SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF
1934
For the Fiscal Year Ended December 31, 1997
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 0-26826
APPLIED COMPUTER TECHNOLOGY, INC.
(Name of Small Business Issuer in its charter)
Colorado 84-1164570
(State of incorporation) (IRS Employer Identification No.)
2573 Midpoint Drive, Fort Collins, CO 80525
(Address of Principal Executive Office) Zip Code
Registrant's telephone number, including Area Code: (970) 490-1849
Securities registered pursuant to Section 12(b) of the Act
Title of Class Name of Exchange
Common Stock Pacific Stock Exchange
Warrants Pacific Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Common Stock and Warrants
(Title of Class)
Check whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the Registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90
days.
Yes [] No [X ]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
The Company's revenues for the most recent fiscal year were $25,555,000. The
aggregate market value of the voting stock held by non-affiliates (3,385,000
shares), based upon the average bid and asked prices of the Company's Common
Stock on June 15, 1998 was approximately $2,300,000
As of June 15, 1998 the Company had 4,800,102 shares of common stock issued and
outstanding.
Documents Incorporated by Reference: None
Transitional Small Business Disclosure Format: Yes [ ] No [X]
<PAGE>
Item 1. DESCRIPTION OF BUSINESS
General
Applied Computer Technology, Inc. (the "Company") markets, installs,
services and supports microcomputer systems and related peripheral products
principally for use by business and large institutional customers in the
corporate, government and retail markets. The Company provides a broad range of
microcomputer products and services including hardware, software, system design,
consulting, maintenance and training, as well as internet access and related
services. The Company assembles custom PCs and peripheral hardware under its own
brand name and markets well-known national brands including Compaq, Apple and
IBM. The Company also markets and installs operating systems and applications
software developed by Microsoft Corporation, Novell, Inc. and other software
developers. In May 1998 the Company was notified that it was awarded contracts
to supply microcomputers to Johnson Space Center in Houston, the Air Force
Academy in Colorado Springs, Colorado, and the United States Naval Academy in
Annapolis, Maryland. The amount for these three contracts is approximately
$7,500,000. The Company's Federal and State Bid Teams continue to submit bids
for similar quantities to customers of a similar profile. Many of these bids,
including a $4.5m proposal to the U.S. Military Academy, have not yet been
awarded. Although the Company cannot guarantee that any of these outstanding
contracts will be awarded to the Company, management is optimistic that certain
additional contracts will be awarded to the Company this year.
The Company's current customers include Colorado State University, NASA,
the University of Colorado, Metropolitan State College, University of Oklahoma,
U.S. Military Academy, the U.S. Air Force Academy and the U.S. Naval Academy.
Management estimates the Company and its predecessors, which from 1986 to 1991
carried on the business now conducted by the Company, have sold over 60,000
microcomputers.
The microcomputer products segment of the computer industry was
characterized in its early development by stand alone personal computers with
limited capabilities. Advances in semiconductor technology were the driving
force behind significant upgrades in the capabilities of microcomputer products,
which in turn resulted in a wider range of software applications which were
suitable for use on microcomputers. This expansion in microcomputer capabilities
has been accompanied by significant price reductions in microcomputers and
peripheral products as the cost of semiconductor chips has fallen and
manufacturing efficiencies have been realized.
The growth in the microcomputer industry is also the result of local and
wide area networks which permit a wide distribution of applications software and
databases throughout a business or other organization, the use of a variety of
different hardware and software products from location to location or even user
to user, and the flexible addition or deletion of software applications. In most
cases, hardware and software products produced by a variety of manufacturers can
be used interchangeably in PCs.
The Company's customers desire a system's integrator who has the technical
know how, the purchasing discretion, and the production capacity to manufacture
personal computers custom configured to meet their needs. The Company has the
technical staff, purchasing experience, and manufacturing flexibility to meet
these needs.
Today lower performance computers, "off the shelf" computers, and much of
the end user market are catered to through large discount computer chains. The
Company markets its products and services to clients who require more
sophisticated computers with a range of technical support services. Many high
volume clients, including State and Federal agencies and institutions and highly
technical private and public corporations, evaluate criteria such as product
life cycle, future expansion capabilities, the availability of technical
services, and installed client referrals when selecting a PC vendor. The Company
markets its products to clients who evaluate their purchases of microcomputers
according to these criteria.
The microcomputer products segment of the computer industry is highly
competitive. A number of computer resellers which compete with the Company with
respect to some or all of the products or services offered by it have
experienced downturns in operating results due in part, in the Company's
opinion, to excessive competition. Because of an industry trend toward
decreasing prices for microcomputer products and peripherals, the Company has
adopted a "just in time" inventory management system. The Company believes that
by selling various microcomputer products, peripherals and services as
customized integrated systems, the Company is able to charge higher prices and
thereby earn higher gross profits than those attributable to commodity hardware
sales.
Products and Services
The Company provides turnkey solutions designed to meet its customers'
information system requirements. Systems typically include microcomputer and
networking hardware, peripheral equipment, operating system software and network
system software. The Company also derives a portion of its sales and service
revenues from installation, integration, consulting, upgrades, maintenance and
training.
The Company believes that its customers have, and will continue, to
utilize computer networks to allow a wider distribution of information and
applications. The Company offers network hardware and software to its customers,
providing support and maintenance for network systems, and focusing certain of
its marketing and sales resources on developing customers with networking
requirements.
Hardware. The Company's microcomputer systems are customarily sold using
components and peripherals provided by the Company's suppliers. Hardware
included in these systems may include, among other items, personal computers and
PC workstations (including monitors, disk drives and memory), peripherals
including modems, printers and scanners, network file servers, hard disks, tape
drives, power supplies, printers, high speed modems, network interface cards and
cabling. The Company assembles its microcomputer systems using products from a
number of manufacturers. In addition to branded computer products, the Company
purchases components from a number of suppliers from which the Company assembles
microcomputers which bear the Company's brand name and logo. The majority of the
Company's revenues are generated through the sale of PCs which bear the
Company's name. The Company believes that its customers have accepted assembled
microcomputers using the Company's brand name, as opposed to national brands,
due to the increasingly common performance characteristics of most
microcomputers. Furthermore, the Company believes that its customers choose the
Company's computers because of the Company's ability to custom configure
computers at a price acceptable to the client. Custom configuration allows the
Company and client to work closely together to select the right components and
service and support options for the user's environment and information
technology needs. The Company intends to continue to provide custom-assembled
microcomputers to its customers, both as a means of servicing each customer's
particular automation requirements as well as achieving significantly higher
margins than those associated with mass produced national brand microcomputers.
Because the Company is frequently able to source microcomputers or
components from different suppliers, the Company has generally not experienced
delays in obtaining hardware to satisfy customer orders. Although the Company
believes microcomputers and components are available from a number of
alternative suppliers, any significant interruption in delivery of such items
could have a material adverse effect on the Company's operations.
Software. The Company purchases complete software programs, including
operating systems, application software and networking software, from a variety
of vendors. The vast majority of operating systems installed by the Company
operate through the DOS/Windows environment. The Company has also installed
Novell, UNIX and NT Network operating systems. Operating systems installed by
the Company typically allow customers to migrate to different hardware and
software technologies and to upgrade to new releases of application software.
The Company has established reseller and support agreements with two leading
software development firms.
Services. The Company offers a full complement of services which are
designed to meet the Company's goals of providing a customized solution to the
customers information requirements. The services offered by the Company include
component reliability, compatibility and reliability testing, integration and
networking services.
In many bid situations the client desires a specific configuration which
the Company provides. In other situations, the client relies upon the Company to
provide recommendations. In both cases, the Company differentiates itself
competitively by offering a customized solution. These up front services are
built into the Company's pricing structure.
The Company's customer service program provides customers with ongoing
hardware and software maintenance and hotline telephone support. Agreements
which provide for upgrades maintain the customers' hardware, operating systems
or documentation to the then current standard release level supported by the
Company. Where contracted for separately, maintenance services are billed
monthly in advance and implementation and consulting services are billed monthly
as incurred.
<PAGE>
Sales and Marketing
The Company's products and services are marketed and sold principally on a
direct basis by the Company's sales and marketing personnel. As of March 31,
1998 the Company had 8 full-time employees engaged in sales and marketing
activities, including representatives serving the corporate and government and
in-house sales associates. The sales representatives are compensated using a
combination of salary and commissions.
The other principal means by which the Company markets its products and
services is through its Business Centers. Each Business Center is designed as a
showroom with key demonstration models, but stocks relatively little inventory.
Orders received at the Company's Business Centers are transmitted to the
Company's headquarters, where products are ordered or assembled for delivery to
the Business Center. Although the Company has adopted a "just in time" inventory
management system, the Company has been successful in delivering products
ordered by its Business Centers in an average of 10 to 14 days. If required, the
Company can have components or microcomputers delivered by overnight delivery,
at an additional charge to the customer, and generally fill an order in three to
five days.
The Company's customer base principally consists of various corporate and
government entities. During 1997, approximately 79% of the Company's revenues
were the result of sales to government and educational institutions, 11% to
commercial accounts, and 10% to retail customers, although a significant amount
of these retail sales were to smaller businesses. The Company's three largest
customers during 1997 were: the U.S. Air Force Academy, the U.S. Military
Academy, and U.S. Naval Academy. The Company anticipates that its sales to the
Departments of the Army, Air Force, and Navy will be in excess of 30% of the
Company's sales and service revenues in 1998.
Sales to the Company's government customers in particular are
characterized by a lengthy sales cycle which generally extends for a period from
six to 12 months. Purchases by government entities are often characterized by
bidding and contracting procedures which may place significant demands on the
Company's administrative and sales personnel. Although the Company's status as a
non-exclusive approved vendor to the State of Colorado has simplified some of
the bidding procedures to state-funded colleges and governmental entities, there
can be no assurance the Company will continue to remain an approved vendor by
the State of Colorado.
The Company actively attends Federal trade shows and utilizes a variety of
bid services to generate State and Federal leads. The Company also engages in
print and radio advertising when appropriate.
The Company offers installation, upgrades, maintenance, training and
technical support to its customers and estimates that approximately 75% of its
customers purchase one or more of these services from the Company within one
year of the purchase of hardware.
The Company sells its computer systems at prices which are comparable to
competitor's systems having similar features. The Company sets its rates for
service, repair and training so as to be comparable with the rates charged by
competitors. The Company believes that its pricing policy allows the Company to
differentiate itself from competitors on the basis of service.
Because the Company ships microcomputer products and software shortly
after receipt of an order, the Company typically does not have a significant
backlog of unfilled orders, and revenues in any quarter are substantially
dependent on orders received and delivered in that quarter. However, the Company
from time to time experiences higher than normal backlog depending on factors
such as the configuration of the microcomputer systems ordered, the size of
orders received and availability of hardware or software from suppliers.
As of March 31, 1998 the Company had a sales backlog of approximately
$474,000.
Business Centers
The Company believes that the Business Centers establish customer
recognition of the Company, its products and services and provide the Company a
venue through which higher margin services can be provided to its customer base.
The Company also utilizes its Business Centers as a sales and marketing tool to
identify and provide services to its corporate and government customers.
The following table provides information concerning the location and
services offered by the Company's Business Centers:
Current
Services Monthly Lease
Location Offered Rental(1) Termination
2573 Midpoint Dr. (2)(3) $10,650 01/00
Fort Collins, Colorado
2601 Midpoint Dr. (4) $15,114 12/02
Fort Collins, Colorado
One Tabor Center (3) $5,092 09/01
1200 17th St.
