 1994, TGS received a credit of $159,000 resulting from the
refund of a previously paid withholding tax penalty.
Acquisition Costs - During 1995, TGS incurred $529,000 of acquisition
expenses relating the issuance of securities in connection with the
reverse acquisition. The acquisition expenses reflect the value of
Common Stock issued as a finder fee and issued in consideration of
agreements by certain of TGS's stockholders to enter into lock-up
agreements. No comparable expenses were incurred in 1996 or 1994.
Operations of RMI - RMI was not acquired until November 1994, and as
such, selling, general and administrative expenses for 1994 did not
include a full year of such amounts which approximated $2.0 million for
1995.
Contingency Reserve - During 1996, the Company established a
contingency reserve of $300,000 in connection with a claim by the DOL
arising from the acquisition of RMI.
Interest expense was approximately $712,000, $963,000 and $696,000 for 1996,
1995 and 1994, respectively. TGS finances its payroll obligations by borrowing
from a non-affiliated asset-based lender at an interest rate of prime plus 2%.
TGS also pays a fee of 0.3% of the face amount of the invoices financed,
regardless of the amount borrowed against the invoice. This reflects a reduction
in the financing charges resulting from a June 1995 amendment to its borrowing
agreement. Prior to the amendment, TGS paid interest at a rate of 4% in excess
of prime and a fee of 1% of its borrowings relating to RMI's operations.
Pursuant to a January 1997 amendment to TGS's agreement with its asset-based
lender, on April 1, 1997 or earlier at the request of TGS, the borrowing
availability will be reduced to $3.0 million and TGS will pay a fixed monthly
fee of $10,500 to the asset-based lender. The fee will be subject to increases
to the extent that receivables in any month exceed $10.0 million. The interest
rate of 2% in excess of prime will not be affected by the amendment. The
borrowings are secured by a security interest in all of the Company's assets. At
December 31, 1996, such borrowings from the asset-based lender were
approximately $3.7 million. The ability of TGS to operate profitably is
dependent in part upon its ability to reduce its financing costs. The interest
rates (exclusive of the fee) payable by TGS at December 31, 1996 and 1995 was
10.25%.
As a result of the foregoing, TGS sustained a net loss of $681,000, for 1996, as
compared with a loss of $4.7 million, for 1995 and a loss of $434,000 for 1994.
TGS believes that, with the reduced level of selling, general and administrative
expenses and improved gross margin, which are reflected in the results of its
operations for 1996, it can improve its operations by reducing its interest
expense through its amended agreement with its asset-based lender combined with
a lower level of borrowing and eliminating future late withholding tax
penalties, which affected TGS's operations since its organization. TGS may also
seek to reduce its financing costs further by seeking to enter into agreements
with other financing sources which would offer lower financing costs. However,
no assurance can be given that TGS can or will operate profitably in the future.
Medical Diagnostics
This segment consists of the operations of International magnetic Imaging, Inc.,
("IMI"), a medical diagnostic imaging company, which primarily performs MRI and
other diagnostic imaging modalities, that was purchased in September 1994. In
the following analysis of the medical diagnostics segment, the years ended
December 31, 1996 and 1995, reflect the operations of the Company. The year
ended December 31, 1994 includes operations of the centers that were acquired
from the predecessor companies for the nine months ended September 30, 1994 and
operations of the Company for the three months ended December 31, 1994.
53
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Net patient service revenue for performing MRI and other diagnostic modality
procedures increased $3.16 million, or 11%, from 1995 to 1996 and $21.5 million,
or 328% from 1994 to 1995. As noted in Table I below, the mix of procedures by
class of payer remained relatively level for all years. Additionally, the
reimbursement rates remained relatively level from 1995 to 1996 and decreased
modestly from 1994 to 1995. Accordingly, the increase in revenues is a result of
increases in overall procedure volume which increased 32% from 1995 to 1996 and
9% from 1994 to 1995. A significant portion of the increase in volume for 1996
relates to multi-modality procedures which have a lower reimbursement rate than
MRI procedures, and as such, the net patient service revenues increased at a
lower percentage than the increase in volume. For 1995, the increase in volume
was partially offset by a decrease in reimbursement rates. The revenues earned
by IMI in the fourth quarter of 1996 were approximately $600,000 less than the
average revenues for the first three quarters of 1996. During the fourth quarter
of 1996, two Florida Centers significantly reduced the procedures performed for
scan brokers and such decreases in volume are intended to be recaptured by
marketing other payer revenue sources, although such recapture has not yet been
realized. Additionally, during the fourth quarter of 1996, the Puerto Rican
Center experienced a decrease in workers compensation procedures because IMI's
equipment required an upgrade to become competitive in that market. During the
first quarter of 1997, such upgrade has been made. Contractual adjustments,
which represent the difference between IMI's standard billing rate and the
amount contracted with the payer source, was 49%, 45% and 34%, respectively of
gross patient service revenue for 1996, 1995 and 1994. Contractual adjustments
increased significantly from 1994 through 1996 due to a general decrease in
reimbursement rates from all payer classes and the increase in IMI's brokered
scan business which had a substantially lower reimbursement rate than any of
IMI's other revenue sources. The participation of IMI with third party insurers
requires that IMI accept specified reimbursement rates which are not currently
based on capitated contracts.
Table I - Mix of Procedures by Payer Class
Percentage of Procedure Mix
Class of Payer 1996 1995 1994
- -------------- ---- ---- ----
MRI Procedures (representing 89%, 91%
and 92%, respectively of net patient
service revenue for 1996, 1995 and 1994):
Managed Care 37% 38% 41%
Commercial 17% 17% 20%
Medicare 13% 9% 14%
Worker's Compensation 11% 14% 16%
Brokered 10% 9% --
Contract Worker's Compensation 6% 6% --
Liability 4% 4% 5%
Other 2% 3% 4%
Multi-modality procedures, other than
MRI(1) (representing 11%, 9% and 8%,
respectively of net patient service
revenue for 1996, 1995 and 1994):
Managed Care 84% 85% 85%
Medicare 8% 6% 6%
Commercial 6% 6% 6%
Other 2% 3% 3%
- -------
(1) Includes CAT scans, nuclear medicine, mammography, fluoroscopy and X-Rays.
Other service revenues and management fee income represented only 3.5%, 2.4% and
0.3% of total revenues, respectively, for 1996, 1995 and 1994. Other service
revenues and management fee income increased $433,000 from 1995 to 1996 due
primarily to the operations of MRI Net and for 1994 to 1995, no significant
fluctuation occurred.
IMI's operating expenses for 1996 increased by $4 million, or 18%, from $22.6
million for 1995 to $26.7 million for 1996. The operating expenses for 1995
increased by $371,000, or 2%, from $22.3 million for 1994 to $22.6 million for
1995. The overall increase in operating expenses reflected a number of factors
discussed below.
54
<PAGE>
Radiology fees increased $336,000 or 11% when comparing 1996 to 1995 and $2
million or 194% when comparing 1995 to 1994. For 1996 and 1995, radiology fees
were incurred based on cash collections related to services performed. Cash
collections for services were $27.4 million and $25.4 million, respectively, for
1996 and 1995, representing an overall increase of approximately 8%. From
January through November of 1994 a significant portion of the radiologists were
employees of IMI and accordingly, compensation to radiologists of approximately
$1.2 million is included in salaries and benefits for 1994. The remaining
increase of $700,000, when comparing 1995 and 1994 is due to the fact that the
radiology agreements entered into with radiologists and independent radiology
companies required larger fees based on the achievement of certain bonus levels
and such fees for 1995 were higher than the amounts paid to radiologists when
they were employees of IMI in 1994. IMI entered into four radiology agreements
which expire approximately four years from December 31, 1996 and which require
that radiologists interpret and report the results of the MRI and multi-modality
procedures and which require IMI to pay the radiology company's fees based on
the terms of the agreements. The following summarizes the four agreements and
generally describes their terms.
1) The Florida Centers - The radiology agreement requires payment by IMI to
the radiology company, of fees that range from 10%-20% of collections. Each of
the Florida Centers has a separate fee schedule as a part of the agreement. The
agreements require increased payment based on Center specific bonus criteria. At
the beginning of each year new bonus criteria are negotiated pursuant to the
terms of the agreement. For the Florida Centers, over the past two years, the
radiology fees have averaged 11% to 12% of cash collections for MRI procedures
and 16% to 17% of cash collections for multi-modality procedures.
2) San Juan Center - The facilities use agreement requires payment by IMI,
to the radiology company, of fees that are 10% of cash collections, plus 3% of
the annual cash collections between $2 million and $3 million, plus 5% of annual
cash collections in excess $3 million. The terms of this agreement are
negotiated at the end of each year and may be terminated upon 90 days notice by
either party if such negotiations are not successful.
3) Virginia Center - The radiology agreement, which is effective until March
31, 2000, requires payment by IMI, to the radiology company, of a fixed fee of
$275,000 per year plus an incentive of 15% of collections in excess of $2.4
million.
4) Kansas City Center - The radiology agreement requires payment by IMI, to
the radiology company, of based on the following schedule:
Procedures Fee per
Interpreted Procedure
----------- ---------
1-275 $ 75
276-350 $100
351 and Greater $150
Equipment maintenance costs relate primarily to fixed contract payment schedules
and generally do not fluctuate from period to period unless repairs and
maintenance are required that are not covered by the equipment contracts or new
equipment is placed into service or removed from service. Substantially all
maintenance costs incurred for 1996, 1995 and 1994 were incurred pursuant to
fixed maintenance contracts, and as a result such costs did not fluctuate
significantly, increasing $39,000 from 1995 to 1996 and decreasing $57,000 from
1994 to 1995.
Patient service costs and expenses consist primarily of film, contrast agents
and utility costs used in the MRI and multi-modality procedures. Such costs
increased $289,000, or 15%, from 1995 to 1996. Approximately $104,000 of this
increase related to an increase in medical supplies used by a multi-modality
Center that performs CAT scans, nuclear medicine, mammography, fluoroscopy and
X-ray's which had a significant increase in volume. The remaining increase is
due to the additional procedure volume which inherently requires more patient
service costs which was partially offset by negotiated decreases in overall per
unit film and contrast agent costs. Such costs increased only $12,000, or 1%,
from 1994 to 1995 which reflects increases in procedure volume that were offset
by modest decreases in film and contrast agent costs.
55
<PAGE>
Salaries and benefits increased $733,000 or 12% from 1995 to 1996. Of this
increase, approximately $105,000 relates to a bonus paid to IMI's chief
financial officer, who is also the chief financial officer of Consolidated, for
services relating to the DVI loans incurred in 1996. Additionally, during 1996,
the Centers increased their hours of operations in order to increase volume.
These increased hours of operation required additional personnel in certain
Centers and required some overtime in all Centers. The per employee base salary
and benefit costs did not significantly increase. Salaries and benefits
decreased $1.8 million or 24% from 1994 to 1995. The salaries and benefits for
1994 include approximately $1.2 million paid to radiologists based on fixed fee
contracts and 1995 does not include any such amounts paid to radiologists as
discussed above. Additionally, during 1995, management implemented a cost
reduction plan which included the reduction of overall salary and wage levels
which accounts for the remaining decrease in salaries and benefits.
Professional services, consisting primarily of legal, accounting and consulting
services, remained relatively level, increasing only $15,000 or 2% when
comparing 1995 to 1996. Professional services decreased $643,000, or 45%, from
1994 to 1995, which reflects the significant accounting and legal fees that were
incurred by the Company during 1994 in conjunction with the acquisition.
Other management, general and administrative expenses, increased $765,000, or
19%, from 1995 to 1996. During 1996, one of the Centers was in the process of
relocating to a new facility and in connection therewith, it rented, on a
short-term basis, MRI equipment at a rental cost of approximately $441,000 and
was paying rent at two locations on a temporary basis resulting in additional
rental expense of $27,000. Other significant increases include $95,000 for an
administrative fee paid to DVI related to the revolver loan incurred subsequent
to 1995 and $40,000 for compensation to temporary employees of MRI Net who
replaced permanent employees whose compensation in 1995 is included under
salaries and benefits. During 1995 and 1994, other management, general and
administrative expense, remained relatively level, decreasing $80,000 or 2% from
1994 to 1995.
Provision for bad debts increased $1.5 million, or 176%, from 1995 to 1996.
Substantially all of this increase reflects an evaluation of the collectibility
of receivables from third-party liability payers which were generated prior to
the September 30, 1994 acquisition of the Centers. Additionally, during the
fourth quarter of 1996, the provision for bad debts was $850,000 greater than
the average of the first three quarters of which $350,000 was from the write-off
of amounts due from scan brokers who went out of business. The remaining
$500,000 increase is due to liability accounts receivable whose aging had
reached the point where IMI's receivable policy and evaluation required that
such receivables be provided for with an allowance. Revenue from third-party
liability payers represented only 4% of revenue for 1996 and 1995. Provision for
bad debts decreased $242,000, or 22%, from 1994 to 1995. During 1994 the
composition of revenues and the related accounts receivable balances included
more payer types with a higher estimate of provision rate than for 1995.
Depreciation and amortization consists of the depreciation of purchased
equipment, buildings, leasehold improvements and capital leases and the
amortization of goodwill, customer lists, restrictive covenants and loan costs.
Depreciation expense increased $224,000, or 8%, from 1995 to 1996, which
reflects the addition of equipment in certain Centers, which was partially
offset by a decrease in Centers where equipment is fully depreciated as of 1996.
Amortization increased $103,000, or 5%, from 1995 to 1996 due to an increase in
capitalized loan costs which were incurred at the beginning of 1996 resulting
from the subordinated debt refinancing with DVI. Depreciation and amortization
expense in total increased $1.2 million, or 33%, from 1994 to 1995, due
primarily to increased amortization from the addition of goodwill, restrictive
covenants and customer lists as part of the September 30, 1994 acquisition.
Interest and other income increased $368,000, or 191%, from 1995 to 1996. During
August of 1995, IMI entered into a joint venture agreement with respect to an
MRI Center in the Orlando, Florida area. Income from the joint venture during
1996 and 1995 was $281,000 and $120,000, respectively. Additionally, 1996
includes a change in an estimate related to prior period over-accruals of
tangible personal property taxes of approximately $140,000 for the San Juan
Center. Other components of interest income and other income were not
significant for the September 1996 and 1995 periods. Interest and other income
decreased $385,000, or 67%, from 1994 to 1995, which reflects the inclusion in
1994 of approximately $300,000 of debt forgiveness from certain shareholders of
nonaffiliated companies, that were not acquired by IMI in the 1994 acquisition.
Interest expense increased $440,000, or 17%, from 1995 to 1996. At the beginning
of 1996, IMI refinanced certain Subordinated Notes, which were short-term notes
on which the Company paid interest at 7%, with long-term debt with rates varying
from 11% to 12%. The increase in interest expense from the higher rate was
partially offset by reductions on the debt on which the interest was paid..
Interest expense increased $1.3 million, or 95%, from 1994 to 1995, due to the
fact that as a part of the September 30, 1994 acquisition, approximately $20
million in subordinated debt was incurred with interest rates ranging from 4% to
7%. Other increases in interest expense from 1994 to 1995 are due to additions
of equipment financing and interest from new capital lease obligations.
56
<PAGE>
Loss on sale and disposal of assets, which was $28,000, $25,000 and $524,000,
respectively for 1996, 1995 and 1994, consisted primarily of leasehold
improvements and medical equipment which was sold or disposed of during the
periods.
Overall profitability decreased $720,000, or 41% from 1995 to 1996, reflecting
increased overall costs in excess of gains in net revenues. During 1996, five of
the Centers operated at an aggregate net loss of $784,000 while the remaining
Centers generated net income of $1.8 million. During 1995, five of the Centers
operated at an aggregate net loss of $2 million while the remaining Centers
generated net income of $3.8 million. Overall profitability remained relatively
level for 1995 and 1994, reflecting increased overall costs in excess of
increased revenue of $13,000. During 1994, two of the Centers operated at an
aggregate net loss of $550,000 while the remaining Centers generated net income
of $2.3 million.
Electro-Mechanical and Electro-Optical Products Manufacturing:
This segment consists of two companies which manufactures optical encoders,
encoded motors and limit programmers, debit card vending machines and various
avionics instrumentation devices, a company that markets telephone debit cards
which commenced operations in 1995 and a company that designs, develops and
integrates all of the critical building blocks of a Fingerprint ID System.
Optical-encoders, encoded motors and limit programmers, debit card vending
machines and avionics instrumentation device revenues, when comparing 1996 to
1995, decreased 33% from $4,223,000 for 1995 to $2,837,000 for 1996.
Additionally, gross profit was negative for 1996 due primarily to the write-off
of obsolete inventory of $350,000 for 1996. Write-off of obsolete inventory for
1995 amounted to $270,000. Excluding such write-offs, the gross profit
percentages for 1996 and 1995 were 6% and 12%, respectively. The significant
decrease in revenues and gross margins is attributed to lower levels of
shipments to existing customers while new customers have not been obtained to
replace the lost revenues and the gross margins on current period contracts have
lower margins than on revenues that were lost. Selling, general and
administrative expenses remained relatively level approximating $1,341,000 and
$1,380,000 for 1996 and 1995, respectively, reflecting increased spending of
approximately $200,000 on developing new technologies, which was offset by
planned cutbacks in expenses related to existing operations. Interest expense
was approximately $150,000 for both 1996 and 1995. A significant portion of the
interest expense is related party interest charged from the parent company, (SIS
Capital Corp.) charged on advances made to this segment to fund its operations.
Net losses increased from $1,050,000 for 1995 to $1,709,000 for 1996, reflecting
the decrease in gross profit while other expenses remained relatively level. In
prior periods, this segment focused primarily on sales to the governmental
sector and currently management is attempting to place more emphasis on sales to
the private sector through the sale of encoders to private manufacturing
companies while also trying to capitalize on the recent potential for increased
governmental military spending and while there exists a possibility that there
will be reversals in government spending cutbacks no assurance can be made that
this segment will be able to qualify for the related government contracts.
Management plans to continue placing more emphasis on sales to the private
sector although no assurances can be given that the segment will ever be able to
operate profitably.
Prepaid telephone calling card revenues, gross profit and operating loss, from
the date of acquisition through December 31, 1996, approximated $387,000,
($152,000) and $313,000. This segment operates in a highly competitive market
and is competing against companies that are larger, more well established and
have significantly greater resources. The impact of this competition has
required the segment to sell the calling cards at below cost in order to attempt
to establish a market presence which has resulted in a negative gross margin.
Selling, general and administrative costs were $153,000 from the period of
acquisition to December 31, 1996 which consists primarily of salaries and
related expenses. Based on the competitive environment that this segment
operates in, no assurances can be given that its operations will ever reach
profitable levels.
Finger print identification products activity to date have been the costs of
developing its products. Such amounts for 1996 approximated $144,000. Due to the
nature of a development stage company, no assurances can be given that it will
ever be able to develop a marketable product and achieve revenues that will
allow it to operate profitably.
Medical Information Services:
The medical information services segments consists of the activity of two
companies, Netsmart Technologies, Inc., ("Netsmart") and Creative Socio Medics,
Inc.' ("CSM"). CSM was acquired in June 1994 and accounted for all of the
revenues and gross margin in this segment for 1994. Since CSM was not a part of
the consolidated operations until July 1, 1994, the prior periods operating
results are not comparable to those of the years ended December 31, 1996 and
1995. For purposes herein, references to Netsmart relate to the operations of
both Netsmart and CSM unless indicated otherwise.
57
<PAGE>
The segment's revenue for 1996 was $8.5 million, an increase of $1.1 million, or
15% from the revenue for 1995 which was $7.4 million. approximately $1,550,000
of the increase in revenue is due to revenue generated pursuant to an agreement
with IBN. IBN represented Netsmart's most significant customer for 1996,
accounting for approximately 22% of revenue. Furthermore, through December 31,
1996 IBN has generated revenue of $2.4 million, or approximately 89.6% of
Netsmart's total revenue from the SmartCard systems during the two years ended
December 31, 1996 and 1995 on a combined basis. The revenue generated to date
includes approximately $419,000 of guaranteed royalties. As of December 31,
1996, the contract was more than 80% complete. Netsmart is continuing to provide
professional services to IBN, although revenues from such services have declined
substantially from the level at the beginning of the year. Netsmart intends to
expand its marketing effort for its CarteSmarte System, however, at December 31,
1996, the Company did not have any significant contracts for the CarteSmart
system.
Revenue from Netsmart's health information systems continued to represent the
Netsmart's principal source of revenue in 1996, accounting for $6.5 million or
76% of revenue. However, as a result of the increase of revenue from SmartCard
systems, principally from IBN, revenue from health information systems and
services declined as a percentage of total revenue. Except for revenue from the
IBN contract, the largest component of revenue in 1996 was data center (service
bureau) revenue which increased to $2,207,000 in 1996 from $1,742,000 in 1995,
reflecting an increase of 27%. The turnkey systems revenue decreased to
$1,663,000 in 1996 from $1,777,000 in 1995, reflecting a decrease of 6%.
Maintenance revenue increased to $1,226,000 in 1996 from $1,099,000 in 1995,
reflecting a 11%. Revenue from third party hardware and software decreased to
$1,114,000 in 1996 from $2,148,000 in 1995, a decrease of 48%. Sales of third
party hardware and software are made only in connection with the sales of
turnkey systems. License revenue increased to $329,000 in 1996 from $162,000 in
1995. License revenue is generated as part of a sale of a turnkey system
pursuant to a contract or purchase order that includes development of a turnkey
system and maintenance. Netsmart believes that the increase in 1996
installations should enable the Company to increase the maintenance revenue in
future periods.
