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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 0-25297
SMITH-GARDNER & ASSOCIATES, INC.
(Exact name of registrant as specified in its charter)
FLORIDA 65-0090038
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
1615 SOUTH CONGRESS AVENUE, DELRAY BEACH, FLORIDA 33445-6368
(Address of Principal Executive Offices) (Zip Code)
(Registrant telephone number, including area code): (561) 265-2700
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE PER SHARE (NASDAQ NATIONAL MARKET)
(Title of each Class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of March 7, 2000, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $146,099,196 based on the
closing price on that date of $18.688 per share. As of that date, there were
12,337,988 shares of the registrant's Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by items 10, 11, 12 and 13 of Part III of this
Form 10-K is incorporated by reference to the Definitive Proxy Statement of the
Company relating to the 2000 Annual Meeting of Shareholders.
Certain exhibits listed in Part IV of this Form 10-K are incorporated by
reference from prior filings made by the registrant under the Securities Act of
1933, as amended.
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SMITH-GARDNER & ASSOCIATES, INC. AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
INDEX
PAGE
NUMBER
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 15
Item 3. Legal Proceedings........................................... 15
Item 4. Submission of Matters to a Vote of Security Holders......... 15
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 16
Item 6. Selected Financial Data..................................... 17
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 18
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 26
Item 8. Financial Statements and Supplementary Data................. 26
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 26
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 27
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PART I
This report contains or incorporates by reference forward-looking
statements that are subject to risks and uncertainties. Forward-looking
statements include information concerning the financial condition, results of
operations, plans, objectives, future performance and business of Smith-Gardner
& Associates, Inc. and its subsidiaries (the "Company" or "Smith-Gardner"). The
Company includes forward-looking statements in descriptions of future earnings
and cash flows, anticipated capital expenditures and management's strategies,
plans and objectives. Statements preceded by, followed by or that include the
words "believes," "expects," "anticipates" or similar expressions are generally
considered to be forward-looking statements.
Forward-looking statements involve both known and unknown risks and
uncertainties and actual results or performance may therefore differ materially
from the expected results or performance expressed or implied by the
forward-looking statements. The following important factors, in addition to
factors the Company discusses elsewhere in this report, could affect the
Company's actual results or performance:
- the Company's dependence on the development, introduction and client
acceptance of new and enhanced versions of its software products;
- the Company's ability to control costs;
- the Company's dependence on new product development;
- the Company's reliance on a combination of trade secret, copyright and
trademark law, nondisclosure agreements and technical measures to protect
its proprietary technology;
- the Company's ability to sell its products in new markets within the
direct commerce industry;
- the Company's dependence on proprietary technology licensed from third
parties;
- the Company's ability to continue to resell a variety of hardware
developed and manufactured by third parties;
- competitive pricing for the Company's products;
- customer concentration;
- fluctuations in demand for the Company's products which are dependent
upon the condition of the software and direct commerce industries;
- the Company's ability to collect receivables;
- changes in government regulation;
- the availability to the Company of expansion and acquisition
opportunities on attractive terms;
- the Company's ability to develop and implement systems to manage its
rapidly growing operations;
- the availability of capital to fund Company growth; and
- adverse conditions in the capital markets or in the general economy.
In light of these risks and uncertainties, the forward-looking events
discussed in this report might not occur. The Company undertakes no obligation
to publicly update or revise any forward-looking statements, whether as a result
of new information, future events or otherwise.
ITEM 1. BUSINESS
GENERAL
The Company is a leading provider of end-to-end software solutions and
services to the direct commerce industry. The Company's clients include direct
marketing and catalog companies, Internet-only retailers, fulfillment houses as
well as traditional retailers and manufacturers with significant direct sales
channels. The Company's WebOrder family of software products ("WebOrder") is
designed to automate direct commerce
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activities, including marketing, advertising analysis, sales, telemarketing,
ordering, customer services, merchandising, procurement, electronic and Internet
commerce, warehousing, shipping, accounting and systems operation. The WebOrder
products also provide managers and sales personnel with real-time operations,
inventory and customer data to improve both management decision making and
customer service.
Since its inception in 1988, management of the Company has concentrated on
providing software-based systems and services to leading direct marketing
companies and to retailers and manufacturers with significant direct sales
channels. By focusing on this market, management believes that the Company has
been able to develop a significant industry expertise that has been incorporated
in the functionality of the Company's products and services. The Company's
WebOrder Commerce Engine offers over 3,000 functional options, the ability to
process up to 300,000 transactions per day and is used primarily by companies
with high-volume direct sales operations. WebOrder Enterprise Edition, the
Company's end-to-end Internet commerce solution comprised of WebOrder Commerce
Engine, WebOrder Gateway and WebOrder Publisher, is a highly scalable system
that enables real-time interactive customer ordering and customer services, and
automates the processing of front and back-office functions for companies
selling products over the Internet.
The Company's solutions are used by more than 280 clients located primarily
in North America, Europe and Australia. Smith-Gardner's client base includes
companies such as Nordstrom, RedEnvelope.com, Outpost.com, Egghead.com,
KBkids.com, Hickory Farms, Lego, MicroWarehouse, QVC Network and Time Life.
The Company was incorporated as a Florida corporation in 1988. The
Company's principal offices are located at 1615 South Congress Avenue, Delray
Beach, Florida 33445-6368 and the telephone number at that location is (561)
265-2700.
INDUSTRY BACKGROUND
Historically, the direct commerce industry in the United States principally
consisted of companies engaged in marketing and selling their products and
services through traditional direct marketing channels, such as catalogs, direct
mailings, print ads, telemarketing, television or radio. Typically, the selling
process involved marketers contacting and soliciting potential customers through
these traditional direct marketing channels. Those customers ordered their
products by mail, paid by check and received purchased products by carrier
thereafter. This process normally took four to six weeks due to lengthy
processing times and slow delivery via postal service. As the direct sales
industry matured, the sales process evolved to include toll-free telephone
numbers for ordering and customer service, faster delivery methods and
customers' increasing preference to pay by credit card. Until the mid 1980s, the
direct sales industry remained dominated by companies selling exclusively
through traditional direct marketing channels.
In the last decade, many companies selling exclusively through traditional
direct marketing channels achieved significant success due to their ability to
address growing customer demand for greater convenience and more personalized
service. As a result, many retailers who had previously sold only through retail
outlets entered the direct commerce industry. Examples of such retailers include
Macy's, Bloomingdale's, Nordstrom and Saks Fifth Avenue, which currently market
and sell their products through retail outlets as well as catalogs, direct
mailings and other direct sales channels. The advantages of direct sales for
retailers include an increased ability to target existing clients, better
customer service and decreased costs of operations.
With the emergence and acceptance of the Internet as a business-to-business
and business-to-consumer sales channel and the rapid growth in interactive
Internet commerce, the direct commerce industry has expanded to include a much
broader range of companies. In addition to traditional direct marketing efforts,
direct sales over the Internet has become a new, important sales channel for a
wide range of retailers and manufacturers who traditionally relied predominantly
on in-store sales, large in-house direct sales organizations, independent
distributors, or person-to-person solicitation. Also, the emergence of
Internet-only marketers has further expanded the direct commerce industry.
Examples of these retailers, manufacturers and Internet-only marketers include
Amazon.com, Buy.com, Dell and Egghead.com. The growth in interactive Internet
commerce coupled with increasing competition among store-based and
non-store-based retailers and
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marketers have significantly increased the use of direct marketing and sales
strategies and expanded the range of marketers and retailers deploying such
strategies.
THE DIRECT COMMERCE INDUSTRY TODAY
The direct commerce industry encompasses those companies selling products
directly to customers through direct channels other than traditional in-store
sales, such as catalogs, direct mail, TV infomercials, radio, print ads,
outbound telemarketing, the Internet and other direct sales based channels.
According to a recent study sponsored by the Direct Marketing Association
("DMA"), these marketing channels accounted for approximately $1.4 trillion in
annual sales in the United States in 1998.
According to the DMA, the fastest growing segment within the direct
commerce industry is interactive marketing over the Internet. Companies using
this marketing channel distribute advertising over the Internet via Web-sites or
paid advertisements on targeted third-party sites or browsers and frequently
offer customers the convenience of purchasing merchandise directly through
Internet commerce applications. Since 1994, when interactive marketing results
were first charted, there have been triple digit annual growth rates -- from
156.0 percent per year for business to business ("b to b") advertising
expenditures, to 217.3 percent per year for consumer sales revenue growth. Sales
revenue that results from interactive media expenditures is expected to reach
$11 billion in 1999. Online direct marketing sales are expected to grow annually
by 50.2 percent to reach $84.4 billion in 2004. As in other areas of direct
marketing, projected sales growth rates for the next five years are much higher
than projected growth rates for interactive marketing expenditures.
THE DIRECT COMMERCE SOFTWARE MARKET
As a result of the growth in Internet commerce and the increased use of
multiple direct sales channels, many marketers need to enhance their information
technology solutions to accommodate the direct sales business model. The Company
believes that such companies seek information technology solutions that can help
them effectively manage their order flow from web pages and other direct sales
channels while simultaneously centralizing and automating their front and
back-office operations and managing all aspects of their direct sales
operations. These solutions must be able to integrate seamlessly with the other
systems or applications that these companies currently use, and must enable
real-time information flow to help managers target potential customers, analyze
sales and product strategies, enhance and access customer service records and
synchronize key data. Direct marketing companies, Internet-only retailers and
companies complementing their existing sales strategies with direct sales
channels require systems that are flexible and that support innovative new
marketing initiatives and methods of operation which may be implemented in the
future. Since certain direct commerce marketing segments, particularly the
Internet commerce segment, are growing rapidly, direct sales systems must also
be highly scalable and efficient.
Current technology alternatives for companies with direct commerce
operations are typically comprised of general purpose or retail-oriented
enterprise resource planning ("ERP") software and electronic commerce add-on
applications without real-time access to enterprise databases. This technology
solution is prevalent among companies that traditionally sell through
wholesalers, distributors, in-house sales forces or retail outlets. Another
common technology alternative consists of point solutions targeted to direct
commerce, but with limited breadth and depth of functionality. These point
solutions tend to be difficult to use and do not help managers access and
leverage the enterprise knowledge residing in company databases. In-house
technology solutions are also common in the direct commerce industry, especially
among larger companies. These in-house solutions are typically expensive to
develop, modify and maintain and require a sophisticated in-house software
development staff. Also, technology development is typically not the core
strength of direct commerce companies, and in-house software often lacks the
vision and perspective to keep up with technological change. As a result,
management of the Company believes that a significant opportunity exists for
third-party technology providers to offer enterprise-wide, best-of-breed
software solutions designed specifically for direct commerce.
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THE SMITH-GARDNER SOLUTION
The Company's cornerstone software-based solution is MACS (MailOrder and
Cataloging System), which was renamed WebOrder Commerce Engine in 1999. WebOrder
Commerce Engine is an enterprise-wide, mission-critical software solution
developed specifically for the direct commerce industry. WebOrder Commerce
Engine helps managers of direct commerce companies operate their businesses more
effectively and efficiently by automating operations and making available
real-time information relating to nearly every facet of these companies'
operations. WebOrder Commerce Engine incorporates analytical tools, best-of-
breed methodologies, in-depth functionality and enterprise-wide information
flow. The Company also provides extensive customer support services, custom
development and integration services, consulting, installation and training.
The Company's WebOrder Enterprise Edition is comprised of WebOrder
Publisher, WebOrder Gateway and WebOrder Commerce Engine, providing a real-time
interactive end-to-end Internet commerce solution. WebOrder Enterprise Edition,
first installed in November 1997, positions the Company to benefit from the
strong growth in the Internet commerce segment of the direct commerce industry.
WebOrder Enterprise Edition provides all front and back-office features needed
to manage sales transactions over the Internet including real-time customer
access to inventory availability, order status and customer service functions.
WebOrder enables Internet marketers to effectively manage order flow from Web
pages and other direct sales channels while simultaneously integrating
marketing, sales and back-office operations.
The Company's EuroMACS product offers a solution targeted at direct
commerce companies based abroad. EuroMACS is specifically designed to address
issues that are unique to these companies, such as value-added tax requirements,
multiple currencies, international document formats, local banking and shipping
carrier interfaces, and different mailing and address formats.
The Company's solutions are designed to provide its clients with the
following benefits:
Fully Integrated and Highly Functional Solutions. WebOrder supports
all of the major areas of direct commerce including marketing, advertising
analysis, merchandising, sales, purchasing, accounting, telemarketing,
ordering, customer service, electronic and Internet commerce, warehousing,
shipping, production and systems operation. WebOrder enables real-time
information flow that supports marketing and database analytics and
sophisticated management reports. WebOrder also eliminates potential errors
arising from the maintenance of multiple unsynchronized databases. In
addition to approximately 3,000 standard features, the Company's software
solutions offer approximately 1,500 customization options and enable its
users to tailor this solution to their changing business needs and
processes without disrupting the underlying data model and interrupting the
business.
Versatility and Open Technology Environment. The WebOrder solutions
use open technology and readily integrate with many third-party systems and
software applications. WebOrder Publisher resides on the front-end web
server and runs on Unix, Linux and NT platforms. WebOrder Commerce Engine
resides on a back-end server and runs on HP 3000, HP 9000 and NT platforms.
The solution is ODBC compliant, which enables the exchange of data with
other common computing platforms used by manufacturers and retailers, such
as IBM's AS400 and various other systems. WebOrder has been successfully
integrated with software solutions provided by third-party vendors such as
Island Pacific, Manhattan Associates, PeopleSoft and Great Plains. The
entire direct commerce market can be addressed by its present platforms,
because NT platforms address the lower end of the market and the HP 3000
and 9000 platform addresses the mid to large tier clients.
High Volume Internet Commerce Capability. WebOrder provides an
Internet commerce solution, which incorporates the scalability and
functionality of its proven WebOrder Commerce Engine and can accommodate
the Internet commerce requirements of very large retailers. WebOrder
enables traditional retailers, manufacturers, Internet-only marketers and
other direct commerce companies to add a high volume Internet commerce
channel to their marketing and sales activities without changing their core
ERP systems.
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Processing Scalability and Reduced Operating Costs. WebOrder enables
companies to process up to 300,000 direct sales orders per day, minimize
overhead costs, enhance decision support and data analytics, improve the
efficiency and quality of customer services and streamline overall
operations. WebOrder can also reduce the operating costs that would
otherwise be associated with the ongoing maintenance and updating of
legacy, batch and mainframe systems.
STRATEGY
The Company's objective is to become the world's leading provider of
software solutions to the direct commerce industry. The Company's strategies to
achieve this objective include the following:
Capitalize on Internet Commerce Growth. The Company intends to expand
its marketing and sales of WebOrder to new Internet retailers and other
Internet commerce participants. WebOrder Enterprise Edition, which was
first installed in November 1997, offers a sophisticated, highly scalable
technology solution for Internet commerce activities. Internet commerce is
the fastest growing segment in the direct commerce industry and experienced
a compound annual revenue growth of nearly 250% from 1994 to 1998. To date,
the Company has sold its WebOrder Enterprise Edition to more than 100
clients including companies such as KBkids.com, Outpost.com and Hickory
Farms.
Develop New Product Offerings. The Company is expanding its product
line with new complementary front-end modules that are designed to be
integrated with WebOrder. One such product offering, released in November
1999, is Predictive Response, an online personalization and merchandising
tool designed to increase the conversion rate of web browsers to buyers.
Predictive Response dynamically generates cross-sell and up-sell
recommendations to online customers using advanced collaborative filtering
techniques. The Predictive Response module is a cost effective solution
that is designed to leverage behavioral profiles, purchase history and
rules based logic to stimulate web purchases. The Company believes that
Predictive Response will assist in increasing its users' profitability and
provide a competitive business advantage.
