SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Date of Report (Date of Earliest Event Reported): July 24, 1996 CUC International Inc. ---------------------- (Exact name of registrant as specified in its Charter) Delaware 1-10308 06-0918165 - ------------------------------------------------------------------------------- (State or other (Commission File Number) (I.R.S. Employer jurisdiction of Identification No.) incorporation) 707 Summer Street, Stamford, Connecticut 06901 - ---------------------------------------- --------------------------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code (203) 324-9261 Not Applicable ------------------------------------------------------------ (Former Name or Former Address, if Changed Since Last Report ITEM 5. OTHER EVENTS As previously disclosed by CUC International Inc., a Delaware corporation (the "Company") in prior fillings: During July 1996, the Company merged certain of its subsidiaries with Davidson & Associates, Inc. ("Davidson") and Sierra On-Line, Inc. ("Sierra") by issuing approximately 30.1 million shares and 25.6 million shares of the Company's common stock, par value $.01 per share ("Common Stock"), respectively. Davidson and Sierra develop, publish and distribute educational and entertainment software for home and school use. During August 1996, the Company merged one of its subsidiaries with Ideon Group, Inc. ("Ideon"), principally a provider of credit card enhancement services, by issuing approximately 11 million shares of Common Stock (the "Ideon Merger"). The above mergers have been accounted for as poolings-of-interests. Generally accepted accounting principles proscribe giving effect to a consummated business combination accounted for by the pooling-of-interests method in financial statements that do not include the date of consummation. The Company has prepared restated supplemental consolidated financial statements reflecting the above-described transactions and is filing them as Exhibit 99.1 to this Current Report on Form 8-K so that the Company may incorporate such financial statements into any future registration statements by reference to this report. Unaudited restated supplemental interim consolidated financial statements as of April 30, 1996 and July 31, 1996 and for the three month periods ended April 30, 1996 and 1995 and for the three month and the six month periods ended July 31, 1996 and 1995 reflecting the above-described transactions have also been included herein as Exhibit 99.2. The supplemental consolidated financial statements do not extend through the date of consummation of the Ideon Merger. However, they will become the historical consolidated financial statements of the Company after financial statements covering the date of consummation of the business combination are issued. In addition, the selected supplemental consolidated financial data and management's discussion and analysis of financial condition and results of operations of the Company have been prepared to give retroactive effect to the above-described transactions and appear herein as Exhibits 99.3 and 99.4, respectively. ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS (a) Financial statements of businesses acquired: 1. Audited consolidated financial statements of Sierra On-Line, Inc. and subsidiaries for the fiscal year ended March 31, 1996. 2. Audited consolidated financial statements of Davidson & Associates, Inc. for the year ended December 31, 1995. 3. Audited consolidated financial statements of Ideon Group, Inc. for the year ended December 31, 1995. (b) Exhibits 23.1 Consent of Ernst & Young LLP. 23.2 Consent of Deloitte & Touche LLP. 23.3 Consent of Deloitte & Touche LLP. -1- 23.4 Consent of Price Waterhouse LLP. 23.5 Consent of KPMG Peat Marwick LLP. 27 Financial Data Schedule. 99.1 Supplemental Consolidated Financial Statements of CUC International Inc. for the fiscal year ended January 31, 1996 (as restated to reflect the acquisitions of Sierra On-Line, Inc. on July 24, 1996, Davidson & Associates Inc. on July 24, 1996 and Ideon Group, Inc. on August 7, 1996). 99.2 Supplemental Interim Consolidated Financial Statements of CUC International Inc. for the three month period ended April 30, 1996 and for the three month and the six month periods ended July 31, 1996 (as restated to reflect the acquisitions of Sierra On-Line, Inc. on July 24, 1996, Davidson & Associates, Inc. on July 24, 1996 and Ideon Group Inc. on August 7, 1996). 99.3 Selected Supplemental Consolidated Financial Data of CUC International Inc. (as restated to reflect the acquisitions of Sierra On-Line Inc. on July 24, 1996, Davidson & Associates, Inc. on July 24, 1996 and Ideon Group, Inc. on August 7, 1996). 99.4 Supplemental Management's Discussion and Analysis of Financial Condition and Results of Operations of CUC International Inc. (as restated to reflect the acquisitions of Sierra On-Line, Inc. on July 24, 1996, Davidson & Associates, Inc. on July 24, 1996 and Ideon Group, Inc. on August 7, 1996). -2- (a) 1. Sierra On-Line, Inc. and Subsidiaries Consolidated Financial Statements March 31, 1996 and 1995 With Independent Auditors' Report INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders Sierra On-Line, Inc. Bellevue, Washington We have audited the accompanying consolidated balance sheets of Sierra On-Line, Inc. and subsidiaries (the "Company") as of March 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended March 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of March 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended March 31, 1996 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Seattle, Washington June 24, 1996 SIERRA ON-LINE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS MARCH 31, 1996 AND 1995 (in thousands, except share data) ASSETS 1996 1995 -------- -------- CURRENT ASSETS: Cash and cash equivalents ....................................................... $ 40,220 $ 50,186 Marketable investment securities ................................................ 48,741 50,573 Accounts receivable, net of allowances of $14,022 and $7,265........................ 43,677 12,984 Inventories ....................................................................... 8,054 4,903 Deferred income taxes............................................................... 8,159 1,777 Other current assets (including $792 note receivable from related parties at March 31, 1995) .................................................. 5,945 4,932 ---------- ---------- Total Current Assets ..................................................... 154,796 125,355 PROPERTY, PLANT AND EQUIPMENT, net ................................................. 11,490 9,068 GOODWILL, net of accumulated amortization of $4,635 and $2,871...................... 9,785 6,498 DEFERRED INCOME TAXES .............................................................. 1,241 1,522 OTHER ASSETS ...................................................................... 1,585 2,911 ---------- ---------- $ 178,897 $ 145,354 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable ............................................................... $ 15,536 $ 6,127 Accrued compensation and related benefits ...................................... 7,012 4,118 Accrued incentive payments ..................................................... 538 1,562 Royalties payable (including $10 and $633 payable to a related party)............ 2,327 2,938 Deferred revenue ............................................................... 3,906 1,261 Accrued interest ................................................................ 33 1,160 Other accrued expenses (including $1,954 and $247 payable to related parties).... 7,268 5,028 ---------- ---------- Total Current Liabilities .................................................. 36,620 22,194 ADVANCES UNDER PUBLISHING AGREEMENT AND OTHER LIABILITIES .............................................................. 1,030 5,907 MINORITY INTEREST IN JOINT VENTURE ................................................. 1,233 --- CONVERTIBLE DEBT, net of unamortized discount and issuance costs of $586 and $1,066.............................................................. 23,389 34,634 COMMITMENTS AND CONTINGENCIES (Note 9) ........................................... --- --- STOCKHOLDERS' EQUITY: Preferred stock, par value $.01 per share; 1,000,000 shares authorized, none outstanding ................................ --- --- Common stock and paid-in capital, par value $.01 per share; 40,000,000 shares authorized; 20,518,871 and 18,726,519 shares issued and outstanding..... 93,018 70,052 Retained earnings ............................................................... 24,728 12,696 Net unrealized holding gains (losses)............................................ (67) 101 Cumulative translation adjustment .............................................. (705) 119 ---------- ---------- 116,974 82,968 Less common stock in treasury, 94,154 shares, at cost .......................... 349 349 ---------- ---------- Total Stockholders' Equity ............................................... 116,625 82,619 ---------- ---------- $ 178,897 $ 145,354 ========== ========== See Notes to Consolidated Financial Statements. SIERRA ON-LINE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED MARCH 31, 1996, 1995 AND 1994 (in thousands, except per share data) 1996 1995 1994 ---------- ---------- ---------- REVENUES: Net sales.............................................. $ 156,123 $ 95,821 $ 70,712 Other ................................................. 2,054 2,058 2,389 ---------- ---------- ---------- 158,177 97,879 73,101 ---------- ---------- ---------- OPERATING EXPENSES: Manufacturing costs ................................... 32,821 21,663 20,058 Amortization of software development costs ............ 865 9,689 8,379 Royalties (including $1,294, $819, and $256 earned by related party)................................... 11,777 7,370 4,005 Selling, general and administrative ................... 52,135 32,777 25,685 Research and development .............................. 35,899 21,967 17,686 Purchased in-process research and development ......... --- --- 1,102 Amortization .......................................... 2,075 1,212 722 ---------- ---------- ---------- 135,572 94,678 77,637 ---------- ---------- ---------- INCOME (LOSS) FROM OPERATIONS .............................. 22,605 3,201 (4,536) ---------- ---------- ---------- OTHER INCOME (EXPENSE): Gain on sale of The ImagiNation Network ............... --- 19,739 --- Equity in loss from The ImagiNation Network............ --- (1,990) (5,066) Shareholder litigation costs........................... --- (1,500) --- Contract termination and consulting fees .............. (2,302) Interest income (including $12, $84 and $152 earned from related parties)........................ 5,022 3,713 1,331 Interest expense ...................................... (2,690) (4,306) (280) ---------- ---------- ---------- 30 15,656 (4,015) ---------- ---------- ---------- INCOME (LOSS) BEFORE INCOME TAXES .......................... 22,635 18,857 (8,551) INCOME TAX PROVISION (BENEFIT) ............................. 7,680 5,865 (679) CHANGE IN VALUATION ALLOWANCE .............................. (1,215) --- --- ---------- ---------- ---------- NET INCOME (LOSS) .......................................... $ 16,170 $ 12,992 $ (7,872) ========== ========== ========== NET INCOME (LOSS) PER SHARE: Primary ............................................... $ 0.77 $ 0.70 $ (0.46) Fully diluted ......................................... 0.76 0.68 (0.46) WEIGHTED AVERAGE SHARES OUTSTANDING: Primary ............................................... 21,007 18,513 17,143 Fully diluted ......................................... 23,009 22,216 17,143 See Notes to Consolidated Financial Statements. SIERRA ON-LINE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED MARCH 31, 1996, 1995 AND 1994 (in thousands, except share data) Common Stock Net Total and Paid-in Capital Retained Unrealized Cumulative Treasury Stock Stock- ------------------- Earnings Holding Translation ---------------- holders' Shares Amount (Deficit) Gains Adjustment Shares Amount Equity ------ ------ --------- ---------- ----------- ------ ------ -------- BALANCE, APRIL 1, 1993 16,776,183 $44,311 $ 7,898 $ --- $ (247) 104,474 $ (392) $ 51,570 Net loss (7,872) (7,872) Stock options exercised 595,108 3,256 3,256 Tax benefit of stock option transactions 442 442 INN liquidation preference 3,977 3,977 S Corporation distributions (295) (295) Foreign currency translation adjustment 28 28 ---------- ------- ------- --------- ----------- ------- ------- -------- BALANCE, MARCH 31, 1994 17,371,291 51,986 (269) (219) 104,474 (392) 51,106 Net income 12,992 12,992 Equity contributions 266 266 Stock options exercised 333,807 2,131 2,131 Tax benefit of stock option transactions 1,772 1,772 Conversion of convertible debt 1,021,421 13,897 13,897 Treasury stock issued (10,320) 43 43 S Corporation distributions (27) (27) Net unrealized holding gains on marketable investment securities available-for-sale 101 101 Foreign currency translation adjustment 338 338 ---------- ------- ------- --------- ---------- ------- ------- -------- BALANCE, MARCH 31, 1995 18,726,519 70,052 12,696 101 119 94,154 (349) 82,619 Net income 16,170 16,170 Stock options exercised and stock purchased under the Employee Stock Purchase Plan 624,611 3,758 3,758 Tax benefit of stock option transactions 3,624 3,624 Conversion of convertible debt 837,498 11,379 11,379 S Corporation distributions (4,138) (4,138) Stock issued for bonuses and an amendment to an incentive payment plan 182,285 4,107 4,107 Stock issued in business acquisitions 147,958 98 98 Net unrealized holding gains on marketable investment securities available-for-sale (168) (168) Foreign currency translation adjustment (824) (824) ---------- ------- ------- --------- ---------- ------- ------- -------- BALANCE, MARCH 31, 1996 20,518,871 $93,018 $24,728 $ (67) $ (705) 94,154 $ (349) $ 116,625 ========== ======= ======= ========= ========== ======= ======= ========= See Notes to Consolidated Financial Statements. SIERRA ON-LINE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED MARCH 31, 1996, 1995 AND 1994 (in thousands) 1996 1995 1994 ----------- ----------- ----------- OPERATING ACTIVITIES: Net income (loss) ................................................... $ 16,170 $ 12,992 $ (7,872) Reconciliation to net cash provided by (used for) operating activities: Depreciation ....................................................... 4,187 3,298 3,085 Amortization of intangible assets and issuance costs ............... 2,763 11,153 9,102 Gain on sale of The ImagiNation Network ............................ --- (19,739) --- Equity loss from The ImagiNation Network ........................... --- 1,990 5,066 Sierra Pioneer Joint Venture minority interest...................... 1,233 --- --- Purchased in-process research and development ...................... --- --- 1,102 Provision for doubtful accounts ................................... 1,205 829 650 Deferred income taxes ............................................. (2,476) (2,840) (1,394) Other ............................................................. --- 1,880 (661) Cash provided (used) by changes in assets and liabilities: Accounts receivable ............................................... (32,370) (2,670) (5,020) Inventories ....................................................... (3,151) 127 (898) Other current assets .............................................. (1,013) 2,937 1,880 Software development costs ........................................ --- (5,037) (6,060) Research and development acquired ................................. --- --- (2,452) Other assets ...................................................... 461 (1,090) (225) Accounts payable .................................................. 9,125 1,498 (219) Accrued compensation and related benefits .......................... 2,894 2,067 212 Royalties payable ................................................. (611) 1,583 570 Deferred revenue .................................................. 2,645 268 993 Accrued interest ................................................... (1,127) 1,160 --- Other accrued expenses ............................................ 218 1,093 489 Advances under publishing agreement and other liabilities........... (4,877) 4,692 (14) ----------- ----------- ----------- Net cash provided by (used for) operating activities ............ (4,724) 16,191 (1,666) INVESTING ACTIVITIES: Proceeds from sale of The ImagiNation Network ........................ --- 19,739 --- Proceeds from matured marketable investment securities................ 93,556 40,319 67,865 Purchases of marketable investment securities .......................... (91,724) (69,880) (65,550) Net purchases of property, plant and equipment ......................... (6,609) (4,901) (3,628) Loan to The ImagiNation Network ......................................... --- (2,895) --- Payment for purchase of subsidiaries, net of cash acquired and research and development ....................................... (1,987) (1,620) (2,797) Net repayment of advances to The ImagiNation Network ................. --- --- 1,646 ----------- ----------- ----------- Net cash used by investing activities ............................. (6,764) (19,238) (2,464) FINANCING ACTIVITIES: Net proceeds from convertible debt offering .......................... --- 48,250 --- Proceeds from exercise of options and warrants ...................... 3,758 2,131 3,255 S Corporation distributions .......................................... (2,184) (27) (295) Other ................................................................ (312) (780) 40 ----------- ----------- ----------- Net cash provided by financing activities ......................... 1,262 49,574 3,000 ----------- ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ......................................................... (10,226) 46,527 (1,130) EFFECT OF EXCHANGE RATE CHANGES ON CASH ................................ 260 96 --- CASH AND CASH EQUIVALENTS: BEGINNING OF YEAR................................................... 50,186 3,563 4,693 ----------- ----------- ----------- END OF YEAR ....................................................... $ 40,220 $ 50,186 $ 3,563 =========== =========== =========== See Notes to Consolidated Financial Statements SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Supplemental disclosure of cash flow and noncash investing and financing information for the years ended March 31 is as follows (in thousands): 1996 1995 1994 ---- ---- ---- Cash paid (received) during the year for: Income taxes, net ...................... $ 9,584 $ 7,181 $ (739) Interest ............................... $ 3,817 $ 4,578 $ --- During fiscal 1996 and 1995, the Company converted $11,725,000 and $14,300,000 of convertible debt into 837,500 and 1,021,421 shares of common stock, respectively. In fiscal 1994, the Company purchased all of the capital stock of Coktel Vision for $5,332,000. In connection with the acquisition, liabilities assumed were as follows (in thousands): Fair value of net assets acquired ............................... $ 7,641 Cash paid ...................................................... (5,332) -------- Liabilities assumed ............................................ $ 2,309 ======== See Notes to Consolidated Financial Statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED MARCH 31, 1996, 1995 AND 1994 NOTE 1: BASIS OF PRESENTATION AND ACCOUNTING POLICIES Pending Sale of the Company to CUC International, Inc. On February 17, 1996, the Board of Directors approved the sale of the Company to CUC International Inc. (CUC). Under the terms of the merger agreement, the shareholders of the Company will receive 1.225 shares of CUC common stock for each share of the Company's common stock. The sale is subject to shareholder approval. Consulting fees related to the merger have been expensed as incurred and approximate $0.6 million. Upon shareholder approval of the merger, the Company will be obligated to pay approximately $7.7 million in additional consulting fees. Basis of Presentation The consolidated financial statements include the accounts of Sierra On-Line, Inc. (Sierra), a Delaware corporation, its wholly-owned subsidiaries, and its 51% interest in a corporate joint venture (collectively referred to as the Company). Significant subsidiaries include Sierra On-Line Limited (Sierra U.K.), Dynamix, Inc. (Dynamix), Bright Star Technology, Inc. (Bright Star), Coktel Vision, S.A. (Coktel), Software Inspiration, Ltd. (Inspiration), PXL Acquisition Corp. (Pixellite), Papyrus Design Group, Inc. (Papyrus), and Sierra/Pioneer Joint Venture (Pioneer). The accounts of The ImagiNation Network, Inc. (INN) were consolidated with those of the Company through July 26, 1993 and accounted for under the equity method from July 1993 to December 1994 when the Company sold its remaining interest in INN to AT&T Corp. All significant intercompany balances and transactions are eliminated. Nature of Operations The Company designs, develops, publishes, markets and distributes interactive entertainment and education software for personal computers, CD-ROM-based PC systems and selected emerging platforms. Using its design and development capabilities, the Company creates branded product series for existing and emerging hardware platforms. The Company's products are distributed in North America, Europe, and Asia. Sales are generated through a domestic field sales organization and electronic superstores, software specialty stores, mass merchants, direct mail, and bundling arrangements. The Company performs its own disk duplicating and packaging for diskette-based products at its Oakhurst, California and Paris, France facilities. The Company does not internally replicate CD-ROM-based products but rather subcontracts that work to several third parties. The Company is subject to certain business risks which could affect future operations and financial performance. These risks include changing computing environments, rapid technological change, development of new products, concentrations in manufacturing facilities, competitive pricing, and reliance on distribution channels. