<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[Mark One]
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
Commission File Number: 0-24087
ITERATED SYSTEMS, INC.
(Exact name of registrant as specified in Its charter)
GEORGIA 58-1741516
(State or other Jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
3525 PIEDMONT ROAD
SEVEN PIEDMONT CENTER 30305-1530
SUITE 600 (Zip Code)
ATLANTA, GEORGIA
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (404) 264-8000
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 [_] No [X]
The number of shares of the issuer's class of capital stock as of July 1, 1998,
the latest practicable date, is as follows: 13,073,125 shares of Common Stock,
$.01 par value.
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ITERATED SYSTEMS, INC.
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 1998
(unaudited) and December 31, 1997
Condensed Consolidated Statements of Operations for the three and
six months ended June 30, 1998 and 1997 (unaudited)
Condensed Consolidated Statements of Cash Flows
for the six months ended June 30, 1998 and 1997 (unaudited)
Notes to Condensed Consolidated Financial Statements (unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures
2
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ITERATED SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 1997 JUNE 1998
------------- ------------
(unaudited)
ASSETS
Current assets
Cash and equivalents $ 7,633,283 $ 4,582,749
Short-term investments 9,999,420 7,749,458
Accounts receivable 495,668 254,835
Inventory 8,275 5,280
Other current assets 360,752 271,322
------------ ------------
Total current assets 18,497,398 12,863,644
Property and equipment 4,336,989 4,581,821
Accumulated depreciation (3,103,756) (3,610,138)
------------ ------------
Net property and equipment 1,233,233 971,683
Other assets 44,464 44,920
------------ ------------
TOTAL ASSETS $ 19,775,095 $ 13,880,247
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 206,321 $ 131,578
Accrued liabilities 639,460 655,754
Deferred revenue 5,126 5,126
Current maturities of debt 119,615 16,026
Other current liabilities 34,572 34,572
------------ ------------
Total current liabilities 1,005,094 843,056
Non-current liabilities
Long-term debt 4,874 2,538
Other liabilities 48,977 31,691
------------ ------------
Total non-current liabilities 53,851 34,229
Shareholders' equity
Common stock 131,020 130,731
Additional paid-in capital 30,012,721 29,777,008
Retained earnings (11,436,434) (16,917,343)
Currency translation adjustments 8,843 12,566
------------ ------------
Total shareholders' equity 18,716,150 13,002,962
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 19,775,095 $ 13,880,247
============ ============
3
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ITERATED SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
1997 1998 1997 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Development and exclusive license fees $ 2,894,000 $ 0 $ 5,777,000 $ 105,000
Software products and related revenues 114,835 0 250,867 904
Other license and contract revenues 9,407 153,333 18,725 328,426
----------- ----------- ----------- -----------
Total revenues 3,018,242 153,333 6,046,592 434,330
OPERATING EXPENSES:
Costs of product revenues 48,285 0 109,590 0
Sales and marketing 1,434,624 1,039,499 2,903,414 2,241,181
Research, development and engineering 2,352,914 1,361,717 4,731,466 2,915,061
General and administrative 446,692 613,203 995,138 1,172,434
----------- ----------- ----------- -----------
Total operating expenses 4,282,515 3,014,419 8,739,608 6,328,676
OPERATING LOSS (1,264,273) (2,861,086) (2,693,016) (5,894,346)
OTHER INCOME/(EXPENSE):
Interest income 33,332 198,013 74,909 434,171
Interest expense (35,174) (7,161) (56,767) (15,700)
Foreign currency exchange gain (loss) 2,472 193 2,381 (1,033)
----------- ----------- ----------- -----------
Total other income/(expenses) 630 191,045 20,523 417,438
----------- ----------- ----------- -----------
NET LOSS BEFORE INCOME TAXES (1,263,643) (2,670,041) (2,672,493) (5,476,908)
INCOME TAXES 0 0 0 4,000
----------- ----------- ----------- -----------
NET LOSS $(1,263,643) $(2,670,041) $(2,672,493) $(5,480,908)
=========== =========== =========== ===========
Basic and diluted net loss per share of
common stock $ (0.12) $ (0.20) $ (0.25) $ (0.42)
=========== =========== =========== ===========
Weighted average number of shares of
common stock outstanding 10,716,800 13,084,458 10,715,700 13,095,112
=========== =========== =========== ===========
</TABLE>
See accompanying notes.
