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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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FORM 10
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AMENDMENT NO. 1
GENERAL FORM FOR REGISTRATION OF SECURITIES
PURSUANT TO SECTION 12(b) OR 12(g) OF
THE SECURITIES EXCHANGE ACT OF 1934
ITERATED SYSTEMS, INC.
(exact name of registrant specified in its charter)
Georgia 58-1741516
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3525 Piedmont Road
Seven Piedmont Center
Suite 600 30305-1530
Atlanta, Georgia (zip code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (404) 264-8000
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Securities registered pursuant to Section 12(b) of the Act:
None
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Securities registered pursuant to Section 12(g) of the Act:
Title of each class
Common Stock, par value $.01 per share
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ITEM 1. BUSINESS.
General
Iterated develops, licenses and markets digital still image and video
science technology based upon its emerging Imaging Systems Architecture (ISA),
to original equipment manufacturers (OEM's) seeking innovative, high performance
solutions to problems arising from the convergence of the content,
communications and computer markets.
The Company was founded in 1987 by Dr. Michael Barnsley and Dr. Alan Sloan,
who at that time were tenured members of the mathematics faculty at the Georgia
Institute of Technology. Their early work was based on the discovery that
real-world images could be generated by plotting fractal equations. The term
fractal was developed by Benoit Mandelbrot to describe a structure (i.e. image)
possessing similar looking forms of many different sizes. Using fractal
relationships, images can be described as a series of relationships among its
various parts rather than by a series of independent dots (pixels). By using
mathematical equations incorporating fractal relationships, Drs. Barnsley and
Sloan developed processes to reproduce and manipulate digital images using file
sizes that are signficicantly smaller and easier to use than when dealing with
pixel representations. An early experiment produced the Iterated Systems fern
logo from only a few bits of data, using a fractal process known as an Iterated
Function System.
Iterated's initial products provided fractal image compression and included
its Fractal Imager. Iterated's fractal compression products, based on Dr.
Barnsley's patented Fractal Transform algorithm method (which was assigned to
Iterated), store and display fractal-compressed images in Microsoft's Encarta
CD-ROM encyclopedia, the Great Artists CD-ROM series, and other CD-ROM and
screen saver titles.
Iterated developed its ClearFusion, ClearVideo, ClearVideo Live and Fractal
Viewer applications to meet the demand for high quality, easy to download images
and video on the Internet. By working with customers such as RealNetworks,
Terran Interactive, The Altimira Group and Microsoft, Iterated's video products
work with various standard applications and video formats.
Iterated's technologies are based upon the Company's research and
development expertise in digital image science and fractal-based mathematics
that have evolved over more than ten years in the digital image business.
Through Iterated's ongoing research, the Company expects to continue to evolve
its Imaging Systems Architecture and to develop software products and new
technologies for incorporation by OEMs into end user products.
The Company was organized under the laws of the State of Georgia on May
28,1987. On May 20, 1991, Iterated Systems Limited was incorporated in the
United Kingdom as a wholly-owned subsidiary of the Company to function as the
Company's European sales office.
Industry Trends
The Company operates in the high technology marketplace and develops
technology to help its customers exploit the evolution of image management
workflows from the traditional analog to new digital systems. Image management
workflows involve the creation, editing and distribution of images. The
Company's target customers are experiencing rapid changes in these workflows.
The Company believes there are three concurrent events creating instability and
opportunity for information based companies searching for imaging solutions.
These are the convergence of the content, communications and computer markets;
the advancement of digital media; and the demand for more features, applications
and user options.
Convergence. Alliances between companies like Microsoft and NBC, and MCI
and NewsCorp, illustrate the convergence of content, communications and computer
markets. Frequent mergers occur among companies in the related industries of
telecommunications, cable TV, and Internet services. The Company believes that
computing and television giants will compete to deliver television programming
to computer screens and to deliver the Internet to television screens.
Converging industries will require image and video technologies that can cross
over from their traditional formats and delivery systems to their new
partners.
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The Digital Age. The Company believes that the final days of analog media
are here, heralding the fruition of a digital age. The Company anticipates that
digital still image and video cameras, digital scanners, and digital
high-definition television (HDTV) will be only a few of the consumer products in
high demand in the digital age. The Company also believes that content producers
will need entire workflow systems, including production-quality digital
scanners, cameras and printing presses; digital editing and broadcasting
studios; and digital distribution systems for news, entertainment and games. As
a result, in the Company's view, tremendous opportunity exists for new digital
image science technologies to replace traditional analog methods.
Feature Demand. The Company believes consumer and professional users of
technology products will demand the new features and flexibility that digital
images and video can offer. Already, the desire to transmit photographs over the
Internet has caused photo processors to offer digitization and output to
diskette. As digital image and video data become more prevalent, the Company
expects that the possibilities for using and reusing data will multiply, along
with the products needed in the marketplace.
The Company's Strategy for the Digital Age
The Company's strategy is to continue developing component technologies for
OEMs seeking to provide enhanced quality digital images at faster speeds. Taking
advantage of its core competencies, the Company sees significant potential in
providing digital imaging science components in a range of vertical markets
across the converging image industries. During the last year the Company has
evolved a business plan to take advantage of the changes in the digital imaging
industry.
Imaging Systems Architecture
Evolving from over ten years of digital image science research, the Company
is continuing to develop its ISA from which component products will be
constructed. By building its components from one foundation, the Company plans
to offer individual solutions for its customers and an entire suite of
compatible and complementary products that the Company believes can
significantly advance digital imaging.
The ISA is the technological basis for the Company's development and its
objectives are:
- To provide a common foundation for the development of component
technology products.
- To bring digital quality to entire workflows. The Company expects that
acceptable digital solutions must apply to the entire workflow, from
creation of original content to viewing by the end-user. Users are expected
to demand digital quality and capabilities at all steps in the process,
with easy transitions between the steps. For example, content should be
easy to digitize and should be editable without format conversion.
- To unify converging technologies. Within the converging imaging
industries, demand is expected to increase for technologies that converge
in a like manner. Image and video data formats and the tools which
manipulate them should be designed with the expectation that end-users will
want to use the same data for multiple purposes and will demand the same
features across platforms and applications.
- To be adaptable to rapid change in unstable markets. New market demands
and new technologies are expected to cause the Company's technologies to
change. The Company believes that its technical strategy must be flexible
and integrated while extending existing standards in the marketplace.
The ISA offers the following technology features:
- Resolution-on-demand is a feature of fractal encoding which can be the
basis for technical solutions to eliminate or reduce the need to redigitize
data at multiple resolutions. Using the Company's patented compression
methods, an image can be efficiently stored in terms of its internal
similarities and not in terms of a pixel grid. Therefore, one encoded image
could be rendered to many sizes and resolutions for screen display,
downloading over networks, and printing on a laser printer or a
high-quality printing press. In this case, no additional content creation
(reformatting or redigitizing) is needed because one master image serves
many purposes. Images retain quality with minimal compromises for smaller
file size.
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- Bandwidth scalability makes it possible to transmit or deliver data with
quality, subject to bandwidth limitations. As new imaging technologies are
developed, they are expected to employ a wider range of bandwidths to
transmit data. The Company believes that the Internet already demonstrates
a need for specially prepared and reduced image content to meet bandwidth
constraints. The Company's data types are scalable to varying bandwidths in
most cases. One image file can generally be transmitted at many data rates,
preserving image quality.
- Variable loss encoding is one of the Company's technologies allowing
original images to be reconstructed after decompression. This technology is
designed to meet the end-user's demand for high-quality viewing of
images.
The overall benefit of the ISA is multi-purpose image representation. ISA
permits image representation throughout the content creation, editing,
transmission, and viewing processes of the digital imaging workflow. This
technology can also be used on various devices, with different outputs, rendered
at differing resolutions and delivered at various bandwidths.
Markets and Applications
The Company's primary target customers are OEMs seeking to improve their
competitive position and time to market by incorporating the Company's
technology into the OEM's own workflows and products. The Company seeks to build
relationships with large systems vendors with substantial stakes in one or more
segments of the emerging digital convergence markets, with the intent of
licensing components of the ISA to these vendors. This strategy is intended to
improve target customers' competitive positions within existing market
segments.
One of the Company's goals is to generate recurring royalties and license
fees from its OEMs. In some cases, the Company may receive non-recurring
engineering fees or fees for shared-risk development.
Although the ISA has applications in a variety of markets, the Company has
identified three specific Line of Business initiatives with associated target
markets. These initiatives represent both near-term and long-term prospects:
<TABLE>
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MARKET ENTRY POINT INITIAL PRODUCT
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<S> <C> <C>
Graphic Arts Large image handling Adobe Photoshop plug-in
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Digital Photography Sensor enhancement and image CCD array interpolator and low
scaling cost printer devices
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Digital Video for High Quality VHS video at sub-MPEG rates Digital Video for ADSL/xDSL and
applications Advertising and training cable modem delivery
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The Company's markets and its customers' markets as described in this
document use terms that are defined below:
. CCD - Charge Couple Device is a light sensitive electronic device used
to capture an image on a digital camera disc.
. VHS - Video Home System refers to the video systems used in the home,
such as tape and disc players.
. JPEG - Joint Photographic Experts Group establishes standards for still
images.
. MPEG - Motion Picture Experts Group is the international body that
establishes standards for use in the motion picture video image
industry.
. ADSL - Asymmetric Digital Subscriber Line is a transmission method by
which video can be delivered over existing phone lines at relatively low
bandwidths.
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. xDSL - represents a range of bandwidths, higher than ADSL that may be
developed in the future for the transmission of video.
Each of these opportunities is discussed in the following sections.
Graphic Arts
The graphic arts industry consists primarily of independent prepress shops,
advertising agencies, design firms, stock houses and printers, all preparing
digital content. Massive and complex digital image files are transmitted
physically between stock houses, design firms, the prepress house and the
printer. The work often occurs under tight deadlines with large penalties for
missed deadlines (e.g., if the finished ad is not delivered to the magazine on
time, the client is billed for the space even though the ad will not run).
The graphic arts workflow can be substantially improved by applying
components of the ISA family of still image handling technologies collectively
known as STiNG. Using STiNG, graphic arts professionals may experience the
following improvements in process and workflow over their current practices:
- Image asset management allows the integration of traditional graphic arts
workflows with Internet publishing workflows. By storing just one image,
users may re-purpose that image for higher and lower resolution
applications. For example, the same image may be used in low resolution on
a Web site, in medium resolution on a printed brochure, and in high
resolution on a poster. In this example, one image is used three times for
very different applications, whereas three images would be needed in the
current system. Using a single image provides savings in time, space and
money.
- Fractal-based image enlargement technology enables users to create very
large, high-quality images, such as posters, to meet the demanding
standards of the corporate advertising world.
- Smaller image files will facilitate the transmission of images over
existing digital networks like the Internet. Stock houses and advertising
agencies could more efficiently send images to clients. (Existing
compression techniques enable image transfers over networks, but often
quality is sacrificed for file size.)
STiNG is available today for use in the prepress, printing and graphic arts
industries. Initial sales are expected in the third quarter of 1998.
Digital Photography
Digital still image cameras for widespread consumer use did not exist two
years ago. One year ago they were expensive curiosity items for early adopters.
Now they are available at price points which rival those of their film-based
predecessors. However, the quality of the output images is still inferior to
comparably priced film cameras. The Company believes that quality must improve
before digital cameras will have a significant market share. The Company's KLiCK
family of digital photography technology is expected to provide substantial
quality/cost enhancements over current methods through ISI developed methods
that improve the quality of the image being captured in a digital camera at the
moment of capture and through the storage and output process. The Company
believes that by applying the KLiCK technology early in the image processing
cycle, the captured image can be used to produce a larger output image of equal
quality for the same cost or to produce a similar size and quality image at a
lower cost than other options available to camera manufacturers today. The
Company believes that this strategy is important for two reasons:
- The earlier in the image workflow that information is digitized in a high
quality form, the greater the opportunity to maintain high quality throughout
the life of the image (editing, re-use, re-edit, etc.); and
- It opens up a new set of devices as targets for the Company's technology
as well as a new set of potential customers for this technology.
Incorporation of KliCK technology in digital cameras provides the Company
with the opportunity to add value to the entire digital image workflow. Certain
components of the architecture are suitable for inclusion in the camera itself.
The Company believes that other components can enhance image quality during the
downstream
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process of editing, transmission and output/printing. KliCK is under development
and initial target offering is expected in fourth quarter of 1998.
Digital Video for High Quality Applications
The main challenge facing the digital video world is the delivery of video
to the digital advertising, educational/training and entertainment markets that
meets or exceeds the quality of its analog predecessors. The Company believes
that consumer demand will require television quality video and the Company is
developing ViO technology to meet this demand. The Iterated ViO family of
digital video technology is designed to deliver entertainment-quality digital
video over communications bandwidths that are substantially lower in capacity
than those required by the traditional approaches incorporating MPEG. The
current digital network infrastructure is predominantly designed to handle
relatively small data transmissions (letters, e-mails, faxes) in units of
transmission that are not time dependent and which can be measured in thousands
of bytes per second. The bandwidth needed for the transmissions of entertainment
quality video in digital form is measured in million of bytes per second and is
very time dependent. The ViO technology is built to help provide the highest
quality video experience in the smallest possible bandwidth and is specifically
adapted to the 380kbps - 2.0mbps bandwidth range that represents a potential
market for entertainment video. As more types of devices such as TV set top
boxes, direct broadcast satellite tuners and personal computers are developed to
deliver video to the customer, a video technology that is flexible enough to
work in all of these environments is necessary. ViO is designed to meet this
need.
There are many applications that potentially fall under the entertainment
video umbrella, but the Company believes the following to be the most promising
because it appears that significant funding may be committed to these
initiatives:
- Telecommunications and Regional Bell Operating Companies (RBOCs):
companies providing analog voice and data to consumers through fiber-optic
or wireless cable. Telephone companies, including RBOCs, are aggressively
investing in technology to compete with satellite and cable companies for
provision of video services directly to the consumer. RBOCs are using
wireless cable and ADSL (Asynchronous Digital Subscriber Line) to compete
with the cable companies.
- Cable companies: companies providing analog content via coaxial cables to
local cable companies which direct the analog signal to consumers. Given
intense competition from DBS, cable companies are evaluating technology
investments for conversion to digital services.
- Corporate communications: companies that desire to use digital video to
communicate to remote locations, i.e., distance learning. Systems
integration providers typically supply Fortune 500 corporations with the
tools and services needed for the implementation of these applications.
- DBS companies: companies providing digital content via satellites
directly to the consumer (also known as DTH: Digital To Home).
- Advertising on the Internet: companies that provide digital video
advertisements to Internet Service Providers for insertion into programming
and distribution to the consumer through high speed digital access such as
xDSL and cable modems.
Competition
The Company has classified competition to its ISA-based strategy into three
categories: (1) single solution component providers; (2) product and system
providers; and (3) international standards.
Single Solution Component Providers. Many competitors are focused on
providing single solutions based on compression technology for video and still
images. Many of these competitors offer solutions to specific problems in the
area of compression/decompression.