Revenue from contracts from government agencies represented 31% of revenue for
1996. Netsmart believes that such contracts will continue to represent an
important part of its business, particularly its health information systems
business. In 1996, contracts from government agencies accounted for
approximately 40% of its revenue from health information systems.
Gross profit decreased to $1,332,000 in 1996 from $1,973,000 in 1995, a 32%
decrease. The decrease in the gross profit was substantially the result of costs
associated with the completion of the IBN contract. At December 31, 1996 the IBN
contract was more than 80% complete.
Selling, general and administrative expenses were $1.9 million in 1996, a
decrease of 24% from the $2.5 million in 1995. The decline was substantially the
result of a one time charge in 1995 of a write off deferred public offering
costs in the amount of $460,000 as well as a reduction in executive compensation
and a reduction in staff.
During 1996, Netsmart incurred non cash compensation charges of $3.5 million
arising out of the issuance of warrants and options having exercise prices which
were less than the market value of the Common Stock at the date of approval by
the board of directors. During 1996, Netsmart issued 500,000 common shares to
certain noteholders and 25,000 common shares to Netsmart 's asset based lender.
As a result of such issuance, Netsmart incurred a financing cost charge to
operations of approximately $1.7 million.
In 1996, Netsmart did not incur any research and development expenses, since the
personnel who had been engaged in such activities were reassigned to work on the
IBN contract and the development of SmartCard products. As s result, their
salaries and related expenses were included in costs of revenue with respect to
the work on the IBN contract and capitalized software development costs with
respect to their work on the SmartCard product. As a result of such product
development, Netsmart incurred $279,000 in capitalized software costs of which
$28,000 has been amortized in 1996 and charged to cost of sales. In 1995,
Netsmart incurred research and development expenses in the amount of $699,000.
In 1996 Netsmart recognized its 50% share of its loss in its joint venture
corporation with respect to the purchase of SATC software. The amount of such
loss was $264,000.
Interest expense was $473,000 in 1996, a decrease of $81,000, or 15% from the
interest expense in 1995. The most significant component of the interest expense
on an ongoing basis is the interest payable to Netsmart's asset-based lender,
which it pays interest equal to the greater if 18% per annum or prime plus 8%
plus a fee of 1% of the face amount of the invoice.
As a result of the foregoing factors, Netsmart incurred a net loss of $6.6
million compared with a net loss of $2.9 million in 1995.
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<PAGE>
The results of Netsmart's operations for the year ended December 31, 1995 are
not comparable with the results of operations for 1994 since the acquisition of
CSM was effective July 1, 1994, and the results of operations for 1994 include
the CSM business only from such date.
Revenue for 1995 was $7.4 million, representing an increase of 152% from revenue
for 1994 of $2.9 million. The increase reflected the inclusion of CSM's
operation for only the last six months of the year. Revenue from health
information systems and services accounted for $6.8 million, or 91.5% of total
revenue for 1995 and more than 99% of pro forma combined revenue of Netsmart and
CSM for 1994. CarteSmart Systems revenue accounted for the balance of the
revenue for the periods. In 1994, Netsmart generated CarteSmart Systems revenue
of $90,000 from the pilot project in San Diego County. In 1995, revenue from
CarteSmart technology was $631,000.
The largest component of revenue for 1995 was $2.0 million from the sale of
third party hardware and software, as compared with $519,000 for 1994. Such
revenue represented 26.7% and 17.7% of revenue for 1995 and 1994, respectively.
A significant portion of revenue in 1995 represented the sale of hardware
($842,000) and software and related services ($524,000) pursuant to a purchase
order from the State of Colorado for its Department of Human Services. Revenue
from services related to turnkey systems and data center revenue accounted for
$1.8 million and $1.7 million, or 24.1% and 23.6% of revenue, respectively, for
1995, as compared with $664,000 and $884,000, or 22.7% and 30.2% of revenue,
respectively, for 1994. Maintenance revenue was $1.1 million and $500,000 in
1995 and 1994, respectively, representing 14.9% and 17% of revenue,
respectively. Netsmart believes that the increase in installations at December
31, 1995 from the prior year should enable Netsmart to increase the maintenance
revenue in future periods. Revenue from CarteSmart Systems increased to $631,000
in 1995, representing 8.6% of revenue, from $90,000 in 1994, representing 3.1%
of revenue. The CarteSmart System revenue reflected revenue from IBN ($481,000),
Virginia Commenwealth University ($118,000) and the San Diego pilot program
($31,000) in 1995 and the San Diego Prom ($90,000) in 1994. The overall increase
in revenue reflects the inclusion of CarteSmart Systems revenue combined with
the revenue from the Colorado agreement.
Both the increase in revenue and the change in revenue mix reflected increased
revenue resulting from an enhanced marketing effort following the June 1994
acquisition of CSM. During the second half of 1994, Netsmart received
significant purchase orders from the State of Colorado for its Department of
Human Services and the State of Oklahoma. The Colorado order covered the
purchase of Netsmart's health information system, including software, consulting
services and hardware, at a total purchase price of approximately $1.2 million.
Of the purchase price, approximately $700,000 represented the purchase price of
the software and consulting services, and the balance represents the cost of the
hardware. In July 1994, Netsmart received a purchase order from a state agency
of the State of Oklahoma for a health information system which includes the
graphical interface. The order called for the installation of the system in ten
hospitals for a purchase price of approximately $430,000. Netsmart is continuing
to market its health information systems to entitlement programs. It believes
that the inclusion of the graphical and smart card functions, which were
implemented during the second half of 1994 and the first half of 1995, will
assist it in marketing its products to entitlement programs. It also believes
that the successful pilot project for the smart card interface in San Diego
provides the Company with an important tool in marketing this function to both
new and existing clients. Netsmart is commencing a marketing effort for its
CarteSmart System directed at the financial services industry and educational
institutions. However, in the industries to which Netsmart is marketing its
products, there is typically a long selling cycle, as a result of which Netsmart
must continue to support its marketing effort for a significant period before
any revenue is realized.
Gross profit increased to $2.0 million in 1995 from $601,000 in 1994, an
increase of 352%, which reflected an increase in the gross margin to 23.9% in
1995 from 13.3% in 1994. The increase in gross profit resulted from both the
improved gross margin and the inclusion of twelve months of CSM operations in
1995 and six months of such operations in 1994. The improved margin reflects the
significant increase in CarteSmart revenue, on which Netsmart realized a higher
margin than on its health information systems and services. However, the
amortization of capitalized software costs of $419,000 during 1995 is reflected
as a cost of revenue, which offset the higher margin for the CarteSmart System.
During 1995, Netsmart changed its CarteSmart System from a DOS-based system to a
Windows-based system. The capitalized costs related to the DOS-based system. As
a result, at December 31, 1995, Netsmart wrote off the unamortized software
development costs, which increased cost of sales. In addition, Netsmart expensed
the development of the Windows-based system, which was charged to research and
development. The gross profit for 1995 benefited from the gross margin for
maintenance services. During 1995, the gross profit from maintenance services
increased to $356,000 from $52,000 in 1994, reflecting an increase in the gross
margin from such services to 32.4% for 1995 from 10.4% for 1994. The increase in
margin resulted from increased services performed on a time and materials basis
as well as a reduction in staff as Netsmart was able to perform the same
services with a smaller staff.
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Selling, general and administrative expenses were $2.5 million and $1.5 million
for 1995 and 1994, respectively, representing a 66.0% increase. In 1994,
selling, general and administrative expenses included approximately $236,000 of
compensation expense arising out of the issuance of Consolidated common stock to
former officers of CSM and the grant by SISC to such persons of options to
purchase shares of the Netsmart's Common Stock which were owned by SISC.
However, in 1995, selling, general and administrative expenses included a
$200,000 increase in annualized expenses resulting from an increases in the
marketing staff, a $100,000 increase in the level of compensation for Netsmart's
and CSM's officers following the June 1994 acquisition of CSM, $150,000 in legal
expenses, a portion of which related to the acquisition of CSM, and $313,000 of
the amortization of customer lists resulting from the CSM acquisition.
Commencing July 1, 1994, general and administrative expenses reflects the
amortization of customer lists resulting from the CSM acquisition.
Research and development was $699,000 and $367,000 for 1995 and 1994,
respectively, representing a 90.5% increase. The increase reflects research and
development for smart card and related products and the graphical interface for
Netsmart's health information systems.
During 1995, Netsmart incurred financing costs of $863,000, representing the
write-off of deferred financing costs relating to a proposed initial public
offering which had been scheduled for early 1995, but which had been canceled.
No such expenses were incurred in 1994.
Interest Expense - The most significant component of the interest on an ongoing
basis is the interest payable to Netsmart 's asset-based lender, on which it
pays interest equal to the greater of 18% per annum or prime plus 8% plus a fee
of 1% of the face amount of the invoice.
As a result of the foregoing factors, Netsmart sustained losses of $2.9 million
for 1995, as compared with a loss of $1.8 million for 1994. If certain
additional compensation expenses were incurred during the year, the pro forma
loss would have been $3.5 million, or $.73 per share.
In addition, at December 31, 1995 and 1994, the estimated profit included in
cost and estimated profit in excess of interim billings and interim billings in
excess of cost and estimated profit decreased substantially from approximately
$1.4 million to approximately $500,000. This decrease reflected a reduction in
the number of contracts that have billing schedules which differ from revenue
recognition. As a result of a reduced number of such contracts at December 31,
1995, the estimated profits from such contracts declined.
Telecommunications:
Revenue for the year ended December 31, 1996 was $5.6 million, reflecting an
increase of 52.6% from $3.3 million revenue in the year ended December 31, 1995.
ARC's business has two segments -- telephone services and data cable
installation services. The increase in revenue in 1996 reflected a change in
ARC's business resulting from the increase in local telephone service, and the
introduction during 1996 of telephone debit card service and, to a lesser
extent, long-distance telephone service. The following table sets forth the
revenue and percentage of revenue during 1996 and 1995 from its services.
<TABLE>
<CAPTION>
Year ended December 31, 1996 Year ended December 31, 1995
------------------------------- ----------------------------
<S> <C> <C> <C> <C>
Revenue Percent Revenue Percent
Telephone services $4,415,000 79.1% $1,275,000 39.2%
Data cabling installation services $1,167,000 20.9% $1,978,000 60.8%
</TABLE>
Cost of revenue for 1996 was $5.1 million, reflecting an increase of $2.5
million, or 97%, from the cost of revenue of $2.6 million in 1995. The increase
in cost of revenue substantially exceeded the increase in revenue, resulting in
a decrease in gross margin from 21.4% in 1995 to 9.1% in 1996. ARC's gross
margin in 1996 reflects gross margin of 7.2% for telephone services and 16.3%
for data cable installations services. The comparable gross margins in 1995 were
15.1% and 25.4%, respectively.
60
<PAGE>
The ability of ARC to generate an adequate gross margin from telephone services
is dependent upon the volume of service provided by ARC, which is in turn
dependent upon both the prices at which ARC can obtain telephone service from
the underlying carriers and the price at which ARC can sell the service to its
customers. The cost of revenue for ARC's telephone service include the
operational expenses associated with the operation of ARC's debit card platform
in New York City which it uses for processing calls for users of its prepaid
telephone debit cards and, to a lesser extent, calling card charges. The low
profit margin for telephone services in 1996 reflected high costs incurred in
connection with the introduction of ARC's telephone debit cards, including an
insufficient call volume to cover the costs of the debit card platform, errors
in pricing certain international calls and problems with telephone line
security. The problems in line security reflected charges approximately $105,000
paid by ARC for telephone service which was either unauthorized or unaccounted
for, which generated cost of revenue which did not generate revenue. In order
for ARC to improve its gross margin for telephone services, ARC must generate
sufficient telephone debit card revenue on a continuing basis to cover not only
the cost of the service but the cost of the debit card platform. ARC believes
that unless its monthly revenue from telephone debit cards is at least $300,000,
it will not be able to generate a positive gross margin from telephone debit
card operations.
ARC's profit margin on telephone services is subject to a variety of factors
which affect both the cost of providing services and the prices at which such
services can be sold. Reductions in local and domestic and international
long-distance rates affect the rates that ARC can charge for calls through its
service. Rate reductions by AT&T, MCI and Sprint and their announced plans to
offer local telephone service, especially when directed at businesses and other
major users of telephone service, would compel ARC to lower its rates in order
to compete effectively, thereby reducing its margins. ARC's costs of service are
affected by the cost of transmission and switching facilities and the cost of
obtaining access to local telephone users.
The principal components of cost of revenue with respect to its data cable
installation service is the cost of personnel. The decrease in data installation
margins is due to competitive pricing pressures, which have driven down the
margins from 1995 to 1996. ARC's cabling installation business remains under
significant pricing pressures.
Selling, general and administrative expenses for 1996 were $1.4 million, an
increase of 23% from $1.2 million in 1995. The increase in selling, general and
administrative expenses reflected start-up expenses which were incurred as ARC
opened offices in Chicago and South Florida in November 1996. Additional
overhead was incurred in the New York office to manage its telephone business.
During 1996, ARC did not generate significant revenue from either of such
offices.
ARC incurred an operating loss of $929,000 for 1996, representing a 96.0%
increase from the operating loss of $474,000 in 1995. The 1996 operating loss
reflects an operating loss of $934,000 from telephone service and operating
income of $5,000 from data cable installation services. The 1995 operating loss
reflects operating losses of $266,000 and $208,000 from telephone services and
data cable installation services, respectively. The 1996 operating loss from
telephone service reflected the loss profit margin combined with high selling,
general and administrative expenses relating to this segment of its business.
During 1996, ARC devoted a significantly greater portion of its resources to the
telephone services segment and as a result, a greater proportion of costs were
allocated to that segment in 1996 as compared to 1995.
Interest expense increased by $98,000, or 142%, from $69,000 in 1995 to $167,000
in 1996. This increase reflected increased borrowings principally to finance the
purchase of capital equipment and interest expense on funds advanced to ARC by
SISC. In September 1996, ARC entered into a term-loan agreement with a
non-affiliated asset-based lender, pursuant to which ARC may borrow up to
$350,000 to purchase equipment. The loan is due in August 2000. ARC pays
interest on such loan at prime plus 12%, which rate shall not be less than
20.8%. ARC also has a revolving credit facility with another non-affiliated
asset-based lender . Under such agreement, ARC finances payments to its
telephone carriers through loans secured by selected accounts receivable. ARC
pays such lender interest at an interest rate of 2% in excess of prime. ARC also
pays a fee of .30% of the face amount of the invoices financed, regardless of
the amount borrowed against the invoice. The effective average interest rate
during 1996 was 10.25%. In addition, accrued interest to Trans Global and SISC
was $107,000 in 1996 and $69,000 in 1995. During 1995, ARC had no borrowings
from non-affiliated parties and, accordingly, the interest expense for 1995 was
solely the interest to Trans Global and SISC. ARC pays its international
carriers on a bi-monthly basis and bills its customers monthly, with the result
that ARC must finance more of its telephone costs than would be necessary if it
was billed and billed its customers on a monthly basis.
As a result of the foregoing factors, ARC sustained a net loss of $1.1 million
in 1996 as compared with a loss of $543,000 in 1995.
In connection with the issuance of interim notes in February 1997, ARC issued
warrants to purchase an aggregate of 1,000,000 shares of Common Stock at $1.00
per share and 500,000 shares of Common Stock at $5.00 per share. As a result of
the issuance of the warrants with an exercise price below the market value of
the Common Stock, ARC anticipates that, for the first quarter of 1997, it will
incur a non-cash charge in the amount of approximately $3.2 million.
61
<PAGE>
Revenue for the year ended December 31, 1995 was $3.3 million, reflecting an
increase of 43.4% from $2.3 million revenue in the year ended December 31, 1994.
The increase in revenue reflected an increase in revenue from local telephone
service of $1.3 million, offset by a decrease of $300,000 in revenue from data
cable installation services. During 1994, ARC was principally engaged in data
cable installation services.
Cost of revenue for 1995 was $2.6 million, reflecting an increase of $1.8
million, or 41.2%, from the cost of revenue of $1.8 million in 1994. The
increase in cost of revenue was slightly less than the increase in revenue,
resulting in an increase in gross margin from 20.1% in 1994 to 21.4% in 1995.
The increase in gross margin reflected the addition of revenue from local
telephone service.
Selling, general and administrative expenses for 1995 were $1.2 million, an
increase of 108% from $600,000 in 1994. The increase in selling, general and
administrative expenses reflected an increase in personnel and other expenses
resulting from the expansion of local telephone service in 1994.
During 1994, ARC incurred nominal interest. Interest expense was $69,000 in
1995, reflecting borrowings from Trans Global and SISC.
As a result of the foregoing factors, ARC sustained a net loss of $543,000 as
compared with a loss of $144,000 in 1994.
Three Dimensional Products and Services:
This segment is engaged in the business of developing and marketing products and
services in the three dimensional imaging and digitizing technology which the
segment categorizes in three primary market groups: 1) Surfacer imaging
products, 2) Computer Aided Design ("CAD")/Computer Aided Manufacturing ("CAM")
software products and services and 3) laser scanning products. Comparing 1996 to
1995, revenues and gross margins decreased $850,000 or 48% and $146,000 or 22%,
respectively. The primary reason for such decreases is due to the closure of one
of the companies operating in this segment which produced revenues and gross
margins in 1995 of $453,000 and $69,000, respectively. Additionally, in July
1996, this segment significantly reduced its operations in Europe and sold
certain assets resulting in a one time gain of approximately $450,000, which is
included in other income. The decision to close such operations was based on the
fact that such companies operations did not align with the planned future for
this segment and was not producing margins at a level sufficient to cover its
operating costs. Selling, general and administrative expenses from 1996 to 1995
decreased $1,363,000 of which $746,000 relates to the 1995 expense of the closed
company. The remaining decrease is related to the reduction of the European
operations. Included in 1996 expenses is a charge of $192,000 in noncash expense
for the write-off of goodwill that could not be supported by the segment's
current cash flows. The operations of 1994 resulted in revenues of $849,000,
gross margins of $295,000 and selling general and administrative expense of
$1,850,000 which is comparable to 1996 results with the same operating entities.
On an overall basis, the net loss for 1996 was $1,472,000, a decrease of
$813,000 from 1995 and a decrease of $319,000 from 1994. Management currently
anticipates that revenues and operating profits will improve for this segment if
the proper financing can be obtained which would allow this segment to acquire a
European partner to market and expand its existing product lines. However, no
assurances can be made that such financing will be obtained and the ultimate
profitability of this segment is significantly dependent on the success of such
acquisition.
62
<PAGE>
Audio Products Manufacturing
This segment consists of WWR Technology, Inc., ("WWR"), which is engaged in the
business of manufacturing and marketing a professional line of loudspeakers. WWR
was acquired effective March 31, 1995. As such, the operations reported herein
reflect only the results from the date of acquisition through December 31, 1996
and the prior periods are not comparable. During 1996, this segment's revenues,
gross profit and loss from operations were $5,582,000, $470,000 and $752,000,
respectively. During 1996, approximately, 79% of revenues were generated from
domestic customers, approximately 15% of sales were from customers in the Far
East and approximately 6% of sales were from other foreign market customers.
From the date of acquisition through December 31, 1995 revenues, gross margins
and losses from operations were $2,150,000, $202,000 and $492,000, respectively.
From the date of acquisition through December 31, 1995, approximately, 75% of
revenues were generated from domestic customers, approximately 12% of sales were
from customers in the Far East and approximately 13% of sales were from other
foreign market customers.
During the period from the acquisition through December 31, 1995, costs of sales
included $200,000 and excluding such write-off, the gross margin percentage was
19% and during 1996 was 14%. Since the acquisition of this segment, the gross
margins have been less than that required to operate profitably. A significant
cause of the low margins relates to idle plant capacity, an outdated production
machine and a lack of funds to purchase the parts required to build product.
During the fourth quarter of 1996, WWR replaced its existing debt with financing
obtained from an asset based lender, that has allowed the segment to purchase
product for production but not at a level that will allow the segment to
significantly increase production. The fourth quarter financing was from an
asset based lender which bears interest at 12%, plus a fee on advances of 1%. As
of December 31, 1996, WWR has received net advances of $216,000 from the lender.
Management is attempting to obtain financing to purchase a new production
machine which would produce products significantly faster and additionally,
reduce the need to purchase assembly parts from an outside source since the new
production machine would be able to produce such parts on a timely basis. No
assurance can be given that such financing will be obtained.
Selling, general and administrative expenses were $1,221,000 for 1996 and were
$694,000 from the date of acquisition through December 31, 1995. This excess of
expenses over gross profit is a reflection of the volume problem of this
segment. In January management implemented a price increase of approximately 10%
and management believes that this will not have a significant impact on sales
volume due to high product quality and the name recognition of "KLIPSCH
PROFESSIONAL" in the market place. Interest expense for 1996 was $150,000 and
for the period from acquisition to December 31, 1995 was $67,000. The increase
in annual interest expanse id due to the aforementioned asset based financing
that was obtained in 1996.
Management believes that if this segment is able to find an appropriate
financing package, it will be able to significantly increase its revenues and
overall profitability during 1997. However, due to the uncertainties surrounding
the ability of the segment to obtain adequate financing, management is unable to
determine at this time whether the segment will ever be profitable.
Business Consulting Services:
During 1996, 1995 and 1994, revenues and gross margins of the business
consulting operations were not significant which is consistent with management's
decision to concentrate time and resources managing internal operations of the
preexisting and newly acquired companies. Selling, general and administrative
expenses were also not significant for 1996 and 1995 but amounted to $623,000
for 1994 which is a factor of the significant acquisition activity that occurred
during 1994. During 1997, management anticipates that consulting revenues and
related expenses will not be a significant portion of THE Company's operations.