4
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ITERATED SYSTEMS, INC.
Condensed Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30
------------------------------
1997 1998
----------- -----------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $(2,672,493) $(5,480,908)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 665,612 507,167
Compensatory stock options, net 94,804 0
Foreign currency transaction gain (loss) (7,452) 1,033
Gain on disposal of assets 0 (35)
Changes in operating assets and liabilities:
Accounts receivable (112,030) 240,833
Prepaid expenses and other 85,033 91,969
Accounts payable and accrued expenses (110,966) (58,449)
Other liabilities (133,442) (17,286)
----------- -----------
Net cash used in operating activities (2,190,934) (4,715,676)
INVESTING ACTIVITIES
Purchases of property and equipment (241,941) (244,832)
Net change in short-term investments 4,878 2,249,962
----------- -----------
Net cash provided by (used in) investing activities (237,063) 2,005,130
FINANCING ACTIVITIES
Proceeds from note payable to stockholder 3,000,000 0
Principal payments of notes and capitalized leases (146,983) (105,925)
Repurchase of common stock 0 (236,002)
Issuance of common stock 27,800 2,293
----------- -----------
Net cash provided by (used in) financing activities 2,880,817 (339,634)
Effect of exchange rate fluctuation on cash 369 (354)
----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 453,189 (3,050,534)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,150,834 7,633,283
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,604,023 $ 4,582,749
=========== ===========
</TABLE>
See accompanying notes.
5
<PAGE>
ITERATED SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(unaudited)
1. PRESENTATION OF INTERIM INFORMATION
The accompanying condensed consolidated financial statements include all
adjustments consisting of normal recurring adjustments that Iterated Systems,
Inc. and its wholly owned subsidiary, Iterated Systems, Limited (collectively,
the "Company") considers necessary for a fair presentation of its unaudited
results of operations for the six months ended June 30, 1997 and 1998. Results
for the three months ended June 30, 1998 are not necessarily indicative of the
results for the year.
2. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its wholly owned United Kingdom subsidiary, Iterated Systems, Limited.
Significant intercompany accounts and transactions have been eliminated in
consolidation.
3. PURCHASES AND SALES OF COMMON STOCK
During the six months ended June 30, 1998, the Company repurchased 36,100
shares of its common stock on the open market for a cost of approximately
$236,000. The Company also issued 7,200 shares upon the exercise of stock
options by employees for net proceeds of $2,000.
4. NET LOSS PER SHARE OF COMMON STOCK
In February 1997 the Financial Accounting Standards Board ("FASB") issued
Statement No. 128, Earnings Per Share ("Statement 128"), which establishes
standards for computing and presenting earnings per share ("EPS") for entities
with publicly held common stock. Statement 128 requires the presentation of
basic and diluted EPS on the face of the income statement for all entities with
complex capital structures. The Company adopted Statement 128 in 1997 and, in
accordance with the requirements thereof, restated its net loss per share for
all prior periods. The effect of adoption was not material to the accompanying
condensed consolidated financial statements. Net loss per share of common stock
is computed based on the weighted average number of shares outstanding during
the year.
5. COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement No. 130, Reporting Comprehensive
Income ("Statement 130"), which establishes standards for reporting and display
of comprehensive income and its components (revenues, expenses, gains and
losses) in financial statements. Statement 130 is effective for fiscal years
beginning after December 15, 1997. The Company adopted Statement 130 in 1998 and
has not presented a statement of comprehensive income because the effect of the
components of comprehensive income is not material to its consolidated financial
statements.
6
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ITEM 2.
ITERATED SYSTEMS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
LIQUIDITY AND FINANCIAL CONDITION
At June 30, 1998, the Company had cash and short-term investments in excess
of $12,000,000 and shareholders' equity in excess of $13,000,000. The Company
believes it has adequate cash to cover its needs for the next year. However,
the Company will require significant increases in revenue to cover operating
costs and achieve a profitable level of operations. If this level of revenues
is not achieved on a timely basis, the Company will need to raise additional
capital.
