SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended ______________September 30, 1997______________ or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from________________to____________________ Commission file number _______________________0-20109___________________________ _______________________________Kronos Incorporated______________________________ (Exact name of registrant as specified in its charter) __________Massachusetts________ ________04-2640942______ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) ________________________400 Fifth Avenue, Waltham____MA_________02154___________ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code__(781) 890-3232_______ Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes_X_ No___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] 1 State the aggregate market value of the voting stock held by non-affiliates of the registrant. Non-Affiliate Voting Aggregate Date Shares Outstanding Market Value November 28, 1997 7,342,239 $229,444,969 Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Date Class Outstanding Shares Common Stock, $0.01 par November 28, 1997 value per share 8,200,183 DOCUMENTS INCORPORATED BY REFERENCE. The Company's definitive proxy statement dated December 12, 1997 for the Annual Meeting of Stockholders to be held on January 30, 1998 (Part III - Items 10,11,12 and 13). 2 PART I Item 1. Business Kronos Incorporated (the "Company" or "Kronos") designs, develops, manufactures and markets time and attendance, labor management and shop floor data collection systems, and application software that enhance productivity in the workplace. The Company's systems, which consist of fully integrated software and intelligent data collection terminals, capture time and task-related information from employees in the workplace utilizing a variety of data collection technologies. The fully integrated software processes the data for a wide range of management activities including time and attendance, scheduling and shop floor labor allocation enabling management the ability to better optimize their labor resources. In fiscal 1997 the Company initiated strategic alliances with third party technology providers such as SAP and Oracle. Revenues generated to date under these alliances have not been material. Kronos(R) also maintains an extensive professional service and technical support organization which provides a suite of maintenance, professional and educational services. The Company was organized in 1977 as a Massachusetts corporation. Products and Services Kronos' products include fully-integrated software, intelligent data collection terminals and related components for time and attendance, labor management and shop floor data collection systems and complementary software designed to expand the functions of its systems. These products are designed for a wide range of businesses and applications from single-user to large multi-site enterprises. In addition, the Company maintains an extensive service and support organization that is responsible for maintaining systems and providing professional and educational services. To date, the majority of the Company's revenues and profits have been derived from its time and attendance systems and related services. TIME AND ATTENDANCE, WORKFORCE MANAGEMENT AND SHOP FLOOR DATA COLLECTION SYSTEMS Kronos' Time and Attendance, Workforce Management and Shop Floor Data Collection systems are designed to operate independently or in conjunction with other Kronos systems, or to interface with third party systems. The software incorporated in Kronos' systems is parameter-driven, which allows it to be configured upon installation to meet the needs of an individual customer and reconfigured as customer needs evolve. Currently, the Company offers various releases of its software which run on such popular operating systems as Windows, UNIX, DOS, and VMS. The Company's client/server time and attendance system runs on Windows 95 and Windows NT and supports a variety of standard databases including Oracle, Informix, Microsoft and SQL. In addition, the Company offers an IBM AS/400 based time and attendance package and shop floor data collection package. 3 Kronos provides a wide range of data collection options to accommodate various work environments and markets, and to satisfy the price/performance requirements of its customers. The Company manufactures a family of intelligent data collection terminals which collect time and attendance and factory-floor data via keypad, bar code readers, lasers and charged coupled device ("CCD") scanners. Terminal choices include wall-mounted, desk-mounted and hand-held devices which are available in various sizes and models, some of which are designed to operate in harsh environments. The Company also offers desktop computer and telephone based data collection options. The Company believes that the functions and features of its time and attendance software and the flexibility of its data collection options provide it with an important advantage over its competition. Major Systems The major systems currently offered by the Company include: TIME AND ATTENDANCE SYSTEMS. The Company's desktop, workgroup and enterprise Timekeeper(R) and Timekeeper Central(R) systems are designed to reduce payroll preparation time, consistently apply payroll rules, improve labor scheduling and control labor costs. These systems automatically calculate employee hours data according to the payroll policies of the individual customer and are user-configurable. Information is consolidated within a number of standard labor management reports such as absenteeism, tardiness, projected overtime, on-premises, and budget versus actual costs. The Company's client/server system offers open database connectivity and powerful query and reporting tools. The Company's time and attendance systems work in conjunction with a variety of data collection methods described above. SHOP FLOOR DATA COLLECTION SYSTEMS. The ShopTrac(R) Data Collection System and Timekeeper/AS Labor Data Collection System consist of a suite of software applications and intelligent data collection terminals for use primarily in manufacturing plants. They are designed for discrete manufacturers that build product in a series of operations such as work order-based job shop environments and repetitive manufacturing. The systems capture labor and material data to provide real-time information on labor allocation for the measurement of costs, quality control and the status of work-in-process for communication to ERP (enterprise resource planning), advanced planning and scheduling systems. WORKFORCE MANAGEMENT SYSTEM. The Workforce Management System is an integrated labor management solution developed for the retail and hospitality markets. It produces detailed employee schedules automatically while balancing labor costs with service goals. It consists of several integrated functions which forecast the level of activity a location can expect by analyzing key business volume indicators and then apply the appropriate work standards to generate the optimum staffing level required for the expected level of business. The core of the system is the Smart Scheduler(TM) module which combines this data along with 4 detailed employee information about skill level, availability, seniority and work preferences to produce a complete and detailed work schedule. This information can be automatically integrated with the Kronos time and attendance system enabling management to evaluate key performance indicators. Together these modules provide a full set of tools to increase productivity, manage labor costs and meet customer service goals. Complementary Products The Company offers optional application software and other products designed to expand and enhance the range of functions performed by its time and attendance systems. Such products include the following: KRONOS SCHEDULING MODULE. Software which assists in the process of creating and assigning employee schedules and reports to help managers make labor scheduling decisions. KRONOS ARCHIVE PROGRAM. Software which automatically performs long-term record keeping by accumulating labor hours, absences, late arrivals, vacation time and wages. KRONOS CARDSAVER(R) MODULE. Software which automatically saves employee in and out data for wage and hour inquiries, performance reviews or resolving employee grievances. KRONOS ACCRUALS MODULE. Software which automatically calculates the balances of each employee's available benefit time ensuring that benefit time is administered fairly, consistently and automatically across all classes of employees. KRONOS ATTENDANCE TRACKER MODULE. Software which systematically records and documents all types of employee absences and provides for attendance and performance data to be reported in detail or summary reports. TIME BANK MODULE. Software which provides an interface to most major payroll service bureau software and also supports interfaces to major human resources and automated scheduling systems. The Company purchases this product from a third party. GATEKEEPER(R) MODULE. Software used in access control applications which can restrict access to authorized personnel or allow scheduled access based on schedules in the Timekeeper system. TELETIME(R) SYSTEM. System which allows customer telephones to serve as data input devices. This product incorporates technology which is licensed from a third party. IMAGEKEEPER(TM)SYSTEM. System which utilizes high-resolution video imaging to create and store digital photographs and signatures of employees. 5 Finally, the Company markets a number of other accessories to its products including badges, traditional badge making equipment, time cards, bar code labels and modems. Services and Support Kronos maintains an extensive professional service and technical support organization which provides a suite of maintenance, professional and educational services. These services are designed to support the Company's customers throughout the product life cycle. Maintenance service options are delivered through the Company's centralized Global Support operation or through local service personnel. The Company's professional services include implementation support, technical and business consulting as well as system integration and optimization. The Company's educational services offer a full range of curriculums which are delivered through local training centers or via computer based training courses. When necessary, the Company may also provide software customization services to meet any unique customer requirements. Marketing and Sales Kronos markets and sells its products in the United States and other countries through its direct sales and support organization and through independent dealers. In addition, the Company has a joint marketing agreement with ADP, Inc. ("ADP"). Under the terms of the agreement, ADP markets a proprietary version of the Company's PC-based time and attendance software, together with data collection terminals manufactured by the Company, to both new and existing ADP clients. The Company recognizes that the information needs of businesses in various industries continue to be increasingly specialized and sophisticated. As a result, the Company's marketing, field sales and service personnel are organized into industry specific divisions. These divisions focus on the needs of the manufacturing, healthcare, retail/hospitality and government/education markets. These divisions operate with the following objectives: o To gain expertise in their respective industry environments and pursue opportunities for growth and product leadership. o To focus engineering and marketing resources on industry specific product development efforts required to deliver products and services that meet those industry needs. o Develop long-term business relationships with select industry partners. o Educate and train sales and service staff as industry specialists. Focusing on industry specific divisions permits Kronos to better understand the needs of its customers and to respond quickly to the opportunities presented by these markets. 