Denver, Colorado
5975 N. Academy Blvd. (3) $ 2,312 08/97
Colorado Springs, Colorado
6501 E. Belleview Ave. (3) (*) $12,895 12/01
Suite l20
Englewood, CO 80lll
1640 Range Street (3) $ 2,600 07/00
Boulder, Colorado
3 Bethesda Metro Center, Ste. 700 (3) $1,440 12/98
Bethesda, MD 20814
(1) Base rent plus common area and maintenance fees, excluding taxes. (2) This
facility includes the Company's Executive Offices, Computer Assembly Facility
and Service Center. (3) Sales, technical service, repairs and training services.
(4) Manufacturing facility (*) In the process of subletting.
The Company expects that its existing executive and assembly facilities
will be adequate for the Company's needs for the foreseeable future. In late
1997 the Company expanded its manufacturing facility. However, should the
Company require additional space for assembly of microcomputers for large
contracts, the Company believes additional facilities are available near the
Company's existing headquarters at a cost comparable to that now paid. The
Company recently negotiated a release from half its space at E. Belleview Ave.
effective June 30, 1998 saving $5,900 in monthly rent.
Suppliers
The Company purchases microcomputers, software and components used in the
assembly of its own brand of microcomputers from outside suppliers. The Company
has no long term agreements with its suppliers with respect to the price or
supply of components or peripherals purchased by the Company.
The Company is an authorized reseller of network operating software
developed by Microsoft and Novell. The agreements with Microsoft and Novell
authorize the Company to sell and support Microsoft and Novell network operating
software. These agreements obligate Microsoft and Novell to provide the Company
with sales leads, technical support, introductory product releases, product
promotion literature and technical documentation and may be terminated by either
party without cause on 30 days notice.
Proprietary Rights
Neither the Company nor any of its directors, officers or shareholders own
any patents or patent rights respecting products marketed by the Company. The
Company holds license agreements with one supplier which grant the Company a
limited, nonexclusive license to use the trademarks, service marks and logos of
such supplier in the promotion of the software provided by the supplier to the
Company. The Company has registered its Applied Computer Technology name as a
trademark and service mark, and has registered the stylized handprint logo, as a
trademark and service marks with the United States Patent and Trademark Office.
The Company intends to maintain the integrity of its service marks, trade names
and trademarks against unauthorized use and to protect against infringement and
unfair competition where circumstances warrant. The Company is not aware of any
currently infringing uses.
Competition
The microcomputer segment of the computer industry is intensely
competitive and is characterized by rapid technological advances, evolving
industry standards and technological obsolescence. Many of the Company's current
competitors have longer operating histories and have greater financial,
technical, sales, marketing and other resources than the Company. In addition,
there are a number of large, well capitalized firms that could, should they
choose to do so, market microcomputer hardware, peripherals and software in
direct competition with the Company. The Company believes that the principal
competitive factors in the market for microcomputer products include price,
service and support, ease of use and the ability to integrate with other
technologies, brand availability and market presence. The Company currently
views Dell, Gateway, Tangent, and Micron as its principal competition in the
microcomputer market in which the Company is active. The Company also competes
to a lesser extent with a number of value added resellers, computer retailers,
electronic specialty stores and mail order distributors active in the
microcomputer hardware or software markets. There can be no assurance the
Company will be able to compete successfully against its competitors or that the
competitive pressures faced by the Company will not adversely affect its
financial performance.
Internet Services
In October 1996, the Company began offering internet access to the
Company's customers and the general public. As an Internet Service Provider, the
Company provides Internet access to persons wishing to view and/or use
information stored on the Internet. Persons using the Company for Internet
access have unlimited E-Mail usage through the Internet. In addition, the
Company offers World Wide Web ("Web") sites (one or more pages of information on
the Internet) to businesses that want to advertise their products or services on
the Web. The Company presently provides 56K dial up connections along the front
range and installs ISDN and T1 connections, including hardware, to corporate
clients. Customers can establish initial access to the Internet using the
Company's dial-up service and standard analog modems. Basic service includes
unlimited usage for non-commercial purposes and E-Mail. Customers can obtain
additional E-Mail names (so that family members can receive E-mail addressed to
them) without incurring the full expense of an additional account. Each personal
account also includes, at no extra charge, 10Mb of storage space for Web
documents.
The Company believes that its primary source of Internet related revenues
will be fees from providing Internet access and telecommunications integration
services to businesses.
Employees
The Company employed 66 persons as of March 31, 1998. Of these, 16 were employed
in administration, 14 in assembly and shipping, 8 in sales and marketing and 25
in support, services, training and technical support. The Company's employees
are not covered by any collective bargaining agreements. The Company believes
that its employee relations are good.
Item 2. DESCRIPTION OF PROPERTY
See "Business Centers" in Item 1 of this report.
Item 3. LEGAL PROCEEDINGS
In November 1996 the Securities and Exchange Commission (SEC) commenced a
formal investigation of the Company. The Company understands this investigation
relates primarily to the Company's capitalization of labor and related costs
associated with enhancements to the Company's internal software systems, the
development of software for the Company's internet service, the development of
the Company's new marketing program and the opening of new business centers. At
December 31, 1996 the Company changed its accounting policy concerning these
costs and elected to expense a substantial portion of the costs which had
previously been capitalized during 1996 in the areas mentioned above. As of
March 31, l998, the investigation is still open. The Company intends to enter
into discussions with the SEC to resolve this matter.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
Item 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
As of March 31, 1998, there were approximately 500 beneficial holders
of the Company's Common Stock and Warrants. The Company's Common Stock and
Warrants are traded on the National Association of Securities Dealers Automatic
Quotation ("NASDAQ") System. Set forth below are the range of high and low bid
quotations for the periods indicated as reported by NASDAQ. The market
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commissions and may not necessarily represent actual transactions.
Quarter Ending Common Stock Warrants
High Low High Low
12/31/95 (1) $4.50 $4.31 $0.88 $0.63
3/31/96 $5.63 $5.00 $1.06 $0.69
6/30/96 $5.63 $3.88 $1.06 $0.56
9/30/96 $5.00 $4.25 $0.82 $0.82
12/31/96 $5.44 $3.50 $l.00 $0.38
3/31/97 $4.06 $2.62 $0.50 $0.25
6/30/97 $3.43 $1.75 $0.25 $0.12
9/30/97 $8.06 $1.50 $1.62 $0.06
12/31/97 $5.25 $2.25 $0.81 $0.37
(1) The Company's Common Stock and Warrants began trading on October 26, 1996.
Holders of Common Stock are entitled to receive such dividends as may be
declared by the Board of Directors out of funds legally available for the
payment of dividends and, in the event of liquidation, to share pro rata in any
distribution of the Company's assets after payment of liabilities. The Board of
Directors is not obligated to declare a dividend. The Company has not paid any
dividends and the Company does not have any current plans to pay any dividends.
The Company has issued shares of Series A Preferred Stock (see below) which
restrict the payment of dividends.
Recent Sales of Unregistered Securities. During the year ending
December 31, 1996 the Company issued 22,116 shares of common stock to a former
employee as the result of the exercise of stock options held by the former
employee. The issuance of the shares was exempt from registration pursuant to
section 4(2) of the Securities Act of 1933 since the issuance of the shares was
not a transaction involving a public offering. The shares issued as a result of
the exercise of the options were restricted securities as that term is defined
in Rule 144 of the Securities and Exchange Commission.
In November 1997, the Company sold 900 shares of Series A Preferred
Stock to a supplier of the Company for $900,000. Payment for the shares was made
by the vendor cancelling $900,000 of payables owed by the Company to the vendor.
At the option of the holder of the Series A Preferred Shares, the Preferred
Shares may be converted into shares of the Company's common stock on the basis
of one share of Preferred Shares for shares of Common Stock equal in number to
the amount determined by dividing $1,000 by the Average Closing Price of the
Corporation's Common Stock over the five-day trading period ending on the day
prior to the conversion of the Preferred Stock. The conversion price however may
not be less than $1.00 per share of more than $3.00 per share. As of June 15,
1998 none of the Series A Preferred Shares had been converted into shares of the
Company's common stock.
On November 24, 1997, the Company sold 1,500 shares of its Series B
Preferred Stock, plus 82,192 Common Stock Purchase Warrants, to a foreign
investor for $1,500,000. The number of shares issuable upon the conversion of
each Series B Preferred Share is determined by dividing $1,000 by the lower of
(i) $3.65, or (ii) 75% of the average closing bid price of the Company's common
stock on the five trading days preceding the conversion date. Each Warrant
allows the holder to purchase one share of the Company's common stock for $4.02
at any time prior to November 21, 2000. The sale of the Series B Preferred Stock
and Warrants was made in reliance upon Regulation S of the Securities and
Exchange Commission. As of May 31, 1998 all shares of the Series B Preferred
Stock had been converted into 1,679,859 shares of the Company's Common Stock.
Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
The following selected financial data should be read in conjunction
with the Financial Statements and related Notes thereto appearing elsewhere in
this Report and "Management's Discussion and Analysis of Financial Condition and
Results of Operations." The selected financial data provided below is not
necessarily indicative of the future results of operations or financial
performance of the Company.
Years Ended December 31,
1997 1996
(in thousands, except per share data)
Statements of Operations Data:
Sales and service revenues $25,555 $20,239
Cost of goods sold 25,730 17,577
Gross profit (loss) (175) 2,662
Operating expenses 4,332 3,951
Loss from operations (4,507) (1,289)
Other income (expense), net (429) (228)
Income tax benefit -- 175
Net loss $(4,936) $(l,342)
Preferred Stock Dividends $(257) 0
Net loss per common share $(1.69) $(0.44)
Weighted Avg Common Shares Outstanding 3 3,042
Balance Sheet Data as of December 31, 1997 (in thousands):
Current Assets 4,165
Current Liabilities 5,723
Working capital deficit (1,558)
Total assets $6,507
Total liabilities $6,164
Shareholders' equity $343
GENERAL
Revenues from product and system sales are recognized when title to the product
or system passes to the customer. Revenues from maintenance agreements are
recognized ratably over the term of the maintenance agreement.
The Company may experience significant fluctuations in quarterly operating
results due to a number of factors including, among others, the size and timing
of customer orders.
DISCUSSION OF 1997 AND 1996
The Company has suffered significant losses during the years ended December 31,
1997 and 1996. These losses are the result of increases in the areas of Sales
and Marketing, Network Services, and reductions in gross margin. These costs
include wages, depreciation, rents, and impairment of long-lived assets
(leasehold improvements). The Company's communicated strategy was to expand its
business into the Corporate marketplace by offering the Company's traditional
products and services as well as training services, systems integration
services, and `branded' products including Compaq, IBM, and HP. The Company
established Business Centers with sales and technical staff to this end.
These expansion efforts did not yield the anticipated results, and Management
began discontinuing investments in these areas during the 2nd quarter of 1997.
In June of 1997, the Company accepted the resignation of its VP of Sales and
Marketing and began eliminating much of its expansion related Sales and
Marketing related expenses. In the 3rd and 4th quarters of 1997, Management
restructured its Sales and Marketing department and its products and services to
redirect its efforts back into the Company's traditional markets. During this
restructuring, the Company intensified its sales resources dedicated to
expanding the Company's business on the State of Colorado contract. A Federal
bid team was also established to solicit and respond to Federal bids. The
Company continues to service certain Corporate accounts with purchasing
requirements consistent with the Company's core focus but has discontinued
investments in expanding this market. Management believes that its restructuring
will enable the Company to continue sales growth at margins acceptable to the
Company while eliminating much of the expense associated with expansion into
other markets. There can, however, be no assurance that the Company will be
successful in returning to a state of operational profitability.