Product and System Providers. Many companies outside the compression and
image science markets are developing image-based products and systems such as
digital printers, scanners, cameras, and editors. Historically, many of these
companies have funded certain image-related development work internally. The
Company believes
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that global market pressures and rapid technology change provide the Company
with an opportunity to develop business relationships with companies in this
category which are seeking to develop unique image products in their respective
markets.
International Standards. To date many companies have used products based on
international standards such as MPEG and JPEG. These standards are widely
accepted and generally available, some at low or no cost to the user. To
overcome the competition of standards, the Company must provide technology
solutions with enhanced value to offset or be compatible with the broad
acceptance of existing standards. The Company believes that (i) its ISA will
provide enhanced value, and (ii) the current standards will undergo substantial
modification and replacement to keep up with technological changes and the
Company can develop compatible OEM solutions. When such modifications and
replacements occur, the Company believes it may have an opportunity to propose
that the Company's technology be included in the standardization process.
Moreover, because of available computation power from personal computers, the
Company believes that it may become increasingly possible to make its ISA
compatible with international standards. In addition, the Company believes there
are significant opportunities where standards are not considered to be a
dominant factor, such as in the Company's current digital photography
effort.
Within the graphic arts market for which STiNG technology is directed no
single company is dominant. Several single solution component providers supply
the market with products that solve only a portion of the total workflow
problem. They include Warp10, LivePicture and Pegasus.
In the digital photography market the internal development teams of camera
hardware manufacturers themselves represent Iterated's major competitors.
Iterated feels that its technology and the ability to rapidly adapt its
technology to the entire workflow process, from camera to PC to output device,
offer an overall cost-effective solution for the quality production of digital
images.
In the market for digital video image solutions, as specifically addressed
by ViO, there are no dominant companies. Several companies who are significant
in one or more related segments of the industry include Xing, RealNetworks,
Microsoft and Intel.
In each market segment the Company is attempting to provide technology to
OEM customers to effectively improve the quality/cost ratio of their
products.
Research and Development/Patents
During 1995, 1996 and 1997 the Company has spent $8,685,000, $8,966,000 and
$8,261,000 respectively in the research and development of new technologies,
refining and improving its technologies and the customization of its
technologies to the needs of specific customers. The Company expects that
continued significant expenditures in this area will be necessary to
successfully introduce new products and improve its core technology and no
assurances can be made that these development efforts will be successful.
Consistent with its emphasis on research and development, the Company
maintains an aggressive patent filing program. To date, the Company holds six
issued U.S. patents with expiration dates from 2009-2015, holds an exclusive
license to a seventh issued U.S. patent expiring in 2007, and has received
notices of allowance of claims on four additional pending applications.
A significant portion of its past research and development expenditures
have been funded by its customers.
Since March 1995, the Company has filed a total of 21 new U.S. patent
applications, and several are under preparation. To date, international
applications corresponding to certain of the new U.S. applications have been
filed utilizing the Patent Cooperation Treaty (PCT) procedure, which generally
requires that PCT applications be filed within one year of the original national
filing.
The Company's patents and patent applications are intended to provide a
degree of patent protection of the Company's technology as applied to products
developed under the Company's ISA, particularly as applied in the area of
real-time video codecs (technology for compression and decompression of images),
store and forward video codecs and still image codecs. The markets for these
lossy codecs are highly competitive, and the Company believes that its research
and development efforts and resulting patents are essential to an effective
market presence.
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In addition to its research and development of lossy codec products, the Company
is pursuing advanced research in the area of lossless codecs, and has filed
certain relevant patent applications.
The term lossless refers to compression/decompression technology in which
all of the data in an image is retained throughout the process. The term lossy
refers to compression/decompression technology in which some of the data is lost
in the process but is either not noticeable to the viewer (visually lossless) or
is required to be eliminated to reduce file size in order to make the file
manageable.
Recent Changes to Business Plan
The Company's current strategies and business direction, including the
decision to focus its primary efforts on the development of OEM relationships
for its technology, were developed during the first half of 1997 due to the
anticipated expiration of the MCI agreement and changes in market conditions
relating to software products for use on the Internet. For the years 1994-1997
these two markets provided over 77% of the Company's revenues. A reevaluation of
the Company's strengths and expertise lead the Company to believe that its
expertise is better suited to developing and delivering its technology to OEMs
for inclusion in their products. As a result of this shift, during 1997 the
Company experienced a significant reduction in its workforce and reduced the
value of inventory of its Internet products. The Company expects its business
plans to continue to evolve based on competitive forces and the ongoing need to
generate new and innovative products on a continual basis. External market
factors make estimates of product acceptance and financial performance of the
Company difficult to predict, and in response thereto the Company expects to
make ongoing revisions to its business plan as necessary to adjust to rapidly
changing markets.
History with MCI
An agreement between the Company and MCI Telecommunications Corporation
("MCI") (the "MCI Agreement"), providing for the development of certain advanced
fractal imaging technology ("Deliverables") for use in telecommunications
applications, expired in September 1997. MCI paid the Company approximately
$36,000,000 over the three year term of the MCI Agreement for (i) the
development of the Deliverables, (ii) the perpetual exclusive right to use
Deliverables accepted by MCI in telecommunications applications, and (iii) an
exclusive right to use the Company's commercial off the shelf products in
telecommunications applications during the three year term of the MCI Agreement.
The MCI Agreement provided that during and after its term, the Company and MCI
would share in revenues generated by the distribution of Deliverables. The
Company and MCI are currently engaged in discussions in an effort to resolve
whether the Company adequately delivered the last phase of Deliverables and the
scope of MCI's exclusivity. If the parties are not successful in resolving such
matters, then an arbitration proceeding would be necessary.
Employees
The Company currently has approximately 77 full time employees based in its
offices in Atlanta, Georgia and Reading, England. The Company also makes
extensive use of independent contractors to fulfill short term specialized
needs.
Risk Factors
You should carefully read and evaluate all of the information in this
document, including the risk factors listed below. All statements other than
statements of historical fact included in this Registration Statement,
including, without limitation, statements regarding the Company's business
strategy, plans, intentions and objectives of management of the Company, are
forward-looking statements that involve risks and uncertainties.
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.
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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.
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.
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
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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.
Forward-Looking Statements - Cautionary Statements
The discussions herein contain trend information and other forward-looking
statements that involve a number of risks and uncertainties. The actual results
of Iterated Systems, Inc. and its wholly owned subsidiary, Iterated Systems
Limited (collectively, the "Company" or "Iterated"), could differ materially
from its historical results of operations and those discussed in the
forward-looking statements. The forward-looking statements 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. The
forward-looking statements should be read in light of these factors and the
factors identified in "Item 1. Business" and in "Item 2. Financial
Information--Management's Discussion and Analysis of Financial Condition and
Results of Operations." All references to year periods refer to the Company's
fiscal years ended December 31, 1997.
ITEM 2. FINANCIAL INFORMATION
Selected Consolidated Financial Data
The selected consolidated financial data (excluding the quarterly financial
data) presented below under the captions "Consolidated Statement of Operations
Data" and "Consolidated Balance Sheet Data" are derived from the consolidated
financial statements of the Company, which financial statements have been
audited by Ernst & Young LLP, independent auditors, whose report appears
elsewhere herein.
The selected consolidated financial data set forth below is qualified in
its entirety by, and should be read in conjunction with, "Management's
Discussion and Analysis of Financial Condition and Results of Operations," the
Consolidated Financial Statements, the notes thereto and the other financial
information included elsewhere herein.
9
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended
Year Ended March 31
December 31 (unaudited)
-------------------------------------------------------------- ----------------
1993 1994 1995 1996 1997 1997 1998
CONSOLIDATED STATEMENT OF
OPERATIONS DATA: (In Thousands, Except Per Share Data)
<S> <C> <C> <C> <C> <C> <C> <C>
Total Revenues $6,837 $8,385 $14,430 $15,558 $9,471 $ 3,028 $ 281
Operating loss (826) (1,218) (612) (1,701) (6,551) (1,429) (3,037)
Net loss (783) (1,190) (509) 1,606) (6,329) (1,409) (2,811)
Basic and diluted net loss per
share of common stock (0.08) (0.11) (0.05) (0.15) (0.56) (0.13) (0.21)
Weighted average common
shares outstanding 10,323 10,421 10,501 10,564 11,320 10,715 13,106
<CAPTION>
CONSOLIDATED BALANCE
SHEET DATA:
<S> <C> <C> <C> <C> <C> <C> <C>
Cash and cash equivalents $2,485 $3,034 $6,281 $4,151 $7,633 $3,322 $5,228
Short-term investments 0 0 0 0 9,999 0 10,071
Total assets 3,852 4,468 10,032 7,487 19,775 6,038 17,045
Non-current liabilities 0 66 1,429 208 54 147 44
Stockholders' equity 3,162 2,689 2,514 3,211 18,716 1,863 15,827
</TABLE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following discussion should be read in conjunction with the Selected
Consolidated Financial Data and the Consolidated Financial Statements and Notes
thereto included elsewhere in the Registration Statement. Certain statements in
this "Management's Discussion and Analysis of Financial Condition and Results of
Operations" are forward-looking statements. Such forward-looking statements are
based on current expectations and entail various risks and uncertainties that
could cause actual results to differ materially from those expressed in such
forward-looking statements. For a more detailed discussion of these and other
business risks, see "Risk Factors."
Overview
Historically, the Company has derived its revenues from development fees
and exclusive license fees, packaged software products and related revenues, as
well as other OEM license and contract revenues. The Company expects that
revenues from packaged software products will decline in the future as business
efforts are focused on developing relationships with OEM's whose competitive
position and time to market would be positively impacted by using the Company's
technology in their own products. During 1997, the Company reduced its workforce
to focus on a more effective implementation of this OEM market strategy. If this
plan is successful, the Company believes that a majority of its future revenues
will be derived from license fees and recurring royalties from its OEM
relationships. In some cases, the Company expects to generate non-recurring
development fees or fees for shared risk development from its OEM relationships.
OEM's that would be potential customers for Iterated's technology in its target
markets include:
. Graphic Arts - designers, commercial printers, prepress trade shops
. Digital Photography - digital camera manufacturers, PC printer and
scanner manufacturers
. Video - providers of video technology to developers of new video
applications in the areas of education, training, conferencing, etc.
On September 30, 1997 the Company's agreement with MCI, which provided
revenues of $7,100,000 in 1997, expired. From September 1994 to September 1997,
revenues from the MCI Agreement accounted for 84% of the Company's revenues.
Partially to compensate for the loss of revenues resulting from the expiration
of the
10
<PAGE>
Agreement, the Company has revised its business plan (as discussed in the
previous paragraph) to focus its efforts more on licensing its technology to
OEM's rather than developing technology under contract for specific customers.
If the Company is unsuccessful in this change in its business plan, the
expiration of the Agreement could have a material adverse effect on the
financial condition and results of operations of the Company.
Results of Operations
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31,
1997
Revenues
Total revenues decreased 90.7% to $281,000 in the three months ended March
31, 1998 compared to $3,028,000 in the same period in 1997. The decrease was
primarily the result of the expiration of the MCI development contract at
September 30, 1997. 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 March 31, 1997.
Cost of Product Revenues
Cost of product revenues decreased 100% to $0 in the three months ended
March 31, 1998 from $61,000 in the same period in 1997. The Company was not
confident in the long-term sales growth of its 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 18.2% to $1,202,000 in the three
months ended March 31, 1998 from $1,469,000 during this period in 1997. During
the third quarter of 1997, the Company 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
first quarter of 1998 compared to the same period in 1997.
Research, Development and Engineering
Research, development and engineering expenses decreased 34.7% to
$1,553,000 in the three months ended March 31, 1998 from $2,379,000 in the same
period in 1997. The decrease is primarily the result of fewer personnel and a
decrease in related expenses resulting from the Company's personnel reductions
during the third quarter of 1997.
General and Administrative
General and administrative expenses increased 2.7% to $563,000 in the three
months ended March 31, 1998 from $548,000 in the same period in 1997. The
increase is principally due to increases related to the hiring of a Chief
Operating Officer in the third quarter of 1997.
Net Interest Income
Net Interest Income increased 1,039% to $228,000 in the three months ended
March 31, 1998 from $20,000 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 interest earnings on the increased cash and short-term investment balances
resulting from the proceeds of the public offering.
Liquidity and Capital Resources
Three Months Ended March 31, 1998
At March 31, 1998, the Company had cash and short-term investments in
excess of $15,200,000 and shareholders' equity in excess of $15,800,000. The
Company believes it has adequate cash to cover its short-term needs. However,
the Company will require significant increases in revenue to cover projected
development, selling, marketing and other operating costs and to 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.
11
<PAGE>
The Company has no material capital commitments at this time.
On June 30, 1997, the Company amended the Bridge Financing Credit Facility
with Mosvold Farsund AS (the "Lender"), one of its shareholders. The amended
Credit Facility allowed the Company to borrow up to $6,000,000 ($3,000,000 at
March 31, 1998) from the Lender until June 30 1998, at which time the Company
can convert the outstanding balance into a four year term loan. There are no
borrowings currently outstanding under this credit facility.
Cash used in operating activities increased from $612,000 in the three
months ended March 31, 1997 to $2,036,000 in the same period in 1998 primarily
due to the increased net loss that occurred in 1998 as discussed above.
Results of Operations
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenues. Total revenues decreased 39.1% to $9,471,000 in 1997 compared to
$15,558,000 in 1996. The decrease in revenues is mainly due to MCI making its
final development fee payment in 1997 under the 1994 MCI Agreement (discussed
previously under "Item 1--Business--History with MCI"). In addition, during
1996, the Company executed a one-time sale of custom built decompression
hardware boards resulting in $1,484,000 of revenue being recognized.
Cost of Product Revenues and Inventory Writedowns. Cost of product revenues
decreased 86.1% to $128,000 in 1997 from $923,000 in 1996. The decrease from
1996 to 1997 is the result of the one-time sale of custom built decompression
hardware boards discussed above. Cost of product revenues from this transaction
amounted to $685,000 in 1996.
In 1996, there was an inventory writedown relating to the Company's older
compression accelerator hardware boards to net realizable value in the amount of
$238,000.
Sales and Marketing. Sales and marketing expenses decreased 3.0% to
$4,993,000 in 1997 from $5,146,000 in 1996. Sales and marketing workforce
reductions in the third quarter of 1997 offset the higher levels of staffing
during the first six months of 1997, and resulted in slightly lower expenses for
1997.
Research, Development and Engineering. Research, development and
engineering expenses decreased 7.9% to $8,261,000 in 1997 from $8,966,000 in
1996. The decrease is primarily the result of the workforce reductions discussed
previously.
General and Administrative. General and administrative expenses increased
32.9% to $2,640,000 in 1997 from $1,986,000 in 1996. The increase is due to
charges the Company recorded in the fourth quarter of 1997. Major components of
the charges include a $399,000 write-off of uncollectible accounts receivable
from a single customer.