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements. Changes in these estimates and assumptions may have a material impact on the financial statements. The Company has used estimates in determining certain provisions including sales returns, uncollectible trade accounts receivable, useful lives for fixed assets and intangible assets, and tax liabilities. Cash and Cash Equivalents Cash and cash equivalents include cash, certificates of deposit and short term investments with original maturities of three months or less. Marketable Investment Securities Marketable investment securities consist of corporate bonds, U.S. Treasury notes, and commercial paper. All securities are classified as available-for-sale and are reported at fair value with net unrealized holding gains and losses excluded from earnings and reported in stockholders' equity. Fair value is based upon quoted market prices using the specific identification method. Inventories Inventories are stated at the lower of cost (first-in, first-out method) or market. Property, Plant and Equipment Property, plant and equipment is stated at cost. Depreciation and amortization are provided using a straight-line method over estimated useful lives ranging from two to 18 years. Software Development Costs and Purchased In-Process Research and Development Expenses Under the criteria set forth in SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, capitalization of software development costs begins upon the establishment of technological feasibility of the product. The establishment of technological feasibility and the on-going assessment of the recoverability of costs require considerable judgment by management with respect to certain external factors, including, but not limited to, anticipated future gross product revenues, estimated economic life and changes in software and hardware technology. Amounts that have been capitalized under this statement, after consideration of the above factors, are amortized on either a straight-line basis over the estimated useful lives of the products (six to 24 months) or the ratio of current product revenues to the total revenues expected over the life of the product, whichever produces the greater expense. Purchased in-process research and development is charged to expense on the date acquired if it has no alternative future use and technological feasibility is not established. Goodwill Goodwill represents the excess purchase price paid over the net assets of acquired companies. Goodwill is amortized on a straight-line basis over seven years. The carrying value of goodwill is reviewed on a regular basis for the existence of facts or circumstances both internally and externally that may suggest impairment. To date, no such impairment has been indicated. Should there be an impairment in the future, the Company will measure the amount of the impairment based on the discounted expected future cash flows from the impaired assets. Foreign Currency Assets and liabilities denominated in foreign currencies are translated to U.S. dollars at the exchange rate on the balance sheet date. Revenues, costs and expenses are translated at average rates of exchange prevailing during the year. The translation adjustment resulting from this process is presented separately in shareholders' equity. The gains and losses from foreign currency transactions are included in selling, general and administrative expense in the statements of operations. Revenue Recognition The Company recognizes revenue in accordance with the American Institute of Certified Public Accountants Statement of Position (SOP) No. 91-1, Software Revenue Recognition. Revenue from product sales is recognized upon shipment, provided no significant vendor obligations remain and collection of the resulting receivable is deemed probable. Other insignificant vendor obligations consisting primarily of costs associated with telephone support to customers after delivery of software are accrued. Revenue from royalty and service arrangements is insignificant. The Company's agreements with certain distributors and retailers permit them to exchange products or provide price protection under certain circumstances. The Company provides an allowance for estimated exchanges and price protection. Advertising The Company accounts for advertising costs in accordance with SOP No. 93-7, Reporting on Advertising Costs. Direct response advertising is capitalized only if customer sales can be directly correlated to the advertising and if future benefit can be demonstrated. Capitalized advertising costs are amortized using the straight-line method over the estimated benefit period of three months. Advertising expense for fiscal 1996, 1995 and 1994 was $7,530,000, $8,750,000 and $7,850,000, respectively. Amounts capitalized at March 31, 1996 and 1995 approximated $561,000 and $598,000, respectively. Income Taxes (Benefit) The Company computes income taxes using an asset and liability method, under which deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. Net Income (Loss) Per Share Net income (loss) per share is based upon the weighted average number of common shares outstanding during the period and after consideration of the dilutive effect, if any, of stock options granted using the treasury stock method. In addition, conversion of the Company's 6-1/2% Convertible Subordinated Notes are included in fully diluted income per share using the if-converted method when such securities are dilutive. As a result of applying the if-converted method, net income for the purposes of computing fully diluted net income per share amounts has been adjusted for the assumed decrease in interest expense, net of income taxes, as follows (in thousands): 1996 1995 --------- --------- Net income.................................. $ 16,170 $ 12,992 Adjustment.................................. 1,205 2,115 --------- --------- $ 17,375 $ 15,107 ========= ========= Stock Split On March 3, 1995, the Company recorded a two-for-one stock split to holders of record on February 17, 1995. Outstanding shares, stock options and per share data have been retroactively restated for all periods to give effect to the stock split. Concentration of Credit Risk Accounts receivable include amounts from geographically dispersed dealers and distributors in the computer software industry. Concentrations of credit risk are considered minimal and bad debts have not been significant. The Company does not require collateral or other security to support credit sales. Reclassifications Certain reclassifications have been made to the 1994 and 1995 balances to conform with the 1996 presentation. NOTE 2: BUSINESS COMBINATIONS Pixellite, Inspiration and Papyrus On May 31, 1995 the Company merged with Pixellite, a developer of personal printing software, in exchange for 245,779 shares of Sierra's common stock. On June 20, 1995 the Company also merged with Inspiration, a developer of strategy games, in exchange for 730,352 shares of Sierra's common stock. On November 30, 1995 the Company merged with Papyrus, developers of NASCAR Racing and Indy Car Racing, in exchange for 1,169,404 shares of Sierra's common stock. These mergers have been accounted for as poolings-of-interests. The pooling-of-interests method of accounting is intended to present as a single interest two or more common shareholders' interests which were previously independent; accordingly, the historical financial statements for the periods prior to the mergers are restated as though the companies had been combined. The following summarizes amounts previously reported by Sierra prior to the transaction for the years ended March 31, 1995 and 1994 (in thousands, except per share data): 1995 1994 ---------- ---------- REVENUES: Sierra.................................. $ 83,440 $ 62,745 Pixellite, Inspiration and Papyrus .... 14,439 10,356 ---------- ---------- Combined ............................... $ 97,879 $ 73,101 ========== ========== NET INCOME (LOSS) Sierra.................................. $ 11,938 $ (8,676) Pixellite, Inspiration and Papyrus ..... 1,054 804 ---------- ---------- Combined ............................... $ 12,992 $ (7,872) ========== ========== PRIMARY NET INCOME (LOSS) PER SHARE: Sierra ................................. $ 0.74 $ (0.59) Pixellite, Inspiration and Papyrus ..... (0.04) 0.13 ---------- ---------- Combined ............................... $ 0.70 $ (0.46) ========== ========== FULLY DILUTED NET INCOME (LOSS) PER SHARE: Sierra ................................. $ 0.71 $ (0.59) Pixellite, Inspiration and Papyrus...... (0.03) 0.13 ---------- ---------- Combined ............................... $ 0.68 $ (0.46) ========== ========= Green Thumb and Arion The Company also merged with Green Thumb in July 1995 and with Arion in September 1995 in exchange for 87,762 and 60,196 shares of Sierra Common Stock, respectively. The financial statements have not been restated for the Green Thumb and Arion mergers as these companies did not impact the Company's operations significantly. All fees and expenses related to the Pixellite, Inspiration, Papyrus, Green Thumb and Arion mergers have been expensed as required under the pooling-of-interests accounting method. Such fees and expenses approximated $2.3 million and include legal, accounting and finders fees. Coktel On October 29, 1993, the Company acquired Coktel Vision S.A. ("Coktel"), a French developer and publisher of educational and entertainment software products, for an initial purchase price of approximately $5,332,000. This business combination was accounted for as a purchase, and, accordingly, the net assets and operations of Coktel have been included in the Company's consolidated financial statements since October 29, 1993. Approximately $1,102,000 of the purchase price was attributed to in-process research and development and accordingly was charged to expense at the date of acquisition. Amounts allocated to software development costs approximated $1,350,000 and amounts allocated to goodwill were approximately $2,419,000. Goodwill is being amortized over an estimated useful life of seven years on a straight-line basis. Contingent purchase payments were due under an incentive payment plan. During fiscal years 1995 and 1994, approximately $1,562,000 and $1,313,000 was earned and paid under this plan. At March 31, 1995, incentive payments due approximated $1,562,000. In December 1995, the Company amended the Coktel acquisition agreement whereby it issued 150,000 shares of Common Stock in exchange for each former Coktel shareholder relinquishing their rights to receive any further incentive payments. As a result of this amendment, the Company recorded goodwill of approximately $4.1 million which is being amortized over its remaining useful life of approximately five years on a straight-line basis. The Company could be obligated to make additional payments as provided in the agreement, however, management believes that the likelihood of additional payments is remote. NOTE 3: MARKETABLE INVESTMENT SECURITIES The Company's investments, including aggregate fair values, cost, gross unrealized holding gains, and gross unrealized holding losses, consist of the following at March 31 (in thousands): Gross Gross Unrealized Unrealized Fair Holding Holding Value Cost Gains Losses ----------- ----------- ----------- ----------- 1996: U.S. Government obligations $ 15,471 $ 15,481 $ --- $ 10 Corporate debt securities 27,438 27,521 24 107 Commercial paper 5,832 5,832 --- --- ----------- ----------- ----------- ----------- $ 48,741 $ 48,834 $ 24 $ 117 =========== =========== =========== =========== 1995: U.S. Government obligations $ 10,394 $ 10,357 $ 39 $ 2 Corporate debt securities 23,050 22,996 80 26 Commercial paper 17,129 17,067 64 2 ----------- ----------- ----------- ----------- $ 50,573 $ 50,420 $ 183 $ 30 =========== =========== =========== =========== Fair values of investments are based on quoted market prices on the last business day of the fiscal year. All investments available-for-sale at March 31, 1996 will mature within one year. NOTE 4: INVENTORIES Inventories consist of the following at March 31 (in thousands): 1996 1995 --------- --------- Raw materials ......................... $ 3,207 $ 2,841 Work in progress ...................... --- 65 Finished goods ........................ 4,847 1,997 --------- --------- $ 8,054 $ 4,903 ========= ========= NOTE 5: PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consists of the following at March 31 (in thousands): 1996 1995 ---------- ---------- Land .................................. $ 142 $ 203 Buildings and improvements ............ 3,858 3,591 Computers and equipment ............... 20,669 16,703 Furniture and fixtures ................ 1,936 1,312 ---------- ---------- 26,605 21,809 Less accumulated depreciation and amortization.......................... (15,115) (12,741) ---------- ---------- $ 11,490 $ 9,068 ========== ========== NOTE 6: FINANCING ARRANGEMENTS Line of Credit In fiscal 1996, the Company entered into an unsecured bank line of credit that provides for borrowings of up to $10 million, expiring August 31, 1996. Any borrowings under this line of credit would be collateralized by substantially all the Company's assets and incur interest at either the bank's prime rate or IBOR plus 150 basis points, at the Company's choice. The line contains covenants requiring the Company to maintain certain financial ratios and minimum balances in cash and cash equivalents. The Company is in compliance with all covenants under this line of credit as of March 31, 1996. There have been no borrowings by the Company under this line of credit to date. Convertible Notes On April 12, 1994, the Company issued $50,000,000 in principal amount of 6-1/2% convertible subordinated notes due April 1, 2001 (the "Notes"). Interest on the Notes is payable semi-annually on April 1 and October 1 of each year. The Notes are convertible into common stock of the Company, at a conversion price of $14.00 per share, subject to adjustment under certain conditions. The Notes are redeemable after April 2, 1997, at the option of the Company, at specified redemption prices. The Notes will be subordinated to all existing and future Senior Indebtedness (as defined in the Indenture governing the Notes) of the Company. Issuance costs have been netted against the principal convertible debt balance are being amortized on a straight-line basis over seven years. The fair value of these notes at March 31, 1996 was $58.3 million as determined by the Private Offerings, Resales and Trading through Automated Linkages Market. During fiscal 1996 and 1995 the Company paid $0.9 million and $1.0 million, included in interest expense, to induce conversion of $11,725,000 and $14,300,000 of convertible debt into 837,500 and 1,021,421 shares of common stock. NOTE 7: INCOME TAX PROVISION (BENEFIT) A reconciliation of the statutory federal income tax rate to the Company's effective income tax rate is as follows for the years ended March 31: 1996 1995 1994 ------- -------- -------- Statutory rate .............................................. 35.0% 35.0% (35.0)% State income taxes, net of federal income tax benefit ....... 3.0 3.0 --- Utilization of net operating losses ......................... --- (3.9) --- Non-consolidated losses ..................................... --- (4.5) 18.3 Foreign subsidiaries ........................................ --- (2.2) 3.4 Non-deductible expenses ..................................... 8.9 4.5 2.1 Subchapter S Corporation earnings ........................... (5.5) (1.3) (0.6) Reduction in valuation allowance ............................ (14.3) --- --- Other ....................................................... 1.4 0.5 3.9 ------- -------- -------- Effective rate ............................................. 28.5% 31.1% (7.9)% ======= ======== ======== The provision for income taxes (benefit) consists of the following for the years ended March 31 (in thousands): 1996 1995 1994 ---------- ---------- ---------- Current: Federal .................................................. $ 6,095 $ 7,772 $ 540 State .................................................... 516 922 32 Foreign .................................................. 1,207 (55) 143 ---------- ---------- ---------- 7,818 8,639 715 Deferred: Federal .................................................. (1,179) (2,298) (1,003) State .................................................... (183) (268) (391) Foreign ................................................... --- (208) --- ---------- ---------- ---------- (1,362) (2,774) (1,394) ---------- ---------- ---------- $ 6,456 $ 5,865 $ (679) ========== ========== ========== Deferred income tax liabilities (assets) reflect the tax effect of temporary differences between the amounts of assets and liabilities for financial reporting purposes and amounts as measured for tax purposes. A valuation allowance against deferred tax assets has been provided for when it is more likely than not that some or all of the deferred tax assets will not be realized. The effect of temporary differences that cause significant portions of deferred tax assets and liabilities are as follows at March 31 (in thousands): 1996 1995 --------- --------- Deferred Assets: Inventory overhead allocation .. $ (327) $ (398) Accrued expenses ............... (7,012) (5,638) Tax credits ..................... --- (77) Stock Option Benefit ............ (1,509) --- Net operating losses ............ --- (334) Other ........................... (651) (187) --------- --------- Subtotal ....................... (9,499) (6,634) Valuation allowance.............. --- 3,230 --------- --------- (9,499) (3,404) Deferred Liabilities: Software development costs ..... 99 105 --------- --------- $ (9,400) $ (3,299) ========= ========= NOTE 8: STOCK OPTION AND STOCK PURCHASE PLANS Stock Option Plans The Company has reserved 6,170,000 shares of common stock for issuance under its 1995 Stock Option and Award Plan and the 1987 Stock Option Plan for officers, employees, directors, vendors, consultants and independent contractors. Options granted under these plans may be either incentive stock options or nonqualified stock options and are granted at the fair market value of the Company's common stock at the date of grant. Options vest and expire under the terms established at the date of grant. The Company also has 218,556 shares reserved for issuance under an option plan it acquired through its merger with Papyrus. A summary of stock option transactions under all plans follows: Range of Price Shares Per Share ----------- ------------------ Options outstanding, April 1, 1993 ... 2,114,768 $0.47 - $10.13 Granted .......................... 760,838 0.09 - 11.50 Exercised ........................ (541,108) 0.47 - 10.13 Canceled ......................... (457,366) 3.86 - 10.13 ----------- ------------------ Options outstanding, March 31, 1994.... 1,877,132 0.09 - 11.50 Granted ........................... 963,217 0.09 - 22.00 Exercised ......................... (333,807) 0.47 - 11.50 Canceled .......................... (215,482) 4.59 - 11.88 ----------- ------------------ Options outstanding, March 31, 1995 ... 2,291,060 0.09 - 22.00 Granted ........................... 754,613 0.80 - 41.75 Exercised ......................... (616,592) 0.09 - 17.69 Canceled .......................... (229,161) 4.92 - 35.13 ----------- ------------------ Options outstanding, March 31, 1996 ... 2,199,920 $0.09 - $41.75 ============ Of the options outstanding at March 31, 1996, 501,888 options are currently exercisable at prices ranging from $0.09 to $22.00 per share, and 1,770,873 options remain available for future grants. Employee Stock Purchase Plan The Company has reserved 200,000 shares of common stock for issuance under the Employee Stock Purchase Plan for officers and full-time employees with six months of service. Under the Plan, stock may be purchased at the completion of the semi-annual purchase periods at a price equal to 85% of the lowest fair market value of either the first or last day of the purchase period. During fiscal 1996, 8,019 shares of common stock was purchased under the Plan. The Board of Directors has approved the termination of the Plan effective June 30, 1996, subject to completion of the merger with CUC International Inc. New Accounting Standard In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards, Accounting for Stock-Based Compensation (SFAS 123), which will be effective for the Company beginning April 1, 1996. SFAS 123 requires expanded disclosures of stock-based compensation arrangements with employees and encourages (but does not require) compensation cost to be measured based on the fair value of the equity instrument awarded. Companies are permitted, however, to continue to apply APB Opinion No. 25, which recognizes compensation cost based on the intrinsic value of the equity instrument awarded. The Company will continue to apply APB Opinion No. 25 to its stock based compensation awards to employees and will disclose the required pro forma effect on net income and earnings per share. NOTE 9: COMMITMENTS AND CONTINGENCIES Lease Commitments The Company has entered into long-term lease obligations for certain office and warehouse facilities in addition to various leases for office equipment and company vehicles. These commitments expire at various times through fiscal 2003. The Company's expense for lease obligations for the years ended March 31, 1996, 1995 and 1994 were $2,774,000, $2,062,000, and $1,356,000, respectively. Future minimum annual lease payments on these obligations are as follows for the years ended March 31 (in thousands): Payments -------- 1997 .................................... $ 2,852 1998 .................................... 2,672 1999 .................................... 2,190 2000 .................................... 2,071 2001 .................................... 