Throughout the 3rd and 4th quarters of 1997 and into 1998 Management has
implemented significant cost reduction programs. The Company has consolidated
its operations to run more efficiently, and inventory controls and pricing
structures have been deployed to improve margins. The Company's sales force has
been focused on expanding the Company's business in its traditional markets,
including State and Federal agencies and institutions and High Tech
Manufacturing firms. The Company believes that it will be successful in
expanding its business in its traditional markets and that the Company's new
conservative budget will enable the Company to return to a state of operational
profitability. There can, however, be no assurance that the Company will
successfully expand its business in its traditional markets or that the Company
will be successful in returning to a state of operational profitability.
Management is disappointed by results for the years ended December 31, 1996 and
1997, but it is encouraged by the reduced spending in the 1st quarter of 1998 as
wage expense has fallen by 40%. Other expenses, including advertising and
promotions, have decreased as well. The Company declined to renew its lease for
its Ft Collins based Business Center during the 3rd quarter of 1997 and has
moved those operations to its Corporate Service Center. The Company has
successfully negotiated out of its lease on one Business Center facility in the
Denver Tech Center and is working to terminate another Business Center lease.
While the Company believes that these activities will improve its financial
results, there can be no assurance that these reductions in overhead will
restore the Company to a state of operational profitability, and the Company
expects to continue to incur operational losses at least through the 1st quarter
of 1998.
<PAGE>
Sales
The Company is highly focused on participation in numerous new Federal agencies'
bids which will be awarded throughout 1998. The Company is selectively targeting
agencies which intend to purchase large quantities of custom configured systems.
The Company has experience with these types of contracts and believes that it
compares favorably against its competitors in these markets. The recently
announced NASA contract for $1.5 million demonstrated the Company's ability to
compete successfully in this market. There can, however, be no assurance that
the Company will be awarded additional contracts. The Company continues to
de-emphasize retail and corporate accounts in favor of State, Federal and high
tech accounts.
The Company's annual contract with the State of Colorado was renewed during the
1st qtr of 1998. Sales, nevertheless, remained soft during that quarter. The
Company has mobilized to capitalize on this and other on-going opportunities and
is aggressively pursuing orders for the State's fiscal year end this June. Sales
orders in the 2nd quarter improved over those of 1st quarter due to increased
demand on the State of Colorado. contract and the award of some smaller Federal
contracts. During the 2nd quarter sale of 1998, the Company's sales orders
include a significant order to NASA and orders to several State of Colorado
colleges and school districts, the University of Oklahoma, the State of
Colorado. Dept of Labor, and a small order to the US Military Academy at West
Point. As of May 31, 1998 the Company had approximately $850,000 in backlog in
addition to the major contracts recently announced in press releases which are
expected to provide for total sales of $6.5 million during fiscal 1998.
The National Institute of Health (NIH) Contract awarded to the Company last fall
has been slow to develop sales for the Company. This five year award allows the
Company and approximately 40 other information technology vendors to sell
directly to the government without the need to competitively bid each of their
purchases. The Company realizes that, even with this contract, a targeted sales
force calling on federal agency procurement personnel is mandatory. The
Company's representative in Washington DC has been actively attending trade
shows in the Washington, D.C. area. The Company's Federal bid team, which was
established during the 2nd quarter of 1997, is actively soliciting Federal
business using the NIH contract and other procurement vehicles established by
the Federal government. Additionally, the Company is pursuing inclusion under
other government procurement schedules. There can, however, be no assurance that
the Company will be successful in generating sales from the NIH contract or in
being included in other government procurement schedules.
Margin
Margins continue to be under increased pressure from competition. With the
advent of the sub $1,000 computer system, certain markets have become more price
sensitive. Manufacturing costs for these systems, however, are less than for
more sophisticated systems, as these systems typically integrate more on the
system board. The Company believes that it can compete favorably with a sub
$1,000 PC within its traditional markets by leveraging its quality products and
its reputation for service and support within its existing customer base. The
Company is further addressing margins by focusing on customers with more
sophisticated technical and servicing requirements. It is the Company's
experience that sales to this group of customers permit better margins.
Overalls margin suffered in 1997 due to significant inventory adjustments. The
Company experienced $681,000 in adjustments in the 2nd quarter of 1997 due
primarily to significant reduction within the industry on costs of parts below
the amounts such items were carried in the Company's inventory. The Company
experienced an additional $65,000 in inventory adjustments during the 3rd
quarter, 1997. Management has implemented inventory procedures and controls to
reduce the Company's inventory exposure going forward. Whereas Management is
satisfied that the problems of the 2nd and 3rd quarter have been resolved, the
Company will be challenged, as is the industry, with inventory valuation issues
as component costs continue to decrease. In the fourth quarter of 1997,
approximately $305,000 was recorded as expense from inventory valuation related
to the year end lower of cost or market analysis. This adjustment reduced
overall margins by 1% of sales. Management is addressing this valuation issue by
reducing the number of components which are inventoried, implementing strict JIT
(Just in Time) purchasing procedures, and implementing secondary distribution
channels for older inventory.
The Company's large contracts generally allow the Company to obtain favorable
pricing due to the increased volume of purchases. The Company's ability to
command preferred vendor status and receive favorable pricing has come under
increased pressure due to working capital constraints.
Overhead
Staffing reductions, particularly in the area of Sales and Marketing, were made
during the 3rd and 4th qtrs of 1997. Additional staffing reductions were made at
the end of December 1997 and early January 1998 which will reduce unabsorbed
service costs and production overhead which Management expects will improve the
Company's gross margins in 1998. Manufacturing volume, which was low in the 4th
quarter of 1997 caused the cost of overhead to increase as a percentage of gross
sales. Increased volume in subsequent quarters would improve gross margins as
indirect fixed costs expenses would be absorbed by the higher sales volume.
Other significant overhead reductions include the elimination of the Company's
Ft Collins Business Center and the termination of one of the Company's leases in
the Denver Tech Center. Negotiations are underway to assign the Company's second
Denver Tech Center lease.
The Company experienced losses in 1997 and in 1996 due to expansion related
spending. Although the marketplace remains highly competitive, the Company has
demonstrated its ability to retain long term customers and to successfully
obtain new business from new clients. The Company's production capacity is
flexible, and it is adequate to sustain significant volume. Management believes
that increased volume at acceptable margins combined with significantly reduced
spending will restore the Company to a state of operational profitability. There
can, however, be no assurance that the Company will be successful in obtaining
additional orders or that Management will be successful in implementing
additional expense controls.
<PAGE>
RESULTS OF OPERATIONS
The Company generated a net loss of $4.9 million on $25.6 million in sales in
1997. The Company attributes much of this loss to expenses incurred in an
unsuccessful attempt to gain market share in new markets and to expand its
Network Services Organization. These expansion programs, which were launched in
1996, added significant expense to the Company, particularly in the areas of
wages, rents, and depreciation. When the anticipated sales did not materialize
according to plan, the Company accepted the resignation of its Vice President of
Sales and Marketing and restructured the Company's Sales and Marketing efforts
to be more consistent with the Company's traditional business. Concurrently, the
Company began significant cost cutting programs, particularly in the areas of
Sales and Marketing. These restructuring activities began in the 3rd quarter of
1997 and continue into 1998.
COMPARISON OF FISCAL YEARS ENDED DECEMBER 31, 1997 AND 1996
NET REVENUES. Net revenues increased $5.3 million, or 26.3%, to $25.6 million in
fiscal 1997 from $20.2 million in fiscal 1996. The increase in net sales was
attributable to sales to new customers, increased sales to existing customers,
and increased sales of value-added services. WEBAccess, the Company's internet
subsidiary increased its revenues $300,000 to $311,000 in fiscal 1997 from
$11,000 in fiscal 1996 (startup period).
GROSS PROFIT (LOSS). Gross profit decreased $2.8 million, or 81.1% to a loss of
($175,000) in fiscal 1997 from $2.6 million profit in fiscal 1996, and decreased
as a percentage of net sales to (0.7%) in fiscal 1997 from 13.1% in fiscal 1996.
Gross profit is displayed below as (Revenues - Materials and Overhead -
Inventory Adjustments - Unabsorbed Service Cost - Internet Access
Cost).
COST OF GOODS SOLD. Presented below is a breakdown of the principal
components of Cost of Goods Sold for the years ended 1997 and 1996.
. ($ in thousands)
1997 % 1996 %
Cost of materials and overhead $22,256 86.50 $16,181 92.06
Inventory Adjustments 1,051 4.08 88 0.50
Unabsorbed Service Cost 1,620 6.30 815 4.64
Internet Access Cost 803 3.12 493 2.80
$25,730 100.00 $17,577 100.00
Presented below is a reconciliation of the approximate impact of key factors
affecting the change in margins from 1996 to 1997.
($ in thousands)
$ %
1996 Gross Profit 2,662 13.1
Margin lost from competitive market conditions (874) (4.3)
Margin lost from additional inventory cost adjustments (900) (4.4)
Margin lost from additional service cost (753) (3.7)
Margin lost from additional internet cost (310) (1.4)
1997 Gross Loss $(175) (0.7)%
Materials costs have been negatively impacted by more competitive market
conditions. During 1997, the industry introduced a sub $1,000 PC which has been
accepted by many computer users. This sub $1,000 PC is desirable to price
conscious buyers but is not suitable for purchasers who desire high performance
PCs. Management has responded to market conditions by focusing its sales and
marketing efforts on specific clients who recognize value in the Company's
products and services. The Company has refocused its Sales and Marketing efforts
on traditional Federal and State Government and Institutional clients and on
high tech and Manufacturing firms. The Company has de-emphasized sales of
products and services to certain SOHO (Small Office Home Office) and end user
market segments which tend to favor commodity prices. The Company has also
developed a sub $1,000 PC using 3rd party components to offer this product to
its traditional markets. There can, however, be no guarantee that the Company
will be successful in improving margins on its products and services or in
gaining market share in its target markets.
The 4th quarter of 1997 physical inventory resulted in a slight increase to
inventory prior to valuation. Management attributes this to the enforcement of
strict inventory controls which were implemented after a significant inventory
adjustment was posted in the 2nd quarter of 1997. However, the year end
computation of lower of cost or market resulted in an approximate $300,000
inventory valuation write down. This write down reflects a downward trend in
component pricing in the computer industry. Management believes that this
exposure can be minimized by adhering to strict Just in Time (JIT) purchasing
practices and by reducing the variety of products offered by the Company.
Management is also researching certain secondary distribution channels to
liquidate 'end of life' inventory components before they valuations decline.
There can, however, be no assurance that these strategies will be successful in
reducing future inventory valuation write downs.
The Company believes that direct labor was higher than necessary, particularly
in the 3rd quarter 1997, due to the limitations of the Company's previous
manufacturing facility. Additionally, the Company outsourced certain contracts
at additional expense. The Company has leased additional space to increase
capacity and believes that the implementation of this new facility will decrease
overall direct labor and eliminate the need to outsource during peak periods.
There can, however, be no assurance that the implementation of this facility
will reduce these costs.
Unabsorbed service costs increased as the result of the Company's expansion of
its Network Services Organization and as the result of service technician
overhead associated with performing warranty work. Late in the 4th quarter of
1997, the Company eliminated under utilized technical staff and consolidated its
Network services. During the 1st quarter, of 1998, a central dispatch system was
implemented to maximize technician efficiency and reduce unabsorbed service
costs. Additional programs designed to increase revenue in the Company's
hardware maintenance, networking and integration services are currently
underway. There can, however, be no assurance that the Company will be
successful in eliminating these unabsorbed service costs.
In accordance with FAS 121, the Company reserved $120,000 for impairment of a
long-lived asset. This reserve was established to provide for certain leasehold
improvements which will not be utilized as intended.