Extend Product Offerings Across New Platforms. The Company will be
focused on its deployment of WebOrder on the Unix platform in 2000. The
Company released the Unix product for beta implementation in December 1999,
and expects to provide general availability of the product in the second
quarter of 2000.
Extend Product Offerings With Strategic Alliances. The Company seeks
to further extend its product line through partnerships with companies
offering best of breed solutions. The Company is establishing a formal
Business Alliance Program targeted at establishing new strategic technology
and service partners to enhance WebOrder software and services. As an
example, the number of partnerships with companies offering complementary
front-end e-commerce solutions such as OneSoft is expected to grow in 2000.
Develop Global Markets. The Company seeks to further develop its
international presence and sales. The Company opened offices in the United
Kingdom and Australia in mid-1997 and has since added approximately 50
employees to its international operations. The Company plans to add
additional offices in Western Europe in the future. The Company intends to
leverage its strong domestic presence to increase its sales in
international markets, particularly in Europe and Australia.
Increase Sales to Existing Clients. In 2000, the Company's product
marketing management team and the aftermarket sales team intend to build on
the momentum begun in 1999 for selling optional product modules to its
existing clients. Optional modules such as Predictive Response, Computer
Telephony Integration (CTI), Inventory Forecasting, and other new modules
planned for release in 2000 are examples of the optional modules expected
to be marketed to existing and new clients.
Expand Direct Sales Force. The Company intends to increase the size
of its current sales force in order to expand its marketing of existing
products and modules. In addition, the Company is creating new sales teams
and intends to hire additional sales personnel to market and sell its
products to the growing
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direct commerce industry. The Company also intends to add offices in
Western Europe and to hire additional sales personnel to service
international markets.
Expand Service Offerings. The Company's consulting and service
offerings are critical components of its client-driven solution. The
Company intends to continue to expand its comprehensive consulting and
client support services to facilitate the timely installation,
implementation and effective utilization of its products. For example, in
1999, the Company added a northeast based training center in addition to
its existing West Coast and Florida based training centers.
Pursue Strategic Opportunities. The Company believes that the market
for software which automates direct commerce operations is highly
fragmented and rapidly evolving, with many new product introductions and
many large and small industry participants. These factors may create the
opportunity to effect strategic transactions, including acquisitions,
alliances or other partnerships, in order to increase the breadth of the
Company's product offerings, establish new sales and marketing channels and
exploit evolving market opportunities. While the Company presently has no
commitments to effect any such transactions, it intends to pursue such
opportunities in order to enhance further its competitive position as the
marketplace evolves.
PRODUCTS
The WebOrder family of products offers an integrated, flexible, modular
solution for front and back-office operations, decision support analytics,
Internet commerce marketing and transaction processing functionality. The first
version of the WebOrder Commerce Engine (previously marketed as MACS) was
installed in 1990. In 1997, the Company released a new Internet based end-to-end
solution called WebOrder Enterprise Edition, which consists of WebOrder
Publisher, WebOrder Gateway and WebOrder Commerce Engine. Additionally, the
Company introduced WebOrder Standard Edition in 1999, which is comprised of
WebOrder Gateway and WebOrder Commerce Engine and facilitates the use of third
party or in-house proprietary e-commerce front-end applications. Also part of
the WebOrder family is EuroMACS, which was designed to accommodate specific
European business requirements and was introduced by the Company in January
1998.
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The following chart summarizes the current WebOrder products and typical
users:
PRODUCT DESCRIPTION OF FUNCTIONS TYPICAL USERS
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WEBORDER ENTERPRISE EDITION End-to-end direct commerce Direct marketing companies,
(comprised of WebOrder solution that includes Internet-only based companies,
Commerce Engine, WebOrder software running on the web and traditional retailers and
Gateway, and WebOrder server and back-end commerce manufacturers with significant
Publisher) server. It automates and direct sales channels with
integrates all major daily transaction volumes of
functional areas of direct up to 300,000.
commerce companies that sell
through the Internet,
catalogs, direct mail,
telemarketing, print ads
telephone, mail, television,
radio and other direct sales
channels; includes over 3,000
functions encompassing
marketing, advertising, sales,
merchandising, purchasing,
accounting, shopping cart and
taking orders, customer
services, warehousing,
shipping, production and
systems operation; displays
real-time management
information by maintaining
mini data marts for each
functional area.
WEBORDER STANDARD EDITION Back-end direct commerce Direct marketing companies,
(comprised of WebOrder system with capability to Internet-only based companies,
Commerce Engine and WebOrder interface with 3rd party or and traditional retailers and
Gateway) in-house e-commerce front end manufacturers with significant
applications; incorporating direct sales channels with
all the features of the daily transaction volumes of
WebOrder Enterprise Edition up to 300,000.
except for the WebOrder
Publisher module which
includes the web server CGI's
and HTML web page templates.
WebOrder Standard Edition
offers integration of the
back-end and e-business
software of the WebOrder
Commerce Engine and WebOrder
Gateway to a 3rd party
front-end system which
provides web customers
real-time, secure information
including inventory
availability, order status and
customer service functions.
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PRODUCT DESCRIPTION OF FUNCTIONS TYPICAL USERS
- ------- ------------------------ -------------
EUROMACS WebOrder Commerce Engine International-based direct
modified to accommodate the commerce companies and
needs of clients located traditional retailers selling
abroad in areas relating to through direct sales channels,
value-added tax requirements, with daily transaction volumes
international mailing address of up to 300,000.
formats, and interfacing with
international shipping
carriers and banking
institutions.
The prices of WebOrder Enterprise Edition, WebOrder Standard Edition and
EuroMACS, range from $20,000 to more than $5 million, depending on the number of
users and CPUs required.
In addition to the current WebOrder products, there are a number of
optional modules available to WebOrder users. The following chart summarizes the
functions and benefits of the more widely used optional modules:
MODULE DESCRIPTION OF FUNCTIONS BENEFITS
- ------ ------------------------ --------
Point of Sale................. Interfaces with catalog Enables companies to run a
customer database and store and a direct commerce
facilitates the display of company via one centralized
separate store inventories; database.
provides cash register
processing and optional drop
shipping of unavailable items.
Data Mining System ("DMS").... Provides access to customer Assists clients in increasing
and business information and profitability and provides
facilitates decision support clients a competitive business
needs. advantage.
Assembly...................... Facilitates the procurement of Enables companies to run light
raw materials and creates manufacturing operations.
bills of materials to track
assembly process; tracks costs
of assembly (including labor
and machine time) and
forecasts demand for raw
materials.
Continuity.................... Enables negative option-type Streamlines operations of
promotions and facilitates companies that sell books,
monthly club programs, records, videos and other
customer maintenance continuing-demand products.
procedures and other incentive
programs.
Installment Billing........... Facilitates installment Enables billing of customers'
payments, returns and credit cards in multiple
cancellations. installments.
Outbound Telemarketing........ Uses existing selection Enables companies to become
criteria and MACS database to more proactive in selling to
create campaigns; automates existing customers and
customer service and prospects.
solicitation functions.
Computer Telephony
Integration................. Provides a caller ID feature Decreases telephone line and
which facilitates. personnel costs.
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MODULE DESCRIPTION OF FUNCTIONS BENEFITS
- ------ ------------------------ --------
(CTI)......................... order entry and customer associated with a phone
service functions. operator requesting customer
information to search the
database and bring up their
account.
PREDICTIVE RESPONSE........... Facilitates dynamic cross-sell Enables companies to increase
and upsell recommendations to conversion of web browsers to
online customers using buyers and increase the
behavioral profiling, past average dollars per order.
purchase history and rules
based logic. Automatic e-mail
routing based on keywords.
E-MAIL RESPONSE MANAGEMENT
SYSTEM...................... Automatic e-mail routing based Enables companies to
on keywords. Intelligent efficiently manage all inbound
e-mail responses can be driven customer e-mails and automate
from predefined templates and the response process.
the knowledge database.
INTERNET GIFT REGISTRY Offers customers the ability Enables companies to
to create "wish lists" and facilitate the gift purchasing
gift registries for personal process for their customers
use or for sharing with via the Internet.
friends and family.
WIRELESS APPLICATION PROTOCOL
(WAP)....................... WebOrder marketing, ordering Enables companies to increase
and customer service functions sales penetration by offering
via wireless devices (mobile ordering and service
phones, digital assistants, capabilities via wireless
etc.). devices.
Pricing for these optional modules is based on individual user requirements
and needs.
WebOrder's back-end commerce engine operates in a HP Series 3000, MPE/iX
environment, HP 9000 Unix environment or Microsoft Windows NT environment.
WebOrder is a scalable, fully upward compatible computer system in which all
hardware upgrades are performed at the CPU site. The main programming language
used for WebOrder is COBOL, although some functionality is written in C++ and
Visual Basic.
All HP3000 and HP9000 WebOrder systems provide high online transaction
processing performance and functionality and support major networking protocols
such as OSI, TCP/IP, SNA, and OSF/DCE. The Company has developed its own TCP/IP
Application Program Interface ("API"), which serves as the foundation to
communicate directly between WebOrder and the Internet. This socket-based API
also has the ability to communicate with other Windows-based applications.
WebOrder requires a Microsoft Internet information server and communicates with
the HP3000 or HP9000 through the Company's own API. The API enables WebOrder to
communicate with other platforms through an exchange of data from WebOrder to
databases including Oracle, Microsoft SQL Server and Microsoft Access.
PRODUCTS UNDER DEVELOPMENT
The Company is currently developing new products in response to demands
presented by companies in the direct commerce marketing industry including:
Enterprise Marketing
Automation Suite............ Internet Campaign Management, Direct commerce companies
Web Content Management, selling through the Internet.
Customer Relationship
Management, DataMining, and
Analytics
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The Company expects to introduce the Enterprise Marketing Automation Suite
of products during the next twelve to eighteen months.
CLIENTS
The Company's clients include traditional direct marketing and catalog
companies, Internet-only based retailers, fulfillment houses, and traditional
brick and mortar retailers and manufacturing companies with significant direct
sales operations. The Company generally targets leading direct commerce
companies in their respective industry segments. The Company has sold its
products to more than 280 clients. The following is a representative list of the
Company's clients as of December 31, 1999, generally categorized by industry
segment:
APPAREL/SHOES GENERAL MERCHANDISE GIFTS
Coldwater Creek, Inc RedEnvelope.com
dELiA*s KBkids.com
Huntington Clothiers, Inc Lego Direct Marketing, Inc.
Nine West Group Brookstone, Inc.
Nordstrom, Inc. Hammacher Schlemmer
COMPUTER SOFTWARE/HARDWARE TV HOME SHOPPING
Creative Computers Arcadia
Outpost.com, Inc. The Shopping Channel
Egghead.com, Inc. Littlewoods
Micro Warehouse QVC Network, Inc.
Multiple Zones International Inc.
EDUCATIONAL
SUPPLIES/BOOKS OTHERS
BigWords.com JC Penney Logistics, Inc.
Marboro Books Corp. (Barnes & Zomax
Noble) United Methodist Publishing House
Rodale Press, Inc United States Mint
Time Life, Inc.
FOOD AND BEVERAGE
eCandy.com
Ethel M. Chocolates
Hickory Farms, Inc
Wine Enthusiast
None of the Company's clients accounted for more than 10% of the Company's
revenue in 1999, 1998 or 1997. For the year ended December 31, 1998, the
Company's two largest clients, United States Mint and Multiple Zones, in the
aggregate accounted for 16.8% of the Company's revenue. In 1997, the Company's
three largest clients, Genesis Direct, Inc., dELiA*s and KAO Infosystems Co., in
the aggregate accounted for 18.6% of the Company's revenue.
CLIENT SERVICES
Client Support
The Company believes that a high level of service and support is critical
to its success and an important competitive advantage. The Company's
installation teams consist of a project manager, a technical lead, two support
analysts and as many installers or trainers as are required for a given
installation. The installation teams configure the system for new clients,
install the software, set all the proper control switches, train the client's
executives and managers, and resolve all installation issues for up to three to
six months after the client begins processing orders through the system.
Thereafter, the Company transitions the client to its standard
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support services provided by the Company. The Company's installation teams
completed 32 installations of WebOrder in 1997, 46 installations in 1998, and 77
installations in 1999.
The Company's client support function is responsible for servicing its
clients after the initial implementation project is complete. The Company has
client support operations in the United States and the United Kingdom and
currently supports approximately 280 clients in over 17 countries. These
operations enable the Company to respond more quickly and effectively to the
needs of its multinational and international clients. Approximately 80% of
current WebOrder users participate in the Company's support services program.
The Company believes that a close and active service and support
relationship is important to client satisfaction and also provides the Company
with information regarding evolving client requirements. For example, the
Company assigns to each of its clients an Account Manager who is responsible for
the account. Each Account Manager has a dedicated team of Support Analysts
reporting to their team to ensure that issues are resolved in an expedient
manner. In addition, the Company provides telephone support from 8:00 a.m. to
9:00 p.m. (EST) weekdays and 24 hours-a-day for emergencies, and uses electronic
bulletin boards and other forms of electronic distribution to provide clients
with the latest information regarding the Company's products.
In general, the Company provides two kinds of support: standard and Major
Account. The Company's standard support services provide complete, full time
technical support. When a client calls the Company with a question or issue, it
is initially reviewed by the Account Manager and then assigned to a team member
for resolution. More complex issues can then be referred to the Company's
technical support team and, if necessary, to the Company's programming unit. The
Company provides its clients with telephone support to give timely responses to
systems issues. The Company continually communicates with its clients through
newsletters and seminars, and Account Managers provide weekly reports to each
client detailing the status of the account. Event schedules, product enhancement
requests and electronic mail are available to clients on the Company's Internet
web site as well. In addition, this Internet support site contains a knowledge
database where searches can be done based on key-words, a section for frequently
asked questions and how-to's, an archive of release notes for current and prior
upgrades, as well as a complete set of on-line user documentation.
The Company's Major Account support services provide premier technical
service for its larger clients through the assignment of a dedicated Account
Manager and a team of support personnel. For these clients, the Company
maintains a copy of their production software environment on the Company's
client support system to enable the Account Manager to expedite the resolution
of all client issues. The Company believes that such services build a strong
strategic relationship, which enhances the future business prospects of the
Company.
Support contracts are typically service agreements pursuant to which
clients pay a monthly fee based on a percentage of the total software license
fee. Installation and training are included in the initial license fee.
Depending on the services delivered, support services typically are priced at
18% to 20% of the total license fee per year and include, without charge, any
new version releases of software. Major Account services are typically priced
based on the level of support services provided and number of CPU's.
The Company's Client Services function contains a separate specialized
group for WebOrder Implementation and Support. This group is responsible for
assisting the customers with the implementation of the WebOrder Gateway and
WebOrder Publisher, as well the resolution of all related issues.
As of December 31, 1999, the Company employed 158 client support services
personnel, consisting of 52 implementation, 79 standard support, 19 major
account support and 8 Web Implementation and Support personnel.
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Consulting and Customization
The Company's consultants conduct site examinations and assist clients in
developing and implementing advanced WebOrder strategies. With significant
experience in the direct commerce industry, the Company's consultants provide
practical and proven direction in developing strategies which apply
best-practice WebOrder methodologies that meet the client's requirements.
Depending on the client's needs, the Company offers:
- Requirements analysis and WebOrder software evaluation services;
- Advanced WebOrder methodology consulting;
- Benchmarking and other advanced strategy workshops involving clients and
industry experts;
- Integration services and technical consulting in areas such as data
conversion, system interfaces and database/network tuning;
- Project management services intended to lead the client through the
implementation activities required to achieve successfully the client's
business objectives; and
- Custom programming for system enhancements and system interfacing.