Corporate and Other:
Selling, General and Administrative Expense
Corporate selling, general and administrative expenses decreased by $3,336,000
when comparing 1996 to 1995 and remain level when comparing 1995 to 1994. In
1995 and 1994 selling, general and administrative expenses include noncash
consulting fee expenses incurred upon the issuance of non employee directors and
consultants stock options of $3,869,000 and $4,140,000, respectively, for 1995
and 1994. No such consulting fees were incurred at the holding company level
during 1996. The remaining expenses, which consist primarily of executive and
administrative salaries and benefits, accounting and legal and consulting fees,
remained relatively level with the prior periods. During 1997, it is anticipated
that corporate selling, general and administrative expense levels will be a
factor of the activity of additional acquisitions and capitalization activities
which cannot be quantified on a prospective basis.
63
<PAGE>
Gain (Loss) from Security Sales:
During 1996, the Company realized a gain of $823,000 from sales of securities.
During 1995, losses on investment activity were nominal. For 1994, the loss on
sales of securities consisted primarily of the recognition of investments that
were determined to have a permanent decline in market value and as such, the
decline was recognized in that period. Security sales vary from period to period
based on, among other things, market activity and cash needs, and management
cannot estimate the amount of future security sales gains or losses, if any,
that will be generated from such transactions.
Income Taxes
The Company's provision for income taxes were (4.6%), (1.5%) and (0.2%) of
income before taxes for the years ended December 31, 1996, 1995 and 1994,
respectively. The Company will have a net operating loss carryforward of
approximately $53,891. The net operating loss carryforward expires beginning in
1997 through 2011. Investment tax credit and job tax credit carryforwards of
approximately $105 are available to reduce future income taxes. These credits
expire beginning in various years through 1999. These credits have been reduced
to reflect changes made by the "Tax Reform Act of 1986". See Note 12 To the
Financial Statements.
Minority Interest in Loss of Subsidiaries
For 1996, 1995 and 1994, the minority interest in loss of subsidiaries was
$3,098,000 and $3,724,000, and $132,000, respectively. Changes to the minority
interest in the gain and loss of subsidiaries, other than those changes related
to the inherent differences in the net income and loss of subsidiaries from
period to period, resulted from the minority issuance of stock options and stock
purchase warrants and the initial public offering in the medical information
services segment, the issuance of minority owned stock in the contract
engineering services segment and the sale of 10% of the equity position of the
Company's investments in subsidiaries to the Company's CEO.
Impact of Inflation:
The Company is subject to normal inflationary trends and anticipates that any
increased costs would be passed on to its customers.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data begin on page F-1 of this Form
10-K.
Item 9. Changes and Disagreements with Accountants on Accounting and Financial
Disclosure
None
PART III
Item 10. Directors and Executive Officers of the Registrant
Set forth below is information concerning the executive officers of the
registrant.
Name Age Position
- ---- --- --------
Lewis S. Schiller 67 Chairman of the Board, President,
and Chief Executive Officer
George W. Mahoney 37 Chief Financial Officer
Norman J. Hoskin 63 Director
Grazyna B. Wnuk 34 Secretary
Mr. Schiller is chairman of the board and chief executive officer and a director
of Consolidated and SISC and is chief executive officer and/or chairman of
Consolidated's operating subsidiaries. Mr. Schiller has held such positions for
more than the past five years.
Mr. Mahoney has been chief financial officer of Registrant since October 1994.
From December 1991 until September 1994, Mr. Mahoney was chief financial officer
of IMI and IMI's affiliated entities. Consolidated acquired the assets of IMI
and certain of its affiliated entities during 1994.
64
<PAGE>
Mr. Norman J. Hoskin has been a director of the Company since September 1992. He
is chairman of Atlantic Capital Group, a financial advisory services company, a
position he has held for more than the past five years. He is also chairman of
the board and a director of Tapistron International, Inc., a high tech
manufacturer of carpeting, and is a director of Trans Global Services, Inc., a
subsidiary of the Company. Mr. Hoskin is also a director of Aqua Care Systems,
Inc., a water media filtration and remediation company, and Spintek Gaming,
Inc., a manufacturer of gaming equipment.
Ms. Wnuk has been the secretary of the registrant since 1991.
Officers are elected by, and serve at the pleasure of, the board of directors.
Pursuant to an employment agreement dated October 1, 1994 and superseded by an
agreement dated May 1996, the Company has agreed to employ Mr. Schiller as its
chief executive during the term of the agreement, which continues until December
31, 2000. Pursuant to an employment agreement dated October 1, 1994, which was
amended on March 21, 1995 and again on April 11, 1997, the Company has agreed to
employ Mr. Mahoney as its chief financial officer during the term of the
agreement, which continues until December 31, 2007.
Item 11. Executive Compensation
Set forth below is information concerning the Registrant's chief executive
officer and chief financial officer of the Registrant who are the only executive
officers of the Registrant who received or accrued compensation from the
Registrant and its subsidiaries in excess of $100,000 (on an annualized basis)
during the years ended December 31, 1996, 1995 and 1994.
<TABLE>
<CAPTION>
Annual
Compensation Awards Payouts
------------ ------ -------
Bonus and Securities
Other Restricted Underlying
Compen- Stock Options/ LTIP
Summary Compensation Table Salary sation Awards SARS (#) Payout
------ ------ ------ -------- ------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1996:
Lewis S. Schiller, CEO (1) $286,000 -- -- -- --
========
George W. Mahoney, CFO (2) $189,000 $200,000 -- -- --
======= =======
Year Ended December 31, 1995:
Lewis S. Schiller, CEO (1) $250,000 -- -- -- --
=======
George W. Mahoney, CFO (2) $177,000 $36,000 -- -- --
======= ======
Year Ended December 31, 1994:
Lewis S. Schiller, CEO (1) $199,000 -- -- (3) --
=======
George W. Mahoney, CFO (2) $50,000 -- -- (4) --
======
</TABLE>
(1) - The annual salary payable by the Company to Mr. Schiller pursuant to his
employment agreement with Consolidated was $250,000, subject to a cost of
living increase, prior to September 1, 1996. Effective September 1, 1996,
Mr. Schiller's annual salary from Consolidated was increased to $500,000.
In addition, Mr. Schiller receives incentive compensation from
Consolidated based on the results of Consolidated's operations and has a
right to purchase 10% of Consolidated's or SISC's equity interest in each
of their operating subsidiaries and investments for 110% of Consolidated's
or SISC's cost.
(2) - Mr. George W. Mahoney, chief financial officer of the Company, has an
employment agreement with Consolidated for a term commencing October 1,
1994 and ending December 31, 2007. Mr. Mahoney's annual salary increases
to $189,000 for the current contract year, which ends on December 31, 1997
and increases annually thereafter until the twelfth year for which his
annual salary is $353,000. The agreement also provides for two bonuses to
Mr. Mahoney. One bonus is equal to the greater of 2.5% of Consolidated's
net pre-tax profits or 2.5% of Consolidated's net cash flow, and the other
is equal to the greater of 2.5% of IMI's net pre-tax profits or 2.5% of
IMI's net cash flow. In addition, the Company paid Mr. Mahoney bonuses of
$100,000 and $40,000 in 1996 for services relating to certain of the
Company's loans from DVI pursuant to amendments to his employment
agreement. Mr. Mahoney also receives a $6,000 allowance for an automobile
which may be used for personal as well as business purposes and life
insurance of $1,000,000 on which he may designate the beneficiary.
(3) - Pursuant to a stock purchase plan dated December 15, 1994, Mr. Schiller
received the right to purchase 2,500,000 unregistered shares at the fair
market value on that date ($.50 per share). Mr. Schiller did not exercise
his right to purchase such shares and such rights expired in July 1995.
65
<PAGE>
(4) - Pursuant to a stock purchase plan dated December 15, 1994, Mr. Mahoney
received the right to purchase 750,000 unregistered shares at the fair
market value on that date ($.50 per share). Mr. Mahoney did not exercise
his right to purchase such shares and such rights have expired in July
1995.
No other officers or directors have employment agreements with the Registrant.
No officers or directors hold options to purchase any of the Registrant's common
stock.
Item 12. Security Ownership of Certain Beneficial Owners and Management
No person or group known to the Registrant owns 5% or more of any of the
Registrant's voting securities as of April 9, 1997. However, the chief executive
officer and a director own shares of the Company's Series A preferred stock
which is convertible into common .stock. The following table sets forth, as of
April 9, 1997, the number and percentage of outstanding Series A Preferred Stock
owned by directors and officers of the Registrant and all directors and officers
as a group:
Amount and Nature of Percent of
Name and Address(1) Beneficial Ownership(2) Common Stock
- ------------------- ----------------------- ------------
Lewis S. Schiller 4,480 20%
Norman J. Hoskin 1,280 5%
All officers and directors as a group
(two individuals owning stock) 5,760 25%
The above preferred shares are convertible into a total of 750,000 shares of
common stock which represents 2% of the total outstanding common stock of the
Company.
[1] - The address of each person is c/o Consolidated Technology Group Ltd., 160
Broadway, New York, NY 10038.
[2] - Each person named has the sole voting and sole investment power and has
direct beneficial ownership of the shares.
Item 13. Certain relationships and Related Transactions
Loan Receivable from an Officer of a Subsidiary:
During the year ended December 31, 1996, the Medical Diagnostics segment
subsidiary loaned the chief executive officer of such subsidiary $300,000 with
interest accruing at 5.5% and maturing December 31, 1998. Total principal and
interest amounted to $308,000 as of December 31, 1996. During the year ended
December 31, 1995, the Contract Engineering Services segment subsidiary loaned
$45,000 to the chief executive officer of such subsidiary. The loan has no fixed
due dates or terms.
Loan Receivable from Sale of Common Stock Investments to an Officer:
During 1996 and 1995, the chief executive officer of the Company exercised an
option to purchase common stock investments held by the Company at 110% of the
book value of such investments. The purchase of such investments was consummated
in a noncash transaction and such officer is to issue a note in favor of the
Company with interest at prevailing rates and maturing five years from the date
of the purchase. Total amounts outstanding under such receivable was $356,000
and $72,000, respectively at December 31, 1996 and 1995. Gains realized by the
Company on the sale of these investments to the CEO approximated $22,000 and
$7,000, respectively, for the years ended December 31, 1996 and 1995.
66
<PAGE>
Reverse Acquisition of Lafayette Industries, Inc.:
On December 20, 1996, SIS Capital Corp., a wholly-owned subsidiary of the
Company ("SISC"), entered into an agreement among SISC, DLB, Inc. ("DLB") and
Lafayette Industries, Inc., ("Lafayette"), pursuant to which SISC and DLB
transferred to Lafayette all of the issued and outstanding common stock of SES
Holdings, Corp. ("SESH"), in exchange for a controlling interest in Lafayette.
At the date of the acquisition, SESH was an 80% owned subsidiary of SISC.
Lafayette issued to SISC 1,000 shares of Class A preferred stock which is
convertible at a ratio that will give SISC a 65% ownership of Lafayette's fully
diluted common stock upon stockholder approval of an increase in the authorized
number of common shares of Lafayette. Contemporaneously with the reverse
acquisition, Lafayette issued 1,000 shares of Class B preferred stock which has
a redemption value of $6,750,000. The Series B preferred stock was issued as
payment to SISC for $4,000,000 of subordinated debt due to SISC and in exchange
for the cancellation of $2,750,000 of preferred stock of the underlying entities
of SESH which was held by SISC. The amounts due SISC from SESH and its
subsidiaries as of December 20, 1996, as well as any future advances made by
SISC to SESH or its subsidiaries, are collateralized by a pledge of all of the
stock of SESH's subsidiaries and the 1,060,000 shares of TGS stock that is held
by SISC for the benefit of SESH. Pro forma information on this transaction is
not presented as, at the date of this transaction, the Lafayette was considered
a public shell and, accordingly, the transaction was not considered a business
combination. Lafayette's prior principal business, which was principally the
manufacture and sale of store fixtures, has been discontinued.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
1. Financial Statements
F-1 Report of Moore Stephens, P.C. Independent Certified
Accountants
F-2 & F-3 Consolidated Balance Sheets as of December 31, 1996 and 1995
F-4 Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1995 and 1994
F-5 - F-7 Consolidated Statements of Shareholders' Equity for the
Years Ended December 31, 1996, 1995 and 1994
F-8 - F-10 Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994
F-11 Notes to Consolidated Financial Statements
2. Financial Statement Schedules
None
3. Reports on Form 8-K
On December 20, 1996, the Company filed an 8-K regarding the acquisition of
Lafayette Industries, Inc.
4. Exhibits
3.1 Certificate of Incorporation(1)
3.2 By-laws(1)
10.1 Agreements relating to the acquisition and financing of
International Magnetic Imaging, Inc. and its affiliated
companies.(2)
10.2 Plan and agreement of reorganization dated as of April 13, 1994 by
and among the Registrant, CSM Acquisition Corp., Carte medical
Corporation, Creative Socio-Medics Corp. and Advanced Computer
Techniques, Inc., as amended.(3)
10.3 Employment agreement dated March 21, 1995, between the Registrant
and George W. Mahoney.(6)
10.4 Employment agreement dated October 1, 1994, between the Registrant
and Lewis S. Schiller.(6)
10.5 Agreement dated as of March 31, 1995 among SIS Capital Corp., DLB,
Inc., Joseph G. Sicinski and Concept Technologies Group, Inc.,
including exhibits and disclosure letters.(5)
10.6 Agreement dated December 20, 1996 relating to the acquisition of
Lafayette Industries, Inc.(8)
10.7 Employment agreement dated April 11, 1997, between the Registrant
and George W. Mahoney.
11.1 Calculation of earnings per share
21.1 List of Subsidiaries of Registrant.
27 Financial Data Schedule.(7)
- -------
67
<PAGE>
(1) Filed as an exhibit to the Company's annual report on Form 10-K for the
fiscal year ended July 31, 1994 and incorporated herein by reference.
(2) Included as exhibits to the Registrant's report on Form 8-K, as amended,
dated July 19, 1994, and incorporated herein by reference.
(3) Included as exhibits to the Registrant's report on Form 8-K, as amended,
dated June 16, 1994, and incorporated herein by reference.
(4) Filed as an exhibit to the Company's annual report on Form 10-K for the
year ended December 31, 1995 and incorporated herein by reference.
(5) Filed as exhibit to the Company's report on Form 8-K, dated April 19, 1995,
and incorporated herein by reference.
(6) Filed as an exhibit to the Company's annual report on Form 10-K for the
five month transition period from August 1, 1994 to December 31, 1994.
(7) Filed only to the SEC in electronic format.
(8) Included as exhibits to the Registrant's report on Form 8-K dated December
20, 1996, and incorporated herein by reference.
68
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CONSOLIDATED TECHNOLOGY GROUP, LTD.
Date: April 14, 1997 /S/_____________________
Lewis S. Schiller
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/S/ President and Director April 14, 1997
Lewis S. Schiller (Principal Executive
Officer)
/S/ Chief Financial Officer April 14, 1997
George W. Mahoney (Principal Financial and
Accounting Officer)
/S/ Director April 14, 1997
Norman J. Hoskin
69
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders of
Consolidated Technology Group Ltd,
New York, New York
We have audited the accompanying consolidated balance sheets of
Consolidated Technology Group Ltd. and its subsidiaries as of December 31, 1996
and 1995, and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 1996. 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 consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Consolidated Technology Group Ltd. and its subsidiaries as of December 31, 1996
and 1995, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As shown in the consolidated
financial statements and as discussed in Note 2 to the consolidated financial
statements, the Company has suffered recurring losses from operations has
certain debt in default; and has an accumulated deficit at December 31, 1996 of
approximately $50,000,000. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 2. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
MOORE STEPHENS, P.C.
Certified Public Accountants,
Cranford, New Jersey
April 10, 1997
F-1
<PAGE>
Consolidated Technology Group Ltd. and Subsidiaries
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31, December 31,
1996 1995
---- ----
<S> <C> <C>
Assets:
Current assets:
Cash and cash equivalents $ 3,866,000 $ 1,636,000
Receivables, net of allowances 21,134,000 19,216,000
Inventories 3,138,000 3,701,000
Loans receivable 318,000 397,000
Prepaid expenses and other current assets 643,000 436,000
Excess of accumulated costs over related billings 937,000 1,002,000
Investments in common stock -- 20,000
---------- ----------
Total current assets 30,036,000 26,408,000
---------- ----------
Property, plant and equipment, net 14,421,000 11,034,000
---------- ----------
Other assets:
Capitalized software development costs 251,000 118,000
Goodwill, net 10,553,000 11,881,000
Covenants not to compete, net 886,000 2,168,000
Customer lists, net 10,775,000 11,684,000
Deferred offering costs 589,000 --
Loans receivable, long-term 448,000 219,000
Receivables, related parties 1,381,000 544,000
Trademark, net 368,000 383,000
Investments in common stock 241,000 404,000
Other assets 1,865,000 1,469,000
--------- ---------
Total Other Assets 27,357,000 28,870,000
---------- ----------
Total Assets $71,814,000 $66,312,000
=========== ===========
</TABLE>
See notes to consolidated financial statements
F-2
<PAGE>
Consolidated Technology Group Ltd. and Subsidiaries
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31, December 31,
1996 1995
---- ----
<S> <C> <C>
Liabilities and Shareholders' Equity:
Current liabilities:
Accounts payable and accrued expenses $12,387,000 $11,095,000
Accrued payroll and related expenses 2,731,000 2,332,000
Accrued interest 170,000 284,000
Income taxes payable 738,000 269,000
Interim billings in excess of costs and estimated profits 1,444,000 1,701,000
Notes payable, related parties 985,000 290,000
Current portion of long-term debt 9,641,000 9,080,000
Current portion of subordinated debt 7,193,000 13,354,000
Convertible debentures 700,000 --
Current portion of capitalized lease obligations 1,476,000 1,362,000
--------- ---------
Total current liabilities 37,465,000 39,767,000
---------- ----------
Long-term liabilities:
Deferred interest 568,000 --
Long-term debt 16,467,000 6,210,000
Capitalized lease obligations 2,981,000 2,198,000
Subordinated debt 312,000 5,003,000
------- ---------
Total long-term liabilities 20,328,000 13,411,000
---------- ----------
Minority interest 12,617,000 2,087,000
---------- ---------
Shareholders' equity:
Preferred stock 26,000 70,000
Additional paid-in-capital, preferred stock 92,000 266,000
Common stock (50,000,000 shares authorized, 45,795,828 and
26,655,071 shares issued and outstanding as of December 31,
1996 and 1995, respectively) 458,000 267,000
Additional paid-in-capital, common stock 50,944,000 51,020,000
Accumulated deficit (50,218,000) (40,648,000)
Unrealized gain (loss) on exchange translation 86,000 (17,000)
Net unrealized gain on long-term investments in common stock 16,000 89,000
------ ------
Total shareholders' equity 1,404,000 11,047,000
--------- ----------
Total Liabilities and Shareholders' Equity $71,814,000 $66,312,000
=========== ===========
</TABLE>
See notes to consolidated financial statements
F-3
<PAGE>
Consolidated Technology Group Ltd. and Subsidiaries
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Revenues $114,924,000 $110,097,000 $41,578,000
Direct Costs 92,760,000 89,174,000 35,427,000
---------- ---------- ----------
Gross Profit 22,164,000 20,923,000 6,151,000
Selling, General and Administrative 31,502,000 32,035,000 16,615,000
---------- ---------- ----------
Loss from Operations (9,338,000) (11,112,000) (10,464,000)
----------- ------------ ------------
Other Income (Expense):
Interest expense (4,546,000) (4,084,000) (1,220,000)
Other income, net 954,000 373,000 447,000
Gain (loss) from security sales 823,000 (35,000) (299,000)
------- -------- ---------
Total other expense, net (2,769,000) (3,746,000) (1,072,000)
----------- ----------- -----------
Loss Before Income Taxes and Minority Interest (12,107,000) (14,858,000) (11,536,000)
Income Taxes (561,000) (226,000) (24,000)
Minority Interest in Loss of Subsidiaries 3,098,000 3,724,000 132,000
--------- --------- -------
Net Loss ($9,570,000) ($11,360,000) ($11,428,000)
============ ============= =============
Net loss per common share ($0.23) ($0.51) ($0.80)
======= ======= =======
Weighted average number of common shares 41,639,293 22,423,035 14,205,789
========== ========== ==========
</TABLE>
See notes to consolidated financial statements
F-4
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Consolidated Statement of Shareholders Equity
for the Year Ended December 31, 1996
<TABLE>
<CAPTION>
Stock Issued Equity
Balance Stock in Lieu Recapitali-
at Conversion Issued of Cash for zation from
December 31, of Series A for Services Reverse
1995 Preferred Offerings Rendered Acquisition
---- --------- --------- -------- -----------
<S> <C> <C> <C> <C> <C>
Preferred stock $1.00 par value,
6% Series A, Authorized
77,713 shares:
Shares 66,596 (43,705) -- -- --
Amounts $ 67,000 ($ 44,000) -- -- --
Preferred stock, $1.00 par value,
$3.50 and $.10, Series B and E,
8,000 shares authorized each:
Shares 262 -- -- -- --
Amounts $ 1,000 -- -- -- --
Preferred stock, $1.00 par value,
$8.00 subordinated Series F,
6,000 shares authorized:
Shares 2,700 -- -- -- --
Amounts $ 2,000 -- -- -- --
----------- ------------ ----------- ---------- ----------
Total Preferred stock, par $ 70,000 ($ 44,000) -- -- --
Additional paid-in capital
preferred stock $ 266,000 ($ 174,000) -- -- --
Common stock, $0.01 par value.