6 DIRECT SALES ORGANIZATION The Company has 37 direct sales and support offices located in the United States. In addition, the Company has two sales and support offices located in Canada, two in the United Kingdom, one in Mexico, two in South Africa and three in Australia. Each direct sales office covers a defined territory, and has sales and support functions. For the fiscal years ended September 30, 1997, 1996 and 1995, the Company's international subsidiaries generated net revenues of $13,635,000, $8,025,000 and $5,598,000, respectively. Total assets at these locations for these periods were $10,675,000, $7,276,000 and $2,868,000, respectively. DEALERS Kronos also markets and sells its products through independent dealers within designated geographic territories generally not covered by Kronos' direct sales offices. These dealers provide sales, support, and installation services for Kronos' products. There are presently approximately 35 dealers in the United States actively selling and supporting Kronos' products. Sales to independent U.S. dealers for the years ended September 30, 1997, 1996 and 1995 were $22,742,000, $21,829,000, and $19,459,000, respectively. Kronos also has dealers in Australia, Argentina, Canada, Columbia, Guam, Guatemala, Hong Kong, Lebanon, Malaysia, Mexico, Netherland Antilles, New Zealand, Panama, Phillipines, Puerto Rico, Singapore, Venezuela and the West Indies. Sales to independent international dealers for the years ended September 30, 1997, 1996 and 1995 were $1,809,000, $2,367,000, and $2,508,000, respectively. Kronos supports its dealers with training, technical assistance, and major account marketing assistance. Customers End-users of the Company's products include companies of all sizes from the manufacturing, service, public and private sectors. The Company believes that the dollar amount of backlog is not material to an understanding of its business. Although the Company has contracts to supply systems to certain customers over an extended period of time, substantially all of the Company's product revenue in each quarter results from orders received in that quarter. Product Development The Company's product development efforts are focused on enhancing and increasing the performance of its existing products and developing new products and interfaces to third party products on a timely basis for the increasingly sophisticated needs of its customers. During fiscal 1997, 1996 and 1995, Kronos' engineering, research and development expenses were $15,758,000, $12,730,000 and $8,192,000, respectively. The Company intends to continue to commit substantial resources to enhance and extend its product lines and develop interfaces to third party products. Although the Company is continually seeking to further enhance its product offerings and to develop new products and interfaces, there 7 can be no assurance that these efforts will succeed, or that, if successful, such product enhancements or new products will achieve widespread market acceptance, or that the Company's competitors will not develop and market products which are superior to the Company's products or achieve greater market acceptance. The Company also depends upon the reliability and viability of a variety of software development tools owned by third parties to develop its products. If these tools are inadequate or not properly supported, the Company's ability to release competitive products in a timely manner could be adversely impacted. Competition The Company, which operates within the data collection industry, provides time and attendance, labor management and data collection solutions that can enable businesses to optimize their labor resources. The industry is highly competitive. Competition is increasing as competitors in related industries, such as human resources management and payroll processing, enter the market. Advances in software development tools have accelerated the software development process and, therefore, can allow competitors to penetrate certain of the Company's markets. Although the Company believes it has certain technological and other advantages over its current competitors, maintaining such advantages will require continued investment by the Company in research and development, and sales and marketing. The Company competes primarily on the basis of price/performance, quality, reliability and customer service. In the time and attendance industry, the Company competes against firms that sell automated time and attendance products to many industries, against firms that focus on specific industries, and against firms selling related products, such as payroll processing or human resources management systems. Proprietary Rights The Company relies on a combination of patents, copyrights, trade secret law and contracts to protect its proprietary technology. The Company generally provides software products to end-users under non-exclusive shrink-wrap licenses or under signed licenses, both of which may be terminated by Kronos if the end-user breaches the terms of the license. These licenses generally require that the software be used only internally subject to certain limitations, such as the number of employees, simultaneous users, computer model and serial number, features and/or terminals for which the end-user has paid the required license fee. The Company authorizes its dealers to sublicense software products to end-users under similar terms. In certain circumstances, the Company also makes master software licenses available to end-users which permit either a specified limited number of copies or an unlimited number of copies of the software to be made for internal use. Some customers license software products under individually negotiated terms. 8 Despite these precautions, it may be possible to copy or otherwise obtain and use the Company's products or technology without authorization. In addition, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries. The Company has registered trademarks for Kronos, Timekeeper, Timekeeper Central, Jobkeeper, Jobkeeper Central, Datakeeper, Datakeeper Central, Gatekeeper, Gatekeeper Central, TeleTime, TimeMaker, CardSaver, ShopTrac, the ShopTrac logo, Start.Time, Keep.Trac, Solution In A Box and the Company's logo in the United States. In addition, certain trademarks have been obtained or are in process in various foreign countries. The Company purchases the Time Bank payroll interface software from a single vendor for resale in certain of its time and attendance systems. Although the Company believes its relationship with this vendor is good, any interruption or termination of the Company's right to resell such software could delay shipment of certain of the Company's products and require the Company to write its own software to perform this function. Although the Company believes it would be able to produce its own payroll interface software, any delay or problems encountered in doing so could temporarily and adversely affect the Company's results of operations. Manufacturing and Sources of Supply The duplication of the Company's software and the printing of documentation are outsourced to suppliers. The Company currently has three suppliers who have been certified to the Company's manufacturing specifications to perform the software duplication process. The Company's data collection terminals are assembled from the printed circuit board level in its facility in Chelmsford, Massachusetts. Although most of the parts and components included within the Company's products are available from multiple suppliers, certain parts and components are purchased from single suppliers. The Company has chosen to source these items from single suppliers because it believes that the supplier chosen is able to consistently provide the Company with the highest quality product at a competitive price on a timely basis. While the Company has to date been able to obtain adequate supplies of these parts and components, the Company's inability to transition to alternate sources on a timely basis if and as required in the future could result in delays or reductions in product shipments which could have a material adverse effect on the Company's operating results. Employees As of December 8, 1997, the Company had 1,341 employees. None of the Company's employees is represented by a union or other collective bargaining agent, and the Company considers its relations with its employees to be good. 9 Item 2. Properties The Company leases approximately 75,000 square feet at its headquarters in Waltham, Massachusetts and leases 47 sales and support offices located throughout North America, Europe, Africa and Australia. The Company also leases a total of approximately 165,000 square feet in two facilities located in Chelmsford, Massachusetts. The Company's manufacturing operations, Global Support Center and various engineering and administrative operations are located in these facilities. The Company's aggregate rental expense for all of its facilities in fiscal 1997 was approximately $6,107,000. The Company considers its facilities to be adequate for its current requirements and that additional space will be available as needed in the future. Item 3. Legal Proceedings From time to time, the Company is involved in legal proceedings arising in the normal course of business. None of the legal proceedings in which the Company is currently involved is considered material by the Company. Item 4. Submission of Matters to a Vote of Security Holders None. 10 Executive Officers of the Registrant Name Age Position Mark S. Ain 54 Chief Executive Officer and Chairman of the Board W. Patrick Decker 50 President, Chief Operating Officer Laura L. Woodburn 50 Vice President, Engineering Paul A. Lacy 50 Vice President, Finance and Administration, Treasurer and Clerk Aron J. Ain 40 Vice President, Marketing and Worldwide Field Operations Lloyd B. Bussell 52 Vice President, Manufacturing Sally J. Wallace 47 Vice President, General Counsel Mark S. Ain, a founder of the Company, has served as Chief Executive Officer and Chairman since its organization in 1977. He also served as President from 1977 until October, 1996. Mr. Ain is the brother of Aron J. Ain, Vice President, Marketing and Worldwide Field Operations of the Company. W. Patrick Decker served as Vice President, Marketing and Field Operations from 1982 until October, 1996, when he was appointed President and Chief Operating Officer. Mr. Decker was elected to the Board of Directors in January, 1997. Laura L. Woodburn has served as Vice President, Engineering since November, 1996. She held various positions at Digital Equipment Corporation from 1979 to 1996, most recently serving as Vice President of the Storage Big Business segment. Paul A. Lacy has been Vice President, Finance and Administration, Treasurer and Clerk since 1988. Aron J. Ain served as Vice President, Sales and Service from 1988 until October, 1996, when he was appointed Vice President, Marketing and Worldwide Field Operations. Mr. Ain is the brother of Mark S. Ain, Chief Executive Officer and Chairman. Lloyd B. Bussell has served as Vice President, Manufacturing since 1987. Sally J. Wallace has served as General Counsel since 1988 and was appointed Vice President in October, 1994. 