Consulting and customization services are delivered directly by the Company
but are also delivered in conjunction with third-party service providers such as
systems integrators and specialist consulting firms.
Training and Education
The Company offers a variety of standard and customized training and
education services at client sites, at the Company's headquarters in Delray
Beach, Florida, and at selected regional sites throughout the country. Upon the
installation of WebOrder, the Company provides a two week training course for
each client's staff. The training curriculum is delivered by specialists who
utilize proven education techniques and advanced technology. The Company also
offers 48 courses per year for training in the application of its WebOrder
products through the Smith-Gardner Academy. The Company also offers a "train the
trainer" program in which the Company trains client employees designated as
trainers within their organization. These trainers are educated in both training
techniques and the optimal use of the Company's products. The Company believes
its train-the-trainer methodology is a crucial element in the success of its
implementations, which often span multiple departments, plants and countries.
Continuing education and training is delivered through standard courses with
package prices or can be contracted for on a time and materials basis.
SALES AND MARKETING
The Company markets and sells its products and services to new prospects
and existing clients primarily through its direct sales force. These personnel
are trained in the Company's products and service offerings and in the
operations of the Company's clients. The Company's personnel use a
"consultative" selling approach, because the sales process requires an
understanding of the direct commerce industry as well as comprehensive computer
and systems expertise.
The Company's sales force is supported by marketing personnel who generate
and qualify leads through advertising and marketing campaigns, produce product
literature, periodic newsletters and direct mail campaigns, arrange attendance
at trade shows and conventions, and sponsor seminars. The marketing department
also supports the sales force with appropriate documentation or presentation and
demonstration materials for use during the sales process. The Company also
supports its direct sales and marketing force with a group of systems
engineering professionals, many of who also possess vertical market and
practical WebOrder expertise.
As of December 31, 1999, the Company employed 42 sales and marketing
personnel (37 domestically and 5 internationally), consisting of 26 sales
representatives and 16 marketing and other support personnel.
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The Company's method of marketing and selling to a new prospect consists of
identifying the prospect, qualifying the prospect and, if the prospect is
qualified, preparing and presenting a sales proposal. The prospecting process
includes placing advertisements in trade publications, acquiring mailing lists,
telemarketing, direct mailing, conducting seminars and participating in trade
shows to generate leads for the direct sales force. Once a prospect is
qualified, the appropriate direct sales personnel visit the prospect to
understand the prospect's specific requirements. This process usually results in
the preparation of a written proposal describing the hardware, software and
services that meet the prospect's requirements. While the Company's sales
personnel generally make the initial sales contact, large and complex
installations generally involve the use of the Company's professional services
group. This group works closely with the sales team to identify the optimal
configuration of WebOrder required for such prospects. This sales cycle
typically ranges from three to six months.
The Company has executed a hardware resale agreement with Client Systems,
Inc., a distributor of HP products. The Company also has a strategic
relationship with Hewlett-Packard consisting of cooperative marketing and sales
activities in the direct commerce industry. Currently, the Company is one of the
leading resellers of the HP3000 products.
The WebOrder user community and the Company have organized an international
users' group whose advisory committee plays an important role in helping the
Company develop and refine its WebOrder products and services strategies. In
addition, the Company hosts an annual World Conference, which includes
presentations by the Company and clients concerning the features and
capabilities of the Company's products. The Company also participates in trade
conferences worldwide to promote global sales and use of the WebOrder products.
All of these conferences include workshops, round table discussions and special
sessions devoted to products, technologies and WebOrder methodologies. More than
400 attendees participated in the Company's 1999 SG World Conference held in
Delray Beach, Florida
RESEARCH AND DEVELOPMENT
The Company's business analysis, programming, quality assurance and
advanced technologies teams perform the Company's research and development
function. The business analysis group performs the functional and technical
requirements for the enhancements that are requested either from the Company's
clients or internal product management group. The programming group is
responsible for the WebOrder software maintenance and enhancement process. The
Company uses a version and patch approach to software release control and
uniformly maintains a current version of each of its products, which is not
subject to enhancements, and a development version, which is regularly enhanced.
The Company releases quarterly patch updates of its current versions upon code
corrections and believes that this process maximizes the stability of its
products, which is critical to the day-to-day operations of a direct commerce
company. The quality control group tests the software each time it passes
through the business and programming groups and performs regression testing
prior to the release of any patch updates or new releases. The advanced
technologies group is responsible for the identification and initial development
of new technology opportunities.
The Company follows a structured development methodology to ensure the
timely and cost-effective production of high-quality software. The Company has a
formal process through which clients may have input as to modifications of the
Company's products and believes that this input helps it deliver a leading
industry solution to its current and prospective clients.
As of December 31, 1999, the research and development staff consisted of 92
employees globally. From time to time, the Company has also engaged outside
consultants in its product development efforts. Total expenses for research and
development in the fiscal years ended December 31, 1997, 1998 and 1999 were
approximately $2.0 million, $2.3 million and $3.4 million, respectively. No
software development costs were capitalized in fiscal 1997, 1998 or 1999. The
Company anticipates that it will continue to commit substantial resources to
product development in the future.
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COMPETITION
The market for direct commerce software is competitive, rapidly evolving
and highly sensitive to new product introductions and marketing efforts by
industry participants. This market is also highly fragmented and served by ERP
software providers, electronic commerce software providers, consulting firms and
point solution providers targeting the direct commerce industry. The Company's
products also compete with information systems developed and serviced internally
by in-house MIS departments. Although the Company believes that none of its
competitors currently compete against the Company in all industry segments,
there can be no assurance that such competitors will not compete against the
Company in the future in additional industry segments. Many of the Company's
potential future competitors may have significantly greater financial, technical
and marketing resources, generate higher revenues and may have greater name
recognition than does the Company. In addition, as the Company expands into new
segments of the direct commerce industry, such as Internet commerce, it will
face competition from other software companies, MIS departments and unforeseen
sources. Compared with the Company, these competitors may have greater
resources, operating experience, credibility and relationships in such new
segments. Although the Company believes that it currently competes favorably in
all industry segments and against all competitors, there can be no assurance
that it will do so in the future.
PROPRIETARY RIGHTS AND LICENSES
The Company primarily relies on a combination of copyright, trademark and
trade secret laws, unpatented proprietary know-how, license agreements,
non-disclosure and other contractual provisions and technical measures to
protect its proprietary rights in its products and technology. The Company
typically distributes its software products under software license agreements
which contain, among other things, provisions limiting the use, copying and
transfer of the licensed program. The Company has obtained a United States
copyright registration for the source code of certain of its WebOrder software.
The Company currently has operations in the United States, Australia and
the United Kingdom, and its products are licensed for use by clients in over 17
countries. The Company has registered MACS, MACSII, MACSIII, EUROMACS, THE
MACSIMUM and the "SG" logo as trademarks in the United States. The Company also
has applied for the registration as trademarks in the United States of
MACSACCESS, VISUALMACS, WEBORDER, PREDICTIVE RESPONSE and "SMITH-GARDNER". The
Company believes that international protection and enforcement of intellectual
property rights for software products in particular may be more limited than in
the United States. Specifically, intellectual property laws in certain countries
may not protect software companies from the loss of intellectual property rights
through reverse engineering.
The Company has entered into several agreements regarding the integration
of the intellectual property of third parties into its products. Parties to such
agreements include Cognos, First Logic, GTS and DISC.
The Company generally enters into confidentiality agreements with employees
and clients which limit rights and access to, and distribution of, any
proprietary or confidential information. Furthermore, employees execute
agreements requiring disclosure and assignment to the Company of all of the
intellectual property rights associated with any ideas, concepts, techniques,
inventions, processes, or works of authorship relating to the business of the
Company and developed or created during the course of performing work for the
Company or its clients.
The Company does not believe that any of its products infringe the
proprietary rights of third parties. There can be no assurance that the steps
taken by the Company to protect its proprietary rights will be adequate to
prevent misappropriation of its technology or development by others of similar
technology. Because the software development industry is characterized by rapid
technological change, however, the Company believes that factors such as the
technological and creative skills of its personnel, new product developments,
frequent product enhancements, industry reputation and client support are more
important to establishing and maintaining a leadership position than the various
legal protections available for its technology.
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EMPLOYEES
As of December 31, 1999, the Company had a total of 337 full-time employees
in the United States: 75 in product development, 37 in sales and marketing, 47
in training and professional services, 158 in client support services and 20 in
management, administration and finance. In addition, as of December 31, 1999,
the Company had 49 employees in the United Kingdom and 2 employees in Australia.
None of the Company's employees are subject to a collective bargaining
agreement, and the Company has not experienced any work stoppages. The Company
believes that its employee relations are good.
ITEM 2. PROPERTIES
The Company is headquartered in Delray Beach, Florida, where it leases
approximately 73,000 square feet of office space pursuant to a lease that
expires in December 2006. The annual rent expense under such lease is
approximately $940,000. The Company also leases office space in the United
Kingdom and Australia to house its operations abroad. The annual rent under such
leases is approximately $100,000 and $30,000, respectively. The Company also
leases office space in Texas and Maryland for certain of its marketing and sales
activities. The annual rent under such leases is $3,600 and $7,200,
respectively. The aggregate annual facility lease payments of the Company during
the fiscal year ended December 31, 1999 was $508,899. The Company is currently
evaluating the need for additional facilities domestically and abroad to
accommodate additional marketing and sales activities, and believes that it will
be able to obtain such space on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
In November 1995, Robelle Consulting Ltd. ("Robelle") filed suit against
the Company and Allan J. Gardner in United States District Court for the
Southern District of Florida. Robelle alleged copyright and trademark
infringement, breach of contract, and unfair competition arising out of the
Company's distribution of two of Robelle's software products which had been
incorporated as part of WebOrder. Robelle sought, among other relief, an
indeterminate amount of damages. In January 1998, Robelle was granted summary
judgment with respect to its copyright infringement claim for one of the Robelle
products, but was denied summary judgment as to its claim for statutory damages
for such infringement and denied several of its damages claims. In February
1998, the Company filed a suit against Robelle in Circuit Court in Palm Beach
County, Florida. The Company alleged that Robelle wrongfully terminated its VAR
License Agreement with the Company and breached the terms thereof. Robelle
denied any wrongdoing.
On October 26, 1999 the Company entered into a settlement agreement with
Robelle. Under the terms of the settlement agreement, the Company paid to
Robelle the sum of $100,000, which was paid on October 27, 1999. In addition,
the Company also agreed to pay $90,000 on or before April 14, 2000. These
amounts were provided for at December 31, 1998 in the consolidated financial
statements. Under the terms of the Settlement Agreement, each party agreed to
dismiss all suits filed against the other party, and to mutually release all
claims in connection with the subject matter of such suits.
From time to time, the Company is involved in other legal proceedings
incidental to the conduct of its business. The Company believes that this other
litigation, individually or in the aggregate, to which it is currently a party
is not likely to have a material adverse effect on the Company's business,
financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock began trading in the NASDAQ National Market
under the symbol "SGAI" on January 29, 1999. Accordingly, market price
information is not available for 1998. The following table sets forth the range
of high and low bid prices for the company's common stock for the period from
January 1999 to December 1999, as reported by NASDAQ. The quotes represents
"Inter-dealer" prices without retail markups, markdowns or commissions and may
not necessarily represent actual transactions.
HIGH LOW
------- ------
First Quarter............................................... $21.875 $9.750
Second Quarter.............................................. 16.625 7.875
Third Quarter............................................... 10.750 6.938
Fourth Quarter.............................................. 21.375 7.375
As of March 7, 2000, there were 12,337,988 shares of Common Stock
outstanding, held by 58 stockholders of record. The Company believes that
certain holders of record hold a substantial number of shares of Common Stock as
nominees for a significant number of beneficial owners. The closing price for
the Company's Common Stock on March 7, 2000 was $18.688 per share.
The Company terminated its S Corporation election effective January 1, 1999
in connection with its initial public offering (the "Offering"). As an S
Corporation, the Company paid dividends to its shareholders from time to time in
part to partially fund or offset their tax liability with respect to S
Corporation earnings. In 1995, in connection with the sale of $12.0 million
aggregate principal amount of convertible debentures (the "Convertible
Debentures"), the Company paid an aggregate dividend to its shareholders in the
amount of $12.0 million and an additional $3 million to offset its shareholders'
1995 tax liability. In September 1998, the Company; paid an aggregate dividend
to its shareholders in the aggregate amount of $70,610 to offset its
shareholders' 1997 tax liability. In September 1999, the Company, pursuant to an
agreement with its pre-Offering shareholders, made a distribution in the amount
of approximately $835,000 which represented the shareholders' individual income
tax liabilities for the period beginning January 1, 1998 and ending on December
31, 1998.
The payment of dividends is within the discretion of the Board of
Directors. It is the present intention of the Board of Directors to retain all
future earnings for use in the Company's business operations and, accordingly,
the Board does not anticipate declaring any dividends in the foreseeable future.
USE OF PROCEEDS FROM REGISTERED SECURITIES
In connection with the Offering, the Company's Registration Statement on
Form S-1 (No. 333-63125) (the "Registration Statement") was declared effective
on January 28, 1999. Pursuant to such Registration Statement, on February 3,
1999, the Company and certain selling shareholders sold 4,000,000 and 410,000
shares of Common Stock, respectively, at a price of $12 per share. The managing
underwriters for this sale of Common Stock were BT Alex. Brown Incorporated and
SoundView Technology Group (collectively, the "Underwriters"). On March 3, 1999,
pursuant to the Underwriters' over-allotment option, the Company sold an
additional 661,500 shares of Common Stock at a price of $12 per share. All of
the securities offered by the Registration Statement were sold in the Offering
and thereafter the Offering terminated. The aggregate gross proceeds to the
Company in connection with the Offering were approximately $55.9 million. The
total expenses incurred in connection with the Offering, including underwriting
discounts and commissions, and fees for registration, legal, accounting,
transfer agent, printing and other miscellaneous fees, were approximately $5.1
million, resulting in net offering proceeds of approximately $50.8 million to
the Company.
As of March 7, 2000, the net proceeds of the Offering have been used as
follows: (i) $12.0 million to redeem all of the 12,000 shares of redeemable
preferred stock, par value $.01 per share and $1,000 per share preference value
(the "Redeemable Preferred Stock"), issued to certain lenders (Advent VII L.P.,
Advent Atlantic and Pacific II L.P., Advent Industrial II L.P., Advent New York
L.P., Chestnut Capital Interna-
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tional III Limited Partnership and TA Venture Investors Limited Partners (each a
"Lender" and collectively the "Lenders")) upon the conversion of the Convertible
Debentures, (ii) approximately $4.7 million to pay accrued interest due and
payable on the Convertible Debentures, and (iii) approximately $835,000 in the
form of a distribution to Wilburn Smith, Allan J. Gardner and Thomas Quigley,
who were the Company's sole shareholders prior to the Offering, in the aggregate
amount representing the individual income tax liability of each of such
shareholders for the period beginning January 1, 1998 and ending on December 31,
1998, the date immediately preceding the Company's voluntary S Corporation
revocation. The remaining net proceeds are being used for working capital,
capital expenditures and for general corporate purposes.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below as of December 31,
1998 and 1999 and for each of the years in the five-year period ended December
31, 1999 are derived from the Consolidated Financial Statements of the Company
which have been audited by KPMG LLP, independent public accountants. The
Company's consolidated balance sheets as of December 31, 1999 and 1998, and
consolidated statements of operations for each of the years in the three year
period ended December 31, 1999 appear elsewhere in this report. The following
data should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and the Consolidated Financial
Statements and Notes thereto, included elsewhere in this report.