50,000,000 shares authorized
Shares 26,655,071 5,690,757 13,250,000 200,000 --
Amounts $ 267,000 $ 57,000 $ 132,000 $ 2,000 --
Additional paid-in capital,
common stock $51,020,000 $ 161,000 $ 780,000 $ 43,000 ($1,060,000)
Accumulated deficit ($40,648,000) -- -- -- --
Unrealized exchange translation ($ 17,000) -- -- -- --
Net unrealized gain on long-term
investments in common stock $ 89,000 -- -- -- --
----------- ---------- ----------- ---------- ------------
Total shareholders' equity $11,047,000 ($ 0) $ 912,000 $ 45,000 ($1,060,000)
=========== ============ =========== ========== ============
(continued)
</TABLE>
See notes to consolidated financial statements.
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Consolidated Statement of Shareholders Equity
for the Year Ended December 31, 1996
<TABLE>
<CAPTION>
Unrealized Net Balance
Gain on Unrealized at
Net Exchange Investment December 31,
Loss Translation Security Gains 1996
---- ----------- -------------- ----
<S> <C> <C> <C> <C>
Preferred stock $1.00 par value,
6% Series A, Authorized
77,713 shares:
Shares -- -- -- 22,891
Amounts -- -- -- $ 23,000
Preferred stock, $1.00 par value,
$3.50 and $.10, Series B and E,
8,000 shares authorized each:
Shares -- -- -- 262
Amounts -- -- -- $ 1,000
Preferred stock, $1.00 par value,
$8.00 subordinated Series F,
6,000 shares authorized:
Shares -- -- -- 2,700
Amounts -- -- -- $ 2,000
----------- --------- --------- ------------
Total Preferred stock, par -- -- -- $ 26,000
Additional paid-in capital
preferred stock -- -- -- $ 92,000
Common stock, $0.01 par value.
50,000,000 shares authorized
Shares -- -- -- 45,795,828
Amounts -- -- -- $ 458,000
Additional paid-in capital,
common stock -- -- -- $ 50,944,000
Accumulated deficit ($9,570,000) -- -- ($ 50,218,000)
Unrealized exchange translation -- $ 103,000 -- $ 86,000
Net unrealized gain on long-term
investments in common stock -- -- ($ 73,000) $ 16,000
----------- --------- ---------- ------------
Total shareholders' equity ($9,570,000) $ 103,000 ($ 73,000) $ 1,404,000
=========== ========= ========== ============
(concluded)
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Consolidated Statement of Shareholders Equity
for the Year Ended December 31, 1995
<TABLE>
<CAPTION>
Stock Issued
Balance Stock in Lieu Stock Issued
at Conversion Issued of Cash for for the
December 31, of Series A for Services Exercise of
1994 Preferred Offerings Rendered Stock Options
---- --------- --------- -------- -------------
<S> <C> <C> <C> <C> <C>
Preferred stock $1.00 par value,
6% Series A, Authorized
77,713 shares:
Shares 77,713 (11,117) -- -- --
Amounts $ 78,000 ($ 11,000) -- -- --
Preferred stock, $1.00 par value,
$3.50 and $.10, Series B and E,
8,000 shares authorized each:
Shares 262 -- -- -- --
Amounts $ 1,000 -- -- -- --
Preferred stock, $1.00 par value,
$8.00 subordinated Series F,
6,000 shares authorized:
Shares 2,700 -- -- -- --
Amounts $ 2,000 -- -- -- --
----------- ------------ ----------- ---------- ----------
Total Preferred stock, par $ 81,000 ($ 11,000) -- -- --
Additional paid-in capital
preferred stock $ 310,000 ($ 44,000) -- -- --
Common stock, $0.01 par value.
50,000,000 shares authorized
Shares 17,577,260 1,447,807 1,000,000 130,004 6,500,000
Amounts $ 176,000 $ 15,000 $ 10,000 $ 1,000 65,000
Additional paid-in capital,
common stock $45,597,000 $ 42,000 $ 240,000 $ 113,000 ($5,028,000)
Accumulated deficit ($29,288,000) -- -- -- --
Unrealized exchange translation ($ 33,000) -- -- -- --
Net unrealized gain on long-term
investments in common stock ($ 139,000) -- -- -- --
----------- ---------- ----------- ---------- ------------
Total shareholders' equity $16,704,000 $ 2,000 $ 250,000 $ 114,000 ($5,093,000)
=========== ========== =========== ========== ============
(continued)
</TABLE>
See notes to consolidated financial statements.
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Consolidated Statement of Shareholders Equity
for the Year Ended December 31, 1995
<TABLE>
<CAPTION>
Net
Unrealized Unrealized Balance
Gain on Investment at
Net Exchange Security December 31,
Loss Translation Gain (Loss) 1995
---- ----------- ----------- ----
<S> <C> <C> <C> <C>
Preferred stock $1.00 par value,
6% Series A, Authorized
77,713 shares:
Shares -- -- -- 66,596
Amounts -- -- -- $ 67,000
Preferred stock, $1.00 par value,
$3.50 and $.10, Series B and E,
8,000 shares authorized each:
Shares -- -- -- 262
Amounts -- -- -- $ 1,000
Preferred stock, $1.00 par value,
$8.00 subordinated Series F,
6,000 shares authorized:
Shares -- -- -- 2,700
Amounts -- -- -- $ 2,000
----------- --------- --------- ------------
Total Preferred stock, par -- -- -- $ 70,000
Additional paid-in capital
preferred stock -- -- -- $ 266,000
Common stock, $0.01 par value.
50,000,000 shares authorized
Shares -- -- -- 26,655,071
Amounts -- -- -- $ 267,000
Additional paid-in capital,
common stock -- -- -- $ 51,020,000
Accumulated deficit ($11,360,000) -- -- ($ 40,648,000)
Unrealized exchange translation -- $ 16,000 -- ($ 17,000)
Net unrealized gain on long-term
investments in common stock -- -- $ 228,000 $ 89,000
------------- --------- -------- ------------
Total shareholders' equity ($11,360,000) $ 16,000 $ 228,000 $ 11,047,000
============= ========= ======== ============
(concluded)
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Consolidated Statement of Shareholders Equity
for the Year Ended December 31, 1994
<TABLE>
<CAPTION>
Stock Issued
Balance Stock Stock in Lieu Stock Issued
at Issued Issued of Cash for for the
December 31, for for Services Exercise of
1993 Acquisitions Offerings Rendered Stock Options
---- ------------ --------- -------- -------------
<S> <C> <C> <C> <C> <C>
Preferred stock $1.00 par value,
6% Series A, Authorized
77,713 shares:
Shares 77,713 -- -- -- --
Amounts $ 78,000 -- -- -- --
Preferred stock, $1.00 par value,
$3.50 and $.10, Series B and E,
8,000 shares authorized each:
Shares 262 -- -- -- --
Amounts $ 1,000 -- -- -- --
Preferred stock, $1.00 par value,
$8.00 subordinated Series F,
6,000 shares authorized:
Shares 2,700 -- -- -- --
Amounts $ 2,000 -- -- -- --
----------- ----------- ----------- ---------- ----------
Total Preferred stock, par $ 81,000 -- -- -- --
Additional paid-in capital
preferred stock $ 310,000 -- -- -- --
Common stock, $0.01 par value.
50,000,000 shares authorized
Shares 5,074,260 5,803,000 3,500,000 200,000 3,000,000
Amounts $ 51,000 $ 58,000 $ 35,000 $ 2,000 30,000
Additional paid-in capital,
common stock $23,384,000 $6,679,000 $ 8,330,000 $ 94,000 $7,110,000
Accumulated deficit ($17,860,000) -- -- -- --
Unrealized exchange translation -- -- -- -- --
Net unrealized gain on long-term
investments in common stock ($ 269,000) -- -- -- --
----------- ---------- ----------- ---------- ----------
Total shareholders' equity $ 5,697,000 $6,737,000 $ 8,365,000 $ 96,000 $7,140,000
=========== ========== =========== ========== ==========
(continued)
</TABLE>
See notes to consolidated financial statements.
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Consolidated Statement of Shareholders Equity
for the Year Ended December 31, 1994
<TABLE>
<CAPTION>
Net
Unrealized Unrealized Balance
Gain on Investment at
Net Exchange Security December 31,
Loss Translation Gain (Loss) 1994
---- ----------- ----------- ----
<S> <C> <C> <C> <C>
Preferred stock $1.00 par value,
6% Series A, Authorized
77,713 shares:
Shares -- -- -- 77,713
Amounts -- -- -- $ 78,000
Preferred stock, $1.00 par value,
$3.50 and $.10, Series B and E,
8,000 shares authorized each:
Shares -- -- -- 262
Amounts -- -- -- $ 1,000
Preferred stock, $1.00 par value,
$8.00 subordinated Series F,
6,000 shares authorized:
Shares -- -- -- 2,700
Amounts -- -- -- $ 2,000
----------- --------- --------- ------------
Total Preferred stock, par -- -- -- $ 81,000
Additional paid-in capital
preferred stock -- -- -- $ 310,000
Common stock, $0.01 par value.
50,000,000 shares authorized
Shares -- -- -- 17,577,260
Amounts -- -- -- $ 176,000
Additional paid-in capital,
common stock -- -- -- $ 45,597,260
Accumulated deficit ($11,428,000) -- -- ($ 29,288,000)
Unrealized exchange translation -- ($ 33,000) -- ($ 33,000)
Net unrealized gain on long-term
investments in common stock -- -- $ 130,000 ($ 139,000)
------------- ----------- --------- --------------
Total shareholders' equity ($11,428,000) ($ 33,000) $ 130,000 $ 16,704,000
============= =========== ========= ============
(concluded)
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE>
Consolidated Technology Group Ltd. and Subsidiaries
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net loss ($9,570,000) ($11,360,000) ($11,428,000)
------------ ------------- -------------
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 6,967,000 7,602,000 2,187,000
Impaired asset write-offs 701,000 -- 338,000
Minority interest in net loss of consolidated subsidiaries (3,098,000) (3,724,000) (132,000)
Bad debt expense 2,588,000 1,223,000 83,000
Loss from equity method investments 264,000 -- --
Noncash expenses paid with the issuance of stock 45,000 114,000 97,000
Noncash expenses paid with the issuance of subsidiaries stock 1,827,000 11,000 --
Noncash expense from issuance of options -- 3,869,000 4,140,000
Noncash expense from subsidiaries issuance of options 3,722,000 2,214,000 --
Write-down of fixed assets to fair value -- -- 225,000
Write-off of loans receivable -- -- 279,000
(Gain) loss from security sales (823,000) 35,000 299,000
Loss on disposal of fixed assets 167,000 60,000 --
Deferred interest 568,000 -- --
Change in assets and liabilities:
(Increase) decrease in assets:
Receivables (4,511,000) (3,301,000) (1,900,000)
Inventories 562,000 577,000 789,000
Prepaid expenses and other current assets (184,000) (10,000) 559,000
Excess of accumulated costs over related billings 65,000 (1,002,000) --
Increase (decrease) in liabilities:
Accounts payable and accrued expenses 90,000 3,667,000 2,263,000
Accrued payroll taxes and related expenses 399,000 558,000 (968,000)
Accrued interest (114,000) 171,000 (532,000)
Income taxes payable 469,000 249,000 (7,000)
Interim billings in excess of costs and estimated profits (256,000) 1,046,000 (89,000)
---------- --------- --------
Total adjustments 9,448,000 13,359,000 7,631,000
--------- ---------- ---------
Net cash provided by (used in) operating activities (122,000) 1,999,000 (3,797,000)
--------- --------- -----------
(continued)
</TABLE>
See notes to consolidated financial statements
F-8
<PAGE>
Consolidated Technology Group Ltd. and Subsidiaries
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C>
Cash Flows from Investing Activities:
Increase in other assets (292,000) (463,000) (532,000)
Capital expenditures (4,920,000) (684,000) (2,150,000)
Proceeds from disposal of fixed assets -- 220,000 --
Capitalized software development costs (279,000) (20,000) (337,000)
Investments in securities (385,000) (7,000) (392,000)
Proceeds from sale of securities 1,244,000 530,000 45,000
Acquisition of a subsidiary -- (983,000) (8,358,000)
Cash of company acquired 1,020,000 504,000 2,422,000
Cash of company sold -- -- (6,000)
Payments for loans made (3,523,000) (3,022,000) (1,493,000)
Collections for repayment of loans made 3,449,000 3,223,000 106,000
--------- --------- -------
Net cash used in investing activities (3,686,000) (702,000) (10,695,000)
----------- --------- ------------
Cash Flows from Financing Activities:
Deferred offering costs (589,000) (129,000) (331,000)
Net advances from asset based lender 165,000 366,000 550,000
Proceeds from issuance of notes payable 19,468,000 1,297,000 7,169,000
Repayment of notes payable (9,267,000) (6,909,000) (2,452,000)
Repayment of subordinated debt (10,852,000) -- --
Payments on capital lease obligations (1,565,000) (1,194,000) (165,000)
Issuance of common stock 912,000 250,000 8,162,000
Subsidiaries issuance of common stock 7,510,000 2,990,000 --
Costs of subsidiaries stock issuance (1,369,000) -- --
Issuance of stock options -- 1,225,000 3,000,000
Subsidiaries issuance of stock options 1,625,000 716,000 --
--------- ------- ---------
Net cash provided by (used in) financing activities 6,038,000 (1,388,000) 15,933,000
--------- ----------- ----------
Net Increase (Decrease) in Cash and Cash Equivalents 2,230,000 (91,000) 1,441,000
Cash and Cash Equivalents at Beginning of Period 1,636,000 1,727,000 286,000
--------- --------- -------
Cash and Cash Equivalents at End of Period $3,866,000 $1,636,000 $1,727,000
========== ========== ==========
Supplemental Disclosures of Cash Flow Information:
Cash paid for:
Interest $4,092,000 $3,912,000 $1,062,000
========== ========== ==========
Income taxes $93,000 $23,000 --
======= =======
(concluded)
</TABLE>
See notes to consolidated financial statements
F-9
<PAGE>
Consolidated Technology Group Ltd. and Subsidiaries
Consolidated Statements of Cash Flows
Supplemental Disclosures of Noncash Investing and Financing Activities:
During the year ended December 31, 1996:
(1) A subsidiary of the Company issued stock options and warrants to purchase
stock and in connection therewith recorded a noncash expense of $3,492,000
which is the amount that the fair market value of the stock exceeded the
exercise price.
(2) Two subsidiaries of the Company issued common stock with a value of
$1,827,000 in lieu of cash payment for services rendered and in connection
therewith recorded a noncash expense for the value of the stock issued.
(3) Pursuant to the terms of his employment agreement, an officer and director
of the Company exercised his option to purchase ten percent of the equity
holdings of the Company. In connection therewith the Company recorded a
receivable of $300,000, the amount of the exercise price.
(4) Purchased equipment under capital lease obligations with a net present
value of $2,363,000.
(5) Pursuant to an acquisition of another entity by one of the Company's
subsidiaries, in a transaction accounted for as a reverse merger, the
subsidiary recorded an excess of liabilities over assets of $1,061,000
resulting in a decrease in additional paid-in capital.
During the year ended December 31, 1995, the Company:
(1) Acquired equipment under capital lease obligations with a net present
value of $817,000.
(2) Recived common stock in lieu of cash payments for notes and accrued
interest receivable with a book value of $217,000.
(3) Pursuant to an acquisition of another entity by one of the Company's
subsidiaries, in a transaction accounted for as a reverse merger:
a) Reduced the Company's equity ownership in such subsidiary which
resulted in an increase in minority interest of $5,811,000.
b) Acquired net assets with a book value of $983,000.
(4) Issued stock options and received exercise proceeds of $1,225,000 and
incurred noncash expenses of $3,869,000.
(5) Issued common stock with a value of $114,000 in lieu of cash payment for
services rendered.
During the year ended December 31, 1994, the Company:
(1) Purchased equipment in the amount of $186,000 and assumed capital lease
obligatons for $137,000 and notes payable for $49,000.
(2) Acquired capitalized software costs in the amount of $150,000 and and
assumed notes payable for the full amount.
(3) Acquired equipment in the amount of $35,000 and assumed notes payable
for the full amount.
(4) Acquired a covenant not-to-compete in the amount of $800,000 and assumed
notes payable for the full amount.
(5) Acquired Creative Socio-Medics and in connection therewith assumed
long-term debt approximating $530,000.
(6) Acquired International Magnetic Imaging and in connection therewith
assumed subordianted notes approximating $19,800,000, long-term debt
approximating $12,000,000 and capital lease obligations approximating
$3,700,000.
(7) Acquired Job Shop Technical Services and Computer Engineering Services and
in connection therewith assumed subordinated debt approximating $1,500,000
and long-term debt approximating $2,600,000 and issued stock with a
discounted value of $900,000.
(8) Incurred $4,140,000 in noncash expense from the issuance and exercise of
3,000,000 options.
See notes to consolidated financial statements
F-10
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(1) Summary of Significant Accounting Policies
Nature of Operations - Consolidated Technology Group, Ltd., (the "Company",
"Consolidated" or the "Registrant") is a publicly held holding company which has
controlling interests, (either directly or indirectly through its wholly owned
subsidiary, SIS Capital Corp., ("SISC")), in its consolidated subsidiaries
operating in eight primary business segments throughout the United States:
(i) Contract Engineering Services consists of Trans Global Services, Inc.,
("TGS"), and its subsidiaries, Avionics-Research Holdings, ("Avionics"), and
Resource Management International, Inc., ("RMI"), which provide engineers,
designers and technical personnel on a temporary basis pursuant to contracts
with major corporations
(ii) Medical Diagnostics consists of a International Magnetic Imaging, Inc.,
("IMI") which performs magnetic resonance imaging and other medical diagnostic
services
(iii) Electro-Mechanical and Electro-Optical Products Manufacturing consists of
Sequential Electronic Systems, Inc., ("SES"), S-Tech, Inc., ("S-Tech"),
Televend, Inc., ("Televend"), and FMX, Corp., (FMX") which are all subsidiaries
of SES Holdings Inc., ("SESH") which is a wholly owned subsidiary of Lafayette
Industries, Inc., which are companies that manufacture and sell products such as
devices that measure distance and velocity, instrumentation devices, debit card
vending machines, prepaid telephone calling cards and finger print
identification products
(iv) Medical Information Services consists of Netsmart Technologies, Inc.,
("Netsmart") and its subsidiary, Creative Socio-Medics, Corp., ("CSM") which are
companies that provide medical information database services, health care
industry related software packages and the SmartCard medical identification
cards and related software program
(v) Telecommunications consists of a ARC Networks, Inc., ("ARC") which, among
other things, installs telephonic network systems and buys and resells local
telephone service
(vi) Three Dimensional Products and Services consists of 3D Holdings
International, Inc., (3D"), and its subsidiaries, 3D Technology, Inc., ("3D
Tech"), 3D Imaging International, Inc., ("3DI"), and Vero International, Inc.,
("Vero"), which are companies that provide three dimensional imaging services
that are used in a variety of applications, such as prototype building and
reverse engineering
(vii) Audio Products Manufacturing consists of WWR Technology, Inc., ("WWR"),
a subsidiary of SESH which manufactures and sells a professional line of
loudspeakers
(viii) Business Consulting Services consists of The Trinity Group, Inc.,
("Trinity") which provides a variety of financial and business related services.
Corporate and Other consists of the operating activities of the holding company
entities, primarily Consolidated and SISC. The percentage of revenues produced
by the various business segments for the years ended December 31, 1996, 1995 and
1994 are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Contract Engineering Services 54% 57% 60%
Medical Diagnostics 27% 25% 15%
Electro-Mechanical and Electro-Optical Products Manufacturing 3% 4% 9%
Medical Information Services 7% 7% 7%
Telecommunications 5% 3% 6%
Three Dimensional Products and Services 1% 1% 2%
Audio Products Manufacturing 3% 2% --
Business Consulting Services -- 1% 1%
</TABLE>
For a complete discussion of the Company's business segments, see Footnote 15,
"Industry Segments".
F-11
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Principles of Consolidation - The accompanying consolidated financial statements
include the accounts of the Company and all of its majority-owned and voting
controlled subsidiaries. Investments in 20% to 50% owned companies in which the
Company does not have voting control are accounted for on the equity method. All
significant intercompany balances and transactions have been eliminated.
Accounting Period - Effective December 31, 1994, the Company changed to a
calendar year. Prior to 1994 the Company utilized a fiscal year ending July 31
of each year. The accompanying financial statements include balance sheets for
the year ended December 31, 1996 and 1995 and statements of operations, cash
flows and changes in stockholder's equity for the years ended December 31, 1996,
1995 and 1994
Cash and Cash Equivalents - The Company considers all highly liquid instruments
purchased with a maturity of three months or less to be cash equivalents.
International Magnetic Imaging, Inc. ("IMI"), a wholly owned subsidiary of the
Company, has cash balances of $1,539,000 and $1,411,000 at December 31, 1996 and
1995, respectively, which represents 40% and 86% of total cash for the same
respective periods. The use of IMI's cash is restricted pursuant to an IMI
financing agreement with its principle lender, whereby IMI may not make payments
out of the ordinary course of IMI operations and specifically, not to the parent
company, (Consolidated), or any subsidiary or affiliate.
Inventories - Inventories are valued at the lower of cost or market. Cost is
determined by the first-in, first out method with the exception of the Audio
Products Manufacturing segment which values inventory at standard cost which
approximates first-in, first out. Costs accumulated under government contracts
are net of progress payments.