1,537 Thereafter .............................. 1,192 ---------- Total ................................ $ 12,514 ========== Contingencies The Company is a defendant in various lawsuits arising in the ordinary course of business. Management believes that losses to the Company from these lawsuits, if any, will not have a material adverse effect on its financial condition or results of operations. In fiscal 1995, the Company paid approximately $1.5 million in shareholder litigation costs in settlement of a securities class action lawsuit filed in December 1992. NOTE 10: SALE OF THE IMAGINATION NETWORK The operating activities of INN were consolidated with those of the Company through July 26, 1993. On July 27, 1993, the Company sold 42% of INN's voting stock and reduced its ownership interest to 58% and reduced its voting control such that the Company began recording INN operations utilizing the equity method. Upon sale of its 42% interest, the Company recorded its liquidation preference in excess of recorded book value as shareholders' equity. In December 1994, the Company sold its remaining equity interest in INN to AT&T and recorded a gain of $19,739,000. The Company also entered into a multi-year publishing agreement with AT&T to provide content for INN. The publishing agreement provides for AT&T to fund up to $4,000,000 of the Company's development expenditures under an existing publishing agreement and up to $23,000,000 of Sierra's development expenditures, subject to certain limitations, through non-refundable royalty advances. The non-refundable royalty advances are reflected net of research and development expense. A summary of gross research and development expense and non-refundable royalty advances for the years ended March 31, are as follows (in thousands): 1996 1995 --------- ------- Research and development expense $ 39,685 $23,552 Non-refundable royalty advances (3,786) (1,585) --------- ------- $ 35,899 $21,967 ========= ======= NOTE 11: RELATED PARTY TRANSACTIONS The Company pays royalties to certain independent developers, including a director of the Company. Royalty expense related to this director was approximately $1,294,000, $819,000, and $256,000 during the years ended March 31, 1996, 1995 and 1994, respectively. Royalties payable to the director at March 31, 1996 and 1995 were $10,000 and $633,000, respectively. From July 1993 through December 1994, the Company paid certain operating expenses on behalf of INN. Total amounts advanced under this arrangement totaled $456,000 and $3,271,000 during fiscal 1995 and fiscal 1994, respectively. In April 1994, the Company accepted an unsecured Promissory Note from INN for approximately $2,895,000. This amount was paid in full, including interest accrued at Bank of America's prime rate, in December 1994. The Company held certain notes receivable from officers of a subsidiary. Amounts receivable from those officers at March 31, 1995 was $792,000. Interest earned under these agreements was $12,000, $84,000, and $152,000 for the years ended March 31, 1996, 1995 and 1994, respectively. The notes were paid in full in May 1995. During fiscal years 1996, 1995 and 1994, the Company has reported distributions which represent dividends for undistributed S Corporation earnings to the shareholders of Pixellite and Papyrus. At March 31, 1996 and 1995, notes payable associated with these dividends approximated $2.0 million and $247,000, respectively. NOTE 12: GEOGRAPHIC INFORMATION The following schedule presents financial information of the Company classified by geographic area for the years ended March 31 (in thousands): United States Europe Eliminations Consolidated ----------- ----------- ------------ ------------ 1996 Sales to unaffiliated customers $ 119,014 $ 37,109 $ --- $ 156,123 =========== =========== =========== =========== Income from operations $ 17,914 $ 4,691 $ --- $ 22,605 =========== =========== =========== =========== Identifiable assets $ 161,788 $ 17,109 $ --- $ 178,897 =========== =========== =========== =========== 1995 Sales to unaffiliated customers $ 76,305 $ 19,516 $ --- $ 95,821 Intercompany transfers 880 --- (880) --- ----------- ----------- ----------- ----------- $ 77,185 $ 19,516 $ (880) $ 95,821 =========== =========== =========== =========== Income from operations $ 1,291 $ 1,910 $ --- $ 3,201 =========== =========== =========== =========== Identifiable assets $ 137,116 $ 8,238 $ --- $ 145,354 =========== =========== =========== =========== 1994 Sales to unaffiliated customers $ 61,606 $ 9,106 $ --- $ 70,712 Intercompany transfers 3,901 720 (4,621) --- ----------- ----------- ----------- ----------- $ 65,507 $ 9,826 $ (4,621) $ 70,712 =========== =========== =========== =========== Income (loss) from operations $ (4,962) $ 514 $ (88) $ (4,536) =========== =========== =========== =========== Identifiable assets $ 63,003 $ 5,902 $ --- $ 68,905 =========== =========== =========== =========== Intercompany transfers primarily represent shipments of finished goods inventory to international subsidiaries. The intercompany transfers are made at transfer prices which approximate prices charged to unaffiliated customers and have been eliminated from consolidated net sales. In the years ended March 31, 1996, 1995 and 1994, the majority of the Company's sales in Europe were conducted by Coktel, a French corporation, and Papyrus and Sierra U.K., both U.K. corporations. NOTE 13: QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) Summarized quarterly financial information for fiscal 1996 and fiscal 1995 is as follows (in thousands, except per share data): Primary Fully Net Diluted Net Income Net Income (Loss) Income Revenues (Loss) Per Share Per Share -------- ------ --------- --------- Quarter ended: June 30, 1995 $ 24,872 $ 852 $ 0.04 $ 0.04 September 30, 1995 34,522 3,609 0.17 0.15 December 31, 1995 63,220 12,284 0.58 0.55 March 31, 1996 35,563 (575) (0.03) (0.03) ---------- ---------- $ 158,177 $ 16,170 ========== ========== Quarter ended: June 30, 1994 $ 13,550 $ (4,304) $ (0.25) $ (0.25) September 30, 1994 20,966 (1,220) (0.07) (0.07) December 31, 1994(1) 41,213 17,796 0.97 0.83 March 31, 1995 22,150 720 0.05 0.05 ---------- ---------- $ 97,879 $ 12,992 ========== ========== - ---------- (1) Includes $19,739,000 gain on sale of the Company's 58% interest in The ImagiNation Network to AT&T. (a) 2. Davidson & Associates, Inc. Consolidated Financial Statements December 31, 1995 and 1994 With Independent Auditors' Report The Board of Directors Davidson & Associates, Inc.: We have audited the accompanying consolidated balance sheets of Davidson & Associates, Inc. and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of earnings, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Davidson & Associates, Inc. and subsidiaries as of December 31, 1995 and 1994 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Long Beach, California February 21, 1996 Consolidated Balance Sheets -- December 31, 1995 and 1994 Assets 1995 1994 --------------- --------------- Current assets: Cash and cash equivalents $ 3,117,000 3,858,000 Marketable investment securities 14,682,000 11,286,000 Accounts receivable: Trade, less allowance for doubtful receivables and returns of $10,363,000 for 1995 and $4,556,000 for 1994 36,637,000 23,937,000 Other 251,000 568,000 Inventories 11,792,000 7,444,000 Prepaid expenses and other current assets 1,340,000 1,528,000 Deferred tax assets 5,324,000 2,240,000 --------------- --------------- Total current assets 73,143,000 50,861,000 Net property and equipment, at cost 8,001,000 6,529,000 Intangible assets, net of accumulated amortization 2,029,000 2,438,000 Other assets 2,549,000 754,000 --------------- --------------- $ 85,722,000 60,582,000 --------------- --------------- Liabilities and Shareholders' Equity : Current liabilities Accounts payable $ 13,032,000 7,407,000 Accrued expenses 7,722,000 5,211,000 Deferred revenues 199,000 791,000 Income taxes payable 4,123,000 1,464,000 --------------- --------------- Total current liabilities 25,076,000 14,873,000 --------------- --------------- Minority interest 1,048,000 -- --------------- --------------- Shareholders' equity: Preferred stock, no par value. Authorized 1,000,000 shares; no shares issued and outstanding in 1995 and 1994 -- -- Common stock, $.00025 par value. Authorized 100,000,000 shares in 1995 and 60,000,000 shares in 1994; issued and outstanding 34,965,904 shares in 1995 and 34,868,504 shares in 1994 8,000 8,000 Additional paid-in capital 35,432,000 34,103,000 Retained earnings 24,158,000 11,840,000 Net unrealized loss on marketable investment securities -- (242,000) --------------- --------------- Net shareholders' equity 59,598,000 45,709,000 Contingencies --------------- --------------- $ 85,722,000 60,582,000 --------------- --------------- See accompanying notes to consolidated financial statements. Consolidated Statements of Earnings -- Three-year period ended December 31, 1995 1995 1994 1993 --------------- -------------- -------------- Net revenues $ 147,226,000 93,171,000 62,372,000 Cost of revenues 72,527,000 44,262,000 29,385,000 --------------- -------------- -------------- Gross profit 74,699,000 48,909,000 32,987,000 --------------- -------------- -------------- Operating costs and expenses: Research and development 19,745,000 10,419,000 3,547,000 Selling, general and administrative 33,861,000 23,224,000 18,654,000 Non-recurring expense (in-process research & development) -- 3,950,000 -- --------------- -------------- -------------- Total operating costs and expenses 53,606,000 37,593,000 22,201,000 --------------- -------------- -------------- Operating income 21,093,000 11,316,000 10,786,000 Other income (expense): Interest income, net 819,000 691,000 469,000 Other income (expense), net 1,000 83,000 (88,000) --------------- -------------- -------------- Earnings before income taxes 21,913,000 12,090,000 11,167,000 Income taxes 8,225,000 5,612,000 4,218,000 Earnings before minority interest 13,688,000 6,478,000 6,949,000 Minority interest in net earnings of subsidiary 111,000 -- -- --------------- -------------- -------------- Net earnings $ 13,577,000 6,478,000 6,949,000 --------------- -------------- -------------- Net earnings per share $ .38 .19 .21 --------------- -------------- -------------- Weighted average number of common shares and common share equivalents outstanding during year 35,768,000 34,986,000 33,599,000 --------------- -------------- -------------- Additional unaudited pro forma data (note 10) Earnings before income taxes $ 21,913,000 12,090,000 11,167,000 Less: Pro forma income tax expense 8,525,000 6,145,000 4,406,000 Less: Minority interest in net earnings of subsidiary 111,000 -- -- --------------- -------------- -------------- Pro forma net earnings $ 13,277,000 5,945,000 6,761,000 --------------- -------------- -------------- Pro forma net earnings per share $ .37 .17 .20 --------------- -------------- -------------- See accompanying notes to consolidated financial statements. Consolidated Statements of Shareholders' Equity -- Three-year period ended December 31, 1995 Unrealized gain (loss) Common Stock Additional Investment Net ---------------------- paid-in Retained Securities shareholders' Shares Amount capital earnings Valued at Market equity ------ ------ ------- -------- ---------------- ------ Balance at December 31, 1992 30,095,106 $ 7,000 4,772,000 233,000 -- 5,012,000 Proceeds from issuance of common stock, net of offering costs 4,380,000 1,000 25,581,000 -- -- 25,582,000 Net earnings -- -- -- 6,949,000 -- 6,949,000 Distributions to shareholders of pooled companies (note 2) -- -- -- (210,000) -- (210,000) ---------------------------------------------------------------------------------- Balance at December 31, 1993 34,475,106 8,000 30,353,000 6,972,000 -- 37,333,000 Issuance of stock in connection with acquisition of Learningways, Inc. 358,648 -- 3,586,000 -- -- 3,586,000 Exercise of stock options 34,750 -- 164,000 -- -- 164,000 Valuation of marketable investment securities to market -- -- -- -- (242,000) (242,000) Net earnings -- -- -- 6,478,000 -- 6,478,000 Distributions to shareholders of pooled companies (note 2) -- -- -- (1,610,000) -- (1,610,000) ---------------------------------------------------------------------------------- Balance at December 31, 1994 34,868,504 8,000 34,103,000 11,840,000 (242,000) 45,709,000 Exercise of stock options 97,400 -- 717,000 -- -- 717,000 Tax benefits arising from exercise of non-qualified stock options -- -- 437,000 -- -- 437,000 Net increase in unrealized gain -- -- -- -- 242,000 242,000 Net earnings -- -- -- 13,577,000 -- 13,577,000 Undistributed earnings of subchapter S subsidiaries -- -- 175,000 (175,000) -- -- Distributions to shareholders of pooled companies (note 2) -- -- -- (1,084,000) -- (1,084,000) ---------------------------------------------------------------------------------- Balance at December 31, 1995 34,965,904 $ 8,000 35,432,000 24,158,000 -- 59,598,000 ---------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements. Consolidated Statements of Cash Flows -- Three-year period ended December 31, 1995 1995 1994 1993 Cash flows from operating activities: Net earnings $ 13,577,000 6,478,000 6,949,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 2,428,000 1,329,000 1,223,000 Non-recurring expense: write-off of purchased in- process research & development (non-cash portion) -- 3,587,000 -- Proceeds from sales of capital equipment -- 19,000 -- Increase in allowance for doubtful receivables and returns 5,807,000 974,000 1,901,000 Changes in assets and liabilities, net of effects from acquisition of business: Accounts receivable (18,507,000) (13,119,000) (5,988,000) Other receivables 317,000 (140,000) (251,000) Inventories (4,348,000) (3,606,000) (345,000) Prepaid expenses and other current assets 188,000 (707,000) (584,000) Deferred tax assets (3,084,000) (444,000) (1,016,000) Other assets (1,795,000) (1,031,000) (102,000) Accounts payable 5,625,000 3,752,000 1,829,000 Accrued expenses 2,511,000 3,535,000 75,000 Income taxes payable 3,096,000 (46,000) 1,159,000 Deferred revenues (592,000) 23,000 384,000 Minority interest 111,000 -- -- ---------------------------------------------------- Total adjustments (8,243,000) (5,874,000) (1,715,000) ---------------------------------------------------- Net cash provided by operating activities 5,334,000 604,000 5,234,000 ---------------------------------------------------- Cash flows from investing activities: Marketable investment securities, net (3,154,000) 5,468,000 (16,996,000) Capital expenditures (3,491,000) (4,870,000) (1,070,000) Acquisition of business, net of cash acquired -- 60,000 -- ---------------------------------------------------- Net cash provided (used) by investing activities (6,645,000) 658,000 (18,066,000) ---------------------------------------------------- Cash flows from financing activities: Proceeds from issuance of common stock, net 717,000 164,000 25,582,000 Payment of distributions payable to shareholders -- -- (1,295,000) Payment of dividend notes to shareholders -- -- (10,458,000) Capital contribution from minority interest 937,000 -- -- Distribution of S corporation earnings to pooled companies (1,084,000) (1,610,000) (210,000) ---------------------------------------------------- Net cash provided (used) by financing activities 570,000 (1,446,000) 13,619,000 ---------------------------------------------------- Net increase in cash and cash equivalents (741,000) (184,000) 787,000 Cash and cash equivalents at beginning of year 3,858,000 4,042,000 3,255,000 ---------------------------------------------------- Cash and cash equivalents at end of year $ 3,117,000 3,858,000 4,042,000 ---------------------------------------------------- Supplementary disclosures of cash flow information: Cash paid during the year for: Income taxes $ 8,182,000 4,999,000 590,000 ---------------------------------------------------- See accompanying notes to consolidated financial statements. Notes to Consolidated Financial Statements -- December 31, 1995 and 1994 (1) Summary of Significant Accounting Principles Principles of Consolidation The consolidated financial statements include the accounts of Davidson & Associates, Inc. , its wholly owned subsidiaries, First Byte and Davidson & Associates Europe Limited, and its 75%-owned subsidiary, New Media Express L.L.C. (collectively the "Company"). All significant intercompany transactions and balances have been eliminated in consolidation. Cash and Cash Equivalents Cash and cash equivalents include commercial paper, money market funds and certificates of deposit having original maturities of three months or less. Marketable Investment Securities The Company adopted the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (Statement 115) at December 31, 1994. Under Statement 115, the Company classifies its marketable investment securities as available-for-sale. Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses, net of the tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of shareholders' equity until realized. Declines in the market value of available-for-sale securities deemed to be other than temporary result in charges to current earnings and establishment of a new cost basis. At December 31, 1995 and 1994 the Company's marketable investment securities consisted principally of highly liquid investments in tax-free municipal obligations with various maturity dates through 2010. As of December 31, 1995, the Company's aggregate investment securities had a cost basis of $14,670,000 and a fair market value of $14,671,000. Unrealized holding losses and unrealized holding gains were immaterial as of December 31, 1995. Accounts Receivable and Concentrations of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash, short-term investments, and accounts receivable. The Company has investment policies that limit investments to short-term investment grade securities. Accounts receivable are principally from distributors, retail chains, software specialty retail chains, computer superstores, school districts and individual schools. The Company performs periodic credit evaluations of its customers and maintains reserves, including reserves under the Company's stock balancing policy, which estimate the potential for future product returns. Allowance for returns at December 31, 1995 and 1994 was approximately $9,634,000 and $2,684,000, respectively. Such reserves have been included in allowance for doubtful receivables. Inventories Inventories are valued at the lower of cost (first-in, first-out) or market. Cost includes materials, labor and overhead for published software and acquisition cost for computer manuals and peripheral equipment. Property and Equipment Property and equipment are stated at cost. Depreciation is provided on furniture and equipment using the straight-line method over the estimated economic life of the assets, generally five years. Depreciation is provided on leasehold improvements using the straight-line method over the estimated economic life or the lease term, whichever is shorter. Intangible Assets Intangible assets primarily consist of goodwill and capitalized costs related to a non-competition agreement. Such assets are amortized on a straight-line basis over the expected periods to be benefited, generally five to twenty years. The Company assesses the recoverability of these intangible assets by determining whether the amortization of the balance over their remaining lives can be recovered by undiscounted future operating cash flows. Revenue Recognition The Company recognizes revenues as products are shipped, net of allowances for returns, provided that no significant vendor obligations remain and collection of the resulting receivable is deemed probable by management. Returns by the Company's publishing business customers aggregated $7,226,000, $4,229,000 and $1,773,000 in 1995, 1994 and 1993, respectively. The Company provides customer support as an accommodation to purchasers of its products for a limited time. Costs associated with such post-sale customer support were immaterial. Revenues from non-refundable license fees are recognized as income when earned. Revenue under royalty arrangements is recognized as unit sales are reported by the licensee. The Company also develops software for others under contracts calling for payment of development fees and ongoing royalties in certain circumstances. Development revenues are recognized as earned and the related costs under development contracts are recognized as incurred in the same period. Royalty Costs Royalties are accrued based on net revenues, pursuant to contractual agreements with authors of software products published by the Company. Royalty costs, which are included in cost of revenues, for each of the years in the three-year period ended December 31, 1995 were $14,748,000, $8,719,000, and $554,000 in 1995, 1994 and 1993, respectively. Research and Development Costs Research and development costs related to designing, developing and testing new software products are charged to expense as incurred. Investments in Joint Ventures The Company accounts for investments in joint ventures on the equity method of accounting when its ownership percentage is between 20% and 50%. The joint ventures had minimal operations during 1995 and 1994 and accordingly, the investments were immaterial to the accompanying consolidated financial statements. Income Taxes The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (Statement 109). Statement 109 requires that deferred income taxes be recognized for the tax consequences of "temporary differences." This is achieved by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. New Accounting Pronouncements The Financial Accounting Standards Board has issued Statement No. 123 which is effective for years commencing after December 15, 1995. The Company intends to apply the pro forma disclosure requirements of Statement No. 123 in its 1996 financial statements. Accordingly, the pro forma effect of stock options granted during the year ended December 31, 1995 has not yet been determined. Net Earnings per Share Net earnings per share is