Interest Income. Interest income increased 107.0% to $396,000 in 1997
from $191,000 in 1996. The increase is due to the higher levels of interest on
cash equivalents and short-term investments the Company experienced during 1997
as a result of the proceeds from the initial public offering of Common Stock.
Interest Expense. Interest expense increased 104.7% to $176,000 in 1997
from $86,000 in 1996. The increase in 1997 is due to interest expense on the
$3,000,000 in outstanding borrowings under the Mosvold Credit Facility. Prior to
its conversion to equity in October 1997, interest expense on these borrowings
amounted to $112,000.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Revenues. Total revenues increased 7.8% to $15,558,000 in 1996 from
$14,430,000 in 1995. The increase in revenue reflects the $1,484,000 one-time
sale of custom built decompression hardware boards discussed previously.
Development and license fee revenues recognized under the 1994 MCI Agreement
amounted to
12
<PAGE>
$12,673,000 in 1996 and $12,775,000 in 1995, representing 81% and 89% of total
revenues for those years, respectively.
Cost of product revenues and inventory writedowns. Cost of product revenues
increased 234.4% to $923,000 in 1996 from $276,000 in 1995. The increase in cost
of product revenues is the result of the $685,000 cost associated with the
one-time sale of custom built decompression hardware boards discussed
previously.
During 1995, the Company recorded reserves totaling $380,000 to reduce the
carrying value of certain inventory items and to reflect inventory purchase
commitments in excess of net realizable value. During 1996, the Company reserved
an additional $238,000 for the remaining hardware boards.
Sales and Marketing. Sales and marketing expenses increased 49.8% to
$5,146,000 in 1996 from $3,435,000 in 1995. The increase is attributable to
hiring of additional marketing personnel and expanded advertising, public
relations and trade show activities.
Research, Development and Engineering. Research, development and
engineering expenses increased 3.2% to $8,966,000 in 1996 from $8,685,000 in
1995. The primary components of the increase were salaries and other personnel
costs, contract labor for independent contractors and recruiting and hiring
expenses.
General and Administrative. General and administrative expenses decreased
12.4% to $1,986,000 in 1996 from $2,267,000 in 1995. In 1995, the Company had
bad debt expense charges in the amount of $123,000. As sales of packaged
software products declined in 1996, bad debt expense decreased accordingly to
$29,000. In 1995, the Company moved to a new office location and incurred
additional administrative expenses in conjunction with the move.
Liquidity and Capital Resources
Year Ended December 31, 1997
In an initial public offering on September 29, 1997 on the Oslo Stock
Exchange in Norway, the Company sold 2,040,000 shares of its common stock, par
value $.01 per share resulting in net proceeds of approximately $18,600,000. In
addition, certain shareholders sold 710,300 shares of Common Stock at
approximately $10 per share.
The Company has not registered any securities with the U.S Securities and
Exchange Commission under the Securities Act of 1933, as amended (the
"Securities Act"). Securities of the Company may not be offered for sale or sold
in the U.S., or to or for the account or benefit of any "U.S. person" (as
defined in the Securities Act), unless the securities are registered under the
Securities Act or an exemption from such registration requirements is
available.
At December 31, 1997, the Company had cash, cash equivalents and
short-term investments in excess of $17,600,000 and shareholders' equity in
excess of $18,700,000.
In 1996 and 1997, the Company used cash in operating activities of
$2,727,000 and $7,511,000, respectively. In 1996, the use of cash reflects a
reduction in deferred revenue of $2,557,000. In 1997, the use of cash reflects a
reduction in deferred revenue of $2,552,000.
In 1996 and 1997, the Company used cash in investing activities of
$1,142,000 and $10,445,000, respectively. In 1996, cash used in investing
activities was used primarily for the purchase of property and equipment and in
1997 cash was primarily used for the purchase of short-term investments with the
proceeds from the Company's initial public offering.
In 1996 and 1997, the Company had cash provided by financing activities of
$1,739,000 and $21,439,000, respectively. In 1996, cash provided by financing
activities was primarily attributable to the proceeds from the issuance of
$2,000,000 of Common Stock to Mitsubishi Corporation and its affiliates. In
1997, cash provided by financing activities was primarily attributable to
borrowings of $3,000,000 under the Credit Facility described below and
$18,600,000 net proceeds from the Company's initial public offering.
13
<PAGE>
On June 30, 1997, the Company amended the Bridge Financing Credit Facility
(the "Credit Facility") with Mosvold Farsund AS ("Mosvold"), one of its
shareholders. The amended Credit Facility allowed the Company to borrow up to
$6,000,000 ($3,000,000 at December 31, 1997) from Mosvold until June 30, 1998,
at which time the Company can convert any outstanding balance into a four year
term loan. During the second quarter of 1997, the Company borrowed $3,000,000
from Mosvold under this financing agreement. During the fourth quarter of 1997,
Mosvold 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. As a result,
there are currently no outstanding borrowings under the Credit Facility and an
available amount of credit thereunder of $3,000,000 which the Company may borrow
at any time until June 30, 1998.
Impact of Year 2000
The Company recognizes the need to ensure its operations will not be
adversely impacted by year 2000 software failures. The Company intends to take
the actions necessary to ensure that systems and applications will recognize and
process the year 2000 and beyond. The Company does not expect the year 2000
issue to be reasonably likely to affect its future financial results, or cause
its reported financial information not to be necessarily indicative of future
operating results or future financial condition. Further, the Company does not
believe that the year 2000 issues will materially affect the Company's products,
services or competitive position.
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.
Earnings 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 or potential 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 consolidated financial statements. Net loss per
share of common stock is computed based on the weighted average number of shares
outstanding during each period.
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.
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,
14
<PAGE>
1997. The Company will adopt Statement 131 during 1998 and does not expect the
effect of such adoption to be material to its consolidated financial statements.
Inflation
The effects of inflation on the Company's operations were not significant
during the periods presented in the 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.
ITEM 3. PROPERTIES.
The Company leases approximately 30,000 square feet of office space in
Atlanta, Georgia for its corporate, sales and development operations. The lease
runs through July 31, 2000.
The Company also leases approximately 3,000 square feet of office space
near Reading, England for its European office. The lease runs through June 27,
2012 with an option to terminate in June 2007.
The aggregate monthly rental for these leased offices and facilities is
currently approximately $47,000, and the Company's management believes that
these facilities are adequate for its intended activities in the foreseeable
future.
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.
The following table sets forth, as of March 31, 1998, the beneficial
ownership of the Company's outstanding Common Stock of (i) each person known by
the Company to own beneficially more than 5% of the Company's outstanding Common
Stock, (ii) each executive officer of the Company, (iii) each director of the
Company, and (iv) all executive officers and directors as a group:
<TABLE>
<CAPTION>
Common Stock Beneficially Owned/(2)/
---------------------------------------------------
Name and Address of Number of Shares of
Beneficial Owners/(1)/ Common Stock Percentage of Class
- -------------------------------------- ---------------------- -------------------------
<S> <C> <C>
John C. Bacon/(3)/ 65,000 *
John R. Festa/(4)/ 706,000 5.1
Michael F. Barnsley/(5)/ 1,317,700 9.9
Alan D. Sloan/(5)/ 3,390,000 25.6
Terje Mikalsen/(6)/ 2,178,630 16.6
Asmund R. Slogedal/(7)/ 80,000 *
James D. Robinson, III/(8)/ 60,000 *
Diane Barnsley 799,900 6.1
Haines H. Hargrett 0 *
Deborah N. Gable/(9)/ 20,000 *
Ruth Mednikow/(9)/ 20,000 *
David G. Gibson/(10)/ 6,667 *
Burton M. Smith/(10)/ 6,667 *
Fidulex Management Inc. 796,300 6.1
Tarald Brovig/(11)/ 872,900 6.7
Mosvold Farsund AS/(12)/ 1,432,230 10.9
Tarald Glastad/(13)/ 1,520,230 11.6
All executive officers and directors
as a group (12 persons).............. 7,850,664 54.9
</TABLE>
- ----------------------------------------
*Less than 1% of the outstanding Common Stock
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Except as indicated by
footnote, the persons named in the table above have sole voting and
investment power with respect to all shares of Common Stock shown as
beneficially
15
<PAGE>
owned by them. Percentage of beneficial ownership is based on 13,088,125
shares of Common Stock outstanding as of February 28, 1998. The business
address of each beneficial owner other than Ms. Barnsley, Fidulex Management
Inc., Mosvold Farsund AS and Mr. Brovig is c/o Iterated Systems, Inc., Seven
Piedmont Center, Suite 600, 3525 Piedmont Road, Atlanta, Georgia 30305-1530.
The business address of Ms. Barnsley is 2153 Allaire Lane, Atlanta, Georgia
30345. The business address of Fidulex Management Inc. is 1, Places Des
Florentins, 1204 Geneva, Switzerland, Attention: M. Allegro. The business
address of Mosvold Farsund AS is P.B. 113, 4551 Farsund, Norway. The
business address of Mr. Brovig is Radhusgt. 5b, 0151 Oslo, Norway. The
business address of Mr. Glastad is 10 Stratton, Street, London, UK W1X
4EJ.
(2) Includes shares of Common Stock subject to options which may be exercised
within 60 days of March 31, 1998. Such shares are deemed to be outstanding
for the purposes of computing the percentage ownership of the individual
holding such shares, but are not deemed outstanding for purposes of
computing the percentage of any other person shown in the table.
(3) Includes options to purchase 65,000 shares of Common Stock.
(4) Includes options to purchase 706,000 shares of Common Stock.
(5) Includes options to purchase 150,000 shares of Common Stock.
(6) Includes 1,322,230 shares held by Mosvold Farsund AS , 493,500 shares held
by Mega Pacific International, Ltd, 84,600 shares held by Teto Invest AS,
88,000 shares held by Westland Shipping AS and 80,300 shares held by Eiken
Invest AS. Mr. Mikalsen owns a controlling interest in each of these
entities except Eiken Invest AS. Also includes 100,000 shares issuable upon
exercise of a warrant held by Mosvold Farsund A.S.
(7) Includes options to purchase 30,000 shares of Common Stock.
(8) Includes options to purchase 60,000 shares of Common Stock.
(9) Includes options to purchase 20,000 shares of Common Stock.
(10)Includes options to purchase 6,667 shares of Common Stock.
(11)Includes 787,800 shares held by Brovigtank AS, in which Mr. Brovig holds the
controlling interest, and 85,100 shares held by immediate family
members.
(12)Include 100,00 shares issuable upon the exercise of a warrant
(13)Includes 1,332,230 shares held by Mosvold Farsund AS and 88,000 shares held
by Westland Shipping AS.
ITEM 5. DIRECTORS AND OFFICERS.
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
John C. Bacon 52 President, Chief Executive Officer and Director
John R. Festa 46 Director and Vice Chairman of the Board of Directors
Michael F. Barnsley 51 Executive Vice President and Director
Alan D. Sloan 52 Executive Vice President and Director
Haines H. Hargrett 55 Chief Financial Officer
Deborah N. Gable 43 Vice President, Human Resources
David G. Gibson 40 Vice President, Sales
Burton M. Smith 42 Vice President, Marketing
Asmund R. Slogedal 59 Director and Chairman of the Board of Directors
Terje Mikalsen 57 Director
James D. Robinson, III 61 Director
</TABLE>
John C. Bacon has served as President and Chief Executive Officer of the Company
since February 1998. He joined the Company in March 1997 as Senior Vice
President/General Manager and in August 1997 was named Executive Vice President
and Chief Operating Officer. From 1989 until 1997, Mr. Bacon served as
President, Chief Operating Officer and Director of XcelleNet, Inc. a publicly
traded, remote access software company. Mr. Bacon holds a BSIE degree from
Georgia Institute of Technology.
John R. Festa served as President, Chief Executive Officer and a director of
the Company from May 1994 until February 1998. From 1984 until May 1994, Mr.
Festa served as President, Chief Executive Officer and Chairman of BUYPASS
Corporation, a financial transaction processing services company. Mr. Festa
attended Valparaiso University.
Dr. Michael F. Barnsley co-founded the Company in 1987 and served as Chief
Executive Officer until becoming Executive Vice President, Science and
Technology in May 1994. From 1979 until founding the Company, Dr. Barnsley was a
mathematics professor at the Georgia Institute of Technology. Dr. Barnsley holds
a degree in
16
<PAGE>
mathematics from Oxford University in England and a Ph.D. in theoretical
chemistry from the University of Wisconsin.
Dr. Alan D. Sloan co-founded the Company in 1987 and served as President until
becoming Executive Vice President, Strategic Business Development in May 1994.
Dr. Sloan obtained a BA in mathematics from the Massachusetts Institute of
Technology and a Ph.D. in mathematics from Cornell University.
Haines H. Hargrett has served as Chief Financial Officer of the Company since
September 1997. From 1994 to 1997 he was Chief Financial Officer/Treasurer of
Medifax, Inc., a high technology medical transcription company. From 1992 to
1994 he was Chief Financial Officer for Park `N Fly, Inc., a company involved in
developing and managing parking facilities near major city airports. Mr.
Hargrett holds an A.B. in Economics from Duke University and an MBA in Finance
from Indiana University.
Deborah N. Gable has served as Vice President, Human Resources of the Company
since February 1995. From 1985 until 1995, Ms. Gable served as Vice President of
Human Resources of COIN Dealership Systems and as Director of Human Resources of
The Reynolds and Reynolds Company, a turnkey computer systems company, after its
acquisition of COIN Dealership Systems. Ms. Gable obtained a bachelor's degree
in business and behavioral sciences from Lewis University.
David Gibson has served as Vice President, Sales since February 1998. He served
as Director of OEM Sales of the Company from August 1997 to February 1998. From
July 1995 to August 1997, Mr. Gibson served as Regional Sales Manager for the
Company. From June 1986 to July 1995, Mr. Gibson held various sales, marketing
and business management positions with Integraph Corporation. Mr. Gibson has a
BS degree in Engineering from Tennessee Technological University.
Burton Smith has served as Vice President, Marketing since February 1998. He
served as Director of Marketing of the Company since June 1997. From July 1995
to June 1997, Mr. Smith served as Regional Sales Manager for the Company. From
February 1984 to July 1995, Mr. Smith held various sales and marketing positions
with Integraph Corporation. Mr. Smith has a Bachelor of EE degree from the
Georgia Institute of Technology.
Asmund R. Slogedal has served as Chairman of the Board of Directors since
August 1991. He served as the Company's Chief Financial Officer from May 1991
until September 1994. Mr. Slogedal has been a partner in the Norway-based
venture capital firm Teknoinvest Management AS since 1989. Mr. Slogedal is a
director of Mosvold Farsund AS, a Norwegian shipping and investment company, a
director of Tandberg Data ASA and serves on the board of several other Norwegian
and U.S.-based technology companies. Mr. Slogedal holds a B.S. degree in
engineering from Purdue University.
Terje Mikalsen joined the company as a director in April 1996. Mr. Mikalsen is
Chairman of Mosvold Farsund Group, which has 45% ownership of Teknoinvest
Management AS. He is a director of Mega Pacific Group, a Hong Kong-based
investment company. Mr. Mikalsen is also an outside director of Norwegian Cruise
Line, Ltd. (US-based) and its parent company, NCL Holding ASA (Norway-based).