Property, Plant and Equipment - Property, plant and equipment are carried at
cost less allowances for accumulated depreciation. The cost of furniture and
equipment held under capital leases is equal to the lower of the net present
value of the minimum lease payments or the fair value of the leased property at
the inception of the lease. Depreciation is computed generally by the
straight-line method at rates adequate to allocate the cost of applicable assets
over their expected useful lives which ranges from 5-7 years for furnitures and
fixtures, 6 years for medical equipment, 5-10 years for tooling and dies and
machinery and equipment, 5 years for vehicles and 25 years for buildings.
Leasehold improvements are amortized over periods not in excess of applicable
lease terms. Amortization of capitalized leases and leasehold improvements is
included with depreciation expense.
Research and Development - The Company's research and product development
activities are conducted by the Electro-Mechanical and Electro-Optical Products
Manufacturing, Medical Information Services, Audio Products Manufacturing and
Three Dimensional Products and Services segments. The Company's research and
development expenses for the years ended December 31, 1996, 1995 and 1994
approximated $276,000, $893,000 and $4,842,000, respectively. All of the
Company's research and development activities were performed by the subsidiaries
and were company financed. Research and development costs are expensed as
incurred.
Intangible Assets - Intangible assets consist of capitalized software
development costs, goodwill, covenants not to compete, customer lists and
trademarks. The Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", in
March of 1995. SFAS 121 established accounting standards for the impairment of
long-lived assets, certain identifiable intangibles, and goodwill related to
those assets to be held and used, and for long-lived assets and certain
identifiable intangibles to be disposed of. SFAS No. 121 became effective for
financial statements issued for fiscal years beginning after December 15, 1995.
Capitalized Software Development Costs - Capitalization of computer software
development costs begins upon the establishment of technological feasibility.
Technological feasibility for the Company's computer software products is
generally based upon achievement of a detail program design free of high risk
development issues. The establishment of technological feasibility and the
ongoing assessment of recoverability of capitalized computer software
development costs requires considerable judgment by management with respect to
certain external factors, including, but not limited to, technological
feasibility, anticipated future gross revenues, estimated economic life and
changes in software and hardware technology. Amortization of capitalized
software development costs commences when the related products become available
for general release to customers. Amortization is provided on a product by
product basis using the straight-line method over the estimated economic life of
the product, estimated to be approximately 2-5 years. Research and development
costs incurred to establish technological feasibility are expensed as incurred.
F-12
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Goodwill - Goodwill represents the excess of the cost of companies acquired over
the fair value of their net assets at dates of acquisition and is being
amortized over a twenty year period on the straight-line method. Management of
the Company evaluates the period of goodwill amortization to determine whether
latter events and circumstances warrant revised estimates of useful lives. This
evaluation is done, on the subsidiary level, by comparing the carrying value of
goodwill to the value of projected net cash flows from related operations.
Impairment is recognized if the carrying value of goodwill is greater than the
projected discounted cash flows from related operations. IMI accounts for $9.7
million, or 92%, of the goodwill and is able to support this level of goodwill
based on the cash flow of this subsidiary.
Covenants Not to Compete - The capitalized value of covenants not to compete are
being amortized on the straight-line basis over their contractual lives which
range from three to five years.
Customer Lists - Customer lists are being amortized over twelve to fifteen years
on the straight-line basis.
Trademark - The trademark, which was acquired as a part of a reverse merger in
May 1995, relates to the Audio Products Manufacturing segment and has a cost
basis which represents the net present value of the payments for such trademark
at the time it was acquired. This trademark gives the Company a nonexclusive
trademark license to use the "KlipschTM" name for the production and sale of
various professional loudspeaker products. The Klipsch name and related speakers
were developed in the 1940's and is an established name as a leader in
loudspeaker design and innovation. The Company believes that the acquisition of
the KlipschTM trademark gives the Company one of the most long-established and
recognizable brand names in the industry. The trademark is being amortized over
25 years on a straight line basis.
Impairment - Certain long-term assets of the Company including the above
described intangible assets, are reviewed on a quarterly basis as to whether
their carrying value has become impaired, pursuant to guidance established in
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed."
Management considers assets to be impaired if the carrying value exceeds the
future projected net cash flows from related operations. If impairment is deemed
to exist, the assets will be written-down to fair value or projected net cash
flows from related operations. Management also re-evaluates the periods of
amortization to determine whether subsequent events and circumstances warrant
revised estimates of useful lives. Impairment and the method of projecting net
cash flows (discounted or undiscounted) is determined at the subsidiary
level. Based on this evaluation, as of December 31, 1996, the balances as
reported in the accompanying balance sheet are expected to be fully recoverable.
During the year ended December 31, 1996, the Company wrote-off impaired goodwill
of $701,000 of which $509,000 related to the telecommunications segment and
$192,000 related to the three dimensional products and services segment.
Deferred Offering Costs - Deferred offering costs represent amounts paid or
accrued for costs associated with anticipated public offerings for three of the
Company's a subsidiaries. During 1996, deferred offering costs amounted to
$322,000, $151,000 and $116,000, respectively, in the medical diagnostics,
contract engineering services and three dimensional products and services
segments. Additionally, during 1996, the medical information services segment
completed a public offering in which offering costs of $1,370,000 were incurred
and offset against the total gross proceeds of the offering. During 1995 and
1994 the medical information services segment incurred deferred offering costs
of $129,000 and $331,000, respectively, and such amounts would have been
recorded as a reduction of the net proceeds of the anticipated offering,
however; the total accumulated amount of such costs of $460,000 was expensed
during the year ended December 31, 1995 since the offering was not consummated.
Investments in Common Stock -The Company adopted Statement of Financial
Accounting Standards ("SFAS") 115 "Accounting for Certain Investments in Debt
and Equity Securities", in 1994. SFAS 115 requires certain investments that have
readily determinable fair values to be categorized as either trading,
available-for-sale, or held-to-maturity. All of the Company's equity investments
in common stock are categorized as available-for-sale and are recorded at fair
value with unrealized gains and losses recorded as a separate component of
stockholders' equity. Additionally, available-for-sale investments that are
deemed to be permanently impaired are written down to fair market value and such
write down is charged to earnings as a realized loss. The adoption of this
standard has not impacted the Company's financial statements since previous
unrealized losses on such investments were already reflected as a separate
component of stockholders' equity.
Minority Interest - For consolidated subsidiaries that are not wholly owned, the
Company eliminates the minority interest portion of the related profits and
losses. The allocable losses of such minority interests is in excess of the
Company's investment in such subsidiaries by approximately $1,649,000 and
$1,132,000, respectively, at December 31, 1996 and 1995.
F-13
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Revenue Recognition - Revenue for the service sector is recognized as services
are provided. Revenue from the manufacturing sector is recognized primarily
under fixed price type contracts and are accounted for under the unit of
delivery method. Anticipated losses on contracts in progress are charged to
operations as soon as losses can be determined. Revenues from fixed price
software development contracts and revenue under license agreements which
require significant modification of the software package to the customer's
specification, are recognized on the estimated percentage-of-completion method.
Revisions in cost estimates and recognition of losses on these contracts are
reflected in the accounting period in which the facts become known. Revenue from
the software package license agreements without significant vendor obligations
is recognized upon delivery of the software. Information processing revenues are
recognized in the period in which the service is provided. Net patient service
revenues are reported at the estimated net realizable amounts from patients,
third-party payers, and others for services rendered, including provisions for
estimated contractual adjustments under reimbursement agreements with
third-party payers. The Medical Diagnostic Segment has historically not provided
any significant amount of charity care. Maintenance contract revenue is
recognized on a straight-line basis over the life of the respective contract.
Software development revenues from time-and-materials contracts are recognized
as services are performed.
Contract terms which provide for billing schedules that differ from revenue
recognition give rise to costs and estimated profits in excess of billings and
billings in excess of costs and estimated profits. Costs, estimated profits, and
billings on uncompleted contracts are summarized as follows:
December 31,
------------
1996 1995
---- ----
Costs Incurred on Uncompleted Contracts $3,490,000 $2,697,000
Estimated Profits 653,000 490,000
Less Billings to Date (4,650,000) (3,886,000)
--------- --------
Net ($ 507,000) ($ 699,000)
========== ==========
Included in the accompanying balance sheet
under the following captions:
Excess of accumulated costs over related
billings $ 937,000 $1,002,000
Interim billings in excess of costs and
estimated profits (1,444,000) (1,701,000)
--------- ---------
Net ($ 507,000) ($ 699,000)
========== ==========
Loss Per Share - Earnings (loss) per share are computed by dividing the net
income (loss) for the year by the weighted average number of common shares
outstanding. For purposes of computing weighted average number of common shares
outstanding the Company has common stock equivalents consisting of stock options
and warrants and Series "A" Preferred Convertible Stock. The Series "A"
Preferred Stock was deemed to be a common stock equivalent when issued. The
common stock equivalents are assumed converted to common stock, when dilutive.
During periods of operations in which losses were incurred, common stock
equivalents were excluded from the weighted average number of common shares
outstanding because their inclusion would be anti-dilutive.
Fair Value of Financial Instruments - Generally accepted accounting principles
require disclosing the fair value of financial instruments to the extent
practicable for financial instruments which are recognized or unrecognized in
the balance sheet. The fair value of the financial instruments disclosed herein
is not necessarily representative of the amount that could be realized or
settled, nor does the fair value amount consider the tax consequences of
realization or settlement. In assessing the fair value of these financial
instruments, the Company used a variety of methods and assumptions, which were
based on estimates of market conditions and risks existing at that time. For
certain instruments, including cash and cash equivalents, trade receivables and
trade payables and officer advances, it was estimated that the carrying amount
approximated fair value for the majority of these instruments because of their
short maturities. For long-term investment in marketable securities, fair value
is estimated based on current quoted market price. Management estimates that the
fair value of its long-term obligations are as follows:
<TABLE>
<CAPTION>
Carrying Amount Fair Value
December 31, December 31,
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Current Portion of Subordinated Debt $7,193,000 $13,354,000 $6,583,000 $13,354,000
Long-term Debt 16,467,000 6,210,000 16,324,000 6,026,000
Convertible Debentures 700,000 -- 700,000 --
Subordinated Debt 312,000 5,003,000 266,000 4,312,000
------- --------- ------- ---------
Total $24,672,000 $24,567,000 $23,873,000 $23,692,000
========== ========== ========== ==========
</TABLE>
F-14
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Concentration of Credit Risk - Financial instruments which potentially subject
the Company to concentrations of credit risk are cash and cash equivalents and
accounts receivable arising from normal business activities. The Company
routinely assesses the financial strength of its customers and based upon
factors surrounding the credit risk of its customers, establishes an allowance
for uncollectible accounts, and as a consequence, believes that its accounts
receivable credit risk exposure beyond such allowances is limited. The Company
does not require collateral from its customers. The Company places its cash and
cash equivalents with high credit quality financial institutions. The amount on
deposit in any one institution that exceeds federally insured limits is subject
to credit risk. As of December 31, 1996 and 1995, the Company had cash balances
in excess of federally insured limits of approximately $1,784,000 and $602,000,
respectively. For the year ended December 31, 1996, significant customers are as
follows: (1) three customers represented $16,000,000, $13,000,000 and
$9,000,000, respectively of sales in the contract engineering services segment,
and; (2) the medical information services segment received 31%, or $2,647,000 of
its revenue from contracts with government agencies and $1,879,000 from one
customer.
Stock Options and Similar Equity Instruments - On January 1, 1996, the Company
adopted the disclosure requirements of Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock Based Compensation," for stock
options and similar equity instruments (collectively "Options") issued to
employees, however, the Company will continue to apply the intrinsic value based
method of accounting for options issued to employees prescribed by Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees" rather than the fair value based method of accounting prescribed by
SFAS No. 123. SFAS No. 123 also applies to transactions in which an entity
issues its equity instruments to acquire goods or services from non-employees.
Those transactions must be accounted for based on the fair value of the
consideration received or the fair value of the equity instruments issued,
whichever is more reliably measurable.
Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Reclassifications - Certain year ended December 31, 1995 and 1994 items have
been reclassified to conform to the December 31, 1996 presentation.
(2) Going Concern
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As shown in the financial
statements, the Company incurred a net loss of $9,570,000 for the year ended
December 31, 1996, has an accumulated deficit to that date of $50,218,000 and as
of December 31, 1996 and $7,227,000 of debt that is in default. These conditions
raise substantial doubt about the Company's ability to continue as a going
concern. The ability of the Company to continue as a going concern is dependent
upon the success of the Company's subsidiary's marketing efforts and their
efforts to obtain sufficient funding to enable them to continue operations.
Management's plan is to continue efforts to raise capital through initial public
offerings of the underlying subsidiary's equity and to manage them to profitable
levels once adequate funding is in place. There can be no assurances that
management's plans to raise additional capital and to manage the subsidiaries to
profitable levels will be successful. The failure of the subsidiaries to raise
capital by equity offerings of their stock may force the Company to reduce
operations via the closure of certain segments of operations and could
ultimately force the Company as a whole to cease operations. The financial
statements do not include any adjustments relating to the recoverability and
classification of recorded assets, or the amounts and classifications of
liabilities that might be necessary in the event the Company cannot continue in
existence.
F-15
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(3) Receivables, Net of Allowances
December 31,
------------
1996 1995
---- ----
Receivables $23,146,000 $22,433,000
Less: Allowance for bad debts (2,012,000) (3,217,000)
--------- ---------
Receivable, net of allowances $21,134,000 $19,216,000
========== ==========
The contract engineering services, the medical information services, the audio
products manufacturing and the telecommunications segments all finance a
significant portion of their receivables with asset based lenders under
agreements which are renewable annually and have a maximum availability of funds
of $8,000,000. Funds can be advanced in an amount ranging from 75% to 85% of
eligible receivables, with the lender having the right to reserve a portion of
the outstanding and unpaid receivables financed. The effective interest rate on
such financing agreements as of December 31, 1996 was 10.25% for the contract
engineering services and telecommunications segments, 18% for the medical
information services segment and 12% for the audio products manufacturing
segment. Additionally, the agreements require fees that range from 0.3% to 1% of
the receivables financed. The lenders have security interests in all accounts
receivables, contract rights, personal property, fixtures and inventory of the
related segments. At December 31, 1996 and 1995 the total amount of outstanding
advances from asset based lenders was $4,550,000 and $4,386,000, respectively.
The medical diagnostics segment has a revolving loan that has a borrowing
ceiling of $6,000,000 and bears interest at prime plus 2.75%. Net borrowings on
the revolving loan as of December 31, 1996 was $4,715,000 and substantially all
of the segment's accounts receivable are pledged as collateral.
The changes in the allowance for bad debts are as follows:
December 31,
------------
1996 1995
---- ----
Balance at beginning period $3,217,000 $2,850,000
Provision for the period 2,588,000 1,223,000
Recoveries 221,000 256,000
Write-offs for the period (4,014,000) (1,112,000)
--------- ---------
Balance at end of period $2,012,000 $3,217,000
========= =========
(4) - Inventories
December 31,
------------
1996 1995
---- ----
Finished Goods $ 69,000 $ 98,000
Work-in-Process 1,663,000 1,336,000
Raw Materials and Parts 2,187,000 2,617,000
--------- ---------
3,919,000 4,051,000
Less: Allowance for Obsolescence (781,000) (350,000)
Inventories, Net of Allowance for Obsolescence $3,138,000 $3,701,000
========= =========
The work-in-process represents accumulated costs of raw materials, direct labor
and factory overhead expenses on current work orders. Finished goods represent
computer software inventory purchased for resale. During the years ended
December 31, 1996,1995 and 1994 approximately $381,000, $470,000 and $307,000 of
inventory was written-off due to obsolescence.
(5) Loans Receivable
December 31,
------------
1996 1995
---- ----
Assignment of Mortgage Loan $ 497,000 --
Fingermatrix 217,000 $ 621,000
Other 222,000 170,000
------- -------
936,000 791,000
Less: Allowance for doubtful accounts (170,000) (175,000)
------- --------
Loans Receivable, Net 766,000 616,000
Long-term portion 448,000 219,000
------- -------
Current portion $ 318,000 $ 397,000
======= =======
F-16
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Assignment of Mortgage Loan - In December 1996, Lafayette Industries, Inc., a
subsidiary of the Company, accepted assignment of a purchase mortgage loan. The
loan bears interest at prime plus 2% and matures on May 1, 2002.
Fingermatrix was in Chapter 11 pursuant to a petition filed on September 11,
1993 and whose plan was confirmed in March of 1995. The bankruptcy court has
classified the Company as having a first security in the assets of the debtor.
On March 31, 1995, Fingermatrix emerged out of bankruptcy and the Company
received its first payment of $250,000 on its secured debt and its initial
payment of $2,000 on its unsecured debt. The Company received 150,000 common
shares and 250,000 warrants equaling less than 5% of the emerging debtor upon
confirmation. The common shares and warrants received were recorded at $240,000
which was the book value of the receivable and the related accrued interest
exchanged for the receipt of such common stock and warrants. The allowance for
doubtful accounts relates to notes receivable other than the Fingermatrix loan.
(6) Receivables from Related Parties
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<S> <C> <C>
Universal International, an unconsolidated affiliate - Loan consists
of cash advances and has no fixed due dates or terms. $ 587,000 $ 427,000
Loan to the president of IMI, including interest of $8,000,
calculated at 5.5% per annum, due in 1998. 308,000 45,000
Loan to the president of TGS, loan has no interest or repayment terms. 45,000 --
Receivable from the chief executive officer of Consolidated with
interest at 9%, payable quarterly and matures in the year 2000 356,000 72,000
Advances to Director of Lafayette Industries, Inc. which is to
be repaid in 1997 85,000 --
------ ------
Receivables, Related Parties $1,381,000 $ 544,000
========= =======
</TABLE>
F-17
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(7) Investments in Common Stock
December 31,
------------
1996 1995
---- ----
Cost basis $ 225,000 $ 335,000
Net unrealized gain (loss) included as a separate
component of shareholders' equity 16,000 89,000
------ ------
Market Value 241,000 424,000
Current portion -- 20,000
------- ------
Long-term portion $ 241,000 $ 404,000
======= =======
Change in the Net Unrealized gain on long-term
investments in common stock:
Balance at Beginning of Period $ 89,000 ($ 139,000)
Adjust Investments to fair Market Value 250,000 172,000
Realization of Previously Unrealized (Gain) Loss (323,000) 56,000
--------- ------
Balance at End of Period $ 16,000 $ 89,000
========= ========
For purposes of determining gain or (loss) on the sale of securities, the cost
is based on the average cost of all shares of each such security held at the
date of sale. Gain (Loss) on security sales is calculated as follows:
Year Ended December 31,
1996 1995 1994
---- ---- ----
Proceeds from Security Sales $1,244,000 $ 530,000 $ 45,000
Cost of Securities Sold 421,000 565,000 344,000
------- ------- -------
Gain (Loss) on Security Sales $ 823,000 ($ 35,000) ($ 299,000)
========= ======== ========
(8) Property, Plant and Equipment
December 31,
------------
1996 1995
---- ----
Land $ 664,000 $ 664,000
Buildings 3,467,000 3,242,000
Medical Equipment 17,489,000 14,590,000
Machinery and Equipment 2,536,000 2,019,000
Tools and Dies 654,000 601,000
Furniture and Equipment 3,638,000 4,097,000
Vehicles 25,000 25,000
Leasehold Improvements 2,034,000 1,504,000
--------- ---------
30,507,000 26,742,000
Less: Accumulated Depreciation (19,610,000) (18,110,000)
---------- ----------
10,897,000 8,632,000
---------- ---------
Equipment Held Under Capital Lease 9,163,000 6,843,000
Less: Accumulated Depreciation (5,639,000) (4,441,000)
--------- ---------
3,524,000 2,402,000
--------- ---------
Property, Plant and Equipment, Net $14,421,000 $11,034,000
========== ==========
Depreciation expense charged to operations was $3,729,000, $3,472,000 and
$952,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
F-18
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(9) Intangible Assets
December 31,
------------
1996 1995
---- ----
Capitalized Software Development Costs $1,242,000 $963,000
Less: Accumulated Amortization ( 991,000) (845,000)
---------- -------
Capitalized Software Development Costs, Net $ 251,000 $118,000
========== =======
Goodwill $12,199,000 $12,901,000
Less: Accumulated Amortization ( 1,646,000) ( 1,020,000)
----------- -----------
Goodwill, Net $10,553,000 $11,881,000
========== ==========
Covenants Not to Compete $3,954,000 $3,954,000
Less: Accumulated Amortization (3,068,000) (1,786,000)
--------- ---------
Covenants Not to Compete, Net $ 886,000 $2,168,000
========== =========
Customer Lists $13,046,000 $13,046,000
Less: Accumulated Amortization ( 2,271,000) ( 1,362,000)
----------- -----------
Customer Lists, net $10,775,000 $11,684,000
========== ==========
Trademark $429,000 $429,000
Less: Accumulated Amortization ( 61,000) ( 46,000)
-------- --------
Trademark, Net $368,000 $383,000
======= =======
Amortization expense charged to operations was $3,238,000 $4,130,000 and
$1,235,000 for the years ended December 31, 1996, 1995 and 1994. During the
years ended December 31, 1996 and 1994 the Company wrote-off approximately
$701,000 and $338,000, respectively, of goodwill cost for subsidiaries where it
was deemed to be impaired.