based on the weighted average number of common and common equivalent shares outstanding during each period, after retroactive adjustment for stock splits, plus the shares that would be outstanding assuming exercise of dilutive stock options, which are considered common stock equivalents. The number of shares that would be issued from the exercise of stock options has been reduced by the number of shares that could have been purchased from the proceeds at the current market price of the Company's common stock (see note 8). Following is an analysis of the components of the shares used to compute net earnings per share in 1995, 1994 and 1993: 1995 1994 1993 ----------------------------------------------- Weighted average shares outstanding during the period* 33,659,000 33,408,000 32,119,000 Incremental shares issued in connection with mergers accounted for as poolings of interest (note 2) 1,274,000 1,274,000 1,274,000 Incremental shares issuable under stock option plans 835,000 304,000 206,000 ----------------------------------------------- Number of shares used in the computation of net earnings per share 35,768,000 34,986,000 33,599,000 ----------------------------------------------- *All share data has been adjusted retroactively to reflect the 2-for-1 stock split effected on September 6, 1995. Reclassifications Certain 1994 and 1993 accounts have been reclassified to be consistent with 1995. The effect of the reclassifications was not material to the accompanying financial statements. (2) Acquisitions On November 21, 1995, the Company acquired all of the outstanding shares of Maverick Software, Inc. by issuing 223,476 shares of its common stock. On March 1, 1995, the Company acquired all of the outstanding shares of The Cute Company, which subsequently changed its name to FUNNYBONE Interactive, by issuing 423,076 shares of its common stock. Both mergers were accounted for as poolings of interests. Maverick Software, Inc. and FUNNYBONE Interactive are now operated as divisions of the Company. All financial information included in the accompanying consolidated financial statements has been restated to include the operating results of FUNNYBONE Interactive and Maverick Software, Inc. A summary of the impact of these poolings on operations for 1994 and 1993, as previously reported, is as follows: As Previously Effect of Pooled Restated Reported Companies for Poolings --------------------------------------------------- 1994: Net revenues $ 87,914,000 5,257,000 93,171,000 Earnings before income taxes 10,756,000 1,334,000 12,090,000 Net earnings 5,144,000 1,334,000 6,478,000 Pro forma net earnings 5,144,000 801,000 5,945,000 As Previously Effect of Pooled Restated Reported Companies for Poolings --------------------------------------------------- 1993: Net revenues $ 59,078,000 3,294,000 62,372,000 Earnings before income taxes 10,696,000 471,000 11,167,000 Net earnings 6,478,000 471,000 6,949,000 Pro forma net earnings 6,478,000 283,000 6,761,000 On June 1, 1994, the Company acquired all of the outstanding shares of Learningways, Inc. ("Learningways") for cash of approximately $664,000 and 358,648 shares of the Company's common stock. Total consideration was valued at $4,225,000. The acquisition was accounted for as a purchase. In connection with this acquisition, the Company expensed certain in-process research and development for technology in process of approximately $3.9 million which was recorded as a non-recurring expense in the accompanying 1994 consolidated statement of earnings. The results of operations of Learningways have been included in the Company's consolidated financial statements since the date of acquisition. Had the acquisition occurred at the beginning of 1994, the impact on the Company's reported results of operations would not have been material. Learningways is now operated as a division of the Company. On February 18, 1994, the Company acquired all of the outstanding shares of Chaos Studios, Inc., which subsequently changed its name to Blizzard Entertainment, by issuing 626,980 shares of its common stock. The merger was accounted for as a pooling of interests. All financial information included in the accompanying consolidated financial statements has been restated to include Blizzard's operating results. Blizzard Entertainment is now operated as a division of the Company. In May, 1992, the Company acquired Educational Resources Ltd. (Educational Resources). The acquisition was accounted for as a purchase. The Company issued 2,400,000 shares of its common stock for all of the outstanding common stock of Educational Resources. The value of the consideration given exceeded the fair value of the net assets of Educational Resources, resulting in goodwill totaling $1,387,000. Educational Resources is now operated as a division of the Company. In connection with the acquisition of Educational Resources, the Company entered into employment and non-competition agreements with the former sole stockholder and with an officer of Educational Resources. The non-competition agreements required the immediate payment of an aggregate $1,500,000 by the Company to the sole stockholder and to an officer of Educational Resources for agreements not to compete with the Company for a five-year period. Intangible assets arising from the above transactions at December 31, 1995 and 1994 consist of the following: 1995 1994 ---------------------------------- Goodwill $ 1,936,000 1,936,000 Covenant not to compete 1,650,000 1,650,000 Other intangible assets 364,000 364,000 Less accumulated amortization (1,921,000) (1,512,000) ---------------------------------- $ 2,029,000 2,438,000 ---------------------------------- (3) Inventories Inventories at December 31, 1995 and 1994 consist of the following: 1995 1994 --------------------------------- Raw materials $ 2,611,000 2,051,000 Finished goods 9,181,000 5,393,000 --------------------------------- $ 11,792,000 7,444,000 --------------------------------- (4) Property and Equipment Property and equipment at December 31, 1995 and 1994 consist of the following: 1995 1994 --------------------------------- Furniture and equipment $ 10,669,000 7,363,000 Leasehold improvements 2,628,000 2,280,000 --------------------------------- 13,297,000 9,643,000 Less accumulated depreciation and amortization (5,296,000) (3,114,000) --------------------------------- $ 8,001,000 6,529,000 --------------------------------- (5) Other Assets In 1995, the Company made a $2,000,000 investment in IVI Publishing, Inc. In exchange, the Company received 2,000 shares of six percent, preferred stock which are convertible into the investee's common shares at $11.21 per share, representing less than 3% of the investee's common shares outstanding at the time of the Company's investment. In addition, the Company received 12,500 common share warrants to purchase shares of the investee's common stock at $11.21 per share. The Company has recorded this investment under the cost method and has included the investment in other assets in the accompanying consolidated balance sheet. (6) Line of Credit The Company has an unsecured working capital line of credit agreement with a bank (the Agreement). The Agreement expires in April 1996 and provides for total advances up to $1,000,000 bearing interest at the bank's prime rate. As of December 31, 1995, there were no borrowings under the agreement. (7) Accrued Expenses Accrued expenses at December 31, 1995 and 1994 consist of the following: 1995 1994 --------------------------------- Due to affiliated label companies $ 675,000 1,709,000 Accrued royalties 1,488,000 225,000 Accrued payroll and related expenses 2,033,000 977,000 Other 3,526,000 2,300,000 --------------------------------- $ 7,722,000 5,211,000 --------------------------------- (8) Shareholders' Equity Common Stock On September 6, 1995, the Company effected a 2-for-1 stock split. Concurrently, the par value of the common stock was decreased to $.00025 from $.0005. The accompanying consolidated financial statements and related notes have been retroactively adjusted to reflect this stock split and the change in par value. In April 1995, the Board of Directors and the Company's shareholders approved an increase in the number of authorized shares of common stock from 60,000,000 to 100,000,000. During 1995, the Company issued 423,076 shares and 223,476 shares in connection with its acquisitions of FUNNYBONE Interactive and Maverick Software, Inc., respectively. Since both acquisitions were accounted for as poolings of interests, the accompanying consolidated financial statements and related notes have been retroactively adjusted for such shares issued in connection with the acquisitions. At the time of the mergers, both FUNNYBONE Interactive and Maverick Software, Inc. (the Acquirees) were "S corporations." During 1995, the Acquirees' undistributed earnings under S corporation status have been reclassified to additional paid-in capital in the consolidated financial statements. Distributions to the Acquirees' shareholders, amounting to $1,084,000, $1,610,000 and $210,000 for the years ended December 31, 1995, 1994 and 1993, respectively, have been charged to retained earnings. During 1994, the Company issued 626,980 shares and 358,648 shares in connection with its acquisition of Chaos Studios, Inc. (Chaos) and Learningways, Inc., respectively. Since the acquisition of Chaos was accounted for as a pooling of interests, the accompanying consolidated financial statements and related notes have been retroactively adjusted for such shares issued in connection with the acquisition. On March 31, 1993, the Company issued 4,380,000 shares of common stock, at $6.50 a share in an initial public offering. The proceeds to the Company aggregated $25,581,000, net of underwriting discount and direct expenses. Preferred Stock The Company is authorized to issue up to 1,000,000 shares of a series of no par value preferred stock. As of December 31, 1995, no shares of preferred stock had been issued by the Company. Stock Option Plans The Company has the following stock option plans: (i) Davidson & Associates, Inc. 1992 Incentive Stock Option Plan, (ii) Davidson & Associates, Inc. 1992 Nonstatutory Stock Option Plan and (iii) Davidson & Associates, Inc. 1992 Stock Purchase Plan (collectively, the Plans). The Plans provide for the grant of options to purchase the Company's common stock to officers, directors and consultants or independent contractors of the Company, or of any subsidiary of the Company. Only employees may be granted options under the Davidson & Associates, Inc. 1992 Incentive Stock Option Plan. The exercise price of the incentive stock options shall not be less than the fair market value of the Company's stock on the date of grant. The exercise price of the options under other plans are at the discretion of the Board of Directors. The Plans provide that the options are exercisable upon vesting schedules, as determined by the Board of Directors and are exercisable no later than ten years from the date of grant. Options issued under the Plans generally vest ratably over a five-year period. The Plans expire December 31, 2002. The Board of Directors has set aside 3,000,000 shares of the Company's common stock for issuance under the plans. The stock option activity for the Plans follows: Number of shares Price per share Balance at December 31, 1992 518,000 $ 4.75 Options granted 70,000 5.50 Options terminated (39,000) 4.75 Options exercised -- -- --------------------------- Balance at December 31, 1993 549,000 $ 4.75-5.50 Options granted 720,000 7.5-11.75 Options terminated (29,200) 4.75-10.75 Options exercised (34,750) 4.75 --------------------------- Balance at December 31, 1994 1,205,050 $ 4.75-11.75 Options granted 905,000 10.88-27.25 Options terminated (97,200) 4.75-10.75 Options exercised (97,400) 4.75-10.88 --------------------------- Balance at December 31, 1995 1,915,450 $ 4.75-27.25 --------------------------- At December 31, 1995, 420,360 of the above options were exercisable at $4.75 to $13.88 per share, and 952,400 options were available for grant. (9) License, Royalty and Development Revenues The Company has certain license and royalty agreements with manufacturers of personal computers, multimedia components, integrated circuits, telecommunications products, hand-held electronic products and certain software publishers to license its First Byte "text-to-speech" technology. Certain agreements provide for an up-front non-refundable license fee upon signing of the agreement. Revenue under such arrangements is recognized upon the delivery of the related software and documentation. Additionally, the agreements typically provide for continuing royalties on unit sales by the licensee which may be partially prepaid by the licensee. The royalty fees under these agreements are either based on unit sales or a fixed annual fee and are recognized as unit sales are reported by the licensee. Royalties received in advance are deferred until shipments are reported by licensees. License fees and royalty revenues earned for 1995, 1994 and 1993 were $1,530,000, $2,475,000 and $2,032,000, respectively. Additionally, the Company develops software for others under contracts calling for payment of development fees and ongoing royalties in certain circumstances. Development revenues aggregated $7,716,000 and $3,344,000 in 1995 and 1994, respectively, and were nominal in 1993. Costs incurred under development contracts are included in research and development in the accompanying consolidated financial statements. (10) Income Taxes The provisions for income taxes consist of the following for each respective year: 1995 1994 1993 --------------------------------------------------- Income taxes Federal: Current $ 8,503,000 4,755,000 4,117,000 Deferred (2,438,000) (352,000) (841,000) ---------------------------------------------------- Total Federal 6,065,000 4,403,000 3,276,000 ---------------------------------------------------- State: Current 2,806,000 1,301,000 1,116,000 Deferred (646,000) (92,000) (174,000) ---------------------------------------------------- Total state 2,160,000 1,209,000 942,000 ---------------------------------------------------- Total income taxes 8,225,000 5,612,000 4,218,000 Incremental pro forma tax expense related to pooled "S corporations" 300,000 533,000 188,000 ---------------------------------------------------- Pro forma tax expense $ 8,525,000 6,145,000 4,406,000 ---------------------------------------------------- Income tax expense differs from the statutory tax rate of 35% (34% for 1993) as applied to earnings before income taxes as follows: 1995 1994 1993 ---------------------------------------------------- Expected income tax expense $ 7,670,000 4,231,000 3,797,000 Technology under development at Learningways. Recorded as an expense for financial reporting purposes not deductible for tax purposes. -- 1,381,000 -- State income taxes, net of Federal benefit 1,404,000 785,000 622,000 Federal environmental taxes -- 16,000 -- Earnings of pooled companies under S corporation status not subject to corporate tax (262,000) (466,000) (160,000) Tax-exempt interest (279,000) (233,000) (175,000) Research and experimentation credits (594,000) (219,000) (194,000) Other, principally non-deductible amortization of goodwill 286,000 117,000 328,000 -------------------------------------------- $ 8,225,000 5,612,000 4,218,000 ---------------------------------------------------- Prior to their acquisition during 1995, Maverick Software, Inc. and FUNNYBONE Interactive elected to be taxed as S corporations whereby the income tax effects of their activities accrued directly to their shareholders. Maverick and FUNNYBONE Interactive terminated their S corporation election on their respective dates of acquisition. The consolidated statements of operations include a pro forma presentation for income taxes which would have been recorded if Maverick and FUNNYBONE Interactive had been C corporations for all periods presented. The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 1995 and 1994 are presented below: 1995 1994 -------------------------------- Allowance for doubtful accounts and reserve for returns $ 4,290,000 1,510,000 Inventories 556,000 120,000 Accrued expenses 337,000 480,000 Deferred revenues 249,000 323,000 -------------------------------- Deferred tax assets 5,432,000 2,433,000 Deferred tax liability - accelerated depreciation and amortization (108,000) (193,000) -------------------------------- Net deferred tax assets $ 5,324,000 2,240,000 -------------------------------- In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based on the level of historical taxable income and projections of future taxable income over the periods in which the deferred tax assets are deductible, as of December 31, 1995 management believes it is more likely than not the Company will realize the benefits of these deductible differences. Accordingly, no valuation allowance has been provided against deferred tax assets for any period presented. (11) Commitments The Company's corporate offices are leased from the Company's principal shareholders. The corporate offices lease is renewable at a rental amount mutually agreed upon by the Company and the shareholders. The minimum rental commitments under all leases are as follows: Year ending Related December 31: Parties Other ------------------------------------------------------------------ 1996 $ 649,000 1,153,000 1997 536,000 973,000 1998 424,000 580,000 1999 424,000 418,000 2000 424,000 175,000 Thereafter 566,000 -- -------------------------------- $ 3,032,000 3,299,000 -------------------------------- Total rent expense aggregated $1,648,000, $1,157,000, and $937,000 in 1995, 1994 and 1993, respectively. Total rent expense paid to related parties aggregated $649,000, $713,000, and $756,000 in 1995, 1994 and 1993, respectively. (12) 401(k) Plan The Company's 401(k) plan covers eligible employees who elect to participate and the Company has the discretion to make contributions to the plan. Company contributions vest based on length of service and were $372,000, $264,000 and $168,000 in 1995, 1994 and 1993, respectively. (13) Significant Customers The Company has a significant customer that comprised 7% and 18% of total trade accounts receivable at December 31, 1995 and 1994, respectively. Two other customers comprised 24% of total trade accounts receivable at December 31, 1995 and had immaterial balances at December 31, 1994. These two customers constituted over 15% of net revenues during 1995. There were no customers constituting over 10% of net revenues during 1994 and 1993. (14) Supplemental Disclosure of Non-Cash Financing and Investing Activities On June 1, 1994, the Company acquired Learningways, Inc. (Learningways) by exchanging 358,648 shares of its common stock and $664,000 cash for all of the common stock of Learningways. In connection with the acquisition, liabilities were assumed as follows: Fair value of assets acquired $ 622,000 In-process research and development, written off as non-recurring expense 3,950,000 Value of common stock issued (3,561,000) Cash paid (664,000) --------------- Liabilities assumed $ 347,000 --------------- (15) Contingencies The Company is involved from time to time in litigation incidental to its business. The management of the Company believes that none of its litigation individually or in the aggregate will have a material adverse effect on the Company's financial position. (16) Subsequent Events On February 20, 1996, the Company entered into an agreement to merge with CUC International, Inc. Under the terms of the agreement, Company shareholders receive .85 shares of CUC stock for each share of Company stock. The merger will be structured as a tax-free reorganization and accounted for as a pooling of interests. The merger is subject to regulatory approval. On February 26, 1996, the Company acquired Condor, Inc., a developer of entertainment software. The acquisition was financed through the issuance of 225,409 shares of common stock for all of the outstanding shares of Condor, Inc. The acquisition will be accounted under the pooling-of-interests method. Pro forma results of operations for 1995 are not presented, as the impact of this pooling of interests is not material. (17) Quarterly Financial Data (Unaudited) The following selected quarterly financial data for the years ended December 31, 1995 and 1994 has been restated to reflect the poolings of Blizzard Entertainment (formerly Chaos Studios, Inc.), FUNNYBONE Interactive and Maverick Software, Inc.: First Second Third Fourth quarter quarter quarter quarter --------------------------------------------------------------------- 1995: Net revenues $ 25,552,000 37,388,000 37,349,000 46,937,000 Gross profit 13,568,000 15,955,000 20,133,000 25,043,000 Net earnings 1,237,000 1,758,000 4,547,000 6,035,000 Net earnings per share .03 .05 .13 .17 Pro forma net earnings 1,162,000 1,683,000 4,472,000 5,960,000 Pro forma net earnings per share .03 .05 .12 .17 --------------------------------------------------------------------- First Second Third Fourth quarter quarter quarter quarter 1994: Net revenues $ 14,684,000 18,934,000 23,517,000 36,036,000 Gross profit 8,021,000 9,228,000 13,298,000 18,362,000 Net earnings (loss) 1,082,000 (2,410,000) 3,747,000 4,059,000 Net earnings (loss) per share .03 (.07) .11 .11 Pro forma net earnings 949,000 (2,543,000) 3,614,000 3,925,000 Pro forma net earnings per share .03 (.07) .10 .11 --------------------------------------------------------------------- (a) 3. Ideon Group, Inc. Consolidated Financial Statements December 31, 1995 and 1994 With Independent Auditors' Report REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Ideon Group, Inc. In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Ideon Group, Inc. (formerly known as SafeCard Services, Incorporated), and its subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for the year ended December 31, 1995, the two months ended December 31, 1994, and each of the two years in the period ended October 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As discussed in Note 