Mr. Mikalsen formerly held the position of Chairman of the following publicly
traded companies: Norsk Data AS until 1993; Hafslund Nycomed ASA until 1996, and
Maritime Hydraulics AS until 1987, and holds several other directorships. He is
also a member of the Norwegian Government's Advisory Board on industrial
policies and the Norwegian Technical Scientific Academy and Norsk Investorforum,
an association of Norwegian private investors. Mr. Mikalsen holds a Master of
Science degree from Norges Tekniske Hoyskole.
James D. Robinson III became a director of the Company in November 1994. Mr.
Robinson is Chairman and Chief Executive Officer of RRE Investors, LLC, a
private venture investment firm, and Chairman of Violy Byorum & Partners
Holdings, LLC, a private firm specializing in financial advisory and investment
banking activities in Latin America. From 1970 until 1993 he held various senior
management positions with American Express Company, including Chairman and Chief
Executive Officer from 1977 until 1993. Mr. Robinson presently serves
17
<PAGE>
as a director of Bristol-Myers Squibb Company, The Coca-Cola Company, First Data
Corporation, Union Pacific Corporation, Cambridge Technology Partners and The
Coleman Company. Mr. Robinson holds a bachelor's degree in science and
technology from the Georgia Institute of Technology and a master's degree in
business administration from Harvard Business School.
Election of Directors
All directors hold office until the next annual meeting of shareholders
of the Company and until their successors have been elected and qualified.
Director Compensation
The Company's non-employee directors receive no cash compensation, but are
reimbursed for their out-of-pocket expenses and are eligible for stock option
grants under the Company's 1994 Directors Stock Option Plan. Under the Directors
Stock Option Plan, the Company may grant to nonemployee directors options
covering an aggregate of 180,000 shares of common stock which options generally
vest over three years.
There are no family relationships among any of the directors or officers of the
Company.
Consulting Agreement
Pursant to an agreement between the Company and Mosvold Farsund AS, the
Company pays an annual consulting fee to Mosvold Farsund AS in the amount of
$15,000 for services relating to financial and investment management. Mosvold
Farsund AS is a Norwegian corporation controlled by Mr. Mikalsen, a director of
the Company. Mr. Slogedal, a director of the Company, is an employee of Mosvold
Farsund AS.
ITEM 6. EXECUTIVE COMPENSATION
The following table sets forth certain summary information with respect to
the compensation earned for services rendered by the Company's Chief Executive
Officer and the other four most highly compensated executive officers of the
Company (collectively, the "Named Executive Officers") for the fiscal years
ended December 31, 1997, 1996 and 1995.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Annual Compensation Compensation
Awards
-------------------------------- -----------------
Number of All Other
Name and Principal Position Year Salary($) Bonus($)/(1)/ securities Compensation/(2)/
underlying
Options
- ------------------------------- --------- ------------- --------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C>
John R. Festa/(3)/ 1997 $ 300,000 $ 150,000 124,100 $ 0
President, Chief Executive 1996 291,667 0 200,000/(4)/ 0
Officer and Director 1995 286,458 0 0 0
John C. Bacon/(5)/
Executive Vice President 1997 $ 141,121 $ 0 300,000 $ 0
and Chief Operating 1996 0 0 0 0
Officer 1995 0 0 0 0
Michael F. Barnsley 1997 $ 243,750 $ 0 0 $ 0
Executive Vice President 1996 275,000 255,000 0 0
and Director 1995 286,458 137,500 0 0
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
Long-Term
Annual Compensation Compensation
Awards
-------------------------------- -----------------
Number of All Other
Name and Principal Position Year Salary($) Bonus($)/1/ securities Compensation/2/
underlying
Options
- ------------------------------- --------- ------------- --------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C>
Alan D. Sloan 1997 $ 243,750 $ 0 0 $ 0
Executive Vice President 1996 275,000 75,000 0 0
and Director 1995 286,458 275,000 0 0
David G. Gibson 1997 $ 154,583 $ 0 30,000 $ 0
Director of OEM Sales 1996 125,000 0 0 0
1995 44,263 48,741/6/ 10,000 0
</TABLE>
- -------------------------------
(1) Bonuses were for services rendered in the prior fiscal year except with
respect to the bonus paid to Mr. Festa during 1997 which was payable for
services during 1997.
(2) In accordance with the rules of the Securities and Exchange Commission,
other compensation in the form of perquisites and other personal benefits
has been omitted because such perquisites and other personal benefits
constituted less than the lesser of $50,000 or 10% of the total annual
salary and bonus for the Named Executive Officer for such year.
(3) Mr. Festa served as President and Chief Executive Officer until February
1998.
(4) Options were forfeited in 1997 in conjunction with new grant of 124,100
options.
(5) Mr. Bacon joined the Company in March 1997 and was named the Company's
President and Chief Executive Officer in February 1998.
(6) Consists of reimbursement to Mr. Gibson for certain relocation-related
expenses.
Option Grants in Last Fiscal Year
The following table sets forth information concerning options granted to
the Named Executive Officers during the year ended December 31, 1997:
<TABLE>
<CAPTION>
Individual Grants
---------------------------------------------------------------------------------------------
Number of Percent of
Securities Total
Underlying Granted to Exercise or Potential Realizable
Options Employees Base Price Expiration Value/4/
Executive Officer Granted Fiscal Year Per Share /1/ Date 5% 10%
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
John R. Festa 124,100/2/ 22.4 $ 7.40 12/31/04 $ 373,857 $ 871,245
John C. Bacon 195,000/3/ 35.5 10.00 3/1/07 1,226,345 3,107,798
105,000/3/ 19.0 10.00 8/14/07 660,339 1,673,430
Michael F. Barnsley 0 0 -- -- -- --
Alan D. Sloan 0 0 -- -- -- --
David G. Gibson 30,000/3/ 5.4 10.00 6/1/07 188,668 478,123
</TABLE>
- ---------------------------
(1) These options were granted with an exercise price equal to the fair market
value of the Common Stock on the date of grant as determined by the Board
of Directors. Prior to October 1, 1997, the Board of Directors determined
the fair market value based on various factors including values of
similarly situated companies and the Company's future prospects. From
October 1, 1997, fair market value was the closing price of shares as
traded on the Oslo Stock Exchange.
19
<PAGE>
(2) Grant becomes exercisable on the first anniversary of the date of grant.
Vesting may be accelerated in the event of a change in control of the
Company which is defined to include the transfer of ownership of more than
50% of the common stock or assets of the Company or closing of a public
offering of common stock under the Securities Act of 1933.
(3) Grants become exercisable in equal installments on the first three
anniversaries of the date of grant. Vesting may be accelerated in the event
of a change in control of the Company which is defined to include the
transfer of ownership of more than 50% of the common stock or assets of the
Company or closing of a public offering of common stock under the
Securities Act of 1933.
(4) This column shows the hypothetical gain or option spreads of the options
granted based on assumed annual compound stock appreciation rates of 5% and
10% over the full terms of the options. The 5% and 10% assumed rates of
appreciation are mandated by the rules of the Securities and Exchange
Commission and do not represent the Company's estimate or projection of
future Common Stock prices.
Option Exercises in Last Fiscal Year and Year-End Option Values
The following table sets forth the aggregate dollar value of all options
exercised and the total number of unexercised options held, on December 31,
1997, by the Named Executive Officers:
<TABLE>
<CAPTION>
Number of Securities
Shares Underlying Unexercised Value of Unexercised
Acquired Value Options at In-the-Money Options at
Executive Officer on Exercise Realized December 31, 1997 December 31, 1997(1)
- ----------------- ----------- -------- ----------------- --------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
John C. Bacon 0 0 0 300,000 $ 0 $ 0
John R. Festa 0 0 706,000 124,000 1,792,103 0
Michael F. Barnsley 0 0 150,000 0 210,000 0
Alan D. Sloan 0 0 150,000 0 210,000 0
David G. Gibson 0 0 6,667 3,333 9,334 4,666
</TABLE>
- ---------------------------
(1) The closing price for the Company's Common Stock as reported by the Oslo
Stock Exchange on December 31, 1997 was $7.40. Value is calculated on the
basis of the difference between the option exercise price and $7.40,
multiplied by the number of shares of Common Stock underlying the option.
Employee Benefit and Stock Option Plans
Description of 1994 Employee Plan. In 1992, the Company approved a stock
option plan which became effective December 2, 1992 and reserved shares for
future issuance. The plan was replaced by the 1994 Amended and Restated Stock
Option Plan (the "1994 Employee Plan"). The purpose of the 1994 Employee Plan is
to provide incentives for employees and key persons to promote the success of
the Company and to enhance the Company's ability to attract and retain the
services of such persons. Options granted under the 1994 Employee Plan may be
either (i) options intended to qualify as "incentive stock options" under
Section 422 of the Code, or (ii) non-qualified stock options. Stock options may
be granted under the 1994 Employee Plan for all employees and key persons of the
Company or of any subsidiary or parent of the Company. The 1994 Employee Plan is
administered by the Board of Directors or by a Compensation Committee, in whole
or in part, as delegated by the Board. The Board of Directors has the authority
to determine exercise prices applicable to the options, the eligible employees
or key persons to whom options may be granted, the number of shares of Common
Stock subject to each option, and the extent to which options may be
exercisable. Options granted under the 1994 Employee Plan generally vest over
three or four years. No option is transferable by the optionee other than by
will or the laws of descent and distribution or as a bona fide gift and each
option is exercisable during the lifetime of the optionee only by such optionee
or donee.
Any incentive stock option that is granted under the 1994 Employee Plan may
not be granted at a price less than the fair market value of the Company's
Common Stock on the date of grant (or less than 110% of fair market value in the
case of holders of 10% or more of the total combined voting power of all classes
of stock of the Company or a subsidiary or parent of the Company). Non-qualified
stock options may be granted at the exercise
20
<PAGE>
price established by the Board of Directors, which may be less than the fair
market value of the Company stock on the date of grant.
Each option granted under the 1994 Employee Plan is exercisable for a
period not to exceed ten years from the date of grant (or, with respect to
incentive stock options, five years in the case of a holder of more than 10% of
the total combined power of all classes of stock of the Company or of a
subsidiary or parent of the Company) and shall lapse upon expiration of such
period, or earlier after a designated period of time following termination of
the recipient's employment with the Company, or as determined by the Board of
Directors.
On February 12, 1998, the Board of Directors approved the grant of an
option, effective February 16, 1998, to John C. Bacon, the Company's President
and Chief Executive Officer, to purchase 1,000,000 shares of Common Stock
subject to the approval of an amendment (the "Amendment") to the 1994 Employee
Plan to increase the number of shares reserved for issuance under the plan. The
Amendment was adopted by the Board of Directors in February 1998 and approved by
the shareholders at the Company's annual meeting of shareholders on April 15,
1998, increasing the number of shares of Common Stock reserved for issuance
under the 1994 Employee Plan from 2,400,000 shares to 3,400,000 shares. The
table below provides information regarding the dollar value and the number of
shares underlying awards granted to Mr. Bacon under the 1994 Employee Plan.
<TABLE>
<CAPTION>
Dollar Value of Shares Underlying Number of Shares Underlying Stock
--------------------------------- ---------------------------------
Name and Position Stock Options ($)/(1)/ Options
- ----------------- ---------------------- -------
<S> <C> <C>
John C. Bacon,
President and $400,000 1,000,000
Chief Executive Officer
</TABLE>
- ---------------------------------------
(1) Based upon the closing sale price of the Company's Common Stock of $7.66
per share as reported on the Oslo Stock Exchange on February 28, 1998, less
the exercise price of the options granted.
Description of Non-Employee Director Plan. In 1994, the Company approved
the 1994 Directors Stock Option Plan (the "Directors Plan"). The purposes of the
Directors Plan are to enhance the Company's ability to attract and retain the
services of experienced and knowledgeable non-employee directors and to
encourage such directors to acquire an increased proprietary interest in the
Company. Stock options may be granted under the Directors Plan to any director
who is not an employee of the Company or a parent or subsidiary. The Directors
Plan is administered by the Board of Directors or by a Compensation Committee,
in whole or in part, as delegated by the Board. The Board of Directors has the
authority to determine exercise prices applicable to the options, the number of
shares of Common Stock subject to each option, and the extent to which options
may be exercisable. Options granted under the Directors Plan generally vest over
three years. No option is transferable by the optionee other than by will or the
laws of descent and distribution or as a bona fide gift and each option is
exercisable during the lifetime of the optionee only by such optionee or donee.
Options granted under the Directors Plan are non-qualified stock options
and may be granted at the exercise price established by the Board of Directors,
which may be less than the fair market value of the Company stock on the date of
grant.
Each option granted under the Directors Plan is exercisable for a period
not to exceed ten years from the date of grant and shall lapse upon the earlier
of the expiration of such period or 90 days after termination of the recipient's
service as a member of the Board of Directors.
An aggregate of 180,000 shares of Common Stock are reserved for issuance
under the Directors Plan.
Employment Contracts and Termination and Change-in-Control Arrangements
On February 16, 1998, the Company entered into an employment agreement with
Mr. Bacon who serves as the President and Chief Executive Officer of the
Company. The employment agreement provides for a base salary of $285,000 per
annum. Pursuant to the agreement, Mr. Bacon was granted stock options pursuant
to the Company's 1994 Employee Plan for 500,000 shares, at an exercise price of
$7.26 per share vesting ratably over a
21
<PAGE>
three year period at the exercise price per share of the Company's Common Stock
equal to the closing price of the Company's Common Stock traded on the Oslo
Stock Exchange as of the date of the agreement. In addition, pursuant to the
agreement, Mr. Bacon was granted options for a number of shares at an exercise
price of $7.26 per share vesting upon the first to occur of the closing of a
public sale of Common Stock by the Company under certain circumstances (the
"Offering Closing Date"), a Change in Control (as defined in the agreement) or
completion of seven years of continuous service following the date of the
agreement. Pursuant to the agreement, Mr. Bacon was also granted options to
purchase an additional number of shares at an exercise price of $7.26 per share
vesting upon the first to occur of either 180 days after the Offering Closing
Date, or after completion of seven years of continuous service following the
date of the agreement. The agreement further provides that Mr. Bacon is entitled
to receive a cash bonus on the first to occur of either the Offering Closing
Date or a Change in Control. The term of the employment agreement is three
years. If the Company terminates Mr. Bacon's employment without cause, the
Company would be required to continue to pay Mr. Bacon an amount equal to his
monthly salary at the then current rate for a period of 18 months.
On February 16, 1998, the Company entered into an Executive Severance
Agreement with Mr. Festa which supersedes and cancels his prior employment
agreement. Pursuant to the Executive Severance Agreement, Mr. Festa agreed to
serve as the Vice Chairman of the Board of Directors and a Special Advisor to
the Company for a two-year period for an annual base salary of $150,000. Mr.