On June 30, 1997, the Company amended the Bridge Financing Credit Facility
with Mosvold Farsund AS (the "Lender"), one of its shareholders, to allow the
Company to borrow up to $6,000,000 from the Lender until June 30, 1998. During
the second quarter of 1997, the Company borrowed $3,000,000 from the Lender
under this financing agreement. During the fourth quarter of 1997, the Lender
exercised its option to convert the $3,000,000 in outstanding borrowings into
300,000 shares of the Company's common stock at $10 per share. The Credit
Facility expired on June 30, 1998.
In the first six months of 1997 and 1998 the Company used cash in operating
activities of $2,190,000 and $4,716,000. This cash was used to fund the net
loss for the respective periods. The increase in cash utilized in 1998 over
1997 was due to the significant reduction in revenues as discussed in "Results
of Operations" below.
In the first six months of 1997 and 1998 the Company had cash provided by
(used in) investing activities of ($237,000) and $2,005,000 respectively. The
funds provided in 1998 were from the maturity of short-term investments.
In the first six months of 1997 and 1998 the Company had cash provided by
(used in) financing activities of $2,880,000 and ($340,000), respectively.
During 1997 a loan from a stockholder for $3,000,000 provided the significant
source of funds. In the first six months of 1998 the company repurchased
approximately 36,000 shares of Company common stock on the open market at a cost
of $236,000 in accordance with a plan authorized by the Company's Board of
Directors having a maximum limit of $1,500,000.
7
<PAGE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
Revenues
Total revenues decreased 95% to $153,000 in the three months ended June 30,
1998 compared to $3,018,000 in the same period in 1997. The decrease was the
result of the expiration of the MCI development contract at September 30, 1997
and the decrease in the sale of packaged software products resulting from the
Company's planned shift in focus from research based revenue and packaged
software products to the development of relationships with OEMs whose position
and time-to-market would be positively impacted by using the Company's
technology in their own products. The MCI contract resulted in development fee
and exclusive license fee revenue in the amount of $2,367,000 during the three
month period ended June 30, 1997.
Cost of Product Revenues
Cost of product revenues decreased 100% to $0 in the three months ended
June 30, 1998 from $48,000 in the same period in 1997. The Company is not
confident in the long-term sales growth of codec packaged software products, and
as a result has reduced its focus, expenditures and marketing efforts in these
markets.
Sales and Marketing
Sales and marketing expenses decreased 28% to $1,039,000 in the three
months ended June 30, 1998 from $1,435,000 during the same period in 1997.
During the third quarter of 1997, the Company restructured and reduced its
workforce to focus on a more effective implementation of its business plan. This
resulted in decreased personnel and associated expenses in the sales and
marketing area during the second quarter of 1998 compared to the same period in
1997.
Research, Development and Engineering
Research, development and engineering expenses decreased 42% to $1,362,000
in the three months ended June 30, 1998 from $2,353,000 in the same period in
1997. The decrease is primarily the result of lower personnel and related
expenses resulting from the Company's personnel reductions during the third
quarter of 1997 as discussed above.
General and Administrative
General and administrative expenses increased 37% to $613,000 in the three
months ended June 30, 1998 from $447,000 in the same period in 1997. This
increase is due to the increased legal and professional costs associated with
the Company currently being publicly traded on the Oslo Stock Exchange and an
SEC reporting company in the United States, whereas it was a privately held
company in 1997.
Interest Income
Interest income increased 494% to $198,000 in the three months ended June
30, 1998 from $33,000 in the same period in 1997. In September 1997, the Company
received approximately $18,600,000 in net proceeds from an initial public
offering of common stock on the Oslo Stock Exchange. The increase is due to
higher interest earnings on the increased cash and short-term investment
balances resulting from the proceeds of the Company's public offering in the
third quarter of 1997.
8
<PAGE>
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
Revenues
Total revenues decreased 93% to $434,000 in the six months ended June 30,
1998 compared to $6,047,000 in the same period in 1997. The decrease in
revenues is due to the expiration of the MCI development agreement at September
30, 1997 and the decrease in the sale of packaged software products resulting
from the Company's planned shift in business focus, as discussed previously.
Cost of Product Revenues
Cost of product revenues decreased 100% to $0 in the six months ended June
30, 1998 from $110,000 in the same period in 1997 due to the Company's reduced
focus on the sale of packaged software products.