F-19
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(10) Debt
<TABLE>
<CAPTION>
December 31,
------------
Long-term Debt: 1996 1995
---- ----
<S> <C> <C>
Bank and installment loans - with interest rates ranging from 6%
12.5%, and collateralized by certain assets and stock of subsidiaries
of the Company, $467,000 currently in default, $2,939,000 is due in
1997 and the remainder is due is due through 2001. Included in bank
and installment loans is a note payable of $458,000 which is guaranteed
by a subsidiary of Lafayette. The note agreement includes covenants
which include among others, covenants restricting dividend payments
and requiring a stated net worth. At December 31, 1996, Lafayette was
in default with a negative covenant preventing mergers with outside
parties and a covenant requiring consolidated net worth in excess of
$1,000,000. Additionally, Lafayette failed to make a required payment
in the first quarter of 1997. Due to the above defaults, the interest
on such note is increased by 3% per annum (effective rate of 13.25%) $ 9,058,000 $ 6,134,000
Revolving loan due in 1998 with interest at prime plus 2.75% 4,715,000 --
Former stockholders of an acquired subsidiary that bears interest at 7%
repayment is deferred until the settlement of a claim that was made
against the Company prior to the acquisition by Consolidated 138,000 138,000
Equipment loans - payable in various monthly installments at interest
rates ranging from 7.75% to 11.5%, collateralized by the related
equipment, due through 2000, $135,000 is currently in default 5,743,000 1,629,000
Building mortgages - payable in various monthly installments at interest
rates ranging from 9.25% to 9.75% due through September 2000,
collateralized by the related buildings 1,237,000 1,711,000
Investor loans bear interest at 13.5% as of December 31, 1996. During
1995 and 1996 certain payments were not made timely and the
loan is in technical default. The note agreement includes covenants
which include, among other covenants, restrictions on dividend payments
and borrowings of additional debt 325,000 825,000
Loans payable to asset based lenders collateralized by accounts
receivables, personal property, fixtures and inventory. Advances
are made based on a percentage of eligible receivables. Fees on
advances range from 0.3% to 1% and interest rates range from prime
plus 2.75% to 18% 4,692,000 4,386,000
Note payable - covenants not-to-compete, payable in monthly installments
of $22,000. The notes are noninterest bearing and mature September 1997 200,000 467,000
------- -------
Total Long-term Debt 26,108,000 15,290,000
Current Portion 9,641,000 9,080,000
--------- ---------
Long-term Portion $16,467,000 $ 6,210,000
========== =========
</TABLE>
F-20
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
------------
Notes Payable, Related Parties: 1996 1995
---- ----
<S> <C> <C>
Notes payable to stockholders of 3D Technology f or cash received and
office equipment contributed by these stockholders in 1992. The
loans are noninterest bearing and have no fixed due date $ 183,000 $ 183,000
Note payable to an employee of 3D Technology for cash advances with 112,000 107,000
interest at 9%.
Advances to Lafayette made by two directors of Lafayette. The
advances are noninterest bearing and have no fixed due dates 690,000 --
------- -------
Total notes payable, related parties $ 985,000 $ 290,000
======= =======
</TABLE>
F-21
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
------------
Subordinated Debt: 1996 1995
---- ----
<S> <C> <C>
Subordinated notes payable issued in connection with acquisitions, payable
in various quarterly installments at interest rates ranging from 4% to
7%. The notes are unsecured and required balloon payments of $2,808,000
in 2001, $3,504,000 in 1997 and $1,193,000 in 1996. Certain timely
payments of principle and interest have interest have not been made
on these loans and the holders have a right to a right to declare a
default as such $6,300,000 is included in current debt $ 7,505,000 $17,657,000
Internal Revenue Service for payment of taxes that were due at the
time the Company purchased a subsidiary, paid in full in 1996 -- 700,000
---------- -------
Total Subordinated Debt 7,505,000 18,357,000
Current Portion 7,193,000 13,354,000
--------- ----------
Long-term Portion $ 312,000 $ 5,003,000
======= =========
Subsidiary's Convertible Debentures are due in 1998 and bear interest
at 8.5% and are currently in default and classified as current. $700,000 --
=======
Total Notes Payable Related Parties, Long-term Debt, Subordinated Debt
and Convertible Debentures $35,298,000 $33,937,000
========== ==========
</TABLE>
Five Year Maturities are as follows as of December 31, 1996:
1997 $18,519,000
1998 8,757,000
1999 3,754,000
2000 2,297,000
2001 1,359,000
Thereafter 612,000
-------
Total $35,298,000
==========
F-22
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(11) Lease Obligations
Capitalized Lease Obligations - The Company leases equipment under noncancelable
capital leases. For some of the leases, a balloon payment representing the
buyout of the leased equipment is due at the end of the lease term. Capitalized
lease obligations are collateralized by leased equipment which has a net book
value of $3,524,000 at December 31, 1996.
Future minimum payments under capital lease obligations are as follows at
December 31, 1996:
1997 $1,861,000
1998 1,541,000
1999 851,000
2000 474,000
2001 309,000
Thereafter 392,000
-------
Total Minimum Lease Payments 5,428,000
Portion Representing Interest ( 971,000)
----------
Present Value of Net minimum payments 4,457,000
Current Portion 1,476,000
---------
Long-term Portion $2,981,000
=========
Operating Lease Obligations - The Company leases real estate for certain of its
operational and administrative facilities under noncancelable operating leases
expiring during the next fifteen years. The real estate leases contain clauses
which permit adjustments of lease payments based upon changes in the "Consumer
Price Index", options to renew the leases for periods up to an additional
fifteen years and additional payments for a proportionate share of real estate
taxes and common area operating expenses. The Company's present executive
offices are located at 160 Broadway, New York, New York 10038, which it occupies
pursuant to a lease expiring February 28, 1999. The current base rent for such
premises is $7,000 per month. The Company's subsidiaries occupy various
facilities pursuant to leases expiring through 2001 The current base rent for
such premises approximates $128,000 month.
Minimum future rental payments under noncancelable operating leases having a
remaining term in excess of one year are as follows:
1997 $1,275,000
1998 1,234,000
1999 915,000
2000 463,000
2001 256,000
Thereafter 482,000
-------
Total $4,625,000
=========
Rent expense for the years ended December 31, 1996, 1995 and 1994 approximated
$1,629,000, $1,560,000 and $569,000, respectively.
F-23
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(12) Income Taxes
Under SFAS No. 109 "Accounting for Income Taxes", deferred income taxes reflect
the net tax effects of (a) temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and the amounts used for
income tax purposes, and (b) operating loss and tax credit carryforwards. The
tax effects of significant items composing the Company's net deferred tax
liability as of December 31, 1996 and 1995 are as follows:
December 31,
1996 1995
---- ----
Deferred Tax Liabilities:
Book Basis of Assets in Excess of Tax Basis -- $50,000
Marketable Securities $199,000 --
------- ------
199,000 50,000
------- ------
Deferred Tax Assets:
Reserves and Allowances 1,114,000 1,527,000
Tax Basis of Assets in Excess of Book Basis 1,311,000 --
Stock Based Compensation 1,668,000 --
Federal Net Operating Loss Carryforward 18,323,000 13,758,000
State Net Operating Loss Carryforward 5,120,000 4,418,000
--------- ---------
27,536,000 19,703,000
---------- ----------
Valuation Allowance $27,337,000 $19,653,000
---------- ----------
Net Deferred Tax Asset -- --
========== ==========
The Company's deferred tax asset valuation allowance was $27,337,000 and
19,653,000 as of December 31, 1996 and 1995, respectively. The increase in the
valuation allowance of $7,684,000 for the year ended December 31, 1996 is
comprised of the following:
Marketable Securities ($ 199,000)
Tax Basis of Assets in Excess of Book Basis 1,361,000
Reserves and Allowances (413,000)
Stock Based Compensation 1,668,000
Federal Net Operating Loss Carryforward 4,565,000
State Net Operating Loss Carryforward 702,000
-------
Total Increase $7,684,000
=========
The current and deferred income tax components of the provision (benefit) for
income taxes consist of the following:
December 31,
1996 1995 1994
---- ---- ----
Current:
Federal -- -- --
State $561,000 $143,000 $19,000
Puerto Rico -- 83,000 5,000
------- ------ -----
561,000 226,000 24,000
Deferred -- -- --
------- ------- ------
Total $561,000 $226,000 $24,000
======= ======= ======
F-24
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The provision for income taxes varies from the amount computed by applying the
statutory rate for the reasons below:
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Provision Based in Statutory Rate 35.0 35.0% 35.0%
Benefit of Graduated Rates ( 1.0) (1.0%) (1.0%)
Other Income Taxes (Net of Federal Benefit) -- (0.6%) --
State Taxes (Net of Federal Benefit) (4.6) (0.9%) (0.2%)
Valuation Allowance (34.0) (34.0%) (34.0%)
Net Operating Loss n/a n/a n/a
--- --- ---
(4.6%) (1.5%) (0.2%)
=== === ===
</TABLE>
The Company's provision for income taxes is comprised of state income taxes for
the year ended December 31, 1996 and state and Puerto Rico income taxes for the
years ended 1995 and 1994. The Company will have a federal net operating loss
carryforward of approximately $53,891,000 and a state net operating loss
carryforward of approximately $53,890,000. The federal net operating loss
carryforwards expire in years 1997 through 2011 and the state net operating loss
carryforwards expire in years 1997 through 2011 (the expiration dates vary based
on individual state income tax laws).
(13) Capital Stock
Common Stock
Reverse Split - Effective September 1, 1993, the capitalization of the Company
changed from 300,000,000 shares of common stock, $.01 par value, into 50,000,000
shares of common stock, $.01 par value. Effective the same time, the presently
issued and outstanding shares of common stock were reverse split on the basis of
one (1) new share for each sixty (60) issued and outstanding shares. All share
data has been adjusted retroactively.
Stock Options - On August 20, 1993, the Company authorized a stock option plan
for Non Employee Directors, Consultants and Advisors to provide compensation for
services rendered to the Company in lieu of cash payment. At various times the
Company has registered and granted options pursuant to the plan. During the
years ended December 31, 1995 and 1994, 6,500,000 and 3,000,000 shares,
respectively, were granted and exercised. The expense for these years was
calculated in accordance with APB #25.
Acquisitions - Common stock was issued to acquire subsidiaries as follows:
(i) In December, 1993 issued 850,000 shares in connection with the
acquisitions of Arc Acquisition Group, Inc. and ARC Networks, Inc.
(ii) In August 1993, issued 120,000 shares in connection with the
acquisition of the remaining 20% of S-Tech.
(iii) In June 1994, issued 840,000 in connection with the acquisition of
Creative Socio-Medics Corp.
(iv) In September 1994 issued 3,343,000 shares in connection with the
acquisition of the International Magnetic Imaging, Inc. and
affiliated entities.
(v) In November 1994 issued 1,500,000 shares in connection with the
acquisition of Job Shop Technical Services, Inc. and Computer
Engineering Services, Inc.
Stock Issued for Services Rendered - For the years ended December 31, 1996, 1995
and 1994 the Company issued 200,000, 130,004 shares and 200,000 shares,
respectively, in connection with consulting and financing services valued at
$45,000, $114,000 and $97,000, respectively. The expense calculated for 1996 was
determined in accordance with SFAS #123 and the expense for prior years was
calculated in accordance with APB #25
Regulation S Offerings - Pursuant to offerings in September 1996, October 1995
and March 1994 made under Regulation S of the Securities Act of 1933, the
Company received net proceeds of $912,000 $250,000 and $8,162,000, respectively,
in conjunction with the respective issuance of 13,250,000, 1,000,000 shares and
3,500,000 shares of common stock.
Conversion of Series A Preferred Stock - During the years ended December 31,
1996 and 1995, respectively, the Company issued 5,690,757 and 1,447,807 shares
of common stock upon the conversion of 43,705 and 11,117 shares of series A
preferred stock.
F-25
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Preferred Stock - Effective September 1, 1993, the authorized number of shares
of undesignated preferred stock, par value $1.00 per share, was increased from
1,000,000 to 2,000,000 shares.
Series A - The series A convertible preferred stock, which was all issued during
the period April 1993 through July 1993, bears a cumulative dividend of 6%, is
redeemable at any time at the option of the Company at a redemption price of $10
per share, and is convertible at the option of the holder at any time commencing
two years from the date of issuance, unless sooner called for redemption by the
Company at the rate of 130.208 (7,812.5 prior to 60:1 reverse split) shares of
common stock for each share of preferred stock if and when sufficient shares of
common stock are available for issuance. No dividends were declared for the
years ended December 31, 1996, 1995 and 1994. As of December 31, 1996 54,822
shares of series A preferred stock was converted into 7,138,564 shares of common
stock.
Series B - The Series B subordinated preferred stock is redeemable at the option
of the Company at the issue price of $87.50 per share. The stock is entitled to
a $3.50 annual dividend which is contingent upon after tax earnings in excess of
$200,000. In the event of involuntary liquidation, the holders may receive
$87.50 per share and all dividends. No dividends were declared for the years
ended December 31, 1996, 1995 and 1994
Series E - The Series E preferred stock is entitled to an annual dividend of
$.10 per share contingent upon after tax earnings being in excess of $200,000.
No dividends were declared for the years ended December 31, 1996, 1995 and 1994.
Series F - As consideration for granting extensions on former debts, the Company
issued, in 1984, 2,700 shares of preferred stock at $1.00 per share. The
nonvoting preferred stock, designated Series F, with a dividend rate of $8.00
per share is redeemable at the option of the Company after July 1993 for $1.00
per share. One share will be issued for each $100 (one hundred dollars) of
principal indebtedness owed. The dividend will be noncumulative and is payable
within 100 days from the close of any year where net income after tax exceeds
$500,000, and all dividends due on the Series B preferred stock are paid or
provided for. No dividends were declared for the years ended December 31, 1996,
1995 and 1994.
(14) Non-Employee Directors, Consultants and Advisors Stock Options
On August 20, 1993, the Company authorized a stock option plan for Non-Employee
Directors, Consultants and Advisors. The Company has calculated the expense of
issuing such options using the intrinsic value method per APB #25 as follows.
Pursuant to the plan, in 1994, the Company registered and granted 3,000,000
shares, which were exercised at $1.00 per share, resulting in $4,140,000 of
expenses computed as follows:
Shares 3,000,000
Value of stock at date of grant $2.975*
-----------
8,925,000
20% discount ( 1,785,000)
----------
7,140,000
Exercise proceeds (3,000,000)
---------
Expense $4,140,000
=========
* - Represents weighted average.
In accordance with the agreements relating to the various parties involved, for
the years ended December 31, 1994 $4,140,000 was charged as consulting services
in the determination of income from operations. A 20% discount was utilized
because the shares issued represents a large block of stock.
F-26
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Pursuant to the plan during the year ended December 31, 1995, 6,500,000 shares
were granted and exercised of which 1,500,000 were exercised at $0.25 per share,
1,000,000 were exercised at $0.35 per share 1,000,000 were exercised at $0.50
per share and 3,000,000 were exercised at $0.00 per share, resulting in
$3,869,000 of expenses computed as follows:
Shares 6,500,000
Value of stock at date of grant $0.9796*
----------
6,367,000
20% discount (1,273,000)
---------
5,094,000
Exercise proceeds (1,225,000)
---------
Total consulting costs $3,869,000
=========
* - Represents weighted average.
In accordance with the agreements relating to the various parties involved, for
the years ended December 31, 1994 $4,140,000 was charged as consulting services
in the determination of income from operations. A 20% discount was utilized
because the shares issued represents a large block of stock.
F-27
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
SFAS 123 applies to the above stock option transactions wherein the calculation
of the expense must be disclosed and pro forma results are to be presented.
The following disclosures are pursuant to FASB 123 although the amounts actually
reported in the Company's accompanying financial statements are based on APB
#25. As of December 31, 1996, 1995 and 1994, the Company had no outstanding,
unexercised stock options. The activity in the Companies stock option plan is as
follows:
<TABLE>
<CAPTION>
Weighted
Weighted Average
Number Average Exercise Remaining
of Price Contractual
Options ----- Life
------- ----
<S> <C> <C> <C>
Options Outstanding at December 31, 1993 --
Granted 3,200,000 $0.94
Exercised 3,200,000 $0.94
Expired --
---------
Options Outstanding at December 31, 1994 -- None
Granted 6,630,004 $0.19
Exercised 6,630,004 $0.19
Expired --
---------
Options Outstanding at December 31, 1995 -- None
Granted 200,000 $0.00
Exercised 200,000 $0.00
Expired --
Options Outstanding at December 31, 1996 -- None None
Options Exercisable at December 31, 1996 --
</TABLE>
The Company's expense for the year ended December 31, 1996 for the issuance of
options under SFAS 123 was approximately $45,000. If the Company had accounted
for the issuance of all options pursuant to the fair value based method of SFAS
123, the Company would have recorded additional compensation expense of
approximately $1,400,000 for the year ended December 31, 1995 and the Company's
net loss and loss per share would have been as follows:
Year Ended
December 31,
1995
----
Net loss as reported ($11,360,000)
==========
Pro forma net loss ($12,760,000)
==========
Loss per share as reported ($0.51)
====
Pro forma net loss ($0.57)
====
The fair value of options to purchase common stock at the date of grant was
estimated using the fair value based method with the following weighted average
assumptions:
1996 1995
---- ----
Expected Life (Exercised on date of issuance) 1 year 1 year
Interest Rate 6% 6%
Annual rate of Dividends None None
Volatility 86.10% 87.48%
The weighted average fair value of options at date of grant using the fair value
based method during 1996 and 1995 was estimated at $0.0 and $0.19, respectively.
F-28
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Series A Common Stock Purchase Warrant:
On September 30, 1994, in conjunction with the financing of the IMI acquisition,
the Company issued to a financing company, a warrant to purchase 1,000,000
shares of the Company's common stock at an exercise price of $0.75 per share.
This warrant is exercisable on or before September 30, 1999 and expires on
October 1, 1999. The number and kind of securities purchasable upon the exercise
of this warrant and the exercise price is subject to adjustment from time to
time upon the happening of (a) certain stock reclassification, consolidation or
merger events; (b) certain stock split transactions; or (c) certain dividend
declarations, such that the value of shares that would have been received upon
exercise of the warrant immediately prior to the above events is equivalent to
the value of shares receivable upon exercise of the warrant immediately
subsequent to the above events. The weighted average exercise price of such
warrants is $0.50 for each of the years ended December 31, 1996, 1995 and 1994
and the weighted average remaining contractual life of such warrants as of
December 31, 1996, 1995 and 1994 was 3 years, 4 years and 5 years, respectively.
(15) Industry Segments
The Company currently classifies its operations into eight business segments:
(i) Contract Engineering Services consists of subsidiaries that provide
engineers, designers and technical personnel on a temporary basis pursuant to
contracts with major corporations; (ii) Medical Diagnostics consists of a
subsidiary that performs magnetic resonance imaging and other medical diagnostic
services; (iii) Electro-Mechanical and Electro- Optical Products Manufacturing
consists of subsidiaries that manufacture and sell products such as devices that
measure distance and velocity, instrumentation devices, debit card vending
machines, prepaid telephone calling cards and finger print identification
products; (iv) Medical Information Services consists of subsidiaries that
provide medical information database services, health care industry related
software packages and the SmartCard medical identification cards and related
software program; (v) Telecommunications consists of a subsidiary that, among
other things, installs telephonic network systems and buys and resells local
telephone service; (vi) Three Dimensional Products and Services consists of
subsidiaries that provide three dimensional imaging services that are used in a
variety of applications, such as prototype building and reverse engineering;
(vii) Audio Products Manufacturing consists of a subsidiary that manufactures
and sells a professional line of loudspeakers, and (viii) Business Consulting
Services consists of subsidiaries that provide a variety of financial and
business related services. Corporate and Other consists of the operating
activities of the holding company entities. Certain reclassifications have been
made from the prior year presentation whereby the holding company of Trans
Global Services, Inc. is presented as a part of the contract engineering
services segment and in the prior year it was included with corporate and other.
Inter segment sales and sales outside the United States are not material.