Internet access costs for the Company from its investment in WEBAccess, the
Company's internet subsidiary, increased $310,000 or 62.9% to $803,000 in fiscal
1997 from $493,000 in fiscal 1996. Sales of internet services rose 311% to
$300,000 over fiscal 1996. As a percentage of net sales, internet access costs
increased to 3.1% in fiscal 1997 from 2.8% in fiscal 1996.
SALES AND MARKETING EXPENSES. Sales and marketing expenses decreased $91,000 or
3.8% to $2.3 million in fiscal 1997 from $2.4 million in fiscal 1996, primarily
as a result of less advertising and wage expenses. With this decrease in Sales
and Marketing expense, the Company increased its revenues 26.3% over 1996. As a
percentage of net sales, selling and marketing expenses decreased to 9.1% in
fiscal 1997 from 11.9% in fiscal 1996. The Company is continuing to reduce
expenses in the Sales and Marketing area, including expenses associated with
certain unprofitable Business Centers. The Company has been successful in
negotiating out of one of its leases in the Denver Tech Center location and is
working to eliminate other lease and depreciation expenses related to Sales &
Marketing. There can, however, be no assurance that the Company will be
successful in further reducing Sales and Marketing related expenses.
Mid 1997, Management began cost cutting programs designed to flatten the
organizational structure of the Sales and Marketing department and to refocus
the Company's Sales and Marketing efforts on the Company's traditional markets.
The results of these programs are evident in a decline in Sales and Marketing
expenses from the 4th quarter of 1996 to the 4th quarter of 1997. As compared to
the 4th quarter in 1996, Sales and Marketing wages were down 71.2% from $472,642
to $136,078, and Advertising and Promotion expenses were down 51.4% from
$356,859 to $173,416. Prior to Management's restructuring, the Company had
invested in expanding into the Corporate marketplace and in growing the
Company's Professional Services Organization. The Company was unsuccessful in
obtaining sufficient market share in that market at margins acceptable to the
Company and began eliminating the associated expenses in mid 1997.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $352,000, or 22.8% to $1.9 million in fiscal 1997 from $1.5 million in
fiscal 1996. Wage expense held constant while professional fees, cash discounts
and telephone expenses accounted for a majority of the increase. As a percentage
of net sales, general and administrative expenses decreased to 7.4% in fiscal
1997 from 7.6% in fiscal 1996.
OPERATING LOSS. Operating loss increased $3.2 million or 350% to $4.5 million in
fiscal 1997 from $1.3 million in fiscal 1996 primarily as a result of tighter
margins and additional overhead costs including inventory adjustment expenses
and increased sales and marketing spending. As a percentage of net sales,
operational losses increased to 17.6% in fiscal 1997 from 6.4% in fiscal 1996.
Management has been working since mid 1997 to improve margins, cut costs, and to
restructure the Company's Sales and Marketing efforts on the Company's
traditional markets and products (see discussions above). There can, however, be
no assurance that the Company will be successful in returning the Company to a
state of profitability.
A significant portion of the Company's losses occurred during the 4th quarter as
the result of were significantly lower than projected sales which resulted in a
net loss of approximately $2M for the quarter. Management believes that this is
largely the result of the Company's restructuring activities. 4th quarter sales
of personal computers have typically come from retail and SOHO clients. The
Company has identified these market segments as being unprofitable and has
discontinued investments in these markets. State of Colorado buying has
historically been flat 4th quarter, and the Company's Federal bid team, which
was launched during this restructuring period, experiences buy cycles of 6 - 12
months. Because of this ramp up period, only one Federal contract was awarded to
the Company during the 4th quarter. As a result, revenues for 4th quarter were
just under $3.4M and at very low margin. Although disappointed with the results
of 4th quarter, Management believes that its decision to cut costs and refocus
its Sales and Marketing efforts for 1998 better position the Company going
forward. The Company is currently bidding on multiple significant State and
Federal contracts which are due to be awarded 4th quarter, 1998. There can,
however be no assurance that the Company will be awarded any or all of these 4th
quarter contracts or that the Company's redirected Sales and Marketing effort
will be successful in meeting sales projections.
INTEREST EXPENSE. Interest expense increased $286,000 or 26.3% to $461,000 in
fiscal 1997 from $125,000 in fiscal 1996. The increase in interest expense was
primarily due to increased borrowing due to working capital constraints. The
Company's new operating loan agreement effective October 1997 had interest rates
from approximately 14% to 18%.
NET LOSS. Net loss increased $3.6 million to $4.9 million in fiscal 1997 from
$1.3 million in fiscal 1996. The increase in net loss resulted primarily from
the gross profit decline and additional interest expense. As a percentage of net
sales, the net loss increased to 19.3% in fiscal 1997 from 6.6% in fiscal 1996.
SUMMARY. Management is disappointed with the results of 1997 and with the
results of its expansion efforts. Management has taken proactive steps to
control costs and to focus the Company's Sales and Marketing activities in an
effort to return the Company to a state of operational profitability.
Significant savings, particularly in the areas of wages, are already evident. At
present the Company has been awarded several contracts for 1998, including
contracts with NASA, the US Air Force Academy, and the US Naval Academy.
Additionally, the Company has submitted proposals for additional contracts which
have not yet been awarded.. The Company is pursuing the elimination of certain
other expenditures and is working to leverage its existing customer base and
other potential customers of similar profile. There can, however, be no
assurance that Management will be successful in returning the Company to a state
of operational profitability.
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's losses in 1997 have impaired working capital by $2,599,000
as the Company's working capital balance from December 31, 1996 of $1,241,000
has gone to a deficit of $1,558,000 at December 31, 1997. Current year net
losses have caused liquidity problems and may impact the Company's future
operations. The Company is pursuing additional cash generating strategies, which
include cutting losses, liquidation of certain Company assets, and near term
equity infusions. There can, however, be no assurance that the Company will be
successful in any of these strategies.
The Company completed an equity infusion for $1,500,000 in November 1997
(Preferred Series B) and converted $900,000 of accounts payable to equity
(Preferred Series A) in October 1997.
The Company has been in negotiations with various parties to provide an equity
infusion for approximately $2 million and received a letter of intent to fund
from a prospective investor. Additionally, the Company is also contemplating the
sale of its internet subsidiary.
The Company's current assets were $4,165,000 on December 31, 1997 and decreased
by $2,703,000 during the year ended December 31, 1997. The Company's current
liabilities increased slightly from $5,627,000 on December 31, 1996 to
$5,723,000 on December 31, 1997. The Company's accounts payable balance
increased approximately $1,200,000 while current debt maturities and accrued
liabilities decreased by $1,296,000 principally from less borrowing.
The Company's property and equipment increased by $765,000 for the year ended
December 31, 1997. Depreciation and amortization expense for the period was
$614,000 compared with $274,000 for the comparable prior year period.
As of December 31, 1997, the Company's principal sources of liquidity were its
cash, accounts receivable of $1,377,000 and inventories of $2,404,000. Efforts
are continuing to decrease `days sales outstanding' (DSO) and inventory levels
to increase cash. At March 31, 1998 the Company has reduced accounts receivable
and inventory by $960,000. There can be no assurance the Company will be capable
of raising additional capital or that the terms upon which such capital will be
available to the Company will be acceptable.
The Company continues to reduce its manufacturing overhead, as well as sales,
general and administrative expenses. There can, however, be no assurance that
the Company can generate profits, and management may require other actions.
Management, however, believes that the actions taken to reduce overhead and the
additional bid efforts will increase revenues and efforts to raise additional
capital will enable the Company to continue operations through 1998.
As of May 31, 1998, the Company had a sales backlog of approximately $850,000.
These sales are at margins acceptable to the Company, and the Company continues
to pursue additional sales for 1998 through its increased bid efforts. The
Company was recently awarded the annual contracts to provide computers to the
incoming freshman at the U.S. Air Force Academy and the U.S. Naval Academy.
These contracts are estimated to be worth $4 million dollars in revenue. Also,
NASA has awarded the Company a contract worth $1.3 million.
Disclosure Regarding Forward-Looking Statements
This report on Form 10-KSB includes "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). All statements other than statements of historical
facts included in this report, including, without limitation, statements under
"Business and Properties" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" regarding the Company's financial position,
business strategy, plans and objectives of management of the Company for future
operations are forward-looking statements and the assumptions upon which such
forward-looking statements are based are believed to be reasonable. The Company
can give no assurance that such expectations and assumptions will prove to be
correct. Additionally, any statements contained in this report regarding
forward-looking statements are subject to various known and unknown risks,
uncertainties and contingencies, many of which are beyond the control of the
Company. Such things may cause actual results, performance, achievements or
expectations to differ materially form the anticipated results, performance,
achievements or expectations. Factors that may affect such forward-looking
statements include, but are not limited to: the Company's ability to generate
additional capital to fund operating activities; risks inherent in production;
competition; government regulation; environmental matters; and other matters
beyond the Company's control. All written and oral forward-looking statements
attributable to the Company or persons acting on its behalf subsequent to the
date of this report are expressly qualified in their entirety by this
disclosure.
Year 2000 Issue
The Company has begun to address possible remedial efforts in connection with
computer software that could be affected by the Year 2000 problem. The Year 2000
problem is the result of computer programs being written using two digits rather
than four to define the applicable year. Any programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a major system failure or miscalculations. The
Company has been informed by the suppliers of substantially all of the Company's
software that all of those suppliers' software that is used by the Company is
Year 2000 compliant. After reasonable investigation, the Company has not yet
identified any Year 2000 problems but will continue to monitor the issue.
However, there can be no assurance that Year 2000 problems will not occur with
respect to the Company's computer systems. The Year 2000 problem may impact
other entities with which the Company transacts business and the Company cannot
predict the effect of the Year 2000 problem on such entities.
Item 7. FINANCIAL STATEMENTS
See the financial statements attached to this report.
Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
Item 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS, COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Directors and Executive Officers
Name Age Position
Wiley E. Prentice, Jr. 34 President, Chief Executive Officer
and a Director
Cynthia E. Koehler 33 Executive Vice President, Secretary
and a Director
Daniel T. Radford 46 Vice President of Finance - Chief
Financial Officer
J. Roger Moody 64 Director
Collis Woodward 52 Director
Officers are appointed by and serve at the discretion of the Board of
Directors. Each director holds office until the next annual meeting of
shareholders or until a successor has been duly elected and qualified. All of
the Company's officers devote their full-time to the Company's business and
affairs.
Wiley E. Prentice, Jr. is the founder of the Company and has been
the President, Chief Executive Officer and a director since the Company's
inception. Mr. Prentice also served as Treasurer from inception to February
1995. Mr. Prentice's principal responsibilities now include strategic
planning, vendor relationships, and sales and marketing activities. In 1986,
Mr. Prentice formed Applied Computer Technology, a Colorado sole
proprietorship which until 1989 conducted the business now engaged in by the
Company. In 1989, Mr. Prentice co-founded Applied Computer Technology, a
Colorado general partnership, which continued the business of the sole
proprietorship until 1991, at which time the assets of the partnership were
acquired by the Company.
Cynthia E. Koehler has been Executive Vice President, Secretary and
a director of the Company since its inception. Ms. Koehler's principal
responsibilities include human resources, corporate policy and practices and
logistics. Ms. Koehler also co-founded Applied Computer Technology, the
general partnership which from 1989 through 1991 conducted the business now
engaged in by the Company. Ms. Koehler received her Bachelor of Science
degree in computer science from Colorado State University in 1987.