11 Officers of the Company hold office until the first meeting of directors following the next annual meeting of stockholders and, in the case of the President, Treasurer and Clerk, until their successors are chosen and qualified. PART II Item 5. Market for Registrant's Common Equity and Stockholder Matters STOCK MARKET INFORMATION The Company's common stock is traded on the Nasdaq National Market under the symbol KRON. The following table sets forth the high and low sales prices for fiscal 1997 and fiscal 1996. Such over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. 1997 --------------------------------------------------- High Low - ---------------------------- ------------------------- ------------------------- First quarter $32 1/2 $24 1/8 Second quarter 35 3/4 16 3/4 Third quarter 28 3/4 16 1/4 Fourth quarter 28 1/2 20 5/8 1996 --------------------------------------------------- High Low - ---------------------------- ------------------------- ------------------------- First quarter $33 5/8 $25 Second quarter 37 25 1/2 Third quarter 35 1/2 25 1/2 Fourth quarter 37 24 3/4 HOLDERS On November 30, 1997 there were approximately 3,000 shareholders of record of the Company's common stock. DIVIDENDS The Company has not paid cash dividends on its common stock, and the present policy of the Company is to retain earnings for use in its business. 12 Item 6. Selected Financial Data The following table data should be read in conjunction with the consolidated financial statements and notes thereto. Financial Highlights In thousands, except share data Year Ended September 30, --------------------------------------------------------------------------- 1997 1996 1995 1994 1993 (1) ------------- -------------- ------------- ------------ ------------- Operating Data: Net revenues $170,538 $142,957 $120,373 $92,919 $67,960 Net income $11,272 $11,425 $8,398 $4,892 $3,870 Per share data (2): Net income per common share $1.34 $1.37 $1.03 $0.62 $0.50 Average common and common equivalent shares outstanding 8,407,051 8,330,060 8,150,903 7,859,513 7,745,691 Balance Sheet Data: Total assets $128,114 $104,866 $78,518 $60,284 $46,788 Long-term obligations $28 $164 - -------------------------------------------- (1) Included in net income and net income per common share is a $264,000 and $.03 per share benefit, respectively, due to a change in accounting principle. (2) The per share data presented above are for primary net income per common share. Fully diluted net income per common share amounts have not been presented as they did not differ significantly from primary net income per common share amounts in any year. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward Looking Statements This discussion includes certain forward-looking statements about the Company's business and its expectations. Any such statements are subject to risk that could cause the actual results to vary materially from expectations. For a further discussion of the various risks that may affect the Company's business and expectations, see "Certain Factors That May Affect Future Operating Results" at the end of Management's Discussion and Analysis of Financial Condition and Results of Operations. 13 Results of Operations REVENUES. Revenues amounted to $170.5 million, $143.0 million and $120.4 million in fiscal 1997, 1996 and 1995, respectively. Annual revenue growth amounted to 19% in fiscal 1997 and 1996, and 30% in fiscal 1995. Revenue growth during fiscal 1997 and 1996 was principally driven by customer demand. The accelerated revenue growth during fiscal 1995 was driven by a variety of factors including customer demand and the effect of acquisitions of distribution rights to certain domestic sales territories previously held by certain of the Company's independent dealers. Although revenue growth in fiscal 1997 was consistent with the revenue growth experienced in fiscal 1996, it was lower than management's expectations. The shortfall in revenue growth from management's expectations is primarily attributable to the impact of the Company's product transition from DOS and UNIX platforms to the Windows and client/server environments. The Company has, in certain cases, experienced a longer sales cycle than anticipated for client/server transactions due to their complexity and size. In addition, the Company has not realized the revenue growth anticipated in the government and education market due to slower than expected penetration of that market. Product revenues amounted to $116.2 million, $101.0 million and $87.9 million in fiscal 1997, 1996 and 1995, respectively. Product revenues grew by 15% in fiscal 1997 and 1996, and 28% in fiscal 1995. Product revenue growth in fiscal 1997 and 1996 was principally the result of an increase in sales volume driven by customer demand. The rate of product revenue growth experienced in fiscal 1996 as compared with the accelerated rate of product revenue growth in fiscal 1995 is attributable to the factors described above. Service revenues amounted to $54.4 million, $42.0 million and $32.5 million in fiscal 1997, 1996 and 1995, respectively. Service revenues grew by 29% in fiscal 1997 and 1996, and 33% in fiscal 1995. Service revenues amounted to 32%, 29% and 27% of total revenues in fiscal 1997, 1996 and 1995, respectively. The growth in service revenues in all periods reflects an increase in maintenance revenue from expansion of the installed base and the level of services sold to that installed base, as well as an increase in the level of maintenance contracts and professional services accompanying new sales. International revenues, which include both revenues from the Company's international subsidiaries and sales to independent international dealers, grew 49% in fiscal 1997 to $15.4 million from $10.4 million in fiscal 1996. International revenues in fiscal 1995 were $8.1 million. International revenues amounted to 9% of total revenues in fiscal 1997 as compared to 7% of total revenues in fiscal 1996 and 1995, respectively. The growth in international revenues experienced in fiscal 1997 principally reflects the results of the Company's fiscal 1996 acquisition of distribution rights to certain international sales territories previously held by certain independent dealers of the Company. GROSS PROFIT. Gross profit as a percentage of revenues was 62% in fiscal 1997 and 1996, and 59% in fiscal 1995. Product gross profit as a percentage of product revenues was 74% in fiscal 1997 and 1996, and 72% in fiscal 1995. The improvement in product gross profit in fiscal 1997 and 1996 as compared to 14 fiscal 1995 was primarily attributable to improved product mix. In fiscal 1996 the Company's product revenue was derived from sales of systems in which software, which typically generates higher gross profit, was an increasingly higher proportion of product revenues. Product mix in fiscal 1997 was consistent with that experienced in fiscal 1996. Service gross profit as a percentage of service revenues was 35%, 33% and 24% for fiscal 1997, 1996 and 1995, respectively. The increase in service gross profit in all periods is primarily attributable to the growth in service revenues without a proportionate increase in service expenses. This has been accomplished by the implementation of programs which focus on revenue enhancement for services provided, as well as improved efficiency in the delivery of such services. EXPENSES. Expenses as a percentage of revenues were 51%, 49% and 48% in fiscal 1997, 1996 and 1995, respectively. Sales and marketing expenses were $59.5 million, $47.0 million and $40.1 million in fiscal 1997, 1996 and 1995, respectively. The increase in sales and marketing expenses in all periods relates to increased business volume. Sales and marketing expenses as a percentage of sales were 35% in fiscal 1997 and 33% in fiscal 1996 and 1995. The increase in sales and marketing expenses as a percentage of revenues in fiscal 1997 is a result of management's decision to invest in staffing and programs to develop the Company's international and corporate marketing operations as well as its government and education division. Engineering, research and development expenses were $15.8 million, $12.7 million and $8.2 million in fiscal 1997, 1996 and 1995, respectively. These expenses are net of capitalized software development costs of $5.2 million, $4.0 million and $2.4 million, respectively. Engineering, research and development expenses as a percentage of revenues were 9% in fiscal 1997 and 1996, and 7% in fiscal 1995. The growth in engineering, research and development expenses resulted primarily from the development of new products in the Windows and client/server environments. Increased spending on software development costs reflects the Company's commitment to further enhance existing products, making them easier to use, and on new product development. General and administrative expenses were $11.6 million, $9.9 million and $8.5 million in fiscal 1997, 1996 and 1995, respectively. As a percentage of revenues, general and administrative expenses were 7% in fiscal 1997, 1996 and 1995. Fiscal 1997 general and administrative expenses included an immaterial amount of expenses recognized in conjunction with the Company's plan to ensure its information systems are Year 2000 compliant. Other expense, net amounted to less than 1% of revenues in fiscal 1997, 1996 and 1995. Other expense, net is composed primarily of amortization of intangible assets related to acquisitions made by the Company which is offset by interest income earned on its investments. INCOME TAXES. The provision for income taxes as a percentage of pretax income was 38% in fiscal 1997, 39% in fiscal 1996 and 38% in fiscal 1995. The Company's effective income tax rate may fluctuate between periods as a result of various factors, none of which is material, either individually or in the aggregate, to the consolidated results of operations. 15 Liquidity and Capital Resources Working capital as of September 30, 1997 amounted to $41.2 million as compared with $36.3 million at September 30, 1996. Cash and equivalents and marketable securities at those dates amounted to $36.2 million and $32.8 million, respectively. Cash provided by operations decreased to $18.9 million in fiscal 1997 from $23.7 million in fiscal 1996. Cash provided by operations amounted to $18.3 million in fiscal 1995. The decrease in operating cash flows in fiscal 1997 was principally due to an increase in accounts receivable related to year end sales volume. The increase in operating cash flows in fiscal 1996 as compared to fiscal 1995 was principally due to increased earnings and unearned service revenues as well as non-cash charges related to depreciation, amortization and deferred taxes, partially offset by investments in the Company's internal customer lease program. Cash provided by operations was more than sufficient to fund investments in equipment and capitalized software development costs in fiscal 1997, 1996 and 1995. Investments in equipment in fiscal 1997, 1996 and 1995 totaled $8.7 million, $9.7 million and $4.1 million, respectively. The Company anticipates that investment in equipment in fiscal 1998 will be comparable to fiscal 1997. The Company expects to finance these investments from available cash and operating cash flow generated in fiscal 1998. Certain Factors That May Affect Future Operating Results Except for historical matters, the matters discussed in the Annual Report and/or Form 10-K are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act"). The Company desires to take advantage of the safe harbor provisions of the Act and is including this statement for the express purpose of availing itself of the protection of the safe harbor with respect to all forward looking statements that involve risks and uncertainties. The