1, the Company changed the amortization periods for deferred subscriber acquisition costs effective December 31, 1994. PRICE WATERHOUSE LLP Tampa, Florida February 2, 1996 Ideon Group, Inc. Consolidated Balance Sheet (in thousands, except share data) December 31, 1995 1994 ----------- ----------- Assets Current assets: Cash and cash equivalents $ 25,071 $ 9,315 Securities available for sale maturing within one year 33,741 43,532 Receivables, net 71,953 58,337 Income taxes receivable 16,153 11,441 Deferred subscriber acquisition costs and related commissions amortizing within one year 91,150 85,435 Deferred income tax asset 3,370 995 Other current assets 3,228 3,262 ----------- ----------- Total current assets 244,666 212,317 Securities available for sale maturing after one year 13,328 116,134 Deferred subscriber acquisition costs and related commissions amortizing after one year 40,403 46,482 Property and equipment, net 32,389 23,381 Excess of cost over fair value of net assets acquired 45,002 28,451 Deferred income tax asset, noncurrent 5,223 Other assets 4,899 1,949 ----------- ----------- Total assets $ 385,910 $ 428,714 =========== =========== Liabilities Current liabilities: Notes payable to bank $ 15,414 $ 12,083 Accounts payable 32,523 33,037 Accrued expenses 35,165 30,535 Product abandonment and related liabilities 20,796 Subscribers' advance payments amortizing within one year 119,805 117,203 Allowance for cancellations 9,548 9,197 ----------- ----------- Total current liabilities 233,251 202,055 Subscriber advance payments amortizing after one year 49,799 54,862 Deferred income tax liability 4,991 ----------- ----------- Total liabilities 283,050 261,908 ----------- ----------- Commitments and Contingencies (Note 16) Stockholders' Equity Preferred stock--authorized 10,000,000 shares ($.01 par value); no shares issued or outstanding Common stock--authorized 90,000,000 shares ($.01 par value); 34,946,000 shares issued (34,946,000 at December 31, 1994); 27,981,831 shares outstanding (28,933,599 at December 31, 1994) 349 349 Additional paid-in capital 41,230 41,058 Retained earnings 118,999 174,066 Unrealized gain on securities available for sale 345 ----------- 160,923 215,473 Less cost of 6,964,169 common shares in treasury (6,012,401 shares at December 31, 1994) (58,063) (48,667) ----------- ----------- Total stockholders' equity 102,860 166,806 ----------- ----------- Total liabilities and stockholders' equity $ 385,910 $ 428,714 =========== =========== The accompanying notes are an integral part of these consolidated financial statements. Ideon Group, Inc. Consolidated Statement of Operations (in thousands, except per share data) Two Months Year Ended Ended Year Ended December 31, December 31, October 31, 1995 1994 1994 1993 ---- ---- ---- ---- Revenues Membership and subscription revenue, net $ 176,951 $ 28,579 $ 162,591 $ 146,173 Card acquisition and services revenue 23,332 2,915 2,107 Consumer marketing revenue 26,337 1,796 10,843 10,427 Interest income 5,690 1,394 8,421 8,736 Other income 1,658 14 5,124 1,790 ------------- ------------ ------------ ------------ 233,968 34,698 189,086 167,126 ------------- ------------ ------------ ------------ Costs and expenses Subscriber acquisition costs and related commissions 112,632 14,967 98,150 87,852 Other costs of revenue 22,837 4,475 8,353 7,396 Research and product development costs 7,043 8,163 7,682 Service costs and other operating expenses 38,351 10,063 26,351 16,891 General and administrative expenses 33,318 5,606 16,451 12,542 Costs related to products abandoned and restructuring 97,029 7,900 Unrealized loss on securities available for sale 1,943 Effect of change in amortization periods for deferred subscriber acquisition costs 65,500 311,210 110,717 164,887 124,681 ------------- ------------ ------------ ------------ Income (loss) before income taxes (77,242) (76,019) 24,199 42,445 Provision for (benefit from) income taxes (27,801) (26,075) 6,178 10,968 ------------- ------------ ------------ ------------ Income (loss) before cumulative effect of change in accounting for income taxes (49,441) (49,944) 18,021 31,477 Cumulative effect of change in accounting for income taxes 2,000 Net income (loss) $ (49,441) $ (49,944) $ 20,021 $ 31,477 ============= ============ ============ ============ Earnings per share: Income (loss) before cumulative effect of accounting change $ (1.73) $ (1.70) $ .63 $ 1.10 Cumulative effect of accounting change .07 -------------- ------------- ------------ ------------ Net income (loss) $ (1.73) $ (1.70) $ .70 $ 1.10 ============= ============ ============ ============ Weighted average number of common and common equivalent shares 28,500 29,297 28,411 28,572 The accompanying notes are an integral part of these consolidated financial statements. Ideon Group, Inc. Consolidated Statement of Changes In Stockholders' Equity (in thousands, except share data) Unrealized Gain (Loss) on Common Stock Common Stock Additional Securities in Treasury Total ------------------ Paid-in Retained Available ------------------------ Stockholders' Shares Amount Capital Earnings for Sale Shares Amount Equity ---------- ------ --------- ---------- ------------ ----------- ----------- ---------- Balance at October 31, 1992 33,426,048 $ 334 $ 9,625 $ 194,534 (6,780,015) $ (38,995) $ 165,498 Net earnings 31,477 31,477 Cash dividends paid, $.20 per share (5,113) (5,113) Exercise of employee stock options 769,952 8 4,213 172,059 1,159 5,380 Tax benefit from exercise of employee stock options 2,152 2,152 Purchase of treasury stock (3,469,860) (41,699) (41,699) ---------- ----- --------- ---------- ------ ---------- ---------- ---------- Balance at October 31, 1993 34,196,000 342 15,990 220,898 (10,077,816) ( 79,535) 157,695 Net earnings 20,021 20,021 Cash dividends paid, $.20 per share (5,320) (5,320) Exercise of employee stock options 750,000 7 3,440 (10,140) 4,090,165 31,351 24,658 Tax benefit from exercise of employee stock options 21,628 21,628 Issuance of restricted common stock 11,950 Change in unrealized gain (loss) on securities available for sale $ (607) (607) Purchase of treasury stock (36,700) (483) (483) ---------- ----- --------- ---------- ------ ---------- ---------- ---------- Balance at October 31, 1994 34,946,000 349 41,058 225,459 (607) (6,012,401) (48,667) 217,592 Net loss (49,944) (49,944) Cash dividends paid, $.05 per share (1,449) (1,449) Change in unrealized gain (loss) on securities available for sale 607 607 ---------- ----- --------- ---------- ------ ---------- ---------- ---------- Balance at December 31, 1994 34,946,000 349 41,058 174,066 (6,012,401) (48,667) 166,806 Net loss (49,441) (49,441) Cash dividends paid, $.20 per share (5,626) (5,626) Exercise of employee stock options 51 49,832 405 456 Tax benefit from exercise of employee stock options 121 121 Issuance of restricted common stock 3,500 Change in unrealized gain (loss) on securities available for sale 345 345 Purchase of treasury stock (1,005,100) (9,801) (9,801) ---------- ----- --------- ---------- ------ ---------- ---------- ---------- Balance at December 31, 1995 34,946,000 $ 349 $ 41,230 $ 118,999 $ 345 (6,964,169) $ (58,063) $ 102,860 ========== ===== ========= ========== ====== ========== ========== ========== The accompanying notes are an integral part of these consolidated financial statements. Ideon Group, Inc. Consolidated Statement of Cash Flows (in thousands) Two Months Year Ended Ended Year Ended December 31, December 31, October 31, 1995 1994 1994 1993 ---- ---- ---- ---- Cash Flows From Operating Activities Net cash received from subscribers/customers $ 238,835 $ 31,070 $ 194,584 $ 175,596 Cash paid to suppliers and employees (311,971) (38,763) (168,831) (139,290) Interest received 7,857 3,094 13,922 13,952 Interest paid (1,287) (146) Income tax refunds (payments), net 11,047 (7) 3,114 (21,413) Gain from litigation settlements 4,257 ------------ ------------ ------------ ----------- Net cash (used in) provided by operating activities (55,519) (4,752) 47,046 28,845 ------------ ------------ ------------ ----------- Cash Flows From Investing Activities Purchases of investment securities (52,961) (12,752) (96,986) (63,174) Proceeds from sales of investment securities 135,111 17,463 73,748 64,539 Proceeds from maturing investment securities 30,185 18,035 7,068 Cost of acquisitions, net of cash acquired (12,977) (35,276) Acquisition of property and equipment, net (16,443) (7,406) (8,044) (719) ------------ ------------ ------------ ------------ Net cash provided by (used in) investing activities 82,915 (2,695) (48,523) 7,714 ------------ ------------ ------------ ------------ Cash Flows From Financing Activities Net borrowings (repayments) on notes payable to bank 3,331 290 (2,792) Proceeds from exercise of stock options 456 24,658 5,380 Dividends paid (5,626) (1,449) (5,320) (5,113) Payments for purchase of treasury shares (9,801) (483) (41,699) ------------ ------------ ------------ ------------ Net cash (used in) provided by financing activities (11,640) (1,159) 16,063 (41,432) ------------ ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents 15,756 (8,606) 14,586 (4,873) Cash and cash equivalents at beginning of period 9,315 17,921 3,335 8,208 ------------ ------------ ------------ ------------ Cash and cash equivalents at end of period $ 25,071 $ 9,315 $ 17,921 $ 3,335 ============ ============ ============ ============ The accompanying notes are an integral part of these consolidated financial statements. Ideon Group, Inc. Notes to Consolidated Financial Statements 1. Summary of Significant Accounting Policies On April 27, 1995, the stockholders of SafeCard Services, Incorporated ("SafeCard") approved a plan of reorganization whereby SafeCard became a wholly-owned subsidiary of Ideon Group, Inc. ("Ideon" or the "Company"), a newly formed Delaware corporation. All shares of SafeCard common stock were converted into shares of Ideon common stock. Ideon is a holding company with current business units as follows: SafeCard, Wright Express Corporation, National Leisure Group, Inc. and Ideon Marketing and Services Company. The operations of an additional business unit, Family Protection Network, Inc., have been discontinued as described in Note 10 Costs Related to Products Abandoned and Restructuring. SafeCard, the Company's principal operating subsidiary, is a credit card enhancement marketing company. Subscriptions for continuity services are primarily marketed through credit card issuers by mail or telephone. SafeCard's principal service is credit card registration and loss notification ("Hot-Line"), whereby SafeCard gives prompt notice to credit card issuers upon being informed that a subscriber's credit cards have been lost or stolen. Subscriptions for continuity services typically continue annually or periodically unless canceled by the subscriber. SafeCard also markets other continuity services including those related to fee-based credit cards ("Fee Card"), date reminder services, a personal credit information service ("CreditLine"). SafeCard is also developing new lines of business including travel and shopping related products. Wright Express Corporation ("Wright Express"), acquired in September 1994, provides transaction and information processing services to oil companies and commercial transportation fleets primarily through a national credit card network program, the Wright Express Universal Fleet card (the "WEX card") and through private label processing arrangements for retail fuel marketers. National Leisure Group, Inc. ("National Leisure Group"), acquired in January 1995, provides vacation travel packages and cruises directly to the public in partnership with established retailers and warehouse clubs throughout New England and with credit card issuers and membership clubs nationwide. Ideon Marketing and Services Company ("IMS") manages an initiative between the Company, the PGA TOUR and SunTrust BankCard, N.A. to develop and market an expanded PGA TOUR Partners program, including a co-branded credit card. The activities of IMS have been significantly curtailed due to lower than expected response rates to the expanded PGA TOUR Partners program and related credit card offering during 1995 (see Note 10 - Costs Related to Products Abandoned and Restructuring). On February 14, 1995, the Company filed a Transition Period Form 10-Q for the two months ended December 31, 1994 in order to effect a change in its year end from October 31 to December 31. References herein to the year 1995 refer to the Company's calendar year ended December 31, 1995. References herein to the Transition Period refer to the two months ended December 31, 1994. References herein to the years 1994 and 1993 refer to the Company's previous fiscal years ended October 31. Principles of Consolidation The consolidated financial statements include the accounts of Ideon and its subsidiaries, after elimination of intercompany accounts and transactions. On September 14, 1994, the Company acquired 100% of the outstanding common stock of Wright Express. Effective January 1, 1995, the Company acquired substantially all of the assets and assumed substantially all of the liabilities of National Leisure Group. These transactions were accounted for under the purchase method and accordingly the consolidated financial statements include the results of operations of Wright Express and National Leisure Group from the respective dates of purchase (see Note 3 Acquisitions). Cash and Cash Equivalents Cash and cash equivalents include cash-on-hand, demand deposits and short-term investments with original maturities of three months or less. Securities Available for Sale In May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, ("FAS 115") "Accounting for Certain Investments in Debt and Equity Securities." FAS 115 requires that all investments in debt and equity securities that fall within its scope be classified as either held to maturity, trading or available for sale. Management elected early adoption of FAS 115 as of October 31, 1994 and classified its entire securities portfolio as "available for sale" at that time. Securities classified as available for sale are stated at market value with any unrealized gains or losses included as a separate component of stockholders' equity. Approximately $11,600,000 of securities available for sale at December 31, 1995 were held in escrow as required contractually by certain credit card issuers (see "Revenue Recognition/Cost Amortization"). Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Maintenance and repairs are charged to expense while betterments are capitalized. Depreciation is computed using the straight-line method over the assets' estimated useful lives. Estimated useful lives range from 3 to 7 years for equipment, furniture and fixtures to 30 years for buildings. Capitalized leasehold improvements are amortized over the lesser of the estimated useful life of the asset or the lease term. Excess of Cost Over Fair Value of Net Assets Acquired Excess of cost over fair value of net assets acquired ("goodwill") represents the difference between the purchase price of Wright Express and National Leisure Group and the value of the net assets acquired in each of the acquisitions (see Note 3 Acquisitions). Such goodwill is being amortized on a straight-line basis over 25 years. Accumulated amortization was $2,216,000 and $440,000 as of December 31, 1995 and 1994, respectively. Periodically, the Company reviews its intangible assets for events or changes in circumstances that may indicate that the carrying amounts of the assets are not recoverable. Based upon this review, the Company believes that the unamortized balance of goodwill at December 31, 1995 is fully recoverable. Revenue Recognition/Cost Amortization Subscription Revenue and Commission Expense The Company generally receives advance payments from subscribers for its products and services. The subscription period and advance payments are generally for periods of 12 or 36 months. These advance payments, less an appropriate allowance for cancellations, are deferred and amortized to revenue ratably over the subscription period. Credit card issuers earn commissions based on percentages of subscription billings or other profit sharing arrangements. Such commissions, less an appropriate allowance for cancellations, are also deferred and amortized to expense ratably over the subscription period. The allowance for cancellations, net of related commissions, relates to amounts which may be refunded at a future time to subscribers who may cancel their subscriptions prior to the completion of the subscription period. Previously paid commissions related to canceled subscriptions are reimbursed to the Company by the credit card issuer. The Company places funds in escrow as required contractually by certain credit card issuer clients. The contractual requirement as of December 31, 1995 was approximately $11,600,000. Restricted funds are released ratably over the subscription period (which coincides with the period of revenue recognition) and are invested primarily in tax-exempt municipal securities and United States Treasury securities. Card Acquisition and Services Revenue Card acquisition and services revenue is principally in the form of transaction fees deducted from amounts remitted to retail fueling merchants and monthly fees charged to fleet customers of Wright Express. Consumer Marketing Revenue Revenue from the sale of vacation packages by National Leisure Group, which is included in the "Consumer marketing revenue" caption in the consolidated statement of operations, is recognized at the date when substantially all obligations to the customer have been performed and at least 90 percent of the total booking price has been received (see Note 3 - Acquisitions). Consumer marketing revenue also includes revenues from SafeCard's date reminder service which is amortized over each calendar year. Subscriber Acquisition Costs Subscriber acquisition expenditures directly relate to the acquisition of new subscribers through "direct-response" type marketing campaigns and primarily include payments for telemarketing, printing, postage, mailing services, certain direct salaries and other direct costs incurred to acquire new subscribers. Prior to December 31, 1994, these expenditures were deferred and amortized to expense in proportion to expected revenues over the expected subscription periods, including renewal periods (life of subscriber). These amortization periods ranged from 10 to 12 years for single year and multi-year subscriptions, respectively. After a general review of the Company's business plans and related accounting practices during the Transition Period, the Company's Board of Directors approved a change in the amortization periods for deferred subscriber acquisition costs. The change was made in response to the Company's plans to incur additional marketing expenditures to enhance renewal rates. Under generally accepted accounting principles, if additional expenditures are incurred to maintain or enhance the renewal stream, the Company is required to amortize such subscriber acquisition costs over periods greater than the initial subscription period. Accordingly, based on efforts to enhance renewal rates, the Company changed its amortization periods. Effective December 31, 1994, the amortization periods were shortened to one year and three years for single year and multi-year subscriptions, respectively (initial subscription period without regard for anticipated renewals). The effect of reducing the amortization periods resulted in a one-time, non-cash, pre-tax charge to earnings of $65,500,000 during the two months ended December 31, 1994. The change in the amortization periods for deferred subscriber acquisition costs does not affect the amortization of commissions which continue to be amortized over the one to three year subscription period, as appropriate. Income Taxes Effective November 1, 1993, the Company prospectively adopted Statement of Financial Accounting Standards No. 109 ("FAS 109"), "Accounting for Income Taxes." Adoption of FAS 109 required a change from the deferred method to the liability method of accounting for income taxes. One of the principal differences of the liability method from the deferred method used in previous financial statements is that changes in tax laws and rates are reflected in income from continuing operations in the period such changes are enacted. The impact of the adoption of FAS 109 had a cumulative positive effect on the Company's reported earnings in 1994 of $2,000,000. Income (Loss) Per Share Income per share is calculated by dividing net income by the weighted average number of shares of common stock and common stock equivalents (common stock issuable upon exercise of stock options) outstanding. Loss per share is calculated by dividing net loss by the weighted average number of shares of common stock outstanding. 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 at the date of financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain reclassifications have been made in prior period financial statements to conform to the 1995 presentation. 