Daniel T. Radford has been the Company's Vice President of Finance and
Chief Financial Officer since June 1997. From 1994 through 1997 Mr. Radford
served as chief financial officer of Brite-Line Industries, Inc., a manufacturer
of highway marking products. From 1992 to 1993 Mr. Radford was chief financial
officer of Waveframe Corporation, a digital sound recording equipment
manufacturer. Prior to that, Mr. Radford served for four years at
MiniScribe/Maxtor in various positions including Group CFO, Orient CFO, and
Director of Treasury and Finance Systems. Mr. Radford obtained a Master of
Business Administration from Chapman College, Syracuse, New York in 1988, and a
Bachelor of Science in Business Administration from Syracuse University,
Syracuse, New York, He earned his CPA and CMA from the State of New York
J. Roger Moody has been a director of the Company since July 1995. Mr.
Moody has been an independent business consultant since 1994 providing advice in
the areas of marketing and operations to development stage companies. From 1991
to 1994, Mr. Moody served as president, chief executive officer and a director
of Data Switch Corp., a publicly traded manufacturer of computer products. From
1986 to 1991, Mr. Moody served as president, chief executive officer and a
director of Coordination Technology, Inc., Trumbull, Connecticut, a software
development and marketing company. From 1985 to 1986, he was president, chief
executive officer and a director of InfoCenter Software, Inc., New Paltz, New
York, a software development and marketing company. From 1983 to 1984, he was
president, chief executive officer and a director of U.S. Satellite Systems,
Inc., New York, New York, a satellite design and production company. From 1981
to 1983, he was a vice president of CBS and between 1974 to 1981, a vice
president of AT&T. From 1959 to 1972, he held various sales and management
positions with IBM. Mr. Moody received his Bachelor of Science degree in
electrical engineering from Columbia University in 1958 and his Master of
Business Administration degree from the University of Michigan in 1959.
Collis R. Woodward has been a director of the Company since February of
1998. Since 1991 Mr. Woodward has been the managing director for Westerly
Partners, an investment firm. In this capacity Mr. Woodward is responsible for
fund management, business development and operations. Prior to that, Mr.
Woodward was the Chief Executive Officer of UVP, Inc., a manufacturer of
ultraviolet light products, for three years. Prior to his association with UVP,
Inc. Mr. Woodward was the Chief Operating Officer and Chief Financial Officer of
Gish Biomedical for seven years. He began his career with Ernst and Young where
he planned and managed a wide range of consulting services for seven years. Mr.
Woodward earned his Backelor of Science degrees in Electrical Engineering and
Accounting at UCLA and is a non practicing CPA.
Item 10. EXECUTIVE COMPENSATION
The following table sets forth the annual and long-term compensation
for services in all capacities to the Company for the three years ended December
31, 1997 of Wiley E. Prentice, Jr., the President and Chief Executive Officer of
the Company (the "Named Officer"), and any other officers of the Company who
received annual salary and bonus exceeding $100,000 during such three-year
period.
Name and Annual compensation All Other
Position Year Salary Bonus Compensation(1)
Wiley E. Prentice, Jr.1997 $66,495 -0- $ --
President and Chief 1996 $71,910 -0- $ --
Executive Officer 1995 $44,263 -0- $ --
(1) Excludes personal use of a Company-furnished automobile valued at less than
$l,000 and car allowance of $l,800.
During the period covered by the above table, no shares of restricted
stock were issued as compensation for services to the person listed in the
table. As of December 31, 1997, the number of shares of the Company's restricted
common stock, owned by the officer included in the table, and the value of such
shares at such date, based upon the market price of the Company's common stock
were:
Name Shares Value
Wiley E. Prentice, Jr. 1,060,000 $2,650,000
Dividends may be paid on shares of restricted stock owned by the
Company's officers and directors, although the Company has no plans to pay
dividends. The Company has issued a Series A Preferred Stock series which
prohibits the payment of dividends on common stock.
No employee of the Company receives any additional compensation for his
or her services as a director. Non-management directors receive a retainer of
$500 per month plus $1,000 per meeting attended. Additionally, each of the
non-management directors received a grant of 10,000 options exercisable at $2.00
per share which vest 25% on grant and 25% following each year of service. The
Company has also agreed to grant each of the non-management directors options to
acquire 10,000 shares of the Company's Common Stock on the first anniversary of
service and options to acquire 10,000 shares of Common Stock on the second
anniversary of service. These options will be granted at market value and will
vest at the rate of 25% per year. The Board of Directors has also authorized
payment of reasonable travel or other out-of-pocket expenses incurred by
non-management directors in attending meetings of the Board of Directors.
The Company has no retirement, pension or profit sharing program for
the benefit of its directors, officers or other employees, but the Board of
Directors may recommend one or more such programs for adoption in the future.
Employment Agreements. The Company has entered into employment
agreements with Mr. Prentice and Ms. Koehler. Each agreement requires that the
executive devote their full business time to the Company, and may be terminated
by the Company for "cause" (as defined in the agreements). The Company has also
entered into agreements with Mr. Prentice and Ms. Koehler which prohibit the
executive from directly competing with the Company for one year within a 50 mile
radius of Fort Collins, Colorado following termination of the agreement.
Pursuant to their employment agreements, Mr. Prentice and Ms. Koehler were to
receive annual salaries of $80,000 and $60,000, respectively, with scheduled
minimum increases of 5% annually. Both officers elected to go unpaid during the
last 2 months of 1997. Both officers may also receive such bonuses or
compensation as may be awarded by the Board of Directors. The employment
agreement with Mr. Prentice extends through March 2000 and the employment
agreement with Ms. Koehler extends through March 1998, subject to the right on
the part of either the Company or the executive to terminate the employment
agreement at any time upon 30 days written notice.
Stock Option and Bonus Plans
The Company has an Incentive Stock Option Plan, a Non-Qualified Stock
Option Plan and a Stock Bonus Plan. A summary description of these Plans
follows. In some cases these Plans are collectively referred to as the "Plans".
Incentive Stock Option Plan. The Incentive Stock Option Plan authorizes
the issuance of up to 600,000 shares of the Company's Common Stock to persons
that exercise options granted pursuant to the Plan. Only Company employees may
be granted options pursuant to the Incentive Stock Option Plan.
To be classified as incentive stock options under the Internal Revenue
Code, options granted pursuant to the Plans must be exercised prior to the
following dates:
(a) The expiration of three months after the date on which an option
holder's employment by the Company is terminated (except if such termination is
due to the death or permanent and total disability);
(b) The expiration of 12 months after the date on which an option
holder's employment by the Company is terminated, if such termination is due to
the Employee's permanent and total disability;
(c) In the event of an option holder's death while in the employ of the
Company, his executors or administrators may exercise, within three months
following the date of his death, the option as to any of the shares not
previously exercised;
The total fair market value of the shares of Common Stock (determined
at the time of the grant of the option) for which any employee may be granted
options which are first exercisable in any calendar year may not exceed
$100,000.
Options may not be exercised until one year following the date of
grant. Options granted to an employee then owning more than 10% of the Common
Stock of the Company may not be exercisable by its terms after five years from
the date of the grant. Any other option granted pursuant to the Plan may not be
exercisable by its terms after ten years from the date of grant.
The purchase price per share of Common Stock purchasable under an
option is determined by the Committee but cannot be less than the fair market
value of the Common Stock on the date of the grant of the option (or 110% of the
fair market value in the case of a person owning more than 10% of the Company's
outstanding shares).
Non-Qualified Stock Option Plan. The Non-Qualified Stock Option Plan
collectively authorizes the issuance of up to 600,000 shares of the Company's
Common Stock to persons that exercise options granted pursuant to the Plans. The
Company's employees, directors, officers, consultants and advisors are eligible
to be granted options pursuant to the Plans, provided however that bona fide
services must be in connection with the offer or sale of securities in a
capital-raising transaction. The option exercise price is determined by the
Committee but cannot be less than the market price of the Company's Common Stock
on the date the option is granted.
Stock Bonus Plan. Up to 200,000 shares of Common Stock may be granted
under the Stock Bonus Plan. Such shares may consist, in whole or in part, of
authorized but unissued shares, or treasury shares. Under the Stock Bonus Plan,
the Company's employees, directors, officers consultants and advisors are
eligible to receive a grant of the Company's shares, provided however that bona
fide services must be rendered by consultants or advisors and such services must
not be in connection with the offer or sale of securities in a capital-raising
transaction.
Other Information Regarding the Plans. The Plans are administered by
the Company's Compensation Committee ("the Committee"), each member of which is
a director of the Company. The members of the Committee were selected by the
Company's Board of Directors and serve for a one-year tenure and until their
successors are elected. A member of the Committee may be removed at any time by
action of the Board of Directors. Any vacancies which may occur on the Committee
will be filled by the Board of Directors. The Committee is vested with the
authority to interpret the provisions of the Plans and supervise the
administration of the Plans. In addition, the Committee is empowered to select
those persons to whom shares or options are to be granted, to determine the
number of shares subject to each grant of a stock bonus or an option and to
determine when, and upon what conditions, shares or options granted under the
Plans will vest or otherwise be subject to forfeiture and cancellation.
In the discretion of the Committee, any option granted pursuant to the
Plans may include installment exercise terms such that the option becomes fully
exercisable in a series of cumulating portions. The Committee may also
accelerate the date upon which any option (or any part of any options) is first
exercisable. Any shares issued pursuant to the Stock Bonus Plan and any options
granted pursuant to the Incentive Stock Option Plan or the Non-Qualified Stock
Option Plan will be forfeited if the "vesting" schedule established by the
Committee administering the Plan at the time of the grant is not met. For this
purpose, vesting means the period during which the employee must remain an
employee of the Company or the period of time a non-employee must provide
services to the Company. At the time an employee ceases working for the Company
(or at the time a non-employee ceases to perform services for the Company), any
shares or options not fully vested will be forfeited and cancelled. At the
discretion of the Committee payment for the shares of Common Stock underlying
options may be paid through the delivery of shares of the Company's Common Stock
having an aggregate fair market value equal to the option price, provided such
shares have been owned by the option holder for at least one year prior to such
exercise. A combination of cash and shares of Common Stock may also be permitted
at the discretion of the Committee.
Options are generally non-transferable except upon death of the option
holder. Shares issued pursuant to the Stock Bonus Plan will generally not be
transferable until the person receiving the shares satisfies the vesting
requirements imposed by the Committee when the shares were issued.
The Board of Directors of the Company may at any time, and from time to
time, amend, terminate, or suspend one or more of the Plans in any manner they
deem appropriate, provided that such amendment, termination or suspension will
not adversely affect rights or obligations with respect to shares or options
previously granted. The Board of Directors may not, without shareholder
approval: make any amendment which would materially modify the eligibility
requirements for the Plans; increase or decrease the total number of shares of
Common Stock which may be issued pursuant to the Plans except in the case of a
reclassification of the Company's capital stock or a consolidation or merger of
the Company; reduce the minimum option price per share; extend the period for
granting options; or materially increase in any other way the benefits accruing
to employees who are eligible to participate in the Plans.
Summary. The following sets forth certain information, as of March 31,
1998, concerning the stock options and stock bonuses granted by the Company.
Each option represents the right to purchase one share of the Company's Common
Stock.
Total Shares Shares Remaining
Shares Reserved for Issued Options/
Reserved Outstanding as Stock Bonus Shares
Name of Plan Under Plan Options Bonus Under Plan
Incentive Stock
Option Plan 600,000 328,500 -- 232,784
Non-Qualified Stock
Option Plan 600,000 -- -- 600,000
Stock Option Plan 200,000 N/A -- 200,000
Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of June 15, 1998, by (i) each person
who is known by the Company to own beneficially more than 5% of the Company's
outstanding Common Stock, (ii) each of the Company's executive officers and
directors, and (iii) all executive officers and directors as a group. Shares not
outstanding but deemed beneficially owned by virtue of the right of an
individual to acquire them within 60 days are treated as outstanding only when
determining the amount and percentage of Common Stock owned by such individual.