following important factors, among others, could cause actual operating results to differ materially from those indicated by forward-looking statements made in this Annual Report and/or Form 10-K and presented elsewhere by management from time to time. POTENTIAL FLUCTUATIONS IN RESULTS. The Company's operating results may fluctuate as a result of a variety of factors, including the timing of the introduction of new products and product enhancements by the Company and its competitors, market acceptance of new products, mix of products sold, the purchasing patterns of its customers, competitive pricing pressure and general economic conditions. The Company historically has realized a relatively larger percentage of its annual revenues and profits in the fourth quarter and a relatively smaller percentage in the first quarter of each fiscal year, although there can be no assurance that this pattern will continue. In addition, while the Company has contracts to supply systems to certain customers over an extended period of time, substantially all of the Company's product revenue and profits in each quarter result from orders received in that quarter. If near-term demand for the Company's products weakens or if significant anticipated sales in any quarter do 16 not close when expected, the Company's revenues for that quarter will be adversely affected. The Company believes that its operating results for any one period are not necessarily indicative of results for any future period. PRODUCT DEVELOPMENT AND TECHNOLOGICAL CHANGE. The markets for time and attendance, labor management, and data collection systems are characterized by continual change and improvement in computer software and hardware technology. The Company's future success will depend largely on its ability to enhance its existing product lines and to develop new products and interfaces to third party products on a timely basis for the increasingly sophisticated needs of its customers. Although the Company is continually seeking to further enhance its product offerings and to develop new products and interfaces, there can be no assurance that these efforts will succeed, or that, if successful, such product enhancements or new products will achieve widespread market acceptance, or that the Company's competitors will not develop and market products which are superior to the Company's products or achieve greater market acceptance. The Company is transitioning its product offerings from DOS and UNIX platforms to the Windows and client/server environments. The Company's revenue growth and results of operations in fiscal 1998 will depend in part on the success of this product transition. COMPETITION. The time and attendance, labor management, and data collection industries are highly competitive. Competition is increasing as competitors in related industries, such as human resources and payroll, enter the market. Advances in software development tools have accelerated the software development process and, therefore, can allow competitors to penetrate certain of the Company's markets. Maintaining the Company's technological and other advantages over competitors will require continued investment by the Company in research and development and marketing and sales programs. There can be no assurance that the Company will have sufficient resources to make such investments or be able to achieve the technological advances necessary to maintain its competitive advantages. Increased competition could adversely affect the Company's operating results through price reductions and/or loss of market share. YEAR 2000. Many currently installed computer systems and software products will not function properly in the year 2000 and beyond. As a result, computer systems and/or software used by many companies may need to be upgraded to comply with such "year 2000" requirements. Significant uncertainty exists in the software industry concerning the potential effects associated with the century change. Although the Company currently offers software products that are designed to work properly in the year 2000 and beyond, there can be no assurance that the Company's software products contain all necessary date code changes. The Company has warranted, and may in the future warrant, to certain customers that its products will work in the year 2000 and beyond. In addition, the Company has initiated a program to identify and correct or reprogram its systems where necessary. If the Company's program is not completed on a timely basis, if the systems of other companies on which the Company relies fail, if customer demand is reduced due to customers' concerns about year 2000 issues, or if the Company's own products fail in the year 2000 and beyond, there could be a material adverse effect on the Company's business, financial condition or results of operations. 17 ATTRACTING AND RETAINING SUFFICIENT TECHNICAL PERSONNEL FOR PRODUCT DEVELOPMENT, SUPPORT AND SALES. The Company has encountered intense competition for experienced technical personnel for product development, technical support and sales and expects such competition to continue in the future. Any inability to attract and retain a sufficient number of qualified technical personnel could adversely affect the Company's ability to produce, support and sell robust products in a timely manner. DEPENDENCE ON ALTERNATE DISTRIBUTION CHANNELS. The Company markets and sells its products through its direct sales organization, independent dealers and OEMs. For the fiscal year ended September 30, 1997, approximately 22% of the Company's revenue was generated through sales to dealers and OEMs. Reduction in the sales efforts of the Company's major dealers and/or OEMs, or termination or changes in their relationships with the Company, could have a material adverse effect on the results of the Company's operations. DEPENDENCE ON TIME AND ATTENDANCE PRODUCT LINE. To date, more than 90% of the Company's revenues have been attributable to sales of time and attendance systems and services. Competitive pressures or other factors could cause the Company's time and attendance products to lose market acceptance or experience significant price erosion, adversely affecting the results of the Company's operations. RELIANCE ON KEY VENDORS. The Company depends upon the reliability and viability of a variety of software development tools owned by third parties to develop its products. If these tools are inadequate or not properly supported, the Company's ability to release competitive products in a timely manner could be adversely impacted. Also, certain parts and components used in the Company's hardware products are purchased from single vendors. The Company has chosen to source these items from single vendors because it believes that the vendor chosen is able to consistently provide the Company with the highest quality product at a competitive price on a timely basis. While the Company has to date been able to obtain adequate supplies of these parts and components, the Company's inability to transition to alternate sources on a timely basis if and as required in the future could result in delays or reductions in product shipments which could have a material adverse effect on the Company's operating results. In addition, the Company purchases payroll interface software from a single vendor for resale in certain of its time and attendance systems. Although the Company believes its relationship with this vendor is good, any interruption or termination of the Company's rights to resell such software could delay shipment of certain of the Company's products and require the Company to write its own software to perform this function. Although the Company believes it would be able to produce its own payroll interface software, any delay or problems encountered in doing so could temporarily and adversely affect the Company's results of operations. 18 Item 8. Financial Statements and Supplementary Data The financial statements and supplementary data are listed in the Index to Consolidated Financial Statements at Item 14 of this Form 10-K. Item 9. Changes in and Disagreement with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant Information relating to the executive officers of the registrant appears under the caption "Executive Officers of the Registrant" in Part I, following Item 4 of this Form 10-K. Information relating to the directors is incorporated by reference from pages 4 through 6 of the Company's definitive proxy statement for the 1998 Annual Meeting of Stockholders to be held on January 30, 1998 under the caption "Election of Directors." Item 11. Executive Compensation Incorporated by reference from pages 6 through 12 of the Company's definitive proxy statement for the 1998 Annual Meeting of Stockholders to be held on January 30, 1998 under the following captions: "Director Compensation," "Executive Compensation," "Option Grants and Exercises," and "Report of Compensation Committee." Item 12. Security Ownership of Certain Beneficial Owners and Management Incorporated by reference from pages 2 through 3 of the Company's definitive proxy statement for the 1998 Annual Meeting of Stockholders to be held on January 30, 1998 under the caption "Security Ownership of Certain Beneficial Owners and Management." Item 13. Certain Relationships and Related Transactions None. 19 PART IV Item 14. Exhibits, Financial Statement Schedules, and Related Transactions (a) The following are filed as a part of this report: 1. Financial Statements Page Consolidated Statements of Income for the Years Ended F-1 September 30, 1997, 1996 and 1995 Consolidated Balance Sheets as of September 30, 1997 and 1996 F-2 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended September 30, 1997, 1996 and 1995 F-3 Consolidated Statements of Cash Flows for the Years Ended September 30, 1997, 1996 and 1995 F-4 Notes to Consolidated Financial Statements F-5 Report of Ernst & Young LLP, Independent Auditors F-19 2. Financial Statement Schedule II - Valuation and Qualifying Accounts F-20 All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. 3. Exhibits Exhibit No. Description 3.1(9) Restated Articles of Organization of the Registrant, as amended. 3.2* Amended and Restated By-laws of the Registrant. 4* Specimen Stock Certificate. 10.1*(14) 1986A Stock Option Plan. 10.2(8)(14) 1992 Equity Incentive Plan, as amended and restated. 20 3. Exhibits (continued) Exhibit No. Description 10.3(13)(14) 1992 Employee Stock Purchase Plan, as amended and restated. 10.4(3) Lease dated November 16, 1993, between Teachers Realty Corporation and the Registrant, relating to premises leased in Chelmsford, MA. 10.5(5) Lease dated August 8, 1995, between Principal Mutual Life Insurance Company and the Registrant, relating to premises leased in Chelmsford, MA. 10.6(12) Fleet Bank Letter Agreement and Promissory Note dated January 1, 1997, relating to amendment of $3,000,000 credit facility. 10.7(2)(15) Software License and Support and Hardware Purchase Agreement dated April 2, 1993, between ADP, Inc. and the Registrant. 10.7.1(10)(15)Amendments dated July 22, 1996 to Software License and Support and Hardware Purchase Agreement dated April 2, 1993, between ADP, Inc. and the Registrant. 10.8* Sales Agreement dated December 6, 1990, between Integrated Design, Inc. and the Registrant. 10.8.1(6) Amendment dated November 2, 1995 to Sales Agreement dated December 6, 1990, between Integrated Design, Inc. and the Registrant. 10.9(3)(15) Acquisition Agreement dated November 2, 1993 between Interboro Systems Corporation and the Registrant. 10.10* Form of Indemnity Agreement entered into among the Registrant and Directors of the Registrant. 