Information concerning the Company's business segments is as follows:
F-29
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(15) Industry Segments:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Revenues:
Contract Engineering Services $ 62,595,000 $ 63,156,000 $25,292,000
Medical Diagnostics 31,110,000 28,044,000 6,558,000
Audio Products Manufacturing (I) 3,309,000 2,150,000 --
Electro-Mechanical and Electro-Optical Products Manufacturing 2,837,000 4,223,000 3,606,000
Medical Information Services 8,540,000 7,380,000 2,924,000
Telecommunications 5,582,000 3,253,000 2,268,000
Three Dimensional Products and Services 925,000 1,775,000 849,000
Business Consulting Services 26,000 116,000 81,000
------ ------- ------
Total Revenues $114,924,000 $110,097,000 $41,578,000
============ ============ ===========
Gross Profit (Loss):
Contract Engineering Services $ 5,157,000 $ 3,997,000 $ 1,580,000
Medical Diagnostics 14,469,000 12,237,000 2,662,000
Audio Products Manufacturing (I) 470,000 202,000 --
Electro-Mechanical and Electro-Optical Products Manufacturing (307,000) 1,049,000 180,000
Medical Information Services 1,332,000 1,973,000 601,000
Telecommunications 509,000 695,000 640,000
Three Dimensional Products and Services 508,000 654,000 295,000
Business Consulting Services 26,000 116,000 193,000
------ ------- -------
Total Gross Profits $ 22,164,000 $ 20,923,000 $ 6,151,000
============ ============ ===========
Income (Loss) from Operations:
Contract Engineering Services $ 306,000 ($ 3,817,000) ($ 291,000)
Medical Diagnostics 4,425,000 5,367,000 1,035,000
Audio Products Manufacturing (I) (752,000) (493,000) --
Electro-Mechanical and Electro-Optical Products Manufacturing (1,866,000) (842,000) (1,361,000)
Medical Information Services (5,783,000) (2,274,000) (1,529,000)
Telecommunications (959,000) (503,000) (143,000)
Three Dimensional Products and Services (1,532,000) (2,241,000) (1,555,000)
Business Consulting Services (224,000) (20,000) (429,000)
Corporate and Other (2,953,000) (6,289,000) (6,191,000)
----------- ----------- -----------
Total Loss from Operatio ($ 9,338,000) ($ 11,112,000) ($10,464,000)
============== ============== =============
</TABLE>
F-30
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(15) Industry Segments:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Net Income (Loss):
Contract Engineering Services ($ 485,000) ($ 4,770,000) ($ 435,000)
Medical Diagnostics 1,446,000 2,682,000 449,000
Audio Products Manufacturing (I) (893,000) (553,000) --
Electro-Mechanical and Electro-Optical Products Manufacturing (2,017,000) (1,002,000) (1,349,000)
Medical Information Services (3,809,000) (2,803,000) (1,601,000)
Telecommunications (1,126,000) (573,000) (149,000)
Three Dimensional Products and Services (1,472,000) (2,285,000) (1,791,000)
Business Consulting Services (25,000) 9,000 (442,000)
Corporate and Other (1,189,000) (2,065,000) (6,110,000)
----------- ----------- -----------
Total Net Loss ($9,570,000) ($11,360,000) ($11,428,000)
============ ============= =============
Depreciation and Amortization:
Contract Engineering Services $ 478,000 $ 707,000 $ 324,000
Medical Diagnostics 5,315,000 4,988,000 1,295,000
Audio Products Manufacturing (I) 201,000 74,000 --
Electro-Mechanical and Electro-Optical Products Manufacturing 67,000 37,000 24,000
Medical Information Services 486,000 1,333,000 373,000
Telecommunications 47,000 30,000 29,000
Three Dimensional Products and Services 356,000 417,000 133,000
Business Consulting Services 2,000 2,000 1,000
Corporate and Other 15,000 14,000 8,000
------ ------ -----
Total Depreciation and Amortization $6,967,000 $ 7,602,000 $ 2,187,000
========== =========== ===========
F-31
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(15) Industry Segments:
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Capital Expenditures:
Contract Engineering Services $ 56,000 $ 111,000 $ 3,000
Medical Diagnostics 3,962,000 227,000 12,418,000
Audio Products Manufacturing (I) 104,000 439,000 --
Electro-Mechanical and Electro-Optical Products Manufacturing 6,000 70,000 2,000
Medical Information Services 181,000 138,000 1,104,000
Telecommunications 416,000 2,000 --
Three Dimensional Products and Services 188,000 49,000 494,000
Business Consulting Services -- -- 1,000
Corporate and Other 7,000 21,000 61,000
----- ------ ------
Total Capital Expenditures (II, III) $4,920,000 $1,057,000 $14,083,000
========== ========== ===========
</TABLE>
(I) - The Audio Products Manufaturing segment only includes operations from
March 31, 1995 (date of acquisition) through December 31, 1996.
(II) - For 1995, capital expenditures includes $373,000 for amounts allocated
to property, plant and equipment from the acquisition of a subsidiary.
(III) - For 1994, capital expenditures includes $11,933,000 for amounts
allocated to property, plant and equipment from the acquisition of a
subsidiary.
At December 31,
---------------
1996 1995
---- ----
Identifiable Assets:
Contract Engineering Services $ 9,691,000 $ 9,597,000
Medical Diagnostics 42,988,000 39,873,000
Audio Products Manufacturing 1,478,000 1,781,000
Electro-Mechanical and Electro-Optical
Products Manufacturing 3,387,000 3,714,000
Medical Information Services 8,258,000 6,937,000
Telecommunications 1,654,000 1,362,000
Three Dimensional Products and Services 1,068,000 1,558,000
Business Consulting Services 277,000 250,000
Corporate and Other 3,013,000 1,240,000
--------- ---------
Total Identifiable Assets $71,814,000 $66,312,000
=========== ===========
F-32
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(16) Related Party Transactions
Loans Payable to Officers and Former Shareholders:
A subsidiary of the Company operating in the Three Dimensional Products and
Services segment is indebted to stockholders for cash received and office
equipment contributed by these stockholders in 1992. The loans are noninterest
bearing and have no fixed due date. The amount due at December 31, 1996 and 1995
was $183,000. The same subsidiary of the Company is indebted to an employee for
cash received from such employee during 1996 and 1995. The loan bears interest
at 9% and the due date was extended verbally to 1997. The amount due at December
31, 1996 and 1995 was $112,000 and $107,000.
A subsidiary of the Company operating in the Electro-Optical Electro-Mechanical
Products Manufacturing segment is indebted for short-term advances made to the
subsidiary by two directors of the subsidiary. The advances are non-interest
bearing and were made through several entities in which the directors hold a
controlling interest.
Approximately $924,000 and $969,000 at December 31, 1996 and 1995, respectively,
of the subordinated debt issued in connection with the acquisition of IMI is
payable to an officer of IMI. The officer was a shareholder in IMI prior the
acquisition.
Purchase of a Portion of a Subsidiary from Employees:
Trans Global Services, Inc. ("Trans Global") was organized by SIS Capital Corp.
("SISC") in January 1995 to hold all of the stock of Avionics Research Holdings,
Inc. ("Avionics"), (formerly ARC Acquisition Group, Inc.), which was acquired by
SISC in December 1993, and Resource Management International, Inc.
("RMI"),(formerly ITS Management Corp.), which was acquired by SISC in November
1994. Trans Global also issued to SISC warrants to purchase shares of its common
stock. The Trans Global stock and warrants were issued to SISC in consideration
for the transfer of the stock of Avionics and RMI and the advances made by SISC.
All of the Trans Global stock and warrants owned by SISC are held subject to the
right of Mr. Lewis S. Schiller, chairman of the board and chief executive
officer of the Company, to purchase 10% of SISC's equity position for 110% of
SISC's cost. In connection with the organization of Trans Global, Trans Global
also issued a 3.4% interest to Mr. Joseph G. Sicinski, president of Trans
Global, in exchange for certain rights Mr. Sicinski has with respect to the
stock of Avionics.
In connection with the organization of Trans Global in January 1995, SISC
transferred a 5% interest in its common stock and warrants in Trans Global to
DLB in exchange for DLB's 10% interest in another subsidiary of Consolidated.
At the time of the organization of Trans Global, Trans Global issued to SISC, in
consideration for the equity consideration issued by Consolidated in connection
with the acquisitions of Avionics and RMI, 500 shares of Series A 5% Redeemable
Cumulative Preferred Stock.
During 1995, SISC, DLB, Inc. and Mr. Joseph G. Sicinski, the stockholders of
Trans Global, entered into an agreement (the "Trans Global Agreement") with
Concept Technologies Group, Inc. ("Concept") pursuant to which they would
transfer to Concept all of the issued and outstanding capital stock of Trans
Global in exchange for a controlling equity interest in Concept.
Pursuant to the Trans Global Agreement, Concept issued to SISC in respect of its
Trans Global Common Stock, preferred stock and warrants, 850,000 shares of
Concept Common Stock, two-year warrants (the "Concept Warrants") to purchase
475,000 shares of Concept Common Stock, 23,750 shares of Concept's Series A
Participating Convertible Preferred Stock ("Series A Preferred Stock"), which
are convertible into 1,900,000 shares of Concept Common Stock upon the filing of
an amendment to Concept's certificate of incorporation which increases its
capital stock, 23,750 shares of each of Concept's Series B and C Preferred
Stock, which are convertible into an aggregate of 2,375,000 shares of Concept
Common Stock if certain levels of income before income tax are met, and 25,000
shares of Concept's Series D 5% Redeemable Cumulative Preferred Stock ("Series D
Preferred Stock"), which is not convertible and which is redeemable after three
years for an aggregate of approximately $1.7 million. The Series D Preferred
Stock is also redeemable from the sale by Concept of its equity securities,
including the sale of stock upon exercise of options and warrants. The Concept
Warrants become exercisable until the Warrants included in the Units either
expire or are exercised in full. The exercise price of the Concept Warrants is
$3.50 per share or the exercise price of the warrants included in a proposed
private placement by Concept, whichever is lower.
F-33
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Pursuant to the Trans Global Agreement, Concept issued to DLB in respect of its
Trans Global stock and warrants, 50,000 shares of Concept Common Stock, Concept
Warrants to purchase 25,000 shares of Concept Common Stock, 1,250 shares of
Concept's Series A Preferred Stock, which are convertible into 100,000 shares of
Common Stock, and 1,250 shares of each of Concept's Series B and C Preferred
Stock, which are convertible into in aggregate of 125,000 shares of Concept
Common Stock if certain levels of income before income taxes are attained.
Pursuant to the Trans Global Agreement, Concept issued to Mr. Sicinski in
respect of his Trans Global Stock, 100,000 shares of Concept Common Stock.
The Trans Global Agreement provides SISC and DLB with certain registration
rights with respect to their Concept warrants and the underlying common stock
and provides Mr. Sicinski with certain registration rights with respect to the
100,000 shares of Common Stock issued to him pursuant to the Trans Global
Agreement. Mr. Sicinski's shares are subject to a one-year lockup agreement,
subject to earlier release under certain conditions.
All of the Trans Global stock and warrants owned by SISC are held subject to the
right of Mr. Lewis S. Schiller, chairman of the board and chief executive
officer of the Company, to purchase 10% of SISC's equity position for 110% of
SISC's cost. In connection with the transaction contemplated by the Trans Global
Agreement, Mr. Schiller's option will be converted to an option to purchase 10%
of SISC's interest in the Concept equity securities at a price equal to 110% of
SISC's cost.
Advances to an Unconsolidated Subsidiary:
The Company has made advances to Universal International, a 39% owned
subsidiary, from time to time in various amounts. These advances have no fixed
due dates or terms and $145,000 of such advances have been written-off. The
outstanding balances owed to the Company from this subsidiary was $587,000 and
$427,000 at December 31, 1996 and 1995 and the greatest amount outstanding to
such subsidiary during the years ended December 31, 1996, 1995 and 1994 was
$600,000. The Company's secretary, owns a 31% interest in the subsidiary
receiving such advances.
Loan Receivable from an Officer of a Subsidiary:
On February 7, 1996, IMI, a subsidiary operating in the medical diagnostics
segment loaned the president of such subsidiary $300,000 on which $8,000 of
interest has accrued as of December 31, 1996. The loan is due in 1998 and bears
interest at 5.5%. During the year ended December 31, 1995, the Contract
Engineering Services segment subsidiary loaned $45,000 to the president of such
subsidiary. The loan has no fixed due dates or terms.
Loan Receivable from Sale of Common Stock Investments to an Officer:
During 1996 and 1995, the chief executive officer of the Company exercised an
option to purchase common stock investments held by the Company at 110% of the
book value of such investments. The purchase of such investments was consummated
in a noncash transaction and such officer is to issue a note in favor of the
Company with interest at prevailing rates and maturing five years from the date
of the purchase. Total amounts outstanding under such receivables was $356,000
and $72,000, respectively at December 31, 1996 and 1995. Gains realized by the
Company on the sale of these investments to the Company's CEO approximated
$22,000 and $7,000, respectively, for the years ended December 31, 1996 and
1995.
(17) Litigation
Although the Company is a party to certain legal proceedings which have occurred
in the ordinary course of business, the Company does not believe such
proceedings to be of a material nature with the exception of the following:
Holding Company:
The Company has been named as a defendant in a lawsuit filed by a company it was
contemplating acquiring in January 1995 for alleged unauthorized use of
proprietary information specific to that line of business. Outside counsel
handling this case has advised the Company that it has meritorious defenses to
obtain a dismissal of the lawsuit.
F-34
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Contract Engineering Services:
The DOL has filed a complaint against Job Shop and its principal stockholder for
civil violations of ERISA resulting from the failure of Job Shop to deposit
employee contributions to Job Shop's 401(k) retirement plan. A similar complaint
was filed by former employees of Job Shop against Job Shop, its principal
stockholder and others. At November 22, 1994, the amount due to the Job Shop
401(k) plan was approximately $3.0 million, which amount may have increased
since such date as a result of interest and penalties. Neither TGS nor RMI, the
subsidiary which acquired assets and assumed certain obligations of Job Shop in
November 1994, has been named as a defendant in either of such actions. The DOL
has raised with TGS the possibility that RMI may by liable with respect to Job
Shop's ERISA liability as a successor corporation or purchaser of plan assets,
even though RMI did not assume such obligations and paid value for the Job Shop
assets which it did purchase. Although TGS believes that RMI is not a successor
corporation to Job Shop and is not responsible for Job Shop's ERISA violations,
the DOL may take a contrary position. If the DOL takes such a position and
prevails, it would have a material adverse effect upon the operations of RMI and
possibly TGS as a whole. Although TGS is engaged in discussions with the DOL, no
assurance can be given that such discussions will result in any settlement
acceptable to TGS. During 1996, TGS established a $300,000 reserve with respect
to the DOL's claim, however, no assurance can be given that such reserve will be
adequate.
In May 1991, prior to the acquisition of Avionics by TGS, the Government
Printing Office wrote Avionics asking for reimbursement of approximately
$300,000 for allegedly unauthorized work on two programs. Avionics believes that
these claims are without merit and intends to contest these claims vigorously if
reasserted. Avionics believes that the ultimate disposition of this matter will
not have a material adverse affect on consolidated TGS financial position.
Medical Diagnostics:
In May 1996, IMI commenced an arbitration proceeding before the American
Arbitration Association in Los Angeles, California against Radman, Inc.
("Radman"), a manufacturer of teleradiology systems and equipment, entitled
International Magnetic Imaging, Inc. v. Radman, Inc., alleging fraud and breach
of contract and seeking rescission of a purchase agreement between IMI and
Radman for a teleradiology system as well as an award of money damages in an
amount not less than $485,000, together with interest, attorneys' fees and
costs. Radman has asserted certain counterclaims against IMI in such proceeding
seeking an award of money damages in the sum of at least $236,000, together with
interest, 'exemplary and punitive damages, reasonable attorneys' fees and other
costs of the action. This matter is presently pending. IMI believes that it has
meritorious defenses to Radman's counterclaims.
In December 1994, IMI placed a purchase order with Advanced NMR Systems, Inc.
("ANMR"), for Instascan MRI equipment upgrade systems for an aggregate of $1.5
million. Three of the systems have been installed at the Centers and the
remaining two have not yet been installed at IMI's facilities. By letter dated
February 25, 1996, IMI notified ANMR that it was terminating and rescinding the
purchase agreements for such equipment as well as certain other related
agreements between the parties and seeking the return of the approximate
$723,000 previously paid to ANMR as well as money damages as a result of certain
material deficiencies in such equipment. By letter dated March 22, 1996, ANMR's
counsel denied such claimed deficiencies, disputed IMI's right to terminate such
agreements and claimed that IMI is in breach thereof for, among other things,
failing to pay the approximate $752,000 balance of the purchase price for such
equipment. ANMR also threatened to commence an action against IMI to assert its
rights under such agreements. In October 1996, IMI commenced a state court
action against ANMR in Florida.
In January 1996, Drs. Ashley Kaye and James Sternberg, two of the former
stockholder-directors of IMI-Florida, and Dr. Sternberg's wife, threatened to
commence an action against two subsidiaries of IMI, Consolidated and Mr. Lewis
S. Schiller, chairman of the board of Consolidated and IMI, for alleged
violations of securities and common law in connection with the execution in 1994
of an asset purchase agreement between MD Corp. and a subsidiary of IMI and
non-payment of the $3,375,000 Subordinated Notes of two subsidiaries of the
Company issued to MD Corp. in connection therewith. Although IMI reflects the
principal and interest on such subordinated notes as current liabilities on its
consolidated balance sheet and no notice of default has been given, no assurance
can be given that an adverse decision in any action based on such claims will
not have a material adverse effect upon IMI.
F-35
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Vanguard, on its own behalf or on behalf of other persons who may be affiliated
with Vanguard, based on a purported agreement relating to the introduction of
Consolidated and the Company to IMI-Florida and assistance in the negotiation of
the acquisition of the Centers, has asserted a claim against the Company and/or
SISC that it has the right, among other things, to a 10% interest in the Common
Stock of the Company, on a fully-diluted basis, prior to the anticipated initial
public offering by IMI and prior to the issuance of certain warrants to DVI, for
no cash consideration. In addition, Vanguard has claimed that it is entitled to
a $200,000 fee due at the time of the acquisition of the Centers, consulting
fees of $240,000 per year for five years, reimbursement of nonaccountable
expenses and a 5% interest in any future medical acquisition by the Company. No
assurance can be given that any litigation which may ensue would not seek
damages exceeding the claim described above and, if decided unfavorably to the
Company, would not have a material adverse affect on the Company. If Vanguard
commences an action against the Company and prevails, it would have a material
adverse effect upon the Company, and, furthermore, if it prevails with respect
to its claim for Common Stock, the issuance of such Common Stock could result in
a non-cash charge to earnings for the value of such Common Stock, dilution to
the stockholders, including the stockholders who purchased stock in the
anticipated public offering of IMI, and a reduction in the net tangible book
value per share. In addition, the Company may not be able to use Consolidated's
net loss or tax loss carryforward to reduce its tax liability if a sufficient
number of shares of Common Stock were issued to Vanguard.
Electro-Mechanical and Electro-Optical Products Manufacturing:
Lafayette Industries, Inc., a subsidiary acquired during 1996 via a reverse
acquisition, whose business prior to the reverse acquisition was the
manufacturer and sale of store fixtures, was discontinued in 1996. The
manufacturing facilities for these operations were located in Mexico and were
sieved by the landlord. Although Lafayette is contesting the seizure, no
assurances can be given that Lafayette will be able to realize any future
benefit from these assets and has placed a reserve on the full amount of such
assets. Lafayette and its subsidiaries, including SES Holdings and its
subsidiaries, are contingently liable individually and jointly with others as
guarantors of long-term debt and obligations principally relating to various
debt agreements, leased equipment and facilities. In connection with those
transactions, Lafayette has been notified that it is party to various litigation
with individual claims ranging to approximately $1,600,000. Although management
has made what it feels is its best estimate of the liability, the nature of the
liability is subject to substantial uncertainty. The amount of potential
additional liability above that accrued can not be reasonably estimated. Due to
the uncertainty of the pending litigation, substantial doubt about Lafayette's
ability to continue as a going concer and, certain scope limitations, Lafayette
and its subsidiaries received a disclaimer of opinion from its independent
auditors who are the same as Consolidated's independent auditors. Lafayette and
its subsidiaries represents 5.2% of Consolidated's consolidated revenue and 6.8%
of Consolidated's consolidated assets.
Medical Informations Services
On or about September 29, 1995, an action was commenced against Netsmart by the
filing of a summons with notice in the Supreme Court of the State of New York,
County of New York. The action was commenced by Jacque W. Pate, Jr., Melvin
Pierce, Herbert A. Meisler, John Gavin, Elaine Zanfini, individually and
derivatively as shareholders of Onecard Health Systems Corporation and Onecard
Corporation, which corporations are collectively referred to as "Onecard". The
named defendants include, in addition to the subsidiary, officers and directors
of the subsidiary and the Company. A complaint was filed on November 15, 1995.
The complaint makes broad claims respecting alleged misappropriation of
Onecard's trade secrets, corporate assets and corporate opportunities, breach of
fiduciary relationship, unfair competition, fraud, breach of trust and other
similar allegations, apparently arising at the time of, or in connection with
the organization of the subsidiary in September 1992. The complaint seeks
injunctive relief and damages, including punitive damages of $130,000,000.
Management believes that the action is without merit, and it will vigorously
defend the action. Nevertheless, due to uncertainties in the legal process, it
is at least reasonably possible that management's view of the outcome will
change in the near term and there exists the possibility that there could be a
material adverse impact on the operations of Netsmart.
(18) New Authoritative Pronouncements
The following describes new authoritative pronouncements that are expected to be
applicable to the accounting of the Company's operations:
The Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities." SFAS No. 125 is effective
for transfers and servicing of financial assets and Extinguishment of
liabilities occurring after December 31, 1996. The provisions of SFAS No. 125
must be applied prospectively, retroactive application is prohibited, and early
application is not allowed. SFAS No. 125 supersedes SFAS No. 77, "Reporting by
Transferors for Transfers of Receivables with Recourse". While both SFAS 125 and
SFAS No. 776 required a surrender of "control" of financial assets to recognized
a sale, the SFAS No. 125 requirements of sale are generally more stringent. SFAS
No. 125 is not expected to have a material impact on the Company because they
have not been recognizing sales under SFAS No. 77 and will also not be under
SFAS No. 125. Some provisions of SFAS No. 125, which are unlikely to apply to
the Company, have been deferred by the FASB.
The FASB has issued SFAS N0. 128 "Earnings Per Share" and SFAS 129 "Disclosure
of Information About Capital Structure." Both are effective for financial
statements issued for periods ending after December 15, 1997. SFAS No. 128
simplifies the computation of earnings per share by replacing the presentation
of primary earnings per share with a presentation of basic earnings per share.
The statement requires dual presentation of basic and diluted earnings per share
by entities with complex capital structures. Basic earnings per share includes
no dilution and is computed by dividing income available to common stockholders
by the weighted average number of shares outstanding for the period. Diluted
earnings per share reflects the potential dilution of securities that could
share in the earnings of an entity similar to fully diluted earnings per share.