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenue:
License fees and software sales................ $26,102 $18,097 $ 8,471 $ 5,932 $ 6,594
Computer hardware sales........................ 8,598 6,703 4,757 7,370 13,641
Support........................................ 7,630 5,335 4,100 4,038 3,343
Services....................................... 4,268 3,567 1,324 1,189 1,351
------- ------- ------- ------- -------
Total revenue.......................... 46,598 33,702 18,652 18,529 24,929
Cost of sales and services:
License fees and software sales................ 7,957 7,371 3,956 585 808
Computer hardware sales........................ 6,372 4,916 3,558 5,805 10,607
Support........................................ 5,050 3,222 3,271 3,141 2,491
Services....................................... 3,165 2,271 1,104 902 1,016
------- ------- ------- ------- -------
Total cost of sales and services....... 22,544 17,780 11,889 10,433 14,922
------- ------- ------- ------- -------
Gross Profit..................................... 24,054 15,922 6,763 8,096 10,007
Operating expenses:
General and administrative..................... 8,061 6,538 4,567 4,776 3,206
Research and development....................... 3,421 2,254 2,011 2,254 2,166
Sales and marketing............................ 5,585 2,430 1,482 980 523
------- ------- ------- ------- -------
Total operating expenses............... 17,067 11,222 8,060 8,010 5,895
------- ------- ------- ------- -------
(Loss)income from operations................... 6,987 4,700 (1,297) 86 4,112
Other income (expense):
Interest expense:
Interest on outstanding debt................... (165) (1,800) (1,500) (1,200) (1,200)
Amortization of original issue discount(1)..... -- -- (680) (1,378) (1,378)
Interest income.................................. 1,749 102 109 42 129
------- ------- ------- ------- -------
Total interest income (expense), net... 1,584 (1,697) (2,071) (2,536) (2,449)
------- ------- ------- ------- -------
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1999 1998 1997 1996 1995
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Income (loss) before provision for income
taxes.......................................... 8,571 3,003 (3,368) (2,450) 1,663
Provision for income taxes....................... (3,048) -- -- -- --
------- ------- ------- ------- -------
Net income (loss)................................ $ 5,523 $ 3,003 $(3,368) $(2,450) $ 1,663
======= ======= ======= ======= =======
Net income (loss) per share:
Basic.......................................... $ 0.48 $ 0.57 $ (.64) $ (.47) $ .32
======= ======= ======= ======= =======
Diluted........................................ $ 0.44 $ 0.50 $ (.64) $ (.47) $ .22
======= ======= ======= ======= =======
Weighted average shares used in calculating net
income (loss) per share:
Basic.......................................... 11,622 5,263 5,263 5,263 5,263
======= ======= ======= ======= =======
Diluted........................................ 12,426 8,131 5,263 5,263 7,519
======= ======= ======= ======= =======
Pro forma data (unaudited):
Income (loss) before income tax (expense)
benefit..................................... $ 8,571 $ 3,003 $(3,368) $(2,450) $ 1,663
Pro forma income tax (expense) benefit
(unaudited)(2)................................. (3,378) (1,215) 948 360 (1,155)
------- ------- ------- ------- -------
Pro forma net income (loss) (unaudited)(2)....... $ 5,193 $ 1,788 $(2,420) $(2,090) $ 508
======= ======= ======= ======= =======
1999 1998
------- --------
BALANCE SHEET DATA:
Cash and cash equivalents..................... $39,246 $ 1,577
Working capital............................... 43,335 3,904
Total assets.................................. 51,468 9,470
Convertible debt and accrued interest(1)...... -- 16,500
Stockholders' equity (deficit)(1)............. 45,162 (10,951)
- ---------------
(1) The fair value of the conversion features of the Convertible Debentures was
determined to be $3.5 million based on the difference between the stated
interest rates and the estimated market rate of such Convertible Debentures
on the date of issuance. The amount is included in additional paid-in
capital in the accompanying consolidated balance sheet, with the resulting
OID on the convertible debt being amortized from the date of issuance
(December 19, 1994) to the date the security first became convertible (June
30, 1997). This interest expense is a non-cash item.
(2) Prior to completing its initial public offering of Common Stock and as a
result of its election to be treated as an S Corporation for income tax
purposes, the Company was not subject to federal or certain state income
taxes. Upon the Company's voluntary revocation of its S Corporation status
effective January 1, 1999, the Company is subject to federal and certain
state income taxes at applicable rates for a C Corporation. The unaudited
pro forma income tax (expense) benefit presented in the consolidated
statements of operations represents the estimated taxes that would have been
recorded had the Company been a C Corporation for income tax purposes for
each of the periods presented.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING SHOULD BE READ IN CONJUNCTION WITH THE COMPANY'S CONSOLIDATED
FINANCIAL STATEMENTS AND THE RELATED NOTES THERETO INCLUDED ELSEWHERE HEREIN.
OVERVIEW
The Company is a leading provider of mission-critical, enterprise-wide
software solutions, and related hardware and services, to the direct commerce
industry. The Company's clients in the direct commerce industry are traditional
direct marketing companies and Internet-only retailers, as well as wholesalers,
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fulfillment houses and retailers with significant non-store sales channels. The
Company's WebOrder family of software products is designed to automate direct
commerce activities, including advertising analysis, sales, telemarketing,
ordering, merchandising, procurement, electronic and Internet commerce,
warehousing, shipping, accounting and systems operation. The WebOrder products
also provide managers and sales personnel with real-time operations, inventory
and customer data to improve both management decision making and customer
service.
Since its inception in 1988, management of the Company has concentrated on
providing software-based systems and services to leading direct commerce
companies and to retailers, wholesalers and fulfillment houses with significant
non-store sales channels. By focusing on this market, management believes that
the Company has been able to develop a significant industry expertise that has
been incorporated in the functionality of the Company's products and services.
The Company's WebOrder products offer over 3,000 functional options, process up
to 300,000 transactions per day and are used primarily by companies with high-
volume direct commerce operations. WebOrder enables real-time interactive
customer ordering, and automates processing and back-office operations for
companies selling products or services over the Internet.
In 1997, the Company's net loss was attributable to a number of factors,
including the Company's continued investment in infrastructure. To accommodate
its new client sales and to fuel potential future revenue growth, the Company
increased its number of installation and support personnel, added salespeople,
continued the development of its UNIX and Windows NT products, and started the
development of the WebOrder Gateway. In addition, the Company opened offices in
the United Kingdom and Australia to expand its presence abroad.
Since the end of 1997, the Company has experienced a continued increase in
new client sales. Total revenue increased 80.7% during the year ended December
31, 1998, compared to the same period in 1997, which resulted in increased
income from operations for the year ended December 31, 1998. The revenue growth
in 1998 was attributable to a number of factors, including clients seeking to
replace systems that were not Year 2000 compliant, the Company's greater focus
on services revenue, increasing sales of the WebOrder Gateway and increasing
demand for EuroMACS. The Company's expanding client base also contributed to
revenue growth during 1998 through purchases of upgrades and additional
services.
In 1999, the Company continued to experience increases in both new and
existing client sales. Total revenue increased 38.3% during the year ended
December 31, 1999, compared to the same period in 1998. Income from operations
increased 48.6% in 1999 compared to 1998. The revenue increase in 1999 is
attributable to several factors, including increased demand for the Company's
WebOrder and EuroMACS products and the Company's expanding client base.
The Company generates revenue from four principal sources: (i) license fees
for software products; (ii) sales of related computer hardware components; (iii)
software support; and (iv) services consisting of consulting, training and
custom programming. System revenue, which includes software license fees and
hardware components, is generated by sales to new and existing clients.
The Company's revenue and long-term growth are largely dependent on the
sale of its systems to new clients. These new system sales have a fairly
predictable implementation cycle. System sales to new clients represented 32.9%
of total revenue during the year ended December 31, 1999, and increased 25.4%
from the year ended December 31, 1998. System sales to new clients represented
36.5% of total revenue during the year ended December 31, 1998, and increased
64.0% from the year ended December 31, 1997. System upgrades represented 41.6%
of total revenue for the year ended December 31, 1999 compared to 37.3% and
40.2% for the years ended December 31, 1998 and 1997, respectively. System
upgrades consist primarily of additional software user license fees and central
processing unit ("CPU") upgrades for its existing clients.
The Company believes that computer hardware upgrades are generally
performed during the one to two-year period following a new sale. In 1995 and
1996, new customer revenue declined substantially, thus causing hardware and
software upgrade revenue to decline in fiscal year 1997. Increased new customer
revenue in 1997 and 1998 and additional upgrades from existing clients
contributed to higher upgrade sales in 1999. The Company believes that upgrades
are dictated solely by the business requirements of individual clients and,
19
22
therefore, the Company is unable to accurately predict or explain the actual mix
between software and hardware upgrades.
The Company recognizes revenue in accordance with Statement of Position
("SOP") 97-2, Software Revenue Recognition. Under this provision, hardware and
software license fees for new systems are recognized as revenue when the
hardware and software has been delivered and installed, the fee is fixed and
determinable and the collectibility is probable. Revenue relating to system
upgrades is recognized upon installation, provided that all significant
obligations have been met. Revenue from hardware and software upgrades is
recognized upon receipt by the client.
Each new client executes a contract which identifies the number of licensed
WebOrder users, hardware configuration, and pricing for the software license and
support services. The contract also contains pricing provisions for supplemental
software user licenses and CPU upgrades. The Company typically receives a
deposit equal to 25% of the system selling price upon contract signing and the
remaining balance is payable in accordance with the system implementation
schedule. The differences between amounts received and amounts recognized are
recorded as deferred revenue.
Support services are billed monthly, in advance, and revenue from such
services is recognized ratably over the contract term. The Company's software
support agreements typically have one-year terms, are automatically renewed
annually and may be terminated at the discretion of the client. Historically,
more than 80% of all clients utilizing the Company's software have renewed their
support agreements.
Training and consulting services are performed on a time-and-materials
basis and revenue is recognized as the services are completed. Contract
programming services are generally short-term in nature and performed on a
fixed-fee basis. When performed in conjunction with a sale to a new client,
contract-programming revenue is recognized upon delivery and receipt of a signed
client acknowledgment that hardware and software have been installed.
In accordance with Statement of Financial Accounting Standards No. 86,
software development costs are expensed as incurred until technological
feasibility of the software is established, after which any additional costs are
capitalized. To date, the Company has expensed all software development costs
because development costs incurred subsequent to the establishment of
technological feasibility have been minimal.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship of certain statement of operations items to total revenue:
YEAR ENDED DECEMBER 31,
-----------------------
1999 1998 1997
----- ----- -----
Revenue:
License fees and software sales........................... 56.0% 53.7% 45.4%
Computer hardware sales................................... 18.4 19.9 25.5
Support................................................... 16.4 15.8 22.0
Services.................................................. 9.2 10.6 7.1
----- ----- -----
Total revenue..................................... 100.0 100.0 100.0
Cost of sales and services:
License fees and software sales........................... 17.1 21.9 21.2
Computer hardware sales................................... 13.7 14.6 19.1
Support................................................... 10.8 9.6 17.5
Services.................................................. 6.8 6.7 5.9
----- ----- -----
Total cost of sales and services.................. 48.4 52.8 63.7
----- ----- -----
Gross profit...................................... 51.6 47.2 36.3
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23
YEAR ENDED DECEMBER 31,
-----------------------
1999 1998 1997
----- ----- -----
Operating expenses:
General and administrative................................ 17.3 19.4 24.5
Research and development.................................. 7.3 6.7 10.8
Sales and marketing....................................... 12.0 7.2 7.9
----- ----- -----
Total operating expenses.......................... 36.6 33.3 43.2
----- ----- -----
Income (loss) from operations..................... 15.0 13.9 (6.9)
Other income (expense):
Interest expense:
Interest on outstanding debt........................... (0.4) (5.3) (8.0)
Amortization of original issue discount................ -- -- (3.6)
Interest income........................................... 3.8 .3 0.6
----- ----- -----
Total interest expense, net....................... 3.4 (5.0) (11.0)
----- ----- -----
Income (loss) before pro forma income tax (expense) Benefit
18.4 8.9 (17.9)
Pro forma provision for income tax (expense) benefit........ (6.5) (3.6) 5.1
----- ----- -----
Pro forma net income (loss)................................. 11.9% 5.3% (12.8)%
===== ===== =====
The following table sets forth, for the periods indicated, the dollar and
percentage changes of statement of operations items:
CHANGE CHANGE
YEAR ENDED DECEMBER 31, 1999 VS. 1998 1998 VS. 1997
--------------------------- ---------------- ----------------
1999 1998 1997 $ % $ %
------- ------- ------- ------- ------ ------- ------
Revenue:
License fees and software
sales......................... $26,102 $18,097 $ 8,471 $ 8,005 44.2% $ 9,626 113.6%
Computer hardware sales......... 8,598 6,703 4,757 1,895 28.3 1,946 40.9
Support......................... 7,630 5,335 4,100 2,295 43.0 1,235 30.1
Services........................ 4,268 3,567 1,324 701 19.7 2,243 169.4
------- ------- ------- ------- ------ ------- ------
Total Revenue............ 46,598 33,702 18,652 12,896 38.3 15,050 80.7
Cost of sales and services
License fees and software
sales......................... 7,957 7,371 3,956 587 8.0 3,415 86.3
Computer hardware sales......... 6,372 4,916 3,558 1,456 29.6 1,358 38.2
Support......................... 5,050 3,222 3,271 1,828 56.7 (49) (1.5)
Services........................ 3,165 2,271 1,104 894 39.4 1,167 105.7
------- ------- ------- ------- ------ ------- ------
Total cost of sales and
services............... 22,544 17,780 11,889 4,765 26.8 5,890 49.5
------- ------- ------- ------- ------ ------- ------
Gross Margin...................... 24,054 15,922 6,763 8,131 51.1 9,160 135.4
Operating expenses:
General and administrative...... 8,061 6,538 4,567 1,523 23.3 1,971 43.2
Research and development........ 3,421 2,254 2,011 1,167 51.8 243 12.1
Sales and marketing............. 5,585 2,430 1,482 3,155 129.8 948 64.0
------- ------- ------- ------- ------ ------- ------
Total operating
expenses............... 17,067 11,222 8,060 5,845 52.1 3,162 39.2
------- ------- ------- ------- ------ ------- ------
Income (loss) from operations..... 6,987 4,700 (1,297) 2,287 48.6 5,997 462.4
Total interest income
(expense), net......... 1,584 (1,697) (2,071) 3,281 193.3 374 18.1
------- ------- ------- ------- ------ ------- ------
Income (loss) before income tax
(expense) benefit............... 8,571 3,003 (3,368) 5,568 185.4 6,371 189.2
Pro forma provision for income tax
(expense) benefit............... (3,378) (1,215) 948 2,163 (178.0) (2,163) (228.2)
------- ------- ------- ------- ------ ------- ------
Pro forma net income (loss)....... $ 5,193 $ 1,788 $(2,420) $ 3,405 190.4% $ 4,208 173.9%
======= ======= ======= ======= ====== ======= ======
21
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YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
License Fees and Software Sales. Computer software license fees consist of
license fees for the new installation of the Company's WebOrder software and
related modules, license fees for third-party software, and additional user
license fees and software upgrades for its existing clients. License fees and
software sales are based on the number of users and type and number of CPUs. The
increase in computer software license fees in 1999 compared to 1998 is a result
of increased sales to both new and existing clients. New client computer
software sales increased from $9.1 million for the year ended December 31, 1998
to $11.2 million for the same period in 1999, and computer software upgrades
increased from $9.0 million to $14.9 million for the same periods.