Festa also agreed to forfeit 218,300 options granted to him as of December 31,
1997 and received a new grant of 124,100 non-qualified stock options at an
exercise price of $7.40 per share exercisable at the price as of the date of the
agreement on the Oslo Stock Exchange, vesting in full one year after the date of
the Agreement with a term of seven years, subject to the terms of the Company's
1994 Amended and Restated Stock Option Plan. Mr. Festa also received, upon the
signing of the agreement, a bonus in the amount of $150,000 for service in 1997.
The agreement further provides that the Company will pay up to $400 per month
for a leased automobile for Mr. Festa's use during the term of the agreement,
and, as additional compensation, an amount which, after deducting federal and
state income taxes, would equal the amount which the Company would contribute as
a "matching contribution" to Mr. Festa's account under the Company's 401(k)
plan, assuming that Mr. Festa was still an active participant in the plan and
elected to defer $833.33 in compensation each month under the plan. The
agreement contains covenants restricting disclosure of confidential information
and non-competition and non-solicitation covenants. Pursuant to the agreement,
if Mr. Festa's employment is terminated without cause, the Company would be
required to continue to pay Mr. Festa the annual salary and benefits set forth
in the agreement for the remainder of the stated term of the agreement.
In May 1994, the Company entered into employment agreements with Drs.
Barnsley and Sloan, who each serve as executive officers of the Company. Under
the terms of their respective employment agreements, if the Company terminates
the employment of Drs. Barnsley or Sloan for any reason, other than for cause,
the Company will be required to continue the payment of their base salaries for
a period of two years from the date of termination. The terms of the employment
agreements as amended in 1996 with Drs. Barnsley and Sloan provide for a
reduction in each individual's base annual salary to $150,000 in the event the
Company completes a public offering of shares of the Company's Common Stock in
which each individual is permitted to sell shares owned by him, provided the
public offering is completed before March 28, 1999. This offering was completed
on September 29, 1997 and thus the annual base salaries thereafter payable to
Drs. Barnsley and Sloan have been reduced as provided above.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On May 31, 1996, the Company entered into a credit agreement (the "Credit
Facility") with Mosvold Farsund AS ("Mosvold"), which established a $6,000,000
revolving line of credit (the "Revolving Facility"). Mosvold is a Norwegian
corporation controlled by Mr. Mikalsen, a director of the Company. Advances
under the Revolving Facility must be made in $3,000,000 increments with 30 days
advance notice required. As of February 28, 1998, the Company had no outstanding
borrowings under the Revolving Facility. Outstanding borrowings under the
Revolving Facility accrue interest payable monthly at an annual rate equal to
NationsBank of Georgia N.A. prime lending rate plus 1%. The Company is obligated
to pay a quarterly commitment fee equal to .75% of the unused portion of the
Revolving Facility. Prior to the repayment of any principal by the Company under
the Revolving Facility, Mosvold has the right to elect to convert the amount of
principal being repaid into shares of the Company's Common Stock at a price of
$10.00 per share.
From June 30, 1998, the Company, at its option, may convert any outstanding
balance under the Revolving Facility to a term loan (the "Term Facility"). The
Term Facility would accrue simple interest at an annual rate equal
22
<PAGE>
to NationsBank of Georgia N.A. prime lending rate plus 2.5%. Payments of
principal plus accrued interest under the Term Facility in 16 quarterly
installments is required, commencing on September 30, 1998. Prior to the payment
of any principal under the Term Facility, Mosvold has the right to elect to
convert the amount of principal being repaid into shares of the Company's Common
Stock at a price of $9.00 per share.
If the Company issues any of its securities to a third party who is not an
existing shareholder for an amount that exceeds the greater of $2,000,000 or the
amount of principal then outstanding under the Credit Facility, then following a
demand by Mosvold, the Company would be required to request an advance of funds
under the Credit Facility in an amount equal to the funds received from such
third party, subject to the $6,000,000 aggregate limit under the Credit
Facility.
In connection with the establishment of the Credit Facility, the Company
issued to Mosvold a warrant to acquire up to 100,000 shares of the Company's
Common Stock at a price of $10.00 per share until May 31, 1999. The Credit
Facility restricts the Company from incurring additional bank financing in
excess of $500,000.
On June 9, 1997, the Company borrowed $3,000,000 under the Credit Facility.
On October 31, 1997, Mosvold exercised the option to convert those borrowings
into 300,000 shares of the Company's Common Stock at $10 per share. The Company
paid Mosvold $112,000 in interest on the outstanding borrowings during 1997 and
$32,000 and $26,000 for commitment fees not borrowed during 1996 and 1997,
respectively. Under the Credit Facility, the Company currently may borrow up to
$3,000,000.
Pursant to an agreement between the Company and Mosvold Farsund AS, the
Company pays an annual consulting fee to Mosvold Farsund AS in the amount of
$15,000 for services relating to financial and investment management. Mosvold
Farsund AS is a Norwegian corporation controlled by Mr. Mikalsen, a director of
the Company. Mr. Slogedal, a director of the Company, is an employee of Mosvold
Farsund AS.
ITEM 8. LEGAL PROCEEDINGS
The nature of the Company's business exposes it to the risk of lawsuits for
damages or penalties relating to, among other things, breach of contract,
employment disputes and copyright, trademark or patent infringement. The Company
is not currently a party to any pending material litigation.
ITEM 9. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED SHAREHOLDER MATTERS.
The Company's Common Stock had been traded on the Oslo Stock Exchange under
the symbol "ITR" since October 1,1997. Prior to that time there was no
established market for the shares. The Company has not registered any securities
with the United States Securities and Exchange Commission. Securities of the
Company may not be offered for sale or sold in the US or to or for the account
or benefit of any U.S. person unless the securities are registered or an
exemption from registration requirements is available.
The price per share reflected in the table below represents the range of
low and high closing sale prices for the Company's Common Stock as reported by
the Oslo Stock Exchange for the periods indicated:
Fiscal Period High Price Low Price
---------------------- -------------------- -------------------
10/01/97 - 12/31/97 $ 13.92 $ 6.86
01/01/98 - 03/31/98 $ 9.23 $ 5.98
The closing sale price of the Company's Common Stock as reported by the
Oslo Stock Exchange on March 31, 1998 was U.S. $7.09.
The number of shareholders of record of the Company's Common Stock as of
March 31, 1998, was approximately 780. Shareholders included approximately 16
U.S. citizens holding of record approximately 5,250,000 shares.
23
<PAGE>
As of March 31, 1998, 3,111,850 options and warrants were outstanding of
which 1,466,876 were currently exercisable.
The Company has never paid cash dividends on its capital stock. The Company
currently intends to retain any earnings for use in the business and does not
anticipate paying any cash dividends in the foreseeable future.
There is no public market in the U.S. for the securities of the Company. As
of March 31, 1998, the Company had outstanding 13,098,125 shares of Common
Stock. All of such shares are "restricted shares" under Rule 144 (the
"Restricted Shares"). Restricted Shares may be sold in the public market only if
registered under the Securities Act or if they qualify for an exemption from
registration under Rule 144, Rule 144(k) or Rule 701 promulgated under the
Securities Act. Of the currently outstanding shares, 4,797,700 shares are
eligible for sale under Rule 144, as currently in effect, so long as all other
conditions of Rule 144 are met. No assurances are made; however, that Rule 144
will be available at any time for any shareholder's shares. In general, under
Rule 144, a person (or persons whose shares are aggregated), who has satisfied a
one year holding period, under certain circumstances, may sell within any
three-month period a number of shares which does not exceed the greater of one
percent of the then outstanding Common Stock or the average weekly trading
volume during the four calendar weeks prior to such sale. Rule 144 also permits,
under certain circumstances, the sale of shares without any quantity limitation
by a person who has satisfied a two-year holding period and who is not, and has
not been for the preceding three months, an affiliate of the Company. The
Company has not provided to any shareholder registration rights to register
under the Securities Act any shareholder's shares for sale.
ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES.
During the past three years, the Company has issued the securities set
forth below which were not registered under the Securities Act:
(i) On December 21, 1995, the Company issued to William Douglas Withers a
total of 5,200 shares of the Company's Common Stock at $6.02 per share ($31,286)
for services as a consultant to the Company. The issuance of the shares to Mr.
Withers was exempt from registration under the Securities Act pursuant to
Section 4(2) thereof as a private transaction not involving a public
distribution.
(ii) On May 31, 1996, the Company issued to Mosvold Farsund AS ("Mosvold")
a revolving credit promissory note (the "Mosvold Note"). In addition, the
Company issued to Mosvold a three-year warrant to acquire up to 100,000 shares
of the Company's Common Stock at an exercise price of $10.00 per share, in
connection with the establishment of the Credit Facility. The issuance of the
warrant to Mosvold was exempt from registration under the Securities Act
pursuant to Section 4(2) thereof as a private transaction not involving a public
distribution.
(iii) On September 26, 1996, the Company issued an aggregate of 200,000
shares of its Common Stock for $10.00 per share in a private placement to
Mitsubishi Electric Corporation, Mitsubishi Corporation, Mitsubishi
International Corporation and CSK Corporation. Each issuance was exempt from
registration under the Securities Act pursuant to Section 4(2) thereof and
Regulations D and/or Regulation S promulgated thereunder.
(iv) On April 22, 1997, the Company issued to Barent S. Wagar a total of
2,700 shares of its Common Stock at $10.00 per share ($27,000), for Mr. Wagar's
services as a consultant to the Company. This issuance was exempt from
registration under the Securities Act pursuant to Section 4(2) thereof as a
private transaction not involving a public distribution.
(v) On September 3, 1997, the Company issued 2,040,000 shares of its
Common Stock for the equivalent of $10.00 per share in an offshore transaction
to non-U.S. persons. Elcon Securities AS served as lead manager for the
transaction and DnB Markets and Christiania Markets served as co-managers. The
underwriting discount or commission paid to Elcon Securities AS, DnB Markets and
Christiania Markets by the Company totaled $1,326,000. This issuance was exempt
from registration under the Securities Act pursuant to Regulation S promulgated
thereunder as a sale of securities outside the United States.
(vi) On October 31, 1997, the Company issued 300,000 shares of its Common
Stock to Mosvold for $10.00 per share, upon the conversion of the outstanding
balance on that date under the Mosvold Note. This
24
<PAGE>
issuance was exempt from registration under the Securities Act pursuant to
Regulations S promulgated thereunder as an offshore sale of securities to
non-U.S. persons.
(vii) Since April 30, 1995, the Company has issued stock options to
purchase an aggregate of 2,269,600 shares of its Common Stock under the 1994
Employee Plan and the Directors Plan (together with the 1994 Employee Plan, the
"Plans"), at a weighted average exercise price of $8.24 per share. Of these
options, 409,750 have expired or been exercised. As of March 31, 1998, 13,100
shares of Common Stock at an average weighted exercise price of $8.00 per share
have been issued upon exercise of options granted under the Plans since April
30, 1995. Such shares of Common Stock issued pursuant to options granted under
the Plans were exempt from registration under the Securities Act pursuant to
Section 4(2) thereof and Rule 701 promulgated thereunder.
ITEM 11. DESCRIPTION OF REGISTRANT'S SECURITIES TO BE REGISTERED.
Common Stock
The Company is authorized to issue 20,000,000 shares of common stock, par
value $.01 per share, of which 13,109,225 shares are issued and outstanding as
of March 31, 1998. All shares of common stock have equal rights and privileges
with respect to voting, liquidation and dividend rights. Each share of common
stock entitles the holder thereof (i) to one non-cumulative vote for each share
held of record on all matters submitted to a vote of the stockholders; (ii) to
participate equally and to receive any and all such dividends as may be declared
by the Board of Directors out of funds legally available therefor; and (iii) to
participate pro rata in any distribution of assets available for distribution
upon liquidation of the Company. Stockholders of the Company have no preemptive
rights to acquire additional shares of common stock or any other securities. All
outstanding shares of common stock are fully paid and non-assessable. The shares
of the Company's common stock are uncertificated.
Preferred Stock
The Company does not have any preferred stock authorized or issued.
Warrants to Purchase Common Stock
In connection with the Credit Facility with Mosvold, which established a
$6,000,000 revolving line of credit, the Company issued to Mosvold a warrant to
acquire up to 100,000 shares of the Company's Common Stock at a price of $10 per
share until May 31, 1999.
ITEM 12. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company's Amended and Restated Articles of Incorporation eliminate the
personal liability of directors to the Company or its shareholders for monetary
damages for breaches of such directors' duty of care or other duties as a
director, except with respect to liability for (i) any appropriation, in
violation of the director's duties, of any business opportunity of the Company,
(ii) acts or omissions that involve intentional misconduct or a knowing
violation of law, (iii) liability under Section 14-2-832 (or any successor
provision or redesignation thereof) of the Georgia Business Corporation Code, or
(iv) any transaction from which the director received an improper personal
benefit. In addition, the Company's Restated Bylaws provide broad
indemnification rights to (i) directors, and (ii) officers, employees, or agents
of the Company as directed by the directors. These provisions of the Amended and
Restated Articles of Incorporation and Restated Bylaws will limit the remedies
available to a shareholder who is dissatisfied with a decision of the Board of
Directors that is protected by these provisions.
ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's Consolidated Financial Statements for the years ended
December 31, 1995, 1996 and 1997 and the quarter ended March 31, 1998 are filed
as exhibits to this Registration Statement.
ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on
accounting and financial disclosures.
25
<PAGE>
ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS
(a) The following documents are filed as part of this report:
Consolidated Financial Statements
Included at the page indicated are the Consolidated Financial Statements of
the Company, with Notes, and the related report of the Company's independent
auditors thereon.
<TABLE>
<CAPTION>
Item Page
---- ----
<S> <C>
Unaudited Condensed Consolidated Financial Statements at March 31, 1997 and
1998 and for the Three Months Ended March 31, 1998.
Condensed Consolidated Balance Sheet F-1
Condensed Consolidated Statements of Operations F-2
Condensed Consolidated Statements of Cash Flows F-3
Notes to Condensed Consolidated Financial Statements F-4
Consolidated Financial Statements at December 31, 1996 and 1997 and for the
Years Ended December 31, 1995, 1996 and 1997
Report of Independent Auditors F-5
Consolidated Balance Sheets F-6
Consolidated Statements of Operations F-7
Consolidated Statements of Shareholders' Equity F-8
Consolidated Statements of Cash Flows F-9
Notes to Consolidated Financial Statements F-10-
18
Unaudited Share Market Data F-19
</TABLE>
(b) Exhibits. The following exhibits are filed as part of this report on
Form 10.
Exhibit
- -------
Number
- ------
Description
----------------------------------------------------
3.1+ Amended and Restated Articles of Incorporation of the Registrant
3.2+ Restated Bylaws of the Registrant
4.1+ Warrant for the Purchase of Shares of Common Stock of the Registrant
issued to Mosvold Farsund AS dated May 31, 1996
10.1+ Loan Agreement between Mosvold Farsund AS and the Registrant, dated
May 31, 1996, as amended June 30, 1997
26
<PAGE>
10.2+ Lease between California State Teachers' Retirement System and the
Registrant dated January 31, 1995 for premises situated at 3525
Piedmont Road, N.E., Seven Piedmont Center, Suite 600, Atlanta,
Georgia 30305
10.3+ Lease between T.A. Fisher & Sons Limited and Iterated Systems
Limited dated June 27, 1997 relating to land and office buildings
forming Unit No. 32 at Wellington Business Park, Dukes Ride,
Crowthorne, Berkshire.