2. Change in Fiscal Year End On February 14, 1995, SafeCard filed a Transition Period Form 10-Q for the two months ended December 31, 1994 in order to effect a change in its year end from October 31 to December 31. As a result, the consolidated audited financial statements contain information as of and for the two months ended December 31, 1994. The following supplemental unaudited consolidated statement of operations and unaudited consolidated statement of cash flows for the two months ended December 31, 1993 is presented for comparative purposes only and was presented in the Transition Period Form 10-Q filed in February 1995. Consolidated Statement of Operations Two Months Ended December 31, 1993 (unaudited) ---------------- Revenues Membership and subscription revenue, net $ 25,775,000 Card acquisition and services revenue Consumer marketing revenue 1,743,000 Interest income 1,334,000 Other income 280,000 ---------------- 29,132,000 Costs and expenses Subscriber acquisition costs and related commissions 15,652,000 Other costs of revenue 1,239,000 Service costs and other operating expenses 3,282,000 General and administrative expenses 2,480,000 ---------------- 22,653,000 Income before income taxes 6,479,000 Provision for income taxes 1,652,000 Income before cumulative effect of change in accounting for income taxes 4,827,000 Cumulative effect of change in accounting for income taxes 2,000,000 ---------------- Net Income $ 6,827,000 ================ Earnings per share Income before cumulative effect of accounting change $ .18 Cumulative effect of accounting change .07 Net income $ .25 ===== Weighted average number of common and common equivalent shares 27,325,000 ================ Consolidated Statement of Cash Flows Two Months Ended December 31, 1993 (unaudited) ----------------- Cash Flows From Operating Activities Net cash received from subscribers/customers $ 33,523,000 Net cash paid to suppliers and employees (31,601,000) Interest received 3,627,000 Income tax refunds (payments), net 515,000 ---------------- Net cash provided by operating activities 6,064,000 ---------------- Cash Flows From Investing Activities Purchases of investment securities (18,350,000) Proceeds from sale of investment securities 15,438,000 Proceeds from maturing investment securities 710,000 Acquisition of property and equipment, net (410,000) ----------------- Net cash used in investing activities (2,612,000) ----------------- Cash Flows From Financing Activities Proceeds from exercise of stock options 36,000 Dividends paid (1,207,000) Payments for purchase of treasury shares (483,000) ----------------- Net cash used in financing activities (1,654,000) ----------------- Net increase in cash and cash equivalents 1,798,000 Cash and cash equivalents at beginning of period 3,335,000 ---------------- Cash and cash equivalents at end of period $ 5,133,000 ================ 3. Acquisitions National Leisure Group On February 10, 1995, the Company completed its acquisition of substantially all of the assets and liabilities of National Leisure Group, a provider of vacation travel packages to credit card companies, retailers and wholesale clubs in the United States. The Company paid cash of $15,048,000 and agreed to issue $1,400,000 of common stock on the third anniversary of the acquisition. Also, up to $2,800,000 of additional common stock is issuable based on the attainment of certain earnings hurdles. The acquisition was effective as of January 1, 1995 and was accounted for under the purchase method. Accordingly, the consolidated results of operations of the Company include the results of operations of National Leisure Group for the year ended December 31, 1995. As part of the transaction, the Company acquired $5,631,000 of assets, which included $2,395,000 of cash, and assumed liabilities of $7,153,000. The Company recorded $18,327,000 of goodwill which is being amortized on a straight-line basis over 25 years. Amortization expense through December 31, 1995 related to this acquisition was approximately $725,000. The following presents the unaudited pro forma results of operations of the Company and National Leisure Group as if combined throughout the two months ended December 31, 1994 and the year ended October 31, 1994: Two Months Ended Year Ended December 31, October 31, 1994 1994 (unaudited) (unaudited) ----------- ----------- Revenues, net $ 36,933,000 $ 201,940,000 Costs and expenses 112,708,000 176,570,000 ----------------- ------------------ Income (loss) before provision for income taxes and cumulative effect of accounting change $ (75,775,000) $ 25,370,000 ================= ================== Net (loss) income $ (49,769,000) $ 20,980,000 ================= ================== (Loss) earnings per share $ (1.70) $ .74 ========= ===== The pro forma results are not necessarily indicative of what actually would have occurred if the acquisition had been in effect for the entire periods presented, nor are they intended to be a projection of future results. Wright Express Corporation On September 14, 1994, the Company acquired 100% of the outstanding common stock of Wright Express, a provider of transaction and information processing services to oil companies and commercial transportation fleets in the United States, for $35,500,000 in cash. The acquisition was accounted for under the purchase method and, accordingly, the results of operations of Wright Express are included in the Company's consolidated financial statements from the date of acquisition. In connection with the acquisition, the Company recorded $28,891,000 of goodwill which is being amortized on a straight-line basis over 25 years. The following presents the unaudited pro forma results of operations of the Company and Wright Express as if combined throughout the year ended October 31, 1994: Year Ended October 31, 1994 (unaudited) ----------- Revenues, net $ 200,955,000 Costs and expenses 176,060,000 ------------------ Income before provision for income taxes and cumulative effect of accounting change $ 24,895,000 ================== Net income $ 20,149,000 ================== Earnings per share $ .71 ===== The pro forma results are not necessarily indicative of what actually would have occurred if the acquisition had been in effect for the entire periods presented, nor are they intended to be a projection of future results. 4. Investments The Company's investment portfolio is invested primarily in tax-exempt municipal bonds. Because there is not a regularly published source of accurate current market values for tax-exempt municipal bonds, the Company's investment adviser estimates market values for the Company's securities available for sale using a pricing matrix commonly used in the municipal bond industry, or in certain cases, by soliciting quotations from municipal bond dealers. The financial statement carrying amount, gross unrealized gains, gross unrealized losses and estimated market value of the Company's securities available for sale were as follows: December 31, 1995 ---------------------------------------------------------------------------- Gross Gross Estimated Carrying Unrealized Unrealized Market Amount Gains Losses Value ------ ----- ------ ----- Tax-exempt municipal bonds $ 39,054,000 $ 366,000 $ (21,000) $ 39,399,000 U.S. Treasury bills 7,415,000 7,415,000 Other 255,000 255,000 ----------------- ------------ ------------ ----------------- $ 46,724,000 $ 366,000 $ (21,000) $ 47,069,000 ================= ============ ============ ================= December 31, 1994 ---------------------------------------------------------------------------- Gross Gross Estimated Carrying Unrealized Unrealized Market Amount Gains Losses Value ------ ----- ------ ----- Tax-exempt municipal bonds $ 159,473,000 $ 159,473,000 Other 193,000 193,000 ----------------- ------------ ------------ ----------------- $ 159,666,000 $ 159,666,000 ================= ============ ============ ================= Maturities of the Company's investment portfolio at December 31, 1995 were as follows: Carrying Market Value Value ----- ----- Within one year $ 33,499,000 $ 33,741,000 One to five years 9,187,000 9,282,000 More than five years 4,038,000 4,046,000 ---------------- ----------------- $ 46,724,000 $ 47,069,000 ================ ================= Gross realized gains on sales of securities available for sale totaled $1,237,000, $620,000 and $1,290,000 for the years ended December 31, 1995 and October 31, 1994 and 1993, respectively. Gross realized losses on sales of securities available for sale totaled $143,000, $97,000, $27,000 and $12,000 for the years ended December 31, 1995, the two months ended December 31, 1994 and the years ended October 31, 1994 and 1993, respectively. Gains and losses on sales of securities are computed on the specific identification basis and are included as a component of other income. On October 31, 1994 the Company adopted Statement of Financial Accounting Standards No. 115 ("FAS 115"), "Accounting for Investments in Certain Debt and Equity Securities." Upon adoption of FAS 115, the Company classified its securities portfolio, principally consisting of municipal bonds, as available for sale and disclosed the unrealized loss of $607,000 as a separate component of stockholders' equity. During the two months ended December 31, 1994, the Company experienced further market value declines in its investment portfolio as a result of the increasing interest rate environment. Given the Company's strategy to redeploy its investment resources into operating assets and in view of the then current interest rate environment, management elected to reposition the portfolio. This repositioning helped to minimize additional market risk and complete the Company's effort to shorten the overall maturity of the portfolio. Due to the decision to sell a significant portion of the Company's investment portfolio, management determined that there was an other than temporary decline in the market value of its available for sale portfolio, and consequently the net unrealized losses of $1,943,000 were charged against earnings for the two months ended December 31, 1994. 5. Receivables, net Receivables and the related allowance for doubtful accounts were as follows at December 31: 1995 1994 ---- ---- Receivables for transportation fleet services $ 47,041,000 $ 31,402,000 Receivables for continuity services 24,086,000 25,391,000 Other receivables 1,700,000 Accrued interest receivable 1,121,000 3,288,000 --------------- ---------------- 73,948,000 60,081,000 Allowance for doubtful accounts (1,995,000) (1,744,000) --------------- -------------- $ 71,953,000 $ 58,337,000 =============== ================ The receivables for transportation fleet services primarily relate to amounts due from customers of Wright Express for fleet fueling and other transportation services. 6. Property and Equipment Property and equipment consisted of the following at December 31: 1995 1994 ---- ---- Equipment $ 19,747,000 $ 13,457,000 Building 16,204,000 5,582,000 Furniture and fixtures 7,053,000 1,481,000 Construction in progress 6,877,000 Land 447,000 447,000 --------------- ---------------- 43,451,000 27,844,000 Less: accumulated depreciation (11,062,000) (4,463,000) --------------- ---------------- $ 32,389,000 $ 23,381,000 =============== ================ Construction in progress related to improvements and additions made to SafeCard's operations center in Cheyenne, Wyoming. All costs associated with this project were capitalized as construction in progress and began to be depreciated when the improvements and additions were placed in service during 1995. 7. Accrued Expenses Included within "Accrued expenses" as of December 31, 1995 and 1994 is a disputed liability recorded in 1992 of approximately $10,500,000 relating to the Company's estimated net obligation under a contested lease (the "Ft. Lauderdale Lease") of its former Ft. Lauderdale headquarters. The Company no longer occupies these premises and is no longer making payments on the Ft. Lauderdale Lease, which is now the subject of litigation (see Note 16 - Commitments and Contingencies). 8. Notes Payable to Bank Notes payable to bank represents a revolving loan agreement assumed in connection with the acquisition of Wright Express in 1994. The agreement, as originally structured, provided for maximum borrowings equal to the lesser of $17,500,000 or an amount based on a percentage of eligible accounts receivable as defined therein. In November 1994, the revolving credit agreement was amended increasing the available line to $27,500,000 and the Company was added as a guarantor under the amended agreement. Interest on the outstanding borrowings was, at Wright Express' option, either the bank's prime rate minus 0.5% or the London Interbank Offering Rate ("LIBOR") plus 0.625%. Wright Express paid a fee of 0.25% per annum on the average daily unused portion of the line of credit. Borrowings are secured by substantially all assets of Wright Express. At December 31, 1995, the Company had $15,414,000 outstanding under the revolving line of credit with interest rates ranging from 6.31% to 7.25%. In February 1996, Wright Express entered into a new revolving credit facility agreement replacing the previous revolving line of credit. The new credit facility has an available line of $75,000,000 of which $50,000,000 may be used to finance working capital requirements and for general corporate purposes and $25,000,000 may be used for acquisition financing. The new credit facility expires December 1, 1998. Interest on the outstanding borrowings is computed, at the option of Wright Express, under various methods including the bank's prime rate or LIBOR plus 0.75%. Wright Express pays a quarterly fee of 0.25% on the average daily unused portion of the line of credit and an annual agent's fee of $25,000. Borrowings are secured by substantially all assets of Wright Express. In February 1996, Wright Express also entered into a $5,000,000 capital expenditure line of credit arrangement with a bank. 9. Subscriber Acquisition Costs and Commissions Deferred subscriber acquisition costs and related commissions were as follows at December 31: 1995 1994 ---- ---- Hot-Line $ 65,232,000 $ 61,006,000 Fee Card 5,597,000 4,540,000 Other services 15,905,000 19,500,000 ------------- ------------- Total deferred subscriber acquisition costs 86,734,000 85,046,000 Commissions 44,819,000 46,871,000 ------------- ------------- Total deferred subscriber acquisition costs and commissions $ 131,553,000 $ 131,917,000 ============= ============= 10. Costs Related to Products Abandoned and Restructuring Included in costs related to products abandoned and restructuring in the Consolidated Statement of Operations for the year ended December 31, 1995 are special charges totaling $43,817,000, net of recoveries, related to the abandonment of certain new product developmental efforts and the related impairment of certain assets and the restructuring of SafeCard and the corporate infrastructure as discussed below. The original charge of $45,017,000 was composed of accrued liabilities of $36,248,000 and asset impairments of $8,769,000. As discussed below, in December 1995 the Company recovered $1,200,000 of a $3,900,000 deposit included in the above charges. The components of the product abandonment and related liabilities as of December 31, 1995 are as follows: 1995 Balance at Provisions Activity 12/31/95 ---------- -------- -------- Severance and other employee costs $ 14,960,000 $ 8,950,000 $ 6,010,000 Costs to terminate equipment and facilities leases 9,593,000 2,656,000 6,937,000 Liability for contract impairments 8,400,000 1,000,000 7,400,000 Other costs 3,295,000 2,846,000 449,000 --------------- --------------- ---------------- $ 36,248,000 $ 15,452,000 $ 20,796,000 =============== =============== ================ The $20,796,000 balance of the product abandonment and related liabilities at December 31, 1995 represents the Company's best estimate of the amounts expected to be incurred with respect to its product abandonment and restructuring efforts. The amounts that will ultimately be paid could differ from the amounts included in the product abandonment and related liabilities estimate. The Company anticipates completion of the majority of the actions related to the product abandonment and restructuring during 1996. PGA TOUR Partners In late March and early April 1995, the Company launched an expanded PGA TOUR Partners program through its IMS subsidiary. The program provided various benefits to members including access to PGA TOUR events and a co-branded credit card. Consumer response rates after the launch were significantly less than management's expectations and it was determined that the product as configured was not economically viable. The Company discontinued marketing the product and recorded a special charge of $17,993,000 at June 30, 1995 for costs associated with the abandonment of the product marketing including employee severance payments (approximately 130 employees), costs to terminate equipment and facilities leases, costs for contract impairments and write-downs taken for asset impairments. On September 14, 1995, after a period of product redesign and test marketing, the Company announced that it would discontinue its credit card servicing role in connection with the PGA TOUR Partners credit card program. In connection with this decision, the Company recorded a special charge of $3,612,000 for costs associated with the abandonment of this role, including employee severance payments (approximately 60 employees), costs to terminate equipment and facilities leases and the recognition of certain commitments. The Company continues to provide membership (non-credit card) servicing for the PGA TOUR Partners program. Family Protection Network In April 1995, Family Protection Network launched a nationwide child registration and missing child search program. Consumer response rates from the initial product launch were significantly lower than anticipated and the Company closed this business unit. As a result, the Company recorded an $8,987,000 charge in the second quarter 1995 to cover severance payments (approximately 100 employees), costs to terminate equipment and facilities leases and write-downs taken for asset impairments. As of December 31, 1995, all employees of Family Protection Network have been terminated. Corporate and SafeCard Restructurings As a result of the discontinuance of these products, the Company undertook an overall restructuring of its operations, including a significant reduction of its workforce at its corporate headquarters and at SafeCard. The decision to abandon these products and restructure the Company resulted in the recording of a charge of $7,176,000 in the second quarter 1995 to cover costs to terminate certain operating leases and write-down certain assets to their estimated net realizable value. The Company recorded additional charges of $3,010,000 in the third quarter 1995 for costs associated with the restructuring of SafeCard and $4,239,000 for a restructuring of the corporate infrastructure. Restructuring costs include severance payments and costs to terminate equipment and facilities leases. In May 1995, the Company signed a definitive purchase agreement to acquire a 350,000 square foot building and related property for approximately $39,000,000. As part of the agreement, the Company paid $3,900,000 into an escrow account as a nonrefundable deposit pending the completion of the purchase in early 1996. Included in the $7,176,000 corporate charge recorded in the second quarter was a provision for the full impairment of this deposit. Management worked with the building owner to facilitate a sale of the building to a third party. As a result, the building owner and a third party entered into a purchase agreement and the Company recovered $1,200,000 of its deposit in the fourth quarter of 1995. In April 1994, the Company announced a reorganization of its operations and named a new senior management team. As a part of the reorganization, nine senior executives left the Company and the Ft. Lauderdale sales office was closed. As a result of this reorganization, the Company recorded a restructuring charge of $3,500,000 to cover severance agreements and a lease termination. In addition, the Company recorded an additional charge of $4,400,000 paid to Steven J. Halmos, the Company's co-founder (see Note 14 Transactions with Related Parties). At December 31, 1995 the remaining balance of these reserves of $285,000 was included in "Accrued expenses." 11. Segment Information The operations of the Company are managed along business unit lines and, accordingly, the Company considers each operating subsidiary a separate business segment for financial reporting purposes. Due to their nature and stage of development, the operations of IMS and Family Protection Network have been combined and presented as Developmental Operations in the segment information table below. Two Months Year Ended Year Ended Ended October 31, December 31, December 31, ---------------------------- 1995 1994 1994 1993 ---- ---- ---- ---- SafeCard Operating revenue $ 187,875,000 $ 30,375,000 $ 173,663,000 $ 157,112,000 Operating income (loss) 32,446,000 (59,450,000) 41,961,000 44,682,000 Identifiable assets 195,769,000 217,679,000 270,636,000 206,331,000 Depreciation and amortization 2,549,000 236,000 1,094,000 864,000 Capital expenditures, net 9,881,000 7,241,000 7,913,000 719,000 Wright Express Operating revenue 23,332,000 2,915,000 2,107,000 Operating income 3,434,000 512,000 250,000 Identifiable assets 77,309,000 32,737,000 32,471,000 Depreciation and amortization 1,721,000 421,000 255,000 Capital expenditures, net 1,663,000 165,000 131,000 National Leisure Group Operating revenue 16,018,000 Operating income 1,973,000 Identifiable assets 27,237,000 Depreciation and amortization 1,066,000 Capital expenditures, net 1,969,000 Developmental Operations Operating revenue Operating loss (83,803,000) (6,565,000) (5,006,000) Identifiable assets 521,000 4,218,000 Depreciation and amortization 384,000 Capital expenditures, net 664,000 Corporate and Other Operating revenue 6,743,000 1,408,000 13,316,000 10,014,000 Operating income (loss) (31,292,000) (10,516,000) (13,006,000) (2,237,000) Identifiable assets 85,074,000 174,080,000 177,266,000 171,956,000 Depreciation and amortization 437,000 66,000 Capital expenditures, net 2,266,000 Consolidated Totals Operating revenue 233,968,000 34,698,000 189,086,000 167,126,000 Operating income (loss) (77,242,000) (76,019,000) 24,199,000 42,445,000 Identifiable assets 385,910,000 428,714,000 480,373,000 378,287,000 Depreciation and amortization 6,157,000 723,000 1,349,000 864,000 Capital expenditures, net 16,443,000 7,406,000 8,044,000 719,000 Identifiable assets are those assets of the Company that are identified with the operations of each of the individual business units. Corporate assets are principally cash, securities available for sale and property and equipment. National Leisure Group's identifiable assets include $17,607,000 of unamortized goodwill as of December 31, 1995. Wright Express' identifiable assets included unamortized goodwill of $27,395,000, $28,451,000 and $28,739,000 as of December 31, 1995 and 1994 and October 31, 1994, respectively. Operating income for SafeCard for the two months ended December 31, 1994 includes a pre-tax charge of $65,500,000 for a change in amortization periods for deferred subscriber acquisition costs. Operating revenue for the year ended October 31, 1994 for Corporate and Other includes a gain on litigation settlements of $4,257,000. The Company does not earn material amounts of revenue from sources outside the United States. 