Computer Hardware Sales. Sales of computer hardware consist of sales of
computer systems, peripheral components and third-party software. The increase
in computer hardware revenue in 1999 compared to 1998 is a result of increased
sales to both new and existing clients. Computer hardware revenue relating to
new client sales increased to $4.2 million for the year ended December 31, 1999,
compared to $3.1 million for the same period in 1998. Computer hardware upgrades
increased to $4.4 million for the year ended December 31, 1999, compared to $3.6
million for the same period in 1998.
Support. Support revenue consists of fees for technical support services
and product enhancements for the MACS software and integrated third-party
software utilities. Support revenue typically represents 18% to 20% of the
underlying license fee each year. The increase in support revenue from 1998 to
1999 is a result of new clients added during 1999, as well as support fee
increases related to software user license upgrades.
Services. Services revenue consists principally of revenue derived from
training, consulting, and custom programming. Services revenue increased in 1999
compared to 1998 primarily due to increases in revenue from consulting services.
Total Revenue. New client sales in 1999 increased 25.3% from 1998 due to
more installations and a higher average revenue per installation. Revenue from
client system and component upgrades increased by 54.0% in 1999 compared to 1998
due to the Company's expanding client base and upgrades from internet-only
retailers that tend to make smaller initial purchases and upgrade rapidly.
Cost of License Fees and Software Sales. Cost of computer software
includes installation and training salaries directly related to new software
sales and subcontractor fees. The increase in costs during 1999 compared to 1998
resulted from higher personnel costs related to increased installations of new
systems and sales to new clients. Cost of computer software as a percentage of
software license fees decreased due to a higher percentage of software license
upgrades which have no associated personnel costs.
Cost of Computer Hardware Sales. Cost of computer hardware consists of
purchases of computer systems and peripheral components. The increase in cost
from 1998 to 1999 was directly related to the corresponding increase in computer
hardware revenue during 1999.
Cost of Support. Cost of support consists primarily of personnel costs
associated with the support of the Company's WebOrder product and third-party
computer software packages and the cost of WebOrder user documentation
distributed to clients. Cost of support increased in 1999 compared to 1998 due
to increased compensation expense associated with additional resources required
to accommodate new client growth.
Cost of Services. Cost of services consists of salaries for professional
services employees, and allocated salaries for training and programming
personnel. Cost of services increased from 1998 to 1999 due to increased
compensation expense for professional services resources added to accommodate
higher anticipated client demand combined with a reduced demand for services
during the fourth quarter of 1999.
General and Administrative. General and administrative expenses include
the cost of the Company's finance, human resources, information services, and
administrative functions. General and administrative expenses increased during
1999 compared to 1998 as a result of additional personnel, the costs associated
with being a public company, and increased infrastructure costs to accommodate
the higher employee headcount.
22
25
Research and Development. Research and development expenses include costs
associated with the development of new products and enhancements of existing
products. Such expenses consist primarily of employee salaries and benefits,
consulting expenses (including amounts paid to subcontractors for development
work), and the cost of development software and hardware. Research and
development expenses increased during the year ended December 31, 1999, compared
to the year ended December 31, 1998 due to ongoing development of the UNIX
product, new WebOrder modules and existing product enhancements.
Sales and Marketing. Sales and marketing expenses include personnel costs,
sales commissions related to the sale and marketing of the Company's products
and services, and the cost of advertising, public relations and participation in
industry conferences and trade shows. The increase in sales and marketing
expenses during 1999 compared to 1998 resulted from higher sales commissions,
increased participation in industry trade shows, and expanded marketing and
advertising programs.
Other Income (Expense), Net. Net interest income includes interest income
on available cash and interest on the $12.0 million aggregate principal amount
of Convertible Debentures held by the Lenders. Net interest income increased in
1999 compared to 1998 due to interest income related to cash proceeds from the
Company's initial public offering and the retirement of the Debentures in
conjunction with the initial public offering. See "Liquidity and Capital
Resources" and Note 7 of Notes to the Consolidated Financial Statements.
Pro Forma Income Tax (Expense) Benefit. The pro forma effective tax rate
for the year ended December 31, 1999 was a provision of 39.4% compared to 40.5%
for the year ended December 31, 1998. Effective pro forma income tax rates
differ from the federal statutory rates because of the following: (i) the effect
of state income taxes; and (ii) the full valuation of net losses of foreign
subsidiaries. Also, pro forma effective rates vary between periods because of
the differing effects the net losses of foreign subsidiaries have on pro forma
income before income taxes.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
License Fees and Software Sales. Computer software license fees increased
during the year ended December 31, 1998 compared to the year ended December 31,
1997 due to an increase in computer software sales to both new and existing
clients including material contracts with United States Mint and Multiple Zones
in 1998. Total sales from these two customers amounted to 16.8% of revenue for
1998. New client computer software sales increased 23.1% from $4.8 million for
the year ended December 31, 1997 to $5.9 million for the year ended December 31,
1998, and computer software upgrades increased 56.5% from $3.6 million to $5.6
million for the same periods.
Computer Hardware Sales. The increase in computer hardware revenue in 1998
compared to 1997 is a result of increased sales to both new and existing
clients. Computer hardware revenue relating to new client sales increased 30.6%
to $3.1 million for the year ended December 31, 1998, compared to $2.4 million
for the year ended December 31, 1997, as a result of increases in new system
sales. Computer hardware upgrades increased by 67.8% to $3.6 million for the
year ended December 31, 1998 compared to $2.1 million for the year ended
December 31, 1997 due to many of the Company's larger clients performing major
system upgrades.
Support. Support revenue increased during the year ended December 31, 1998
compared to the year ended December 31, 1997 due to the addition of new clients
in the last half of 1997 and during 1998, as well as support fee increases
related to software user license upgrades.
Services. Services revenue increased for year ended December 31, 1998
compared to the year ended December 31, 1997 due to increases in new client
software modifications, custom interfaces to third-party products and consulting
services.
Total Revenue. New client sales increased 64.0% for the year ended
December 31, 1998. The increase was due to more installations and higher average
revenue per installation than during the year ended December 31, 1997 as a
result of material contracts with the United States Mint and Multiple Zones.
Also contributing to the revenue increase were sales of $3.1 million in 1998
from the Company's United Kingdom
23
26
subsidiary. Revenue from client system and component upgrades increased by
118.3% for the year ended December 31, 1998 compared to the year ended December
31, 1997 due to increased new client sales in 1997 and clients performing major
system upgrades.
Cost of License Fees and Software Sales. Cost of computer software
increased during the year ended December 31, 1998 compared to the year ended
December 31, 1997 due to higher personnel costs related to increased
installations of new systems and sales to new clients. Cost of computer software
as a percentage of software license fees decreased during 1998 compared to 1997
due to greater efficiencies and increased utilization of personnel resources in
1998.
Cost of Computer Hardware Sales. Cost of computer hardware increased for
the year ended December 31, 1998 compared to the year ended December 31, 1997.
The increase in cost from 1997 to 1998 was directly related to the corresponding
increase in computer hardware revenue during 1998.
Cost of Support. Cost of support decreased from 1997 to 1998 due to lower
personnel costs and greater efficiencies in delivering support services. Cost of
support as a percentage of support revenue decreased for the year ended December
31, 1998 compared to the year ended December 31, 1997 as a result of additional
support fees from new clients and increased utilization of existing support
personnel.
Cost of Services. Cost of services increased due to the addition of
professional services employees and a greater allocation of programming
personnel related to the increases in custom programming revenue. Cost of
services as a percentage of services revenue decreased for the year ended
December 31, 1998 compared to the year ended December 31, 1997 due to the
increased utilization of available resources and higher pricing for professional
services.
General and Administrative. General and administrative expenses increased
during 1998 compared to 1997 primarily due to $753,000 of expenses associated
with new offices in the United Kingdom and Australia which were opened during
the second half of 1997, $280,000 in additional salaries and benefits due to
increases in administrative personnel related to an expanding workforce and
client base, and approximately $833,000 of additional communication, recruiting,
insurance, travel, equipment and office expenses as a result of more employees.
Research and Development. Research and development expenses increased
during the year ended December 31, 1998 compared to the year ended December 31,
1997 primarily due to ongoing development of the WebOrder, UNIX and Windows NT
products and existing product enhancements. Research and Development expenses as
a percentage of computer software license fees decreased during 1998 compared to
1997 because license revenues increased at a faster rate than development costs.
Sales and Marketing. Sales and marketing expenses increased for the year
ended December 31, 1998 compared to the year ended December 31, 1997 as a result
of increased sales, modifications to the Company's sales commission plan and
expanded marketing and advertising programs.
Other Income (Expense), Net. Net interest expense, which includes interest
on the $12.0 million aggregate principal amount of Convertible Debentures held
by the Lenders, amortization of original discount ("OID") related to the
conversion feature of the Convertible Debentures and interest income on
available cash, decreased for the year ended December 31, 1998 compared to the
year ended December 31, 1997. The decrease was due to a reduction of OID which
was fully amortized as of June 30, 1997. No OID amortization was recorded for
the year ended December 31, 1998. See "Liquidity and Capital Resources" and Note
7 of Notes to Consolidated Financial Statements.
Pro Forma Income Tax (Expense) Benefit. The pro forma effective tax rate
for the year ended December 31, 1998 was a provision of 40.5% compared to a
benefit of 28.2% in 1997. Effective pro forma income tax rates differ from the
federal statutory rates as a result of the following: (i) OID is not deductible
for federal and state income tax purposes; (ii) the effect of state income
taxes; and (iii) the full valuation of net losses of foreign subsidiaries. Also,
pro forma effective rates vary between periods because of the differing effects
the OID and net losses of foreign subsidiaries have on pro forma income before
income taxes.
24
27
SEASONALITY
The Company generally has realized lower revenue in the fourth quarter of
the year than in the other quarters. The Company believes that this has been due
primarily to the tendency of many of the Company's clients to avoid implementing
a new system or an upgrade of an existing system during the holiday season,
typically the busiest time of year for substantially all of the Company's
clients. Due to all of the foregoing factors, the Company believes that period
to period comparisons of its operating results are not necessarily meaningful
and that such comparisons cannot be relied upon as indicators of future
performance.
LIQUIDITY AND CAPITAL RESOURCES
On February 3, 1999, the Company and selling shareholders sold 4,410,000
shares of its Common Stock in an initial public offering from which the Company
received proceeds of approximately $43.4 million net of underwriter commissions
and offering costs. At that time, the Debentures were converted into the
Convertible Preferred Stock and the Redeemable Preferred Stock. Contemporaneous
with the offering and pursuant to the terms of the Convertible Preferred Stock,
the Lenders converted the Convertible Preferred Stock into 2,255,614 shares of
Common Stock. On February 3, 1999, the Company redeemed in full the Redeemable
Preferred Stock for $12,000,000 and paid accrued interest in the amount of
$4,665,000.
On February 26, 1999, the underwriters exercised their option to purchase
661,500 additional shares of the Company's common stock from which the Company
received proceeds of $7,382,340.
During the 1997 and 1998 fiscal years, the Company financed its operations
and growth with funds generated by operations. For 1999, the Company financed
its operations and growth primarily from the issuance of debt and equity
securities. At December 31, 1999, the Company's primary sources of liquidity
consisted of cash, cash equivalents and short-term investments totaling $39.2
million.
The Company's operating activities have provided cash for the years ended
December 31, 1999, 1998 and 1997, of $64,850, $2.7 million, and $543,000,
respectively. For the year ended December 31, 1999, the Company's operating cash
was provided by net income offset by an interest payment of $4,500,000 related
to the Convertible Debentures.
For the year ended December 31, 1998, the Company's operating cash was
provided by net income, continued deferral of interest payments due under the
Convertible Debentures, client deposits received in advance of recognized
revenue, and increased accounts payable and accrued expenses partially offset by
increases to accounts receivable. In 1997, the Company's primary source of
operating cash was provided by the deferral of interest payments due under the
Convertible Debentures.
Cash used in investing activities was approximately $1.2 million, $585,000,
and $234,000, for the years ended December 31, 1999, 1998, and 1997,
respectively. This cash was used for capital expenditures in the ordinary course
of business. The Company's capital expenditures relate primarily to purchases of
computers, printers and software to support the Company's operations, as well as
furniture, fixtures and leasehold improvements. The Company expects its rate of
purchases of property and equipment will increase as its employee base grows.
For the year ended December 31, 1999, cash provided by financing activities
totaled $38.8 million which consisted primarily of proceeds received from the
Company's initial public offering and the underwriters' option to purchase
additional shares. This was offset by repayment in full of the Convertible
Debentures, payment of offering costs related to the Company's initial public
offering and distributions made to its existing stockholders. For the year ended
December 31, 1998, cash used in financing activities totaled $623,000, which
consisted of distributions to stockholders and deferred offering costs. Cash
used in financing activities totaled $200,000 in 1997, which consisted of
repayment of advances from officers made during 1996.
As of December 31, 1999, the Company had working capital of approximately
$43.3 million as compared to working capital of approximately $3.9 million at
December 31, 1998. The change in working capital from December 31, 1998 to
December 31, 1999, resulted primarily from an increase in current assets of
$42.4
25
28
million due to cash proceeds from the Company's initial public offering and the
underwriters' exercising their option to purchase additional shares from the
Company.
Accounts receivable increased by approximately $2.7 million from December
31, 1998 to December 31, 1999. This increase was primarily attributable to $3.0
million increase in sales between the fourth quarter of 1999 and the fourth
quarter of 1998.
Deferred revenue decreased by approximately $506,000 from December 31, 1998
to December 31,1999. The decrease was primarily due to lower new client sales
activity in the fourth quarter of 1999. Deferred revenue represents amounts
billed to clients for which revenue may will be recognized in future periods.
Based on the initial public offering proceeds, payment of outstanding
convertible debt, increased sales in 1999 and the Company's anticipated
operating results, management believes there is sufficient funding to meet its
operating expenditures for the foreseeable future.
The Company may, in the future, acquire businesses or products
complementary to the Company's business, or otherwise obtain the right to use
complementary technologies, although there can be no assurance that any such
acquisitions will be made. The need for cash to finance additional working
capital or to make acquisitions may cause the Company to seek additional equity
or debt financing. There can be no assurance that such financing will be
available, or that the Company's need for higher levels of working capital will
not have a material adverse effect on the Company's business, financial
condition or results of operations.
YEAR 2000 COMPLIANCE
The Company has reviewed its internal support systems and, to the extent
possible, its vendor systems to confirm Year 2000 compliance and has either
confirmed that these systems are Year 2000 compliant or obtained Year 2000
compliance statements from the respective vendor. Any failure of the Company or
its suppliers or clients to be Year 2000 compliant, however, could result in a
material adverse effect on the Company's business, financial condition and
results of operations. Subsequent to December 31, 1999 the Company has not
experienced any Year 2000 issues internally or with its customers or vendors.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"). SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. It requires an entity to recognize
all derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. SFAS No. 133 is expected to be effective for
the Company's year ending December 31, 2001. The Company does not believe that
the adoption of SFAS No. 133 will have a significant impact on the Company's
financial reporting.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Management believes the risk of loss arising from adverse changes in
interest rates, foreign currency exchange rates, commodity prices and other
relevant market rates and prices, such as equity prices, if any, is immaterial.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements as of December 31, 1999 and
1998 and for each of the years in the three-year period ended December 31, 1999,
and the respective notes thereto, are set forth elsewhere in this report. An
index of these financial statements appears in Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
None.