While the Company has not analyzed SFAS 128 sufficiently to determine its
long-term impact on per share reported amounts, SFAS No. 128 should not have a
significant effect on historically reported per share loss amounts. SFAS No. 129
does not change any previous disclosure requirements, but rather consolidates
existing disclosure requirements for ease of retrieval.
F-36
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(19) Acquisitions
(i) - On June 16, 1994, a subsidiary of the Company, Carte Medical Holdings
("CMH"), through a wholly-owned subsidiary, CSM Acquisition Corp. ("Acquisition
Corporation"), acquired the assets and assumed liabilities of Creative
Socio-Medics Inc. ("CSM") pursuant to a plan and agreement of reorganization
dated as of April 13, 1994, as amended (the "Purchase Agreement"), among the
Company, Carte Medical Corp. ("Carte"), Acquisition Corporation, CSM and
Advanced Computer Techniques, Inc. ("ACT"), the parent of CSM. The Company is
the parent of SISC, which is the parent of CMH. In connection with the purchase,
(i) Acquisition Corporation purchased the assets and assumed liabilities of CSM
in exchange for 800,000 shares of the Company's common stock and $500,000 which
was advanced by Carte to Acquisition Corporation from the proceeds of a loan
made by SISC, (ii) CMH transferred the stock of Acquisition Corporation to
Carte, (iii) in consideration for the transfer of the Acquisition Corporation
stock, Carte is to issue to CMH an aggregate of 1,000,000 shares of common
stock, of which 450,000 shares are issuable on or about the date Carte receives
the proceeds from an initial public offering, and (iv) Acquisition Corporation
changed its corporate name to Creative Socio-Medics Corp. At the time of the
execution of the Purchase Agreement, SISC granted to former officers of ACT and
CSM, options to purchase an aggregate of 202,560 shares of Carte's common stock
owned by SISC. The shares of common stock owned by SISC were transferred to CMH
subject to the options. The options are exercisable at an exercise price of
$.174 per share during the five-year period commencing on June 16, 1994, the
date the acquisition of CSM was consummated. At the closing of the acquisition,
the Company issued to such individuals an aggregate of 40,000 shares of its
common stock. The purchase price of this acquisition included $3,851,000 for
customer lists of CSM which will be amortized over 15 years under the straight
line method. For accounting purposes, the results of operations of CSM are
included with the results of the Company from July 1, 1994 onward.
(ii) - As of September 30, 1994, the Company acquired International Magnetic
Imaging, Inc. and its affiliated entities ("IMI, Inc.") in a business
combination accounted for as a purchase. The principal operations of IMI, Inc.
are in the establishment and operation of outpatient diagnostic centers
providing MRI services and other diagnostic modalities. The results of
operations of IMI, Inc. are included in the accompanying combined financial
statements since the date of acquisition. The total cost of the acquisition was
$31,872,000 which exceeded the fair value of net assets of IMI, Inc. By
$11,069,000. The excess purchase price, or goodwill, will be amortized by the
straight-line method over 20 years.
The other intangibles, specifically restrictive covenants and customer lists,
will be amortized by the straight-line method over 3 years and 15 years,
respectively.
The following summarizes the purchase price allocated to acquired assets at fair
value.
Cash $ 6,960,000
Subordinated Debt 19,863,000
Stock (3,343,000 shares at.$0.87 per share) 2,920,000
Notes [Covenants] 800,000
Acquisition Costs 1,329,000
---------
Purchase Cost $31,872,000
==========
Allocated to:
Cash $ 2,350,000
Other Assets 421,000
Covenants-Not-to-Compete 3,303,000
Property, Plant and Equipment 10,903,000
Accounts Receivable 7,379,000
Managed Care Contracts - Customer Lists 5,656,000
Liabilities Assumed ( 9,209,000)
Goodwill 11,069,000
----------
Total $31,872,000
==========
F-37
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The cash portion of the purchase price was subsequently refinanced through DVI.
The notes issued in connection with the acquisition of the centers balloon
primarily in September 1996, with notes in the principal amount of $860,000
maturing in September 1997. The notes issued to acquire the management and
radiology company, balloon and mature in September 1997 and 1999, respectively.
In connection with this acquisition, the Company, through its subsidiaries,
borrowed an aggregate of approximately $7.1 million on a secured, term-loan
basis over 60 months pursuant to loan and security agreements among the
Company's subsidiaries and DVI Financial Services, Inc. d.b.a. DVI Capital. For
accounting purposes, the results of operations of IMI are included with the
results of the Company from October 1, 1994 onward.
(iii) - In November 1994, the Company acquired the assets of two businesses, Job
Shop Technical Services, Inc. ("Job Shop") and Computer Engineering Services,
Inc. ("CES"). Job Shop provides engineers, designers and technical personnel on
a temporary basis, which is similar to the business performed by Avionics
Research Corporation, a subsidiary of the Company. CES is engaged in the
business of performing CAD (computer aided design) and CAM (computer aided
manufacturing) related services and the marketing and sale CAD/CAM software.
(a) - Pursuant to an asset purchase agreement dated as of August 19, 1994 among
ITS Management Corp., a Delaware Corporation and wholly-owned subsidiary of the
Company ("ITS"), Job Shop and the sole stockholder of Job Shop, ITS acquired
substantially all of the assets of Job Shop in exchange for 750,000 shares of
the Company's common stock valued at $450,000, and the assumption of certain
scheduled liabilities. The principal liability assumed was a $2 million
obligation due to the Internal Revenue Service pursuant to a settlement
arrangement which Job Shop had negotiated. The initial $500,000 payment was made
in November, 1994. The balance is due in 15 monthly installments of $100,000,
commencing May, 1995. Such amounts were paid off in 1996.
(b) - Pursuant to a plan and agreement of reorganization among CDS Acquisition
Corp. ("CDS"), a Delaware corporation and wholly-owned subsidiary of the
Company, CES and the sole stockholder of CES, CDS acquired substantially all of
the assets of CES in exchange for 750,000 shares of the Company's common stock
valued at $450,000, and the assumption of certain scheduled liabilities.
Prior to the acquisition, the businesses of Job Shop and CES were operated as
divisions of the same company, along with one other division which was not
acquired by the Company. For accounting purposes the results of operations of
ITS and CDS are included with the results of the Company from November 22, 1994
onward.
(iv) - In May 1995, SIS Capital Corp., a wholly-owned subsidiary of the Company
("SISC"), entered into an agreement among SISC, DLB, Inc. ("DLB"), Joseph G.
Sicinski and Concept Technologies Group, Inc. ("Concept"), pursuant to which
SISC, DLB and Mr. Sicinski transferred to Concept all of the issued and
outstanding common stock of Trans Global, in exchange for a controlling interest
in Concept. Concepts common stock and warrants are traded on the NASDAQ Small
Cap Market. Trans Global's common stock was owned by SISC (91.6%), DLB (5.0%)
and Mr. Sicinski (3.4%). DLB is owned by Ms. Carol Schiller, wife of Mr. Lewis
S. Schiller, the Company's chairman of the board, president and chief executive
officer. Mr. Schiller disclaims all beneficial interest in the securities owned
by DLB. Mr. Sicinski is president of Trans Global. Trans Global, which operates
through two subsidiaries, ARC and RMI is engaged in the business of providing
engineers, designers and other technical personnel to its clients, which include
major companies in the aerospace, electronics and computer industries. Concept
owns and operates Klipsch Loudspeaker business, and, through a subsidiary, is
the developer and owner of proprietary technologies with applications in
environmental noise cancellation, medical monitoring, defense and
communications. Following the consummation of the transaction, the business of
Trans Global became Concept's principal business.
F-38
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(v) - On December 20, 1996, SIS Capital Corp., a wholly-owned subsidiary of the
Company ("SISC"), entered into an agreement among SISC, DLB, Inc. ("DLB") and
Lafayette Industries, Inc., ("Lafayette"), pursuant to which SISC and DLB
transferred to Lafayette all of the issued and outstanding common stock of SES
Holdings, Corp. ("SESH"), in exchange for a controlling interest in Lafayette.
At the date of the acquisition, SESH was an 80% owned subsidiary of SISC.
Lafayette issued to SISC 1,000 shares of Class A preferred stock which is
convertible at a ratio that will give SISC a 65% ownership of Lafayette's fully
diluted common stock upon stockholder approval of an increase in the authorized
number of common shares of Lafayette. Contemporaneously with the reverse
acquisition, Lafayette issued 1,000 shares of Class B preferred stock which has
a redemption value of $6,750,000. The Series B preferred stock was issued as
payment to SISC for $4,000,000 of subordinated debt due to SISC and in exchange
for the cancellation of $2,750,000 of preferred stock of the underlying entities
of SESH which was held by SISC. The amounts due SISC from SESH and its
subsidiaries as of December 20, 1996, as well as any future advances made by
SISC to SESH or its subsidiaries, are collateralized by a pledge of 1,060,000
shares of TGS stock that is held by SISC for the benefit of SESH. Pro forma
information on this transaction is not presented as, at the date of this
transaction, the Lafayette was considered a public shell and, accordingly, the
transaction was not considered a business combination. Lafayette's prior
principal business, which was principally the manufacture and sale of store
fixtures, has been discontinued.
The following pro forma unaudited results assume the above four acquisitions had
occurred at the beginning of the indicated periods:
Year Ended December 31,
1996 1995 1994
---- ---- ----
Net Revenues $114,924,000 $110,761,000 $ 98,687,000
=========== ======== ==========
Net Loss ($ 8,972,000) ($ 11,421,000) ($11,948,000)
=========== ============ ==========
Net Loss per Share ($0.22) ($0.51) ($0.76)
==== ==== ====
The pro forma information is not necessarily indicative of either the results of
operations that would have occurred had the acquisition been effective at the
beginning of the indicated periods or of the future results of operations.
(20) Commitments
Restated Employment Agreements
Chief Executive Officer:
During May 1996, the Company agreed to an amendment and restatement of the chief
executive officer's ("CEO") employment contract, effective as of January 1996,
which supersedes the prior contract. Per the terms of the restated contract the
CEO receives a salary of $500,000 per year through the year 2000, the expiration
date of the contract. Commencing January 1, 1996 and on each January 1
thereafter during the term of the contract, the CEO shall receive an increase in
annual compensation equal to the greater of (A) 5% of his salary in effect prior
to the increase or (B) a cost of living increase. In addition, the CEO is
entitled to a bonus equal to 10% of the amount by which the greater of (A) the
Company's consolidated income before taxes, determined in accordance with
generally accepted accounting principles or, (B) the Company's consolidated net
cash flow exceeds $600,000. Net cash flow is calculated as consolidated net
income, plus depreciation, amortization and other noncash items of expense,
minus payments of principal amounts of indebtedness, all determined in
accordance with generally accepted accounting principles. Additional benefits to
be received by the CEO include: (a) four weeks paid vacation; (b) disability
insurance providing for the payment to the CEO of a minimum of 60% of his
salary; (c) life insurance with a face value of $2,000,000, payable to the CEO's
designated beneficiary; (d) health, vision and dental insurance; and (e) an
automobile to be provided to the CEO by the Company. Furthermore, the restated
employment agreement confirms the right of the CEO to purchase 10% of the
Company's equity interest in its subsidiaries and other investments. The
purchase price for such interests is 110% of the Company's cost of such
securities as defined in the agreement, which is payable by the CEO's six year
non-interest bearing promissory notes. At December 31, 1996, the amount due from
the CEO with respect to such purchases was approximately $356,000.
F-39
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Chief Financial Officer:
Mr. George W. Mahoney, chief financial officer of the Company, has an employment
agreement with Consolidated for a term commencing October 1, 1994 and ending
December 31, 2007. Mr. Mahoney's annual salary increases to $189,000 for the
current contract year, which ends on December 31, 1997 and increases annually
thereafter until the twelfth year for which his annual salary is $353,000. The
agreement also provides for two bonuses to Mr. Mahoney. One bonus is equal to
the greater of 2.5% of Consolidated's net pre-tax profits or 2.5% of
Consolidated's net cash flow, and the other is equal to the greater of 2.5% of
IMI's net pre-tax profits or 2.5% of IMI's net cash flow. In addition, the
Company paid Mr. Mahoney bonuses of $100,000 and $40,000 in 1996 for services
relating to certain of the Company's loans from DVI pursuant to amendments to
his employment agreement. Mr. Mahoney also receives a $6,000 allowance for an
automobile which may be used for personal as well as business purposes and life
insurance of $1,000,000 on which he may designate the beneficiary.
F-40
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
December 31, 1996
EX-10.7 Employment Agreement Dated March 31, 1997, Between the Registrant and
George W. Mahoney
Reference is made to the Employment Agreement dated March 21, 1995, as amended
October 31, 1995, November 9, 1995, December 22, 1995, April 1, 1996 and June
16, 1996, by and between GEORGE W. MAHONEY and CONSOLIDATED TECHNOLOGY GROUP
LTD. (the "Agreement"). All capitalized terms used herein shall have the
meanings ascribed to them in the Agreement unless a separate definition for such
term is contained herein. The Company and the Executive hereby agree to amend
the Agreement as set forth below.
1. Paragraph 3.1 of the Agreement is hereby amended to read as follows;
3.1. The term of this Agreement shall commence on October 1, 1993 and expire on
December 31, 2007 (or any such later date as Executive may be required to be
employed by the company or any of its subsidiaries pursuant to any Loan and
Security Agreement with DVI Financial Services, Inc. or its affiliates), subject
to earlier termination as hereinafter provided in Paragraph 3.2 hereof (the
"Term") ."
2. Paragraph 4(a) of the Agreement is hereby amended to provide that the
Base Salary during calendar 2003 shall be $270,000, during calendar 2004 shall
be $269,000, during calendar 2005 shall be $309,000, during calendar 2006 shall
be $331,000 and during calendar 2007 which is the last year during the Term
hereof, the Base Salary shall be $353,000.
3. The references in Paragraph 4(b) of the Agreement to it with respect to
Pre-Tax Profits and Net Cash Flow are hereby amended to change such percentage,
in all such instances, to two and one-half percent (2-1/2%).
4. Paragraph 4(b)(aa) through (dd) is hereby amended and a new subparagraph
(ee) is hereby amended to such Paragraph, all of which shall read as follows:
(aa) any compensation or similar expense incurred or recognized by the Company
in connection with the issuance of securities of the Company for purchase prices
which are less than, or warrants, options or other convertible securities which
are exercisable at prices below, fair market value; and
(bb) the greater of (i) $200,000, or (ii) an aggregate of the amount of any
increase in the base salary of Dr. Stephen A. Schulman which exceeds $250,000
per year, plus any increase in Dr. Schulman's bonus which exceeds $700,000, plus
any minimum bonus payments or other advances (including expense allowances or
reimbursements) or payments (including dividends) to Dr. Schulman which may be
granted or paid by the Company after February 1, 1995, plus any additional
incentive compensation that may be granted to Dr. Schulman on and after February
1, 1995 (other than stock options) and plus any expenses incurred by the Company
(including legal fees) in connection with the amendment or modification of any
agreement or other documentation to which Dr. Schulman and the Company are
parties;
(cc) $185,000 representing operating expenses attributable to compensation
payable to IMI's management;
(dd) the amount of any sums due to IMI from any seller (or any principal
thereof) under any purchase agreement between IMI and any such seller which were
previously or are hereafter waived by IMI;
(ee) the amount of all payments made to all officers and directors of the
company or IMI, as the case may be, whether pursuant to existing employment
agreements between such individuals and the Company or IMI, as the case may be,
or otherwise."
Except as set forth above, none of the other terms or provisions of the
Agreement shall be amended or modified by this Amendment, all of which shall
remain in full force and effect. In the event of any inconsistency between the
terms of the Agreement and the terms of this Amendment, the terms of this
Amendment shall control.
IN WITNESS WHEREOF the parties hereto have executed this Agreement on the - 31st
day of March, 1997.
CONSOLIDATED TECHNOLOGY GROUP LTD.
/s/Lewis S. Schiller
Chief Executive officer
/S/George W. Mahoney
<PAGE>
Consolidated Technology Group, Ltd. and Subsidiaries
December 31, 1996
EX-11.1 Calculation of Earnings per Share
Net Loss: ($9,570,000)
Loss per Share:
Loss per share - Note 1 ($0.23)
=======
Loss per Share - assuming full dilution - Note 2
($0.22)
=======
Note 1:
Computed by dividing the net loss for the period by the weighted average number
of common shares outstanding (41,639,293) for the year ended December 31, 1996).
No stock options, warrants or preferred convertible stock are assumed to be
exercised because they are anti-dilutive for the period. The weighted average
number of common shares outstanding is calculated by weighting common shares
issued during the period by the actual number of days that such shares are
outstanding during the periods.
Note 2:
(i) Assumes that 200,000 common shares issued pursuant to the exercise of stock
options were outstanding as of the beginning of the indicated periods.
(ii) Assumes that a warrant to purchase 1,000,000 common shares at $0.75 per
share was exercised at the beginning of the indicated periods, and that all
proceeds from such exercise were used to purchase treasury stock at a price
equal to the average market price of the Company's common shares for the year
ended December 31, 1996 as quoted on the NASD.
(iii) Assumes that the current year conversions of preferred stock into 453,255
and 5,690,757 of common shares for the year ended December 31, 1996 occurred at
the beginning of the indicated periods.
(iv) Assumes that at the beginning of the indicated periods, the 22,891
remaining shares of preferred convertible shares were converted to common shares
at the conversion rate of 130.2083 shares of common for each share of
convertible preferred stock.
NOTE - THIS CALCULATION IS SUBMITTED IN ACCORDANCE WITH THE SECURITIES ACT OF
1934 RELEASE NO. 9083, ALTHOUGH IT IS CONTRARY TO PARA. 40 OF APB 15 BECAUSE IT
MAY PRODUCE AN ANIT-DILUTIVE RESULT
<PAGE>
Consolidated Technology Group, Ltd.
EX 21.1 List of Subsidiaries of the Registrant
State of Company Incorporation
- ---------------- -------------
Consolidated Technology Group Ltd. New York
SIS Capital Corp. Delaware
The Trinity Group Inc. Delaware
Carte Medical Holdings Delaware
Carte Medical Corp. Delaware
Creative Socio-Medics Delaware
IMI Acquisition Corp. Delaware
International Magnetic Imaging Florida
MD Corp. Florida
MRI-Net Florida
IMI Acquisition of Pine Island Corporation Florida
IMI Ltd. Partner Acq. of Pine Island, Inc. Florida
IMI Acquisition of North Miami Beach Corporation Florida
IMI Ltd. Partner Acq. of North Miami, Inc. Florida
IMI Acquisition of Boca Raton Corporation Florida
IMI Ltd. Partner Acq. of Boca Raton, Inc. Florida
IMI Acquisition of South Dade Corporation Florida
IMI Ltd. Partner Acq. of South Dade, Inc. Florida
IMI Acquisition of Oakland Park Corporation Florida
IMI Ltd. Partner Acq. of Oakland, Inc. Florida
IMI Acquisition of Orlando Corporation Florida
IMI Ltd. Partner Acq. of Orlando, Inc. Florida
PODC Acquisition Corporation Florida
PODC Ltd. Partner Acq. Corporation Florida
IMI Acquisition of Puerto Rico Incorporated Puerto Rico
IMI Acquisition of Arlington Corp. Virginia
IMI Acquisition of Kansas Corporation Kansas
MD Acquisition Corporation Delaware
MD Ltd. Partner Acq. Corporation Delaware
TeleVend, Inc. Delaware
ARC Networks Corp. New York
Trans Global Services, Inc. Delaware
Resource Management International, Inc. Delaware
ARC Acquisition Group, Inc. New York
Avionics Research Corp. New York
Avionics Research Corporation of Florida Florida
SES Holdings Corp. Delaware
Sequential Electronic Systems, Inc. Delaware
S-Tech, Inc. Delaware
Industry Lighting, Inc. Delaware
3D Holdings, Inc. Delaware
CDS Acquisition Corp. Delaware
CDS, Inc. Delaware
3D Technology, Inc. Delaware
3D Imaging International, Inc. Delaware
Universal International, Inc. Delaware
Universal International of Orlando, Inc. Florida
WWR Technology, Inc. Delaware
Audio Animation, Inc. Delaware
Prime Access, Inc. Delaware
TGS Services Corp. Delaware
Concept Technologies Group, Inc. Delaware
Vero Technologies, International Delaware
Lafayette Industries, Inc. Delaware
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND THE CONSOLIDATED STATEMENT OF OPERATIONS FILED
AS PART OF THE ANNUAL REPORT ON FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH ANNUAL REPORT ON FORM 10-K.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> DEC-31-1995
<CASH> 3,866,000
<SECURITIES> 241,000
<RECEIVABLES> 23,146,000
<ALLOWANCES> 2,012,000
<INVENTORY> 3,138,000
<CURRENT-ASSETS> 30,036,000
<PP&E> 39,670,000
<DEPRECIATION> 25,249,000
<TOTAL-ASSETS> 71,814,000
<CURRENT-LIABILITIES> 37,465,000
<BONDS> 0
<COMMON> 458,000
0
26,000
<OTHER-SE> 920,000
<TOTAL-LIABILITY-AND-EQUITY> 71,814,000
<SALES> 6,146,000
<TOTAL-REVENUES> 114,924,000
<CGS> 5,983,000
<TOTAL-COSTS> 92,760,000
<OTHER-EXPENSES> 28,914,000
<LOSS-PROVISION> 2,588,000
<INTEREST-EXPENSE> 4,546,000
<INCOME-PRETAX> (9,009,000)
<INCOME-TAX> 561,000
<INCOME-CONTINUING> (9,570,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,570,000)
<EPS-PRIMARY> (.23)
<EPS-DILUTED> 0
</TABLE>