Sales and Marketing
Sales and marketing expenses decreased 23% to $2,241,000 in the six months
ended June 30, 1998 from $2,903,000 in the same period in 1997. The decrease is
primarily the result of the workforce reductions discussed previously.
Research, Development and Engineering
Research, development and engineering expenses decreased 38% to $2,915,000
in the six months ended June 30, 1998 from $4,731,000 in the same period in
1997. The decrease is primarily the result of the workforce reductions discussed
previously.
General and Administrative
General and administrative expenses increased 18% to $1,172,000 in the six
months ended June 30, 1998 from $995,000 in the same period in 1997. This
increase is primarily due to the increased legal and professional costs
associated with the Company currently being publicly traded on the Oslo Stock
Exchange and an SEC reporting company in the United States, whereas it was a
privately held company in 1997.
Interest Income
Interest income increased 480% to $434,000 in the six months ended June 30,
1998 from $75,000 in the same period in 1997. The increase is due to higher
interest earnings on the increased cash and short-term investment balances
resulting from the proceeds of the Company's public offering in the third
quarter of 1997.
Interest Expense
Interest expense decreased 72% to $16,000 in the six months ended June 30,
1998 from $57,000 in the same period in 1997. The decrease in 1998 is primarily
due to reduced interest expense on outstanding borrowings under the Mosvold
credit facility that was converted into equity in the fourth quarter of 1997.
IMPACT OF YEAR 2000
Many currently installed computer systems and software programs were designed
to use only a two digit date field. These date code fields will need to accept
four digit entries to distinguish 21st century dates from 20th century dates.
Until the date fields are updated, the systems and programs could fail or give
erroneous results when referencing dates following December 31, 1999. Such
failure or errors could occur prior to the actual change in century. The
Company does not believe that any of its internally developed
9
<PAGE>
software products will be adversely affected by Year 2000 issues. However, the
Company relies on computer applications to manage and monitor its accounting,
sales, development and administrative functions. In addition, the Company's
customers, suppliers and service providers are reliant upon computer
applications, some of which may contain software that may fail as a result of
the upcoming change in century, with respect to functions that materially affect
their interactions with the Company. The Company has undertaken, but has not
yet completed, an assessment as to whether any of its customers, suppliers or
service providers will be affected by the upcoming change in century. Failure
of software used by the Company or the software of its customers, suppliers or
service providers could have a material impact on the Company's business,
financial condition and result of operations.
While the total cost to address the Company's Year 2000 issues has not yet
been determined, the Company has not identified significant costs to date. The
Company believes it has sufficient resources for the Year 2000 remediation
program from currently available cash, cash equivalents, liquid investments,
cash flow expected from operations and/or borrowings. The Company has not
established a contingency plan to handle any identifiable Year 2000 issues if
they are not adequately addressed prior to December 31, 1999, and it does not
intend to create such a plan.
Software Revenue Recognition
In October 1997 the American Institute of Certified Public Accountants
issued Statement of Position 97-2 ("SOP 97-2"), Software Revenue Recognition, to
clarify guidance on applying generally accepted accounting principles to
software transactions and to provide guidance on when revenue should be
recognized and in what amounts for licensing, selling, leasing, or otherwise
marketing computer software. The Company adopted SOP 97-2 during 1997. Such
adoption had no effect on the Company's methods of recognizing revenue.
INFLATION
The effects of inflation on the Company's operations were not significant
during the periods presented in the condensed consolidated financial statements
and the effects thereof, are not considered to be of significance in the future.
Generally, throughout the periods discussed above, the changes in revenue have
resulted primarily from fluctuations in sales levels, rather than price
increases.
BUSINESS SEGMENTS
In June 1997, the FASB also issued Statement No. 131, Disclosures about
Segments of an Enterprise and Related Information ("Statement 131"), which
establishes standards for the way public business enterprises report information
about operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. Operating segments are components of
an enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision-maker in deciding how to
allocate resources and in assessing performance. Statement 131 also establishes
standards for related disclosures about products and services, geographic areas,
and major customers. Statement 131 is effective for financial statements for
periods beginning after December 15, 1997 but is not required for interim
financial statements in the year of adoption. The Company will adopt Statement
131 at the end of 1998 and does not expect the effect of such adoption to be
material to its consolidated financial statements.