26
29
PART III
The information required by Items 10, 11, 12 and 13 of Part III of Form
10-K will be set forth in the definitive Proxy Statement of the Company relating
to the 2000 Annual Meeting of Shareholders and is incorporated herein by
reference. The Proxy Statement will be filed within 120 days of the fiscal year
ended December 31, 1999.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The following consolidated financial statements are filed as part of
this Form 10-K:
Smith-Gardner & Associates, Inc. and Subsidiaries Consolidated Financial
Statements:
Independent Auditors' Report
Consolidated Balance Sheets at December 31, 1999 and 1998
Consolidated Statements of Operations for each of the years in the
three-year period ended December 31, 1999
Consolidated Statements of Redeemable Preferred Stock and
Stockholders' Deficit for each of the years in the three-year period
ended December 31, 1999
Consolidated Statements of Cash Flows for each of the years in the
three-year period ended December 31, 1999
Notes to Consolidated Financial Statements.
(2) The following financial statement schedule is filed as part of this
Form 10-K:
Schedule II of Valuation and Qualifying Accounts.
(3) See Exhibit Index included elsewhere herein.
(b) Reports on Form 8-K:
None.
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30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
SMITH-GARDNER & ASSOCIATES, INC.
(Registrant)
By: /s/ GARY G. HEGNA
------------------------------------
Gary G. Hegna
Chief Executive Officer,
President and Chairman of the Board
Date: March 29, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf by the Registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ GARY G. HEGNA President, Chief Executive March 29, 2000
- ----------------------------------------------------- Officer and Director
Gary G. Hegna (Principal Executive Officer)
/s/ MARTIN K. WEINBAUM Vice President -- Finance, March 29, 2000
- ----------------------------------------------------- Chief Financial Officer,
Martin K. Weinbaum Secretary and Treasurer
(Principal Financial and
Accounting Officer)
/s/ ALLAN GARDNER Chief Technology Officer and March 29, 2000
- ----------------------------------------------------- Director
Allan Gardner
/s/ WILBURN SMITH Executive Vice March 29, 2000
- ----------------------------------------------------- President -- Sales and
Wilburn Smith Director
/s/ FRANCIS H. ZENIE Director March 29, 2000
- -----------------------------------------------------
Francis H. Zenie
/s/ JACQUELINE C. MORBY Director March 29, 2000
- -----------------------------------------------------
Jacqueline C. Morby
/s/ JAMES J. FELCYN, JR. Director March 29, 2000
- -----------------------------------------------------
James J. Felcyn, Jr.
28
31
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
3.1 -- Amended and Restated Articles of Incorporation of the
Company, as amended(4).
3.2 -- By-Laws of the Company, as amended(5).
4.1 -- Form of Certificate of Common Stock(2).
10.1 -- Smith-Gardner & Associates, Inc.'s Stock Option Plan(1).+
10.2 -- Form of Stock Option Agreement pursuant to Smith-Gardner &
Associates, Inc.'s Stock Option Plan(1).+
10.3 -- Smith-Gardner & Associates, Inc.'s Amended and Restated 1998
Stock Option Plan(3).+
10.4 -- Form of Stock Option Agreement pursuant to Smith-Gardner &
Associates, Inc.'s 1998 Stock Option Plan(1).+
10.5 -- Smith-Gardner & Associates, Inc.'s 401(k)/Profit Sharing
Plan(2).+
10.6 -- Debenture Purchase Agreement dated December 19, 1994(1).
10.7 -- Form of Convertible Debenture Due 2000 issued to Advent VII
L.P.(1).
10.8 -- Form of Convertible Debenture Due 2000 issued to Advent
Atlantic and Pacific II L.P.(1).
10.9 -- Form of Convertible Debenture Due 2000 issued to Advent
Industrial II L.P.(1).
10.10 -- Form of Convertible Debenture Due 2000 issued to Advent New
York L.P.(1).
10.11 -- Form of Convertible Debenture Due 2000 issued to Chestnut
Capital International.(1).
10.12 -- Form of Convertible Debenture Due 2000 issued to TA Venture
Investors Limited.(1).
10.13 -- Registration Rights Agreement dated December 19, 1994(1).
10.14 -- Non-Competition Agreement by and between Smith-Gardner &
Associates, Inc. and Wilburn Smith(1).
10.15 -- Non-Competition Agreement by and between Smith-Gardner &
Associates, Inc. and Allan Gardner(1).
10.16 -- Form of Non-Compete Agreement executed by Smith-Gardner &
Associates, Inc.'s key employees(1).
10.17 -- Lease Agreement dated July 1, 1994, by and between Arbors
Associates, Ltd. and Smith-Gardner & Associates, Inc.(2).
10.18 -- Agreement dated March 17, 1998, by and between Client
Systems, Inc. and Smith-Gardner & Associates, Inc.(1).
10.19 -- Agreement dated February 8, 1994, by and between Cognos
Corporation and Smith-Gardner & Associates, Inc.(1).
10.20 -- Agreement dated December 29, 1989, by and between Dynamic
Information Systems Corporation and Smith-Gardner &
Associates, Inc.(1).
10.21 -- Tax Indemnification Agreement(1).
10.22 -- Second Amendment to Lease Agreement dated December 1, 1999,
by and between Arbors Associates, Ltd and Smith-Gardner &
Associates, Inc.*
21.1 -- Subsidiaries of Smith-Gardner & Associates, Inc.(2).
23.1 -- Consent of KPMG LLP.*
27.1 -- Financial Data Schedule (for SEC use only)*
- ---------------
* Filed herewith.
+ Compensatory plan or arrangement.
(1) Incorporated by reference to the exhibit of like number to Amendment No. 1
to Registrant's Registration Statement on Form S-1, File No. 333-63125,
filed with the Commission on December 18, 1998.
(2) Incorporated by reference to the exhibit of like number to Amendment No. 2
to Registrant's Registration Statement on Form S-1, File No. 333-63125,
filed with the Commission on January 11, 1999.
(3) Incorporated by reference to the exhibit of like number to Amendment No. 3
to Registrant's Registration Statement on Form S-1, File No. 333-63125,
filed with the Commission on January 27, 1999.
(4) Incorporated by reference to Exhibit 3.2 of the Amendment No. 2 to
Registrant's Registration Statement on Form S-1, File No. 333-63125, filed
with the Commission on January 11, 1999.
(5) Incorporated by reference to Exhibit 3.4 of the Amendment No. 2 to
Registrant's Registration Statement on Form S-1, File No. 333-63125, filed
with the Commission on January 11, 1999.
32
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
Consolidated Financial Statements
December 31, 1999 and 1998
(With Independent Auditors' Report Thereon)
33
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Smith-Gardner & Associates, Inc.:
We have audited the accompanying consolidated balance sheets of
Smith-Gardner & Associates, Inc. and subsidiaries as of December 31, 1999 and
1998, and the related consolidated statements of operations, redeemable
preferred stock and stockholders' equity (deficit) and cash flows for each of
the years in the three-year period ended December 31, 1999. In connection with
our audits of the consolidated financial statements, we have also audited the
financial statement schedule for each of the years in the three-year period
ended December 31, 1999, as listed in item 14(a)2 of the Company's 1999 Annual
Report on Form 10-K. These consolidated financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Smith-Gardner & Associates, Inc. and subsidiaries as of December 31, 1999 and
1998, and the results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 1999 in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
/s/ KPMG LLP
Fort Lauderdale, Florida
January 21, 2000
F-2
34
SMITH-GARDNER & ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
1999 1998
------------ -----------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 39,245,784 $ 1,576,804
Accounts receivable, net of allowance for doubtful
accounts of $615,809 in 1999 and $459,000 in 1998...... 8,425,232 5,855,140
Income tax receivable..................................... 382,246 --
Inventory................................................. 275,022 197,465
Prepaid expenses and other current assets................. 597,185 195,173
Deferred taxes............................................ 554,243 --
------------ -----------
Total current assets.............................. 49,479,712 7,824,582
Deferred offering costs..................................... -- 551,946
Property and equipment, net................................. 1,878,988 984,780
Other assets................................................ 108,831 108,195
------------ -----------
$ 51,467,531 $ 9,469,503
============ ===========
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $2,435,556 $ 1,160,773
Accrued expenses.......................................... 2,992,953 1,594,197
Deferred revenue.......................................... 658,979 1,165,275
Current installments of obligations under capital
leases................................................. 57,446 --
------------ -----------
Total current liabilities......................... 6,144,934 3,920,245
Convertible debt............................................ -- 12,000,000
Accrued interest payable.................................... -- 4,500,000
Obligations under capital leases, excluding current
installments.............................................. 121,607 --
Deferred taxes.............................................. 38,850 --
------------ -----------
Total liabilities................................. 6,305,391 20,420,245
Redeemable preferred stock, none authorized at December 31,
1999 and 10,000,000 shares authorized at December 31,
1998; none issued......................................... -- --
Commitments and contingencies
Stockholders' equity (deficit):
Common stock, $0.01 par value. Authorized 50,000,000
shares; issued and outstanding 12,276,578 and 5,263,100
shares as of December 31, 1999 and 1998,
respectively........................................... 122,766 52,631
Preferred stock, $.01 par value. Authorized 10,000,000
shares; none issued and outstanding.................... -- --
Additional paid-in capital................................ 54,871,317 3,516,258
Accumulated deficit....................................... (9,831,943) (14,519,631)
------------ -----------
Total stockholders' equity (deficit).............. 45,162,140 (10,950,742)
------------ -----------
$ 51,467,531 $ 9,469,503
============ ===========
See accompanying notes to consolidated financial statements.
F-3
35
SMITH-GARDNER & ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR EACH OF THE YEARS IN THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1999
1999 1998 1997
----------- ----------- -----------
Revenue:
License fees and software sales....................... $26,101,966 $18,096,841 $ 8,471,139
Computer hardware sales............................... 8,598,354 6,703,253 4,756,509
Support............................................... 7,629,486 5,334,727 4,100,488
Services.............................................. 4,267,864 3,567,451 1,324,074
----------- ----------- -----------
Total revenue................................. 46,597,670 33,702,272 18,652,210
----------- ----------- -----------
Cost of sales and services:
License fees and software sales....................... 7,957,588 7,370,957 3,955,628
Computer hardware sales............................... 6,371,708 4,915,784 3,558,187
Support............................................... 5,049,726 3,222,260 3,271,268
Services.............................................. 3,164,593 2,270,562 1,104,195
----------- ----------- -----------
Total cost of sales and services.............. 22,543,615 17,779,563 11,889,278
----------- ----------- -----------
Gross profit.................................. 24,054,055 15,922,709 6,762,932
Operating expenses:
General and administrative............................ 8,061,036 6,538,097 4,567,292
Sales and marketing................................... 5,584,798 2,430,460 1,482,061
Research and development.............................. 3,420,772 2,253,663 2,010,858
----------- ----------- -----------
Total operating expenses...................... 17,066,606 11,222,220 8,060,211
----------- ----------- -----------
Income (loss) from operations................. 6,987,449 4,700,489 (1,297,279)
Other (expense) income:
Interest expense:
Interest on outstanding debt....................... (165,000) (1,800,000) (1,500,000)
Amortization of original issue discount............ -- -- (679,697)
Interest income....................................... 1,748,428 102,346 109,067
----------- ----------- -----------
Income (loss) before provision for income
taxes....................................... 8,570,877 3,002,835 (3,367,909)
Provision for income taxes.............................. (3,048,446) -- --
----------- ----------- -----------
Net income (loss)....................................... $ 5,522,431 $ 3,002,835 $(3,367,909)
=========== =========== ===========
Net income (loss) per share:
Basic................................................. $ 0.48 $ 0.57 $ (0.64)
=========== =========== ===========
Diluted............................................... $ 0.44 $ 0.50 $ (0.64)
=========== =========== ===========
Weighted average shares used in calculating net income
(loss) per share:
Basic.............................................. 11,621,598 5,263,100 5,263,100
=========== =========== ===========
Diluted............................................ 12,426,427 8,131,344 5,263,100
=========== =========== ===========
Pro forma data (unaudited):
Income (loss) before income tax (expense) benefit..... $ 8,570,877 $ 3,002,835 $(3,367,909)
Pro forma provision for income tax (expense)
benefit............................................ (3,377,446) (1,214,770) 948,427
=========== =========== ===========
Pro forma net income (loss)........................... $ 5,193,431 $ 1,788,065 $(2,419,482)
=========== =========== ===========
Pro forma net income (loss) per share:
Basic......................................... $ 0.45 $ 0.34 $ (0.46)
=========== =========== ===========
Diluted....................................... $ 0.41 $ 0.34 $ (0.46)
=========== =========== ===========
Weighted average shares outstanding used in calculating
pro forma net income (loss) per share (unaudited):
Basic......................................... 11,621,598 5,263,100 5,263,100
=========== =========== ===========
Diluted....................................... 12,426,427 5,263,100 5,263,100
=========== =========== ===========
See accompanying notes to consolidated financial statements.
F-4
36
SMITH-GARDNER & ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
FOR EACH OF THE YEARS IN THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1999
STOCKHOLDERS' EQUITY (DEFICIT)
-------------------------------------------------------------------------
REDEEMABLE PREFERRED TOTAL
STOCK COMMON STOCK ADDITIONAL STOCKHOLDERS'
---------------------- --------------------- PAID-IN ACCUMULATED (DEFICIT)
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT EQUITY
------- ------------ ---------- -------- --------------- ------------ ----------------
Balance, December 31, 1996... -- $ -- 5,263,100 $ 52,631 $ 3,481,562 $(14,083,947) $(10,549,754)
Net loss................... -- -- -- -- -- (3,367,909) (3,367,909)
------- ------------ ---------- -------- ----------- ------------ ------------
Balance, December 31, 1997... -- -- 5,263,100 52,631 3,481,562 (17,451,856) (13,917,663)
Non-cash compensation
expense.................. -- -- -- -- 34,696 -- 34,696
Shareholders
distributions............ -- -- -- -- -- (70,610) (70,610)
Net income................. -- -- -- -- -- 3,002,835 3,002,835
------- ------------ ---------- -------- ----------- ------------ ------------
Balance, December 31, 1998... -- -- 5,263,100 52,631 3,516,258 (14,519,631) (10,950,742)
Issuance of redeemable
convertible participating
preferred stock.......... 22,556 226 -- -- -- -- --
Issuance of redeemable
participating preferred
stock.................... 12,000 12,000,000 -- -- -- -- --
Issuance of common stock in
initial public offering,
net of expenses.......... -- -- 4,661,500 46,615 50,789,857 -- 50,836,472
Conversion of redeemable
participating preferred
stock.................... (22,556) (226) 2,255,614 22,556 (22,556) -- --
Redemption of redeemable
participating preferred
stock.................... (12,000) (12,000,000) -- -- -- -- --
Exercise of stock
options.................. -- -- 96,364 964 243,007 -- 243,971
Non-cash compensation
expense.................. -- -- -- -- 41,588 -- 41,588
Stockholder
distributions............ -- -- -- -- -- (834,743) (834,743)
Tax benefit on exercise of
options.................. -- -- -- -- 303,163 -- 303,163
Net income................. -- -- -- -- -- 5,522,431 5,522,431
------- ------------ ---------- -------- ----------- ------------ ------------
Balance, December 31, 1999... -- $ -- 12,276,578 $122,766 $54,871,317 $ (9,831,943) $ 45,162,140
======= ============ ========== ======== =========== ============ ============
See accompanying notes to consolidated financial statements.