12. Income Taxes As discussed in Note 1, the Company changed its method of accounting for income taxes as of November 1, 1993. The components of the provision for (benefit from) income taxes for the year ended December 31, 1995, the two months ended December 31, 1994 and the years ended October 31, 1994 and 1993 were as follows: Two Months Year Ended Year Ended Ended October 31, December 31, December 31, ------------------------ 1995 1994 1994 1993 ---- ---- ---- ---- Current Federal $ (15,636,000) $ (1,887,000) $ 13,032,000 $ 15,608,000 State (93,000) (54,000) 272,000 101,000 ----------------- ---------------- ---------------- ----------------- Total current (15,729,000) (1,941,000) 13,304,000 15,709,000 ----------------- ---------------- ---------------- ----------------- Deferred Federal (11,530,000) (23,815,000) (7,640,000) (3,588,000) State (542,000) (319,000) 514,000 (1,153,000) ----------------- ---------------- ---------------- ----------------- Total deferred (12,072,000) (24,134,000) (7,126,000) (4,741,000) ----------------- ---------------- ---------------- ----------------- Total $ (27,801,000) $ (26,075,000) $ 6,178,000 $ 10,968,000 ================= ================ ================ ================= The following is a reconciliation of the statutory U.S. federal income tax rate and the Company's effective income tax rate for the year ended December 31, 1995, the two months ended December 31, 1994 and the years ended October 31, 1994 and 1993: Two Months Year Ended Ended Year Ended December 31, December 31, October 31, 1995 1994 1994 1993 ---- ---- ---- ---- Statutory federal income tax rate 35.0% 35.0% 35.0% 34.8% Increase (reduction) in tax rates resulting from: State income tax, net of federal benefit 2.1 1.2 Tax-exempt interest income (1.7) (.6) (10.8) (6.8) Amortization of non-deductible goodwill .5 .1 Reversal of prior years' deferred taxes at the rates in effect at that time (2.9) Other 2.2 (.2) (.8) (.5) ---- ---- ---- ---- Effective tax rate 36.0% 34.3% 25.5% 25.8% ==== ==== ==== ==== The components of the Company's deferred income tax assets and liabilities under FAS 109 were as follows: December 31, December 31, October 31, November 1, 1995 1994 1994 1993 ---- ---- ---- ---- Deferred tax liabilities: Subscriber acquisition costs $ 47,255,000 $ 45,915,000 $ 71,585,000 $ 68,391,000 Depreciation 1,312,000 432,000 549,000 382,000 ----------------- ---------------- ---------------- ----------------- 48,567,000 46,347,000 72,134,000 68,773,000 ----------------- ---------------- ---------------- ----------------- Deferred tax assets: Multi-year subscription revenues 41,928,000 36,968,000 36,226,000 29,051,000 Relocation expenses 3,439,000 3,606,000 3,749,000 3,736,000 Product abandonment and related liabilities 8,005,000 Net operating loss carryforwards 1,347,000 1,474,000 8,217,000 Reminder/reference subscription revenue (2,709,000) (3,643,000) 1,195,000 (1,945,000) Other 5,150,000 3,946,000 1,996,000 1,829,000 ----------------- ---------------- ---------------- ----------------- 57,160,000 42,351,000 51,383,000 32,671,000 ----------------- ---------------- ---------------- ----------------- Net deferred tax (asset) liability $ (8,593,000) $ 3,996,000 $ 20,751,000 $ 36,102,000 ================= ================ ================ ================= The deferred income tax benefit for the year ended October 31, 1993 (under prior accounting method) resulted from the following items: Subscriber costs, net $ 450,000 Multi-year subscription revenues (7,310,000) Reminder/reference subscription revenue 1,952,000 Relocation expenses 698,000 Other (531,000) ---------------- $ (4,741,000) ================ At December 31, 1995, the Company had $4,298,000 of net operating loss carryforwards for tax purposes which, if unused, will expire in 2001. 13. Common Stock And Stock Options The following table presents information for the year ended December 31, 1995, the two months ended December 31, 1994 and the years ended October 31, 1994 and 1993 with respect to options granted and outstanding as follows: Shares Under Option -------------------------------------------------------------------------- Outstanding Outstanding Option at beginning at end of Price Range of period Granted Canceled Exercised period ----------- --------- ------- -------- --------- ------ - ------------------------------------------------------------------------------------------------------------------------------------ Year ended October 31, 1993 1979 Plan $ 5.875 141,040 (141,040) Outside Directors' Options $ 6.375-13.00 200,000 200,000 (100,000) 300,000 1987 Plan $ 5.875 348,100 (348,100) 1989 Executive Options $ 5.125 980,000 (230,000) 750,000 1989 Employee Stock Option Plan $ 6.00 361,004 (5,333) (102,671) 253,000 Peter & Steven J. Halmos $ 5.125-5.50 5,850,000 (1,950,000) 3,900,000 1991 Employee Stock Option Plan $ 9.00 138,000 (24,333) (38,334) 75,333 1992 Employee Stock Option Plan $ 8.875 75,000 (12,500) 62,500 --------- --------- ---------- ---------- --------- 8,018,144 275,000 (1,992,166) (960,145) 5,340,833 ========= ========= ========== ========== ========= - ------------------------------------------------------------------------------------------------------------------------------------ Year ended October 31, 1994 Outside Directors' Options $ 9.00 - 13.00 300,000 300,000 1989 Executive Options $ 5.125 750,000 (750,000) 1989 Employee Stock Option Plan $ 6.00 253,000 (234,000) 19,000 Steven J. Halmos $ 5.125-5.50 3,900,000 (3,900,000) 1991 Employee Stock Option Plan $ 9.00 75,333 (11,667) (36,333) 27,333 1992 Employee Stock Option Plan $ 8.875 62,500 (13,335) (14,164) 35,001 1994 Long-Term Stock-Based Incentive Plan $ 12.625-18.375 2,315,000 (3,000) 2,312,000 Employee Stock Option Plan $ 16.50 42,700 (2,700) 40,000 --------- --------- ---------- ---------- --------- 5,340,833 2,357,700 (30,702) (4,934,497) 2,733,334 ========= ========= ========== ========== ========= - ------------------------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------------------------ Two months ended December 31, 1994 Outside Directors' Options $ 9.00 - 13.00 300,000 300,000 1989 Employee Stock Option Plan $ 6.00 19,000 19,000 1991 Employee Stock Option Plan $ 9.00 27,333 27,333 1992 Employee Stock Option Plan $ 8.875 35,001 35,001 1994 Long-Term Stock-Based Incentive Plan $ 12.625-18.938 2,312,000 193,500 2,505,500 Employee Stock Option Plan $16.50-17.50 40,000 21,500 61,500 --------- ---------- --------- 2,733,334 215,000 2,948,334 ========= ========== ========= - ------------------------------------------------------------------------------------------------------------------------------------ Year ended December 31, 1995 Outside Directors' Options $ 9.00 - 13.00 300,000 300,000 1989 Employee Stock Option Plan $ 6.00 19,000 (19,000) 1991 Employee Stock Option Plan $ 9.00 27,333 (1,667) (17,333) 8,333 1992 Employee Stock Option Plan $ 8.875 35,001 (12,501) (12,500) 10,000 1994 Long-Term Stock-Based Incentive Plan $ 7.625 - 20.75 2,505,500 1,049,200 (936,000) (1,000) 2,617,700 Employee Stock Option Plan $ 9.875 - 19.125 61,500 74,300 (27,500) 108,300 Directors Stock Plan $15.875 30,000 30,000 --------- --------- ---------- ---------- --------- 2,948,334 1,153,500 (977,668) (49,833) 3,074,333 ========= ========= ========== ========== ========= All options to purchase common shares are exercisable and no additional shares are available for granting options under each plan except as noted below. Of the options to purchase 2,617,700 shares outstanding under the 1994 Long-Term Stock-Based Incentive Plan (as amended, the "1994 Plan"), options to purchase 655,583 shares were exercisable at December 31, 1995. A portion of the stock options outstanding under the 1994 Plan vest over time (becoming fully vested in two or four years) beginning one year from the date of grant and a portion vests based on certain stock price hurdles. Of the options to purchase 108,300 shares outstanding under the Employee Stock Option Plan, options to purchase 48,600 shares were exercisable at December 31, 1995. The options under the Employee Stock Option Plan vest one year from the date of grant. Of the options to purchase 30,000 shares outstanding under the Directors Stock Plan, none of the options were exercisable at December 31, 1995. Sixty percent of the options, which are granted automatically upon a director's election to the Board, vest over four years beginning one year after the date of grant and forty percent of the options vest in three equal installments based on achievement of certain stock price hurdles. In addition to the options granted under the 1994 Plan as discussed above, 15,450 shares of restricted stock have been awarded under the 1994 Plan through December 31, 1995. Of the 15,450 shares of restricted stock issued through December 31, 1995, 12,450 shares are vested and 1,000 shares of restricted stock were forfeited upon the grantee's termination of employment. In connection with the exercise of options to purchase common stock, certain employees exchanged 94,332 and 18,134 shares of common stock in lieu of cash in 1994 and 1993, respectively. The exchanged shares are deducted from the number of shares issued upon the exercise of employee stock options for purposes of presentation in the consolidated statement of changes in stockholders' equity. The 1994 Plan was approved by the stockholders at the 1994 Annual Meeting of Stockholders held on March 7, 1994 and amended at the 1995 Annual Meeting of Stockholders held on April 27, 1995. The 1994 Plan, as amended, provides for the award of stock options, stock appreciation rights and restricted stock covering a maximum of 3,740,000 shares. The Directors Stock Plan was approved by the stockholders at the 1995 Annual Meeting of Stockholders and provides for the automatic grant of an option to purchase 15,000 shares of the Company's common stock upon a director's initial election or appointment to the Board. Up to 105,000 shares may be issued pursuant to the Directors Stock Plan. All stock options granted in 1995 and in prior years, except for the grants under the Employee Stock Option Plan, were administered by the Board of Directors or a committee thereof and had an exercise price based on the market price of the Company's common stock on the date of grant. The Employee Stock Option Plan is administered by a committee of Company officers who are not eligible to participate in this plan. As of December 31, 1995, 3,074,333 of the shares held in treasury were reserved for the issuance of shares under the above described stock options. 14. Transactions with Related Parties Until his resignation as Chief Executive Officer and a director on December 19, 1992, Steven J. Halmos, SafeCard's co-founder, provided his services to SafeCard through High Plains Capital Corporation ("HPCC"), a company owned by himself and his brother, Peter Halmos, SafeCard's other co-founder. After that date, Steven J. Halmos, acting in the capacity of an Advisor on Marketing and Operational Strategy, provided services directly to SafeCard pursuant to a written agreement (as amended and restated as of April 1, 1993, the "Steven J. Halmos Agreement"). On May 26, 1994, SafeCard reached a settlement with Steven J. Halmos to terminate the Steven J. Halmos Agreement and various other agreements between SafeCard and Mr. Halmos that provided for payments to Mr. Halmos of $2,000,000 a year through March 31, 1998. The settlement, which arose in connection with the Company's management restructuring in April 1994 and a resulting decision to cease using Mr. Halmos' services, resulted in a $4,400,000 cash payment to Mr. Halmos and charge to 1994 earnings. Subsequent to his termination Mr. Halmos exercised options to purchase 3,900,000 shares of the Company's common stock. Stockholders' equity increased $37,800,000 resulting from the exercise of such options and the related tax benefit (see Note 13 - Common Stock and Stock Options). In 1993, SafeCard paid Steven J. Halmos (or HPCC for Steven J. Halmos' services) a total of approximately $2,100,000. In 1993, SafeCard also entered into an agreement that called for Steven J. Halmos to sell the 1,645,760 shares of Company stock he owned at that time (this representing approximately 6.2% of total outstanding shares at April 1, 1993) to the Company as part of the Company's stock repurchase program. The shares were acquired by the Company on April 21, 1993 for a price of $11.50 per share, a price equal to the average trading price of the Company's common stock over a specific period of days following public disclosure of the repurchase. SafeCard markets its CreditLine product pursuant to an agreement (as amended, the "CreditLine Agreement") with CreditLine Corporation ("CLC"), a corporation owned by Steven J. Halmos and Peter Halmos, SafeCard's co-founders, and their families. The CreditLine Agreement grants SafeCard an exclusive license to market CreditLine through certain credit card issuers (including all issuers with which SafeCard has contractual relationships) and provides that profits and losses, if any, are shared equally between CLC and SafeCard. Net CreditLine billings to subscribers totaled approximately $30,710,000, $7,000,000, $22,900,000 and $15,800,000 while marketing and other expenditures totaled $23,488,000, $3,060,000, $17,400,000 and $13,400,000 for the year ended December 31, 1995, the two months ended December 31, 1994 and the years ended October 31, 1994 and 1993, respectively. In June 1993, SafeCard was notified by CLC that the CreditLine Agreement would not be renewed effective November 1, 1993. Notwithstanding its termination, the CreditLine Agreement gives SafeCard the perpetual right to continue to service existing CreditLine subscribers and to participate in the resulting income. In addition, an amendment to the CreditLine Agreement provides that SafeCard has the perpetual right to market CreditLine, and participate in the resulting income, through all of its existing card issuer clients with which it either had a CreditLine marketing agreement on November 1, 1993 or entered into such a marketing agreement within the following three years. The CreditLine Agreement is the subject of litigation as described in Note 16 Commitments and Contingencies. In 1995, CreditLine and certain services marketed in conjunction with CreditLine accounted for approximately $14,506,000 or 7.7% of the Company's subscription revenue and generated approximately $4,728,000 of pre-tax income. During the Transition Period, CreditLine and related services accounted for approximately $1,913,000 or 6.3% of the Company's subscription revenue and generated approximately $702,000 of pre-tax income. In 1994, such services accounted for approximately $9,100,000 or 5.3% of the Company's subscription revenue and approximately $2,800,000 or 11.6% of the Company's pre-tax income. In 1993, such services accounted for approximately $6,500,000 or 4.2% and $1,900,000 or 4.5% of the Company's subscription revenue and pre-tax income, respectively. The CreditLine Agreement provides for the creation of an escrow in the case of certain disputes between the parties. Effective September 1993, SafeCard began depositing CLC's share of CreditLine profits into escrow. Through December 31, 1995, SafeCard has also deposited approximately $4,265,000 of its share of the CreditLine profits in an escrow account. The Company's cash and cash equivalents include only SafeCard's share of the escrowed amounts. SafeCard made payments under the Ft. Lauderdale Lease to a partnership consisting of Peter Halmos and Steven J. Halmos (the "Halmos Partnership"). Payments made to the Halmos Partnership for the year ended October 31, 1993 for the land and building, were approximately $700,000. No payments were made to the Halmos Partnership in 1994 or 1995. SafeCard no longer occupies the operations center and is no longer making payments on the Ft. Lauderdale Lease which is now the subject of litigation (see Note 16 Commitments and Contingencies). In October 1993, the Company renewed a consulting agreement with the Dilenschneider Group, Inc. ("DGI") to provide public relations counsel and advice to the Company in 1994 for an annual retainer of $180,000. A director of the Company is the majority owner and chief executive officer of DGI. In October 1994, the Company entered into an agreement with DGI for public affairs and public relations assistance during 1995 for an annual retainer of $100,000. These consulting arrangements have not been renewed for 1996. During 1994, DGI consulted on and assisted with investor relations for a monthly fee of $12,500. In addition, another director of the Company provided investor relations consulting services to the Company during 1994 for a monthly retainer of $4,167. These consulting arrangements were terminated effective October 31, 1994. In September 1994, the Company acquired Wright Express. The Company's former Chairman and Chief Executive Officer, Paul G. Kahn, was a director of Wright Express prior to the acquisition. During negotiations between the Company and Wright Express, Mr. Kahn did not attend any meetings or participate in any discussions of the Board of Directors of Wright Express and abstained from voting on the acquisition by the Company's Board of Directors. 15. Employee Benefit Plans In June 1993, the Company implemented a 401(k) and Profit-Sharing Plan for its employees who are at least 20 years of age, have worked at least 1,000 hours in the past year and have completed one year of service. The Company matches 50% of each employee's contribution, up to a maximum of 6% of each employee's salary. Company contributions vest at a rate of 20% per year after one year of service while participating in the plan. Continuation of, and contributions to, the 401(k) and Profit-Sharing Plan are voluntary, at the discretion of the Company and are paid to each eligible employee's account. The total expense recorded under the plan in 1995, the Transition Period, 1994 and 1993 was approximately $686,000, $16,000, $385,000 and $240,000, respectively. Wright Express maintains a separate 401(k) and Profit-Sharing Plan that has been modified to mirror the benefits and conditions of the Company's plan. The total expense recorded under the plan in 1995 and the Transition Period was approximately $5,000 and $1,000, respectively. National Leisure Group maintains a separate 401(k) and Profit-Sharing Plan for its employees who are considered full-time and have completed six months of service. National Leisure Group matches 25% of the each employee's contribution, up to a maximum of 4% of each employee's salary. Continuation of, and contributions to, the plan are voluntary, at the discretion of management and are paid to each eligible employee's account. The total expense recorded under the plan in 1995 was approximately $30,000. 