10.11(1) Lease dated November 9, 1992, as amended, between John Hancock Mutual Life Insurance Company and the Registrant, relating to premises leased in Waltham, MA. 10.11.1(7) Amendment dated January 1, 1996 to Lease dated November 9, 1992, as amended, between John Hancock Mutual Life Insurance Company and the Registrant, relating to premises leased in Waltham, MA. 10.11.2(11) Amendment dated October 11, 1996 to Lease dated November 9, 1992, as amended, between John Hancock Mutual Life Insurance Company and the Registrant, relating to premises leased in Waltham, MA. 10.12 (4) Agreement of Reorganization among Kronos Incorporated; Kronos S/T Corporation, ShopTrac Data Collection Systems, Inc., Thomas J. O'Malia and Mark J. MacWhirter, dated March 31, 1994. 11 Statement re Computation of Per Share Earnings. 21 Subsidiaries of the Registrant. 23 Consent of Independent Auditors. 27 Financial Data Schedule. * Incorporated by reference to the same Exhibit Number in the Company's Registration Statement on Form S-1 (File No. 33-47383). 21 3. Exhibits (continued) (1) Incorporated by reference to the same Exhibit Number in the Company's Form 10-K for the fiscal year ended September 30, 1992. (2) Incorporated by reference to Exhibit Number 10.1 in the Company's Form 10-Q for the quarterly period ended April 3, 1993. (3) Incorporated by reference to the same Exhibit Number in the Company's Form 10-K for the fiscal year ended September 30, 1993. (4) Incorporated by reference to Exhibit Number 2.1 in the Company's Form 10-Q for the quarterly period ended July 2, 1994. (5) Incorporated by reference to Exhibit 10.13 in the Company's Form 10-K for the fiscal year ended September 30,1995. (6) Incorporated by reference to Exhibit Number 10.1 in the Company's Form 10-Q for the quarterly period ended March 30, 1996. (7) Incorporated by reference to Exhibit Number 10.2 in the Company's Form 10-Q for the quarterly period ended March 30, 1996. (8) Incorporated by reference to Exhibit Number 10.2 in the Company's Form 10-K for the fiscal year ended September 30, 1996. (9) Incorporated by reference to Exhibit Number 3.1 in the Company's Form 10-K for the fiscal year ended September 30, 1996. (10) Incorporated by reference to Exhibit Number 10.7.1 in the Company's Form 10-K for the fiscal year ended September 30, 1996. (11) Incorporated by reference to Exhibit 10.1 in the Company's Form 10-Q for the quarterly period ended December 28, 1996. (12) Incorporated by reference to Exhibit 10.2 in the Company's Form 10-Q for the quarterly period ended December 28, 1996. (13) Incorporated by reference to Exhibit Number 10 in the Company's Form 10-Q for the quarterly period ended March 29, 1997. (14) Management contract or compensatory plan or arrangement filed as an exhibit to this Form 10-K pursuant to Items 14(a) and 14(c) of Form 10-K. 22 3. Exhibits (continued) (15) Confidential treatment was granted for certain portions of this agreement. (b) Reports on Form 8-K No reports on Form 8-K were filed during the last fiscal quarter of the fiscal year covered by this report. Kronos, Timekeeper, Timekeeper Central, Jobkeeper, Jobkeeper Central, Datakeeper, Datakeeper Central, Gatekeeper, Gatekeeper Central, TeleTime, TimeMaker, CardSaver, ShopTrac, the ShopTrac logo, Start. Time, Keep.Trac, Solution in a Box and the Company's logo are registered trademarks of the Company. DKC/Datalink, ImageKeeper, Timekeeper Web, HyperFind, Smart Scheduler, Starter Series, Start.Labor, Start.WIP, Start.Quality, Labor Plus, WIP Plus, Comm.Mgr, CommLink, Community Computer, Tempo and the Tempo logo are trademarks of the Company. IBM is a registered trademark of, and AS and AS/400 are trademarks of, International Business Machines Corporation Total Time is a service mark of ADP, Inc. and ADP is a registered trademark of Automatic Data Processing, Inc. Time Bank is a registered trademark of Integrated Design Inc. UNIX is a registered trademark in the U.S. and other countries, licensed exclusively by X/Open Company Ltd. VMS is a registered trademark of Digital Equipment Corporation. Microsoft, Windows, and Windows 95 are registered trademarks of, and Windows NT is a trademark of, Microsoft Corporation. Oracle is a registered trademark of Oracle Corporation. Informix is a registered trademark of Informix Software, Inc. 23 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on December 12, 1997. KRONOS INCORPORATED By /s/ MARK S. AIN Mark S. Ain Chief Executive Officer and Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on December 12, 1997. Signature Capacity /s/ MARK S. AIN Chief Executive Mark S. Ain Officer and Chairman of the Board (Principal Executive Officer) /s/ PAUL A. LACY Vice President, Finance and Paul A. Lacy Administration (Principal Financial and Accounting Officer) /s/ W. PATRICK DECKER Director, President and Chief W. Patrick Decker Operating Officer /s/ RICHARD J. DUMLER Director Richard J. Dumler /s/ D. BRADLEY McWILLIAMS Director D. Bradley McWilliams /s/ LAWRENCE PORTNER Director Lawrence Portner /s/ SAMUEL RUBINOVITZ Director Samuel Rubinovitz Consolidated Statements of Income In thousands, except share data Year Ended September 30, 1997 1996 1995 ---------- ---------- ---------- Net revenues: Product ........................................... $ 116,155 $ 100,951 $ 87,879 Service ........................................... 54,383 42,006 32,494 ---------- ---------- ---------- 170,538 142,957 120,373 Cost of sales: Product ........................................... 29,816 26,281 24,762 Service ........................................... 35,603 28,296 24,552 ---------- ---------- ---------- 65,419 54,577 49,314 ---------- ---------- ---------- Gross profit ............................. 105,119 88,380 71,059 Expenses: Sales and marketing ............................... 59,512 46,982 40,138 Engineering, research and development ............. 15,758 12,730 8,192 General and administrative ........................ 11,554 9,942 8,455 Other expense, net ................................ 7 27 693 ---------- ---------- ---------- 86,831 69,681 57,478 ---------- ---------- ---------- Income before income taxes .................... 18,288 18,699 13,581 Provision for income taxes ............................. 7,016 7,274 5,183 ---------- ---------- ---------- Net income .................................... $ 11,272 $ 11,425 $ 8,398 ========== ========== ========== Net income per common share: Primary and fully diluted ......................... $ 1.34 $ 1.37 $ 1.03 ========== ========== ========== Average common and common equivalent shares outstanding: Primary ....................................... 8,407,051 8,330,060 8,150,903 ========== ========== ========== Fully diluted ................................. 8,413,553 8,343,274 8,156,981 ========== ========== ========== See accompanying notes to consolidated financial statements. F-1 Consolidated Balance Sheets In thousands, except share data September 30, 1997 1996 --------- --------- ASSETS Current assets: Cash and equivalents .............................................................. $ 20,698 $ 10,795 Marketable securities ............................................................. 15,530 21,995 Accounts receivable, less allowances for doubtful accounts of $1,091 in 1997 and $987 in 1996 ............................................................. 38,817 30,622 Inventories ....................................................................... 4,322 4,149 Deferred income taxes ............................................................. 4,277 3,025 Other current assets .............................................................. 6,539 3,765 --------- --------- Total current assets ..................................................... 90,183 74,351 Equipment, net ......................................................................... 17,038 14,738 Net investment in sales-type leases .................................................... 5,312 2,825 Excess of cost over net assets of businesses acquired, net ............................. 7,855 7,221 Other assets ........................................................................... 7,726 5,731 --------- --------- Total assets ............................................................. $ 128,114 $ 104,866 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses ............................................. $ 13,217 $ 11,894 Accrued compensation .............................................................. 10,105 8,445 Federal and state income taxes payable ............................................ 3,497 1,367 Unearned service revenue .......................................................... 22,209 16,388 --------- --------- Total current liabilities ................................................ 49,028 38,094 Deferred income taxes .................................................................. 2,587 2,236 Unearned service revenue ............................................................... 3,523 2,802 Other liabilities ...................................................................... 503 636 Shareholders' equity: Preferred Stock, par value $1.00 per share: authorized 1,000,000 shares, no shares issued and outstanding Common Stock, par value $.01 per share: authorized 12,000,000 shares, 8,246,453 shares and 8,124,133 shares issued at September 30, 1997 and 1996, respectively ........................................................... 82 81 Additional paid-in capital ........................................................ 29,770 27,512 Retained earnings ................................................................. 45,045 33,773 Equity adjustment from translation ................................................ (262) (251) Cost of Treasury Stock (86,493 shares and 583 shares at September 30, 1997 and 1996, respectively) .......................................................... (2,162) (17) --------- --------- Total shareholders' equity ............................................... 72,473 61,098 --------- --------- Total liabilities and shareholders' equity ............................... $ 128,114 $ 104,866 ========= ========= See accompanying notes to consolidated financial statements. F-2 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY In thousands Equity Common Stock Additional Adjustment Treasury Stock ----------- Paid-in Retained from ----------------- Shares Amount Capital Earnings Translation Shares Amount Total ----------- -------- ------- ----- ----------------- -------- Balance at October 1, 1994 ............... 7,702 $77 $ 22,068 $13,950 $(208) $ (5) $ 35,882 Net income ............................... 8,398 8,398 Proceeds from exercise of stock options .. 186 1 249 (54) 1,077 1,327 Proceeds from employee stock purchase plan 52 1 599 600 Impact of compensation relating to ....... nonqualified stock option plans ...... (1) (1) Equity adjustment from translation ....... 2 2 Purchase of treasury stock ............... 54 (1,077) (1,077) Tax benefit associated with the exercise . of stock options ..................... 1,438 1,438 ----- --- -------- ------- ----- ----- -------- -------- Balance at September 30, 1995 ............ 7,940 79 24,353 22,348 (206) (5) 46,569 ----- --- -------- ------- ----- ----- -------- -------- Net income ............................... 11,425 11,425 Proceeds from exercise of stock options .. 144 2 538 (16) 525 1,065 Proceeds from employee stock purchase plan 40 945 945 Impact of compensation relating to ....... nonqualified stock option plans ...... 68 68 Equity adjustment from translation ....... (45) (45) Purchase of treasury stock ............... 17 (537) (537) Tax benefit associated with the exercise . of stock options ..................... 