F-5
37
SMITH-GARDNER & ASSOCIATES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE YEARS IN THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1999
1999 1998 1997
------------ ----------- -----------
Cash flows provided by operating activities:
Net income (loss).................................... $ 5,522,431 $ 3,002,835 $(3,367,909)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization..................... 478,361 285,314 232,548
Amortization of original issue discount........... -- -- 679,697
Deferred taxes, net............................... (515,393) -- --
Non-cash compensation expense..................... 41,588 34,696 --
Bad debt expense.................................. 251,293 458,330 485,185
Change in assets and liabilities:
Accounts receivable............................. (2,821,385) (4,468,245) 359,329
Income tax receivable........................... (79,083) -- --
Inventory....................................... (77,557) 22,498 (207,097)
Prepaid expenses and other current assets....... (402,012) (59,791) 30,067
Other assets.................................... (636) (27,619) (26,246)
Accrued interest payable........................ (4,500,000) 1,800,000 1,500,000
Accounts payable................................ 1,274,783 612,423 268,323
Accrued expenses................................ 1,398,756 173,207 552,243
Deferred revenue................................ (506,296) 781,897 36,510
------------ ----------- -----------
Net cash provided by operating activities.... 64,850 2,615,545 542,650
------------ ----------- -----------
Cash flows used in investing activities:
Capital expenditures................................. (1,193,516) (584,775) (234,277)
------------ ----------- -----------
Net cash used in investing activities........ (1,193,516) (584,775) (234,277)
------------ ----------- -----------
Cash flows provided by (used in) financing activities:
Redemption of preferred stock........................ (12,000,000) -- --
Distributions to stockholders........................ (834,743) (70,610) --
Proceeds from public offering of common stock, net... 51,388,418 (551,946) --
Proceeds from issuance of common stock............... 243,971 -- --
Repayment of advances from officers.................. -- -- (200,000)
------------ ----------- -----------
Net cash provided by (used in) financing
activities................................. 38,797,646 (622,556) (200,000)
------------ ----------- -----------
Net increase in cash and cash equivalents.... 37,668,980 1,408,214 108,373
Cash and cash equivalents at beginning of year......... 1,576,804 168,590 60,217
------------ ----------- -----------
Cash and cash equivalents at end of year............... $ 39,245,784 $ 1,576,804 $ 168,590
============ =========== ===========
Supplemental cash flow information:
Cash paid during the year for interest............... $ 4,665,000 $ -- $ --
============ =========== ===========
Cash paid for income taxes........................... $ 3,430,692 $ -- $ --
============ =========== ===========
Supplemental disclosure of non-cash investing and
financing information:
Capital lease additions........................... $ 179,053 $ -- $ --
============ =========== ===========
Tax benefit on exercise of stock options.......... $ 303,163 $ -- $ --
============ =========== ===========
See accompanying notes to consolidated financial statements.
F-6
38
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Description of Business
Smith-Gardner & Associates, Inc. (the "Company") was incorporated on
December 13, 1988 under the laws of the state of Florida. The Company primarily
licenses a computer software package it designed and developed to automate
companies that sell through catalogs, the Internet, media advertisement, direct
mail or broadcast advertisements, and also sells the computer hardware required
to use the software. The Company also provides consulting, training, programming
and technical support services.
The Company opened satellite offices in Sydney, Australia ("SGA Pty.") and
Cambridge, England ("SGA Ltd.") in September 1997 and June 1997, respectively.
These offices are separately incorporated and are wholly owned subsidiaries of
the Company.
The consolidated financial statements include the accounts of the Company
and its two wholly owned subsidiaries SGA Pty. and SGA Ltd. All significant
intercompany balances and transactions have been eliminated in consolidation.
(b) Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
(c) Inventory
Inventory consists of computer hardware and software held for resale. It is
stated at the lower of cost, as determined on a specific identification basis,
or market.
(d) Property and Equipment
Property and equipment are stated at cost and are depreciated on the
straight-line basis over the estimated useful lives of the assets which range
from five to seven years. Leasehold improvements are amortized on the
straight-line basis over the shorter of the lease term or estimated useful life
of the asset.
Pursuant to Statement of Financial Accounting Standards No. 121 ("SFAS No.
121"), "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of," the Company reviews its long-lived assets (property and
equipment) for impairment whenever events or circumstances indicate that the
carrying amount of an asset may not be recoverable. If the sum of the expected
cash flows, undiscounted and without interest, is less than the carrying amount
of the asset, an impairment loss is recognized as the amount by which the
carrying amount of the asset exceeds its fair value. The Company has no impaired
assets at December 31, 1999.
(e) Software Development Costs
The Company accounts for software development costs under Statement of
Financial Accounting Standards No. 86, "Accounting for Costs of Computer
Software to Be Sold, Leased or Otherwise Marketed" ("SFAS No. 86"). Under SFAS
No. 86, the costs associated with software development are required to be
capitalized after technological feasibility has been established. The Company
considers technological feasibility to be established when the product design
and working model of the software product are completed and confirmed by testing
the software product. Costs incurred by the Company subsequent to the
establishment of technological feasibility have been insignificant and, as a
result, the Company has not capitalized any development costs.
F-7
39
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(f) Revenue Recognition
In 1997, the American Institute of Certified Public Accountants issued SOP
97-2, Software Revenue Recognition, which superseded SOP 91-1. The Company
adopted SOP 97-2 for software transactions entered into in 1997. SOP 97-2
generally requires revenue earned on software arrangements involving multiple
elements to be allocated to each element based on vendor specific objective
evidence ("VSOE") of the relative fair values of the elements. VSOE is
determined by the price charged when the element is sold separately. The revenue
allocated to hardware and software products generally is recognized when the
hardware and software have been delivered and installed, the fee is fixed and
determinable and the collectibility is probable. The revenue allocated to
postcontract customer support is consistent with fees charged for renewals and
is recognized ratably over the term of the support. Revenue allocated to service
elements is recognized as the services are performed.
In March 1999, the Company adopted SOP 98-9, Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions. SOP 98-9
amends SOP 97-2 to require recognition of revenue using the "residual method"
when (1) there is VSOE of the fair values of all undelivered elements in a
multiple-element arrangement that is not accounted for using long-term contract
accounting, (2) VSOE of fair value does not exist for one or more of the
delivered elements in the arrangement, and (3) all revenue recognition criteria
in SOP 97-2 other than the requirement for VSOE of the fair value of each
delivered element of the arrangement are satisfied. Under the residual method,
the arrangement fee is recognized as follows: (1) the total fair value of the
undelivered elements, as indicated by VSOE, is deferred and subsequently
recognized in accordance with the relevant sections of SOP 97-2 and (2) the
difference between the total arrangement fee and the amount deferred for the
undelivered elements is recognized as revenue related to the delivered elements.
The adoption of SOP 98-9 did not have a material impact on results of
operations.
At December 31, 1999 and 1998, the Company had deferred revenue recorded in
the accompanying consolidated balance sheets related to computer hardware and
software sales, customer support and services paid in advance.
(g) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107 ("SFAS No. 107"),
"Disclosures About Fair Value of Financial Instruments," requires disclosure of
fair value of certain financial instruments. Cash and cash equivalents, accounts
receivable, inventory and prepaid expenses and other current assets, as well as
accounts payable, accrued expenses and other current liabilities, as reflected
in the consolidated financial statements, approximate fair value because of the
short-term maturity of these instruments.
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial instrument.
These estimates are subjective in nature and involve uncertainties and matters
of significant judgment and therefore cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.
(h) Income Taxes
The Company elected to be taxed under the provisions of Subchapter S of the
Internal Revenue Code (the "Code") through 1998. Accordingly, the taxable income
(loss) of the Company was reported on the individual tax returns of the
stockholders. The only states in which the Company does business which do not
recognize S corporation status are California and New Jersey.
On January 1, 1999, the Company terminated its S corporation status. In
connection with this termination, the Company now records income taxes in
accordance with Statement of Financial Accounting
F-8
40
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Standards No. 109 ("SFAS No. 109"), "Accounting for Income Taxes." Deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized as a change in income in the period that
includes the enactment date. The pro forma provision for income tax expense
presented on the consolidated statements of operations for the years ended
December 31, 1998 and 1997 represent the estimated taxes that would have been
recorded had the Company been a C corporation for income tax purposes for these
periods.
The pro forma provisions for income tax expense presented on the
consolidated statement of operations for the year ended December 31, 1999
represents the historical income tax expense for the year ended December 31,
1999 less a one-time benefit resulting from the conversion of the S corporation
to C corporation.
The Company's S corporation status was terminated in connection with the
initial public offering. The Company, pursuant to an agreement with the existing
shareholders, made a distribution of $834,743 which represented the
shareholders' individual income tax liabilities for the period beginning January
1, 1998 and ending on December 31, 1998.
(i) Basic and Diluted Net Income per Share
Basic net income per share was computed by dividing net income by the
weighted average number of shares of common stock outstanding for each period
presented. Diluted net income per share for the years ended December 31, 1999
and 1998, was computed by giving effect to common stock equivalents and assuming
conversion of debt to redeemable preferred stock. Incremental shares and
adjustments to net income are determined using the "if converted" and treasury
stock methods as follows:
1999 1998
----------- ----------
Net income as reported..................................... $ 5,522,431 $3,002,835
Plus: interest expense on convertible debt assuming
conversion........................................... -- 1,800,000
Less: preferred stock dividends assuming conversion of debt
to redeemable preferred stock........................ -- (719,541)
----------- ----------
Net income available to common stockholders, as adjusted... $ 5,522,431 $4,083,294
=========== ==========
Weighted average shares outstanding........................ 11,621,598 5,263,100
Common stock equivalents:
Conversion of convertible debt........................... -- 2,255,614
Incremental shares using treasury stock method........... 804,829 612,630
----------- ----------
12,426,427 8,131,344
=========== ==========
Basic net income per share................................. $ 0.48 $ 0.57
=========== ==========
Diluted net income per share............................... $ 0.44 $ 0.50
=========== ==========
Common stock equivalents were not considered for the year ended December
31, 1997 since the effect would be antidilutive.
(j) Pro Forma Net Income and Pro Forma Net Income (Loss) Per Share
Computations (Unaudited)
The pro forma net income (loss) presented in the consolidated statements of
operations reflects the pro forma effects for income taxes as if the Company had
been a taxable entity for the periods presented. In addition, the pro forma net
income for the year ended December 31, 1999 excludes a one-time tax benefit
F-9
41
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
resulting from conversion of the S corporation to C corporation. Pro forma basic
and diluted net income (loss) per share for each of the years in the three-year
period ended December 31, 1999 was computed by dividing pro forma net income
(loss) by the weighted average number of shares of common stock outstanding.
Common stock equivalents in the diluted proforma net income (loss) per
share calculation were not considered for the years ended December 31, 1998 and
1997 since the effect would be antidilutive.
(k) Foreign Currency Translation
The functional currencies of the Company's foreign subsidiaries are their
respective local currencies. The translation of the applicable foreign
currencies into U.S. dollars is performed for balance sheet accounts using
current exchange rates in effect at the balance sheet date and for revenue and
expense accounts using average rates prevailing during the year. Adjustments
resulting from the translation of foreign currency financial statements were
immaterial and were recorded in the consolidated statements of operations for
each year.
The Company enters into transactions based on the Company's local currency
which results in limited foreign currency risk. The Company does not utilize
hedging instruments.
(l) Use of Estimates
The Company's management has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these consolidated financial
statements in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
(m) Start-up Costs
In March 1998, the AICPA issued Statement of Position 98-5 ("SOP 98-5")
"Reporting on the Costs of Start-Up Activities." Pursuant to the provisions of
SOP 98-5, all costs associated with start-up activities, including organization
costs, should be expensed as incurred. Companies that previously capitalized
such costs were required to write off the unamortized portion of such costs as a
cumulative effect of a change of accounting principle. The Company had an
insignificant amount of these costs and the adoption of SOP 98-5 did not have a
significant impact on the Company's financial statements.
(n) Comprehensive Income
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"),
which establishes standards for reporting and displaying comprehensive income
and its components in a full set of financial statements. SFAS No. 130 requires
that companies classify items of other comprehensive earnings by their nature in
a financial statement and display the balance of other comprehensive income
separately from accumulated deficit and additional paid-in capital in the equity
section of the balance sheet. Comprehensive income is defined as a change in
equity during the financial reporting period of a business enterprise resulting
from non-owner sources. There were no differences between net income (loss) and
comprehensive income (loss) for each of the years in the three-year period ended
December 31, 1999.
(o) Segment Reporting
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 supersedes
SFAS No. 14, Financial Reporting for Segments of a Business Enterprise. SFAS No.
131 applies a "management approach" in which the internal organization that is
used by management for making operational decisions and evaluating performance
is the
F-10
42
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
source for the Company's segment reporting. The adoption of SFAS No. 131 did not
affect the results of operations or financial position. The Company currently
operates in one segment for management reporting purposes.
2. INITIAL PUBLIC OFFERING
On February 3, 1999, the Company and certain selling shareholders sold
4,410,000 shares of its common stock in an initial public offering from which
the Company received proceeds of $43,454,132, net of underwriter commissions and
offering costs. At that time, the Company's $12 million outstanding convertible
debentures (the "Convertible Debentures") were converted into redeemable
convertible preferred stock and redeemable participating preferred stock.
Contemporaneous with the offering, the redeemable convertible preferred stock
was converted into 2,255,614 shares of common stock.
On February 3, 1999, the Company redeemed in full the redeemable
participating preferred stock for $12,000,000 and paid accrued interest in the
amount of $4,665,000. On February 26, 1999, the underwriters of the Company's
initial public offering exercised their option to purchase 661,500 additional
shares of the Company's common stock from which the Company received net
proceeds of $7,382,340.
3. PROPERTY AND EQUIPMENT, NET
Property and equipment, net of accumulated depreciation and amortization
consists of the following:
DECEMBER 31,
-----------------------
1999 1998
---------- ----------
Office equipment......................................... $2,760,548 $1,655,823
Office furnishings and fixtures.......................... 375,088 199,953
Leasehold improvements................................... 170,037 77,328
---------- ----------
3,305,673 1,933,104
Less accumulated depreciation and amortization........... 1,426,685 948,324
---------- ----------
$1,878,988 $ 984,780
========== ==========
4. LEASES
The Company entered into an agreement to lease office facilities under a
noncancelable operating lease commencing January 1995 and expiring December 2001
with an option to renew for one five-year term. The lease contains certain
incentives including rent abatements, rent discounts, leasehold improvement
reimbursements, cash allowances and scheduled base rent increases over the term
of the lease. In December 1999, the Company entered into an agreement to lease
additional office facilities and extend the lease for existing facilities under
a noncancelable operating lease commencing December 1999 and expiring December
2006. Generally accepted accounting principles require that the full costs of a
lease be recognized ratably over the term of the lease. Accordingly, the Company
has recorded deferred credits of $678,631 and $205,060 at December 31, 1999 and
1998, respectively, to reflect the excess of rent expense over the incentives
received. The deferred credit is included in accrued expenses in the
accompanying consolidated balance sheets. In addition to the base rent payment,
the Company pays a monthly allocation of the building's operating expenses.
During 1997, the Company also entered into lease agreements for office
facilities in the United Kingdom and Australia which expire in 2003.
F-11
43
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum lease payments under noncancelable facility leases as well
as equipment leases and future minimum capital lease payments as of December 31,
1999 are as follows:
CAPITAL OPERATING
YEAR ENDING DECEMBER 31, LEASES LEASES
------------------------ -------- ----------
2000........................................................ $ 76,518 $ 821,760
2001........................................................ 43,724 881,994
2002........................................................ 43,724 1,164,000
2003........................................................ 43,724 1,128,498
2004........................................................ 10,931 1,154,068
Thereafter.................................................. -- 2,448,500
-------- ----------
Total minimum lease payments...................... $218,621 $7,598,820
==========
Less amount representing interest (at a rate of 9.65%).... 39,568
--------
Present value of net minimum capital lease payments.... 179,053
Less current installments of obligations under capital
leases................................................. 57,446
--------
Obligations under capital leases, excluding current
installments........................................... $121,607
========
Total rent expense associated with operating leases was $1,344,496,
$1,237,607 and $669,543 during 1999, 1998 and 1997, respectively.