10.4+ Amended and Restated Executive Employment Agreement between the
Registrant and John C. Bacon, dated as of February 16, 1998
10.5+ Executive Severance Agreement between the Registrant and John R.
Festa, dated as of February 16, 1998
10.6+ Employment Agreement between the Registrant and Michael F. Barnsley,
dated May 1, 1994, as amended
10.7+ Employment Agreement between the Registrant and Alan D. Sloan, dated
May 1, 1994, as amended
10.8+ Iterated Systems, Inc. 1994 Amended and Restated Stock Option Plan
10.9+ Iterated Systems, Inc. Amended and Restated 1994 Directors Stock
Option Plan
21 + Subsidiaries of the Registrant
27.1+* Financial Data Schedule
99.1+ Schedule II - Valuation and Qualifying Accounts
+ Previously filed
* Amended
27
<PAGE>
Iterated Systems, Inc.
Condensed Consolidated Balance Sheet
March 31, 1998
(unaudited)
<TABLE>
<CAPTION>
Assets
<S> <C>
Current assets:
Cash and cash equivalents $5,227,953
Short-term investments 10,070,659
Accounts receivable 208,006
Prepaid expenses and other assets 359,518
----------
Total current assets 15,866,136
Property and equipment 4,507,705
Accumulated depreciation (3,373,393)
----------
1,134,312
Other assets 45,017
----------
Total assets $17,045,465
==========
Liabilities and shareholders' equity
Current liabilities:
Accounts payable and accrued expenses $ 1,068,778
Current maturities of long-term debt 70,725
Other 34,572
----------
Total current liabilities 1,174,075
Non-current liabilities:
Long-term debt 3,730
Other 40,334
Shareholders' equity:
Common stock 130,981
Additional paid-in-capital 29,931,251
Accumulated deficit (14,247,303)
Currency translation adjustments 12,397
----------
Total shareholders' equity 15,827,326
----------
Total liabilities and shareholders' equity $17,045,465
==========
</TABLE>
See accompanying notes.
F-1
<PAGE>
Iterated Systems, Inc.
Condensed Consolidated Statements of Operations
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31
--------------------------------
1997 1998
------------ ------------
<S> <C> <C>
Revenues: $ 3,028,350 $ 280,998
Costs and expenses:
Costs of product revenues 61,305 0
Sales and marketing 1,468,790 1,201,682
Research, development and engineering 2,378,552 1,553,344
General and administrative 548,446 563,233
------------ ------------
4,457,093 3,318,259
------------ ------------
Operating loss (1,428,743) (3,037,261)
Other income (expense):
Interest income, net 19,984 227,619
Foreign currency exchange loss (91) (1,227)
------------ ------------
Net loss $ (1,408,850) $ (2,810,869)
============ ============
Basic and diluted net loss per share of
common stock $ (0.13) $ (0.21)
============ ============
Weighted average number of shares of
common stock outstanding 10,714,700 13,105,600
============ ============
</TABLE>
See accompanying notes.
F-2
<PAGE>
Iterated Systems, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31
--------------------------------
1997 1998
-------------- ------------
<S> <C> <C>
Operating activities:
Net loss $(1,408,850) $(2,810,869)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 327,640 268,045
Compensatory stock options, net 67,352 0
Foreign currency transaction loss 91 1,227
Changes in operating assets and liabilities:
Accounts receivable 310,367 287,740
Prepaid expenses and other assets 113,482 1,472
Accounts payable and accrued expenses (13,482) 225,291
Other liabilities (8,643) (8,643)
--------- ----------
Net cash used in operating activities (612,043) (2,035,737)
Investing activities
Purchases of property and equipment (143,933) (167,041)
Purchase of short-term investments 0 (71,239)
--------- ----------
Net cash used in investing activities (143,933) (238,280)
Financing activities
Principal payments on long-term debt (72,861) (50,033)
Changes in common stock 0 (81,509)
--------- ----------
Net cash used in financing activities (72,861) (131,542)
Effect of exchange rate fluctuation on cash 2 229
--------- ----------
Decrease in cash and cash equivalents (828,835) (2,405,330)
Cash and cash equivalents at beginning of period 4,150,834 7,633,283
--------- ----------
Cash and cash equivalents at end of period $ 3,321,999 $ 5,227,953
========= ===========
</TABLE>
See accompanying notes.
F-3
<PAGE>
Iterated Systems, Inc.
Notes to Condensed Consolidated Financial Statements
March 31, 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 three months ended March 31, 1997 and
1998. Results for the three months ended March 31, 1998 are not necessarily
indicative of the results for the year.
2. Purchases and Sales of Common Stock
During the quarter ended March 31, 1998, the Company repurchased and
retired 11,100 shares of its common stock on the open market for a cost of
$84,000. The Company also issued 7,200 shares upon the exercise of stock options
by employees for net proceeds of $2,000.
3. 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 period.
4. Comprehensive Income
In June 1997, 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.
5. Litigation
The Company is involved in certain litigation arising in the ordinary
course of business. In the opinion of management, the ultimate resolution of
these matters will not have a material adverse effect on the Company's
consolidated financial position or results of operations.
F-4
<PAGE>
Report of Independent Auditors
Board of Directors
Iterated Systems, Inc.
We have audited the accompanying consolidated balance sheets of Iterated
Systems, Inc. as of December 31, 1997 and 1996, and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
three years in the period ended December 31, 1997. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these 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 financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall 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
Iterated Systems, Inc. at December 31, 1997 and 1996, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997 in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Atlanta, Georgia
January 16, 1998
F-5
<PAGE>
Iterated Systems, Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31
1996 1997
--------------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 4,150,834 $ 7,633,283
Short-term investments - 9,999,420
Accounts receivable, net of reserves for doubtful accounts
of $9,000 in 1997 and $70,000 in 1996 390,848 490,818
Receivables from employees 21,049 4,849
Inventory, net of reserve for obsolescence of $581,000 in
1996 24,396 8,275
Prepaid expenses and other assets 472,767 360,752
--------------------------------------------
Total current assets 5,059,894 18,497,397
Property and equipment:
Computer equipment and purchased software 3,631,909 3,836,507
Furniture and equipment 464,649 366,084
Leasehold improvements 124,002 134,398
--------------------------------------------
4,220,560 4,336,989
Accumulated depreciation and amortization (1,959,544) (3,103,756)
--------------------------------------------
2,261,016 1,233,233
Other assets 165,960 44,464
--------------------------------------------
Total assets $ 7,486,870 $19,775,094
============================================
December 31
1996 1997
--------------------------------------------
Liabilities and shareholders' equity Current liabilities:
Accounts payable $ 310,087 $ 206,321
Accrued expenses 866,623 639,461
Deferred revenue 2,557,126 5,126
Current maturities of long-term debt 138,487 80,784
Current portion of capitalized lease obligations 160,709 38,829
Other 34,572 34,572
--------------------------------------------
Total current liabilities 4,067,604 1,005,093
Non-current liabilities:
Long-term debt 80,784 -
Capitalized lease obligations 43,704 4,874
Other 83,549 48,977
Shareholders' equity:
Common stock, $.01 par value:
Authorized shares - 20,000,000
Issued and outstanding shares - 13,102,025 in 1997 and
10,714,600 in 1996 107,146 131,020
Additional paid-in capital 8,193,984 30,012,720
Accumulated deficit (5,107,385) (11,436,434)
Currency translation adjustments 17,484 8,844
--------------------------------------------
Total shareholders' equity 3,211,229 18,716,150
--------------------------------------------
Total liabilities and shareholders' equity $ 7,486,870 $ 19,775,094
============================================
</TABLE>
See accompanying notes.
F-6
<PAGE>
Iterated Systems, Inc.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Year ended December 31
1995 1996 1997
----------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Development fees and exclusive license fees $12,835,082 $13,253,918 $ 8,829,000
Software products and related revenues 1,164,904 1,951,337 391,588
Other license and contract revenues 430,504 353,004 250,575
----------------------------------------------------------
14,430,490 15,558,259 9,471,163
Costs and expenses:
Costs of product revenues 276,099 923,253 128,392
Sales and marketing 3,434,709 5,145,754 4,993,471
Research, development and engineering 8,684,687 8,965,758 8,260,615
General and administrative 2,266,663 1,986,449 2,640,183
Inventory writedowns 380,105 238,000 -
----------------------------------------------------------
15,042,263 17,259,214 16,022,661
----------------------------------------------------------
Operating loss (611,773) (1,700,955) (6,551,498)
Other income (expense):
Interest income 173,506 191,266 395,927
Interest expense (57,485) (86,129) (176,464)
Foreign currency exchange gain (loss) (13,111) (10,652) 2,986
==========================================================
Net loss $ (508,863) $(1,606,470) $(6,329,049)
==========================================================
Basic and diluted net loss per share of common stock $ (.05) $ (.15) $ (.56)
==========================================================
Weighted average number of shares of common stock
outstanding 10,500,800 10,563,500 11,319,600
==========================================================
</TABLE>
See accompanying notes.
F-7
<PAGE>
Iterated Systems, Inc.
Consolidated Statements of Shareholders' Equity
<TABLE>
<CAPTION>
Common Stock Additional Currency
----------------------- Paid-In Accumulated Translation
Shares Amount Capital Deficit Adjustments Total
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1995 10,495,200 $ 104,952 $ 5,592,777 $ (2,992,052) $ (16,279) $ 2,689,398
Net loss -- -- -- (508,863) -- (508,863)
Currency translation adjustments -- -- -- -- 11,654 11,654
Issuance of common stock 5,700 57 31,229 -- -- 31,286
Exercise of stock options 8,500 85 3,190 -- -- 3,275
Compensation related to options for
726,500 shares of common stock -- -- 287,233 -- -- 287,233
--------------------------------------------------------------------------------------
Balance at December 31, 1995 10,509,400 105,094 5,914,429 (3,500,915) (4,625) 2,513,983
Net loss -- -- -- (1,606,470) -- (1,606,470)
Currency translation adjustments -- -- -- -- 22,109 22,109
Issuance of common stock 200,000 2,000 1,996,634 -- -- 1,998,634
Exercise of stock options 5,200 52 4,605 -- -- 4,657
Compensation related to options for
714,200 shares of common stock -- -- 278,316 -- -- 278,316
--------------------------------------------------------------------------------------
Balance at December 31, 1996 10,714,600 107,146 8,193,984 (5,107,385) 17,484 3,211,229
Net loss -- -- -- (6,329,049) -- (6,329,049)
Currency translation adjustments -- -- -- -- (8,640) (8,640)
Initial public offering of stock, net
of $1,821,000 of offering costs 2,040,000 20,400 18,558,746 -- -- 18,579,146
Conversion of note payable to stockholder
to common stock 300,000 3,000 2,997,000 -- -- 3,000,000
Issuance of common stock 2,600 26 25,974 -- -- 26,000
Exercise of stock options 44,825 448 132,211 -- -- 132,659
Compensation related to options for
570,200 shares of common stock -- -- 104,805 -- -- 104,805
--------------------------------------------------------------------------------------
Balance at December 31, 1997 13,102,025 $ 131,020 $ 30,012,720 $(11,436,434) $ 8,844 $ 18,716,150
=====================================================================================
</TABLE>
See accompanying notes.
F-8
<PAGE>
Iterated Systems, Inc.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Year ended December 31
1995 1996 1997
------------------------------------------------------------------
<S> <C> <C> <C>
Operating activities
Net loss $ (508,863) $ (1,606,470) $ (6,329,049)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 822,204 1,285,317 1,468,109
(Gain) loss on sales of property and equipment (4,094) 832 (180)
Compensatory stock options 287,233 278,316 104,805
Foreign currency transaction (gain) loss 13,111 10,652 (2,986)
Changes in operating assets and liabilities:
Accounts receivable 199,896 (143,249) (100,761)
Receivables from employees (327,348) 311,744 16,200
Inventory (231,022) 249,480 15,789
Prepaid expenses and other (350,361) (125,879) 240,418
Accounts payable 62,433 (57,162) (102,219)
Accrued expenses 414,324 (338,959) (234,842)
Deferred revenue 4,510,384 (2,557,433) (2,552,000)
Other liabilities 152,693 (34,572) (34,572)
------------------------------------------------------------------
Net cash provided by (used in) operating activities 5,040,590 (2,727,383) (7,511,288)
Investing activities
Purchases of property and equipment (2,443,883) (1,158,042) (445,971)
Proceeds from sale of property and equipment 20,881 15,797 400
Purchases of short-term investments -- -- (9,999,420)
------------------------------------------------------------------
Net cash used in investing activities (2,423,002) (1,142,245) (10,444,991)
Financing activities
Proceeds from note payable to stockholder -- -- 3,000,000
Proceeds from note payable to bank 415,461 -- --
Payments on note payable to bank (57,703) (138,487) (138,487)
Proceeds from capital leases 343,513 12,500 --
Principal payments on capital lease obligations (105,792) (138,191) (160,710)
Proceeds on initial public offering of common stock -- -- 18,579,146
Issuance of common stock 34,561 2,003,291 158,659
------------------------------------------------------------------
Net cash provided by financing activities 630,040 1,739,113 21,438,608
Effect of exchange rate fluctuation on cash (255) 416 120
------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 3,247,373 (2,130,099) 3,482,449
Cash and cash equivalents at beginning of year 3,033,560 6,280,933 4,150,834
------------------------------------------------------------------
Cash and cash equivalents at end of year $ 6,280,933 $ 4,150,834 $ 7,633,283
==================================================================
Non-cash items
Conversion of proceeds on note payable to
stockholder to common stock $ -- $ -- $ 3,000,000
==================================================================
</TABLE>
See accompanying notes.
F-9
<PAGE>
Iterated Systems, Inc.
Notes to Consolidated Financial Statements
December 31, 1997
1. Description of Business and Summary of Significant Accounting Policies
Description of Business
Iterated Systems, Inc. (the "Company") develops and markets patented digital
image science technology based upon its emerging Imaging Systems Architecture
(ISA), to original equipment manufacturers (OEM's) needing innovative, high
performance solutions that improve customer satisfaction while making workflows
faster and more efficient.
Iterated's patented technologies are based upon the Company's research and
development expertise in digital image science and fractal-based mathematics
that have evolved over more than ten years in the digital image business. The
industry in which the Company operates is subject to rapid technological change.
Initial Public Offering
In September 1997 the Company sold 2,040,000 shares of common stock in an
initial public offering at $10.00 per share on the Oslo Stock Exchange in
Norway.
The Company has not registered any securities with the United States ("U.S.")
Securities and Exchange Commission. Securities of the Company may not be offered
for sale or sold in the U.S., or to or for the account or benefit of any "U.S.
person" unless the securities are registered or an exemption from the
registration requirements is available.