1,608 1,608 ----- --- -------- ------- ----- ----- -------- -------- Balance at September 30, 1996 ............ 8,124 81 27,512 33,773 (251) 1 (17) 61,098 ----- --- -------- ------- ----- ----- -------- -------- Net income ............................... 11,272 11,272 Proceeds from exercise of stock options .. 78 1 439 (16) 454 894 Proceeds from employee stock purchase plan 44 1,105 1,105 Impact of compensation relating to ....... nonqualified stock option plans ...... (60) (60) Equity adjustment from translation ....... (11) (11) Purchase of treasury stock ............... 101 (2,599) (2,599) Tax benefit associated with the exercise . of stock options ..................... 774 774 ----- --- -------- ------- ----- ----- -------- -------- Balance at September 30, 1997 ............ 8,246 $82 $ 29,770 $45,045 $(262) 86 $ (2,162) $ 72,473 ===== === ======== ======= ===== ===== ======== ======== See accompanying notes to consolidated financial statements. F-3 Consolidated Statements of Cash Flows In thousands Year Ended September 30, 1997 1996 1995 -------- -------- -------- Operating activities: Net income ................................................................ $ 11,272 $ 11,425 $ 8,398 Adjustments to reconcile net income to net cash and equivalents provided by operating activities: Depreciation ..................................................... 6,461 4,764 3,678 Amortization of deferred software development costs and other assets ....................................... 4,718 3,404 2,571 Provision for deferred income taxes .............................. (901) 726 (636) Changes in certain operating assets and liabilities: Accounts receivable, net ..................................... (8,059) (2,945) (3,096) Inventories .................................................. (160) 330 (21) Unearned service revenue ..................................... 6,557 5,367 2,392 Accounts payable, accrued compensation and other liabilities ................................... 4,350 5,609 5,214 Net investment in sales-type leases .......................... (4,787) (3,766) Other ............................................................ (555) (1,165) (170) -------- -------- -------- Net cash and equivalents provided by operating activities 18,896 23,749 18,330 Investing activities: Purchase of equipment ..................................................... (8,694) (9,656) (4,065) Capitalization of software development costs .............................. (5,215) (4,014) (2,364) (Increase) decrease in marketable securities .............................. 6,464 (15,278) (5,914) Acquisitions of businesses ................................................ (1,686) (1,809) (1,322) Other ..................................................................... (4) 43 (45) -------- -------- -------- Net cash and equivalents used in investing activities ... (9,135) (30,714) (13,710) Financing activities: Net proceeds and tax benefits from exercise of stock options and employee purchase plans .............................................. 2,769 3,618 3,363 Purchase of treasury stock ................................................ (2,599) (537) (1,077) Principal payments under capital leases ................................... (27) (116) -------- -------- -------- Net cash and equivalents provided by financing activities 170 3,054 2,170 Effect of exchange rate changes on cash and equivalents ........................ (28) (21) (1) -------- -------- -------- Increase (decrease) in cash and equivalents .................................... 9,903 (3,932) 6,789 Cash and equivalents at the beginning of the period ............................ 10,795 14,727 7,938 -------- -------- -------- Cash and equivalents at the end of the period .................................. $ 20,698 $ 10,795 $ 14,727 ======== ======== ======== See accompanying notes to consolidated financial statements. F-4 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KRONOS INCORPORATED NOTE A--Summary of Significant Accounting Policies PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of Kronos Incorporated and its wholly-owned subsidiaries (the "Company"). All intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, if any, 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. TRANSLATION OF FOREIGN CURRENCIES: The assets and liabilities of the Company's foreign subsidiaries are denominated in each country's local currency and translated at the year-end rate of exchange. The related income statement items are translated at the average rate of exchange for the year. The resulting translation adjustments are excluded from income and reflected as a separate component of shareholders' equity. Realized and unrealized exchange gains or losses arising from transaction adjustments are reflected in operations and are not material. CASH EQUIVALENTS: Cash equivalents consist of highly liquid investments with maturities of three months or less at date of acquisition. MARKETABLE SECURITIES: The Company's marketable securities consist of state revenue bonds and market auction preferred stocks. State revenue bonds, which generally mature within one year, are classified as held to maturity and are carried at amortized cost. Market auction preferred stocks are classified as available-for-sale and are carried at cost which approximates fair value as obtained from outside pricing sources. Unrealized gains and losses on investments classified as held to maturity are not recognized until realized or until a decline in fair value below cost is deemed to be other-than-temporary. Unrealized gains and losses, if any, on available-for-sale securities would be reflected as a separate component of shareholders' equity. Interest income earned on the Company's cash, cash equivalents and marketable securities is included in other expense, net and amounted to $1,401,000, $1,200,000 and $563,000 in fiscal 1997, 1996 and 1995, respectively. INVENTORIES: Inventories are stated at the lower of cost (first-in, first-out method) or market. F-5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE A--Summary of Significant Accounting Policies--(continued) EQUIPMENT: Equipment, which includes assets recorded in connection with capital leases, are stated on the basis of cost less accumulated depreciation, provisions for which have been computed using the straight-line method over the estimated useful lives of the assets, which are principally as follows: Estimated Assets Useful Life - -------------------------------------------------------------------------------- Machinery and equipment 3-5 years Furniture and fixtures 8-10 years Leasehold improvements Shorter of economic life or lease-term ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS: Long-lived assets used in operations, such as the excess of cost over net assets of businesses acquired, capitalized software development costs and equipment, are included in impairment evaluations when events or circumstances exist that indicate the carrying amount of those assets may not be recoverable. If the impairment evaluation indicates the affected asset is not recoverable, the asset's carrying value would be reduced to fair value. No event has occurred which would impair the value of long-lived assets recorded in the accompanying consolidated financial statements. REVENUE RECOGNITION: The Company derives its revenues from the sale of time and attendance, labor management and shop floor data collection systems as well as sales of application software, parts and components. The Company's systems consist of fully integrated software and intelligent data collection terminals. The Company also derives revenues by providing maintenance, professional and educational services to its direct customers. The Company recognizes revenues from sales of its systems, application software, parts and components at the time of shipment, unless the Company has significant obligations remaining. When significant obligations remain, revenue is not recognized until such obligations have been completed or are no longer significant. The Company recognizes revenues from its sales-type leases of systems at time of shipment. Service revenues are recognized ratably over the contractual period or as the services are performed. The Company provides installation services and certain warranties to its customers. It also provides, without additional charge, certain software product enhancements for customers covered under software maintenance contracts. The provision for these expenses is made at the time revenues are recognized. F-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE A--Summary of Significant Accounting Policies--(continued) STOCK-BASED COMPENSATION: The Company accounts for its stock-based compensation plans in accordance with the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations. Under APB 25, no compensation expense is recognized as the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation" (see Note J) effective September 30, 1997. INCOME TAXES: The Company accounts for income taxes under the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. NET INCOME PER SHARE: Net income per share is based on the weighted average number of common shares and, when dilutive, common stock equivalents outstanding during the year. Common stock equivalents are attributable to stock options. In February 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 128, "Earnings per Share," which is required to be adopted in the first quarter of fiscal 1998. At that time, the Company will be required to change the method currently used to compute earnings per share and to restate all prior periods. Under the new requirements for calculating basic earnings per share, the dilutive effect of stock options will be excluded. The impact is expected to result in an increase in basic earnings per share of approximately $.04 per share, $.06 per share and $.04 per share for fiscal 1997, 1996 and 1995, respectively. The impact of SFAS No. 128 on the calculation of diluted earnings per share for these periods is not expected to be material. NEWLY ISSUED ACCOUNTING STANDARDS: In June and November 1997 the FASB issued SFAS No. 130, "Reporting Comprehensive Income," and the Accounting Standards Executive Committee (AcSEC) issued Statement of Position (SOP) 97-2, "Software Revenue Recognition," respectively, which are effective for the Company in fiscal 1999. The Company does not believe the adoption of these standards will have a material effect on the Company's financial statements. F-7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE B--Concentration of Credit Risk The Company markets and sells its products through its direct sales organization, independent dealers and an OEM agreement with ADP, Inc. The Company's dealers have significantly smaller resources than the Company. The Company's direct sales organization sells to customers who are dispersed across many different industries and geographic areas. The Company reviews a customer's (including dealer's) credit history before extending credit and generally does not require collateral. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. NOTE C--Inventories Inventories consist of the following (in thousands): September 30, ----------------------------------- 1997 1996 - -------------------------------------------- ----------------- ----------------- Finished goods $2,654 $2,148 Work-in-process 317 283 Raw materials 1,351 1,718 ------ ------ $4,322 $4,149 ====== ====== NOTE D--Equipment Equipment consists of the following (in thousands): September 30, ----------------------------------- 1997 1996 - -------------------------------------------- ----------------- ----------------- Machinery and equipment $30,077 $24,102 Furniture and fixtures 6,774 5,363 Leasehold improvements 4,313 3,106 ------- ------- 41,164 32,571 Less accumulated depreciation and amortization 24,126 17,833 ------- ------- $17,038 $14,738 ======= ======= F-8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE E--Leases The Company leases systems to customers under sales-type leases as defined in SFAS No. 13, "Accounting for Leases." The current portion of the net investment in sales-type leases amounted to $3,241,000 and $941,000 at September 30, 1997 and 1996, respectively, and is included in other current assets. The components of the net investment in sales-type leases are as follows (in thousands): September 30, ----------------------------------- 1997 1996 - -------------------------------------------- ------------------- --------------- Minimum rentals receivable $10,787 $4,943 Estimated residual values of leased equipment (unguaranteed) 329 214 Less unearned interest income 1,905 963 ------- ------- Net investment in sales-type leases $ 8,553 $3,766 ======= ======= Minimum rentals receivable under existing leases as of September 30, 1997 are as follows (in thousands): Fiscal Year - --------------------------------------------------------------- ---------------- 1998 .................................... $ 3,873 1999 .................................... 3,245 2000 .................................... 1,720 2001 .................................... 838 2002 .................................... 452 Thereafter ........................... 659 ------- $10,787 ======= NOTE F--Acquisitions In fiscal 1997, 1996 and 1995, the Company completed various acquisitions of dealer territories in the United States, Mexico and Australia. These acquisitions were accounted for under the purchase method of accounting and, accordingly, the operating results are included in the consolidated statements of income from the date of each respective acquisition. F-9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE F--Acquisitions--(continued) The combined cost of the acquisitions which amounted to $526,000, $750,000, and $1,000,000 in fiscal 1997, 1996 and 1995, respectively, largely relates to intangible assets which are being amortized using the straight-line method over a period not to exceed eight years. Related amortization expense amounted to $1,505,000, $1,232,000 and $1,006,000 in fiscal 1997, 1996 and 1995, respectively. Certain acquisition agreements contain provisions which require the Company to make additional payments, if specified minimum revenue requirements are met. These provisions expire during fiscal years 1998 and 1999. Amounts earned under the terms of the agreements are recorded as an increase in the excess of the total acquisition cost over the fair value of the net assets acquired. During fiscal 1997, 1996 and 1995, $1,130,000, $903,000 and $428,000 of such payments were made. NOTE G--Deferred Software Development Costs Costs incurred in the research, design and development of software for sale to others are charged to expense until technological feasibility is established. Thereafter, software development costs are capitalized and amortized to product cost of sales on a straight-line basis over the lesser of three years or the estimated economic lives of the respective products, beginning when the products are offered for sale. The unamortized portion of capitalized software development costs included in other assets amounted to $7,312,000 and $5,259,000 at September 30, 1997 and 1996, respectively. Amortization of capitalized software development costs amounted to $3,162,000, $2,115,000, and $1,481,000 in fiscal 1997, 1996 and 1995, respectively. Total research and development expenses charged to operations amounted to $11,455,000, $9,299,000, and $5,060,000 in fiscal 1997, 1996 and 1995, respectively. F-10 NOTES TO CONSOLIDATE FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE H--Lease Commitments The Company leases certain office space, manufacturing facilities and equipment under long-term operating lease agreements. Future minimum rental commitments under operating leases with noncancellable terms of one year or more are as follows (in thousands): Fiscal Year - --------------------------------------------------------------- ---------------- 1998 .................................... $ 5,941 1999 .................................... 5,012 2000 .................................... 3,832 2001 .................................... 2,603 2002 .................................... 1,381 Thereafter ........................... 2,485 ------- $21,254 ======= Rent expense was $7,360,000, $5,756,000 and $4,478,000 in fiscal 1997, 1996 and 1995, respectively. NOTE I--Capital Stock, Stock Repurchase Program and Stock Rights Agreement CAPITAL STOCK: The Board of Directors is authorized, subject to any limitations prescribed by law, from time to time to issue up to an aggregate of 1,000,000 shares of Preferred Stock, $1.00 par value per share, in one or more series, each of such series to have such preferences, voting powers (up to 10 votes per share), qualifications, and special or relative rights and privileges as shall be determined by the Board of Directors in a resolution or resolutions providing for the issue of such Preferred Stock. STOCK REPURCHASE PROGRAM: On March 31, 1997, the Company's Board of Directors authorized the repurchase of up to 500,000 of the Company's outstanding common shares. The common shares purchased under the program are intended, in part, to be issued under the Company's stock-based compensation plans. During fiscal 1997 the Company repurchased 101,000 common shares at a cost of $2,599,000. F-11 NOTES TO CONSOLIDATE FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE I--Capital Stock, Stock Repurchase Program and Stock Rights Agreement--(continued) STOCK RIGHTS AGREEMENT: On November 17, 1995, the Company's Board of Directors adopted a Rights Agreement. Under the Agreement, the Company distributed to stockholders a dividend of one Right for each outstanding share of Common Stock. Each Right initially represents the right to purchase one one-thousandth of a share of a new series of preferred stock at an exercise price of $236, subject to adjustment. The Company reserved 12,500 shares of its Preferred Stock for issuance under the agreement. The Rights may be exercised, in whole or in part, only if a person or group acquires beneficial ownership of 20% or more of the Company's outstanding Common Stock or announces a tender or exchange offer upon consummation of which, such person or group would beneficially own 25% or more of the Company's Common Stock. When exercisable, each Right will entitle its holder (other than such person or members of such group) to purchase for an amount equal to the then current exercise price, in lieu of preferred stock, a number of shares of the Company's Common Stock having a market value of twice the Right's exercise price. In addition, when exercisable, the Company may exchange the Rights, in whole or in part, at an exchange ratio of one share of Common Stock or one one-thousandth of a share of Preferred Stock per Right. In the event that the Company is acquired in a merger or other business combination, the Rights would entitle the stockholders (other than the acquirer) to purchase securities of the surviving company at a similar discount. Until they become exercisable, the Rights will be evidenced by the Common Stock certificates and will be transferred only with such certificates. Under the Agreement, the Company can redeem all outstanding Rights at $.01 per right at any time until the tenth day following the public announcement that a 20% beneficial ownership position has been acquired or the Company has been acquired in a merger or other business combination. The Rights will expire on November 17, 2005. NOTE J--Employee Benefit Plans STOCK OPTION PLANS: The 1992 Equity Incentive Plan enables the Compensation Committee of the Board of Directors of the Company to grant awards in the form of options, stock appreciation rights, restricted or unrestricted stock awards, deferred stock awards and performance awards, as defined in the Plan. During fiscal 1997, 1996 and 1995, the Company granted under the Plan stock options to purchase 341,450, 190,400 and 180,150 shares, respectively, of Common Stock at a purchase price equal to the fair value of the Common Stock at the date of grant. No other awards were made under the Plan through September 30, 1997. Options granted under the 1992 Equity Incentive Plan are exercisable in equal installments over a five year period beginning one year from the date of grant. Options available for grant are 329,580 and 587,255 at September 30, 1997 and 1996, respectively. F-12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE J--Employee Benefit Plans--(continued) The Company also has several nonqualified and incentive stock option plans adopted from 1979 through 1987. No additional options were granted under these plans since fiscal 1992. Options granted under these plans are exercisable five years after the date of grant and generally have a ten year contractual life. The following schedule summarizes the changes in stock options issued under various plans for the three fiscal years in the period ended September 30, 1997. Options exercisable under the plans were 325,959, 312,896 and 352,668 in fiscal 1997, 1996 and 1995, respectively. Weighted - Average Number of Shares Exercise Price Per Share Exercise Price Per Share - ----------------------------------- ---------------------- ------------------------- ---------------------------- Outstanding at October 1, 1994 850,341 $ 7.74 $0.22 - $13.67 Granted 180,150 14.24 13.50 - 23.33 Exercised (239,664) 5.54 0.22 - 13.67 Canceled (21,432) 10.94 0.22 - 13.67 -------- ------- -------------- Outstanding at September 30, 1995 769,395 9.64 0.22 - 23.33 Granted 190,400 27.67 27.00 - 34.50 Exercised (160,727) 6.65 0.22 - 20.33 Canceled (41,214) 14.79 0.22 - 32.50 -------- ------- -------------- Outstanding at September 30, 1996 757,854 14.52 0.22 - 34.50 Granted 341,450 23.78 17.50 - 26.00 Exercised (94,182) 9.49 0.22 - 27.00 Canceled (89,168) 19.99 0.22 - 32.50 -------- ------- -------------- Outstanding at September 30, 1997 915,954 $17.96 $4.89 - $34.50 ======== ======= ============== As discussed in Note A, the Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," and continues to account for stock-based compensation under APB 25. Generally no compensation expense is recorded with respect to the Company's stock option and employee stock purchase plans. F-13 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE J--Employee Benefit Plans--(continued) The following summarizes information about options outstanding and exercisable at September 30, 1997: Outstanding Exercisable ----------------------------------------------------- ------------------------------------ Weighted - Weighted - Weighted - Exercise Price Per Average Remaining Average Exercise Number of Average Exercise Share Number of Shares Contractual Life Price Per Share Shares Price Per Share - -------------------------------------------------------------------------------------------------------------------- $4.89 - $ 5.00 137,679 2.6 years $ 4.93 137,679 $ 4.93 10.33 - 18.13 351,355 2.0 years 13.43 154,830 12.64 20.33 - 34.50 426,920 3.7 years 25.89 33,450 26.82 --------------- ------- --------- ------ ------- ------ $4.89 - $ 34.50 915,954 2.8 years $17.96 325,959 $10.84 =============== ======= ========= ====== ======= ====== The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: September 30, 1997 1996 - ---------------------------------- -------------------- ------------------------ Expected volatility 36.8% 34.6% Risk-free interest rate 6.0% 5.8% Expected