16. Commitments and Contingencies Contracts The Company has written agreements with certain large credit card issuers which account for a large percentage of its subscription revenue. Termination of any of these contracts would adversely affect the Company. Contracts with Citibank (South Dakota), N.A. and related entities contributed 22%, 24%, 26% and 30% of the Company's consolidated revenue in 1995, the Transition Period, 1994 and 1993, respectively. Citibank contributed 30%, 30%, 32% and 36% of the Company's consolidated membership and subscription revenue during the same periods. The principal Citibank contract, as amended, expires December 31, 2000. Citibank has a right to terminate the contract in the event of the sale of a majority of the shares of the Company to specified credit card issuers, to banks and their corporate affiliates and to entities that do not have equity of at least $25,000,000. Contracts with Sears, Roebuck and Co. contributed approximately 10% to the Company's consolidated revenue in 1995, the Transition Period, 1994 and 1993. Sears contributed 13%, 12%, 13% and 12% of the Company's consolidated membership and subscription revenue during the same periods. SafeCard has signed a letter of intent for a new five-year cooperative business relationship with Sears. The new contract will be effective on January 1, 1996 and is expected to be executed shortly. Leases The Company has entered into several operating leases for certain computer and telephone equipment and facilities in the normal course of business. Rent expense for 1995, the Transition Period and 1994 was $5,535,000, $452,000 and $283,000, respectively. There was no material rental expense for 1993. The following is a schedule of future minimum rental payments required under operating leases having initial or remaining non-cancelable lease terms in excess of one year at December 31, 1995: 1996 $ 4,523,000 1997 4,329,000 1998 2,848,000 1999 1,448,000 2000 784,000 Thereafter 2,241,000 -------------- $ 16,173,000 ============== Legal Matters The Company is defending or prosecuting claims in thirteen complex lawsuits, twelve of which involve Peter Halmos, former Chairman of the Board and Executive Management Consultant to SafeCard, and various parties related to him as adversaries. Peter Halmos is also a plaintiff in three other lawsuits, one against a former officer, one against a director of the Company and one against SafeCard's outside counsel, in which neither SafeCard nor the Company have been named as defendant. The thirteen cases in which the Company or its subsidiaries is a party are as follows: A suit initiated by Peter Halmos, related entities, and Myron Cherry (a former lawyer for SafeCard) in April 1993 in Cook County Circuit Court in Illinois against SafeCard and one of the Company's directors, purporting to state claims aggregating in excess of $100 million, principally relating to alleged rights to "incentive compensation," stock options or their equivalent, indemnification, wrongful termination and defamation. SafeCard and the director moved to dismiss this lawsuit. In November 1993, the court granted the motions to dismiss all parts of the complaint, but gave the plaintiffs leave to replead, which they did. Again in March 1994, the court granted the motions to dismiss all of the complaints but permitted the plaintiffs to replead which they did in June 1994. On February 7, 1995, the court dismissed with prejudice Peter Halmos' claims regarding alleged rights to "incentive compensation," stock options or their equivalent, wrongful termination and defamation. Mr. Halmos has appealed this ruling; the initial brief, the answer brief and the reply brief have been filed. No date for oral argument has been set. SafeCard has filed an answer to the remaining indemnification claims. Its obligation to file an answer to the claims of Myron Cherry have been stayed pending settlement discussions. A suit by Peter Halmos, purportedly in the name of Halmos Trading & Investment Company, seeking monetary damages and specific performance against SafeCard, one of its former officers and one of the Company's directors in Circuit Court in Broward County, Florida, making a variety of claims related to the contested lease of SafeCard's former Ft. Lauderdale headquarters. SafeCard has vacated the building, ceased making payments related to the Ft. Lauderdale lease and has filed counterclaims. In May 1994, the court dismissed Peter Halmos' amended counterclaim for breach of contract for indemnity and intentional infliction of emotional distress but gave leave to amend. In June 1994, Peter Halmos filed a second amended counterclaim purporting to state claims for intentional infliction of emotional distress, fraud and negligent misrepresentation and declaratory judgment based on alleged breach of contract for indemnity or, in the alternative, promissory estoppel, related to indemnification of legal expenses in this lawsuit. In January 1995, Peter Halmos filed a third amended counterclaim which was identical in all material respects to the second amended counterclaim. On January 17, 1995, SafeCard filed its answer to the third amended counterclaim. On October 30, 1995, the court dismissed Peter Halmos' claims against the Company for fraudulent misrepresentation and specific performance and dismissed all claims against the Company's director. Halmos also dismissed without prejudice his emotional distress claim, severed his indemnification claims and dismissed with predjudice his claim against the former officer. Trial of the lawsuit began February 26, 1996. A suit which seeks monetary damages and certain equitable relief filed by SafeCard in August 1993 in Laramie County Circuit Court in Wyoming against Peter Halmos and related entities alleging that Peter Halmos dominated and controlled SafeCard, breached his fiduciary duties to SafeCard, and misappropriated material non-public information to make $48 million in profits on sales of SafeCard stock. In March 1994, Mr. Halmos and related entities filed a counterclaim in which claims were made of conspiracy in restraint of trade, monopolization and attempted monopolization, unfair competition and restraint of trade, breach of contract for indemnity and intentional infliction of emotional distress. SafeCard's motion to sever the conspiracy, monopolization and restraint of trade claims was granted in May 1994. The claims for the conspiracy, monopolization, restraint of trade and unfair competition were dismissed without prejudice in June 1994. On April 12, 1995, the trial court granted the motion of Mr. Halmos and certain related entities to amend their counterclaims. The amended counterclaims include claims for indemnification for legal expenses incurred in the action and a claim that SafeCard's contract with CreditLine should be rescinded. On April 19, 1995, the trial court granted Mr. Halmos' motion for summary judgment that certain of SafeCard's claims against him were barred by the statute of limitations. On March 14, 1996, the Wyoming Supreme Court reversed the trial court's ruling that certain of SafeCard's claims were barred by the statute of limitations. A suit seeking monetary damages by Peter Halmos, purportedly in his name and in the name of CreditLine Corporation and Continuity Marketing Corporation against SafeCard, one of its officers and three of the Company's directors in United States District Court in the Southern District of Florida, in September 1994 purporting to state various tort claims, state and federal antitrust claims and claims of copyright infringement. The claims principally relate to the allegation by Peter Halmos and his companies that SafeCard has taken action to prevent him from being a successful competitor. On December 9, 1994, SafeCard, its officer and the Company's directors moved to dismiss the lawsuit. On March 8, 1995, the court granted Mr. Halmos' motion to file a second amended complaint. On March 28, 1995, SafeCard, its officer and the Company's directors again moved to dismiss the lawsuit. All discovery in the case has been stayed pending a ruling on the motion to dismiss. On August 16, 1995, the United States Magistrate Judge filed a Report and Recommendation that the case be dismissed. The parties have filed various briefs and memoranda in response to this Report. On January 4, 1996, the Magistrate recommended ruling that the statute of limitations was tolled during pendency of the case in federal court and the plaintiffs' state law claims were thus not time-barred. Defendants have filed an objection to this recommendation. A suit seeking monetary damages by Peter Halmos, as trustee for the Peter A. Halmos revocable trust dated January 24, 1990 and the Halmos Foundation, Inc., individually and James L. Binder as custodian for Elizabeth Binder; Edward Dubois; Sheila Ann Dubois, as personal representative of the Estate of Winifred Dubois; G. Neal Goolsby, John E. Masters, individually and as custodian for Gregory Halmos and Nicholas Halmos; and J.B. McKinney on behalf of themselves and all others similarly situated against SafeCard, one of its officers, one of its former officers and three of the Company's directors in the United States District Court for the Southern District of Florida in December 1994. This litigation involves claims by a putative class of sellers of SafeCard stock for the period January 11, 1993 through December 8, 1994 for alleged violations of the federal and states securities laws in connection with alleged improprieties in SafeCard's investor relations program. The complaint also includes individual claims made by Peter Halmos in connection with the sale of stock by the two trusts controlled by him. The Complaint was amended on September 13, 1995 to join James L. Binder individually and as custodian for the James L. Binder, D.D.S., P.C. Profit Sharing Trust II. SafeCard and the individual defendants have filed a motion to dismiss. There has been limited discovery on class certification and identification of "John Doe" defendant issues. The Company filed its opposition to the pending motion for class certification on December 11, 1995. Plaintiffs' reply is due March 19, 1996. A suit seeking monetary damages and injunctive relief by LifeFax, Inc. and Continuity Marketing Corporation, companies affiliated with Peter Halmos, in the State Circuit Court in Palm Beach County, Florida in April 1995 against the Company, Family Protection Network, Inc., SafeCard, one of the Company's directors and the Company's Chief Executive Officer purporting to state various statutory and tort claims. The claims principally relate to the allegation by these companies that SafeCard's Early Warning Service and Family Protection Network were conceived and commercialized by, among others, Peter Halmos and have been improperly copied. An amended complaint filed on June 14, 1995 seeking monetary damages adds to the prior claims certain claims by Nicholas Rubino that principally relate to the allegation that SafeCard's Pet Registration Product was conceived by Mr. Rubino and has been improperly copied. The Company and the individual defendants filed a motion to dismiss the amended complaint. A hearing was held on the motion to dismiss on October 13, 1995. On November 27, 1995, the Court entered an Order denying the Company's motion to dismiss. On December 12, 1995 the defendants filed their Answer and Affirmative Defenses to the Amended Complaint. Preliminary discovery is proceeding. A suit seeking monetary damages and declaratory relief by Peter Halmos, individually and as trustee for the Peter A. Halmos Revocable Trust dated January 24, 1990 and by James B. Chambers, individually and on behalf of himself and all others similarly situated against the Company, SafeCard, each of the members of the Company's Board of Directors, three non-board member officers of the Company, the Company's outside auditor and one of the Company's outside counsel in the United States District Court for the Southern District of Florida in June 1995. The litigation involves claims by a putative class of purchasers of the Company stock between December 14, 1994 and May 25, 1995 and on behalf of a separate class of all record holders of SafeCard stock as of April 27, 1995. The putative class claims are for alleged violations of the federal securities laws, for alleged breach of fiduciary duty and alleged negligence in connection with certain matters voted on at the Annual Meeting of SafeCard stockholders held on April 27, 1995. The Company and the individual defendants have filed a motion to dismiss these claims. There has been limited discovery on class certification issues. The Company filed its opposition to the pending motion for class certification on December 11, 1995. Plaintiffs' reply is due March 19, 1996. A purported shareholder derivative action initiated by Michael P. Pisano, on behalf of himself and other stockholders of SafeCard and Ideon Group, Inc. against SafeCard, Ideon Group Inc., two of their officers, and the Company's directors in United States District Court, Southern District of Florida. This litigation involves claims that the officers and directors of SafeCard have improperly refused to accede Peter Halmos' litigation and indemnification demands against the Company. The Company and the individual defendants have filed motions to dismiss the first amended complaint. On September 29, 1995, Pisano filed a second amended complaint which made additional allegations of waste and mismanagement against the Company's officers and directors in connection with the Family Protection Network and PGA Tour Partners products. On December 26, 1995, the Company filed motions to dismiss the Second Amended Complaint for: (i) failure to join an indispensable party (Halmos) and failure to allege demand on the Board of Directors with particularity; and (ii) the failure of Pisano to comply with the fairness and adequacy requirements of Federal Rule of Civil Procedure 23.1. On January 25, 1996, the plaintiff filed a memorandum in opposition to motion to dismiss. The Company filed its reply to the memorandum in opposition on February 23, 1996. A suit seeking monetary damages filed by Peter Halmos against SafeCard, one of its directors, its former general counsel, and its legal counsel in the Circuit Court, Fifteenth Judicial Circuit, in and for Palm Beach County, Florida on August 10, 1995. This litigation involves claims by Peter Halmos for breach of fiduciary duty and constructive fraud, fraud, and negligent misrepresentation and is based on allegations arising out of the resolution of a shareholder class action lawsuit in 1991 and SafeCard's subsequent filing of an action against Halmos and his related companies in Wyoming in 1993. Safe-Card has filed a motion to dismiss which has been set for hearing on March 29, 1996. A suit by Lois Hekker on behalf of herself and all others similarly situated seeking monetary damages against the Company and its former Chief Executive Officer in the United States District Court for the Middle District of Florida on July 28, 1995. The litigation involves claims by a putative class of purchasers of the Company's stock for the period April 25, 1995 through May 25, 1995 for alleged violation of the federal securities laws in connection with statements made about the Company's business and financial performance. Defendants filed a motion to dismiss on October 2, 1995. On January 3, 1996, the court stayed all merits discovery pending rulings on the motion to dismiss and on the plaintiff's motion for class certification. A declaratory judgment action by the Company and its directors against Peter Halmos in Delaware Chancery Court, New Castle County. This action seeks a declaration regarding the Company's advance indemnification obligations, if any, to Peter Halmos who has made numerous advance indemnification demands on the Company in connection with his many lawsuits. Halmos filed a motion to dismiss on jurisdictional grounds on November 17, 1995. The Company filed a brief in opposition and an amended complaint on February 14, 1996. Defendant's response is due March 21, 1996. A suit by High Plains Capital Corporation against the Company, SafeCard, two of its directors and The Dilenschneider Group, Inc. in Circuit Court in Palm Beach County, Florida. This litigation involves claims by High Plains Capital Corporation, a corporation with which Peter Halmos is affiliated, for certain incentive compensation arising out of Halmos' affiliation with SafeCard. The Complaint includes claims for breach of written agreements regarding additional services and expenses, an alternative claim for quantum meruit based on written agreement and a count for tortious interference with advantageous business relationship. The Complaint appears to attempt to revive the incentive compensation claims which have been dismissed with prejudice in Illinois. On November 30, 1995, the Company filed a motion to strike, motion to dismiss and motion to transfer. Hearings have been set on the motion to dismiss on March 29, 1996, and on the motion to strike on April 4, 1996. A suit filed by High Plains Capital Corporation against the Company and SafeCard in Circuit Court in Broward County, Florida. This litigation involves claims by High Plains Capital Corporation, a corporation with which Peter Halmos is affiliated, for alleged breach of oral contract, alleged violation of Florida's Uniform Trade Secrets Act, alleged misappropriation of trade secrets and for declaration that certain alleged trade secrets are the property of High Plains Capital Corporation. The Company filed motions to dismiss and to transfer on December 15, 1995. The Company is involved in certain other claims and litigation, including various employment related claims, arising from the ordinary course of business and which are not considered material to the operations of the Company. The Company believes that it has proper and meritorious claims and defenses in these lawsuits which it intends to vigorously pursue. Resolution of any or all of these litigation matters could have a material impact (either favorable or unfavorable depending on the outcome) upon the Company's operations, liquidity and financial condition. 17. Statement Of Cash Flows The following is a reconciliation of net income (loss) to net cash provided by (used in) operating activities: Two Months Year Ended Ended Year Ended December 31, December 31, October 31, 1995 1994 1994 1993 ---- ---- ---- ---- Net (loss) income $ (49,441,000) $ (49,944,000) $ 20,021,000 $ 31,477,000 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation and amortization 6,157,000 723,000 1,349,000 864,000 Cumulative effect of change in accounting for income taxes (2,000,000) Amortization of investment premiums/discounts, net 1,701,000 802,000 5,281,000 5,233,000 Realized (gain) loss on sales of securities available for sale (1,094,000) 97,000 (593,000) (1,277,000) Unrealized loss on marketable securities 1,943,000 Loss on impairment of assets 7,569,000 Income tax (benefit) provision (27,801,000) (26,075,000) 6,178,000 10,968,000 Income tax (refunds) payments, net 11,047,000 (7,000) 3,237,000 (16,161,000) Billings to subscribers, net 185,297,000 43,886,000 189,925,000 173,769,000 Amortization of subscribers' advance payments to revenue (187,758,000) (30,375,000) (173,434,000) (156,600,000) Effect of change in amortization periods for deferred subscriber acquisition costs 65,500,000 Expenditures for subscriber acquisition costs (68,948,000) (8,792,000) (68,029,000) (63,717,000) Payment of commissions, net (51,566,000) (11,794,000) (52,412,000) (49,511,000) Amortization of subscriber acquisition costs 67,799,000 10,001,000 56,236,000 51,075,000 Amortization of commissions 53,079,000 8,565,000 49,745,000 44,173,000 Increase (decrease) in allowance for cancellations 351,000 1,541,000 (1,237,000) 1,306,000 Changes in assets and liabilities, net of effects of business acquisitions: Receivables, net (12,321,000) (15,888,000) 4,070,000 (877,000) Other current assets 117,000 Other assets (6,076,000) (3,020,000) (1,137,000) 582,000 Accounts payable and accrued expenses (4,427,000) 8,085,000 9,846,000 (2,459,000) Product abandonment and related liabilities 20,796,000 ---------------- ----------------- ----------------- ---------------- Net cash (used in) provided by operating activities $ (55,519,000) $ (4,752,000) $ 47,046,000 $ 28,845,000 ================ ================= ================= ================ 18. Unaudited Quarterly Financial Data Quarters Ended ------------------------------------------------------------------------- 1995 March 31 June 30 September 30 December 31 - ---- -------- ------- ------------ ----------- Operating revenue $ 59,728,000 $ 57,732,000 $ 57,543,000 $ 58,965,000 Operating income (loss) 429,000 (72,881,000) (12,152,000) 7,362,000 Net income (loss) (A) 301,000 (46,670,000) (7,778,000) 4,706,000 Net income (loss) per share (A) $ .01 $ (1.62) $ (.28) $ .17 Weighted average number of common and common equivalent shares 29,870,000 28,860,000 28,222,000 27,986,000 Subscribers at period end 13,024,000 13,139,000 13,174,000 13,172,000 Two Months Ended Transition Period - 1994 December 31 - ------------------------ ----------- Operating revenue $ 34,698,000 Operating income (loss) (76,019,000) Net income (loss) (B) (49,944,000) Net income (loss) per share (B) $ (1.70) Weighted average number of common and common equivalent shares 29,297,000 Subscribers at period end 13,046,000 Quarters Ended ------------------------------------------------------------------------- 1994 January 31 April 30 July 31 October 31 - ---- ---------- -------- ------- ---------- Operating revenue $ 43,694,000 $ 49,313,000 $ 46,415,000 $ 49,664,000 Operating income (loss) 9,153,000 5,260,000 8,278,000 1,508,000 Net income (loss) (C) 8,444,000 3,804,000 6,635,000 1,138,000 Income (loss) per share before cumulative effect of change in accounting for income taxes $ .24 $ .14 $ .23 $ .04 Net income (loss) per share (C) $ .31 $ .14 $ .23 $ .04 Weighted average number of common and common equivalent shares 27,608,000 27,761,000 28,768,000 29,229,000 Subscribers at period end 12,229,000 12,635,000 12,876,000 13,105,000 (A) During the second and third quarters of 1995, the Company recorded pre-tax product abandonment and restructuring charges of $34,156,000 and $10,861,000, respectively, related to the abandonment of certain new product developmental efforts and the related impairment of certain assets and the restructuring of SafeCard and the corporate infrastructure. During the fourth quarter of 1995, the Company recovered $1,200,000 relating to a deposit previously written off in connection with the second quarter product abandonment. (B) During the Transition Period, the Company recorded a pre-tax charge of $65,500,000 related to the change in the amortization periods for subscriber acquisition costs. (C) The first quarter of 1994 includes a $2,000,000 ($.07 per share) positive effect on net earnings from a change in the Company's method of accounting for income taxes. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. CUC INTERNATIONAL INC. (Company) Date: September 16, 1996 By: /s/ Cosmo Corigliano ______________________ ________________________ Name: Cosmo Corigliano --------------------- Title: Senior Vice President --------------------- and Chief Financial Officer EXHIBIT INDEX Exhibit No. Description Page ----------- ----------- ---- 23.1 Consent of Ernst & Young LLP. 23.2 Consent of Deloitte & Touche LLP. 23.3 Consent of Deloitte & Touche LLP. 23.4 Consent of Price Waterhouse LLP. 23.5 Consent of KPMG Peat Marwick LLP. 27 Financial Data Schedule. 99.1 Supplemental Consolidated Financial Statements of CUC International Inc. for the fiscal year ended January 31, 1996 (as restated to reflect the acquisitions of Sierra On-Line, Inc. on July 24, 1996, Davidson & Associates Inc. on July 24, 1996 and Ideon Group, Inc. on August 7, 1996). 99.2 Supplemental Interim Consolidated Financial Statements of CUC International Inc. for the three month period ended April 30, 1996 and for the six month period ended July 31, 1996 (as restated to reflect the acquisitions of Sierra On-Line, Inc. on July 24, 1996, Davidson & Associates, Inc. on July 24, 1996 and Ideon Group Inc. on August 7, 1996). 99.3 Selected Supplemental Consolidated Financial Data of CUC International Inc. (as restated to reflect the acquisitions of Sierra On-Line Inc. on July 24, 1996, Davidson & Associates, Inc. on July 24, 1996 and Ideon Group, Inc. on August 7, 1996). 99.4 Supplemental Management's Discussion and Analysis of Financial Condition and Results of Operations of CUC International Inc. (as restated to reflect the acquisitions of Sierra On-Line, Inc. on July 24, 1996, Davidson & Associates, Inc. on July 24, 1996 and Ideon Group, Inc. on August 7, 1996).