FORWARD-LOOKING STATEMENTS
The discussions herein contain trend information and other forward-looking
statements that involve a number of risks and uncertainties. The actual results
of the Company could differ materially from its historical results of operations
and those discussed in the forward-looking statements. The forward-looking
statements
10
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are based on the beliefs of the Company's management as well as assumptions made
by and information currently available to the Company's management. When used
herein, the words "anticipate," "believe," "estimate," "expect" and "intend" and
words or phrases of similar import, as they relate to the Company or the
Company's management, are intended to identify forward-looking statements.
11
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
The following exhibits are filed with this Report:
Exhibit 27.1 Financial Data Schedule
Exhibit 99.1 Certain Risk Factors Related to the Company
(b) Reports on Form 8-K.
None.
12
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ITERATED SYSTEMS, INC.
Date: August 13, 1998 /s/ John C. Bacon
--------------- ------------------
John C. Bacon
President and Chief Executive Officer
(Principal Executive Officer) and
Director
Date: August 13, 1998 /s/ Haines H. Hargrett
--------------- -----------------------
Haines H. Hargrett
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
13
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 4,582,749
<SECURITIES> 7,749,458
<RECEIVABLES> 258,503
<ALLOWANCES> (3,668)
<INVENTORY> 5,279
<CURRENT-ASSETS> 12,863,644
<PP&E> 4,581,821
<DEPRECIATION> (3,610,138)
<TOTAL-ASSETS> 13,880,247
<CURRENT-LIABILITIES> 843,056
<BONDS> 2,538
0
0
<COMMON> 130,731
<OTHER-SE> 13,002,962
<TOTAL-LIABILITY-AND-EQUITY> 13,880,247
<SALES> 904
<TOTAL-REVENUES> 434,330
<CGS> 0
<TOTAL-COSTS> 2,915,061
<OTHER-EXPENSES> 3,413,615
<LOSS-PROVISION> 975
<INTEREST-EXPENSE> 15,687
<INCOME-PRETAX> (5,476,908)
<INCOME-TAX> 4,000
<INCOME-CONTINUING> (5,480,908)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,480,908)
<EPS-PRIMARY> (0.42)
<EPS-DILUTED> (0.42)
</TABLE>
<PAGE>
Exhibit 99.1
RISK FACTORS
The following factors may affect the Company's future performance.
History of Operating Losses and Accumulated Deficit. The Company was
organized in 1987 and has incurred net operating losses since 1991. The Company
had an accumulated deficit at December 31, 1997 of approximately $11,436,000.
The Company will require significant increases in revenues to cover projected
development, selling, marketing and other operating costs and to achieve a
profitable level of operations, and there can be no assurance as to when or if
such increases in revenues will be achieved.
Loss of Revenues from 1994 MCI Agreement. During the period from September
1994 until September 1997, approximately 84% of the Company's revenues were
derived from MCI under the 1994 MCI Agreement. Due to the expiration of the
1994 MCI Agreement in September 1997, the Company's revenues have decreased
dramatically and no assurance can be made that the Company will be successful in
replacing revenues at this level in the near term.
Shift in Business Focus. The Company has revised its business plan to
reflect its belief that it is better suited to developing and delivering its
technology to OEMs for inclusion in their products. As a result of this shift in
focus and the expiration of the Company's agreement with MCI, total revenues
decreased 93% in the six months ended June 30, 1998 compared to the same period
in 1997. The Company's future financial performance will depend in large part on
the successful implementation of its new business focus. There can be no
assurance that the Company will succeed in implementing its business strategy
and any failure to do so would have a material adverse effect on the Company's
business, financial condition and results of operations.
Dependence on Utilization of Company Products by Emerging Markets.
Currently, only a limited number of applications incorporating the Company's
products or technologies are in commercial production. The Company has derived
substantially all of its product revenues to date from sales of products for
these applications and sales of products for development, trials and early
deployment of applications that are not yet commercially available or are not
yet in volume production. The Company's ability to generate significant
revenues will be dependent on the development of new opportunities for digital
images in the computer and photography markets and/or the adoption of the
Company's technologies by producers and users of such images. The potential
size of these new market opportunities and the timing of their development are
uncertain.