5. LINE OF CREDIT
The Company has a $7.5 million line of credit with a financial institution.
The interest rate is LIBOR plus 1.25% (6.5% at December 31, 1999). As of
December 31, 1999 the Company had no borrowings under this line of credit.
6. ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31,
-----------------------
1999 1998
---------- ----------
Sales tax/VAT payable....................................... $ 256,792 $ 224,964
Sales tax contingencies..................................... 546,091 614,783
Deferred rent............................................... 678,631 205,060
Accrued payroll............................................. 855,944 75,980
Accrued legal............................................... 32,000 127,000
Accrued vacation............................................ 254,591 192,610
Accrued commissions......................................... 88,291 41,667
Other....................................................... 280,613 112,133
---------- ----------
$2,992,953 $1,594,197
========== ==========
7. CONVERTIBLE DEBT
On December 19, 1994, the Company entered into a Debenture Purchase
Agreement (the "Agreement") with various partnerships (the "Lenders") in
connection with the private placement of $12,000,000 convertible subordinated
debentures (the "Debentures"). Principal on the Debentures was payable in two
equal installments of $6,000,000 on December 1, 1999 and December 1, 2000, and
they bore interest at 10 percent through June 30, 1997 and 15 percent thereafter
to maturity.
F-12
44
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On June 30, 1997 the Debentures became convertible at the option of a
majority in interest of the Lenders into 22,556.14 shares of the Company's
redeemable convertible participating preferred stock and one share of redeemable
participating preferred stock for each $1,000 of principal outstanding. The
redeemable convertible participating preferred stock is convertible to common
stock at the rate of 100 shares of common stock for each share of preferred
stock.
The fair value of the conversion feature of the $12,000,000 debentures was
determined to be $3,481,562 based on the difference between the stated interest
rates and the market rate of such debentures on the date of issuance. This
amount is included in additional paid-in capital in the accompanying
consolidated balance sheets. The resulting original issue discount ("OID") on
the convertible debt was amortized from the issue date (December 19, 1994) to
the date it first became convertible (June 30, 1997) to achieve an 18 percent
effective interest rate.
An IPO was closed on February 3, 1999. As discussed in note 2, on February
3, 1999, the debentures were converted into two classes of preferred stock and
the preferred stock was redeemed. Contemporaneous with the offering, the lenders
converted the redeemable convertible participating preferred stock into
2,255,614 shares of common stock.
8. PREFERRED STOCK
In connection with the issuance of $12,000,000 of Debentures (see note 7),
the Company amended its Articles of Incorporation by designating 22,556.14
shares of authorized preferred stock as redeemable convertible participating
preferred stock (the "redeemable convertible preferred stock"). Holders of the
redeemable convertible preferred stock are entitled to receive (i) dividends at
the same rate as dividends are paid with respect to the common stock based on
the number of shares of common stock into which such shares of redeemable
convertible preferred stock are then convertible; and (ii) $31.90 per share
cumulative dividend per year through November 30, 1999 ($15.95 per share for the
year ended December 1, 2000) less the amount of common stock dividends paid.
The redeemable convertible stock is redeemable at the option of the Company
between December 1, 2000 and December 1, 2001 at the fair market value per
share.
Each share of redeemable convertible preferred stock entitles the holders
to such number of votes per share as shall equal the number of shares of common
stock into which such share of redeemable convertible preferred stock is then
convertible. Shares of redeemable convertible preferred stock were convertible
into shares of common stock automatically upon the closing of the IPO discussed
in note 2. Shares of redeemable convertible preferred stock were converted into
shares of common stock at an initial conversion rate of 100 shares of common
stock for each share of preferred stock, whereby each share of convertible
preferred stock was valued for conversion purposes at $532.00 per share.
In addition, as part of the aforementioned amendment to its articles of
incorporation, the Company designated 12,000 shares of authorized preferred
stock as redeemable preferred stock. The holders of the redeemable preferred
stock are not entitled to receive any cash dividends nor any voting rights or
powers. The redeemable preferred stock was subject to mandatory redemption upon
the closing date of the IPO (February 3, 1999). All redeemable preferred stock
was redeemed at a redemption price of $1,000 per share.
9. EMPLOYEE BENEFIT AND STOCK OPTION PLANS
The Company maintains an employee retirement savings plan (the "Plan")
under Internal Revenue Code Section 401(k). The Plan is available to all
full-time employees over 21 years of age with more than three months of
employment with the Company. The Company provides matching contributions which
vest to the employees immediately and range from 10 percent to 35 percent,
depending on years of service of the
F-13
45
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
matchable deferrals of each participant entitled to matching contributions, not
to exceed 2.8 percent of the participant's compensation. There was $160,278,
$102,713 and $46,573 provided by the Company in matching contributions for the
years ended December 31, 1999, 1998 and 1997, respectively.
SGA Ltd. also maintains an employee benefit plan (the "Ltd. Plan"). This is
an employee-directed plan which allows the employees to set aside from 1 to 5
percent of their salary to be deposited to a fund of their choice. SGA Ltd. will
match each employee's contribution up to 5 percent. Provisions of the Ltd. Plan
are substantially the same as the Plan.
On April 1, 1996 the Company adopted a stock option plan. Under this plan,
the Company may grant options for up to 850,000 shares of common stock. An
option's maximum term is ten years. Each option vests as follows: 25 percent one
year after the date of grant and the balance in successive equal quarterly
installments of 6.25 percent each, at the end of each of the next 12 calendar
quarters. At December 31, 1999, the Company has granted 811,413 options under
this stock option plan at exercise prices ranging from $2.53 to $12.00 per
share. Included in these granted options, on April 1, 1996, under the stock
option plan 494,120 options to purchase common stock were granted to an
executive officer of the Company. The options vest as follows: 82,353 shares one
year after the grant date; 20,588 shares at the end of each of the next 12
calendar quarters subsequent to the vesting commencement date; 82,355 shares
upon the date the aggregate market value of the Company's outstanding common
stock has equaled or exceeded $100 million for 30 days (June 8, 1999); and the
remaining 82,356 shares upon the earlier to occur of (a) March 21, 2006 or (b)
the market value of the Company's outstanding common stock has equaled or
exceeded $150 million for 30 days. At December 31, 1999, the officer had 373,532
of exercisable options. 50,000 options have already been exercised.
At June 30, 1998, the Company established an additional stock option plan
("1998 Stock Option Plan"). Under this plan the Company may grant options for up
to 1,500,000 shares of common stock. At December 31, 1999, the Company has
granted 1,056,541 options under the 1998 Stock Option Plan at exercise prices
ranging from $8.06 to $16.25 per share. Each option vests 25 percent one year
after the date of grant (the "vesting date") and an additional 25 percent on
each of the next three anniversaries of the vesting date.
The fair market values of the underlying stock related to these options was
estimated to range from $2.53 to $16.25 as of grant dates. The Company applies
APB Opinion No. 25 in accounting for its stock option plan. Stock compensation
expense is recognized at the date options are vested when the exercise price is
lower than fair market value at the date of grant. There was no compensation
expense recorded for the year ended December 31, 1997. Stock compensation
expense for the years ended December 31, 1999 and 1998 was $41,588 and $34,696,
respectively. Had the Company determined compensation cost based on fair value
at the grant date for its stock options under Statement No. 123, the Company's
net income (loss) and net income (loss) per share for each of the years in the
three-year period ended December 31, 1999 would have changed to pro forma
amounts indicated below:
PRO FORMA DISCLOSURES 1999 1998 1997
- --------------------- ---------- ---------- -----------
Net income (loss):
As reported..................................... $5,522,431 3,002,835 (3,367,909)
Pro forma....................................... $3,832,838 2,655,001 (3,679,434)
Basic net income (loss) per share:
As reported..................................... .48 .57 (.64)
Pro forma....................................... .33 .50 (.70)
Diluted net income (loss) per share:
As reported..................................... .44 .50 (.64)
Pro forma....................................... .31 .46 (.70)
F-14
46
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted-average fair market value per share of options granted to
employees was estimated at $10.65 and $1.62, for the years ended December 31,
1999 and 1998, respectively. The fair value of each option was estimated at the
date of grant using the Black-Scholes model with the following assumptions used:
1999 1998 1997
------- ------- -------
Expected life............................................... 6 years 5 years 5 years
Dividends................................................... None None None
Risk-free interest rate..................................... 6.28% 5.65% 5.45%
Expected volatility......................................... 50% 50% 0%
Stock option activity since inception is indicated as follows:
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING
EXERCISE CONTRACTUAL
SHARES PRICE LIFE (YEARS)
--------- ----------- ------------
Balance outstanding at December 31, 1996............ 631,120 $ 2.53
Granted........................................... 155,000 2.53
Forfeited......................................... (34,000) 2.53
---------
Balance outstanding at December 31, 1997............ 752,120 2.53
Granted........................................... 30,607 2.53
Granted........................................... 637,154 12.00
Forfeited......................................... (6,427) 2.53
---------
Balance outstanding at December 31, 1998............ 1,413,454
Granted........................................... 251,500 12.00
Granted........................................... 3,000 8.56
Granted........................................... 200,000 8.69
Exercised......................................... (96,364) 2.53-12.00
Forfeited......................................... (62,892) 2.53-12.00
---------
Balance outstanding at December 31, 1999............ 1,708,698 $2.53-12.00 8.65
=========
Exercisable at December 31, 1999.................... 726,586 $2.53-12.00 8.65
=========
Subsequent to December 31, 1999, an additional 545,000 shares were granted
at prices ranging from $15.78-$17.06 per share.
The amount of stock compensation expense to be recognized in the future as
of December 31, 1999 is as follows:
YEARS ENDING DECEMBER 31,
- -------------------------
2000........................................................ $30,116
2001........................................................ 20,870
2002........................................................ 1,152
F-15
47
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. INCOME TAXES
Income tax expense for the year ended December 31, 1999 represents the
historical income tax expense of the Company which includes a one-time tax
benefit due to the change from an S corporation to a C corporation. The
unaudited pro forma income tax (expense) benefit for the years ended December
31, 1998 and 1997 represents the estimated taxes that would have been presented
had the Company been a C corporation for income tax purposes for each of the
periods presented. The income tax (expense) benefit is as follows:
HISTORICAL PRO FORMA PRO FORMA
1999 1998 1997
----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
Current:
Federal........................................ $(2,967,293) $(1,004,126) $ 897,416
State.......................................... (596,027) (203,627) 187,580
Deferred:
Federal........................................ 486,379 (4,045) (108,897)
State.......................................... 28,495 (2,972) (27,672)
----------- ----------- ---------
Total income tax (expense) benefit..... $(3,048,446) $(1,214,770) $ 948,427
=========== =========== =========
For the year ended December 31, 1999, the reconciliation represents the
difference between the historical income tax expense calculated using the
statutory federal income tax rate and the actual income tax. For the years ended
December 31, 1998 and 1997, the reconciliation represents the income tax
(expense) benefit calculated using the statutory federal income tax rate and the
pro forma income tax (expense) benefit:
HISTORICAL PRO FORMA PRO FORMA
1999 1998 1997
----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
Income tax (expense) benefit using statutory tax
rate........................................... $(2,914,185) $(1,020,964) $1,145,089
Effect of:
State and local income taxes, net of federal
income tax..................................... (343,873) (136,356) 105,539
Change in valuation allowance.................... (60,857) (56,274) (61,263)
Effect of change to C-corporation................ 329,519 -- --
Difference between US and non-US tax rates....... 10,153 7,298 (27,221)
Original issue discount amortization............. -- -- (231,097)
Change in effective tax rates.................... (5,361) 9,761 22,256
Other, net....................................... (63,842) (18,235) (4,876)
----------- ----------- ----------
Income tax (expense) benefit..................... $(3,048,446) $(1,214,770) $ 948,427
=========== =========== ==========
F-16
48
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1999 are as follows:
Deferred tax assets:
Accrued expenses.......................................... $314,426
Allowance for doubtful accounts........................... 239,817
--------
Net deferred tax assets........................... 554,243
--------
Deferred tax liabilities:
Other..................................................... (243)
Depreciation and amortization............................. (38,607)
--------
Total deferred tax liabilities.................... (38,850)
--------
Net deferred tax asset............................ $515,393
========
The Company's management believes that it is more likely than not that the
results of future operations will generate sufficient taxable income to realize
the deferred tax assets.
11. BUSINESS AND CREDIT CONCENTRATIONS
The Company currently derives substantially all of its revenue from sales
of its WebOrder family of products and related services and hardware. Any factor
adversely affecting the sale of the Company's Web Order products or other new
products, could have a material affect on the Company's business, financial
condition and results of operations.
The Company sells its products primarily to customers located in the United
States. In 1999, 10.5 percent of the Company's sales were to customers outside
the United States.
During 1997, the Company purchased approximately 65 percent of its computer
hardware from Hewlett Packard. At December 31, 1997, the Company owed this
supplier approximately $98,000. In 1998, the Company began purchasing its
hardware from a distributor of Hewlett Packard due to a change in Hewlett
Packard's distribution channels and 84 and 80 percent of its computer hardware
was purchased from this distributor for the years ended December 31, 1999 and
1998, respectively. The Company owed this supplier $769,884 and $259,102 at
December 31, 1999 and 1998, respectively. Accordingly, any adverse change in the
product pricing or the operations of Hewlett Packard could significantly affect
the operating results of the Company.
No single customer accounted for more than 10 percent of total revenue for
each of the years in the three-year period ended December 31, 1999. In addition,
there were accounts receivable from three customers at December 31, 1998 that
exceeded 10 percent of total accounts receivable for approximately $2,325,000.
The Company estimates an allowance for doubtful accounts generally based on
an analysis of collections in prior years, the credit worthiness of its
customers as well as general economic conditions. Consequently, an adverse
change in those factors could affect the Company's estimate of its bad debts.
12. COMMITMENTS AND CONTINGENCIES
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations or liquidity.
F-17
49
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"). SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. It requires an entity to recognize
all derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. SFAS No. 133 is expected to be effective for
the Company's year ending December 31, 2001. The Company does not believe that
the adoption of SFAS No. 133 will have a significant impact on the Company's
financial reporting.
F-18
50
SCHEDULE II
SMITH-GARDNER & ASSOCIATES, INC.
AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR EACH OF THE YEARS IN THE THREE-YEAR PERIOD ENDED DECEMBER 31, 1999
BALANCE AT BALANCE
BEGINNING (A) (B) AT END
OF YEAR CHARGES DEDUCTIONS OF YEAR
---------- ------- ---------- --------
Description:
Reserves and allowances deducted from asset accounts:
1997
Allowance for doubtful accounts................... $936,347 102,816 (569,936) 469,227
======== ======= ======== ========
Description:
Reserves and allowances deducted from asset accounts:
1998
Allowance for doubtful accounts................... $469,227 413,624 (423,851) 459,000
======== ======= ======== ========
Description:
Reserves and allowances deducted from asset accounts:
1999
Allowances for doubtful accounts.................. $459,000 251,293 (94,484) 615,809
======== ======= ======== ========
- ---------------
(a) Charges to the reserve account represent increase in reserve levels and
establishment of specific reserves.
(b) Deductions to the reserve account represent write-offs and net of recoveries
which occurred during the year.
F-19