Each person has sole voting and sole investment power with respect to the shares
shown except as noted.
Shares beneficially owned
Name and Address Number Percent
Wiley E. Prentice, Jr. 1,060,000 (1) 22%
2573 Midpoint Drive
Fort Collins, CO 80525
Cynthia E. Koehler 355,000 (1) 7.4%
2573 Midpoint Drive
Fort Collins, CO 80525
Daniel T. Radford -- --
2573 Midpoint Drive
Fort Collins, CO 80525
J. Roger Moody 30,000 (2) *
7319 East Black Rock Road
Scottsdale, AZ 85255
Collis R. Woodward -- --
1716 Cottonwood Point Drive
Fort Collins, Co. 80524
All directors and officers
as a group (five persons) 1,445,000 (2) 30%
* Less than one percent.
(1) Includes shares of Common Stock currently held in an escrow account and
subject to release on or before December 31, 2002. For further information
regarding the terms of such escrow, see the information set forth below.
(2) Includes options which currently allow for the purchase of 30,000 shares of
the Company's Common Stock.
In September 1995, Mr. Prentice and Ms. Koehler entered into an escrow
agreement (the "Escrow Agreement") with U.S. Escrow Services, Inc., Denver,
Colorado, pursuant to which 330,000 shares of Common Stock owned by Mr. Prentice
and 110,000 shares of Common Stock owned by Ms. Koehler were deposited in an
escrow account (the "Escrow Account"). In accordance with the terms of the
Escrow Agreement 150,000 shares deposited by Mr. Prentice and 50,000 shares
deposited by Ms. Koehler were released from escrow since the Company had
earnings per share equal to or exceeding $.23 in the fiscal year ending December
31, 1995. The shares remaining in escrow will be returned by the escrow agent to
Mr. Prentice and Ms. Koehler on December 31, 2002.
<PAGE>
Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Between January 1, 1996 and December 31, 1997, the Company paid certain
payroll and other expenses on behalf of MCTI, a partnership owned by Mr.
Prentice and Ms. Koehler as well as made advances to these persons individually.
As of December 31, 1997, these advances totaled approximately $98,000 and are
shown on the Company's Balance Sheet at December 31, 1997 as Notes Receivable,
Related Party. These advances bear interest at 9% per annum and are due on
demand and are collateralized by shares of Company's stock owned by Mr. Prentice
and Ms. Koehler.
Mr. Prentice and Ms. Koehler have personally guaranteed the
Company's repayment of amounts advanced under the business loan agreement
with Norwest Business Credit. Neither Mr. Prentice nor Ms. Koehler received
any compensation from the Company for providing such personal guarantees.
Mr. Prentice has also guaranteed certain of the Company's real property
leases, for which he received no compensation.
<PAGE>
Item 13. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
The following is a complete list of Exhibits filed as part of this
Report and which are incorporated herein.
Exhibit No. Page
3.1.1 Articles of Incorporation. *
3.1.2 Amendment to Articles of Incorporation as filed on May 19, 1995 *
3.1.3 Amendment to Articles of Incorporation as filed on June 6, 1995 *
3.2.1 By-Laws. *
4.1 Form of specimen certificate for Common Stock of the Company. *
4.2 Form of specimen certificate for Warrants of the Company. *
4.5 Warrant Agreement between the Company and American Securities
Transfer, Inc. *
10.1.1 Employment Agreement, dated April 1, 1995, by and between
Wiley E. Prentice, Jr. and the Company. *
10.1.2 Employment Agreement, dated April 1, 1995, by and between
Cynthia E. Koehler and the Company. *
10.2 1995 Incentive Stock Option Plan, adopted March 1, 1995,
authorizing 600,000 shares of Common Stock for issuance upon
exercise of options issued pursuant to the Plan. *
10.7 Retail Lease, dated May 29, 1992, by and between Clarmont
Enterprises, Inc. and the Company. *
10.8 Retail Lease, dated August 13, 1990, by and between
University Hill Plaza Partnership, Ltd. and the Company. *
10.9 Lease Agreement, dated August 16, 1989, by and between
G.B. Ventures and the Company, as amended by Lease
Extension Agreement #1, dated September 15, 1994
and Lease Addendum No. 2, dated July 7, 1995. *
10.10 Shopping Center Lease, dated August 13, 1991, by and
between Colorado & Wesley Partners, Ltd. and the Company. *
10.11 Shopping Center Lease, dated July 16, 1993, by and between
Crow-Watson #8, a Texas limited partnership, and the Company. *
10.12 Shopping Center Lease, dated September 14, 1992, by and
between First Interstate Bank, N.A., as Trustee of Heron
North America Property Trust, and the Company. *
10.13 Lease, dated July 8, 1991, by and between Westside
Investment Company and the Company. *
10.24 Share Escrow Agreement. * 23.2 Consent of Hein + Associates LLP *
Incorporated by reference to same exhibit filed with Company's Registration
Statement on Form SB-2 (Commission File #33-95782-D).
Reports on Form 8-K
During the quarter ending December 31, 1997 the following 8-K reports
were filed:
Report dated November 24, 1997 concerning the sale of the Company's
Series B Preferred Stock.
<PAGE>
INDEX TO FINANCIAL STATEMENTS
PAGE
Independent Auditor's Report................................................F-2
Consolidated Balance Sheet - December 31, 1997..............................F-3
Consolidated Statements of Operations - For the Years Ended December 31,
1997 and 1996..............................................................F-4
Consolidated Statements of Stockholders' Equity - For the Years Ended
December 31, 1997 and 1996................................................F-5
Consolidated Statements of Cash Flows - For the Years Ended December 31, 1997
and 1996....................................................................F-6
Notes to Consolidated Financial Statements..................................F-7
F-1
<PAGE>
INDEPENDENT AUDITOR'S REPORT
Board of Directors
Applied Computer Technology, Inc.
Fort Collins, Colorado
We have audited the accompanying consolidated balance sheet of Applied Computer
Technology, Inc. and subsidiaries as of December 31, 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years ended December 31, 1997 and 1996. 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 financial position of Applied Computer
Technology, Inc. and subsidiaries as of December 31, 1997, and the results of
their operations and their cash flows for the years ended December 31, 1997 and
1996, in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern, which contemplates the
realization of assets and liquidation of liabilities in the normal course of
business. As discussed in Note 2 to the financial statements, the Company has
suffered substantial operating losses in 1996 and 1997 and the Company has a
working capital deficit of $1,558,000 at December 31, 1997. These conditions
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also discussed in
Note 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
HEIN + ASSOCIATES LLP
Denver, Colorado
April 3, 1998
F-2
<PAGE>
APPLIED COMPUTER TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1997
ASSETS
CURRENT ASSETS:
Cash $24,000
Receivables:
Trade, less allowance for doubtful accounts of 1,377,000
$55,000
Other 99,000
Inventories 2,404,000
Prepaid expenses and other 261,000
----------
Total current assets 4,165,000
PROPERTY AND EQUIPMENT, at cost, net 1,852,000
OTHER ASSETS:
Customer list, net of accumulated amortization of $34,000 116,000
Notes receivable, related parties 98,000
Deposits and other 276,000
----------
Total other assets 490,000
----------
TOTAL ASSETS $6,507,000
==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of obligations under capital leases $172,000
Current maturities of long-term debt 1,108,000
Accounts payable 3,952,000
Accrued liabilities 491,000
---------
Total current liabilities 5,723,000
LONG-TERM DEBT, less current maturities 42,000
OBLIGATIONS UNDER CAPITAL LEASES, less current maturities 399,000
COMMITMENTS AND CONTINGENCIES (Notes 2 and 7)
STOCKHOLDERS' EQUITY:
Preferred stock, no par value; 5,000,000 shares
authorized:
Series A Preferred Shares, 1,000 shares
authorized; 900 shares issued and outstanding
(liquidation preference $919,000) 900,000
Class B Convertible Preferred Shares, 1,500 shares
authorized; 1,500 shares issued and outstanding
(liquidation preference $1,509,000) 1,326,000
Common stock, no par value; 25,000,000 shares
authorized; 3,085,243 shares issued and outstanding 4,183,000
Accumulated deficit (6,066,000)
-----------
Total stockholders' equity 343,000
-----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $6,507,000
===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
APPLIED COMPUTER TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
1997 1996
----------- ---------
NET REVENUES $25,555,000 $20,239,000
Cost of goods sold 25,730,000 17,577,000
GROSS PROFIT (LOSS) (175,000) 2,662,000
---------- ----------
OPERATING EXPENSES:
Marketing and selling 2,319,000 2,410,000
General and administrative 1,893,000 1,541,000
Impairment of long-lived assets 120,000 -
--------- ---------
Total operating expenses 4,332,000 3,951,000
--------- ---------
LOSS FROM OPERATIONS (4,507,000) (1,289,000)
OTHER INCOME (EXPENSE):
Other (expense) income 32,000 (53,000)
Interest expense (461,000) (175,000)
-------- --------
LOSS BEFORE INCOME TAXES (4,936,000) (1,517,000)
Income tax benefit - (175,000)
----------- ----------
NET LOSS (4,936,000) (1,342,000)
PREFERRED STOCK DIVIDENDS:
Accrued (28,000) -
Imputed (229,000) -
--------- --------
Net loss applicable to common stockholders $(5,193,000)$(1,342,000)
============ ===========
NET LOSS PER COMMON SHARE $(1.69) $ (.44)
====== ======
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 3,067,000 3,042,000
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
APPLIED COMPUTER TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
RETAINED
COMMON STOCK PREFERRED STOCK EARNINGS
SHARES AMOUNT SHARES AMOUNT (DEFICIT) TOTAL
BALANCES, January 1, 1996 3,040,000 $4,139,000 - $- $212,000 $4,351,000
Exercise of options 40,000 80,000 - - - 80,000
Surrender of shares (16,873) (80,000) - - - (80,000)
Net loss - - - - (1,342,000) (1,342,000)
----- ----- ----- ----- ---------- ----------
BALANCES, December 31, 1996 3,063,127 4,139,000 - - (1,130,000) 3,009,000
Exercise of stock options 22,116 44,000 - - - 44,000
Conversion of debt to equity - - 900 900,000 - 900,000
Issuance of Series B Preferred stock - - 1,500 1,500,000 - 1,500,000
Offering costs - - - (174,000) - (174,000)
Net loss - - - - (4,936,000) (4,936,000)
----- ----- ----- ----- ---------- ----------
BALANCES, December 31, 1997 3,085,243 $4,183,000 2,400 $2,226,000 $(6,066,000) $343,000
========= ========== ===== ========== =========== ========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
<PAGE>
APPLIED COMPUTER TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED
DECEMBER 31,
1997 1996
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(4,936,000) $(1,342,000)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 614,000 274,000
Impairment of long-lived assets 120,000 -
Loss on disposal of assets 10,000 68,000
Provision for obsolete and slow-moving
inventories 1,051,000 -
Deferred income taxes - (22,000)
Changes in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable 323,000 (364,000)
Inventories (74,000) (1,809,000)
Prepaid expenses and other 126,000 (317,000)
Income tax refund receivable 280,000 (133,000)
Increase (decrease) in:
Accounts payable 2,150,000 2,270,000
Customer deposits - (53,000)
Accrued liabilities and other 95,000 143,000
------ -------
Net cash used in operating activities (241,000) (1,285,000)
-------- ----------
CASH FLOWS FROM INVESTING ACTIVITY -
Property and equipment acquisitions (276,000) (1,159,000)
-------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of Class B Preferred Stock 1,370,000 -
Principal payments under notes payable (7,595,000) (5,697,000)
Borrowings under notes payable 6,199,000 7,602,000
Principal payments under capital leases (143,000) (28,000)
Offering costs (44,000) -
Net proceeds from exercise of common stock options 44,000 -
------ -------
Net cash provided by financing activities (169,000) 1,877,000
-------- ---------
NET DECREASE IN CASH AND EQUIVALENTS (686,000) (567,000)
CASH AND EQUIVALENTS, at beginning of year 710,000 1,277,000
----------
CASH AND EQUIVALENTS, at end of year $24,000 $710,000
======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION -
Cash paid (received) for:
Interest $461,000 $150,000
======== ========
Income taxes $(280,000) $(25,000)
========= ========
SUPPLEMENTAL DISCLOSURE OF NON-CASH FLOW INVESTING AND
FINANCIAL ACTIVITIES:
Purchase of equipment for notes and capital leases $489,000 $253,000
======== ========
Issuance of Series A Preferred Stock for cancellation
of trade payables $900,000 $ -
======== =========
Issuance of common stock under option for common
stock surrendered $- $80,000
====== =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
APPLIED COMPUTER TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Nature of Operations - Applied Computer Technology, Inc. (the "Company")
principally assembles and distributes personal computers and related
products and services to customers throughout the United States.