Potential Variability of Quarterly Operations and Financial Results.
The Company's quarterly operating results have in the past and may in the future
vary significantly depending on factors such as revenue from software sales, the
timing of new product and service announcements, market acceptance of new and
enhanced versions of the Company's products, the size and timing of significant
orders, changes in operating expenses, changes in Company strategy, and general
economic factors. The Company has limited or no control over many of these
factors. The Company operates with virtually no services or software product
order backlog because its services are purchased on demand and its software
products typically are shipped shortly after orders are received. As a result,
revenues in any quarter are substantially dependent on the quantity of purchases
of services requested and product orders received in that quarter. Quarterly
revenues also are difficult to forecast because the market for the Company's
products is evolving and the Company's revenues in any period are significantly
affected by the announcements and product offerings of the Company's competitors
as well as alternative technologies. As a result, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
Dependence on New Product Development; Risk Associated with Technological
Advances. The Company's operating results will depend to a significant extent
on its ability to successfully introduce new products and improve its core
technology on a timely basis and/or reduce costs of existing products. As a
result, the Company believes that continued significant expenditures for
research and development will be required in the future. There can be no
assurance that new products will be successfully developed or will achieve
market acceptance.
<PAGE>
Competition. The development and marketing of digital image products and
technologies is extremely competitive. Many of the companies developing and
marketing competitive technologies have competitive advantages over the Company,
including established positions in the market, brand name recognition,
established ties with OEMs, and the use of industry standards for digital
compression and decompression such as MPEG and JPEG which can be obtained at
little or no cost to the user. Further, there can be no assurance that the
Company's competitors will not succeed in developing products or technologies
that are more effective than those being developed by the Company or that would
render the Company's products and technologies obsolete. In addition, many of
the Company's competitors have substantially greater financial, technical,
marketing and human resources capabilities than the Company.
Substantial Continuing Capital Needs; Uncertainty of Additional Funding.
The Company anticipates that, in order to maintain a competitive position in its
market, it will have to expend substantial resources to continue research and
development relating to potential applications and new technologies and expand
its sales, marketing and distribution activities. There can be no assurance
that the Company will be able to generate internally the funds necessary to
continue such research and development efforts or to expand sales and marketing
activities, or that additional funds from outside sources will be available for
such purposes.
Dependence on Management. The Company is substantially dependent upon the
efforts and abilities of its officers, directors and certain key employees. The
loss or unavailability to the Company of any of its executive officers, or any
of its directors or key employees could have a material adverse effect upon the
Company. The Company has employment agreements with certain key employees. The
Company does not maintain key man life insurance policies on any of its key
employees. As a result, the Company's operations could be adversely affected
upon the death of any of its key employees.
International Operations. The Company believes that its continued growth
and profitability may require increasing its international revenues.
International operations are subject to inherent risks, including the impact of
possible recessionary environments in economies outside the U.S., changes in
legal and regulatory requirements, changes in tariffs, currency exchange
fluctuations, reduced protection for intellectual property rights in some
countries, potentially adverse tax consequences and political and economic
instability. There can be no assurance that the Company will be able to sustain
or increase international revenue, or that the factors listed above will not
have a material impact on the Company's international operations. This
expansion will require financial resources and significant management attention.
Dependence on Patents and Proprietary Rights. The Company's ability to
compete effectively will depend in part on its ability to maintain the
proprietary nature of its technology through a combination of copyright, patent
and trade secret protection and contractual provisions and non-disclosure
agreements. Competition in the Company's market is intense and there can be no
assurance that the Company's competitors will not independently develop or
obtain patents on technologies that are substantially equivalent or superior to
the Company's technology. The Company could incur substantial costs in
defending itself in patent infringement lawsuits brought by others and in
prosecuting patent infringement lawsuits against third party infringers. The
Company also relies on trade secrets and proprietary know-how that it seeks to
protect, in part, by non-disclosure agreements with its employees, suppliers,
consultants and potential strategic partners and customers. There can be no
assurance that these agreements will not be breached, that the Company will have
adequate remedies for any such breach or that the Company's trade secrets and
proprietary know-how will not otherwise become known or be independently
developed by competitors.