Stock Split
On September 2, 1997: (a) the Company's Board of Directors agreed to effect a
100 for 1 stock split in the form of a stock dividend and to increase the number
of authorized shares of common stock from 10,000,000 shares to 20,000,000
shares, effective September 3, 1997; and (b) the Company's shareholders approved
such Board actions. All share and per share amounts have been adjusted in the
accompanying consolidated financial statements to reflect such stock split.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned United Kingdom subsidiary, Iterated Systems, Limited ("ISL").
Significant intercompany accounts and transactions have been eliminated in
consolidation.
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 amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Short-Term Investments
The Company's short-term investments are classified as held-to-maturity and are
stated at cost. These investments mature within one year and the carrying amount
reported in the balance sheets for these investments approximates their fair
value.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined by
using the first-in, first-out method. Market is defined as net realizable value.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization expense
is calculated over the estimated useful lives of the related assets (three to
seven years) using the straight line method for financial reporting purposes.
Amortization of assets recorded under capital leases is included with
depreciation and amortization expense.
Software Revenue Recognition
In October 1997 the American Institute of Certified Public Accountants ("AICPA")
issued Statement of Position 97-2 ("SOP 97-2") 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.
F-10
<PAGE>
Development fees and contract revenues are recognized based on the Company's
estimate of the percentage of completion using actual costs incurred as a
percentage of expected total costs of individual development agreements or
contracts. Exclusive license fees are recognized over the exclusivity period, if
applicable.
Revenues from the sale of hardware and packaged software products are recognized
upon the shipment of the products to the customers.
The Company's revenues are derived from a variety of customers including a large
telecommunications company. The telecommunications company (see Note 7)
accounted for 89%, 81% and 75% of the Company's revenues during 1995, 1996 and
1997, respectively. There were no amounts outstanding from this customer at
December 31, 1997.
Advertising Costs
Advertising costs are expensed in the period incurred. Such costs amounted to
$187,000, $299,000, and $132,000 during 1995, 1996 and 1997, respectively.
Research and Development and Patent Costs
Research and development expenditures which include patent application and
issuance costs are expensed when incurred.
Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for tax purposes. Such amounts are measured using
enacted tax rates and laws that are expected to be in effect when the
differences reverse.
Foreign Currency Translation
ISL considers the British pound to be its functional currency. The Company
considers its functional currency to be the U.S. dollar. ISL's assets and
liabilities are translated at year-end rates of exchange and its revenues and
expenses are translated at the average rates of exchange during the year.
Gains and losses resulting from currency translation are accumulated as a
separate component of shareholders' equity. Gains and losses resulting from
foreign currency transactions are included in the determination of net loss.
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 or potential 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 consolidated financial statements. Net loss per
share of common stock is computed based on the weighted average number of shares
outstanding during the year.
Accounting for the Impairment of Long-Lived Assets
In March 1995 the FASB issued Statement No. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of ("Statement
121"), which requires impairment losses to be recorded on long-lived assets used
in operations when indicators of impairment are present and the undiscounted
cash flows estimated to be generated by those assets are less than the assets'
carrying amounts. Statement 121 also addresses the accounting for long-lived
assets that are expected to be disposed of. The Company adopted Statement 121 as
of January 1, 1996. The effect of such adoption was not material to the
accompanying consolidated financial statements.
Employee Stock Options
In October 1995 the FASB issued Statement No. 123, Accounting for Stock-Based
Compensation ("Statement 123"). Under Statement 123, the Company may continue
following previously existing accounting rules or adopt a new fair value method
of valuing stock-based awards to employees. The Company elected to continue
following the existing accounting rules under Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), and related
Interpretations in accounting for its employee stock options. The pro forma
effect on the accompanying consolidated statements of operations of adopting
Statement 123 is presented in Note 8.
Impact of Recently Issued Accounting Standards
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 will adopt Statement 130 in 1998 and does
not expect the effect of such adoption to be material to its consolidated
financial statements.
F-11
<PAGE>
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. The Company will adopt Statement 131
in 1998 and does not expect the effect of adoption to be material to its
consolidated financial statements.
2. Financial Instruments
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and cash equivalents,
short-term investments and trade accounts receivable.
The Company maintains cash and cash equivalents and certain other financial
instruments with various financial institutions. Company policy is designed to
limit exposure at any one institution. Certain investments are in excess of
Federal Deposit Insurance Corporation ("FDIC") guaranteed amounts. The Company
performs periodic evaluations of the relative credit standing of those financial
institutions which are considered in the Company's investment strategy.
The carrying amounts reported in the balance sheet for cash and cash
equivalents, short-term investments, accounts receivable, accounts payable and
notes payable approximate their estimated fair values.
3. Inventory
During 1995 the Company upgraded certain of its software products. The upgraded
software operates in such a way that, when used in conjunction with recently
available personal computer central processors and operating systems, the
Company's older hardware products are unnecessary for fully functional
operation. Accordingly, during 1995, the Company recorded reserves totaling
$380,000 to reduce the carrying value of certain inventory items and to reflect
inventory purchase commitments in excess of net realizable value. The Company
reserved an additional $238,000 during 1996. Inventory and reserves associated
with the Company's older hardware products were written off during 1997.
4. Long-Term Debt and Credit Facility Long-term debt consists of the following:
December 31
1996 1997
-------------------------------
Note payable to a bank through July 1998
at approximately $12,000 per month,
plus interest at prime (8.5% at December
31, 1997); secured by certain computer
equipment $ 219,000 $ 81,000
Less current portion (138,000) (81,000)
-------------------------------
$ 81,000 $ -
===============================
On May 31, 1996 the Company entered into a Bridge Financing Credit Facility (the
"Agreement") with one of its shareholders (the "Lender"). The Agreement was
amended on June 30, 1997, and the borrowing term, public offering provisions and
conversion date were extended to June 30, 1998 (previously May 31, 1997). The
Credit Facility allows the Company to borrow up to $6,000,000 ($3,000,000 at
December 31, 1997) at prime plus 1% (9.5% at December 31, 1997) from the Lender
until June 30, 1998 without collateral. In addition, the Lender received a
warrant to purchase 100,000 shares of the Company's common stock at $10 per
share. The warrant expires on May 31, 1999. Company borrowings under the Credit
Facility do not have to be repaid prior to the due date unless there is a public
offering of the Company's stock prior to June 30, 1998. In such event, the
Lender has an option to convert such borrowings into shares of the Company's
common stock at $10 per share in lieu of accepting the Company's repayment. If
borrowings are outstanding at June 30, 1998 and there has not been a public
offering of the Company's common stock, such borrowings convert to a three-year
term note. At the time of conversion to a three-year term note, the Lender is
entitled to secure the note with collateral to be negotiated at that time. After
conversion to a term note, the Lender may at any time covert the unpaid balance
into shares of the Company's common stock at $9 per share.
On June 9, 1997, the Company borrowed $3,000,000 under the Agreement. On October
31, 1997, the Lender exercised the option to convert those borrowings into
300,000 shares of the Company's common stock at $10 per share. The Company paid
the Lender $112,000 in interest on the outstanding borrowings during 1997 and
$32,000 and $26,000 for commitment fees on amounts not borrowed during 1996 and
1997, respectively.
F-12
<PAGE>
5. Capitalized Lease Obligations
Property and equipment includes the following amounts for leases that have been
capitalized:
December 31
1996 1997
--------------------------------
Telephone equipment $ 108,000 $ 108,000
Computer equipment 340,000 340,000
--------------------------------
448,000 448,000
Less accumulated amortization (277,000) (426,000)
--------------------------------
$ 171,000 $ 22,000
================================
Amortization of leased assets is included in depreciation and amortization
expense. The telephone equipment provides for a bargain purchase option at the
end of the lease (May, 1998), while the computer equipment lease provides for a
series of one month extensions at the end of the current term (January, 1998).
Future minimum lease payments under capital leases consist of the following at
December 31, 1997:
1998 $ 42,000
1999 5,000
-----------------
Total minimum lease payments 47,000
Less amounts representing interest (3,000)
-----------------
Present value of net minimum lease payments 44,000
Less current portion (39,000)
-----------------
$ 5,000
=================
6. Operating Leases
The Company leases certain office equipment and office space under
noncancellable agreements. The office equipment lease provides for an extension
of the lease term at fair rental value or a purchase option at fair market
value. The office space lease provides for a five year extension with rent
escalation clauses linked to the Consumer Price Index. Rent expense under all
operating leases approximated $755,000, $727,000 and $695,000 during 1995, 1996,
and 1997, respectively.
During 1995 the Company relocated its principal offices and subleased its former
office space to new tenants. The 1995 rent expense included $172,000 to cover
the remaining lease obligation of such former office space, net of expected
sublease and related income of $359,000, through November 30, 1996.
Future minimum lease payments under noncancellable operating leases, with
initial lease terms of at least one year at the time of inception, are as
follows at December 31, 1997:
<TABLE>
<S> <C>
1998 $ 714,000
1999 707,000
2000 395,000
2001 89,000
2002 and after 934,000
------------------
$2,839,000
==================
</TABLE>
7. Significant Contracts
In 1994 the Company entered into a Development and License Agreement (the
"Agreement") with a major international telecommunications company (the
"Licensee") to provide for further development of certain advanced compression
technology for use in telecommunications applications. The Licensee supplied
significant funding for development and had certain exclusive rights until
September 1997 for specified modules in telecommunications markets. The
Agreement provided for the Company and the Licensee to share in revenues
generated by the sale of such telecommunications modules. The Agreement gives
the Licensee certain rights to continue exclusive licensing of specific
technology components in telecommunications markets after September 1997. Some
of these rights require payment of additional exclusivity licensing fees while
others do not. During 1995, 1996, and 1997 the Company recognized $10,975,000,
$10,873,000, and $5,752,000, respectively, in development fee revenues and
$1,800,000, $1,800,000, and $1,350,000, respectively, in exclusive license fee
revenues under the contract. Except for certain provisions, notably with respect
to the continuing licensing of specific technology components referred to above,
the Agreement expired in September 1997.
The Licensee and the Company have engaged in discussions which resulted in
differing interpretations of various material provisions of the Agreement. If
the parties are not successful in resolving these matters, then issues regarding
the Agreement could result in an arbitration proceeding between the Licensee and
the Company. In the opinion of management, the most likely resolution of these
matters will not have a material adverse effect on the Company's consolidated
financial position.
F-13
<PAGE>
8. Stock Option Plans
In 1992 the Company approved a stock option plan and reserved 450,000 shares of
common stock for future issuance. This plan was amended by the 1994 Amended and
Restated Stock Option Plan (the "Plan") and the number of shares issuable under
the Plan was increased to 1,750,000. During 1995, 1996 and 1997, the number of
shares issuable under the Plan was further increased to 2,000,000, 2,200,000,
and 2,400,000, respectively. Options may be granted only to employees of the
Company. The options may be issued as incentive or nonqualified stock options.
The terms and conditions of options granted under the Plan, including the number
of shares, the exercise price and the time at which such options become
exercisable are determined by the Board of Directors. The terms of options
granted under the Plan may not exceed 10 years.
The Company granted options as to 515,000, 311,000 and 553,100 shares under the
Plan at exercise prices ranging from $6 to $8 during 1995, $10 during 1996, and
ranging from $7.40 to $10 during 1997. Options as to 707,700 shares granted in
1994 resulted in $257,000, $248,000 and $80,000 of compensation expense during
1995, 1996 and 1997, respectively. This expense relates to the aggregate
difference between the estimated fair market values of the shares at the date of
the grant and the exercise prices which is being expensed over the vesting
period.
Options as to 398,025 shares are available for future grants under the Plan at
December 31, 1997.
During 1994 the Company adopted a Directors Stock Option Plan and reserved
180,000 shares for awards to non-employee directors joining the Board during or
after November 1994. Such options are intended to take the place of cash
compensation to such directors. Options granted under this plan vest over a
three-year period. The Company granted options as to 25,000 and 15,000 shares at
exercise prices of $6 and $10 in 1995 and 1996, respectively. Grants issued
under the plan resulted in $30,000, $30,000 and $25,000 of compensation expense
during 1995, 1996 and 1997, respectively, which relates to the aggregate
difference between the estimated fair market values of the shares at the dates
of grant and the exercise prices which is being expensed over the vesting
period.
A summary of stock option activity under both of the above-described plans
follows:
<TABLE>
<CAPTION>
Number Price Weighted -
of Shares Per Share Average Price
-------------------------------------------
<S> <C> <C> <C>
Outstanding options at January 1, 1995 1,435,100 $.32 - $6 $5.04
Options granted 540,500 6 - 8 7.11
Options exercised (8,500) .32 - 6 .39
Options canceled (119,200) .32 - 6 5.22
-----------
Outstanding options at December 31, 1995 1,847,900 .32 - 8 5.66
Options granted 326,000 10 10
Options exercised (5,200) .32 - 6 .82
Options canceled (39,500) 6 - 10 8
-----------
Outstanding options at December 31, 1996 2,129,200 .32 - 10 6.29
Options granted 553,100 7.40 - 10 9.42
Options exercised (44,825) .32 - 8 2.96
Options canceled (634,725) .32 - 10 7.79
-----------
Outstanding options at December 31, 1997 2,002,750 .32 - 10 6.76
===========
Exercisable options at December 31, 1997 1,298,317 .32 - 10 5.43
===========
</TABLE>
The following table summarizes information concerning outstanding and
exercisable options at December 31, 1996:
F-14
<PAGE>
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- ------------------------------------------------------------------- --------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Number Remaining Exercise Number Exercise
Prices Outstanding Contractual Life Price Exercisable Price
- ------------------------------ ---------------- ------------ ---------------- ------------
<S> <C> <C> <C> <C> <C>
$ .32 51,000 6 $ .32 51,000 $ .32
4.50 60,000 3 4.50 40,000 4.50
4.83 707,700 7 4.83 487,000 4.83
6 720,000 6 6 420,400 6
8 267,500 9 8 67,400 8
10 323,000 10 - - -
--------------- ----------------
2,129,200 8 6.29 1,065,800 5.27
=============== ================
</TABLE>
The following table summarizes information concerning outstanding and
exercisable options at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- ------------------------------------------------------------------- ---------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Number Remaining Exercise Number Exercise
Prices Outstanding Contractual Life Price Exercisable Price
- ----------------------------- ----------------- ------------ ---------------- -------------
<S> <C> <C> <C> <C> <C>
$ .32 11,900 5 $ .32 11,900 $ .32
4.50 60,000 2 4.50 60,000 4.50
4.83 689,400 6 4.83 689,400 4.83
6 467,600 5 6 445,934 6
7.40 124,100 10 - - -
8 148,750 8 8 71,000 8
10 501,000 9 10 20,083 10
-------------- ----------------
2,002,750 7 6.76 1,298,317 5.43
============== ================
</TABLE>
F-15
<PAGE>
The Company has elected to follow APB 25 and related Interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under Statement 123 requires use
of option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, when the exercise price of the Company's stock
options equals or exceeds the market price of the underlying stock on the date
of grant, no compensation expense is recognized.