Additionally, the Company has six retail and training locations within
Colorado. During 1996, the Company also expended substantial amounts in
establishing the infrastructure to become an Internet provider.
Principles of Consolidation - In 1996, the Company established two wholly
owned subsidiaries, ACT Far East Limited and ACTNET, Inc. The financial
statements include the accounts of the Company and its subsidiaries. All
intercompany balances and transactions have been eliminated in
consolidation.
Use of Estimates - The preparation of the Company's consolidated financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The Company's financial statements are based on a number of significant
estimates including the allowance for obsolete and slow-moving inventories,
the allowance for doubtful accounts receivable, assumptions affecting the
fair value of stock options and warrants, selection of the useful lives of
property and equipment, and estimates of fair value of long-lived assets.
Accordingly, the Company's estimates are expected to change as future
information becomes available. Due to the nature of the computer industry,
it is reasonably possible that the allowance for obsolete and slow-moving
inventories will materially change in the forthcoming year.
Cash Equivalents - The Company considers all highly liquid debt investments
purchased with an original maturity of three months or less to be cash
equivalents.
Inventories - Inventories consist principally of component parts and are
recorded at the lower of cost (using the first-in, first-out (FIFO) method)
or market. Inventories, net of obsolescence reserve, consist of the
following at December 31:
Computer components, peripherals and $2,243,000
software
Completed computer systems 161,000
----------
$2,404,000
===========
Property and Equipment - Property and equipment is stated at cost. The
Company capitalizes costs associated with major improvements. During 1996,
the Company capitalized payroll costs associated with software developed
for internal communication and information systems and to provide Internet
access to its customers.
F-7
<PAGE>
The Company provides for depreciation of equipment using the straight-line
method over the estimated useful lives of the assets which are generally
five years for computer and promotion equipment and vehicles, and seven
years for office equipment. Leasehold improvements are amortized over the
life of the leases.
Customer List - These costs primarily represent the acquisition in
December 1996 from third parties of certain customer bases. These customers
are utilizing the Company's Internet access services. The cost of these
acquisitions is being amortized over five years using the straight-line
method. Amortization expense for the year ended December 31, 1997 amounted
to $34,000.
Impairment of Long-Lived Assets - The Company performs an assessment for
impairment whenever events or changes in circumstances indicate that the
carrying amount of a long-lived asset may not be recoverable. If the net
carrying value exceeds estimated undiscounted future net cash flows, then
impairment is recognized to reduce the carrying value to the estimated fair
value.
Fair Value of Financial Instruments - The estimated fair values for
financial instruments are determined at discrete points in time based on
relevant market information. These estimates involve uncertainties and
cannot be determined with precision. At December 31, 1997, management's
best estimate is that the carrying amount of all financial instruments
approximates fair value.
Stock-Based Compensation - The Company accounts for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees,
and related interpretations. Accordingly, compensation cost for stock
options granted to employees is measured as the excess, if any, of the
quoted market price of the Company's common stock at the measurement date
(generally, the date of grant) over the amount an employee must pay to
acquire the stock.
In October 1995, the Financial Accounting Standards Board issued a new
statement titled Accounting for Stock-Based Compensation (FAS 123). FAS 123
requires that options, warrants, and similar instruments which are granted
to non-employees for goods and services be recorded at fair value on the
grant date. Fair value is generally determined under an option pricing
model using the criteria set forth in FAS 123. The Company did not adopt
FAS 123 to account for stock-based compensation for employees but is
subject to the pro forma disclosure requirements.
Revenue Recognition - The Company recognizes revenues from product and
system sales upon shipment to the customer. Revenue from service agreements
are recognized ratably over the terms of the agreements. Revenue from
performance contracts are recognized on the completed contract method.
Warranty - The Company provides a warranty to its customers and the
expected costs are accrued at the time of sale.
Advertising - Advertising costs are charged to operations in the period in
which the advertising first takes place. The Company incurred advertising
expenses of $180,000 and $494,000 in 1997 and 1996, respectively.
F-8
<PAGE>
Income Taxes - Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
The effect on previously recorded deferred tax assets and liabilities
resulting from a change in tax rates is recognized in earnings in the
period in which the change is enacted.
Earnings Per Share - Net loss per common share is presented in accordance
with the provisions of Statement of Financial Accounting Standards No. 128,
Earnings Per Share (FAS 128). FAS 128 replaces the presentation of primary
and fully diluted earnings per share (EPS), with a presentation of basic
EPS and diluted EPS. Under FAS 128, basic EPS excludes dilution for
potential common shares and is computed by dividing income or loss
applicable common shareholders by the weighted average number of common
shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock and resulted in the
issuance of common stock. Basic and diluted EPS are the same in 1997 and
1996 as all potential common shares were antidilutive.
Impact of Recently Issued Accounting Standards - Statement of Financial
Accounting Standards 130 Reporting Comprehensive Income and Statement of
Financial Accounting Standards 131 Disclosures About Segments of an
Enterprise and Related Information were recently issued. Statement 130
establishes standards for reporting and display of comprehensive income,
its components and accumulated balances. Comprehensive income is defined to
include all changes in equity except those resulting from investments by
owners and distributions to owners. Among other disclosures, Statement 130
requires that all items that are required to be recognized under current
accounting standards as components of comprehensive income be reported in a
financial statement that displays with the same prominence as other
financial statements. Statement 131 supersedes Statement of Financial
Accounting Standards 14 Financial Reporting for Segments of a Business
Enterprise. Statement 131 establishes standards on the way that public
companies report financial information about operating segments in annual
financial statements and requires reporting of selected information about
operating segments in interim financial statements issued to the public. It
also establishes standards for disclosures regarding products and services,
geographic areas, and major customers. Statement 131 defines operating
segments as components of a company about which separate financial
information is available that is evaluated regularly by the chief operating
decisionmaker in deciding how to allocate resources and in assessing
performance.
Statements 130 and 131 are effective for financial statements for periods
beginning after December 15, 1997 and require comparative information for
earlier years to be restated. Because of the recent issuance of these
standards, management has been unable to fully evaluate the impact, if any,
the standards may have on the future financial statement disclosures.
Results of operations and financial position, however, will be unaffected
by implementation of these standards.
Reclassifications - Certain reclassifications have been made to conform the
1996 financial statements to the presentation in 1997. The
reclassifications had no effect on net loss.
F-9
<PAGE>
2 LIQUIDITY AND LOSSES INCURRED IN OPERATIONS:
The accompanying consolidated financial statements have been prepared on the
going concern basis, which contemplates the realization of assets and
liquidation of liabilities in the normal course of business. The Company has
incurred losses of $1,342,000 and $4,936,000 in 1996 and 1997, respectively, and
expects to incur additional losses in the first quarter of 1998. These losses
have adversely impacted the Company's working capital. At December 31, 1997, the
Company has a working capital deficit of $1,558,000 and $343,000 of
stockholders' equity. Should losses continue, they would cause significant
liquidity problems and may ultimately impact the Company's ability to continue
future operations.
Subsequent to December 31, 1997, the Company has taken action to decrease its
overhead and has been successful in obtaining additional contracts for future
sales. In addition, management believes that certain start-up costs associated
with opening new stores, and establishing the infrastructure for Internet
provider services incurred in 1996 and 1997 should result in increased related
revenues in 1998. However, there can be no assurance that these efforts will
ultimately enable the Company to return to profitability, and other actions may
be required by management. However, management believes the actions taken to
reduce overhead and increase revenues will enable the Company to continue
operations through 1998.
3 PROPERTY AND EQUIPMENT:
Property and equipment consist of the following at December 31, 1997:
Office and computer equipment $2,420,000
Vehicles 156,000
Leasehold improvements 334,000
Other 9,000
----------
2,919,000
Less accumulated depreciation and
amortization (1,067,000)
----------
$1,852,000
==========
Depreciation and amortization expense related to property and equipment
amounted to $580,000 and $274,000 for the years ended December 31, 1997 and
1996, respectively.
F-10
<PAGE>
4 NOTES PAYABLE:
The Company has the following notes payable outstanding at December 31,
1997:
Note payable to vendor, bears interest at 9% and is due on
demand. The note is collateralized by accounts receivable,
inventory, and equipment. The note is personally
guaranteed by a director and major stockholder. $500,000
Notes payable to financial institution related to initial
payment of accounts receivable sold with recourse, bears
interest at an effective rate of 18% and is due on demand.
Note is collateralized by substantially all assets of the
Company. The amounts due are personally guaranteed by
certain stockholders. 588,000
Notes payable to financial institutions; interest at 9% to 10%.
The notes are collateralized by vehicles. 62,000
--------
1,150,000
Less current maturities (1,108,000)
-----------
Long-term debt, less current maturities $42,000
==========
Future principal payments required under notes payable, as of December 31,
1997, are as follows:
Year Ending
December 31,
1998 $1,108,000
1999 22,000
2000 20,000
---------
$1,150,000
============
5 OBLIGATIONS UNDER CAPITAL LEASES:
The Company leases certain equipment under agreements classified as capital
leases. Equipment under these leases has a cost of $726,000 and accumulated
amortization of $135,000 at December 31, 1997. The following is a schedule
of future minimum lease payments under capital leases at December 31, 1997.
Future minimum lease payments $665,000
Less amount representing interest (94,000)
---------
Present value of net minimum lease 571,000
payments
Less current maturities (172,000)
---------
$399,000
=========
F-11
<PAGE>
6 INCOME TAXES:
Income taxes consist of the following at December 31:
1997 1996
--------- --------
Current $ - $(153,000)
Deferred - (22,000)
-------- --------
Income tax expense (benefit) $ - $(175,000)
======== ==========
The Company's effective tax benefit was less than the statutory rate for
the years ended December 31, 1997 and 1996 due to an increase in the
valuation allowance related to the realization of net operating loss
carryforwards. This valuation allowance increased by $1,720,000 and
$350,000 for the years ended December 31, 1997 and 1996, respectively.
Deferred tax assets are comprised of the following at
December 31, 1997:
Assets:
Net operating loss carryforward $1,980,000
Reserve for obsolete inventory 90,000
Property and equipment 4,000
Deferred revenue and other 40,000
----------
2,114,000
Valuation allowance (2,114,000)
----------
Balance $ -
==========
At December 31, 1997, the Company has a net operating loss carryforward of
approximately $5,300,000. This carryforward expires in 2010 through 2012.