lives (in years) 4.5 4.5 The Company has not paid and does not anticipate paying cash dividends; therefore, the expected dividend yield is assumed to be zero. The weighted-average fair value of options granted under the 1992 Equity Incentive Plan during fiscal 1997 and 1996 was $7.63 and $6.83, respectively. F-14 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE J--Employee Benefit Plans--(continued) For purposes of the pro forma disclosure below, the estimated fair value of the Company's stock-based compensation plan and the estimated benefit derived from the Company's Stock Purchase Plan is amortized to expense over the options' vesting period. The Company's pro forma net income and net income per share for the years ended September 30, 1997 and 1996 are as follows: Net income (in thousands): 1997 1996 ------- ------- As reported $11,272 $11,425 Pro forma 10,671 11,017 Earnings per share: As reported $ 1.34 $ 1.37 Pro forma 1.27 1.32 These pro forma disclosures may not be representative of the effects for future years since options vest over several years and options granted prior to fiscal 1996 are not considered in these disclosures. STOCK PURCHASE PLAN: In accordance with the 1992 Employee Stock Purchase Plan, eligible employees may authorize payroll deductions of up to 10% of their compensation (not to exceed $12,500 in a six month period) to purchase shares at the lower of 85% of the fair market value of the Company's Common Stock at the beginning or end of the six month option period. During fiscal 1997, 43,859 shares were issued to employees at prices ranging from $23.38 to $27.20 per share. At September 30, 1997, a total of 1,460,727 shares of Common Stock were reserved for issuance. Included in this amount are 1,107,855 shares for the 1992 Equity Incentive Plan, 192,087 shares for the Employee Stock Purchase Plan and 160,785 shares for the various stock option plans adopted in the period 1979 through 1987. F-15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE J--Employee Benefit Plans--(continued) DEFINED CONTRIBUTION PLAN: The Company sponsors a defined contribution savings plan for the benefit of substantially all employees. Total expense under the plan was $958,000, $777,000 and $501,000 in fiscal 1997, 1996 and 1995, respectively. NOTE K--Income Taxes The provision for income taxes consists of the following (in thousands): Year Ended September 30, --------------------------------------------------- 1997 1996 1995 - ---------------------------- ---------------- ----------------- ---------------- Current: Federal $6,682 $5,566 $4,984 State 1,010 951 835 Foreign 225 31 ------ ------ ------ 7,917 6,548 5,819 Deferred: Federal (797) 654 (555) State (104) 72 (81) ------ ------ ------ (901) 726 (636) ------ ------ ------ $7,016 $7,274 $5,183 ====== ====== ====== F-16 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE K--Income Taxes--(continued) Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. For financial reporting purposes, the Company has determined that recognition of the deferred tax asset resulting from net operating loss carryforwards of foreign subsidiaries does not meet the "more likely than not" criteria of the Standard and, therefore, has provided a valuation allowance for related future tax benefits. Significant components of the Company's deferred tax assets and liabilities are as follows (in thousands): September 30, ------------------------------- 1997 1996 - ------------------------------------------------ --------------- --------------- Deferred tax assets: Inventory reserves $ 501 $ 492 Accounts receivable reserves 696 370 Accrued expenses 2,872 2,264 Unearned service revenue 591 Net operating loss carryforwards of foreign subsidiaries 1,041 694 -------- -------- Total deferred tax assets 5,701 3,820 Valuation allowance (1,041) (694) -------- -------- 4,660 3,126 Deferred tax liabilities: Capitalized software development costs (2,925) (2,130) Other (45) (207) -------- -------- Net deferred tax assets $ 1,690 $ 789 ======== ======== The effective tax rate differed from the United States statutory rate as follows: Year ended September 30, 1997 1996 1995 - ------------------------------- --------------- ---------------- --------------- Statutory rate 35% 35% 34% State income taxes, net of federal income tax benefit 3 4 4 Foreign losses not benefited 3 1 Use of foreign net operating loss carryforwards (1) (1) (1) Income tax credits (1) (1) Other (1) 2 --- --- --- 38% 39% 38% === === === F-17 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED KRONOS INCORPORATED NOTE K--Income Taxes--(continued) There were $393,000 and $200,000 of net operating loss carryforwards utilized in fiscal 1997 and 1996. At September 30, 1997, the Company had $2,601,000 of available net operating loss carryforwards from foreign operations which may be used to reduce future income taxes payable in their respective countries. Of these carryforwards, $1,172,000 expire from 2000 through 2003. The remaining carryforwards, totaling $1,429,000, may be carried forward indefinitely. The Company made income tax payments of $4,847,000, $4,424,000 and $4,352,000 in fiscal 1997, 1996 and 1995, respectively. F-18 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Board of Directors and Shareholders Kronos Incorporated We have audited the accompanying consolidated balance sheets of Kronos Incorporated as of September 30, 1997 and 1996 and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended September 30, 1997. Our audits also included the financial statement schedule listed in the index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Kronos Incorporated at September 30, 1997 and 1996, and the consolidated results of operations and cash flows for each of the three years in the period ended September 30, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. ERNST & YOUNG LLP Boston, Massachusetts October 28, 1997 F-19 KRONOS INCORPORATED SCHEDULE II - Valuation and Qualifying Accounts (In thousands) ================================================================================================================================== COL. A COL. B COL. C COL. D COL. E - ---------------------------------------------------------------------------------------------------------------------------------- Additions ----------------------------- Charged to Balance at Charged to Other Balance at Beginning Costs and Accounts- Deductions- End Description of Period Expenses Describe Describe of Period - ---------------------------------------------------------------------------------------------------------------------------------- Year ended September 30, 1995: Deducted from asset accounts: Allowance for doubtful accounts $864 $571 $434 (1) $1,001 =========== =========== =========== =========== =========== Year ended September 30, 1996: Deducted from asset accounts: Allowance for doubtful accounts $1,001 $322 $336 (1) $987 =========== =========== =========== =========== =========== Year ended September 30, 1997: Deducted from asset accounts: Allowance for doubtful accounts $987 $494 $390 (1) $1,091 =========== =========== =========== =========== =========== (1) Uncollectible accounts written off, net of recoveries. F-20 Exhibit Index Exhibit No. Description 3.1(9) Restated Articles of Organization of the Registrant as amended. 3.2* Amended and Restated By-laws of the Registrant. 4* Specimen Stock Certificate. 10.1*(14) 1986A Stock Option Plan. 10.2(8)(14) 1992 Equity Incentive Plan, as amended and restated. 10.3(13)(14) 1992 Employee Stock Purchase Plan, as amended and restated. 10.4(3) Lease dated November 16, 1993, between Teachers Realty Corporation and the Registrant, relating to premises leased in Chelmsford, MA. 10.5(5) Lease dated August 8, 1995, between Principal Mutual Life Insurance Company and the Registrant, relating to leased premises in Chelmsford, MA. 10.6(12) Fleet Bank Letter Agreement and Promissory Note dated January 1, 1997, relating to amendment of $3,000,000 credit facility. 10.7(2)(15) Software License and Support and Hardware Purchase Agreement dated April 2, 1993, between ADP, Inc. and the Registrant. 10.7.1(10)(15)Amendments dated July 22, 1996 to Software License and Support and Hardware Purchase Agreement dated April 2, 1993 between ADP, Inc. and the Registrant. 10.8* Sales Agreement dated December 6, 1990, between Integrated Design, Inc. and the Registrant. 10.8.1(6) Amendment dated November 2, 1995 to Sales Agreement dated December 6, 1990 between Integrated Design and the Registrant. 10.9(3)(15) Acquisition Agreement dated November 2, 1993 between Interboro Systems Corporation and the Registrant. 10.10* Form of Indemnity Agreement entered into among the Registrant and Directors of the Registrant. 10.11(1) Lease dated November 9, 1992, as amended, between John Hancock Mutual Life Insurance Company and the Registrant, relating to premises leased in Waltham, MA. 10.11.1(7) Amendment dated January 1, 1996 to Lease dated November 9, 1992, as amended, between John Hancock Mutual Life Insurance Company and the Registrant, relating to premises leased in Waltham, MA. 10.11.2(11) Amendment dated October 11, 1996 to Lease dated November 9, 1992, as amended, between John Hancock Mutual Life Insurance Company and the Registrant relating to premises leased in Waltham, MA. 10.12(4) Agreement of Reorganization among Kronos Incorporated, Kronos S/T Corporation, ShopTrac Data Collection Systems, Inc., Thomas J. O'Malia and Mark J. MacWhirter, dated March 31, 1994. 11 Statement re computation of per share earnings. 21 Subsidiaries of the Registrant. Exhibit Index (continued) Exhibit No. Description 23 Consent of Independent Auditors. 27 Financial Data Schedule. * Incorporated by reference to the same Exhibit Number in the Company's Registration Statement on Form S-1 (File No. 33-47383). (1) Incorporated by reference to the same Exhibit Number in the Company's Form 10-K for the fiscal year ended September 30, 1992. (2) Incorporated by reference to Exhibit Number 10.1 in the Company's Form 10-Q for the quarterly period ended April 3, 1993. (3) Incorporated by reference to the same Exhibit Number in the Company's Form 10-K for the fiscal year ended September 30, 1993. (4) Incorporated by reference to Exhibit Number 2.1 in the Company's Form 10-Q for the quarterly period ended July 2, 1994. (5) Incorporated by reference to Exhibit 10.13 in the Company's Form 10-K for the fiscal year ended September 30,1995. (6) Incorporated by reference to Exhibit Number 10.1 in the Company's Form 10-Q for the quarterly period ended March 30, 1996. (7) Incorporated by reference to Exhibit Number 10.2 in the Company's Form 10-Q for the quarterly period ended March 30, 1996. (8) Incorporated by reference to Exhibit Number 10.2 in the Company's Form 10-K for the fiscal year ended September 30, 1996. Exhibit Index (continued) Exhibit No. Description (9) Incorporated by reference to Exhibit Number 3.1 in the Company's Form 10-K for the fiscal year ended September 30, 1996. (10) Incorporated by reference to Exhibit Number 10.7.1 in the Company's Form 10-K for the fiscal year ended September 30, 1996. (11) Incorporated by reference to Exhibit 10.1 in the Company's Form 10-Q for the quarterly period ended December 28, 1996. (12) Incorporated by reference to Exhibit 10.2 in the Company's Form 10-Q for the quarterly period ended December 28, 1996. (13) Incorporated by reference to Exhibit Number 10 in the Company's Form 10-Q for the quarterly period ended March 29, 1997. (14) Management contract or compensatory plan or arrangement filed as an exhibit to this Form 10-K pursuant to Items 14(a) and 14(c) of Form 10-K. (15) Confidential treatment was granted for certain portions of this agreement.