Pro forma information regarding net income is required by Statement 123, which
also requires that the information be determined as if the Company has accounted
for its employee stock options granted subsequent to December 31, 1994 under the
fair value method. The fair values for these options were estimated at the dates
of grant using the minimum value method prior to the Company's Initial Public
Offering in September 1997 and the Black-Scholes method thereafter, with the
following weighted-average assumptions for 1995, 1996 and 1997; risk-free
interest rates of 6.40%, 6.36% and 6.20%, respectively; no dividend yield;
volatility of .01 prior to the effective date of the Company's Initial Public
Offering in September 1997 and .421, thereafter; and a weighted-average expected
life of the options of 5 years.
For purposes of pro forma disclosures, the estimated fair values of the options
are amortized to expense over the options' vesting periods. The Company's pro
forma information, assuming Statement 123 had been adopted, is as follows:
<TABLE>
<CAPTION>
Year ended December 31
1995 1996 1997
------------------- -------------------- ---------------------
<S> <C> <C> <C>
Pro forma net loss $ (638,000) $ (1,866,000) $ (6,755,000)
Pro forma basic and diluted net
loss per share of common stock (.06) (.18) (.60)
</TABLE>
The weighted-average fair values of options granted for the years ended December
31, 1995 and 1996 and 1997 were $2.14, $2.52 and $2.90, respectively. Since
Statement 123 is applicable only to options granted subsequent to December 31,
1994, its pro forma effect will not be fully reflected until 1999.
9. Segment Information
The net assets of the foreign operations exclude intercompany accounts payable
to the Company (for which settlement is not planned or anticipated in the
foreseeable future).
Year ended December 31
1995 1996 1997
-----------------------------------------------------
Operating revenue
United States $13,783,000 $15,462,000 $ 9,425,000
United Kingdom 647,000 96,000 46,000
-----------------------------------------------------
Total $14,430,000 $15,558,000 $ 9,471,000
=====================================================
Net loss
United States $ 28,000 $ 973,000 $ 5,511,000
United Kingdom 481,000 633,000 818,000
-----------------------------------------------------
Total $ 509,000 $ 1,606,000 $ 6,329,000
=====================================================
Identifiable assets, net
United States $ 2,427,000 $ 3,144,000 $18,550,000
United Kingdom 87,000 67,000 166,000
-----------------------------------------------------
Total $ 2,514,000 $ 3,211,000 $18,716,000
=====================================================
10. Significant Employment Agreements
In 1994 the Company entered into employment agreements with its two co-founders,
who each serve as Executive Vice Presidents. The agreements provide for: (a) a
grant of stock options; (b) ongoing annual base salaries; (c) salary
continuation rights in the event of employment termination under certain
circumstances; and (d) possible performance-based cash bonuses each year through
1996. Total charges to expense for cash bonuses under these two agreements
amounted to $330,000 in 1995. No such amounts were charged to expense in 1996 or
1997. Prior to the issuance of the 1995 consolidated financial statements, each
Executive Vice President agreed to a future reduction in annual base salary,
which became effective upon the Company's completion of an Initial Public
Offering of common stock in September 1997.
In 1994 the Company also entered into an employment agreement with the
President/Chief Executive Officer. This agreement included a grant of options as
to 724,300 shares of common stock at exercise prices ranging from $4.83 to $6
per share. Options as to 137,500 of the shares were to vest on the earlier of
eight years from date of grant or the successful completion of certain
performance-based criteria during the three year period following the date of
grant. The remaining options vested over a period
F-16
<PAGE>
of three years from the date of grant. Compensation expense related to these
options aggregated $257,000, $248,000 and $80,000 during 1995, 1996 and 1997,
respectively (see Note 8). The President/CEO was also entitled to receive a
specified bonus in the event of a change in control of the Company and retain
salary continuation rights in the event of employment termination under certain
circumstances.
In December 1997, the Company restated the employment agreement with the
President/Chief Executive Officer. The restated agreement acknowledges his
request to relinquish the President/Chief Executive Officer titles and to become
the Vice-Chairman of the Company's Board of Directors together with: a) a
reduction of base salary to reflect his advisory role; b) an additional grant of
124,100 stock options; c) and a performance-based cash bonus in the amount of
$150,000 which was paid in 1997. The restated agreement also provides for the
immediate vesting of options as to 706,000 shares of common stock previously
granted and the forfeiture of options as to 218,300 shares of common stock
previously granted.
11. Income Taxes
The Company and ISL file income tax returns in the United States and the United
Kingdom, respectively.
At December 31, 1996 and December 31, 1997 the Company has net operating loss
carryforwards in the United States of $3,120,000 and $11,941,000, respectively,
which begin expiring in 2007. In addition, at December 31, 1996 and December 31,
1997 the Company has $720,000 and $920,000, respectively, of research and
development credits available for offset against future United States income
taxes which expire in 2007 through 2011. The utilization of net operating loss
carryforwards to offset future taxable income may be limited due to any future
changes in ownership of the Company.
At December 31, 1996 and December 31, 1997 ISL has net operating loss
carryforwards in the United Kingdom of (Pounds)1,011,000 ($1,592,000) and
(Pounds)1,600,000 ($2,633,000), respectively, which are available for offset
against future United Kingdom taxable income.
For financial reporting purposes, a valuation allowance has been recognized to
reduce the net deferred tax assets to zero due to uncertainties with respect to
the Company's ability to generate taxable income in the future sufficient to
realize the benefit of such deferred income tax assets.
The Company's deferred income tax liabilities and assets are as follows:
<TABLE>
<CAPTION>
December 31
1996 1997
------------------------------------
<S> <C> <C>
Deferred income tax liabilities:
Tax over book depreciation $ 77,000 $ -
Prepaid insurance 13,000 19,000
------------------------------------
Total deferred income tax liabilities 90,000 19,000
Deferred income tax assets:
Book over tax depreciation - 158,000
Research and development credits 720,000 920,000
Allowance for bad debts 22,000 3,000
Inventory reserve 220,000 -
Net operating loss carryforwards-U.S. 1,186,000 4,538,000
Net operating loss carryforwards-U.K. 525,000 869,000
Compensatory stock options 335,000 266,000
Deferred revenue 1,345,000 2,000
Alternative minimum tax credit 115,000 115,000
Bonuses - 10,000
------------------------------------
Total deferred income tax assets 4,468,000 6,881,000
Valuation allowance for deferred income tax assets 4,378,000 6,862,000
------------------------------------
Net deferred income tax assets 90,000 19,000
------------------------------------
Net deferred income taxes $ - $ -
====================================
</TABLE>
12. Retirement Plan
The Company maintains a defined contribution plan (the "401(k) Plan") covering
all employees. The Company makes matching contributions equal to 50% of eligible
employees' contributions, up to 4% of the employees' compensation. The Company
expensed $90,000, $102,000, and $102,000 during 1995, 1996 and 1997,
respectively, related to this plan.
F-17
<PAGE>
13. Litigation
The Company is involved in certain litigation arising in the ordinary course of
business. In the opinion of management, the ultimate resolution of these matters
will not have a material adverse effect on the Company's consolidated financial
position or results of operations.
14. Equity Investment
During 1996 an international general trading company and certain of its
associated companies made an equity investment in the Company. The total
investment amounted to approximately $2,000,000 in exchange for which the
Company issued 200,000 shares of the Company's common stock.
15. Year 2000 Date Conversion (Unaudited)
The Company recognizes the need to ensure its operations will not be adversely
impacted by year 2000 software failures. The Company intends to take the actions
necessary to ensure that systems and applications will recognize and process the
year 2000 and beyond. The Company does not expect the cost of year 2000
compliance to be material to its consolidated financial statements.
F-18
<PAGE>
Share Market Value (unaudited)
The company's shares of common stock have been traded on the Norwegian Stock
Exchange under the symbol ITR since October 1,1997. Prior to that time the
shares were not traded on any public market or exchange.
<TABLE>
<CAPTION>
Quarter Ended December 31, 1997 Quarter Ended March 31, 1998
<S> <C>
High $13.92 High $9.23
Low 6.86 Low 5.98
</TABLE>
The Company has not registered any securities with the United States Securities
and Exchange Commission under the Securities Act of 1933, as amended. Securities
of the Company may not be offered for sale or sold in the U.S., or to or for the
account or benefit of any "U.S. person" (as defined in the Securities Act),
unless the securities are registered under the Securities Act or an exemption
from such registration requirements is available.
F-19
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 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.
By: /s/ John C. Bacon
----------------------------------
John C. Bacon
President and
Chief Executive Officer
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1995 DEC-31-1996 DEC-31-1997
<PERIOD-START> JAN-01-1995 JAN-01-1996 JAN-01-1997
<PERIOD-END> DEC-31-1995 DEC-31-1996 DEC-31-1997
<CASH> 6,280,933 4,150,834 7,633,283
<SECURITIES> 0 0 9,999,420
<RECEIVABLES> 316,538 460,932 499,690
<ALLOWANCES> (70,998) (70,084) (8,872)
<INVENTORY> 288,049 24,396 8,275
<CURRENT-ASSETS> 7,403,135 5,059,894 18,497,397
<PP&E> 3,635,629 4,220,560 4,336,989
<DEPRECIATION> (1,240,515) (1,959,544) (3,103,756)
<TOTAL-ASSETS> 10,031,800 7,486,870 19,775,094
<CURRENT-LIABILITIES> 6,088,511 4,067,604 1,005,093
<BONDS> 411,185 124,488 4,874
0 0 0
0 0 0
<COMMON> 105,094 107,146 131,020
<OTHER-SE> 2,408,889 3,104,083 18,585,130
<TOTAL-LIABILITY-AND-EQUITY> 10,031,800 7,486,870 19,775,094
<SALES> 1,164,904 1,951,337 391,588
<TOTAL-REVENUES> 14,430,490 15,558,259 9,471,163
<CGS> 276,099 923,253 128,392
<TOTAL-COSTS> 9,064,792 9,203,758 8,260,615
<OTHER-EXPENSES> 5,701,372 7,132,203 7,633,654
<LOSS-PROVISION> 123,315 28,857 398,465
<INTEREST-EXPENSE> 57,485 86,129 176,464
<INCOME-PRETAX> (508,863) (1,606,470) (6,329,049)
<INCOME-TAX> 0 0 0
<INCOME-CONTINUING> (508,863) (1,606,470) (6,329,049)
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> (508,863) (1,606,470) (6,329,049)
<EPS-PRIMARY> (0.05) (0.15) (0.56)
<EPS-DILUTED> (0.05) (0.15) (0.56)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996
<PERIOD-START> JAN-01-1996 JAN-01-1996 JAN-10-1996 JAN-01-1996
<PERIOD-END> MAR-31-1996 JUN-30-1996 SEP-30-1996 DEC-31-1996
<CASH> 5,937,278 3,300,448 5,065,272 4,150,834
<SECURITIES> 0 0 0 0
<RECEIVABLES> 420,175 365,234 407,830 460,932
<ALLOWANCES> (62,080) (62,541) (69,496) (70,084)
<INVENTORY> 404,080 647,017 41,884 24,396
<CURRENT-ASSETS> 7,365,555 4,900,135 5,952,792 5,059,894
<PP&E> 4,082,466 4,316,295 4,633,881 4,220,560
<DEPRECIATION> (1,538,104) (1,850,323) (2,180,107) (1,959,544)
<TOTAL-ASSETS> 10,142,485 7,597,691 8,637,166 7,486,870
<CURRENT-LIABILITIES> 4,628,840 4,598,533 4,882,215 4,067,604
<BONDS> 339,145 265,878 191,339 124,488
0 0 0 0
0 0 0 0
<COMMON> 105,094 105,095 107,151 107,146
<OTHER-SE> 4,059,928 2,077,350 3,364,269 3,104,083
<TOTAL-LIABILITY-AND-EQUITY> 10,142,485 7,597,691 8,637,166 7,486,870
<SALES> 62,113 53,159 1,507,072 328,993
<TOTAL-REVENUES> 5,805,848 2,496,482 4,061,343 3,194,586
<CGS> 30,708 26,217 689,606 176,722
<TOTAL-COSTS> 2,473,422 2,666,397 2,354,796 1,709,143
<OTHER-EXPENSES> 1,776,861 1,886,457 1,805,878 1,663,007
<LOSS-PROVISION> 0 460 7,332 21,065
<INTEREST-EXPENSE> 17,858 19,557 25,232 23,482
<INCOME-PRETAX> 1,544,817 (2,034,585) (771,855) (344,847)
<INCOME-TAX> 0 0 0 0
<INCOME-CONTINUING> 1,544,817 (2,034,585) (771,855) (344,847)
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 0 0 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> 1,544,817 (2,034,585) (771,855) (344,847)
<EPS-PRIMARY> 0.15 (0.20) (0.07) (0.03)
<EPS-DILUTED> 0.15 (0.20) (0.07) (0.03)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-01-1997 JAN-01-1997 JAN-01-1997 JAN-01-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997 DEC-31-1997
<CASH> 3,321,999 4,604,024 10,023,944 7,633,283
<SECURITIES> 0 0 9,999,420 9,999,420
<RECEIVABLES> 121,438 541,812 583,656 499,690
<ALLOWANCES> (45,960) (39,660) (35,478) (8,872)
<INVENTORY> 17,654 19,163 13,714 8,275
<CURRENT-ASSETS> 3,831,375 5,521,888 20,913,929 18,497,397
<PP&E> 4,354,560 4,451,114 4,564,969 4,336,989
<DEPRECIATION> (2,283,624) (2,620,028) (2,953,507) (3,103,756)
<TOTAL-ASSETS> 6,038,271 7,533,767 22,569,945 19,775,094
<CURRENT-LIABILITIES> 4,029,264 6,795,805 4,146,239 1,005,093
<BONDS> 71,626 18,564 5,971 4,874
0 0 0 0
0 0 0 0
<COMMON> 107,146 107,174 127,776 131,020
<OTHER-SE> 1,755,329 545,961 18,232,339 18,585,130
<TOTAL-LIABILITY-AND-EQUITY> 6,038,271 7,533,767 22,569,945 19,775,094
<SALES> 136,032 114,836 105,318 35,402
<TOTAL-REVENUES> 3,028,350 3,018,242 2,570,599 853,972
<CGS> 61,304 48,285 11,692 7,111
<TOTAL-COSTS> 2,378,553 2,352,914 1,945,781 1,583,367
<OTHER-EXPENSES> 2,017,236 1,881,316 1,556,151 2,178,951
<LOSS-PROVISION> (10,521) 1,333 1,763 405,890
<INTEREST-EXPENSE> 21,593 35,174 84,599 35,098
<INCOME-PRETAX> (1,408,850) (1,263,643) (978,699) (2,677,857)
<INCOME-TAX> 0 0 0 0
<INCOME-CONTINUING> (1,408,850) (1,263,643) (978,699) (2,677,857)
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 0 0 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> (1,408,850) (1,263,643) (978,699) (2,677,857)
<EPS-PRIMARY> (0.13) (0.12) (0.09) (0.21)
<EPS-DILUTED> (0.13) (0.12) (0.09) (0.21)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
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0
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