7 COMMITMENTS AND CONTINGENCIES:
F-12
<PAGE>
SEC Investigation - In November 1996, the Securities and Exchange
Commission (SEC) commenced a formal investigation of the Company. The
Company understands this investigation relates primarily to the Company's
capitalization of labor and related costs associated with enhancements to
the Company's internal software systems, the development of software for
the Company's Internet Access service, the development of the Company's new
marketing program and the opening of new business centers. During 1996, the
Company changed its accounting policy concerning these costs and elected to
expense a substantial portion of the costs which had previously been
capitalized by the Company in the areas mentioned above. The SEC's
investigation is continuing, however, the Company does not believe the
investigation will have a significant financial impact upon the Company's
December 31, 1997 financial condition.
Operating Leases - The Company leases office, production, warehouse, and
retail facilities under various noncancellable lease agreements which
expire through September 2007. The agreements generally provide for certain
rent-free, or reduced rent periods and escalating rents in future periods.
The Company, however, recognizes rent expense ratably over the terms of the
leases. Rent expense for the years ended December 31, 1997 and 1996 was
$426,000 and $253,000, respectively.
At December 31, 1997, future minimum lease payments required under
noncancellable operating leases are as follows:
Year Ending
December 31,
1998 $538,000
1999 537,000
2000 524,000
2001 420,000
2002 263,000
-------
$2,282,000
============
Retirement Plan - The Company has a defined contribution retirement plan
under Section 401(k) of the Internal Revenue Code. The plan covers
substantially all of the Company's employees and allows the Company to make
discretionary contributions. No contributions have been made by the Company
since the plan's inception.
Contingencies - The Company may from time to time be involved in various
claims, lawsuits, disputes with third parties, actions involving
allegations of discrimination, or breach of contract incidental to the
operations of its business. The Company is not currently involved in any
such incidental litigation which it believes could have a materially
adverse effect on its financial condition or results of operations.
8 PREFERRED STOCK:
The Company has 5,000,000 shares of preferred stock authorized with no par
value. During 1997, the Company authorized a Series of 1,000 Preferred
Shares designated as Series A Preferred Shares. The Company also authorized
a Series of 1,500 Preferred Shares designated as Class B Convertible
shares.
F-13
<PAGE>
Series A Preferred Shares - Holders of Series A Preferred Shares (Series A)
have no voting rights. Dividends on Series A are at 12% per annum payable
quarterly commencing December 31, 1997. Dividends not declared will accrue
on a cumulative basis.
Shares of Series A are convertible into common stock at any time at the
option of the holder, on the basis of one share of preferred stock for
shares of Common Stock equal in number to the amount determined by dividing
$1,000 by an amount equal to the average closing bid price of the Company's
common stock over the five-day trading period ending on the day prior to
the conversion, which may not be less than $2.50 or more than $4.25.
Subsequent to year-end, the Company agreed to reduce the conversion range
to not less than $1.00 or more than $3.00. If the fair value of the
Company's common stock is greater than the conversion price the difference
will be accounted for as an imputed dividend. This amount will be
recognized as a charge in computing net loss applicable to common
shareholders.
In the event of liquidation, dissolution, or winding up of the Company,
Series A holders are entitled to receive a liquidation preference of $1,000
per share plus all dividends in arrears. On November 4, 1997, the Company
sold 900 shares of Series A Preferred Stock to a supplier of the Company
for $900,000. Payment for the shares was made by the vendor canceling
$900,000 of payables owed by the Company to the vendor. The remaining
balance included in accounts payable to this vendor at December 31, 1997
amounts to approximately $1.1 million.
Class B Convertible Shares - Holders of Class B Convertible Shares (Series
B) generally have no voting rights. Dividends on Series B are at 7%,
payable quarterly in cash or shares of the Company's common stock,
commencing on January 31, 1998.
Shares of Series B are convertible into common stock at the option of the
holder as follows: one-third of the shares 45 days after closing, one-third
of the shares 60 days after closing, and one-third of the shares 90 days
after closing. However, no more than 10% may be converted in any one
calendar week.
The conversion rate is one share of Series B for the shares of Common Stock
equal to the stated value plus all accrued but unpaid dividends of such
shares divided by the lessor of (1) 75% of the average closing bid price of
the common stock during the period of five trading days immediately
preceding the date of conversion or (2) $3.65. The difference between the
fair value of the Company's common stock and the conversion price is
accounted for as an imputed dividend. This amount is recognized as a charge
in computing net loss applicable to common shareholders and is recognized
during the period between issuance of the Series B and the initial date
convertible.
The Company may redeem the Series B in whole or in part if the 5-day
average closing bid price for the Company's common stock is less than $3.00
per share by paying to the holder an amount equal to 115% of the
liqiudation preference plus all accrued but unpaid dividends.
In the event of liquidation, dissolution, or winding up of the Company,
Series B holders are entitled to receive a liquidation preference of $1,000
per share plus accrued but unpaid dividends.
F-14
<PAGE>
On November 24, 1997, the Company sold 1,500 shares of Series B, plus
82,192 Common Stock Purchase Warrants, to a foreign investor for
$1,500,000. In connection with this transaction, the Company put 3,000,000
shares of common stock in an escrow account. These shares of common stock
may only be released from escrow to satisfy conversion of outstanding
Series B Preferred shares. Accordingly, these shares are not reflected as
issued and outstanding common shares in the accompanying financial
statements. Through December 31, 1997, no shares of Series B had converted
to common stock. Through April 3, 1998, 900 shares of Series B had
converted to 810,045 shares of common stock. Each Warrant allows the holder
to purchase one share of the Company's common stock for $4.02 at any time
prior to November 21, 2000.
In connection with the Company's sale of Series B Preferred Shares and
Warrants, the sales agent for such offering, received an 8% commission plus
warrants to purchase 41,096 shares of the Company's Common Stock. These
warrants are exercisable at a price of $4.02 per share at any time prior to
November 21, 2000.
The Company recognized $229,000 of imputed dividends through December 31,
1997, and the Company will recognize additional imputed dividends of
$215,000 during the first quarter of 1998.
9. STOCK-BASED COMPENSATION:
A summary of warrants outstanding at December 31, 1997 is as follows:
Number of Exercise Expiration
Issued For Shares Price Date
----------- ---------- -------- ------------
Private offering, underwriter 40,000 $4.55 October 2000
Public offering, unit holders 575,000 4.50 October 1998
Public offering, underwriter 60,000 4.55 October 2000
Public offering, underwriter 50,000 4.83 October 2000
Series B offering 82,192 4.02 November 2000
Series B offering, selling agent 41,096 4.02 November 2000
------
Total shares reserved for
warrants 848,288
=======
Stock Option Plans - During March 1995, the Board of Directors adopted the
1995 Incentive Stock Option Plan (Plan). The Plan authorizes the issuance
of up to 600,000 shares of the Company's common stock to employees. Options
granted pursuant to the plan are incentive stock options within the meaning
of the Internal Revenue Code. The exercise price of the options granted
under the plan is not less than the fair market value of the common stock.
The options are granted for terms of five or ten years and may be increased
at such times as may be determined by the Plan's administrator. Options are
subject to certain acceleration and termination provisions.
F-15
<PAGE>
A summary of incentive stock option activity is as follows:
1997 1996
--------- -------
Weighted Weighted
Average Average
Number Exercise Number Exercise
of Shares Price of Shares Price
Outstanding, beginning
of year 350,500 $ 4.54 212,500 $2.32
Granted 257,000 2.06 249,000 5.04
Exercised (22,116) 2.00 (40,000) 2.00
Canceled (221,000) 5.04 (71,000) 2.23
Repriced (63,000) 3.52 - -
------- ---------
Outstanding, end of year 301,384 2.14 350,500 4.54
======= =======
During 1996, a former officer exercised 40,000 options. Pursuant to the
Plan, the former officer surrendered shares with a market value equivalent
to the exercise price.
For all options granted during 1997 and 1996, the weighted average market price
of the Company's common stock on the grant date was approximately equal to the
weighted average exercise price. At December 31, 1997, options for 115,259
shares were exercisable (at a weighted average exercise price of $2.23) with
85,325 shares becoming exercisable in 1998 and the remaining 100,800 shares
becoming exercisable by December 31, 2000. If not previously exercised, options
outstanding at December 31, 1997, will expire as follows:
Weighted
Average
Number Exercise
Year Ending December 31, of Shares Price
2000 20,000 $ 2.00
2001 20,000 4.62
2005 104,675 2.00
2006 83,709 2.00
2007 73,000 2.00
--------
301,384 2.14
========
F-16
<PAGE>
Pro Forma Stock-Based Compensation Disclosures - The Company applies APB
Opinion 25 and related interpretations in accounting for stock options and
warrants which are granted to employees. Accordingly, no compensation cost
has been recognized for grants of options and warrants to employees since
the exercise prices were not less than the fair value of the Company's
common stock on the grant dates. Had compensation cost been determined
based on the fair value at the grant dates for awards under those plans
consistent with the method of FAS 123, the Company's net loss applicable
to common stockholders and the related per share amounts would have been
reduced to the pro forma amounts indicated below.
Year Ended December 31,
1997 1996
Net income (loss) applicable to common stockholders:
As reported $(5,193,000) $(1,342,000)
Pro forma $(5,351,000) $(1,795,000)
Net income (loss) per common share:
As reported $ (1.69) $ (.44)
Pro forma $ (1.74) $ (.59)
The weighted average fair value of options granted to employees for the
years ended December 31, 1997 and 1996, was $1.52 and $1.41,
respectively. The fair value of each employee option and warrant granted in
1997 and 1996 was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions:
Year Ended December 31,
1997 1996
Expected volatility 124.40% 50.84%
Risk-free interest rate 5.9% 6.5%
Expected dividends - -
Expected terms (in years) 5.0 5.0
10. RELATED PARTY TRANSACTIONS:
During fiscal 1996, the Company provided services totaling $36,000 to a
related party. As of December 31, 1997, the Company has notes receivable
of $98,000 from its stockholders, which are collateralized by their common
stock ownership. These notes bear interest at 8.5% and are due on demand.
F-17
<PAGE>
11. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMER:
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and temporary
cash investments. At times, cash balances held at financial institutions
were in excess of FDIC insurance limits.
The Company sells its products and services primarily to customers in the
education, corporate, and governmental markets. Credit is extended based
on an evaluation of the customer's financial condition and collateral is
generally not required.
Sales in excess of 10% or more of the Company's sales are as follows:
Customer 1997 1996
-------- -------- ------
A 10% 15%
B - 10%
C 17% 16%
D 10% -
At December 31, 1997, the Company had trade receivables due from two
customers for $191,000 and $177,000.
F-18
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, therunto duly authorized.
APPLIED COMPUTER TECHNOLOGY, INC.
By: /s/Wiley E. Prentice
Wiley E. Prentice, Jr., President and
Chief Executive Officer
By: /s/ Daniel Radford
Daniel Radford, Principal Financial and
Accounting Officer
Date: June 15, 1998
In accordance with the requirements of the Securities Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/Wiley E. Prentice President, Chief Executive June 15, 1998
- - ---------------------
Wiley E. Prentice, Jr. Officer and Director
/s/ Cynthia E. Koehler Executive Vice President, June 15, 1998
- - ---------------------
Cynthia E. Koehler Secretary and Director
/s/ J. Roger Moody Director June 15, 1998
- - -----------------
J. Roger Moody
- - --------------- Director June 15, 1998
Collis Woodward
